- Review & Update
- The Bitcoin Ramp – Is It Sustainable
- Here’s What Works For Me
- Sector & Market Analysis
- 401k Plan Manager
What the “heck” was that?
This past week seemed to be the story of Christmas coming early. Earlier this week the markets surged higher on hopes that “Ole’ St. Tax Cuts” would soon be here. But that dream seemed to be short-lived on Friday, at least at the open, as General Mike Flynn seems to embody the “Grinch” trying to steal Christmas.
But at the end of it all, not much actually changed. Well, except for the fact that volatility not only made an appearance as stock prices swung wildly in both directions, but also in Treasury rates. As expectations of tax reform grew, rates spiked higher but then sank just as quickly as fears of turmoil in the Administration sent money into the safety of bonds.
As shown above, despite all of the “sound of fury” the S&P advanced 1.53% for the week while rates, not surprisingly as money rotated from “safety” to “risk,” ticked up from 2.3% to 2.4%. However, while volatility finished week only up mildly, intra-week we saw volatility jump to nearly 15 before settling back at 11.
The sharp advance, as the market went all “bitcoin,” pushed well into 3-standard deviation territory above the longer-term moving average with overbought conditions pushing extremes. While the backdrop remains decidedly bullish, the sharp moved higher has all the earmarks of an exhaustion move which suggests some profit-taking cool things off over the next couple of weeks.
While the market is extremely overbought, the bullish trends remain intact. Furthermore, the month of December tends to bullish for equities which keeps portfolios allocated towards equity risk currently.
With the tax bill now out of the Senate, the real work begins as the House bill and Senate bill will go to conference to work out the rather substantial differences between the two bills. With neither bill even remotely approaching a “fiscally conservative” that will actually lead to stronger economic or reduced debts and deficits, it is a huge windfall for corporations.
This, of course, raises the question as to how much of the “tax cuts” are already priced into the markets.
One thing to be cautious of is the possibility this could well be a “buy the rumor, sell the news” event as we move into the New Year. As I stated last week, I see two potential outcomes:
- A tax bill clears Congress reducing taxes which leads to tax-related selling by money manager to lock in gains at a lower tax rate that will not have to be paid until 2019, or;
- The tax bill fails, a still likely scenario, which leads to tax-related selling by money manager to lock in gains on which taxes will not have to be paid until 2019,
Let me repeat from the last newsletter:
“As I see how December plays out, I will be seriously looking at adding a short-hedge to portfolios before year end. I will keep you apprised.”
This weekend, I am traveling to Florida to give a presentation on the markets and will be joined by some of my friends like Chris Martenson and Nomi Prins. It promises to be fun and I will fill you in on any great insights next week.
The Bitcoin Ramp – Is It Sustainable?
by Michael Lebowitz, CFA
The explosive rise of Bitcoin (BTC) has taken the investing world by storm, and for good reason. Over the past six months alone BTC has quadrupled in value. Since 2012, it has risen over 200,000%. To put that into context, had one invested 10k in 2012 they would be worth over $20 million today. The graph below shows the meteoric rise.
There are predominantly two camps with strong opinions on what the future holds for BTC. One generally believes it to be the currency of the future while the second camp thinks BTC is another financial bubble. Given BTC’s increasing popularity we thought it would be helpful to present these two competing perspectives and then offer our own assessment.
Believers in BTC claim it is quickly becoming a widely accepted global currency. To better understand their view let’s see how BTC meets the definition of a currency, both as a means of transacting (money) as well as a store of value.
Money: money is anything that two parties can agree is acceptable in exchange for goods and services. For example, if I pay you a case of beer to mow my lawn, the beer, in this instance, is money. However, for “money” to be widely accepted, the masses must ascribe similar value to it. While there is an increasing number of vendors accepting BTC, it is nearly impossible to use BTC to meet your everyday needs. Further, the value, or price of money, needs to be relatively stable to be effective. If a dollar bill bought you a case of beer today, but only a single bottle tomorrow and a keg the following week, few consumer or vendors would trust the dollar’s value. BTC’s value can fluctuate 5-10% on an hourly basis
Store of value: a store of value is something that allows one to save money and retain its value. When we save money we want comfort in knowing the money we earned can buy us the same amount of goods and services tomorrow that it can buy today. Again, the extreme volatility of the price of BTC makes it difficult to project how much purchasing power a BTC will buy you in the future. All currencies fluctuate but typically nowhere near the degree we are witnessing in BTC.
If the extreme price movements of BTC subside it is possible that BTC can serve as a widely accepted currency and the believers could be correct.
A second camp believes BTC is a financial bubble. The chart below compares BTC to other recent investment fads.
You will notice in all instances above the bubbles rise steadily in price before transitioning to an exponential increase prior to collapse. Often, in the so-called euphoric phase, prices go well beyond the point most investors think is reasonable. In this respect, BTC is following the path of prior bubbles.
Bubbles are not solely defined by price movements, but more importantly by a lack of supporting fundamental value. If you subscribe to the value of BTC as does the first camp, the rapid increase in price may well be justified. If you believe there is no value, BTC is showing the classic pattern of most bubbles.
We believe BTC can rise even further from current levels. That said, we question whether it has any meaningful fundamental value. In the textbook on sound investing, Security Analysis, Benjamin Graham, and David Dodd define investing as follows:
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Based on this very clear definition of terms, there is no way to classify BTC as anything other than speculation. Furthermore, while we agree with those in camp one that BTC might one day be universally accepted as money and a reliable store of value, we have one major problem with which to contend.
To help you grasp our issue, consider that an investor who bought Bitcoin a few years ago and sold it today would have accumulated a remarkable gain. Even better, unlike a capital gain on stocks, bonds, real estate and all other financial assets, that profit is tax-free.
Now ask yourself, how long will the government allow investors to avoid paying taxes on gains in BTC? Further, will the U.S. government, or any other government, cede control of its currency and ultimately the economy? We expand on this concept below from a primer we wrote on cryptocurrencies- Salt, Wampum, Benjamins – Is Bitcoin next?
The preamble to the U.S. Constitution states the purpose of the Federal government is to:
“…form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.”
In other words, the government’s role is to protect the freedoms and liberties of its citizens. If the government has no ability to fund itself and is unable to provide defense and law enforcement it cannot uphold the Constitution. More precisely – the sovereignty of any nation, regardless of its form of government, rests upon the strength and integrity of its currency.
There may still be gains ahead for BTC, but the volatility of its price and still low adoption as a means of transacting pose obvious problems. The bigger risk, however, is given government incentives to impose taxes on the public and manage economic activity, the speculative value currently being ascribed to BTC does not seem durable and is therefore unlikely to survive.
Here’s What Works For Me
by Doug Kass
“And I said to myself, ‘This is the business we have chosen.'” –Hyman Roth, “The Godfather”
To me, stock price deception is seen with more frequency today than in any time in modern investment history.
Our markets, influenced by massive central bank liquidity and dominated by passive strategies (ETFs, risk parity, and volatility trending), not only are inhibiting price discovery but also are artificially influencing price action — “buyers live higher and sellers live lower” — to both the upside and downside.
In some measure, this is reducing the authenticity and validity of stock prices and charts and is hurting the value of technical analysis, which may be basing its decisions, in part, on artificial patterns/prices/data. On the other hand, it benefits those who view the market without emotion and who are willing to buy extreme weakness and sell extreme strength.
Yesterday underscored the reasons why and how I look at stocks. I would emphasize, again, that I do not have a concession on the process and I recognize that others have different approaches that provide good investment returns.
But I have a logic in my approach and Wednesday’s bifurcated action and its selective and often extreme volatility underscores some of these principles that I have adopted over the last four decades and provides some additional lessons:
* Avoid Volatile and Unpredictable Stocks — It’s Gambling: In the last two days, Riot Blockchain Inc. (RIOT) has had a range from about $12 to $25. There has been no news to account for that volatility and random action.Other collateral bitcoin plays such as Social Reality Inc. (SRAX) and Xunlei Ltd. (XNET) have had similarly large trading ranges. No specific company news there, either. Given my risk profile, I never will trade in these stocks. Others believe differently and believe they successfully can skate on this thin ice, but I will stick to my risk appetite, and I believe all but a few professionals may be kidding themselves in rationalizing these stocks “tradeability.” This also explains my reluctance to trade bitcoin, which had a trading range yesterday of $9,290 to $11,377 — again, on no news.
* No Matter What the Charts Say, I Prefer to View Every Trade/Investment Based on an Assessment of Reward vs. Risk — Seize Those Opportunities: The dynamic of an upside/downside calculation and determining discounts or premiums to intrinsic value form the basis for my trading and investment decisions. Recently, I successfully traded two retail stocks, Macy’s Inc. (M) and Dillard’s Inc. (DDS) , on this basis. Consider Twitter Inc. (TWTR) , which at $22 a share looked technically solid. Nevertheless, I sold off a large portion of my position between $22 and $22.50 recently based on an assessment of a less-favorable upside/downside ratio. Others bought based on an improving chart. Both I and they are likely comfortable with our decisions, but the purpose of this missive is to further explain my tenets and methodology.
* There Are Many Great Charts That Lie at the Bottom of the Sea: Though one or two days don’t make a market, the artificiality of the markets may be underscored by two stocks yesterday — Micron Technology Inc. (MU) and Square Inc. (SQ) . Both recently looked fantastic technically. Embraced by many a talking head in the business media, both have been schmeissed in recent sessions. Like the Nasdaq 100 ((QQQ) was down $3 yesterday), they all looked good on the charts until they didn’t, and all provided little indication to prepare traders for the reversals. At times like these, it is increasingly dangerous to buy stocks on breakouts. Buying calls on these stocks moves one further to the end of the risk curve. This strategy may work well for some time in a trending market, but a swift directional change can evaporate profits and eviscerate a portfolio. Again, such a strategy should be limited to professionals, and even that body of traders may suffer from a steady diet of options activity, as academic studies show.
* Do Not Underestimate the Impact of Price Momentum Strategies on Individual Stocks and Sectors: Over the last month, technology, especially of a FANG kind, has soared and other areas such as retail have collapsed. The possible artificiality of both moves was evident in the reversals this week and yesterday. Amazon.com Inc. (AMZN) , as an example, was down by more than $45 on no news yesterday. Retail stocks such as M and DDS rose by 10% on Wednesday and 20% in the last week, also on no news. This may underscore (1) the reduced value of analyzing stocks on price technically, and (2) that opportunities are provided for those who are emotionless and have a sense of intrinsic values and legitimate upside/downside calculations.
* A Diversified Portfolio Is a Preferable Course: Jim “El Capitan” Cramer detailed the value of this approach late yesterday in a well-thought-out column, “‘Am I Diversified?’ May Be Boring, but It Can Help Avoid the Pain.” Please reread it. As a matter of course, and as most are now aware, I keep my individual stock positions as a low percentage of my total overall portfolio and often have 40 to 50 portfolio names. I am always diversified in position size (typically at about 2% to 3% each) and in sector exposure (limited to 15% of the portfolio). Recognize that when a trader or investor is only buying “good” charts, that is not being diversified. Rather, it is part of a process that leads to a binary outcome that may end badly given the likely artificiality of prices.
The artificiality of stock prices has accelerated in recent years with the domination of passive investment strategies.
I will not trade/invest in stocks solely on the basis that they “look good” on the charts in this sort of setting, which is dominated by influences that create an under-appreciated degree of price deception.
For these reasons and others I will not buy breakouts and sell breakdowns; this may be the wrong approach in the environment we are now in.
Rather, an approach to buying value and breakdowns and selling seemingly irrationally based prices and breakouts is my investment cup of tea based on the fundamental and dynamic assessment of intrinsic values relative to the current prices.
Others disagree and I respect their ability to navigate differently. I am not taking a shot at their approaches; rather, I am saying what serves me well and what may serve the majority of conservative risk-based investors and traders well.
This is how I am handling the markets these days, and, frankly, will forever.
And … buckle up.
Market & Sector Analysis
Data Analysis Of The Market & Sectors For Traders
S&P 500 Tear Sheet
ETF Model Relative Performance Analysis
Sector & Market Analysis:
For a second week running, the market stumbled slightly. However, had it not been for the huge surge on Thursday with the passage of the GOP tax bill, the end result would have been worse. Nonetheless, there has been no change to the current trajectory of the market overall.
Discretionary, Staples, Industrials, Staples, and Financials were the best performing sectors this past week as money chased, well, really everything but primarily clustered in the areas most affected by tax reform and recent commentary from the Fed that was extremely supportive for the banks. These sectors are now GROSSLY extended. Take some profits, rebalance holdings and move stops up to recent supports.
Technology has lagged over the past few weeks, but remains near highs. It appears Technology may have begun a consolidation or topping process. We will need to wait to see how the current price action resolves itself before taking action within the sector.
Health care as I noted previously, the sector had slipped below its 50-day moving average, however, the “buy everything” mode of the market over the last week resolved that situation keeping health care on hold in portfolios for now. Move stops up to recent lows.
Energy – as I noted previously, the energy sector had gotten trapped between the 50 and 200-dma. The positive backdrop, however, was the 50-dma having crossed above the 200-dma, We are looking to add energy back into portfolios after having been out of the sector since 2014 and the move higher last week sets us up for that addition. A bit of profit taking in the week ahead will likely allow us to begin adding some weight to portfolios.
Utilities, we remain long the sector and have moved stops up to the 50-dma. Trends remain positive and interest rates have likely peaked for the current advance.
Small and Mid-Cap stocks continued their strong rebounded off recent supports last week after threating to break down. With the hopes of tax cuts to boost profitability, money is heavily chasing the sector into grossly overbought territory. We harvested some profits recently but remain long the sector. We are moving stops up again to protect gains.
Emerging Markets and International Stocks have shown some weakness as of late in terms of momentum, but remain in a bullish trend overall. We remain long these markets for now but have moved up stops accordingly.
Gold – Gold failed to hold above the 50-dma last week and remains confined in sideways trend. Importantly, with no catalyst to put “fear” into the market, the 50-dma starting to weaken putting the current risk back to the downside. We continue to watch the commodity currently, but remain on the sidelines for now.
NEW! S&P Equal Weight – In our “core portfolios” we carry an equal weighting of both the S&P 500 dividend index and the S&P 500 equal-weight index. This balance gives us historically better performance, lower volatility and a higher yield than just carrying the S&P 500 index. I have added this analysis permanently going forward. The equal-weighted index pushed surged higher last week to record highs. We continue to hold our positions for now married to the S&P Dividend sector.
S&P Dividend Stocks, The index pushed higher last week as dividend stocks take on more capital flows. I noted previously that we are holding our positions for now and have moved stops again to $92.50.
Bonds and REIT’s – With“tax reform” being passed by the Senate, rates did tick up last week slightly. However, given the makeup of the tax bill, the realization that this current iteration will not create surging inflation, growth and interest rates is becoming more apparent. The bullish trend in Bonds and REIT’s continues so we will continue looking for pullbacks to add additional exposure.
The table below shows thoughts on specific actions related to the current market environment.
(These are not recommendations or solicitations to take any action. This is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)
The market continued to hold its bullish trend this past week despite a pickup in volatility. This type of market is extremely dangerous as when markets break, and then immediately rebound, it lulls investors into a high degree of complacency that stocks “simply can’t go down.” While we are in the seasonally strong period of the year, we remain cognizant of the underlying risk.
Furthermore, as noted above, I stated the following at the beginning of November:
“I am now looking to begin building ‘Short S&P 500 and Nasdaq’ positions into portfolios over the next few weeks as a hedge against a January decline as noted above. I will keep you advised as to changes in portfolios ahead if my expectations begin to come to fruition.”
That analysis continues and I suspect we will be looking to add that position in portfolios by year-end. As the Senate and House tax bills enter “conference,” I think we will get a much better picture of the likelihood of passage and what it will actually look like. There is a rather high degree of risk that stocks will sell-off following any passage of a “tax reform” bill as much of the benefit has already been priced into the market. In other words, there is a much higher probability of “disappointment” rather than “surprise” at this juncture.
As always, we remain invested but are becoming highly concerned about the underlying risk. Our main goal remains capital preservation.
THE REAL 401k PLAN MANAGER
The Real 401k Plan Manager – A Conservative Strategy For Long-Term Investors
There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.
Tax Reform Passes The Senate
Despite a “ruckus from the White House” last week, nothing could stop stocks from rising as the Senate passed their version of the tax bill through. There was “no risk” for Senators voting for this bill, despite any form of fiscal conservatism, as much of the bill will run into headwinds when it gets into conference between the House and Senate. The final version of the bill to be passed still has a good ways to go. Nonetheless, as stated previously:
“The surge last week keeps the ‘bulls in the driver’s seat’ which keeps portfolio allocations at target levels for now.”
With volatility likely to pick up over the next few weeks as we head into year end, if you are concerned about the risks in your portfolio, some rebalancing remains advised.
We previously recommended rebalancing risks in portfolios by trimming overweight equity exposure but adding to fixed income exposure. With those actions complete, there is nothing to do currently except wait for the next signal to take action.
All NEW contributions to plans should currently be adjusted to cash or cash equivalents like a stable value fund, short-duration bond fund or retirement reserves. We will use these funds opportunistically to add to weightings when corrections occur.
If you need help after reading the alert; don’t hesitate to contact me.
Current 401-k Allocation Model
The 401k plan allocation plan below follows the K.I.S.S. principle. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)
401k Choice Matching List
The list below shows sample 401k plan funds for each major category. In reality, the majority of funds all track their indices fairly closely. Therefore, if you don’t see your exact fund listed, look for a fund that is similar in nature.
Lance Roberts is a Chief Portfolio Strategist/Economist for RIA Advisors. He is also the host of “The Lance Roberts Podcast” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, Linked-In and YouTube
Customer Relationship Summary (Form CRS)