Tag Archives: financial markets

Michael Markowski: Stock Market Relief Rally High Extended

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The date range for the SCPA’s forecasted relief rally highs for stock markets of the US, Japan, Germany, France, South Korea, and Canada to occur has been adjusted. Based on the adjustment the SCPA’s new 100% statistical probability is that the relief rally highs from the March 2020 lows have been reached or will be reached by April 14, 2020.  Prior to the adjustment, the probability was 100% that relief rally high had been reached on or prior to Friday, April 3, 2020.

The adjustments were required when it was discovered that the empirical data for the Dow Jones Industrial’s index included Saturday trading sessions. From 1871 to 1952 the US market was open for trading on Saturdays. The inclusion of the Saturdays’ data distorted the SCPA’s date-of-event-to-occur forecasts since they increased the empirical data points for the researched periods by 20%. 

All of the event forecast dates by the SCPA (Statistical Crash Probability Analysis) which have been published are in the process of being revised. The only exception is that the final bottom for the Crash of 2020 will occur in Q4 2022 with a decline of 79% to 89% below 2020 highs. None of the previously published interim lows, highs, and final bottom percentages or price targets have changed.

As of Friday, April 3, 2020, all eight of the indices of the six countries had increased by a minimum of 18% from their March 2020 lows.  The SCPA had forecasted on March 24th that the probability for each of the eight indices to increase by 18% was 100% and that the probability of a 23% increase was 50%.  As of today’s April 6, 2020, close the Dow Jones Industrials composite became the first index to reach the 23% threshold with a gain of 24.5%.

My prediction is that the S&P 500’s secular bull market which began in March 2009 ended on February 19, 2020.  The ninth secular bear since 1802 began on February 20th.   Based on the peaks of the last three secular bull markets as compared to the troughs of the three most recent secular bears, the S&P 500 could decline by an additional 47% to 80% from its March 6, 2020 close.

Read my March 31, 2020, article entitled “Embrace the Bear” to learn about:

  • investing strategies that are best utilized during bear markets
  • investing in ETFs which go up when the market goes down
  • algorithms including the Bull & Bear Tracker and SCPA ’s which are being utilized by investors

Michael Markowski: Markets Now At Tipping Point, Ride Will Be Epic.

 Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The market indices of the US, Japan, South Korea, Canada, France and Germany and the share prices for many of the world’s largest companies including Apple and Microsoft are at the tipping point.  Stocks and indices reached their post-crash and relief rally closing highs from March 25th through March 27th.

None of the indices for the six countries has since closed above their highs.  Since making their relief rally highs all eight of the indices have declined by 4.2% to 7.4%.

With each new passing day that the indices are unable to get new post-crash highs, the probability increases that they will careen back to and through their March 2020 lows.

Investors now need to make a decision; stay in the roller coaster or get out?

From my empirical research on the prior notable market crashes in early March 2020, I discovered that the 1929 crash and the bursting of the NASDAQ dotcom bubble in 2000 share the same genealogy as the crashes of the markets of the six countries which have been underway.  The discovery was significant. It enabled the events chronology throughout the lives of the 1929 and 2000 crashes to be utilized to forecast the events for the crashes of six countries which are now underway and future crashes. For more about the genealogy read 03/23/20 “Probability 87% that market is at interim bottom” article.

The table below contains the first four precisely accurate forecasts that were made from the statistical crash probability analysis’ (SCPA).  The SCPA was developed from the findings from my empirical research of the most notable market crashes since 1929.

The charts below depict the almost identical chronology for the post-crash events that occurred after the Dow Jones crashed in 1929 and the NASDAQ dotcom bubble burst in 2000.  The journey to the final bottom took the Dow 32 months and the NASDAQ 31 months. The NASDAQ declined by 78% and the Dow by 89% from their highs.

The “2020”, year to date charts of the US’ Dow Jones, S&P 500 and NASDAQ indices below depict their crash chronologies from February 20th through March 27th.  Again, the chronologies of the 2020 crashes and the 1929 Dow and 2000 NASDAQ crashes though their initial correction and relief rally periods are very similar.

It was no surprise that the chart patterns for Microsoft and Apple mimic the three US indices.  The two companies are the largest members of all three. Since they have significant index weightings, wherever the indices go, they will follow.

The above charts and tables provide the rationale as to why the eight indices of the six countries will soon begin their marches to the following in sequence:

  • new lows 
  • interim bottoms 
  • interim highs 
  • final bottoms in Q4 2022 with declines ranging from 78% to 89% below 2020 highs

According the Statistical Crash Probability Analysis’ (SCPA) forecasts the probability is 100% that:

  • The relief rally highs for markets of the six countries have either already occurred or will occur by Friday, April 3, 2020.  
  • The eight indices will reach new 2020 lows by April 30, 2020.

To be clear.  Those who are still invested in stocks, mutual funds, and ETFs need to give serious consideration as to whether or not they want to stay on the wild roller coaster.  The ride will take everyone to the interim bottoms which will be within 41% to 44% of the eight indices’ 2020 highs.

After reaching the bottom the indices will then ricochet back to and through the recent relief rally highs and to the post-crash highs according to the SCPA’s forecast.  What will likely power the heart-pounding ride to the top is news about a cure or vaccine for the Coronavirus. This is will enable those who choose to stay on the rollercoaster to be able to liquidate at higher prices.  After the post-crash high has occurred the SCPA’s probability is 100% that the indices will then reverse to begin their descents to the final bottom which will 79% below their 2020 highs. The probability is 50% for the bottom to be within 89%

The virus did not cause the crash.   It caused the correction for markets which were ripe for an epic market crash.  Therefore, the probability is extremely low that good news about the virus will be enough to drive the markets back to new all-time highs.  See my March 5, 2020 article “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!”.

The SCPA is also forecasting a 100% probability for the key on the horizon events of the crash of 2020 below to occur in the sequence below.  The events and their probabilities are applicable to the eight indices of the six countries and for their largest members including Microsoft and Apple, etc.

  • Interim bottom by or before May 4, 2020
  • At interim bottom market will be 41% to 44% below 2020 highs
  • Post-crash high before the journey begins to final Q 4 2022 bottom will occur by as early as June 24, 2020 and by as late as September 18, 2020.
  • Post-crash highs to get market to within 17% of 2020 highs.

My only argument with the SCPA’s statistical probability analyses is can the markets get back to above or even to their March/April 2020 post-crash relief rally highs?  The simultaneous crashes in multiple markets for more than one country, let alone six countries, is historically unprecedented.

My hunch is that the damage to the markets and economies of the world’s leading developed countries will be much more severe than the damage caused by the 1929 crash.  The relief rally highs could prove to be the post-crash highs.

Should the recent highs be the post-crash highs, according to the SCPA the probability is 100% that it will take the markets a minimum of 15 years to get back above the highs reached during the week ended March 27, 2020.  Additionally, the findings from my extensive research on all of the secular bear markets since 1929 further support the SCPA’s forecast.

In addition to my empirical research of notable crashes, I also have been conducting empirical research on the Dow’s biggest one day gains from 1901 to 2020.  Based on my findings the probability is 94.4% that the Dow’s media sensationalized gains for the week ended March 27, 2020 were bear market rallies. See, “The TRUTH about Dow’s ‘… one day jump since 1933”.

Everyone should take advantage of markets being in close proximity of their post correction highs to exit the markets.  All mutual funds and stocks over $5.00 per share should be liquidated. I will provide my rationale for holding and also for buying low priced and penny shares in a future article.  My suggestion is to utilize a methodical approach by liquidating 20% of all holdings per day from April 1st to April 8th.

There are only three reasons why anyone would want to hold on to their stocks and mutual funds:

  1. Waiting to get back to break even.  It’s against human nature to take losses.  I knew investors in the 1970s who had been waiting for 10 to 20 years for a blue chip to get back to their purchase price.  Bite the bullet.
  2. Not wanting to pay capital gains.  Securities with gains can be “sold short against the box” to delay a taxable capital gain.   Capital gains taxes will only go up from here.
  3. Financial advisor advising otherwise.  Beware of the following:

a) An advisor’s largest percentage fee that can be charged is for the amount that an investor has in stocks.  If the investor is in cash the advisor can-not charge the fee.

b) The majority of financial advisors are affiliated with big brand name firms including Merrill Lynch, Morgan Stanley, Goldman Sachs and UBS, etc.  These advisors have to follow the party line. They do not have the independence to get their clients out of the market even if they wanted to.

c) The financial services industry utilizes propaganda to keep clients in the market during volatile periods.  Read “No One Saw It Coming’ – Should You Worry About The 10-Best Days” by Lance Roberts. He is among a few of the independent advisors who I know which had his clients’ 90% out of the market.

Michael Markowski: Embrace The Bear – Next Leg Down Is Coming

 Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


Investors must embrace the bear. A savvy investor or advisor can generate significantly more profits from a secular bear, than a secular bull.  It’s also much easier to predict the behavior of a wild and vicious bear than a domesticated bull.

The new 2020 secular bear is the first for which an investor can utilize an inverse ETF (Exchange Traded Fund) to invest in a bear market from start to finish. The share price of an inverse ETF increases when a market goes down. The first inverse ETFs were invented in 2007. The new ETFs enabled investors to make significant profits at the end of the 2000 to 2009 secular bear market.  The chart below depicts the gains for the Dow’s inverse ETF before and after Lehman went bankrupt in 2008.

The increased volatility caused by the secular bear can be leveraged by algorithms which had not been utilized in prior bear markets.   Two of my algorithms have the potential to produce substantial gains:

  • Bull & Bear Tracker (BBT) 

From April 9, 2018, and through February 29, 2020, the Bull & Bear Tracker (BBT) trend trading algorithm which trades both long and inverse ETFs produced a gain of 77.3% vs. the S&P 500’s 14.9%.   March of 2020 will be the BBT’s 9th consecutive profitable month.

The Bull & Bear Tracker thrives on market volatility.  The algorithm’s best performance days since the inception of the signals have been when the markets are most volatile.

  • SCPA (Statistical Crash Probability Analysis)

The SCPA is a crash event forecasting algorithm. The algorithm has been very accurate at forecasting the crash of 2020’s events.  The SCPA’s forecast that the market had reached a bottom on March 23rd was precisely accurate.   From 03/23/20 to 0/3/26/20, the Dow had its biggest one-day gain (11.4%) and three-day percentage gain (21.3%) since 1929 and 1931, respectively.  Those investors who purchased the Dow’s long ETF (symbol: DIA) by close of the market on March 23, 2020, after reading “Probability is 87% that market is at interim bottom”  which was published during market hours, had a one day gain of 11% at the close of the market on March 24, 2020.

The SCPA’s future event forecasts throughout the life of the crash of 2020 are being utilized to trade long and inverse ETFs until the US markets reach their final bottoms in the fourth quarter of 2022.  Had the SCPA and inverse ETFs been available to trade the SCPA’s forecasts in 1929, savvy investors would have made more than 572% from December of 1929 through July of 1932. There were 14 Bear market rallies with average gains of 17%.  The rallies were followed by 14 declines which averaged 23%. could have produced average gains of 23% for inverse ETF investors.

Both the Bull & Bear Tracker (BBT) and SCPA complement each other. The BBT predicts market volatility before it increases. The SCPA forecasts the percentage increases for the bear market rallies and the percentage declines from the bear rally highs. My prediction is that the utilization of both of the algorithms will reduce the failed signals ratio for the Bull & Bear Tracker.

Based on the findings from my recently completed empirical research of the Dow’s best rallies from 1901 to 2020, the markets will remain extremely volatile for the foreseeable future.

The Truth About The Biggest One Day Jump Since 1933

The Wall Street Journal’s “Dow Soars More Than 11% in Biggest One-Day Jump Since 1933” was inaccurate.  It should have read since “1929”.  The article should have been about the Dow Jones industrials composite index having its best one day and three-day percentage gains since 1929 and 1931 respectively.

The gain of 21.3% for the Dow’s three-day rally that ended on March 26th was the index’s second best since 1901.  The one-day gain of 11.4% on March 24th ranks as the Dow’s fourth best day since 1901.  To understand the significance of the error read on.

Nine of the top ten three-day percentage gainers occurred during the first four years of the 1929 to 1949 secular bear market.  The Five rallies which occurred before the 1929 crash reached its final bottom on July 8, 1932 all failed. Their post rally declines ranged from 19% to 82%.

Six of the 10 biggest daily percentage increases in the table below for the Dow over the last 120 years occurred from 1929 to 1933.  There were two 2008 secular bear market rallies, October 13 and 28, 2008 among the top ten one day wonders. The losses for both of the one-day 2008 rallies at the March 2009 were 31.1% and 28.7% respectively.

Of the 100 best percentage gain days for the Dow since 1901, 29 of them occurred between the post 1929 crash and the final July 1932 bottom.  From the 1932 bottom to the end of 1933 accounted for an additional 23 of the 100 best days. All of those rallies were profitable. From the low to the end of 1933, the Dow increased by more than 100%.  The only other period or year which had concentrated representation in the top 100 was 2008 which had seven.

The Wall Street Journal’s error is significant since 100% of the top 100 best one day rallies from:

  • October 1929 to July 1932 resulted in significant losses
  • July 1932 bottom to end of 1933 resulted in significant gains

The error has created a false sense of security for investors and especially for investment professionals, who are aware that after the 1929 crash, the Dow bottomed in 1932.   Had the performance for the Dow’s performance cited in the headline been compared to 1929, the context of the article would have been very bearish instead of somewhat bullish.

From my preliminary empirical research findings there were only seven bull market rallies within the top 100 one day percentage gainers. Three of seven  in the table below were represented by 1987 and two by 2009.

The three post 1987 “Black Monday’ crash rallies enabled the secular bull which began in 2002 to resume. To understand why it’s not possible for the secular bull which began in 2009 to resume read my two March 2020 articles below.  The 1987 crash does not share the genealogy of the Dow 1929, NASDAQ 2000 and the 2020 crashes for the markets of the US, Japan, Germany, Canada, France and South Korea which are now underway.

Based on the findings from my empirical research the probability is 94.4% (17/18) that the Dow 2020’s one day and three-day top ten percentage gainers last week were bear market rallies.         

Many are hopeful that the crash which has been underway since February 20, 2020, is just a correction for the continuation of the secular bull market which began in 2009.  Based on my just concluded empirical research of the Dow’s best daily and three-day gains and my previous findings from my prior statistical crash probability analysis, the rationale is in place for the markets to continue to crash.   My deep fear is that the world is on the verge of a 1930’s style economic depression.

Everyone should take advantage of the Bear market rally that is currently underway to exit the market as soon as possible.

  • According to the Statistical Crash Probability Analysis (SCPA) forecast the probability is 100% that the relief rally high has either already occurred or will occur by April 8, 2020.
  • The probability is the same for the markets of the six countries to make new lows by April 30, 2020.

For more about the SCPA click here for access to all of my 2020 crash related articles.  To view the SCPA’s very accurate track record for March 2020 click here.

All mutual funds and stocks over $5.00 per share should be liquidated by April 8th. My suggestion is to utilize a methodical approach by liquidating 20% of all holdings per day from April 1st to April 8th.

The SCPA is also forecasting the probability is 100% for the coming attractions from the crash of 2020:

  • Interim bottom by or before May 4, 2020
  • At interim bottom market will be 41% to 44% below 2020 highs
  • Post-crash high before the journey begins to final Q 4 2022 bottom will occur from June 24, 2020 to September 18, 2020.
  • Post-crash highs to get market to within 17% of 2020 highs.

My only argument against the SCPA’s statistical probability analyses is can the markets get back to above, or even to their March/April 2020 post-crash relief rally highs?  The simultaneous crashes in multiple markets for more than one country, let alone six countries, is historically unprecedented.

My hunch is that the damage to the markets and economies of the world’s leading developed countries will be much more severe than the damage caused by the 1929 crash.  The relief rally highs could prove to be the post-crash highs.

If that proves to be the case, according to the SCPA the probability is 100% that it will take the markets a minimum of 15 years to get back above the highs already made by the relief rally and longer to get back to their post-crash highs. Additionally, the findings from my extensive research on all of the secular bear markets since 1929 further support the SCPA’s forecast.

There are only three reasons why anyone who is reading my articles would not to sell:

  1. Waiting to get back to break even.  It’s against human nature to take losses.  
  2. Not wanting to pay capital gains.  Securities with gains can be “sold short against the box” to delay a taxable capital gain,
  3. Financial advisor advising otherwise.  Beware of the following:

a) An advisor’s largest percentage fee that can be charged is for the amount that an investor has in stocks.  If the investor is in cash the advisor can-not charge the fee.

b) The majority of financial advisors are affiliated with big brand name firms including Merrill Lynch, Morgan Stanley, Goldman Sachs and UBS, etc.  These advisors have to follow the party line. They do not have the independence to get their clients out of the market even if they wanted to.

c) The financial advisor industry utilizes propaganda to get clients to remain invested during volatile periods. Read “No One Saw It Coming’ – Should You Worry About The 10-Best Days” by Lance Roberts. He is among a few of the independent advisors who I know which had his clients’ 90% out of the market.

TPA Analytics: Death Cross On Russell 3000 Signals More Pain To Come

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


Where “I Bought It For The Dividend” Went Wrong

In early 2017, I warned investors about the “I bought it for the dividend” investment thesis. To wit:

“Company ABC is priced at $20/share and pays $1/share in a dividend each year. The dividend yield is 5%, which is calculated by dividing the $1 cash dividend into the price of the underlying stock.

Here is the important point. You do NOT receive a ‘yield.’

What you DO receive is the $1/share in cash paid out each year.

Yield is simply a mathematical calculation.

At that time, the article was scoffed at because we were 8-years into an unrelenting bull market where even the most stupid of investments made money.

Unfortunately, the “mean reversion” process has taken hold, which is the point where the investment thesis falls apart.

The Dangers Of “I Bought It For The Dividend”

“I don’t care about the price, I bought it for the yield.”

First of all, let’s clear up something.

In January of 2018, Exxon Mobil, for example, was slated to pay an out an annual dividend of $3.23, and was priced at roughly $80/share setting the yield at 4.03%. With the 10-year Treasury trading at 2.89%, the higher yield was certainly attractive.

Assuming an individual bought 100 shares at $80 in 2018, “income” of $323 annually would be generated.

Not too shabby.

Fast forward to today with Exxon Mobil trading at roughly $40/share with a current dividend of $3.48/share.

Investment Return (-$4000.00 ) + Dividends of $323 (Yr 1) and $343 (Yr 2)  = Net Loss of $3334

That’s not a good investment.

In just a moment, we will come and revisit this example with a better process.

There is another risk, which occurs during “mean reverting” events, that can leave investors stranded, and financially ruined.

Dividend Loss

When things “go wrong,” as they inevitably do, the “dividend” can, and often does, go away.

  • Boeing (BA)
  • Marriott (MAR)
  • Ford (F)
  • Delta (DAL)
  • Freeport-McMoRan (FCX)
  • Darden (DRI)

These companies, and many others, have all recently cut their dividends after a sharp fall in their stock prices.

I previously posted an article discussing the “Fatal Flaws In Your Financial Plan” which, as you can imagine, generated much debate. One of the more interesting rebuttals was the following:

If a retired person has a portfolio of high-quality dividend growth stocks, the dividends will most likely increase every single year. Even during the stock market crashes of 2002 and 2008, my dividends continued to grow. The total value of the portfolio will indeed fluctuate every year, but that is irrelevant since the retired person is living off his dividends and never selling any shares of stock.

Dividends usually go up even when the stock market goes down.

This comment is the basis of the “buy and hold” mentality, and many of the most common investing misconceptions.

Let’s start with the notion that “dividends always increase.”

When a recession/market reversion occurs, the “cash dividends” don’t increase, but the “yield” does as prices collapse. However, your INCOME does NOT increase. There is a risk it will decline as companies cut the dividend or eliminate it.

During the 2008 financial crisis, more than 140 companies decreased or eliminated their dividends to shareholders. Yes, many of those companies were major banks; however, leading up to the financial crisis, there were many individuals holding large allocations to banks for the income stream their dividends generated. In hindsight, that was not such a good idea.

But it wasn’t just 2008. It also occurred dot.com bust in 2000. In both periods, while investors lost roughly 50% of their capital, dividends were also cut on average of 12%.

While the current market correction fell almost 30% from its recent peak, what we haven’t seen just yet is the majority of dividend cuts still to come.

Naturally, not EVERY company will cut their dividends. But many did, many will, and in quite a few cases, I would expect dividends to be eliminated entirely to protect cash flows and creditors.

As we warned previously:

“Due to the Federal Reserve’s suppression of interest rates since 2009, investors have piled into dividend yielding equities, regardless of fundamentals, due to the belief ‘there is no alternative.’ The resulting ‘dividend chase’ has pushed valuations of dividend-yielding companies to excessive levels disregarding underlying fundamental weakness. 

As with the ‘Nifty Fifty’ heading into the 1970s, the resulting outcome for investors was less than favorable. These periods are not isolated events. There is a high correlation between declines in asset prices, and the dividends paid out.”

Love Dividends, Love Capital More

I agree investors should own companies that pay dividends (as it is a significant portion of long-term total returns)it is also crucial to understand that companies can, and will, cut dividends during periods of financial stress.

It is a good indicator of the strength of the underlying economy. As noted by Political Calculations recently:

Dividend cuts are one of the better near-real-time indicators of the relative health of the U.S. economy. While they slightly lag behind the actual state of the economy, dividend cuts represent one of the simplest indicators to track.

In just one week, beginning 16 March 2020, the number of dividend cuts being announced by U.S. firms spiked sharply upward, transforming 2020-Q1 from a quarter where U.S. firms were apparently performing more strongly than they had in the year-ago quarter of 2019-Q1 into one that all-but-confirms that the U.S. has swung into economic contraction.

Not surprisingly, the economic collapse, which will occur over the next couple of quarters, will lead to a massive round of dividend cuts. While investors lost 30%, or more in many cases, of their capital, they will lose the reason they were clinging on to these companies in the first place.

You Can’t Handle It

EVERY investor has a point, when prices fall far enough, regardless of the dividend being paid, they WILL capitulate, and sell the position. This point generally comes when dividends have been cut, and capital destruction has been maximized.

While individuals suggest they will remain steadfast to their discipline over the long-term, repeated studies show that few individuals actually do. As noted just recently is “Missing The 10-Best Days:”

“As Dalbar regularly points out, individuals always underperform the benchmark index over time by allowing “behaviors” to interfere with their investment discipline. In other words, investors regularly suffer from the ‘buy high/sell low’ syndrome.”

Behavioral biases, specifically the “herding effect” and “loss aversion,” repeatedly leads to poor investment decision-making. In fact, Dalbar is set to release their Investor Report for 2020, and they were kind enough to send me the following graphic for investor performance through 2019. (Pre-Order The Full Report Here)

These differentials in performance can all be directly traced back to two primary factors:

  • Psychology
  • Lack of capital

Understanding this, it should come as no surprise during market declines, as losses mount, so does the pressure to “avert further losses” by selling. While it is generally believed dividend-yielding stocks offer protection during bear market declines, we warned previously this time could be different:

“The yield chase has manifested itself also in a massive outperformance of ‘dividend-yielding stocks’ over the broad market index. Investors are taking on excessive credit risk which is driving down yields in bonds, and pushing up valuations in traditionally mature companies to stratospheric levels. During historic market corrections, money has traditionally hidden in these ‘mature dividend yielding’ companies. This time, such rotation may be the equivalent of jumping from the ‘frying pan into the fire.’” 

The chart below is the S&P 500 High Dividend Low Volatility ETF versus the S&P 500 Index. During the recent decline, dividend stocks were neither “safe,” nor “low volatility.” 

But what about previous “bear markets?” Since most ETF’s didn’t exist before 2000, we can look at the “strategy” with a mutual fund like Fidelity’s Dividend Growth Fund (FDGFX)

As you can see, there is little relative “safety” during a market reversion. The pain of a 38%, 56%, or 30%, loss, can be devastating particularly when the prevailing market sentiment is one of a “can’t lose” environment. Furthermore, when it comes to dividend-yielding stocks, the psychology is no different; a 3-5% yield, and a 30-50% loss of capital, are two VERY different issues.

A Better Way To “Invest For The Dividend”

“Buy and hold” investing, even with dividends and dollar-cost-averaging, will not get you to your financial goals. (Click here for a discussion of chart)

So, what’s the better way to invest for dividends? Let’s go back to our example of Exxon Mobil for a moment. (This is for illustrative purposes only and not a recommendation.)

In 2018, Exxon Mobil broke below its 12-month moving average as the overall market begins to deteriorate.

If you had elected to sell on the break of the moving average, your exit price would have been roughly $70/share. (For argument sake, you stayed out of the position even though XOM traded above and below the average over the next few months.)  

Let’s rerun our math from above.

  • In 2018, an individual bought 100 shares at $80.
  • In 2019, the individual sold 100 shares at $70.

Investment Return (-$1000.00 ) + Dividends of $323 (Yr 1) and $343 (Yr 2)  = Net Loss of $334

Not to bad.

Given the original $8,000 investment has only declined to $7,666, the individual could now buy 200 shares of Exxon Mobil with a dividend of $3.48 and a 9.3% annual yield.

Let’s compare the two strategies.

  • Buy And Hold: 100 shares bought at $80 with a current yield of 4.35% 
  • Risk Managed: 200 shares bought at $40 with a current yield of 9.3%

Which yield would you rather have in your portfolio?

In the end, we are just human. Despite the best of our intentions, emotional biases inevitably lead to poor investment decision-making. This is why all great investors have strict investment disciplines they follow to reduce the impact of emotions.

I am all for “dividend investment strategies,” in fact, dividends are a primary factor in our equity selection process. However, we also run a risk-managed strategy to ensure we have capital available to buy strong companies when the opportunity presents itself.

The majority of the time, when you hear someone say “I bought it for the dividend,” they are trying to rationalize an investment mistake. However, it is in the rationalization that the “mistake” is compounded over time. One of the most important rules of successful investors is to “cut losers short and let winners run.” 

Unfortunately, the rules are REALLY hard to follow. If they were easy, then everyone would be wealthy from investing. They aren’t because investing without a discipline and strategy has horrid consequences.

#MacroView: The Fed Can’t Fix What’s Broken

“The Federal Reserve is poised to spray trillions of dollars into the U.S. economy once a massive aid package to fight the coronavirus and its aftershocks is signed into law. These actions are unprecedented, going beyond anything it did during the 2008 financial crisis in a sign of the extraordinary challenge facing the nation.” Bloomberg

Currently, the Federal Reserve is in a fight to offset an economic shock bigger than the financial crisis, and they are engaging every possible monetary tool within their arsenal to achieve that goal. The Fed is no longer just a “last resort” for the financial institutions, but now are the lender for the broader economy.

There is just one problem.

The Fed continues to try and stave off an event that is a necessary part of the economic cycle, a debt revulsion.

John Maynard Keynes contended that:

“A general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”

In other words, when there is a lack of demand from consumers due to high unemployment, then the contraction in demand would force producers to take defensive actions to reduce output. Such a confluence of actions would lead to a recession.

On Thursday, initial jobless claims jumped by 3.3 million. This was the single largest jump in claims ever on record. The chart below shows the 4-week average to give a better scale.

This number will be MUCH worse next week as many individuals are slow to file claims, don’t know how, and states are slow to report them.

The importance is that unemployment rates in the U.S. are about to spike to levels not seen since the “Great Depression.” Based on the number of claims being filed, we can estimate that unemployment will jump to 20%, or more, over the next quarter as economic growth slides 8%, or more. (I am probably overly optimistic.)

More importantly, since the economy is 70% driven by consumption, we can approximate the loss in full-time employment by the surge in claims. (As consumption slows, and the recession takes hold, more full-time employees will be terminated.)

This erosion will lead to a sharp deceleration in economic confidence. Confidence is the primary factor of consumptive behaviors, which is why the Federal Reserve acted so quickly to inject liquidity into the financial markets. While the Fed’s actions may prop up financial markets in the short-term, it does little to affect the most significant factor weighing on consumers – their job. 

Another way to analyze confidence data is to look at the consumer expectations index minus the current situation index in the consumer confidence report.

This measure also says a recession is here. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than prior to the “dot.com” crash. Recessions start after this indicator bottoms, which has already occurred.

Importantly, bear markets end when the negative deviation reverses back to positive. Currently, we have only just started that reversion process.

While the virus was “the catalyst,” we have discussed previously that a reversion in employment, and a recessionary onset, was inevitable. To wit:

“Notice that CEO confidence leads consumer confidence by a wide margin. This lures bullish investors, and the media, into believing that CEO’s really don’t know what they are doing. Unfortunately, consumer confidence tends to crash as it catches up with what CEO’s were already telling them.

What were CEO’s telling consumers that crushed their confidence?

“I’m sorry, we think you are really great, but I have to let you go.” 

Confidence was high because employment was high, and consumers operate in a microcosm of their own environment.

“[Who is a better measure of economic strength?] Is it the consumer cranking out work hours, raising a family, and trying to make ends meet? Or the CEO of a company who is watching sales, prices, managing inventory, dealing with collections, paying bills, and managing changes to the economic landscape on a daily basis? A quick look at history shows this level of disparity (between consumer and CEO confidence) is not unusual. It happens every time prior to the onset of a recession.

Far From Over

Why is this important?

Hiring, training, and building a workforce is costly. Employment is the single largest expense of any business, but a strong base of employees is essential for the prosperity of a business. Employers do not like terminating employment as it is expensive to hire back and train new employees, and there is a loss of productivity during that process. Therefore, CEOs tend to hang onto employees for as long as possible until bottom-line profitability demands “leaning out the herd.” 

The same process is true coming OUT of a recession. Companies are “lean and mean” and are uncertain about the actual strength of the recovery. Again, given the cost to hire and train employees, they tend to wait as long as possible to be certain of justifying the expense.

Simply, employers are slow to hire and slow to fire. 

While there is much hope that the current “economic shutdown” will end quickly, we are still very early in the infection cycle relative to other countries. Importantly, we are substantially larger than most, and on a GDP basis, the damage will be worse.

What the cycle tells us is that jobless claims, unemployment, and economic growth are going to worsen materially over the next couple of quarters.

“But Lance, once the virus is over everything will bounce back.” 

Maybe not.

The problem with the current economic backdrop, and mounting job losses, is the vast majority of American’s were woefully unprepared for any type of disruption to their income going into recession. As discussed previously:

“The ‘gap’ between the ‘standard of living’ and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the ‘gap.’ However, following the ‘financial crisis,’ even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $2654 annual deficit that cannot be filled.”

As job losses mount, a virtual spiral in the economy begins as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices until the cycle is complete.

While the virus may end, the disruption to the economy will last much longer, and be much deeper, than analysts currently expect. Moreover, where the economy is going to be hit the hardest, is a place where Federal Reserve actions have the least ability to help – the private sector.

Currently, businesses with fewer than 500-employees comprise almost 60% of all employment. 70% of employment is centered around businesses with 1000-employees, or less. Most of the businesses are not publicly traded, don’t have access to Wall Street, or Federal Reserve’s bailouts.

The problem with the Government’s $2 Trillion fiscal stimulus bill is that while it provides one-time payments to taxpayers, which will do little to extinguish the financial hardships and debt defaults they will face.

Most importantly, as shown below, the majority of businesses will run out of money long before SBA loans, or financial assistance, can be provided. This will lead to higher, and a longer-duration of, unemployment.

One-Percenter

What does this all mean going forward?

The wealth gap is going to explode, demands for government assistance will skyrocket, and revenues coming into the government will plunge as trillions in debt issuance must be absorbed by the Federal Reserve. 

While the top one-percent of the population will exit the recession relatively unscathed, again, it isn’t the one-percent I am talking about.

It’s economic growth. 

As discussed previously, there is a high correlation between debts, deficits, and economic prosperity. To wit:

“The relevance of debt growth versus economic growth is all too evident as shown below. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the growth in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.”

However, simply looking at Federal debt levels is misleading.

It is the total debt that weighs on the economy.

It now requires nearly $3.00 of debt to create $1 of economic growth. This will rise to more than $5.00 by the end of 2020 as debt surges to offset the collapse in economic growth. Another way to view the impact of debt on the economy is to look at what “debt-free” economic growth would be. 

In other words, without debt, there has been no organic economic growth.

Notice that for the 30-year period from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Since then, the economic deficit has only continued to erode economic prosperity.

Given the massive surge in the deficit that will come over the next year, economic growth will begin to run a long-term average of just one-percent. This is going to make it even more difficult for the vast majority of American’s to achieve sufficient levels of prosperity to foster strong growth. (I have estimated the growth of Federal debt, and deficits, through 2021)

The Debt End Game

The massive indulgence in debt has simply created a “credit-induced boom” which has now reached its inevitable conclusion. While the Federal Reserve believed that creating a “wealth effect” by suppressing interest rates to allow cheaper debt creation would repair the economic ills of the “Great Recession,” it only succeeded in creating an even bigger “debt bubble” a decade later.

“This unsustainable credit-sourced boom led to artificially stimulated borrowing, which pushed money into diminishing investment opportunities and widespread mal-investments. In 2007, we clearly saw it play out “real-time” in everything from sub-prime mortgages to derivative instruments, which were only for the purpose of milking the system of every potential penny regardless of the apparent underlying risk.”

In 2019, we saw it again in accelerated stock buybacks, low-quality debt issuance, debt-funded dividends, and speculative investments.

The debt bubble has now burst.

Here is the important point I made previously:

“When credit creation can no longer be sustained, the markets must clear the excesses before the next cycle can begin. It is only then, and must be allowed to happen, can resources be reallocated back towards more efficient uses. This is why all the efforts of Keynesian policies to stimulate growth in the economy have ultimately failed. Those fiscal and monetary policies, from TARP and QE, to tax cuts, only delay the clearing process. Ultimately, that delay only deepens the process when it begins.

The biggest risk in the coming recession is the potential depth of that clearing process.”

This is why the Federal Reserve is throwing the “kitchen sink” at the credit markets to try and forestall the clearing process.

If they are unsuccessful, which is a very real possibility, the U.S. will enter into a “Great Depression” rather than just a “severe recession,” as the system clears trillions in debt.

As I warned previously:

“While we do have the ability to choose our future path, taking action today would require more economic pain and sacrifice than elected politicians are willing to inflict upon their constituents. This is why throughout the entirety of history, every empire collapsed eventually collapsed under the weight of its debt.

Eventually, the opportunity to make tough choices for future prosperity will result in those choices being forced upon us.”

We will find out in a few months just how bad things will be.

But I am sure of one thing.

The Fed can’t fix what’s broken.

While the financial media is salivating over the recent bounce off the lows, here is something to think about.

  • Bull markets END when everything is as “good as it can get.”
  • Bear markets END when things simply can’t “get any worse.”

We aren’t there yet.

TPA Analytics: Time To Buy CLX, KR, & MRK

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


The market has had a great 2-day rally, but the Coronavirus will be with us for a while. It is time to go back to stocks that outperformed when the market sank in February and March. The 3 stocks below (CLX, KR, and MRK) have declined recently, but were huge outperformers as the S&P500 dropped over 33%.

CLX – broke out above 15-month resistance in late February as the crisis began in earnest. CLX was the 8th best performer in the S&P1500 between 2/19/20 and 3/23/20. During that period CLX was up 5.25%, while the S&P500 was down 33.92% (see table below). CLX is down 23% in the past 5 days and is right back to the February breakout level, which should be support. TPA’s target is +20%.

CLX CLOROX CO 165.6600 Stop = 156.5487 Target = 198.7920

KR – rose above its 3 ½ year downtrend line in December. KR was the 10th best performer in the S&P1500 between 2/19/20 and 3/23/20. During that period KR was up 3.2%, while the S&P500 was down 33.92% (see table below). KR is down 18% in the past 4 days and is right back the breakout level, which should be support. TPA notes that the ratio of KR/S&P500 also broke out long term and short term and is at support; so it should outperform from here.

KR KROGER CO 27.9400 Stop = 26.4033 Target = 33.5280

MRK – is down 26% from its high on 12/20/19. It was one of the top 70 best performing stocks in the S&P1500 as the S&P500 fell 33.92% from 2/19/20 to 3/23/20. MRK was only down 19.2% (see table below). MRK is now all the way back to its breakout level from August 2018, which should be support. RSI analysis on a weekly basis shows that MRK is long term oversold. Chart 3 shows that the previous 3 times that MRK was this oversold on a weekly basis (2011, 2015, 2017) it was a good time to buy.

MRK MERCK & CO 68.2200 Stop = 64.4679 Target = 81.8640


Michael Markowski: Why You Should Sell The “Bear Market Rally.”

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


In yesterday’s “Crash events forecasting also accurate at calling market tops and bottoms”, March 24, 2020, article the statistical crash probability analysis (SCPA) algorithm forecasted that the probability was 100% that the stock indices for the US, Japan, Germany, South Korea, and France would rally by at least 18% from their 2020 lows.  At the close of the US markets on March 25, 2020, an index in each of the six countries had rallied by a minimum of 18% off of their lows.

The rallies of 18% from the lows for the six countries is the fourth consecutive precisely accurate forecast by the SCPA.  Prior forecasts are contained in table below:

The probability is now 50%:

  • That the indices will increase by 23% from their 2020 lows during their relief rallies
  • That the high for the relief rallies has occurred 

SCPA’s April forecasts and probabilities:

  • 100%- relief rally will peak by April 8, 2020
  • 100%- 2020 low will be breached by April 30, 2020

SCPA’s long term 100% probability forecast is for all eight of the global indices to bottom between September and November of 2022.  The probability is 100% for the markets of the countries to decline by a minimum of 79% below their 2020 highs and 50% for 89% below 2020 highs.  

Everyone should take advantage of the Bear market rally that is currently underway to GET OUT OF THE MARKET!   The bear who has arrived could potentially be more vicious than the 1929 bear market.

Since the indices have all rallied to within 18% to 27% of their 2020 highs, buy and hold investors and advisors should give serious consideration to take advantage of any rallies to liquidate holdings.  The Bull & Bear Tracker, which is a trend trading algorithm, could be utilized to quickly recoup losses of 30% for investments that are liquidated and also any capital gains taxes that might be owed.  

The Bull & Bear Tracker’s average gain has been above 5% per month since July of 2019.   Since its first signal was published on April 9, 2018, and through the end of February 2020, the gain was 77.3% vs. 14.9% for the S&P 500.  The Bull & Bear Tracker is projecting double digit gains for March 2020 while the S&P 500 will most likely have double digit losses.   For more about the Bull & Bear Tracker’s performance go to https://bullbeartracker.com/news/.

An investor can only allocate capital to be traded by the Bull & Bear Tracker though an approved registered investment advisor.  The investment advisor could also be utilized for an investor to get the maximum proceeds from liquidating their investments.

Fed Trying To Inflate A 4th Bubble To Fix The Third

Over the last couple of years, we have often discussed the impact of the Federal Reserve’s ongoing liquidity injections, which was causing distortions in financial markets, mal-investment, and the expansion of the “wealth gap.” 

Our concerns were readily dismissed as bearish as asset prices were rising. The excuse:

“Don’t fight the Fed”

However, after years of zero interest rates, never-ending support of accommodative monetary policy, and a lack of regulatory oversight, the consequences of excess have come home to roost. 

This is not an “I Told You So,” but rather the realization of the inevitable outcome to which investors turned a blind-eye too in the quest for “easy money” in the stock market. 

It’s a reminder of the consequences of “greed.” 

The Liquidity Trap

We previously discussed the “liquidity trap” the Fed has gotten themselves into, along with Japan, which will plague economic growth in the future. To wit:

“The signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.

Our “economic composite” indicator is comprised of 10-year rates, inflation (CPI), wages, and the dollar index. Importantly, downturns in the composite index leads GDP. (I have estimated the impact to GDP for the first quarter at -2% growth, but my numbers may be optimistic)

The Fed’s problem is not only are they caught in an “economic liquidity trap,” where monetary policy has become ineffective in stimulating economic growth, but are also captive to a “market liquidity trap.”

Whenever the Fed, or other Global Central Banks, have engaged in “accommodative monetary policy,” such as QE and rate cuts, asset prices have risen. However, general economic activity has not, which has led to a widening of the “wealth gap” between the top 10% and the bottom 90%. At the same time, corporations levered up their balance sheets, and used cheap debt to aggressively buy back shares providing the illusion of increased profitability while revenue growth remained weak. 

As I have shown previously, while earnings have risen sharply since 2009, it was from the constant reduction in shares outstanding rather than a marked increase in revenue from a strongly growing economy. 

Now, the Fed is engaged in the fight of its life trying to counteract a “credit-event” which is larger, and more insidious, than what was seen during the 2008 “financial crisis.”  

Over the course of the next several months, the Federal Reserve will increase its balance sheet towards $10 Trillion in an attempt to stop the implosion of the credit markets. The liquidity being provided may, or may not be enough, to offset the risk of a global economy which is levered roughly 3-to-1 according to CFO.com:

“The global debt-to-GDP ratio hit a new all-time high in the third quarter of 2019, raising concerns about the financing of infrastructure projects.

The Institute of International Finance reported Monday that debt-to-GDP rose to 322%, with total debt reaching close to $253 trillion and total debt across the household, government, financial and non-financial corporate sectors surging by some $9 trillion in the first three quarters of 2019.”

Read that last part again.

In 2019, debt surged by some $9 Trillion while the Fed is injecting roughly $6 Trillion to offset the collapse. In other words, it is likely going to require all of the Fed’s liquidity just to stabilize the debt and credit markets. 

Bubbles, Bubbles, Bubbles

Jerome Powell clearly understands that after a decade of monetary infusions and low interest rates, he has created an asset bubble larger than any other in history. However, they were trapped by their own policies, and any reversal led to almost immediate catastrophe as seen in 2018.

As I wrote previously:

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s.”

For quite some time now, we have warned investors against the belief that no matter what happens, the Fed can bail out the markets, and keep the bull market. Nevertheless, it was widely believed by the financial media that, to quote Dr. Irving Fisher:

“Stocks have reached a permanently high plateau.”

What is important to understand is that it was imperative for the Fed that market participants, and consumers, believed in this idea. With the entirety of the financial ecosystem more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” was the most significant risk. 

“The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’”

The Fed had hoped they would have time, and the “room” needed, after more than 10-years of the most unprecedented monetary policy program in U.S. history, to try and navigate the risks that had built up in the system. 

Unfortunately, they ran out of time, and the markets stopped “acting rationally.”

This is the predicament the Federal Reserve currently finds itself in. 

Following each market crisis, the Fed has lowered interest rates, and instituted policies to “support markets.” However, these actions led to unintended consequences which have led to repeated “booms and busts” in the financial markets.  

While the market has currently corrected nearly 25% year-to-date, it is hard to suggest that such a small correction will reset markets from the liquidity-fueled advance over the last decade.

To understand why the Fed is trapped, we have to go back to what Ben Bernanke said in 2010 as he launched the second round of QE:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

I highlight the last sentence because it is the most important. Consumer spending makes up roughly 70% of GDP; therefore increased consumer confidence is critical to keeping consumers in action. The problem is the economy is no longer a “productive” economy, but rather a “financial” one. A point made by Ellen Brown previously:

“The financialized economy – including stocks, corporate bonds and real estate – is now booming. Meanwhile, the bulk of the population struggles to meet daily expenses. The world’s 500 richest people got $12 trillion richer in 2019, while 45% of Americans have no savings, and nearly 70% could not come up with $1,000 in an emergency without borrowing.

Central bank policies intended to boost the real economy have had the effect only of boosting the financial economy. The policies’ stated purpose is to increase spending by increasing lending by banks, which are supposed to be the vehicles for liquidity to flow from the financial to the real economy. But this transmission mechanism isn’t working, because consumers are tapped out.”

This was shown in a recent set of studies:

The “Stock Market” Is NOT The “Economy.”

Roughly 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% to everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population.

“This is not economic prosperity. This is a distortion of economics.”

As I stated previously:

“If consumption retrenches, so does the economy.

When this happens debt defaults rise, the financial system reverts, and bad things happen economically.”

That is where we are today. 

The Federal Reserve is desperate to “bail out” the financial and credit markets, which it may  be successful in doing, however, the real economy may not recover for a very long-time. 

With 70% of employment driven by small to mid-size businesses, the shutdown of the economy for an extended period of time may eliminate a substantial number of businesses entirely. Corporations are going to retrench on employment, cut back on capital expenditures, and close ranks. 

While the Government is working on a fiscal relief package, it will fall well short of what is needed by the overall economy and a couple of months of “helicopter money,” will do little to revive an already over leveraged, undersaved, consumer. 

The 4th-Bubble

As I stated previously:

“The current belief is that QE will be implemented at the first hint of a more protracted downturn in the market. However, as suggested by the Fed, QE will likely only be employed when rate reductions aren’t enough.”

The implosion of the credit markets made rate reductions completely ineffective and has pushed the Fed into the most extreme monetary policy bailout in the history of the world. 

The Fed is hopeful they can inflate another asset bubble to restore consumer confidence and stabilize the functioning of the credit markets. The problem is that since the Fed never unwound their previous policies, current policies are having a much more muted effect. 

However, even if the Fed is able to inflate another bubble to offset the damage from the deflation of the last bubble, there is little evidence it is doing much to support economic growth, a broader increase in consumer wealth, or create a more stable financial environment. 

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is little evidence that growth will recover following this crisis to the degree many anticipate.

There are numerous problems which the Fed’s current policies can not fix:

  • A decline in savings rates
  • An aging demographic
  • A heavily indebted economy
  • A decline in exports
  • Slowing domestic economic growth rates.
  • An underemployed younger demographic.
  • An inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases

The lynchpin in the U.S., remains demographics, and interest rates. As the aging population grows, they are becoming a net drag on “savings,” the dependency on the “social welfare net” will explode as employment and economic stability plummets, and the “pension problem” has yet to be realized.

While the current surge in QE may indeed be successful in inflating another bubble, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. 

There is evidence the cycle peak has already been reached.

One thing is for certain, the Federal Reserve will never be able to raise rates, or reduce monetary policy ever again. 

Welcome to United States of Japan.

Michael Markowski: Why You Should Sell The “Bear Market Rally.”

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The statistical crash probability analysis (SCPA) algorithm’s forecast for an interim market bottom to occur on March 23, 2020, was precisely accurate.  It was the algo’s third consecutive precise major global markets call for March of 2020.

The day after the “Probability is 87% that market is at interim bottom” article was published on March 23, 2020, the Dow Jones Industrials composite index rallied by 11.4%, its biggest one day percentage increase since 1933.  Additionally, Canada’s TSE index set an all-time record with a gain of 12.7%. Below are the gains for all of the global stock indices in the article.

According to the SCPA in the articles below the indices were forecasted to decline by 34% from their 2020 highs by March 21, 2020.

As of March 23, 2020, six of the indices had declined by more than 34%! 

The SCPA now says that the probability is 100% that the indices will rally by 18% off of the lows.  The probability is 50% that the indices could increase by 23% from their lows.

Everyone should take advantage of the Bear market rally that is currently underway to GET OUT OF THE MARKET!   The bear that has arrived could potentially be more vicious than the 1929 bear.  

SCPA’s April forecasts:

  • 100%- relief rally will peak by April 8, 2020
  • 100%- 2020 low will be breached by April 30, 2020

SCPA’s long term forecast is for all eight of the global indices to bottom between September and November of 2022.  At the bottom the minimum decline will be 79% below the 2020 highs.

Since the indices have all rallied to within 30% of their 2020 highs, buy and hold investors and advisors should give serious consideration to take advantage of any rallies to liquidate holdings.  The Bull & Bear Tracker, which is a trend trading algorithm, could be utilized to quickly recoup losses of 30% for investments that are liquidated and also any capital gains taxes that might be owed.  

The Bull & Bear Tracker’s average gain has been above 5% per month since July of 2019.   Since its first signal was published on April 9, 2018, and through the end of February 2020, the gain was 77.3% vs. 14.9% for the S&P 500.  The Bull & Bear Tracker is projecting double digit gains for March 2020 while the S&P 500 will most likely have double digit losses.   For more about the Bull & Bear Tracker’s performance go to https://bullbeartracker.com/news/.

An investor can only allocate capital to be traded by the Bull & Bear Tracker though an approved registered investment advisor.  The investment advisor could also be utilized for an investor to get the maximum proceeds from liquidating their investments.

 

TPA Analytics: Not All Pieces In Place For A Sustained Rally

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


Michael Markowski: 87% Probability The Markets At An Interim Bottom

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


 

Based on my crash statistical probability analysis the probability is 87.5% that the stock markets of the US and the five other leading developed countries, which have been crashing since February 20, 2020, have reached an interim bottom.  

If the interim bottom has been made the statistical probability is 100% that the stock markets of the US, Japan, Germany, Canada, South Korea and France will experience powerful interim rallies that will result in double digit percentage gains as compared to their 2020 lows.  This will occur within days of the interim low being made. What will likely drive the rallies for all of the markets before they reverse to plumb to new lows is the US Congress passing a virus stimulus plan. A deceleration of the growth rate of new Coronavirus cases could also result in a quick and powerful relief rally.   

The probabilities and percentage increase targets in the above paragraphs were derived from my crash statistical probability analysis.  The analysis was explained in two of my recent articles which warned my readers to get out of the market.  As of March 23, 2020, the S&P had declined by 26% as compared to its closing price at March 6, 2020:

US Stock Market to decline by another 22% by Easter”, March 6, 2020

 “2020 Crash is third ‘Category 5 Hurricane’ in 90 years! Get out of market today!”, March 9, 2020

The new 2020 low made by the S&P 500 for today, March 23rd was poignant and increased the probability from 75% to 87.5% that the markets are near their interim bottoms.  It’s because the S&P 500 broke through the crash probability analysis’s 34% correction threshold. My articles of March 6th and March 9th explained the threshold’s significance.  The articles also made two very precise predictions for the markets of the crash inflicted countries that were relative to the threshold:  

  • 34% declines from their 2020 highs
  • declines to occur by March 21, 2020

When the predictions were published on March 6th, the corrections from their 2020 highs had ranged from 11% to 17%.  By March 18th, an index for each of the six countries had declined to or through the 34% threshold. South Korea and France were added after both of the articles were published.  However, two of the US’ indices, the S&P 500 had not corrected by 34%. The S&P 500 breached the threshold as of today (3/23/20) and got to 35.4% below its 2020 high. The NASDAQ’s correction from its 2020 high is at 33.0%.

Upon the markets for the countries reaching their initial post-crash highs the probability is also 100% that they will then reverse and then decline by 52% from their 2020 highs.  The steep declines to lower lows will occur by April 30, 2020. 

My ability to make such precise and accurate predictions is from my experience at conducting empirical research on extreme market anomalies that I have witnessed throughout my 42-year career.  The findings from my research are used to develop and power predictive algorithms which are utilized to predict similar extreme events in the future. The table below contains my algorithms which protect investors and enable them to make money in volatile and bear markets.

If it is not already, the 2020 crash will be recognized by historians as the most infamous stock market crash.  It’s the grand-daddy of all market crashes. The markets of more than one country beginning their crashes simultaneously after reaching all-time highs, then beginning their crashes the very next day is unprecedented.  The markets of three countries, Germany, Canada and the US reached all time highs on February 19, 2020. They then began their violent corrections that became crashes on February 20th, the very next day.

Since February 28th I have been working 18 hours a day to conduct empirical research on the five most infamous US stock market crashes listed in the table below.  My efforts yielded a significant breakthrough. The two crashes, which were by far the most lethal, 1929 and 2000 had the same genealogy as the crashes that have been underway for the six developed countries since February 20, 2020. The history for the two crashes was virtually identical   For example, the Crash of 1929 bottomed after 32 months and the NASDAQ 2000 bottomed after 31 months.

Based on my ongoing empirical research efforts regarding these same six countries, the statistical probability is 100% for the following events:  

  • The markets will have declined by a minimum of 79% when they bottom.  
  • The markets will bottom in fourth quarter of 2022.
  • It will take at least 15 years for the markets to return to their 2020 highs.  

My follow on article dated March 9th “2020 Crash is third ‘Category 5 Hurricane’ in 90 years! Get out of market today!”, was about the 2020 crash being equivalent to a “Category 5” designation which is assigned to only the most intense hurricanes.  To elaborate on this article, the discovery of the genealogy, statistical probabilities and pathology to identify lethal market crashes are analogous to a hurricane’s genealogy, statistical probabilities and pathology.

Unlike the stock market which has 100 years of available data, the ability to conduct empirical research on hurricanes only became available after the first plane few into the eye of a hurricane in 1943 to collect its barometric pressure.   Since then, the forecasting of hurricanes has become increasingly accurate. The intensity, geographical location and arrival times for a hurricane are very predictable. The result has been a significant reduction in hurricane fatalities.

The same forecasting can now be done for market crashes.  Instead of comparing barometric pressure readings, the Statistical Probability Analysis measures the degree of price volatility for market corrections which have the potential to become devastating crashes.   For a market to have the same genealogy as the 1929, 2000 and 2020 crashes, it must reach a specified percentage decline threshold within a consecutive-daily-declines period.   

The chart below covers four NASDAQ crashes.  The 2000 and 2020 category 5s experienced minimum corrections of 10% within days of their all-time highs.   The 2018 crash is not a Category 5 since its initial decline was less than 10%. Finally, the 2008 crash unlike the other three, did not occur after an all-time new high.  The NASDAQ and the S&P 500 peaked in October 2007.

The chart patterns for the indices of the five other countries including Japan, Canada, South Korea and France from February 19th to February 28th are almost identical.  The patterns for the Dow 1929 and the NASDAQ 2000 indices for the week to 10-day periods prior to their corrections becoming crashes were eerily similar.   

Deep research into the post-crash-to-the-final-bottom history for the 1929 and 2000 crashes enabled the identification of shared statistical probabilities and patterns.   The findings were then utilized to develop the indicated pathology for crashes of 1929, 2000 and 2020 as well as the projected pathology for all future crashes which have the same genealogy.  

The pathology and statistical probability analyses are now in the process to be programmed as crash tracking and post event forecasting algorithm.  The algorithm will monitor all markets which are ripe for a crash. It will automatically issue get-out-of-market warnings for future crashes. Finally, and most importantly, the crash tracking algorithm will forecast the following events and additional events as they unfold organically and after a crash has commenced:    

  • Interim low date range and target: enable those with cash to buy the market at the low and sell at the interim high before market reverses to make its final bottom 
  • Interim high date range and target: enables those who did not get out to sell out at higher prices 
  • final bottom and date range for final bottom:  enables long term by and hold investors to invest in something else while waiting for a bottom and reduces risk of buying prematurely and before bottom occurs 
  • number of years for a market that has endured a devastating crash to exceed pre-crash all-time high  

We are currently working as fast as we can to get a website developed for the algorithm. The event forecasts for the 2020 crashes needs to be available to all investors as soon as possible. My fear is that the declines for the markets of these six countries could happen much faster and be much deeper than the 1929 and 2000 crashes.  The probability of the first worldwide economic depression ever could occur.   

In the meantime, it is highly recommended that investors immediately engage a registered investment advisor (RIA) to assist in liquidating securities at the highest prices.  This will enable losses to be minimized. Time is of the essence. Many of the stock market’s biggest spikes over the past 100 years have occurred after crashes and at the beginning of secular bear markets.  

“No One Saw It Coming” – Should You Worry About The 10-Best Days

Pippa Stevens via CNBC recently had some advice:

“Panic selling not only locks in losses, but also puts investors at risk for missing the market’s best days.

Looking at data going back to 1930, Bank of America found that if an investor missed the S&P 500′s 10 best days in each  decade, total returns would be just 91%, significantly below the 14,962% return for investors who held steady through the downturns.”

But here was her key point, which ultimately invalidates her entire premise:

“The firm noted this eye-popping stat while urging investors to ‘avoid panic selling,’ pointing out that the ‘best days generally follow the worst days for stocks.’” 

Think about that for a moment.

“The best days generally follow the worst days.

The statement is correct, as the S&P 500’s largest percentage gain days, tend to occur in clusters during the worst of times for investors.

Here is another way to look at this through Friday’s close. For an investor trying to catch the markets best 10-days, they wound up losing almost 30% of their portfolio, an astounding -9,254 points over the span of 3 weeks.

The analysis of “missing out on the 10-best days” of the market is steeped in the myth of the benefits of “buy and hold” investing. (Read more: The Definitive Guide For Investing.Buy and hold, as a strategy works great in a long-term rising bull market. It fails as a strategy during a bear market for one simple reason: Psychology.

I agree investors should never “panic sell,” as such “emotional” decisions are always made at the worst possible times. As Dalbar regularly points out, individuals always underperform the benchmark index over time by allowing “behaviors” to interfere with their investment discipline.

In other words, investors regularly suffer from the “buy high/sell low” syndrome.

Such is why investors should follow an investment discipline or strategy which mitigates volatility to avoid being put into a situation where “panic selling” becomes an issue.

Let me be clear; an investment disciple does NOT ensure your portfolio against losses if the market declines. This is particularly the case when it plummets, as we’ve seen in the last couple of weeks. However, in any event, it will work to minimize the damage to a recoverable state.

The Market Timing Myth

We previously stated, that when the “crash” came, the mainstream media’s response would be: “Well, no one could have seen it coming.” 

Simply always being “bullish,” like Mr. Santolli, is what leads investors into being blindsided by rising risks in the market.

Yes, you can see, and predict, when risks exceed the grasp of rationality.

This brings us to the basic argument from the financial media which is simply you are NOT smart enough to manage your investments, so your only option is to “buy and hold.”

In 2010, Brett Arends wrote an excellent commentary entitled: “The Market Timing Myth” which primarily focused on several points we have made over the years. Brett really hits home with the following statement:

For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go or what’s going on in the economy. ‘You can’t time the market,’ they warn. ‘Studies show that market timing doesn’t work.’

He goes on:

“They’ll cite studies showing that over the long-term investors made most of their money from just a handful of big one-day gains. In other words, if you miss those days, you’ll earn bupkis. And as no one can predict when those few, big jumps are going to occur, it’s best to stay fully invested at all times. So just give them your money… lie back, and think of the efficient market hypothesis. You’ll hear this in broker’s offices everywhere. And it sounds very compelling.

There’s just one problem. It’s hooey.

They’re leaving out more than half the story.

And what they’re not telling you makes a real difference to whether you should invest, when and how.”

The best long-term study relating to this topic was conducted a few years ago by Javier Estrada, a finance professor at the IESE Business School at the University of Navarra in Spain. To find out how important those few “big days” are, he looked at nearly a century’s worth of day-to-day moves on Wall Street and 14 other stock markets around the world, from England to Japan to Australia.

Correctly, the study did find that if you missed the 10-best days of the market, you did indeed give up much of the gains. What he also found is that by missing the 10-worst days, you did remarkably better.

(The blue highlight shows, as of Friday’s close, investors will need a more than 40% return just to get back to even.)

Clearly, avoiding major drawdowns in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time compounding my invested dollars towards my long term goals.

Over an investing period of about 40 years, just missing the 10-best days would have cost you about half your capital gains. But successfully avoiding the 10-worst days would have had an even bigger positive impact on your portfolio. Someone who avoided the 10-biggest slumps would have ended up with two and a half times the capital gains of someone who simply stayed in all the time.

As Brett concluded:

“In other words, it’s something of a wash. The cost of being in the market just before a crash, are at least as great as being out of the market just before a big jump, and may be greater. Funny how the finance industry doesn’t bother to tell you that.”

The reason that the finance industry doesn’t tell you the other half of the story is because it is NOT PROFITABLE for them. The finance industry makes money when you are invested – not when you are in cash. Since a vast majority of financial advisors can’t actually successfully manage money, they just tell you to “stay the course.”

However, you DO have options.

A Simple Method

Now, let me clarify. I do not strictly endorse “market timing,” which is specifically being “all-in” or “all-out” of the market at any given time. The problem with market timing is consistency.

You cannot, over the long term, effectively time the market. Being all in, or out, of the market will eventually put you on the wrong side of the “trade,” which will lead to a host of other problems.

However, there are also no great investors in history who employed “buy and hold” as an investment strategy. Even the great Warren Buffett occasionally sells investments. True investors buy when they see the value, and sell when value no longer exists.

While there are many sophisticated methods of handling risk within a portfolio, even using a basic method of price analysis, such as a moving average crossover, can be a valuable tool over the long term holding periods. Will such a method ALWAYS be right? Absolutely not. However, will such a method keep you from losing large amounts of capital? Absolutely.

The chart below shows a simple 12-month moving average crossover study. (via Portfolio Visualizer)

What should be obvious is that using a basic form of price movement analysis can provide a useful identification of periods when portfolio risk should be REDUCED. Importantly, I did not say risk should be eliminated; just reduced. 

Here are the comparative results.

Again, I am not implying, suggesting, or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given, that is the time when individuals should perform some basic portfolio risk management such as:

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

By using some measures, fundamental or technical, to reduce portfolio risk by taking profits as prices/valuations rise, or vice versa, the long-term results of avoiding periods of severe capital loss will outweigh missed short term gains.

Small adjustments can have a significant impact over the long run.

As Brett continues:

Let’s be clear what it doesn’t mean. It still doesn’t mean you should try to ‘time’ the market day to day. Mr. Estrada’s conclusion is that a small number of big days, in both directions, account for most of the stock market’s price performance. Trying to catch the 10-biggest jumps, or avoid the 10-big tumbles, is almost certainly a fool’s errand. Hardly anyone can do this sort of thing successfully. Even most professionals can’t.

But, second, it does mean you that you shouldn’t let scare stories dominate your approach to investing. Don’t let yourself be bullied. Least of all by someone who isn’t telling you the full story.”

There is little point in trying to catch each twist and turn of the market. But that also doesn’t mean you simply have to be passive and let it wash all over you. It may not be possible to “time” the market, but it is possible to reach intelligent conclusions about whether the market offers good value for investors.

There is a clear advantage of providing risk management to portfolios over time. The problem, as I have discussed many times previously, is that most individuals cannot manage their own money because of “short-termism.”

Despite their inherent belief that they are long-term investors, they are consistently swept up in the short-term movements of the market. Of course, with the media and Wall Street pushing the “you are missing it” mantra as the market rises – who can really blame the average investor “panic” buying market tops, and selling out at market bottoms.

Yet, despite two major bear market declines, and working its third, it never ceases to amaze me that investors still believe they can invest their savings into a risk-based market, without suffering the eventual consequences of risk itself.

Despite being a totally unrealistic objective, this “fantasy” leads to excessive speculation in portfolios, which ultimately results in catastrophic losses. Aligning expectations with reality is the key to building a successful portfolio. Implementing a strong investment discipline, and applying risk management, is what leads to the achievement of those expectations.

#MacroView: Mnuchin & Kudlow Say No Recession?

“Treasury Secretary Steven Mnuchin on Sunday downplayed the likelihood of an economic recession as the economy takes a beating from the coronavirus outbreak.

When asked on ABC’s ‘This Week’ if the US was now in an economic recession as some have suggested, Munchin said, ‘I don’t think so.’ ” – CNN

However, it wasn’t just Mnuchin making such a claim, but Larry Kudlow as well:

“I just think, in general, I would be very careful to put too much emphasis on what bond rates are doing, what interest rates are doing. Or even in the short, short run, the stock market. I think you have a lot of mood swings here and I don’t think it reflects the fundamentals.” – Larry Kudlow via CNBC

I understand they have to pander to the administration, but this is a stretch to say the least. 

Let’s dig into some facts to determine our real risks.

Even before COVID-19 had infected the planet, economic data, and inflationary pressures were already weakening. This already suggested the decade long economic expansion was “running lean.”

However, the sharp decline in both 5- and 10-year “breakeven inflation rates,” are suggesting economic growth over the next couple of quarters will drop markedly. The last time there was such a sharp drop in inflation expectations at the beginning of the “financial crisis.”

Since then, the markets have been rocked as concerns over the spread of the“COVID-19” virus. The U.S. has shut down sporting events, travel, consumer activities, restaurants, bars, stores, and a host of other economically sensitive inputs. This is on top of the collapse in oil prices, which impacts a very important economic sector of the economy. (The O&G sector either directly or indirectly creates millions of jobs, has some of the highest wages, and is responsible for about 1/4th of all capital expenditures.)

However, this is just in the United States. This is a “global issue,” and the supply chains of the world are tightly interconnected. As we discussed previously:

“Given that U.S. exporters have already been under pressure from the impact of the ‘trade war,’ the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S.”

Our Economic Output Composite Indicator (EOCI) was already at levels which warned of weak economic growth. Furthermore, as shown below, even the Leading Economic Indicators (LEI) were already suggesting something was amiss long before the virus became “a thing.”

Data as of February 2020.

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

One reason we are confident the economic data will worsen near term is the correlation between the index and the annual rate of change of the S&P 500 index.

The financial markets lead the economy by about 6-months as markets begin to “price in” changes to earnings due to the outlook for economic strength. The recent plunge in the S&P 500 has deviated from the current EOCI index reading suggesting the index will decline towards recessionary levels over the next two months.

The Question Isn’t If…

The U.S. economy, along with the bulk of the globe, is already in “recession.”

Let’s start with a bit of historical context. Since the 1800’s, the average length of an economic recession has been 18-months. Some of that length is skewed by a more agricultural-based economy at the beginning, with more modern recessions having been shorter. (We are assuming that March 2020 was the start of a new recession at one-month.)

While the average recession has been somewhat shorter in recent decades, the recessions of 1973, 1991, and 2007 have pushed those long-term averages. The chart below also shows the subsequent decline in asset prices during subsequent recessions.

Given, declines of these magnitudes only occur during recessionary periods, the recent near 30% decline is likely good confirmation a recession has begun. (However, at just one-month, it may be overly optimistic to assume it is over with already. )

Yields Are Screaming: “Recession”

Interest rates are also a very good confirmation of recessionary periods as well. 

Since 2013, I have disagreed the mainstream analysis (including Jeff Gundlach and Bill Gross) that the “bond bull market” was dead. The reality has been substantially different as rates have continued to trend lower, and recently approached our long-term target of ZERO.

“There is an assumption that because interest rates are low, the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. 
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. 
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion, which will push the 10-year yield towards zero.” – August 30, 2016

So, where are we nearly 4-years later?

  • 23% of global debt is now supporting negative interest rates. 
  • The U.S. deficit has well surpassed $1 Trillion on its way to $2 Trillion.
  • Central Banks continue to be a primary buyer of bonds as the Fed’s balance sheet has swelled back to its previous peak and the Fed recently dropped rates to zero and started a $700 billion QE program.

Here is the relevant chart I posted in 2016. At that time rates were hitting lows of 1.6%, which was unthinkable at the time. And, where are rates, today? Approaching zero.

As shown above, over the last sixty years, the yield on the 10 year has approximated real GDP plus inflation (shown in the chart below). Given this historical fact, we can do some basic math to determine what yields are currently predicting for the U.S. economy currently. 

Via Doug Kass:

“Given ZIRP and QE policies around the globe which has pulled an extraordinary amount of sovereign debt into negative territory coupled with secular headwinds to energy prices, I have assumed that the 10 year yield will fall from 1.0x nominal GDP and average about 0.8x nominal GDP. 

According to my pal Peter Boockvar, the 10 year inflation breakeven (in the tips market) stands at 1.41% this morning:

So, let’s solve for what the market expects Real GDP to be (over the next 1-2 years) with this formula:

10 Year Yield (0.744% Actual) = 0.8x (Real GDP + 1.41% Actual (inflation))

The implied U.S. Real GDP of this equation is now negative — at -0.48%. (This compares to the consensus 2020 Real GDP growth forecast of between +1.75% to +2.00%) It also implies that nominal GDP (Real GDP plus Inflation) will be only about +0.93% – substantially below consensus expectations of slightly above 3%.”

It’s markedly worse now as the collapse in oil prices has sent breakeven rates below 1%. 

As we noted in “On The Cusp Of A Bear Market,” the collapse in interest rates, as well as the annual rate of change in rates, is screaming that something “has broken,” economically speaking.

Mnuchin’s suggestion the economy will likely avoid “recession,” is a bit ludicrous. The data suggests an entirely different outcome. However, David Rosenberg recently put some numbers on the impact to the economy from the “economic shutdown” from the virus. To wit:

“The pandemic is a clear ‘black swan’ event. There will be a whole range of knock-on effects. Fully 40 million American workers, or one-third of the private-sector labor force, are directly affected ─ retail, entertainment, events, sports, theme parks, conferences, travel, tourism, restaurants and, of course, energy.

This doesn’t include all the multiplier effects on other industries. It would not surprise me at all if real GDP in Q2 contracts at something close to an 8% annual rate (matching what happened in the fourth quarter of 2008, which was a financial event alone).

The hit to GDP can be expected to be anywhere from $400 billion to $600 billion for the year. But the market was in trouble even before COVID-19 began to spread, with valuations and complacency at cycle highs.

Given the average recession is 18-months, and given the severity of the economic impact, even this 12-month forecast is likely overly optimistic. However, we are still missing a LOT of data, which will come to light over the next several months. 

The recession will be quite severe.

As David concludes:

“A 35% slump in global financial stocks and a similar plunge in U.S. small-cap equities cannot be wrong on this forecast. And the massive volume of leverage complicates the outlook that much more.”

I know you shouldn’t point and laugh, but you almost have to when Mnuchin and Kudlow have the audacity to suggest this is a temporary negative shock. This a collision of multiple shocks impacting an overly leveraged, overly valued, and overly bullish market simultaneously.

  • Coronvirus impact
  • Supply chain shutdowns
  • Economy wide “closures”
  • Consumer confidence collapse.
  • Employment shock
  • Debt crisis

The problem for the Federal Reserve is this is NOT a “financial crisis,” or a simple “business cycle” recession, that monetary policy can fix. Governments have opted for to “contain the virus” by shutting down the economy. Giving households $1000 checks sounds great, but not if you can’t spend them. Maybe they will opt to pay down debt, but that doesn’t spur economic activity, or improve earnings, in the near term. 

Of course, since stocks price in future earnings growth, and since we have a feel for the impact of the recession coming, we can guesstimate the impact to earnings.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits and earnings. In the following series of charts, I have projected the potential reversion.

The reversion in GAAP earnings is pretty calculable as swings from peaks to troughs have run on a fairly consistent trend. (The last drop off is the estimate to for a recession)

“Using that historical context, we can project a recession will reduce earnings to roughly $100/share. The resulting decline asset prices to revert valuations to a level of 18x (still high) trailing earnings would suggest a level of $1800 for the S&P 500 index.”

“If our, and Mr. Rosenberg’s, estimates are correct of a 5-8% recessionary drag in the second quarter of 2020, then an average reduction in earnings of 30% is most likely overly optimistic. 

However, here is the math:

  • Current Earnings = 132.90
  • 30% Reduction = $100 (rounding down for easier math)

At various P/E multiples, we can predict where “fair value” for the market is based on historical assumptions:

  • 20x earnings:  Historically high but markets have traded at high valuations for the last decade. 
  • 18x earnings: Still historically high.
  • 15x earnings: Long-Term Average
  • 13x earnings: Undervalued 
  • 10x earnings: Extremely undervalued but aligned with secular bear market bottoms.

You can pick your own level where you think P/E’s will account for the global recession but the chart below prices it into the market.”

Unfortunately, both Larry Kudlow, Steve Mnuchin, and the Fed, are still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S. Furthermore, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a full repricing of assets.

Yes, we are in a recession, it has just started, and we have quite a ways to go before it is over. 

Fade rallies, and reduce risk accordingly. 

Michael Markowski: Dip Buyers, Beware Of Sensational Headlines

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk.Read more at BullsNBears.com


Many investors are salivating to trade the dips in a stock market which is becoming increasingly more volatile.  It’s because Wall Street for the week ended March 13th according to the headlines had its worst week since 2008.  Its human nature to want to buy at fire sale prices.     

March 13, 2020 headline:

After Worst Week Since 2008, What’s Next For The Stock Market?” , Benzinga March 13, 2020 

Investors became conditioned to buy the dips after the record setting 2008 crash.  The S&P 500 made a quick recovery after crashing down by 40% within six months to its lowest level since 1996 after Lehman declared bankruptcy in September 2008.  

Those who jumped in the last time the markets had their worst week since 2008, the week ended February 28, 2020, lost 8.2% in 10 days based on the S&P 500’s March 13th close.   Secular bear markets are famous for producing one sensational headline after another as a market continues to reach new lows.        

February 28, 2020 headline:

Wall Street has worst week since 2008 as S&P 500 drops 11.5%”, Associated Press February 28, 2020

From September 12, 2008, the last market close prior to Lehman’s bankruptcy to the bottom of the 2000 to 2009 secular bear market which began in 2000 and ended on March 9, 2009:

  • Passive buy and hold investors lost 39%
  • bullish traders who precisely got in at all bottoms and sold at tops made 136.5%
  • bearish traders who precisely sold short at all tops and bought the shares back at all bottoms made 162.3%

What likely happened due to the extreme volatility as depicted in the chart below most non-professional traders lost money.   Buy and hold bargain hunters who bought during the first five months after the 2008 crash began lost a minimum of 20%. From February 9, 2009, which was five months after the decline began, to the March 9th final bottom the market declined by an additional 22%.

The table below reinforces the difficulties that anyone but a professional investor had to make money from the 2008 crash.  $100 traded from September 12th to March 2009, would have declined to $74.20 at the 2000 secular bear’s final bottom.

The current market is much riskier than the 2008 market for dip buying.  Instead of being at the bottom of secular bear, the chart below depicts that the S&P 500 has been in a secular bull market since 2009.  In my March 5th article when the S&P 500 was 10% higher included my prediction that the secular bull likely reached its all-time high on February 19, 2020 and the secular bear began the very next day on February 20, 2020.

Based on my recent empirical research findings from analyzing prior crashes which have similar traits as the crash of 2020, the probability is high that the decline from the top to the bottom will be from 79% to 89%.  The final bottom will be reached between October and December of 2022. 

BullsNBears.com which covers all of the emerging and declining economic and market trends is an excellent resource site.  Click here to view one-minute video about the site.   

Profits & Earnings Suggest The Bear Market Isn’t Over.

Is the bear market over yet?

This is the question that everyone wants to know. Why? So they can “buy the bottom.” 

For that reason alone, I would suggest the current “bear market” is not over yet. Historically speaking, at the bottom of bear market cycles, as we saw in 1932, 1974, 2002, and 2008, there are few individuals willing to put capital at risk.

Given the large number of people on social media clamoring to jump back in the market given the rally this past Friday, it suggests that “optimism,” and “recency bias,” are still far too prevalent in the market.

As noted in this past weekend’s newsletter, Bob Farrell, a legendary investor, is famous for his 10-Investment Rules to follow.

“Rule #8 states:

Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend.”

  1. Bear markets often START with a sharp and swift decline.
  2. After this decline, there is an oversold bounce that retraces a portion of that decline.
  3. The longer-term decline then continues, at a slower and more grinding pace, as the fundamentals deteriorate.

Dow Theory also suggests that bear markets consist of three down legs with reflexive rebounds in between.

While the correction has been sharp in recent weeks, it hasn’t inflicted enough “emotional pain” to deter individuals from jumping back in. As I stated:

“That selloff sets up a ‘reflexive bounce.’  For many individuals, they will ‘feel like’ they are ‘safe.’ This is how ‘bear market rallies’ lure investors back just before they are mauled again in ‘Phase 3.’”

Just like in 2000, and 2008, the media/Wall Street will be telling you to just “hold on.” Unfortunately, by the time “Phase 3” was finished, there was no one wanting to “buy” anything.

That’s how you know a “bear market” is over.

Price To Profits & Earnings

From an investment view, I prefer more data-driven analysis to determine if the current bear market is over.

In a previous post, I discussed the deviation of the stock market from corporate profitability. To wit:

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

It isn’t just the deviation of asset prices from corporate profitability which is skewed, but also reported earnings per share.

As I have discussed previously, the operating and reported earnings per share are heavily manipulated by accounting gimmicks, share buybacks, and cost suppression. To wit:

“It should come as no surprise that companies manipulate bottom-line earnings to win the quarterly ‘beat the estimate’ game. By utilizing ‘cookie-jar’ reserves, heavy use of accruals, and other accounting instruments they can mold earnings to expectations.

‘The tricks are well-known: A difficult quarter can be made easier by releasing reserves set aside for a rainy day or recognizing revenues before sales are made, while a good quarter is often the time to hide a big ‘restructuring charge’ that would otherwise stand out like a sore thumb.

What is more surprising though is CFOs’ belief that these practices leave a significant mark on companies’ reported profits and losses. When asked about the magnitude of the earnings misrepresentation, the study’s respondents said it was around 10% of earnings per share.’

cooking-the-books-2

This is also why EBITDA has become an ineffective measure of financial strength. As I noted in “Earnings Lies & Why Munger Says EBITDA is B.S.:”

“As shown in the table, it is not surprising to see that 93% of the respondents pointed to ‘influence on stock price’ and ‘outside pressure’ as the reason for manipulating earnings figures. For fundamental investors, this manipulation of earnings skews valuation analysis particularly with respect to P/E’s, EV/EBITDA, PEG, etc.”

As Charlie Munger once said:

“I think that every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

Corporate Profits Weaker Than Advertised

Before the recent market rout, the deviation between reported earnings and corporate profits is one of the largest on record. This is an anomaly that should, in reality, not exist.

However, it is worse than it appears.

There is an interesting company included in the calculation of corporate profits, which is not widely recognized in most analysis. If you are an astute follower of our blog, you may recognize this particular company by the size of their balance sheet as shown below.

Yes, you guessed it (and it’s in the title). It’s the Federal Reserve.

When the Treasury Department pays interest one the debt, an expense to the U.S. Government, the Federal Reserve takes that in as “profits” which is reported on their balance sheet. Then, at the end of the year, the Fed remits a portion of the “revenue” back to the Government (who also count it as revenue).

These profits,” which are generated by the Federal Reserve’s balance sheet, are included in the corporate profits discussed here. As shown below, actual corporate profitability is weaker if you extract the Fed’s profits from the analysis.

It’s quite amazing, and with the Fed massively increasing their balance sheet, their profitability will expand further.

Nonetheless, since the Fed’s balance sheet is part of the corporate profit calculation, we must include them in our analysis. While the media is focused on record operating profits, reported corporate profits are roughly at the same level as they were in 2011. Yet, the market has been making consistent new highs during that same period.

Estimating The Risk

The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to “remain irrational longer than logic would predict,” but it never lasts indefinitely.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits and earnings. In the following series of charts, I have projected the potential reversion.

The reversion in GAAP earnings is pretty calculable as swings from peaks to troughs have run on a fairly consistent trend. (The last drop off is the estimate to for a recession)

Using that historical context, we can project a recession will reduce earnings to roughly $100/share. The resulting decline asset prices to revert valuations to a level of 18x (still high) trailing earnings would suggest a level of $1800 for the S&P 500 index.

Let me suggest that I am not being “overly dramatic” or “super bearish.”  There is a good bit of data to support the thesis. As I noted on Twitter, you can pick your valuation range, and do the math.

Don’t believe me?

We can support that thesis with corporate profits.

If we look at inflation-adjusted profit margins as a percentage of inflation-adjusted GDP, we see the same process of mean-reverting activity over time. Of course, these mean reverting events are always coupled with recessions, crisis, or bear markets.

More importantly, corporate profit margins have physical constraints. Out of each dollar of revenue created, there are costs such as infrastructure, R&D, wages, etc. Currently, one of the biggest beneficiaries to expanding profit margins has been the suppression of employment, wage growth, and artificially suppressed interest rates, which have significantly lowered borrowing costs. The oncoming recession will cause a rather marked collapse in corporate profitability as consumption declines.

The chart below shows corporate profits overlaid against the S&P 500 index. As with GAAP Earnings in the chart above, I have projected the potential reversion in corporate profitability as well.

When we measure the cumulative change in the S&P 500 index as compared to the level of profits, we find again that when investors pay more than $1 for a $1 worth of profits, there is an reversal of those excesses

 The correlation is clearer when looking at the market versus the ratio of corporate profits to GDP. Again, since corporate profits are ultimately a function of economic growth, the correlation is not unexpected.  Hence, neither should the impending reversion in both series.

To this point, it has seemed to be a simple formula that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy doesn’t matter. It has been a hard point to argue.

However, what has started, and has yet to complete, is the historical “mean reversion” process which has always followed bull markets. This should not be a surprise to anyone, as asset prices eventually reflect the underlying reality of corporate profitability.

Recessions reverse excesses.

Are we at the bottom yet? Probably not, if history is any guide.

Fox26 Interview: The Economic Impact Of COVID-19

On Friday morning, I visiting with my friends at Fox26 in Houston to discuss the economic, market, and investing impact of COVID-19.

“Will it get worse before it gets better?

Lance Roberts, chief investment strategist with RIA Advisors, explains how the COVID-19 coronavirus is impacting our economy.”


#MacroView: Fed Launches A Bazooka To Kill A Virus

Last week, we discussed in Fed’s ‘Emergency Rate Cut’ Reveals Recession Risks” that while current economic data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

We are likely experiencing more than just a ‘soft patch’ currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.”

The plunge in both 5- and 10-year “breakeven inflation rates,” are currently suggesting that economic growth over the next couple of quarters will drop markedly. The last time there was such a sharp drop in inflation expectations at the beginning of the “financial crisis.”

In the meantime, the markets have been rocked as concerns over the spread of the“COVID-19” virus in the U.S. have shut down sporting events, travel, consumer activities, and a host of other economically sensitive inputs. As we discussed previously:

“Given that U.S. exporters have already been under pressure from the impact of the ‘trade war,’ the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number.”

As noted, with the U.S. now shutting down and entrenching itself in response to the virus, the economic impact will be worsened. However, given that economic data is lagging, and we only have numbers that were mostly pre-virus, the reports over the next couple of months will ultimately reveal the extent of the damage.

We suspect that it will be more significant than most analysts currently expect.

With our Economic Output Composite Indicator (EOCI) at levels which have previously warned of recessions, the “timing” of the virus, and the shutdown of activity in response, will push the indications lower.

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a risk of a recessionary drag within the next 6-months.”

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

One reason we are confident the economic data will worsen near term is the correlation between the index and the annual rate of change of the S&P 500 index.

The financial markets lead the economy by about 6-months as markets begin to “price in” changes to earnings due to the outlook for economic strength. The recent plunge in the S&P 500 has deviated from the current EOCI index reading suggesting the index will decline towards recessionary levels over the next few months.

What the chart above obfuscates is the severity of the recent market rout. As shown below, in just three very short weeks, the market has reversed almost the entirety of the “Trump Stock Market” gains since he took office on January 20th.

The estimation of substantially weaker economic growth is not just a random assumption. In a post next week, I am going through the math of our analysis. Here is a snippet.

“Over the last sixty years, the yield on the 10-year has approximated real GDP plus inflation (shown in the chart below). Given this historical fact, we can do some basic math to determine what yields are currently predicting for the U.S. economy currently.”

Doug Kass recently did the math:

“Given ZIRP and QE policies around the globe which has pulled an extraordinary amount of sovereign debt into negative territory coupled with secular headwinds to energy prices, I have assumed that the 10 year yield will fall from 1.0x nominal GDP and average about 0.8x nominal GDP. 

According to my pal Peter Boockvar, the 10-year inflation breakeven (in the tips market) stands at 1.41% this morning:

So, let’s solve for what the market expects Real GDP to be (over the next 1-2 years) with this formula:

10-Year Yield (0.744% Actual) = 0.8x (Real GDP + 1.41% Actual (inflation))

The implied U.S. Real GDP of this equation is now negative — at -0.48%. (This compares to the consensus 2020 Real GDP growth forecast of between +1.75% to +2.00%) It also implies that nominal GDP (Real GDP plus Inflation) will be only about +0.93% – substantially below consensus expectations of slightly above 3%.”

Doug’s estimates were before to the recent collapse in oil prices, and breakeven inflation rates. With oil prices now at $30/bbl and 10-year breakeven rates to 0.9%, the math is significantly worse, and that is what the severity of the recent selloff is telling us. Over the next two quarters, we could see as much as a 3% clip off of current GDP.

This data is not lost on the Federal Reserve and is why they have been taking action over the last two weeks.

The Fed Bazooka

It’s quite amazing that in mid-February, which now seems like a lifetime ago, we were discussing the markets being 3-standard deviations above their 200-dma, which is a rarity. Three short weeks later, the markets are now 4-standard deviations below, which is even a rarer event. 

That swing in asset prices has cut the “wealth effect” from the market, and will severely impact consumer confidence over the next few months. The decline in confidence, combined with the impact of the loss of activity from the virus, will sharply reduce consumption, which is 70% of the economy.

This is why the Fed cut rates in an “emergency action” by 0.50% previously. Then on Wednesday, increased “Repo operations” to $175 Billion.

However, like hitting a patient with a defibrillator, the was no response from the market.

Then yesterday, the Fed brought out their “big gun.”  In a statement from the New York Fed:

The Federal Reserve said it would inject more than $1.5 trillion of temporary liquidity into Wall Street on Thursday and Friday to prevent ominous trading conditions from creating a sharper economic contraction.

‘These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.’

The New York Fed said it would conduct three additional repo offerings worth an additional $1.5 trillion this week, with two separate $500 billion offerings that will last for three months and a third that will mature in one month.

If the transactions are fully subscribed, they would swell the central bank’s $4.2 trillion asset portfolio by more than 35%.” – WSJ

As Mish Shedlock noted,

“The Fed can label this however they want, but it’s another round of QE.”

As you can see in the chart below, this is a massive surge of liquidity hitting the market at a time the market is sitting on critical long-term trend support.

Of course, this is what the market has been hoping for:

  • Rate cuts? Check
  • Liquidity? Check

For about 15-minutes yesterday, stocks responded by surging higher and reversing half of the day’s losses. Unfortunately, the enthusiasm was short-lived as sellers quickly returned to continue their “panic selling.” 

This has been frustrating for investors and portfolio managers, as the ingrained belief over the last decade has been “Don’t worry, the Fed’s got this.”

All of a sudden, it looks like they don’t.

Will It Work This Time?

There is a singular risk that we have worried about for quite some time.

Margin debt.

Here is a snip from an article I wrote in December 2018.

Margin debt is the ‘gasoline,’ which drives markets higher as the leverage provides for the additional purchasing power of assets. However, that ‘leverage’ also works in reverse as it provides the accelerant for larger declines as lenders ‘force’ the sale of assets to cover credit lines without regard to the borrower’s position.

That last sentence is the most important. The issue with margin debt, in particular, is that the unwinding of leverage is NOT at the investor’s discretion. It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) When lenders fear they may not be able to recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once as falling asset prices impact all lenders simultaneously.

Margin debt is NOT an issue – until it is.”

Given the magnitude of the declines in recent days, and the lack of response to the Federal Reserve’s inputs, it certainly has the feel of a margin debt liquidation process. This was also an observation made by David Rosenberg:

“The fact that Treasuries, munis, and gold are getting hit tells me that everything is for sale right now. One giant margin call where even the safe-havens aren’t safe anymore. Except for cash.”

Unfortunately, FINRA only updates margin debt in arrears, so as of this writing, the latest margin debt stats are for January. What we do know is that due to the market decline, negative free cash balances have likely declined markedly. That’s the good news.

Back to my previous discussion for a moment:

“When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point which triggers an initial round of margin calls. Since margin debt is a function of the value of the underlying ‘collateral,’ the forced sale of assets will reduce the value of the collateral, further triggering further margin calls. Those margin calls will trigger more selling forcing, more margin calls, so forth and so on.

Given the lack of ‘fear’ shown by investors during the recent decline, it is unlikely that the recent drop in margin debt is a function of ‘forced liquidations.’ As I noted above, it will likely take a correction of more than 20%, or a ‘credit related’ event, which sparks broker-dealer concerns about repayment of their credit lines.

The risk to the market is ‘when’ those ‘margin calls’ are made.

It is not the rising level of debt that is the problem; it is the decline which marks peaks in both market and economic expansions.”

That is precisely what we have seen over the last three weeks.

While the Federal Reserve’s influx of liquidity may stem the tide temporarily, it is likely not a “cure” for what ails the market.

However, with that said, the Federal Reserve, and Central Banks globally, are not going to quietly into the night. Expect more stimulus, more liquidity, and more rate cuts. If that doesn’t work, expect more until it does.

We have already reduced a lot of equity risk in portfolios so far, but are going to continue lifting exposures and reducing risk until a bottom is formed in the market. The biggest concern is trying to figure out exactly where that is.

One thing is now certain.

We are in a bear market and a recession. It just hasn’t been announced as of yet.

That is something the Fed can’t fix right away with monetary policy alone, and, unfortunately, there won’t be any help coming from the Government until after the election.

Market Crash Reveals The “Liquidity Problem” Of Passive Investing

When it comes to investing, it’s a losing proposition to try and be anything better than average.

If there’s no point in trying to beat the market through ‘active’ investing – using mutual funds that managers run, selecting what they hope are market-beating investments – what is the best way to invest? Through “passive” investing, which accepts average market returns ­(this means index funds, which track market benchmarks)”Forbes

The idea of “passive indexing” sounds harmless enough, buy an “index” and be an “average” investor.

However, it isn’t as simple as that, and we have spilled a lot of ink digging into the relative dangers of it. Last week, investors saw those risks first hand.

The biggest risk to investors is when “passive indexers” turn into “panic sellers.” 

While the “sell-off” over the last couple of weeks was brutal, with the Dow posting some of the biggest declines in its history, as I will explain, it was exacerbated by the “passive indexing revolution.” 

Jim Cramer previously penned (courtesy of Doug Kass) an interesting note on the active vs. passive conflict.

“The answer is that there are two kinds of sellers in this market: hedge fund sellers, who react off of research, and portfolio shufflers, who buy and sell ETFs and index funds.

The former jumps on anything, right or wrong, as long as it is actionable. The latter, the index funds and ETF traders, rarely jump although they may press down harder on a bedraggled ETF, like one that includes the consumer products group.

But there are two kinds of buyers. The opportunistic buyers, and the index buyers. The opportunists think that the downgrades are noise and give them a chance to buy high-quality stocks with the money that comes in over the transom.

The index and ETF buyers? Well, they just buy.”

The dichotomy explains a lot of the bullish action, and isn’t talked about enough.

While Jim wrote this about those “buying” ETF’s, the same is true when they begin to “sell.” 

“The index and ETF sellers? Well, they just sell.”

It is often suggested that individuals who buy “passive indexes,” such as the SPDR S&P 500 Index (SPY), are they themselves “passive investors.” In other words, these individuals are willing to buy an “index” and hold it for an extended period regardless of market volatility.

Reality has been far different.

This was clear last week as the S&P 500 ETF (SPY) saw some of the biggest outflows in its history with the exception of the February 2018 market plunge as Trump announced his “Trade War with China.” 

The problem with individuals and “passive” investing is they are just “active” investors in a different form. They make all the same mistakes that individual stock investors make, such as “buying high and selling low,” but just using a different instrument to do it.

As the markets declined last week, there was a slow realization “this decline” was something more than another “buy the dip” opportunity. Concerns of the impact on the global supply chain, due to “COVID-19,” slowing earnings, economic growth, and a reduction of liquidity from the Federal Reserve, all culminated in a “panicked exit.”

As losses mounted, anxiety rose until individuals began to sell to “avert further losses” by selling.

Yes….it’s that psychology thing.

Individuals refuse to act “rationally” by holding their investments as losses mount.

The behavioral biases of investors are one of the most serious risks arising from ETFs as too much capital is concentrated into too few places. This concentration risk in ETF’s is not the first time this has occurred:

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy
  • Today, it’s ETF’s and Bitcoin

Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing.

Until it goes in the other direction.

While the sell-off last week was large, it was the uniformity of the price moves, which revealed the fallacy “passive investing” as investors headed for the exits all at the same time.

The Apple Problem

Currently, there more than 1750 ETF”s trading in the U.S., with each of those ETF’s owning many of the same underlying companies. For an ETF company to “sell” you product, they need good performance. In a late-stage market cycle driven by momentum, it is not uncommon to find the same “best performing” stocks proliferating a large number of ETF’s.

For example, out of the 1750 ETF’s in the U.S., there are 175, or 10%, which own Apple (AAPL). Given that so many ETF’s own the same company, the problem of “liquidity” is exposed during a market rout. The head of the BOE, Mark Carney, warned about the risk of “disorderly unwinding of portfolios” due to the lack of market liquidity.

“Market adjustments to date have occurred without significant stress. However, the risk of a sharp and disorderly reversal remains given the compressed credit and liquidity risk premia. As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets.”

Howard Marks, also noted in “Liquidity:”

“ETF’s have become popular because they’re generally believed to be ‘better than mutual funds,’ in that they’re traded all day. Thus an ETF investor can get in or out anytime during trading hours. But do the investors in ETFs wonder about the source of their liquidity?’”

Let me explain.

There is a statement often made by individuals about the market.

“For every buyer, there is a seller.” 

The belief has always been that if an individual wants to sell, there will always be a buyer available to execute the transaction at any given price.

However, such is not actually the case.

The correct statement is:

“For every buyer, there is a seller….at a specific price.”

In other words, when the selling begins, those wanting to “sell” overrun those willing to “buy,” so prices have to drop until a “buyer” is willing to execute a trade.

The “Apple” problem, using our example above, is that while investors who are long Apple shares directly are trying to find buyers, the 175 ETF’s that also own Apple shares are vying for the same buyers to meet redemption requests.

This surge in selling pressure creates a “liquidity vacuum” between the current price and the price at which a “buyer” is willing to step in. As we saw last week, Apple shares fell faster than the SPDR S&P 500 ETF, of which Apple is one of the largest holdings.

Secondly, the ETF market is not a PASSIVE MARKET. Today, advisors are actively migrating portfolio management to the use of ETF’s for either some, if not all, of the asset allocation equation. Importantly, they are NOT doing it “passively.” The rise of index funds has turned everyone into “asset class pickers,” instead of stock pickers. However, just because individuals are choosing to “buy baskets” of stocks, rather than individual securities, it is not a “passive” choice, but rather “active management” in a different form.  

While “passive indexing” sounds like a winning approach to “pace” the markets during the late stages of an advance, it is worth remembering it will also “pace” just as well during the subsequent decline.

The correction had the “perma-bulls” scrambling to produce commentary as to why markets will continue only to rise. Unfortunately, that is not the way markets actually work over the long-term, and why the basic rules of investing are REALLY hard to follow.

Despite the best of intentions, individual investors are NOT passive even though they are investing in “passive” vehicles. When these market swoons begin, the rush to liquidate entire baskets of stocks accelerate the decline making sell-offs much more violently than what we have seen in the past.

This concentration of risk, lack of liquidity, and a market increasingly driven by “robot trading algorithms,” reversals are no longer a slow and methodical process but rather a stampede with little regard to price, valuation, or fundamental measures as the exit becomes very narrow.

February was just a “sampling” of what will happen to the markets when the next bear market begins.

Are you prepared?

Michael Markowski: Market Will Decline 34% To 77% From Highs

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com

The simultaneous double-digit declines for the stock markets of four of the world’s developed countries from February 20 to February 28, 2020 was not only an historic event; but unfortunately, ominous in that it portends dire financial times ahead.  

Based on empirical data and statistics the probability is 100% that the US, German, Japanese and Canadian stock markets will decline by 34% from their 2020 highs by Easter.  The probability for a 77% decline before exceeding their 2020 highs is 66%.      

What caused the double-digit corrections for the five indices and their soon to be crashes was not the Coronavirus.  It was the bidding up of the shares of the four trillion-dollar valued tech stocks to ridiculous prices. See “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!”, March 5, 2020.

The fact that four of the five indices traded at historic highs on February 19, 2020 is extremely troubling.  Clearly, the crash that will soon occur is not your garden variety crash. See also, my March 5, 2020 article “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!

My predictions, based on my statistical research, on how markets behave after minimum swift corrections of 10% and my 43 years of experience:

  1. All of the indices will decline by a minimum of 34% from their February highs.    
  2. The first worldwide recession has begun.
  3. The US and most of the world’s governments will have to bail out their airlines.
  4. The Secular bull market which began in March 2009 ended on February 19th.  
  5. The 9th secular bear since 1802 began on February 20th.

The stocks markets for countries simultaneously reaching all-time highs and then declining by 10% or more within 10 days is unprecedented.  However, there have been cases of this occurring for the US markets. For all three cases, the corrections became crashes with minimum declines of 34% within two to 25 days after the corrections commenced.

Statistical probabilities for the indices of the four countries based on the 1929, 1987 and 2000 crash statistics: 

  • 100% probability for minimum declines of 34%
  • 66% probability for declines of 44% from 2020 peaks to troughs 
  • 66% probability for declines of 77% before getting back to all-time highs
  • 100% probability it will take 1½ to 25 years before exceeding February 19, 2020 highs  
  • 66% probability that indices will bottom in Q4 of 2022

The significant declines coming for the indices of the four developed countries has increased the likelihood of an epic global market crash.  Crashes which begin in a particular country can become viral and cause crashes in other countries. The 10% plus correction for the Dow Jones composite index, which began on October 5, 1987, is a good example.  The Dow’s correction spread to the Nikkei and its decline of 21% began on October 14, 1987; the day after it reached its all-time high. The interaction between the US and Japanese markets likely fueled the infamous “Black Monday” crash which occurred on October 19, 1987.

The crashes which began for the Dow in 1929 and the NASDAQ in 2000 occurred at the end of secular bulls and the beginning of secular bear markets.  The Dow’s 1987 Black Monday crash caused minimal damage to the secular bull which began in 1982 for two reasons:

  • At the age of five years old, the secular bull was an adolescent.  Since 1802, the minimum lifespan of a secular bull or bear has been eight years.
  • The fall of communism, which began in 1989, helped the 1982-2000, secular bull to climb back above its October 1987 pre-crash high by July of 1989

Since the Dow’s 1987 Black Monday crash occurred two days after the index’s 10% correction, most investors did not have an opportunity to get out.  However, after the 1929 Dow and 2000 NASDAQ had corrected by 10%, investors had opportunities to sell out. 

After the NASDAQ, in 2000 declined by 11% from March 5th to 15th, investors had until March 29, 2000 to sell out before the index began to plumb new lows.

On April 14, 2000, which was 25 days after the correction began, the NASDAQ had declined by 34%.  It took the Dow 10 days to reach the 34% decline threshold from October 17, 1929, after its initial 10% correction occurred within a 5-day period.

From researching the 1929 crash and 2000 dotcom bubble crash the indices will decline by more than 70% from their peaks and hit their bottoms sometime in the fourth quarter of 2022.  The 1929 crash bottomed in 32 months and the NASDAQ 30 months after their corrections began.

The February 19, 2020, correction is especially worrisome for the US stock market and economy.   The NASDAQ and S&P 500 were the top performing of the five global indices for the 12 months ended February 19,2020.

For the 12 months prior to the to the dotcom bubble bursting in March of 2000, the S&P 500 lagged the NASDAQ and the three foreign indices.  The low performance of the index mitigated the negative impact that the collapsing NASDAQ could have had on the US economy.

The S&P 500’s underperforming was a blessing since for the 12 months ended March 2001, its 12% decline was much lower than the rates of decline for the five other indices.

The post 10% swift correction from a market peak behavior for precious metals further support my findings for the equities markets.  Since 1979 the prices of both gold and silver each corrected swiftly by 10% or more twice.  On all four occasions the prices of the precious metals went on to crash by a minimum of 34% after experiencing minimum 10% corrections within the same time frames as the two Dow crashes and the NASDAQ crash.

My prediction is that the S&P 500’s secular bull market which began in March 2009 ended on February 19, 2020.  The ninth secular bear since 1802 began on February 20th.   Based on the peaks of the last three secular bull markets as compared to the troughs of the of the three most recent secular bears, the S&P 500 could decline by an additional 47% to 80% from its March 6, 2020 close.

The video of my “Secular Bulls & Bears: Each requires different investing strategies” workshop at the February 2020 Orlando Money Show is highly recommended.  The educational video explains secular bulls and bears and includes strategies to protect assets during secular bear markets and recessions, etc.  

BullsNBears.com which covers all of the emerging and declining economic and market trends is an excellent resource site.  Click here to view one-minute video about the site.   

#MacroView: Fed’s “Emergency Rate Cut” Reveals Recession Risks

Last week, I discussed in “Recession Risks Tick Up” that while current data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

“The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data, which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.”

“The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.”

In this particular case, while the market is suggesting there is an economic problem coming, we also discussed the impact of the “coronavirus,” or “COVID-19,” on the economy. Specifically, I stated:

But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S. 

Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number. 

With our Economic Output Composite Indicator (EOCI) already at levels which has previously denoted recessions, the “timing” of the virus could have more serious consequences than currently expected by overzealous market investors. 

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months.”

That analysis seemed to largely bypass the mainstream economists, and the Fed, who were focused on the “number of people getting sick,” rather than the economic disruption from the shutdown of the supply chain.

On Tuesday, the Federal Reserve shocked the markets with an “emergency rate cut” of 50-basis points. While the futures market had been predicting the Fed to cut rates at their next meeting on March 18th, the half-percent cut shocked equity markets as the Fed now seems more concerned about the economy than they previously acknowledged.

It is one thing for the Fed to cut rates to support economic growth. It is quite another for the Fed to slash rates by 50 basis points between meetings.

It smacks of “fear.” 

Previously, such emergency rate cuts have not been done lightly, but in response to a bigger crisis which was simultaneously unfolding.

While we have spilled a good bit of digital ink as of late warning about the ramifications of COVID-19:

“Clearly, the ‘flu’ is a much bigger problem than COVID-19 in terms of the number of people getting sick. The difference, however, is that during ‘flu season,’ we don’t shut down airports, shipping, manufacturing, schools, etc. The negative impact on exports and imports, business investment, and potential consumer spending are all direct inputs into the GDP calculation and will be reflected in corporate earnings and profits.”

This is not a trivial matter.

“Nearly half of U.S. companies in China said they expect revenue to decrease this year if business can’t return to normal by the end of April, according to a survey conducted Feb. 17 to 20 by the American Chamber of Commerce in China, or AmCham, to which 169 member companies responded. One-fifth of respondents said 2020 revenue from China would decline more than 50% if the epidemic continues through Aug. 30..”WSJ

That drop in revenue, and ultimately earnings, has not yet been factored into earnings estimates. This is a point I made on Tuesday:

“More importantly, the earnings estimates have not been ratcheted down yet to account for the impact of the “shutdown” to the global supply chain. Once we adjust (dotted blue line) for a negative earnings environment in 2020, with a recovery in 2021, you can see just how far estimates will slide over the coming months. This will put downward pressure on stocks over the course of this year.”

It is quite possible even my estimates may still be too high.

While the markets have been largely dismissing the impact of the virus, the Fed’s “panic” move on Tuesday was confirming evidence that we are on the right track.

The market’s wild correction over the past two weeks, also begins to align with the Fed’s previous rate-cutting cycles. While it initially appeared “this time was different,” as the market continued to rise due to the Fed’s flood of liquidity, the markets seem to be playing catch up to previous rate-cutting cycles. If the economic data begins to weaken markedly, we may will see an alignment with the previous starts of bear markets and recessions.

Of course, we need to add some context to the chart above. Historically, the reason the Fed cuts rates, and interest rates fall, is because the Fed has acted in response to a crisis, recession, or both. The chart below shows when there is an inversion between the Fed Funds rate, and the 10-year Treasury, it has been associated with recessionary onset. (This curve will invert when the Fed cuts rates further at their next meeting.)

Not surprisingly, as suggested by the historical data above, the stock market has yielded a negative return a year after an emergency rate cut was initiated.

There is another risk the Fed may not be prepared for, an inflationary spike in prices. What could potentially impact the economy, and inflationary pressures, is the shutdown of the global supply chain which creates a lack of supply to meet immediate demand. Basic economics suggests this could lead to inflationary pressures as inventories become extremely lean, and products become unavailable. Even a short-term inflationary spike would put the Federal Reserve on the “wrong-side” of the trade, rendering the Fed’s monetary policies ineffective.

The rising recession risk is also being signaled by the collapse in the 10-year Treasury yield, a point which I have made repeatedly over the last several years in discussing why interest rates were headed toward zero.

“Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market. 

Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter.”

A chart of monetary velocity tells you there is a problem in the economy as lower interest rates fails to spark an uptick in the flow of money.

My friend Caroline Baum summed up the Fed’s primary problem given the issue of plunging rates:

“All of a sudden, the reality of revisiting the zero lower bound, which the Fed now refers to as the effective lower bound (ELB), is no longer off in the distance. It could be right around the corner.

And this at a time when Fed officials are still saying that the economy and monetary policy are ‘in a good place’ and the fundamentals are sound. So what do policymakers do when the good place deteriorates into something mediocre, and the fundamentals turn sour?

Forward guidance, which I like to call talk therapy? Large-scale asset purchases? Unfortunately, the Fed goes to war with the tools it has, not the tools it might want or wish to have.”

Unfortunately, the Fed is still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S.

The reasons are simple. You can’t cure a debt problem with more debt. Therefore, monetary interventions, and government spending, don’t create organic, sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled.

There is already evidence that lower rates are not leading to expanding consumption, business investment, or economic activity. Furthermore, while QE may temporarily lift asset prices, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a repricing of assets.

Furthermore, there is likely no help coming from fiscal policy, either. As Caroline noted:

“Fiscal-policy measures, which entail tax cuts and government spending, will be difficult to enact in this highly charged political environment. There is little evidence that the Republicans and Democrats can put partisan differences aside to work together.”

Or, as Chuck Schumer said to Ben Bernanke just prior to the “financial crisis:”

“You’re the only game in town.” 

The real concern for investors, and individuals, is the real economy.

We are likely experiencing more than just a “soft patch” currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.

The Fed already realizes they have a problem, as noted by Fed Chair Powell on Tuesday:

“A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that.”

More importantly, this is no longer a domestic question, but rather a global one. Since every major central bank is now engaged in a coordinated infusion of liquidity, fighting slowing economic growth, a rising level of negative yields, and a spreading virus shutting down economic activity, it is “all hands on deck.”

The Federal Reserve is currently betting on a “one trick pony” which is that by increasing the “wealth effect,” it will ultimately lead to a return of consumer confidence, and mitigate the effect of a global contagion.

Unfortunately, there mounting evidence it may not work.

MacroView: The Ghosts Of 2018?

On Jan 3rd, I wrote an article entitled: “Will The Market Repeat The Start Of 2018?” At that time, the Federal Reserve was dumping a tremendous amount of money into the financial markets through their “Repo” operations. To wit:

“Don’t fight the Fed. That is the current mantra of the market as we begin 2020, and it certainly seems to be the right call. Over the last few months, the Federal Reserve has continued its “QE-Not QE” operations, which has dramatically expanded its balance sheet. Many argue, rightly, the current monetary interventions by the Fed are technically “Not QE” because they are purchasing Treasury Bills rather than longer-term Treasury Notes.

However, ‘Mr. Market’ doesn’t see it that way. As the old saying goes, ‘if it looks, walks, and quacks like a duck…it’s a duck.'” 

As I noted then, despite commentary to the contrary, there were only two conclusions to draw from the data:

  1. There is something functionally “broken” in the financial system which is requiring massive injections of liquidity to try and rectify, and;
  2. The surge in liquidity, whether you want to call it a “duck,” or not, is finding its way into the equity markets.

Let me remind you this was all BEFORE the outbreak of the Coronavirus.

The Ghosts Of 2018

“Well, this past week, the market tripped ‘over its own feet’ after prices had created a massive extension above the 50-dma as shown below. As I have previously warned, since that extension was so large, a correction just back to the moving average at this point will require nearly a -6% decline.”

“I have also repeatedly written over the last year:

‘The problem is that it has been so long since investors have even seen a 2-3% correction, a correction of 5%, or more, will ‘feel’ much worse than it actually is, which will lead to ’emotionally driven’ mistakes.’

The question now, of course, is do you “buy the dip” or ‘run for the hills?’”

Yesterday morning, the markets began the day deeply in the red, but by mid-morning were flirting with a push into positive territory. By the end of the day, the Dow had posted its largest one-day point loss in history.”

That was from February 6th, 2018 (Technically Speaking: Tis But A Flesh Wound)

Here is a chart of October 2019 to Present.

Besides the reality that the only thing that has occurred has been a reversal of the Fed’s “Repo” rally, there is a striking similarity to 2018. That got me to thinking about the corollary between the two periods, and how this might play out over the rest of 2020.

Let’s go back.

Heading in 2018, the markets were ebullient over President Trump’s recently passed tax reform and rate cut package. Expectations were that 2018 would see a massive surge in earnings growth, due to the lower tax rates, and there would be a sharp pickup in economic growth.

However, at the end of January, President Trump shocked the markets with his “Trade War” on China and the imposition of tariffs on a wide variety of products, which potentially impacted American companies. As we said at the time, there was likely to be unintended consequences and would kill the effect of tax reform.)

“While many have believed a ‘trade war’ will be resolved without consequence, there are two very important points that most of the mainstream analysis is overlooking. For investors, a trade war would likely negatively impact earnings and profitability while slowing economic growth through higher costs.”

Over the next few months, the market dealt, and came to terms with, the trade war and the Fed’s tightening of the balance sheet. As we discussed in May 2018, the trade war did wind up clipping earnings estimates to a large degree, but massive share repurchases helped buoy asset prices.

Then in September, the Fed did the unthinkable.

After having hiked rates previously, thereby tightening the monetary supply, they stated that monetary policy was not “close to the neutral rate,” suggesting more rate hikes were coming. The realization the Fed was intent on continuing to tighten policy, and further extracting liquidity by reducing their balance sheet, sent asset prices plunging 20% from the peak, to the lows on Christmas Eve.

It was then the Fed acquiesced to pressure from the White House and began to quickly reverse their stance and starting pumping liquidity back into the markets.

And the bull market was back.

Fast forward to 2020.

“The exuberance that surrounded the markets going into the end of last year, as fund managers ramped up allocations for end of the year reporting, spilled over into the start of the new with S&P hitting new record highs.

Of course, this is just a continuation of the advance that has been ongoing since the Trump election. The difference this time is the extreme push into 3-standard deviation territory above the moving average, which is concerning.” – Real Investment Report Jan, 5th 2018

As noted in the chart below, in both instances, the market reached 3-standard deviations above the 200-dma before mean-reverting.

Of course, while everyone was exuberant over the Fed’s injections of monetary support, we were discussing the continuing decline in earnings growth estimates, along with the lack of corporate profit growth To wit:

With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and ‘repo’ operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the ‘coronavirus’ has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which, as stated above, is going to make justifying record asset prices more problematic.”

Just as the “Trade War” shocked the markets and caused a repricing of assets in 2018, the “coronavirus” has finally infected the markets enough to cause investors to adjust their expectations for earnings growth. Importantly, as in 2018, earnings estimates have not been revised lower nearly enough to compensate for the global supply chain impact coming from the virus.

While the beginning of 2020 is playing out much like 2018, what about the rest of the year?

There are issues occurring which we believe will have a very similar “feel” to 2018, as the impact of the virus continues to ebb and flow through the economy. The chart below shows the S&P 500 re-scaled to 1000 for comparative purposes.

Currently, the expectation has risen to more than a 70% probability the Fed will cut rates 3x in 2020. Historically, the market tends to underestimate just how far the Fed will go as noted by Michael Lebowitz previously:

“The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.”

Our guess is that in the next few weeks, the Fed will start using “forward guidance” to try and stabilize the market. Rate cuts, and more “quantitative easing,” will likely follow.

Such actions should stabilize the market in the near-term as investors, who have been pre-conditioned to “buy” Fed liquidity, will once again run back into markets. This could very well lift the markets into second quarter of this year.

But it will likely be a “trap.”

While monetary policy will likely embolden the bulls short-term, it does little to offset an economic shock. As we move further into the year, the impact to the global supply chain will begin to work its way through the system resulting in slower economic growth, reduced corporate profitability, and potentially a recession. (See yesterday’s commentary)

This is a guess. There is a huge array of potential outcomes, and trying to predict the future tends to be a pointless exercise. However, it is the thought process that helps align expectations with potential outcomes to adjust for risk accordingly.

A Sellable Rally

Just as in February 2018, following the sharp decline, the market rallied back to a lower high before failing once again. For several reasons, we suspect we will see the same over the next week or two, as the push into extreme pessimism and oversold conditions will need to be reversed before the correction can continue.

While 2019 ended in an entirely dissimilar manner as compared to 2018, the current negative sentiment, as shown by CNN’s Fear & Greed Index is back to the extreme fear levels seen at the lows of the market in 2018.

On a short-term technical basis, the market is now extremely oversold, which is suggestive of a counter-trend rally over the next few days to a week or so.

It is highly advisable to use ANY reflexive rally to reduce portfolio risk, and rebalance portfolios. Most likely, another wave of selling will likely ensue before a stronger bottom is finally put into place. 

Lastly, our composite technical overbought/oversold gauge is also pushing more extreme oversold conditions, which are typical of a short-term oversold condition.

In other words, in 2019 “everyone was in the pool,” in 2020 we just found out “everyone was swimming naked.” 

Rules To Follow

One last chart.

I just want you to pay attention to the top panel and the shaded areas. (standard deviations from the 50-dma)

We were not this oversold even during the 2015-2016 decline, much less the two declines in 2018.

Currently, not only is the market extremely oversold on a short-term basis, but is currently 5-standard deviations below the 50-dma.

Let me put that into perspective for you.

  • 1-standard deviation = 68.26% of all possible price movement.
  • 2-standard deviations = 95.45% 
  • 3-standard deviations = 99.73%
  • 4-standard deviations = 99.993%
  • 5-standard deviations = 99.9999%

Mathematically speaking, the bulk of the decline is already priced into the market.

“I get it. We are gonna get a bounce. So, what do I do?”

I am glad you asked.

Step 1) Clean Up Your Portfolio

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Take profits in positions that have outperformed during the rally.
  3. Sell laggards and losers (those that lagged the rally, probably led the decline)
  4. Raise cash, and rebalance portfolios to reduced risk levels for now.

Step 2) Compare Your Portfolio Allocation To Your Model Allocation.

  1. Determine areas where exposure needs to be increased, or decreased (bonds, cash, equities)
  2. Determine how many shares need to be bought or sold to rebalance allocation requirements.
  3. Determine cash requirements for hedging purposes
  4. Re-examine the portfolio to ensure allocations are adjusted for FORWARD market risk.
  5. Determine target price levels for each position.
  6. Determine “stop loss” levels for each position being maintained.

Step 3) Be Ready To Execute

  • Whatever bounce we get will likely be short-lived. So have your game plan together before-hand as the opportunity to rebalance risk will likely not be available for very long. 

This is just how we do it.

However, there are many ways to manage risk, and portfolios, which are all fine. What separates success and failure is 1) having a strategy to begin with, and; 2) the discipline to adhere to it.

The recent market spasm certainly reminds of 2018. And, if we are right, it will get better, before it gets worse.

Quick Take: Recession Risks Tick Up

Over the last couple of months, there was a slight uptick in the economic data, which lifted hopes that a “global reflation” event was underway. 

As we have been warning for the last couple of months in our weekly newsletter, the ongoing collapse in commodity prices suggested a problem was emerging that trailing “sentiment” data was clearly overlooking. To wit:

“There are a few indicators which, by their very nature, should be signaling a surge in economic activity if there was indeed going to be one. Copper, energy prices, commodities in general, and the Baltic Dry index, should all be rising if economic activity is indeed beginning to recover. 

Not surprisingly, as the “trade deal” was agreed to, we DID see a pickup in commodity prices, which was reflected in the stronger economic reports as of late. However, while the media is crowing that “reflation is on the horizon,” the commodity complex is suggesting that whatever bump there was from the “trade deal,” is now over.”

Importantly, that decline happened BEFORE the “Coronavirus,” which suggests the virus will only worsen the potential impact.

I want to reiterate an important point.

The risk to the market, and the economy, is not “sick people.” It is the shutdown of the global supply chain.

China is a substantially larger portion, and economically more important, than it was in 2003 when SARS hit. As noted by Johnson & Palmer of Foreign Policy:

“China itself is a much more crucial player in the global economy than it was at the time of SARS, or severe acute respiratory syndrome, in 2003. It occupies a central place in many supply chains used by other manufacturing countries—including pharmaceuticals, with China home to 13 percent of facilities that make ingredients for U.S. drugs—and is a voracious buyer of raw materials and other commodities, including oil, natural gas, and soybeans. That means that any economic hiccups for China this year—coming on the heels of its worst economic performance in 30 years—will have a bigger impact on the rest of the world than during past crises.

That is particularly true given the epicenter of the outbreak: Wuhan, which is now under effective quarantine, is a riverine and rail transportation hub that is a key node in shipping bulky commodities between China’s coast and its interior.

But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S. 

Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number. 

With our Economic Output Composite Indicator (EOCI) already at levels which has previously denoted recessions, the “timing” of the virus could have more serious consequences than currently expected by overzealous market investors. 

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)

Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months. 

This is what the collapsing yield curve is already confirming as the 10-year plunged to the lowest levels on record. Currently, 60% of the yields we track have now inverted. 

Outside of the indicators we track, Eric Hickman previously made similar observations:

“The long history (49+ years) of these indicators can be used to get a sense of timing for when a recession may begin. I have measured historically how long these indicators signaled before (or after) the start of their accompanying recession. Comparing this time-frame to when these indicators triggered recently, suggests a range for when this recession may come. The chart below shows the time ranges (minimum amount of time historically to maximum amount of time historically) in which each indicator would suggest a recession start.”

“There are a few conclusions to this. First, five recession indicators have signaled. Second, there is nothing unusual in the timing that the recession hasn’t started yet. Third, no matter which of the five indicators you use, a recession will likely begin in 2020 and the average center-point of the indicators is in March, just a little over two months away. Don’t confuse the Fed’s ‘on-hold’ stance to have any more meaning than the hope that the consumer and labor market’s strength will continue. History suggests that this is not a good bet to make.”

The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.

The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.

Technically Speaking: Markets Start To Price In “Viral Impacts”

At the end of January, I wrote a piece titled “This Is Nuts: Why We Reduced Risk” discussing why we took profits in our portfolios. Here is the important point:

“When you sit down with your portfolio management team, and the first comment made is ‘this is nuts,’ it’s probably time to think about your overall portfolio risk.” 

At that time, we began the orderly process of reducing exposure in our portfolios:

In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now.

The important sentence came next:

“We did not ‘sell everything’ and go to cash. We simply reduced our holdings to raise cash, and capture some of the gains we made in 2019. When the market corrects, we will use our cash holdings to either add back to our current positions or add new ones.”

At the time we made those changes, it appeared we were clearly wrong as the market continued to grind higher. As Howard Marks once quipped:

“Being early, even if you are right, is the same as being wrong.” 

You Can’t Time Market Corrections

From a portfolio management, and more particularly, a “risk mitigation” view, our job isn’t necessarily to hit the exact tops or bottoms, just to provide a cushion against losses. This is why we constantly measure risk, and make adjustments accordingly.

Over the last couple of weeks, we have continued to repeatedly note the extreme overbought, overly bullish, and over complacent conditions of the market. This was a point we discussed with our RIAPRO subscribers (Try for 30-days RISK FREE) in last Monday’s technical market update.

“As noted last week: ‘With the market now trading 12% above its 200-dma, and well into 3-standard deviations of the mean, a correction is coming.’ But the belief is currently ‘more stimulus’ will offset the ‘virus.’

This is probably a wrong guess.

Extensions to this degree rarely last long without a correction. Maintain exposures, but tighten up stop-losses.”

That extreme deviation from the long-term mean was unsustainable. What was needed was a catalyst to cause the slide. This past weekend, the realization the “coronavirus was NOT contained,” was the trigger needed to revert that overly stretched condition.

This is the misunderstanding of portfolio management. Risk management decisions are not being “all in” or “all out.” Making extreme movements actually increases your portfolio risk due to the high probability of making a “wrong call.”

For us, risk management is like driving a car. When you drive, you are constantly making a myriad of small adjustments from adjusting your lane position, your speed, and your positioning relative to the other cars. You are also simultaneously assessing the “risks” of other drivers, the weather, unexpected obstacles, and traffic signals and signs. After years of driving, you subconsciously make all these decisions without giving it much thought, but in actuality, you did.

The same goes for portfolio management. Small adjustments made to keep the portfolio moving forward while avoiding the potential of a catastrophic accident is the goal. Sure, it is entirely possible we could get into a “fender bender,” and such should be expected. What we want to make sure of, however, is that in the event of a crash, we will walk away relatively unharmed. This is why we make sure our portfolio has a seat belt (cash), airbags (hedges), strong structural support (bonds), and we drive a little slower than the speed limit (allocation.) 

With the markets pushing into 3-standard deviations above the 200-day moving average, it was only a function of time before a correction occurred. Therefore, while we were early taking profits, the end result was reduced portfolio risk against a pending correction.

“Taking profits, and reducing risks now, may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades.”

On Monday, that reduced volatility was greatly appreciated.

While our assessment of the market two-weeks ago was that risk versus reward was unbalanced, as we noted then, such can remain the case for extended periods of time.

“The problem with an economy being propped up by artificially appreciated assets is that this pendulum swings both ways. At some point, prices eventually decline. No one knows what will cause the decline:

  • Higher interest rates like in 2018,
  • A presidential tweet, when he launched the “trade war” with China.
  • The ongoing implosion of the Chinese economy is still a threat.
  • It could just be the realization by the markets that asset prices don’t grow to the sky.
  • Or, it could be triggered by an unexpected, exogenous event, which results in the markets “repricing” risk.”

As we have repeatedly stated, it was the impact of the “coronavirus” which the market has failed to account for. To wit:

Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to China. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave another 1% off that number.

Importantly, this decline happened BEFORE the “Wuhan virus” which suggests the virus will only worsen the potential impact.

The impact of the virus has not been factored in by the market.

Remember, it never just starts raining; clouds gather, skies darken, wind speeds pick up, and barometric pressures decline. When you have a consensus of the evidence, you typically carry an umbrella.

Is It Time To “Buy The Dip?”

With the “sell off” on Monday, the immediate reaction by investors is to jump in and “buy the dip?”

Maybe. Maybe not.

The chart below is part of the analysis we use to “onboard” new client portfolios. The purpose of this measure is to avoid transitioning a new client into our portfolio models near a short-term peak of the market. The vertical red lines suggest we avoid adding equity risk to portfolios and vice versa.

With both “sell signals” being triggered short-term, and the market breaking the 50-dma, this is not an opportune point to dramatically increase equity exposure. In other words, be careful “buying the dip,” if you are so inclined.

There are a few important points to denote in the chart above.

  1. The top and bottom signals are essentially relative strength and momentum measures. Both are currently starting to trigger “sell” signals. 
  2. With the market still very deviated above the longer-term 200-dma, and just coming out of 3-standard deviation territory, there is currently more downside risk, than upside reward. 
  3. Note that corrections, once the “sell signals” are triggered, can last from several weeks, to a couple of months. During the correction process there are often multiple opportunities (counter-trend rallies) to reduce risk and raise cash accordingly. 
  4. The last two times the market pushed into 3-standard deviation territory, the resulting corrections were fairly sharp and lasted for a couple of months.

However, with that said, on a VERY short-term basis the market is now oversold enough to elicit a short-term, reflexive, rally. This type of bounce is often termed a “dead cat” bounce, and basically suggests a one, or two, day rise that quickly fails to retest the previous low.

I have also noted that we are in the process of forming a potential “head and shoulder” topping pattern with a very clear “neckline” at yesterday’s closing price. A rally back to resistance at the previous “left shoulder, and a break of the subsequent “neckline,” would entail a decline to the 200-dma, or about 10% from the recent peak.

Given the MACD has registered a “sell signal” from a fairly high level, investors must consider the risk of further downside even if the market rallies over the next couple of days.

Don’t be fooled that a short-term reflexive rally is an “all-clear” for the bull market to resume. With the bulk of our momentum, relative strength, and overbought/sold indicators just starting to correct from recent highs, it is likely short-term rallies will be “selling opportunities” over the next couple of weeks as the market either corrects further or consolidates recent gains.

As we have detailed over the last few missives, due to the rather extreme extension of the market, a correction would likely encompass a 5-10% decline in totality before it is complete. As of today’s close the market is down 4.74% from its recent highs.

As noted in this past weekend’s missive, the Federal Reserve has begun reducing its torrid pace of liquidity, while already weak economic growth, and potentially weaker earnings growth, is at risk from the impact of the coronavirus.

From that perspective, we are continuing to maintain our higher levels of cash, and are opportunistically rebalancing portfolio risks as needed according to our investment discipline.

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Hedge portfolios against major market declines.
  3. Take profits in positions that have been big winners
  4. Sell laggards and losers
  5. Raise cash and rebalance portfolios to target weightings.

Notice, nothing in there says, “sell everything and go to cash.”

By having reduced risk, we can afford to remain patient and wait for the next opportunity.

Like our car driving analogy above, it is always the ones who are sending a text, holding a breakfast burrito with the other, and driving with one knee who always winds up in the worst possible condition.

We prefer to keep two hands on the wheel at all times.

Technically Speaking: Chasing The Market? Warnings Are Everywhere

This past weekend, we discussed the breakout to all-time highs as the belief the market is immune to risks, due to the Federal Reserve, has become pervasive. As I quoted:

“Yet as a major economic problem looms on the horizon, the cognitive disconnect between current asset prices and reality feels like the market equivalent of ‘peace for our time.’ 

For those investors who perceive the disconnect between risk assets which are priced for a rosy outcome, and the reality of the looming risks to growth and earnings, any attempt to reduce risk leads to underperformance. It is a mind-numbing exercise for investors who see the cognitive dissonance. The frantic race to accumulate securities has cast price discovery to the side.

I have never in my career seen anything as crazy as what’s going on right now, this will eventually end badly.“ – Scott Minerd, CIO of Guggenheim Investments

The current environment remind s me of when I was growing up. My father, probably much like yours, had pearls of wisdom that he would drop along the way. It wasn’t until much later in life that I learned that such knowledge did not come from books, but through experience. One of my favorite pieces of “wisdom” was:

“Exactly how many warnings do need before you figure out that something bad is about to happen?”

Of course, back then, he was mostly referring to warnings he issued for me “not” to do something I was determined to do. Generally, it involved something like trying to replicate Evil Knievel’s jump at Caesar’s Palace using a homemade ramp and a collection of the neighbor’s trash cans.


However, I always based my arguments on sound logic and data analysis:

“But Dad, everyone else is doing it.”

After I had broken my wrist, I understood what he meant.

Likewise, investors are currently rushing to get back into the market with a near reckless disregard for the consequences.

Simply because “everyone else is doing it.” 

So, before you go “hit the ramp”, there are some warning signs to consider.

Warning 1: Deviations From The Mean

There is a funny story about a “defensive driving” class where the instructor asks the class how many thought they were “above average drivers.” About 80% of the class raised their hands. The funny thing is that all of them were in the class because of traffic violations or accidents. But more to the point, 80% of drivers cannot be above average. It is mathematically impossible.

Likewise, in investing, prices must be both above, and below, the “average price” over a set period for an average to exist. To many degrees, “price” is bound by the laws of physics, the farther from the “average price” the current price becomes, the greater the reversion to, and generally beyond, the average. This is shown in the daily chart below.

Currently, the market is more than 11% above its longer-term daily average price. These more extreme deviations tend not to last an extraordinarily long time. Furthermore, reversions from these more extreme deviations tend to be rather quick.

If we view a weekly basis, we see the same warning.

At more than 12% above the long-term weekly moving average, the market is currently pushing the upper end of historical deviations. There have been higher extremes for certain, but discounting risk often doesn’t end well.

On a monthly basis, the almost 17.5% deviation is hitting levels more associated with drawdowns of 20% of more.

The important point to take away from this data is that “mean reverting” events are commonplace within the context of annual market movements. 

Currently, investors have become extremely complacent with the rally from the beginning of the year and are discounting the potential global-supply shock from the “coronavirus.” The assumption that any disruption will be met by more Central Bank intervention, and higher stock prices, is a likely a risky proposition this late into an economic cycle.

In every given year, there are drawdowns that have wiped out some, most, or all of the previous gains. While the market has ended the year higher, more often than not, the declines have often shaken out many an investor along the way.

Let’s take a look at what happened the last time the market finished a year up nearly 30%. Over the next two years, the market consolidated with a near-zero rate of return.

From a portfolio management standpoint, the markets are very extended, and a correction over the next couple of months is highly likely. While it is quite likely the year will end positive, particularly given the current momentum push, taking some profits now, rebalancing risks, and using the coming correction to add exposure as needed will yield a better result.

Warning 2 – Technical Warnings

The technical warnings also confirm our concerns about a near-term correction.

Each week, we post the chart below for our RIA PRO (Try Risk-Free for 30-days) subscribers, which is a composite index of our weekly technical measures including RSI, Williams %R, Stochastics, etc. Currently, the overbought condition of the market is near points which have denoted more significant corrections.

The market/sector analysis, which is also exclusive to RIA PRO members, shows the rather extreme price deviation in Technology, Real Estate, & Utilities. Also, relative performance shows that it has primarily been those three sectors providing a bulk of the “alpha” year-to-date.  (Also, note the lower left-hand panel which shows virtually every sector back to extreme overbought.)

These are abnormalities that tend not to last long in isolation, and rotations tend to occur rather quickly.

Warning 3 – Economic Concerns

Just recently, Barbara Kolmeyer via MarketWatch discussed thoughts from Julien Bittel of Pictet Asset Management. He gives a pretty stern warning to the litany of economic bulls. To wit:

He sees a lot of similarities between what is happening now and the year 2000—the market peaked in the front half of the year, followed by a recession. Bittel has lots of charts to back up his case, such as this one showing Jolts job openings (which measures U.S. job vacancies), at the lowest since the Global Financial Crisis, often a bad omen for employment:”

“He also highlighted trouble for the U.S. long-term business cycle, ‘linked to the less-cyclical areas of the economy so it’s the credit cycle, consumer confidence and the labor markets…these dynamics are all slowing,’ he said.”

He said what makes his call so contrarian is that most economists see a 25% recession possibility, while equity markets are factoring in only a 2% chance.

‘I think investors are a bit naive going into this year, thinking that the gravy trains or rainbows will continue, but in order for that to happen earnings need to come back in a big way. A sustained move in equity markets that’s driven by multiple expansion cannot maintain itself unless you get a huge recovery in earnings.” – Julien Bittel

Speaking of an earnings recovery, that is unlikely to happen.

Warning 4 – Earnings

It is highly unlikely you are going to get a massive surge in earnings to support lofty asset prices and valuations particularly when you have a global supply-chain shock in progress. While the media has been fawning over the latest earnings season, it really isn’t what it seems.

As noted by FactSet:

“ For Q4 2019 (with 77% of the companies in the S&P 500 reporting actual results), 71% of S&P 500 companies have reported a positive EPS surprise and 67% of S&P 500 companies have reported a positive revenue surprise.”

Wow…that’s impressive and certainly would seem to be the reason behind surging asset prices.

The problem is that “beat rate” was simply due to the consistent “lowering of the bar” as shown in the chart below:

Pay attention to the two charts above.

  1. Earnings declined in 2019 and are projected to continue to decline into 2021. 
  2. Investors are not discounting the decline in earnings, and rising valuations, which will eventually become problematic.

Importantly, as I noted this past weekend:

“With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and “repo” operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the “coronavirus” has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which as stated above, is going to make justifying record asset prices more problematic.”

“Conversely, if by some miracle, the economy does show actual improvement, it could result in yields rising on the long-end of the curve, which would also make stocks less attractive.

This is the problem of overpaying for value. The current environment is so richly priced there is little opportunity for investors to extract additional gains from risk-based investments.”

If They Don’t “Buy & Hold” – Why Should You?

Here is the market for you, year to date:

  • S&P 500 +4.62%
    • Alphabet +13.74%
    • Microsoft +17.53%
    • Apple +10.92%
    • Amazon +15.53%
    • Tesla +91.24%

(Disclosure: We are long Apple, Amazon, and Microsoft in our equity portfolio.)

These “warning signs” are just that. None them suggest the markets, or the economy, are immediately plunging into the next recession-driven market reversion.

But as David Rosenberg previously noted:

“The equity market stopped being a leading indicator, or an economic barometer, a long time ago. Central banks looked after that. This entire cycle saw the weakest economic growth of all time coupled with the mother of all bull markets.”

There will be payback for the misalignment of funds.

Past experience suggests that future returns will be far less than historical averages suggest. Furthermore, there is a dramatic difference between investing for 30-years, and whatever time you personally have left to your financial goals. As noted yesterday, many investors are just now getting back to even.

While much of the mainstream media suggests that you should “invest for the long-term,” and “buy and hold” regardless of what the market brings, that is not what professional investors are doing.

The point here is simple.

No professional, or successful investor, every bought and held for the long-term without regard, or respect, for the risks that are undertaken. If professionals are looking at “risk,” and planning on protecting capital from mean-reverting events, then why aren’t you?

After A Decade, Investors Are Finally Back to Even

I recently discussed putting market corrections into perspective, in which we looked at the financial impact of a 10-60% correction. But what happens afterward?

During strongly advancing, and very long bull markets, investors become overly complacent about the potential risks of investing. This “complacency” shows up in the resurgence of “couch potato,” “buy and hold,” and “passive indexing” portfolios. While such ideas work as long as markets are relentlessly rising, when the inevitable reversion occurs, things go “sideways” very quickly.

“While the current belief is that such declines are no longer a possibility, due to Central Bank interventions, we had two 50% declines just since the turn of the century. The cause was different, but the result was the same. The next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of ‘stock buybacks,’ which have accounted for almost 100% of net purchases since 2018.

Market downturns are a historical constant for the financial markets. Whether they are minor or major, the impacts go beyond just the price decline when it comes to investors.”

It is the last sentence I want to focus on today, as it is one of the most important and overlooked consequences of market corrections as it relates to long-term investment goals.

There are a litany of articles touting the massive bull market advance from the 2009 lows, and that if investors had just held onto the portfolios during the 2008 decline, or better yet, bought the March 2009 low, you would have hit the “bull market jackpot.” 

Unfortunately, a vast majority of investors sold out of the markets during the tail end of the financial crisis, and then compounded their financial problems by not reinvesting until years later. It is still not uncommon to find individuals who are still out of the market entirely, even after a decade long advance.

This is what brutal bear markets due to investors psychologically. 

“Bear markets” push investors into making critical mistakes:

  1. They paid premium prices, or rather excessive prices, for the companies they are investing in during the “bull market.” Ultimately, overpaying for value has a cost of lower future returns, as “buying high” inevitably turns into “selling low.” 
  2. Investors Panic as market values decline. It is easy to forget during sharply rising markets the money we invest is the “savings” we are dependent on for our family’s future. Many investors who claim to be “buy and hold” change their mind after large losses. There is a point, for every investors, where they are willing to “get out at any price.”
  3. Volatility is ignored. Volatility is not always a bad word, but rising volatility coupled with large declines, eventually feeds into investor “fear and panic.”
  4. Ignoring Market Analysis. When markets are trending strongly upwards, investors start to “rationalize” why they are overpaying for value in the market. By looking for “confirmation bias,” they tend to ignore any “market analysis” which contradicts their “hope” for higher prices. The phrase “this time is different” is typically a hallmark.

“The underlying theory of buy and hold investing denies that stocks are ever expensive, or inexpensive for that matter, investors are encouraged to always buy stocks, no matter what the value characteristics of the stock market happen to be at the time.” – Ken Solow

The primary problem with “buy and hold” investing is ultimately, YOU!

The Pension Problem

During raging bull markets, individuals do two things which ultimately lead to their financial distress.

  1. Start treating the market like a casino in hopes to “getting rich quick,” and
  2. Reduce their “contributions” given expectations that high returns will “fill the gap.” 

Unfortunately, this is the same problem that plagues pension funds all across America today.

As I discussed in “Pension Crisis Is Worse Than You Think,”  it has been unrealistic return assumptions used by pension managers over the last 30-years, which has become problematic.

“Pension computations are performed by actuaries using assumptions regarding current and future demographics, life expectancy, investment returns, levels of contributions or taxation, and payouts to beneficiaries, among other variables. The biggest problem, following two major bear markets, and sub-par annualized returns since the turn of the century, is the expected investment return rate.

Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating returns, it has artificially inflated future pension values and reduced the required contribution amounts by individuals and governments paying into the pension system

Pensions STILL have annual investment return assumptions ranging between 7–8% even after years of underperformance.”

However, why do pension funds continue to have high investment return assumptions despite years of underperformance? It is only for one reason:

To reduce the contribution (savings) requirement by their members.

This is the same problem for the average American faces when planning for 6-8% average annual returns on their investment strategy. Why should you save money if the market can do the work for you? Right?

This is a common theme in much of the mainstream advice. To wit:

“Suze Orman explained that if a 25-year-old puts $100 into a Roth IRA each month, they could have $1 million by retirement.” 

The problem with Ms. Orman’s statement is that it requires the 25-year old to achieve an 11.25% annual rate of return (adjusting for inflation) every single year for the next 40-years.

That certainly isn’t very realistic.

However, under-saving is one of the primary problems which leaves investors well short of their financial goals by retirement.

The other problem, as noted above, is the most important part of the analysis overlooked by promoters of “buy and hold” investing.

Let me explain.

Getting Back To Even, Isn’t Even

Here is the common mainstream advice.

“If you had invested $100,000 at the market at the peak of the market in 2000, or in 2007, your portfolio would have gotten back to even in 2013. Since then, your portfolio would have grown to more than $200,000.

Here is the relative chart proving that statement is correct. (Real, inflation-adjusted, total return of a $100,000 investment.)

No one talks much about investors who have been in the market since the turn of the century, but it is one of the problems why so many Americans are underfunded for retirement. While Wall Street claims the market delivers 6% annual returns, or more, the annual rate of return since 2000, on an inflation-adjusted, total return basis, is just shy of 4%.

However, since most analysis used to support the “buy and hold” thesis starts with the peak of the market in 2007, that average return does indeed come in at 6.64%.

Here is the problem.

While your portfolio got back to even, on a total return basis, 6 or 13-years after your initial investment, depending on your start date, you DID NOT get back to even.

Remember your investment plan? Yes, that plan touted by the mainstream media, which says to assume a return of 6% annually?

The chart below shows $100,000 invested at 6% annually from 2000 or 2007.

So, what’s wrong with that?

An investor tripled their money from 2000 and doubled it from 2007.

Unfortunately, you didn’t get that.

Let’s overlay our two charts.

If your financial plan was based on reduced saving rates, and high rates of return, you are well short of you goals for retirement if you started in 2000. Fortunately, for investors who started in 2007, congratulations, you are now back to even.

Unfortunately, there are few investors who actually saw market returns over the last 12-years. As noted, a vast majority of investors who were fully invested into the market in 2007, were out of the market by the end of 2008. After such a brutal beating, it took years before they returned to the markets. Their returns are vastly different than what the mainstream media claims.

While there is a case to be made for “buy and hold” investing during rising markets, the opposite is true in falling markets. The destruction of capital eventually pushes all investors into making critical investment mistakes, which impairs the ability to obtain long-term financial goals. 

You may think you have the fortitude to ride it out. You probably don’t.

But even if you do, getting back to even isn’t really an investment strategy to reach your retirement goals.

Unfortunately, for many investors today who have now reached their financial goals, it may be worth revisiting what happened in 2000 and 2007. We are exceedingly in the current bull market, valuations are elevated, and there is a rising belief “this time is different.” 

It may be worth analyzing the risk you are taking today, and the cost it may have on “your tomorrow.” 

Technically Speaking: COT Positioning – Risk Of Correction Still High (Q1-2020)

As discussed in this past weekend’s newsletter, the market remains overly extended as the recent correction sharply reversed on expectations for more Fed liquidity. However, with the market extremely deviated from the long-term moving average, a correction is once again a high probability event. 

“Previously, we discussed that we had taken profits out of portfolios as we were expecting between a 3-5% correction to allow for a better entry point to add equity exposure. While the “virus correction” did encompass a correction of 3%, it was too shallow to reverse the rather extreme extension of the market. The rally this past week has reversed the corrective process, and returned the markets to 3-standard deviations above the 200-dma. Furthermore, all daily, weekly, and monthly conditions have returned to more extreme overbought levels as well.”

But it isn’t just the more extreme advance of the market over the past 5-weeks which has us a bit concerned in the short-term, but a series of other indications which typically suggest short- to intermediate-terms corrections in the market.

Furthermore, the markets are completely entirely the impact the “coronavirus” will have on the supply-chain globally. As David Rosenberg noted Monday:

“The impact of this virus is lasting longer and the effects, relative to SARS, are larger at a time when the Chinese economy is far softer. The follow-on effects on other markets has yet to be fully appreciated.”

Had the markets completed a correction that reduced the extreme overbought and extended conditions of the market, such would have offset the risk of the “viral impact” to the economy. However, without that correction, the eventual slowdown will likely have a great impact than is currently anticipated. 

However, even if we set aside investor sentiment and positioning for a moment, the rapid reversion is price has sent our technical composite overbought/oversold gauge back towards more extreme levels of overbought conditions. (Get this chart every week at RIAPRO.NET)

What we know is that markets move based on sentiment and positioning. This makes sense considering that prices are affected by the actions of both buyers and sellers at any given time. Most importantly, when prices, or positioning, becomes too “one-sided,” a reversion always occurs. As Bob Farrell’s Rule #9 states:

“When all experts agree, something else is bound to happen.” 

So, how are traders positioning themselves currently? 

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three key commodity-trading groups, namely:

  • Commercial Traders: this group consists of traders that use futures contracts for hedging purposes and whose positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and/or processing of the underlying commodity.
  • Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.
  • Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders.

This is the group that speculates on where they believe the market is headed. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to “human fallacy” and “herd mentality” as everyone else.

Therefore, as shown in the series of charts below, we can take a look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

The extreme net-short positioning on the volatility before to the correction last week, had suggested the correction was coming. However, while the correction reduced the net-short positioning somewhat, it remains at historical extremes. What the more extreme positioning tells us is there is plenty of “fuel” to drive a correction when one occurs.

Investors have gotten used to extremely low levels of volatility, which is unique to this market cycle. This complacency, due to low volatility, has encouraged investors to take on greater levels of risk than they currently realize. When volatility eventually makes it return, the consequences to investors will not be kind.

Crude Oil Extreme

The recent attempt by crude oil to get back above the 200-dma coincided with the Fed’s initiation of QE-4. Historically, these liquidity programs tend to benefit highly speculative positions like commodities, as liquidity seeks the highest rate of return. 

However, beginning in December, that support for oil prices gave way, and prices have collapsed along with expectations for global economic recovery. We have been warning our RIAPro Subcribers (30-Day Risk Free Trial) for the last couple of months about the potential for this decline.

  • As noted previously, “Oil completely broke down last week, and collapsed below all of the important levels. Oil is now testing critical support at $51. A failure there and a break into the low $40’s is probable.”
  • The support is barely holding and oil looks extremely weak. However, oil is extremely oversold so a counter-trend rally is highly likely and can be used to “sell” into.
  • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Despite the decline in oil prices over the last year, it is worth noting that crude oil positioning is still on the bullish side with 397,000 net long contracts. 

The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will start to get liquidated which will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.

U.S. Dollar Extreme

Another index we track each week at RIAPRO.NET is the U.S. Dollar.

  • As noted previously: “The dollar has rallied back to that all-important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • That is exactly what happened over the last two weeks. The dollar has strengthened that rally as concerns over the “coronavirus” persist. With the dollar close to testing previous highs, a break above that resistance could result in a sharp move higher for the dollar.
  • The rising dollar is not bullish for Oil, commodities or international exposures.
  • The “sell” signal has began to reverse. Pay attention.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE, but as shown above, that has yet to be the case. However, it is worth noting that positioning in the US Dollar has been weakening. Historically, these reversals are markets of more important peaks in the market and subsequent corrections. 

It is also worth watching the net-short positioning the Euro-dollar as well. Historically, when positioning in the Eurodollar becomes NET-LONG, as it is currently, such has been associated with short- to intermediate corrections in the markets, including outright bear markets.

Net-long Eurodollar positioning has recently started to reverse from an all-time record. While the market hasn’t corrected as of yet, if foreign banks begin to extract dollar-denominated assets to a large degree, the risk to the market rises sharply. 

Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. In March of last year, I wrote “The Bond Bull Market” which was a follow up to our earlier call for a sharp drop in rates as the economy slowed. That call was based on the extreme “net-short positioning” in bonds which suggested a counter-trend rally was likely.

Since then, rates fell back to some of the lowest levels in 10-years as economic growth continues to slow, both domestically and globally. Importantly, while the Federal Reserve turned back on the “liquidity pumps” last October, juicing markets to all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Not surprisingly, despite much commentary to the contrary, the number of contracts “net-short” the 10-year Treasury remains at some of the highest historical readings.

Importantly, even while the “net-short” positioning on bonds has been reversed, rates have failed to rise correspondingly. The reason for this is due to the near-record levels of Eurodollar positioning, as noted above.

This suggests a high probability rates will fall further in the months ahead. This will most likely occur in concert with further deterioration in economic growth as the impact of the “coronavirus” is realized. 

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that financial markets can only rise further. The arguments supporting those beliefs are based on comparisons to previous peak market cycles. Unfortunately, investors tend to be wrong at market peaks and bottoms.

The inherent problem with much of the mainstream analysis is that it assumes everything remains status quo. However, such never tends to be the case for long.  

“Oil prices down 20% is not a good thing, even if it means lower gasoline prices. This is swamped by the negative implications for capital spending and employment in the key oil-producing regions of the U.S. Copper prices have dropped 11% in just the past two weeks and just above a three-year low, and this is a global macro barometer. Money flowing into bond funds, the lagging performance in the high-yield market, the slump in commodity markets and the weakness, both relative and absolute, in the Russell 2000 small-cap index, surely cannot be making the economic growth bulls feeling too comfortable right now..” – David Rosenberg

We agree.

With retail positioning very long-biased, the implementation of QE4 has once again removed all “fears” of a correction, a recession, and a bear market, which existed just this past summer. Historically, such sentiment excesses form around short-term market peaks.

This is a excellent time to remind you of the other famous “Bob Farrell Rule” to remember: 

“#5 – The public buys the most at the top and the least at the bottom.”

What investors miss is that while a warning doesn’t immediately translate into a negative consequence, such doesn’t mean you should not pay attention to it.

It is akin to constantly running red lights and never getting into an accident. We begin to think we are skilled at running red lights, rather than just being lucky.

Eventually, your luck will run out.

Pay attention, have a plan, and act accordingly.

Market Downturn? Putting Corrections Into Perspective

Shawn Langlois recently penned an interesting article:

“Despite a few notable hiccups along the way, the bull market continues to prove insanely resilient.”

What was most interesting, however, was the following quote:

“Current hyper-valued extremes are likely to be followed by market losses on the order of two-thirds of the value of the S&P 500.” 

The immediate response by most individuals is a 60%+ decline is an outlandish and impossible event given ongoing Central Bank interventions.

But is it really?

The risk of a larger mean reverting event is a possibility even though such is entirely dismissed by the mainstream media under the guise of “this time is different.”  With the market trading more than 3-standard deviations above the 50-week moving average, historical reversions have tended to be more brutal. 

The chart below uses key support levels as potential reversion levels. The lows of 2018. The highs and lows of 2015-2016, and the 2007 highs.

At this juncture, a correction back to the 2018 lows would entail a 25% decline. However, if a “bear market” growls, the 2015-16 highs become the target, which is 34% lower. The lows of 2016 would require a 43% draft, with the 2008 highs posting a 52% “crash.” 

Those levels are still short of the 67% decline discussed above.

Such a level certainly seems preposterous, as Shawn quoted:

I recognize that the notion of a two-thirds market loss seems preposterous. Then again, so did similar projections before the 2000-2002 and 2007-09 collapses.”

While the current belief is that such declines are no longer a possibility, due to Central Bank interventions, we had two 50% declines just since the turn of the century. The cause was different, but the end result was the same. The next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of “stock buybacks,” which have accounted for almost 100% of net purchases since 2018.

Market downturns are a historical constant for the financial markets. Whether they are minor, or major, the impacts go beyond just the price decline when it comes to investors. This was a discussion I had in more detail in “Retired, Or Retiring Soon? Yes, Worry About A Correction.”

“In 2000, the average ‘baby boomer’ was around 45-years of age. The ‘dot.com’ crash was painful, but with 20-years to go before retirement, there was time to recover. In 2010, following the financial crisis, the time to retirement for the oldest boomers was depleted, and the average boomer only had 10-years to recover. During both of these previous periods, portfolios were still in accumulation mode. However, today, ONLY the youngest tranche of ‘boomers,’ have the luxury of ‘time\ to work through the next major market reversion. (This also explains why the share of workers over the age of 65 is at historical highs.) 

With the majority of ‘boomers’ now faced with the implications of a transition into the distribution phase of the investment cycle, such has important ramifications during market declines. The following example shows a $1 million portfolio with, and without, an annualized 4% withdrawal rate.”

“While a 10% decline in the market will reduce a portfolio from $1 million to $900,000, when combined with an assumed monthly withdrawal rate, the portfolio value is reduced by almost 14%. This is the result of taking distributions during a period of declining market values. Importantly, while it ONLY requires a non-withdrawal portfolio an 11.1% return to break even, it requires nearly a 20% return for a portfolio in the distribution phase to attain the same level.

Impairments to capital are the biggest challenges facing pre- and post-retirees currently. 

This is an important distinction. Most articles written about retirees, or those ready to retire, is an unrealized assumption of an indefinite timeline.

While the market may not be different than in the past, YOU ARE!”

This is an important point.

Investing is about growing your savings over time, and controlling the risk which could lead to a significant loss of principal. Taking on excruciating losses is not investing, nor is it financially feasible to do so, and still reach your retirement goals successfully. 

Putting Corrections Into Perspective

The real problem with discussing corrections is three-fold:

  1. It is has been so long since we have had a correction of magnitude, many investors have forgotten what happens, and more importantly, how they reacted previously.
  2. The majority of mainstream media advice is written or prognosticated by individuals who don’t manage money for a living, have substantial investment  capital at risk, and have never actually been through a bear market. 
  3. Given the extremely long market expansion, many investors have truly come to believe “this time is different.” 

If we put corrections into a bit of perspective, it becomes easier to visualize that damage which could, and most likely will, eventually occur.

10% Correction 

A correction of 10% is entirely normal for a market in any given year. While a 10% decline in a bit painful, such a decline from current levels would only set the market back October of 2019 when the Federal Reserve started their latest liquidity interventions.

20% Correction

A 20% correction from the recent highs is a bit more serious. The last time we came close to a 20% reset was in December, 2018. Try and remember how you felt during that decline.

Currently, a 20% decline would reset your portfolio back to where it was in December 2017, wiping out all the gains of the past two-years. While not the end of the world, your retirement is now set back by almost 4-years as you will have to make up the 30% gain from 2019 plus two-more years of lost growth.

30% Correction

A 30% correction gets much more serious. A decline of this magnitude takes you back to the beginning of 2017. While losing just 3-years of growth may not seem that bad, assuming you need 6% a year to reach your retirement goal, you will need almost 9-years to recover. (Remember, it takes 42.9% to recover the 30% loss, plus you have to make up the 6% annual gains you needed, but didn’t accrue, during each year of recovering the previous loss.)

40% Correction

Okay, this is starting to get a bit uglier. A 40% decline takes the market back to 2014 levels and has now wiped out 6-years of your gains. While a 40% decline requires a 66.7% recovery to breakeven, (10 years at 6%,) the lost accrual years are going to make it very difficult to meet retirement goals.

50% Correction

I know…I know…this can’t happen. (It just happened twice the century already.)

A 50% decline is effectively “game over” for investors at this point. A decline of this magnitude will reset the market essentially back to the market highs of 2000 and 2007. For individuals who were close to retirement in 2000, their portfolio, on an inflation-adjusted basis, will have been completely reset.

At this point, retiring is no longer an option for most.

60% Correction

A 60% correction is not entirely out of the question. As I have discussed previously, the next mean reverting event will likely be the last. Corrections of such a magnitude would reset portfolios back to 1999 levels. The devastation will be greater than investors can currently imagine and retirement goals would be erased entirely.

There are numerous catalysts which could pressure such a downturn in the equity markets:

  • An exogenous geopolitical event
  • A credit-related event
  • Failure of a major financial institution
  • Recession
  • Falling profits and earnings
  • A loss of confidence by corporations which contacts share buybacks

Whatever the event is, which is currently unexpected and unanticipated, the decline in asset prices will initiate a “chain reaction.”

  • Investors will begin to panic as asset prices drop, curtailing economic activity, and further pressuring economic growth.
  • The pressure on asset prices and weaker economic growth, which impairs corporate earnings, shifts corporate views from “share repurchases” to “liquidity preservation.” This removes a major support of asset prices.
  • As asset prices decline further, and economic growth deteriorates, credit defaults begin triggering a near $5 Trillion corporate bond market problem.
  • The bond market decline will pressure asset prices lower, which triggers an aging demographic who fears the loss of pension benefits, sparks the $6 trillion pension problem. 
  • As the market continues to cascade lower at this point, the Fed is monetizing nearly 100% of all debt issuance, and has to resort to even more drastic measures to stem selling and defaults. 
  • Those actions lead to a further loss of confidence and pressures markets even further. 

The Federal Reserve can not fix this problem, and the next “bear market” will NOT be like that last.

It will be worse.

None of this will happen, you say?

Maybe? I certainly hope not.

But are you actually willing to bet your retirement on it?

MacroView: The Next “Minsky Moment” Is Inevitable

In 2007, I was at a conference where Paul McCulley, who was with PIMCO at the time, was discussing the idea of a “Minsky Moment.”  At that time, this idea fell on “deaf ears” as the markets, and economy, were in full swing.

However, it wasn’t too long before the 2008 “Financial Crisis” brought the “Minsky Moment” thesis to the forefront. What was revealed, of course, was the dangers of profligacy which resulted in the triggering of a wave of margin calls, a massive selloff in assets to cover debts, and higher default rates.

So, what exactly is a “Minskey Moment?”

Economist Hyman Minsky argued that the economic cycle is driven more by surges in the banking system, and in the supply of credit than by the relationship which is traditionally thought more important, between companies and workers in the labor market.

In other words, during periods of bullish speculation, if they last long enough, the excesses generated by reckless, speculative, activity will eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

Hyman Minsky argued there is an inherent instability in financial markets. He postulated that an abnormally long bullish economic growth cycle would spur an asymmetric rise in market speculation which would eventually result in market instability and collapse. A “Minsky Moment” crisis follows a prolonged period of bullish speculation which is also associated with high amounts of debt taken on by both retail and institutional investors.

One way to look at “leverage,” as it relates to the financial markets, is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to be levered (borrow money) to invest, which leaves them with “negative” cash balances.

While margin balances did decline in 2018, as the markets fell due to the Federal Reserve hiking rates and reducing their balance sheet, it is notable that current levels of “leverage” are still excessively higher than they were either in 1999, or 2007.

This is also seen by looking at the S&P 500 versus the growth rate of margin debt.

The mainstream analysis dismisses margin debt under the assumption that it is the reflection of “bullish attitudes” in the market. Leverage fuels the market rise. In the early stages of an advance, this is correct. However, in the later stages of an advance, when bullish optimism and speculative behaviors are at the peaks, leverage has a “dark side” to it. As I discussed previously:

“At some point, a reversion process will take hold. It is when investor ‘psychology collides with ‘leverage and the problems associated with market liquidity. It will be the equivalent of striking a match, lighting a stick of dynamite, and throwing it into a tanker full of gasoline.”

That moment is the “Minsky Moment.”

As noted, these reversion of “bullish excess” are not a new thing. In the book, The Cost of Capitalism, Robert Barbera’s discussed previous periods in history:

The last five major global cyclical events were the early 1990s recession — largely occasioned by the U.S. Savings & Loan crisis, the collapse of Japan Inc. after the stock market crash of 1990, the Asian crisis of the mid-1990s, the fabulous technology boom/bust cycle at the turn of the millennium and the unprecedented rise and then collapse for U.S. residential real estate in 2007-2008.

All five episodes delivered recessions, either global or regional. In no case was there as significant prior acceleration of wages and general prices. In each case, an investment boom and an associated asset market ran to improbably heights and then collapsed. From 1945 to 1985 there was no recession caused by the instability of investment prompted by financial speculation — and since 1985 there has been no recession that has not been caused by these factors. 

Read that last sentence again.

Interestingly, it was post-1970 the Federal Reserve became active in trying to control interest rates and inflation through monetary policy.

As noted in “The Fed & The Stability Instability Paradox:”

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s. As shown in the chart below, when the Fed has lifted the short-term lending rates to a level higher than the 2-year rate, bad ‘stuff’ has historically followed.”

The Fed Is Doing It Again

As noted above, “Minsky Moment” crises occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during prosperous times, or bull markets. The longer a bull market lasts, the more investors borrow to try and capitalize on market moves.

However, it hasn’t just been investors tapping into debt to capitalize on the bull market advance, but corporations have gorged on debt for unproductive spending, dividend issuance, and share buybacks. As I noted in last week’s MacroView:

“Since the economy is driven by consumption, and theoretically, companies should be taking on debt for productive purposes to meet rising demand, analyzing corporate debt relative to underlying economic growth gives us a view on leverage levels.”

“The problem with debt, of course, is it is leverage that has to be serviced by underlying cash flows of the business. While asset prices have surged to historic highs, corporate profits for the entirety of U.S. business have remained flat since 2014. Such doesn’t suggest the addition of leverage is being done to ‘grow’ profits, but rather to ‘sustain’ them.”

Over the last decade, the Federal Reserve’s ongoing liquidity interventions, zero interest-rates, and maintaining extremely “accommodative” policies, has led to substantial increases in speculative investment. Such was driven by the belief that if “something breaks,” the Fed will be there to fix to it.

Despite a decade long economic expansion, record stock market prices, and record low unemployment, the Fed continues to support financial speculation through ongoing interventions.

John Authers recently penned an excellent piece on this issue for Bloomberg:

“Why does liquidity look quite so bullish? As ever, we can thank central banks and particularly the Federal Reserve. Twelve months ago, the U.S. central bank intended to restrict liquidity steadily by shrinking the assets on its balance sheet on “auto-pilot.” That changed, though. It reversed course and then cut rates three times. And most importantly, it started to build its balance sheet again in an attempt to shore up the repo market — which banks use to access short-term finance — when it suddenly froze up  in September. In terms of the increase in U.S. liquidity over 12 months, by CrossBorder’s measures, this was the biggest liquidity boost ever:”

While John believes we are early in the global liquidity cycle, I personally am not so sure given the magnitude of the increase Central Bank balance sheets over the last decade.

Currently, global Central Bank balance sheets have grown from roughly $5 Trillion in 2007, to $21 Trillion currently. In other words, Central Bank balance sheets are equivalent to the size of the entire U.S. economy.

In 2007, the global stock market capitalization was $65 Trillion. In 2019, the global stock market capitalization hit $85 Trillion, which was an increase of $20 Trillion, or roughly equivalent to the expansion of the Central Bank balance sheets.

In the U.S., there has been a clear correlation between the Fed’s balance sheet expansions, and speculative risk-taking in the financial markets.

Is Another Minsky Moment Looming?

The International Monetary Fund (IMF) has been issuing global warnings of high debt levels and slowing global economic growth, which has the potential to result in Minsky Moment crises around the globe.

While this has not come to fruition yet, the warning signs are there. Globally, there is roughly $15 Trillion in negative-yielding debt with asset prices fundamentally detached for corporate profitability, and excessive valuations on multiple levels.

As Desmond Lachman wrote:

“How else can one explain that the risky U.S. leveraged loan market has increased to more than $1.3 trillion and that the size of today’s global leveraged loan market is some two and a half times the size of the U.S. subprime market in 2008? Or how else can one explain that in 2017 Argentina was able to place a 100-year bond? Or that European high yield borrowers can place their debt at negative interest rates? Or that as dysfunctional and heavily indebted government as that of Italy can borrow at a lower interest rate than that of the United States? Or that the government of Greece can borrow at negative interest rates?

These are all clear indications that speculative excess is present in the markets currently.

However, there is one other prime ingredient needed to complete the environment for a “Minsky Moment” to occur.

That ingredient is complacency.

Yet despite the clearest signs that global credit has been grossly misallocated and that global credit risk has been seriously mispriced, both markets and policymakers seem to be remarkably sanguine. It would seem that the furthest thing from their minds is that once again we could experience a Minsky moment involving a violent repricing of risky assets that could cause real strains in the financial markets.”

Desmond is correct. Currently, despite record asset prices, leverage, debt, combined with slowing economic growth, the level of complacency is extraordinarily high. Given that no one currently believes another “credit-related crisis” can occur is what is needed to allow one to happen.

Professor Minsky taught that markets have short memories, and that they repeatedly delude themselves into believing that this time will be different. Sadly, judging by today’s market exuberance in the face of mounting economic and political risks, once again, Minsky is likely to be proved correct.

At this point in the cycle, the next “Minsky Moment” is inevitable.

All that is missing is the catalyst to start the ball rolling.

An unexpected recession would more than likely due to trick.

Technically Speaking: Market Bounce, January, & The Super Bowl.

In this past weekend’s newsletter, we stated the market was likely to bounce due to the short-term oversold condition which existed following Friday’s rout. To wit:

“With a ‘sell signal’ clearly triggered (lower panel), it suggests, on a short-term basis, we are likely to see a ‘tradeable bounce.’ However, until the signal reverses, any short-term bounce should probably be ‘sold into.’

Make no mistake, there is currently downside risk below the 50-dma to both the 38.2% and 50% Fibonacci retracement levels. From recent peaks, such a correction would entail a 5-8% decline, which is well within the normal range of a market correction within an ongoing bullish trend.”

Chart updated through Monday’s close.

The market failed at the bottom of the broken trend line yesterday, which suggests this “short-term” bounce is likely an opportunity to rebalance risks into.

With the fallout of the “coronavirus” being written off very quickly, under the assumption the outcome will be equivalent to the SARS epidemic in 2003, such is likely a mistake. As I wrote previously:

“Following a nearly 50% decline in asset prices, a mean-reversion in valuations, and an economic recession ending, the impact of the SARS virus was negligible given the bulk of the ‘risk’ was already removed from asset prices and economic growth. Today’s economic environment could not be more opposed.”

With global growth already slow, and the U.S. dragging its feet along at roughly 2% annual growth, there isn’t much room to absorb the impact of an event that potentially curtails consumption. 

Given that China, which is roughly 4x the size of global GDP today versus 2003, it occupies a central place in many supply chains used by other manufacturing countries, including pharmaceuticals, and is a voracious buyer of raw materials and other commodities, including oil, natural gas, and soybeans. That means that any economic hiccups for China this year, coming on the heels of its worst economic performance in 30 years, will have a bigger impact on the rest of the world than during past crises.

The was a point made by Mohamed El-Erian, on Monday, who stated the outbreak was going to take a major toll on the Chinese economy and hurt global growth. 

“For a long time I thought the market sentiment was so strong that we could overcome a mounting list of economic uncertainty. But the coronavirus is different. It is big. It’s going to paralyze China. It’s going to cascade throughout the global economy. Importantly, it cannot be countered by central bank policy. 

Investors ‘need to decide if they want to opt for more of the same, by continuing to implement an investment playbook that has served them well, or if they want to treat the viral outbreak for what it is — a big economic shock that could derail global growth and shake markets out of their ‘buy-the-dip’ conditioning.”Mohamed El-Erian

On Monday, the reflexive bounce was primarily supported by “market chatter” the Fed may be forced to extend their current “Not QE” through June, and/or lower rates. El-Erian is likely correct that this is not an event “monetary band-aids” can fix. 

Furthermore, his comments run similar to our own in that the long-running play of dismissing downbeat fundamentals on expectations central banks will be able to ride to the rescue could prove misguided in the current environment. What the current “bullish bias” is potentially missing is that while the effects of the deadly outbreak are substantial in China, and will cascade not only through the world’s second-largest economy, it will also slow global growth. A weaker China is not only a problem for Europe, but also for the U.S. where exports account for about 40% of corporate profits. 

Importantly, the multi-year gap between elevated asset prices and weaker economic conditions is becoming increasingly unsustainable. This is shown in the chart below:

The problem with pulling forward future consumption, is that it leaves a void which eventually must be filled, which requires more interventions to do so. Ultimately, that void becomes too vast.  

So Goes January…

January was a complete bust. After rocketing higher on “Fed Fuel,” the entire month’s gains were wiped out by January 31st.

It reminded me of January 2018, as the S&P 500 was surging higher following the passage of “tax cuts.” The markets were extrapolating earnings estimates to ridiculous levels in the hopes tax cuts would lead to an earnings and economic recovery. As I wrote then, such was never going to happen:

“The same is true for the myth that tax cuts lead to higher wages. Again, as with economic growth, there is no evidence that cutting taxes increases wage growth for average Americans. This is particularly the case currently as companies are sourcing every accounting gimmick, share repurchase or productivity increasing enhancement possible to increase profit growth.

Not surprisingly, our guess that corporations would utilize the benefits of ‘tax cuts’ to boost bottom line earnings rather than increase wages has turned out to be true. As noted by Axios, in just the first two months of this year companies have already announced over $173 BILLION in stock buybacks.

The chart below shows the run up from October to the January peak in 2018. That rally pushed the S&P 500 to 3-standard deviations above the 200-dma, just as the end of the month was approaching. Then, in just a few short days, the entire gain of January evaporated.

The chart below is the S&P 500 from October 2019 to present. Again, we see the market pushing into 3-standard deviation territory, then wiping out the entire gain of January in just a few days.

While I am not suggesting the market will test the 200-dma as it did in 2018, it is a possibility, particularly if the “coronavirus” worsens, or economic impacts begin to become visible. 

However, the reversal of the January gain to a loss does bring up the old Wall Street axiom:

“So goes January…So goes the year.” 

The January barometer was devised by Yale Hirsch in 1972 and has only registered ten major errors since 1950, for an 85.7% accuracy ratio. As noted by StockTraders Almanac:

“Of the ten major errors Vietnam affected 1966 and 1968. 1982 saw the start of a major bull market in August. Two January rate cuts and 9/11 affected 2001. The market in January 2003 was held down by the anticipation of military action in Iraq. The second worst bear market since 1900 ended in March of 2009, and Federal Reserve intervention influenced 2010 and 2014. In 2016, DJIA slipped into an official Ned Davis bear market in January. Including the eight flat years yields a .743 batting average.”

This year’s combination of a positive Santa Claus Rally and First Five Days with a full-month January loss has only occurred 11-times (including this year) since 1950. In the previous 10-occurrences, the S&P 500 was down six times in February with an average loss of 1.5%. However, over the remaining 11 months of the year, S&P 500 advanced 80% of the time with an average gain of 7.4%. Full-year performance was positive 70% of the time, but with an average gain of 2.9%.”

While there are many other factors that could drive the market higher this year, from the election to more Central Bank interventions, there is a growing chorus of indications which suggest we are nearing the end of current cycle. With negative yielding debt back on the rise, numerous yield spreads re-inverting, slower economic growth, and weaker earnings, the ability to sustain high valuations is going to become more challenging. 

Don’t Forget The Super Bowl

The Kansas City Chiefs won “Super Bowl LIV” in a stunning fourth-quarter rally to beat the San Francisco 49ers, which triggered the “Super Bowl Indicator” suggesting a weaker market. (This is a purely coincident indicator, but, given it was the Chiefs’ first Super Bowl championship in 50 years, maybe there is something about odd things happening when everyone else thinks they won’t.)

If you aren’t familiar with the indicator, it says that if the winning team of National Football League’s (NFL) championship game is from the National Football Conference (NFC), then stocks will have a bull market that year. If a team from the American Football Conference (AFC) wins, then it will be a bear market.

The Chiefs are from the AFC, meaning the indicator predicts a bear market this year and the predictor has been right 40 out of 53 games, a 75% success rate. While the last four years have been wrong, statistics suggest odds have increased for the indicator to be correct this year.

Here’s a breakdown of the 20 Super Bowl winners, of the last 53 Super Bowls, and how the S&P 500 has done following their victories:

While investors should never use a “coincident” indicator such as this to manage money, it is interesting nonetheless.

Portfolio Positioning

Yesterday, as we discussed with our RIAPro Subscribers (30-Day Risk-Free Trial) we slightly reduced our holdings in Utilities and Real Estate to raise some cash ahead of what we suspect will be a fairly short-lived rally. The goal is to use a pullback to rebalance exposures and look for a more “washed out” level to take on some “opportunistic” holdings. 

One such area where there is a tremendous amount of “negative sentiment” is in the energy sector. While it isn’t time to start adding exposure, we may be getting a decent “trading setup” here soon. Also, after previously reducing our holdings in some of our Technology, Healthcare, and Communications holdings, we may get the opportunity to rebuild our long-term core holdings at better risk/reward levels. 

While this year could indeed turn out to be a negative year, it doesn’t mean there won’t be some decent trading opportunities along the way. This is portfolio management.

However, make no mistake that we are nearing the end of an exceedingly long bull market cycle, and the eventual “reversion to the mean” will be a brutal event.

While it is easy to dismiss such an outcome under the guise of “this time is different because of the Fed,” every single “bear market” previously came on the heels of similar beliefs. In 1987, it was “Portfolio Insurance.” In 2000, it was the “Internet.”  In 2007, it was the “Goldilocks Economy.” 

Today will not be different, but the eventual outcome will be the same.