Tag Archives: Recession

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

Technically Speaking: The 4-Phases Of A Full-Market Cycle

In a recent post, I discussed the “3-stages of a bear market.”  To wit:

“Yes, the market will rally, and likely substantially so.  But, let me remind you of Bob Farrell’s Rule #8 from our recent newsletter:

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.

However, the “bear market” is only one-half of a vastly more important concept – the “Full Market Cycle.”

The Full Market Cycle

Over the last decade, the media has focused on the bull market, making an assumption that the current trend would last indefinitely. However, throughout history, bull market cycles make up on one-half of the “full market” cycle. During every “bull market” cycle, the market and economy build up excesses, which must ultimately be reversed through a market reversion and economic recession. In the other words, as Sir Issac Newton discovered:

“What goes up, must come down.” 

The chart below shows the full market cycles over time. Since the current “full market” cycle is yet to be completed, I have drawn a long-term trend line with the most logical completion point of the current cycle.

[Note: I am not stating the markets are about to crash to the 1600 level on the S&P 500. I am simply showing where the current uptrend line intersects with the price. The longer that it takes for the markets to mean revert, the higher the intersection point will be. Furthermore, the 1600 level is not out of the question either. Famed investor Jack Bogle stated that over the next decade we are likely to see two more 50% declines.  A 50% decline from the all-time highs would put the market at 1600.]

As I have often stated, I am not bullish or bearish. My job as a portfolio manager is simple; invest money in a manner that creates returns on a short-term basis, but reduces the possibility of catastrophic losses, which wipe out years of growth.

Nobody tends to believe that philosophy until the markets wipe about 30% of portfolio values in a month.

The 4-Phases

AlphaTrends previously put together an excellent diagram laying out the 4-phases of the full-market cycle. To wit:

“Is it possible to time the market cycle to capture big gains? Like many controversial topics in investing, there is no real professional consensus on market timing. Academics claim that it’s not possible, while traders and chartists swear by the idea.

The following infographic explains the four important phases of market trends, based on the methodology of the famous stock market authority Richard Wyckoff. The theory is that the better an investor can identify these phases of the market cycle, the more profits can be made on the ride upwards of a buying opportunity.”

So, the question to answer, obviously, is:

“Where are we now?”

Let’s take a look at the past two full-market cycles, using Wyckoff’s methodology, as compared to the current post-financial-crisis half-cycle. While actual market cycles will not exactly replicate the chart above, you can clearly see Wyckoff’s theory in action.

1992-2003

The accumulation phase, following the 1991 recessionary environment, was evident as it preceded the “internet trading boom” and the rise of the “dot.com” bubble from 1995-1999. As I noted previously:

“Following the recession of 1991, the Federal Reserve drastically lowered interest rates to spur economic growth. However, the two events which laid the foundation for the ‘dot.com’ crisis was the rule-change which allowed the nation’s pension funds to own equities and the repeal of Glass-Steagall, which unleashed Wall Street upon a nation of unsuspecting investors.

The major banks could now use their massive balance sheet to engage in investment-banking, market-making, and proprietary trading. The markets exploded as money flooded the financial markets. Of course, since there were not enough ‘legitimate’ deals to fill demand and Wall Street bankers are paid to produce deals, Wall Street floated any offering it could despite the risk to investors.”

The distribution phase became evident in early-2000 as stocks began to struggle.

Names like Enron, WorldCom, Global Crossing, Lucent Technologies, Nortel, Sun Micro, and a host of others, are “ghosts of the past.” Importantly, they are the relics of an era the majority of investors in the market today are unaware of, but were the poster children for the “greed and excess” of the preceding bull market frenzy.

As the distribution phase gained traction, it is worth remembering the media and Wall Street were touting the continuation of the bull market indefinitely into the future. 

Then, came the decline.

2003-2009

Following the “dot.com” crash, investors had all learned their lessons about the value of managing risk in portfolios, not chasing returns, and focusing on capital preservation as the core for long-term investing.

Okay. Not really.

It took about 27-minutes for investors to completely forget about the previous pain of the bear market and jump headlong back into the creation of the next bubble leading to the “financial crisis.” 

During the mark-up phase, investors once again piled into leverage. This time not just into stocks, but real estate, as well as Wall Street, found a new way to extract capital from Main Street through the creation of exotic loan structures. Of course, everything was fine as long as interest rates remained low, but as with all things, the “party eventually ends.”

Once again, during the distribution phase of the market, the analysts, media, Wall Street, and rise of bloggers, all touted “this time was different.” There were “green shoots,” it was a “Goldilocks economy,” and there was “no recession in sight.” 

They were disastrously wrong.

Sound familiar?

2009-Present

So, here we are, a decade into the current economic recovery and a market that has risen steadily on the back of excessively accommodative monetary policy and massive liquidity injections by Central Banks globally.

Once again, due to the length of the “mark up” phase, most investors today have once again forgotten the “ghosts of bear markets past.”

Despite a year-long distribution in the market, the same messages seen at previous market peaks were steadily hitting the headlines: “there is no recession in sight,” “the bull market is cheap” and “this time is different because of Central Banking.”

Well, as we warned more than once, all that was required was an “exogenous” event, which would spark a credit-event in an overly leveraged, overly extended, and overly bullish market. The “virus” was that exogenous event.

Lost And Found

There is a sizable contingent of investors, and advisors, today who have never been through a real bear market. After a decade long bull-market cycle, fueled by Central Bank liquidity, it is understandable why mainstream analysis believed the markets could only go higher. What was always a concern to us was the rather cavalier attitude they took about the risk.

“Sure, a correction will eventually come, but that is just part of the deal.”

As we repeatedly warned, what gets lost during bull cycles, and is always found in the most brutal of fashions, is the devastation caused to financial wealth during the inevitable decline. It isn’t just the loss of financial wealth, but also the loss of employment, defaults, and bankruptcies caused by the coincident recession.

This is the story told by the S&P 500 inflation-adjusted total return index. The chart shows all of the measurement lines for all the previous bull and bear markets, along with the number of years required to get back to even.

What you should notice is that in many cases bear markets wiped out essentially all or a very substantial portion of the previous bull market advance.

There are many signs suggesting the current Wyckoff cycle has entered into its fourth, and final stage. Whether, or not, the current decline phase is complete, is the question we are all working on answering now.

Bear market cycles are rarely ended in a month. While there is a lot of “hope” the Fed’s flood of liquidity can arrest the market decline, there is still a tremendous amount of economic damage to contend with over the months to come.

In the end, it does not matter IF you are “bullish” or “bearish.” What matters, in terms of achieving long-term investment success, is not necessarily being “right” during the first half of the cycle, but by not being “wrong” during the second half.

Previous Employment Concerns Becoming An Ugly Reality

Last week, we saw the first glimpse of the employment fallout caused by the shutdown of the economy due to the virus. To wit:

“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 when claims are reported later this morning, as many individuals were slow to file claims, didn’t know how, and states were 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 15-20% over the next quarter as economic growth slides 8%, or more. (I am probably overly optimistic.)

The erosion in employment will lead to a sharp deceleration in economic and consumer confidence, as was seen Tuesday in the release of the Conference Board’s consumer confidence index, which plunged from 132.6 to 120 in March.

This is a critical point. Consumer 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 jobs.

The chart below is our “composite” confidence index, which combines several confidence surveys into one measure. Notice that during each of the previous two bear market cycles, confidence dropped by an average of 58 points.

With consumer confidence just starting its reversion from high levels, it suggests that as job losses rise, confidence will slide further, putting further pressure on asset prices. Another way to analyze confidence data is to look at the composite consumer expectations index minus the current situation index in the reports.

Similarly, given we have only started the reversion process, bear markets end when deviations reverse. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than before the “dot.com” crash.

If you are betting on a fast economic recovery, I wouldn’t.

There is a fairly predictable cycle, starting with CEO’s moving to protect profitability, which gets worked through until exhaustion is reached.

As unemployment rises, we are going to begin to see the faults in the previous employment numbers that I have repeatedly warned about over the last 18-months. To wit:

“There is little argument the streak of employment growth is quite phenomenal and comes amid hopes the economy is beginning to shift into high gear. But while most economists focus at employment data from one month to the next for clues as to the strength of the economy, it is the ‘trend’ of the data, which is far more important to understand.”

That “trend” of employment data has been turning negative since President Trump was elected, which warned the economy was actually substantially weaker than headlines suggested. More than once, we warned that an “unexpected exogenous event” would exposure the soft-underbelly of the economy.

The virus was just such an event.

While many economists and media personalities are expecting a “V”-shaped recovery as soon as the virus passes, the employment data suggests an entirely different outcome.

The chart below shows the peak annual rate of change for employment prior to the onset of a recession. The current cycle peaked at 2.2% in 2015, and has been on a steady decline ever since. At 1.3%, which predated the virus, it was the lowest level ever preceding a recessionary event. All that was needed was an “event” to start the dominoes falling. When we see the first round of unemployment data, we are likely to test the lows seen during the financial crisis confirming a recession has started. 

No Recession In 2020?

It is worth noting that NO mainstream economists, or mainstream media, were predicting a recession in 2020. However, as we noted in 2019, the inversion of the “yield curve,” predicted exactly that outcome.

“To CNBC’s point, based on this lagging, and currently unrevised, economic data, there is ‘NO recession in sight,’ so you should be long equities, right?

Which indicator should you follow? The yield curve is an easy answer.

While everybody is ‘freaking out’ over the ‘inversion,’it is when the yield-curve ‘un-inverts’ that is the most important.

The chart below shows that when the Fed is aggressively cutting rates, the yield curve un-inverts as the short-end of the curve falls faster than the long-end. (This is because money is leaving ‘risk’ to seek the absolute ‘safety’ of money markets, i.e. ‘market crash.’)”

I have dated a few of the key points of the “inversion of the curve.” As of today, the yield-curve is now fully un-inverted, denoting a recession has started.

While recent employment reports were slightly above expectations, the annual rate of growth has been slowing. The 3-month average of the seasonally-adjusted employment report, also confirms that employment was already in a precarious position and too weak to absorb a significant shock. (The 3-month average smooths out some of the volatility.)

What we will see in the next several employment reports are vastly negative numbers as the economy unwinds.

Lastly, while the BLS continually adjusts and fiddles with the data to mathematically adjust for seasonal variations, the purpose of the entire process is to smooth volatile monthly data into a more normalized trend. The problem, of course, with manipulating data through mathematical adjustments, revisions, and tweaks, is the risk of contamination of bias.

We previously proposed a much simpler method to use for smoothing volatile monthly data using a 12-month moving average of the raw data as shown below.

Notice that near peaks of employment cycles the BLS employment data deviates from the 12-month average, or rather “overstates” the reality. However, as we will now see to be the case, the BLS data will rapidly reconnect with 12-month average as reality emerges.

Sometimes, “simpler” gives us a better understanding of the data.

Importantly, there is one aspect to all the charts above which remains constant. No matter how you choose to look at the data, peaks in employment growth occur prior to economic contractions, rather than an acceleration of growth. 

“Okay Boomer”

Just as “baby boomers” were finally getting back to the position of being able to retire following the 2008 crash, the “bear market” has once again put those dreams on hold. Of course, there were already more individuals over the age of 55, as a percentage of that age group, in the workforce than at anytime in the last 50-years. However, we are likely going to see a very sharp drop in those numbers as “forced retirement” will surge.

The group that will to be hit the hardest are those between 25-54 years of age. With more than 15-million restaurant workers being terminated, along with retail, clerical, leisure, and hospitality workers, the damage to this demographic will be the heaviest.

There is a decent correlation between surges in the unemployment rate and the decline in the labor-force participation rate of the 25-54 age group. Given the expectation of a 15%, or greater, unemployment rate, the damage to this particular age group is going to be significant.

Unfortunately, the prime working-age group of labor force participants had only just returned to pre-2008 levels, and the same levels seen previously in 1988. Unfortunately, it may be another decade before we see those employment levels again.

Why This Matters

The employment impact is going to felt for far longer, and will be far deeper, than the majority of the mainstream media and economists expect. This is because they are still viewing this as a “singular” problem of a transitory virus.

It isn’t.

The virus was simply the catalyst which started the unwind of a decade-long period of debt accumulation and speculative excesses. Businesses, both small and large, will now go through a period of “culling the herd,” to lower operating costs and maintain profitability.

There are many businesses that will close, and never reopen. Most others will cut employment down to the bone and will be very slow to rehire as the economy begins to recover. Most importantly, wage growth was already on the decline, and will be cut deeply in the months to come.

Lower wage growth, unemployment, and a collapse in consumer confidence is going to increase the depth and duration of the recession over the months to come. The contraction in consumption will further reduce revenues and earnings for businesses which will require a deeper revaluation of asset prices. 

I just want to leave you with a statement I made previously:

“Every financial crisis, market upheaval, major correction, recession, etc. all came from one thing – an exogenous event that was not forecast or expected.

This is why bear markets are always vicious, brutal, devastating, and fast. It is the exogenous event, usually credit-related, which sucks the liquidity out of the market, causing prices to plunge. As prices fall, investors begin to panic-sell driving prices lower which forces more selling in the market until, ultimately, sellers are exhausted.

It is the same every time.”

Over the last several years, investors have insisted the markets were NOT in a bubble. We reminded them that everyone thought the same in 1999 and 2007.

Throughout history, financial bubbles have only been recognized in hindsight when their existence becomes “apparently obvious” to everyone. Of course, by that point is was far too late to be of any use to investors and the subsequent destruction of invested capital.

It turned out, “this time indeed was not different.” Only the catalyst, magnitude, and duration was.

Pay attention to employment and wages. The data suggests the current “bear market” cycle has only just begun.

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.

Shedlock: Recession Will Be Deeper Than The Great Financial Crisis

Economists at IHS Markit downgraded their economic forecast to a deep recession.

Please consider COVID-19 Recession to be Deeper Than That of 2008-2009

Our interim global forecast is the second prepared in March and is much more pessimistic than our 17 March regularly scheduled outlook. It is based on major downgrades to forecasts of the US economy and oil prices. The risks remain overwhelmingly on the downside and further downgrades are almost assured.

IHS Markit now believes the COVID-19 recession will be deeper than the one following the global financial crisis in 2008-09. Real world GDP should plunge 2.8% in 2020 compared with a drop of 1.7% in 2009. Many key economies will see double-digit declines (at annualized rates) in the second quarter, with the contraction continuing into the third quarter.

It will likely take two to three years for most economies to return to their pre-pandemic levels of output. More troubling is the likelihood that, because of the negative effects of the uncertainty associated with the virus on capital spending, the path of potential GDP will be lower than before. This happened in the wake of the global financial crisis.

Six Key Points

  1. Based on recent data and developments, IHS Markit has slashed the US 2020 forecast to a contraction of 5.4%.
  2. Because of the deep US recession and collapsing oil prices, IHS Markit expects Canada’s economy to contract 3.3% this year, before seeing a modest recovery in 2021.
  3. Europe, where the number of cases continues to grow rapidly and lockdowns are pervasive, will see some of the worst recessions in the developed world, with 2020 real GDP drops of approximately 4.5% in the eurozone and UK economies. Italy faces a decline of 6% or more. The peak GDP contractions expected in the second quarter of 2020 will far exceed those at the height of the global financial crisis.
  4. Japan was already in recession, before the pandemic. The postponement of the summer Tokyo Olympics will make the downturn even deeper. IHS Markit expects a real GDP contraction of 2.5% this year and a very weak recovery next year.
  5. China’s economic activity is expected to have plummeted at a near-double-digit rate in the first quarter. It will then recover sooner than other countries, where the spread of the virus has occurred later. IHS Markit predicts growth of just 2.0% in 2020, followed by a stronger-than-average rebound in 2021, because of its earlier recovery from the pandemic.
  6. Emerging markets growth will also be hammered. Not only are infection rates rising rapidly in key economies, such as India, but the combination of the deepest global recession since the 1930s, plunging commodity prices, and depreciating currencies (compounding already dangerous debt burdens) will push many of these economies to the breaking point.

No V-Shaped Recovery

With that, Markit came around to my point of view all along. Those expecting a V-shaped recovery are sadly mistaken.

I have been amused by Goldman Sachs and Morgan Stanley predictions of a strong rebound in the third quarter.

For example Goldman Projects a Catastrophic GDP Decline Worse than Great Depression followed by a fantasyland recovery.

  • Other GDP Estimates
  • Delusional Forecast
  • Advice Ignored by Trump
  • Fast Rebound Fantasies

I do not get these fast rebound fantasies, and neither does Jim Bianco. He retweeted a Goldman Sachs estimate which is not the same as endorsing it.

I do not know how deep this gets, but the rebound will not be quick, no matter what.

Fictional Reserve Lending

Please note that Fictional Reserve Lending Is the New Official Policy

The Fed officially cut reserve requirements of banks to zero in a desperate attempt to spur lending.

It won’t help. As I explain, bank reserves were effectively zero long ago.

US Output Drops at Fastest Rate in a Decade

Meanwhile US Output Drops at Fastest Rate in a Decade

In Europe, we see Largest Collapse in Eurozone Business Activity Ever.

Lies From China

If you believe the lies (I don’t), China is allegedly recovered.

OK, precisely who will China be delivering the goods to? Demand in the US, Eurozone, and rest of the world has collapse.

We have gone from praying China will soon start delivering goods to not wanting them even if China can produce them.

Nothing is Working Now: What’s Next for America?

On March 23, I wrote Nothing is Working Now: What’s Next for America?

I noted 20 “What’s Next?” things.

It’s a list of projections from an excellent must see video presentation by Jim Bianco. I added my own thoughts on the key points.

The bottom line is don’t expect a v-shaped recovery. We will not return to the old way of doing business.

Globalization is not over, but the rush to globalize everything is. This will impact earnings for years to come.

Finally, stimulus checks are on the way, but there will be no quick return to buying cars, eating out, or traveling as much.

Boomers who felt they finally had enough retirement money just had a quarter of it or more wiped out.

It will take a long time, if ever, for the same sentiment to return. Spending will not recover. Boomers will die first, and they are the ones with the most money.

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.

Anatomy of The Bear. Lessons from Russell Napier.

One of my annual re-reads is Russell Napier’s classic tome “Anatomy of the Bear.”

A mandatory study for every financial professional and investor who seeks to understand not only how damaging bear markets can be but also the traits which mark their bottoms. Every bear is shaken from hibernation for different reasons. However, when studying the four great bottoms of bears in 1921, 1932, 1949 and 1982, there are several common traits to these horrendous cycles.  I thought it would be interesting to share them with you.

First, keep in mind, bear markets characteristically purge weakness – weak companies, weak advisors, weak investors. I want you to consider them less a bloodletting and more a cleansing of a system. There will be unsuitable investors who will never return to the market and justifiably so. Businesses that were patronized pre-Covid, will either be gone or completely reinvent. Bear markets slash equity valuations. Unfortunately, this doesn’t mean that stocks return to healthy valuations quickly after a bear departure. Some believe the global economy can turn on and off like a light switch without major repercussions. In other words,  the belief is once the worst of this horrid virus ceases,  business activity invariably will return to normal. I believe it’ll be quite the contrary.

I mentioned on the radio show in December that I expected wage growth to top out in 2019. Keep in mind, through this yet another outlier economic upheaval, there will be employers who will realize they don’t require as many employees and will let them go or cap their wages for years to rebuild profit margins. Without the tailwind of stock buybacks to equity prices, corporate employees will bear the brunt of the pain. In addition, organizations will realize many of their remaining employees are equipped to work from home and perhaps gather in-person perhaps once a month or every couple of weeks. Thus, large commercial space will no longer be required which is going to require massive reinvention by the commercial real estate industry.
The cry of nationalism will rise. Products manufactured overseas especially China, will take a hit which means Americans will face greater inflationary challenges while also dealing with muted or non-existent wage growth. We will experience ‘ more money chasing too-few goods.’ Many, especially younger generations will continue to strip themselves down to basics (I especially envision this in Generation Z;  those born in the mid-late 1990s such as my daughter Haley).  This sea-change will require most of the U.S. population to finally live below their means, dramatically downsize, reinvent, expand, the definition of wealth to include more holistic, ethereal methods that go way beyond household balance sheets and dollars.
I hope I’m wrong. So very wrong about most of what I envision for the future.
Here are several traits that every major market bottom share – courtesy of Russell Napier:

  1. Bears tend to die on low volume, at least the big bears do. 

Low volume represents a complete disinterest in stocks. Keep in mind this clearly contradicts the tenet which states that bears end with one act of massive capitulation – a  downward cascade on great volume. Those actions tend to mark the beginning of a bear cycle, not the end. A rise in volume on rebounds, falling volumes on weakness would better mark a bottoming process in a bear market.

2. Bears are tricky.

There will appear to be a recovery; an ‘all-clear’ for stock prices. It’ll suck in investors who believe the market recovery is upon us just to be financially ravaged again. Anecdotally, I know this cycle isn’t over as I still receive calls from people who are anxious to get into the market and perceive the current market a buying opportunity. At the bottom of a bear, I should be hearing great despair and clear disdain for stock investing.

3. Bears can be tenacious.

They refuse to die or at the least, quickly return to hibernation. The 1921 move from overvaluation to undervaluation took over ten years. Bear markets, where three-year price declines make overvalued equities cheap, are the exception, not the rule. As of this writing,  the Shiller P/E is at 24x – hardly a bargain.  At the bottom market cycle of the Great Recession, the Shiller CAPE was at 15x. There is still valuation adjustment ahead.

4. Bears can depart before earnings actually recover.

Investors who wait for a complete recovery in corporate earnings will arrive late to the stock-investment party.  Most likely it’s going to take a while (especially with their debt burden), for the majority of U.S. companies to reflect healthy earnings growth. CEOs who employ stock buybacks to boost EPS will be considered pariahs and gain unwanted attention from Congress and even the Executive Branch. My thought is a savvy investor should look to minimize indexing and select individual stocks with strong balance sheets which include low debt and plenty of free cash flow within sectors and industries that are nimble to adjust to the global economy post-crisis.

5. Bear market damage can be inconceivable, especially to a generation of investors who never experienced one.

The bear market of 1929-32 was characterized by an 89% decline. The average is 38% for bears;  however, averages are misleading. I have no idea how much damage this bear ultimately unleashes. The closest comparison I have is the 1929-1932 cycle. However, with the massive fiscal and monetary stimulus (and I don’t believe we’ve seen the full extent of it yet),  my best guess is a bear market contraction somewhere between the Great Depression and Great Recession. At the least, I believe we re-test lows and this bear is a 40-45% retracement from the highs.

6. Bear markets end on the return of general price stability and strong demand for durables such as autos.

In 1949, as in 1921 and 1932, a return of general price stability coincided with the end of the equity bear market. Demand and price stability of selected commodities augured well for general price stabilization.  Watch how industrial metals recover such as copper, now at the lowest levels since the fall of 2017. The Baltic Dry Index is off close to 20% so far this year. Low valuations (not there yet), when combined with a return to normalcy in the general price level, may provide the best opportunity for future above-average equity returns. We are not there.

7. Bear markets that no longer decline on bad news are a positive.

The combination of large short positions in conjunction with a market that fails to decline on bad news was overall a positive indicator of a rebound in 1921, 1932 and 1949. Also, limited stock purchases by retail investors may be considered an important building block for a bottom.  Since the worst of economic numbers haven’t been witnessed yet, there remains too much hope of a vicious recovery in stock prices as well as the overall global economies.

8. Not all bear markets lead the economy by six-to-nine months.

Generally, markets lead the economy. However, this tenet failed to hold true for the four great bears. At extreme times, the bottoms for the economy and the equity market were aligned and in several cases, the economy LED stocks higher!  It’s unclear whether this bear behaves in a similar fashion only because of massive fiscal and monetary stimulus. We’re not done with stimulus methods either. If anything, they’ve just begun! I know. Tough to fathom.

For me and the RIA Team, every bear provides an important lesson. The beast comes in all sizes; their claws differ in sharpness. However, they are all dangerous to financial wealth.

I believe the market will eventually witness a “V” shaped recovery due to unprecedented stimulus. Unfortunately, I believe the economy will remain sub-par for a long period. Here’s a vision I shared on Facebook recently:

Let me give you one example how an economy cannot turn off, then on, like a light switch.

Joe’s Donuts is closed. Joe lets his 2 employees go, at least temporarily. Joe employs his wife Emily to assist as she’s just been laid off from her job. Joe is a quick thinker. He creates pre-packaged dough-to-go bags and sells them outside the store. His sales are off 75% as most businesses around him are shuttered. Joe was able to negotiate postponement of his rent for one month but will have to pay two months in May.

Joe has a profitable business but he’s already eaten through a quarter of his cash reserves to pay for supplies, maintain expenses to keep going. He can’t afford another month of quarantine.

The quarantine is lifted May 1 (best case scenario). Joe’s establishment is open! He’s hesitant to have employees return because he wants to gauge business for a month. He discovers that business is still off 40% from last year at the same time. Why? Because his patrons have either been let go or in repair of ravaged household balance sheets. In addition, he notices that purchasing boxes of donuts for office meetings is way off.

Joe contacts his former 2 employees. He tells them he still doesn’t require them. He’s handling the traffic sufficiently alone at this time. Joe now owes 2 months of rent. He takes one month from the business’ reserve account; distributes another from his retirement account.

Joe’s wife Ellen has been called back to work by her former employer, a local car dealership. She’s been asked to work the same job, same responsibilities. However, the pay is 10% less. Out of desperation, she takes the job. Meanwhile, Joe tells Ellen that they need to find a way to continue to cut household expenses…. Well, you get the picture.

I think this is reality for at least a year after the ‘all clear.’

There’s never been a better time to catch up on reading. Russell’s book is available through Amazon. For those interested in market history,  the pages hold invaluable insights.

For me, markets are always battlefields, but I’ve survived several conflicts.

Consider “Anatomy of The Bear,” part of your financial literary war chest.

Technically Speaking: 5-Questions Bulls Need To Answer Now.

In last Tuesday’s Technically Speaking post, I stated:

From a purely technical basis, the extreme downside extension, and potential selling exhaustion, has set the markets up for a fairly strong reflexive bounce. This is where fun with math comes in.

As shown in the chart below, after a 35% decline in the markets from the previous highs, a rally to the 38.2% Fibonacci retracement would encompass a 20% advance.

Such an advance will ‘lure’ investors back into the market, thinking the ‘bear market’ is over.”

Chart Updated Through Monday

Not surprisingly, as we noted in this weekend’s newsletter, the headlines from the mainstream media aligned with our expectations:

So, is the bear market over? 

Are the bulls now back in charge?

Honestly, no one knows for certain. However, there are 5-questions that “Market Bulls” need to answer if the current rally is to be sustained.

These questions are not entirely technical, but since “technical analysis” is simply the visualization of market psychology, how you answer the questions will ultimately be reflected by the price dynamics of the market.

Let’s get to work.

Employment

Employment is the lifeblood of the economy.  Individuals cannot consume goods and services if they do not have a job from which they can derive income. From that consumption comes corporate profits and earnings.

Therefore, for individuals to consume at a rate to provide for sustainable, organic (non-Fed supported), economic growth they must work at a level that provides a sustainable living wage above the poverty level. This means full-time employment that provides benefits, and a livable wage. The chart below shows the number of full-time employees relative to the population. I have also overlaid jobless claims (inverted scale), which shows that when claims fall to current levels, it has generally marked the end of the employment cycle and preceded the onset of a recession.

This erosion in jobless claims has only just begun. As jobless claims and continuing claims rise, it 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. 


Question:  Given that employment is just starting to decline, does such support the assumption of a continued bull market?


Personal Consumption Expenditures (PCE)

Following through from employment, once individuals receive their paycheck, they then consume goods and services in order to live.

This is a crucial economic concept to understand, which is the order in which the economy functions. Consumers must “produce” first, so they receive a paycheck, before they can “consume.”  This is also the primary problem of Stephanie Kelton’s “Modern Monetary Theory,” which disincentivizes the productive capacity of the population.

Given that Personal Consumption Expenditures (PCE) is a measure of that consumption, and comprises roughly 70% of the GDP calculation, its relative strength has great bearing on the outcome of economic growth.

More importantly, PCE is the direct contributor to the sales of corporations, which generates their gross revenue. So goes personal consumption – so goes revenue. The lower the revenue that flows into company coffers, the more inclined businesses are to cut costs, including employment and stock buybacks, to maintain profit margins.

The chart below is a comparison of the annualized change in PCE to corporate fixed investment and employment. I have made some estimates for the first quarter based on recent data points.


Question: Does the current weakness in PCE and Fixed Investment support the expectations for a continued bull market from current price levels? 


Junk Bonds & Margin Debt

While global Central Banks have lulled investors into an expanded sense of complacency through years of monetary support, it has led to willful blindness of underlying risk. As we discussed in “Investor’s Dilemma:”

Classical conditioning (also known as Pavlovian or respondent conditioning) refers to a learning procedure in which a potent stimulus (e.g. food) is paired with a previously neutral stimulus (e.g. a bell). What Pavlov discovered is that when the neutral stimulus was introduced, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological “pairing” of the stimuli.”

That “stimuli” over the last decade has been Central Bank interventions. During that period, the complete lack of “fear” in markets, combined with a “chase for yield,” drove “risk” assets to record levels along with leverage. The chart below shows the relationship between margin debt (leverage), stocks, and junk bond yields (which have been inverted for better relevance.)

While asset prices declined sharply in March, it has done little to significantly revert either junk bond yields or margin debt to levels normally consistent with the beginning of a new “bull market.”

With oil prices falling below $20/bbl, a tremendous amount of debt tied to the energy space, and the impact the energy sector has on the broader economy, it is likely too soon to suggest the markets have fully “priced in” the damage being done.


Question:  What happens to asset prices if more bankruptcies and forced deleveraging occurs?


Corporate Profits/Earnings

As noted above, if the “bull market” is back, then stocks should be pricing in stronger earnings going forward. However, given the potential shakeout in employment, which will lower consumption, stronger earnings, and corporate profits, are not likely in the near term.

The risk to earnings is even higher than many suspect, given that over the last several years, companies have manufactured profitability through a variety of accounting gimmicks, but primarily through share buybacks from increased leverage. That cycle has now come to an end, but before it did it created a massive deviation of the stock market from corporate profitability.

“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.

The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits, and earnings. I have projected the potential reversion in the chart below. The reversion in GAAP earnings is pretty calculable as swings from peaks to troughs have run on a fairly consistent trend.

Using that historical context, we can project a recession will reduce earnings to roughly $100/share. (Goldman Sachs currently estimates $110.) 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. (Yesterday’s close of 2626 is still way to elevated.)

The decline in economic growth epitomizes the problem that corporations face today in trying to maintain profitability. The chart below shows corporate profits as a percentage of GDP relative to the annual change in GDP. The last time that corporate profits diverged from GDP, it was unable to sustain that divergence for long. As the economy declines, so will corporate profits and earnings.


Question: How long can asset prices remain divorced from falling corporate profits and weaker economic growth?


Technical Pressure

Given all of the issues discussed above, which must ultimately be reflected in market prices, the technical picture of the market also suggests the recent “bear market” rally will likely fade sooner than later. As noted above”

Such an advance will ‘lure’ investors back into the market, thinking the ‘bear market’ is over.”

Importantly, despite the sizable rally, participation has remained extraordinarily weak. If the market was seeing strong buying, as suggested by the media, then we should see sizable upticks in the percent measures of advancing issues, issues at new highs, and a rising number of stocks above their 200-dma.

However, on a longer-term basis, since this is the end of the month, and quarter, we can look at our quarterly buy/sell indication which has triggered a “sell” signal for the first time since 2015. While such a signal does not demand a major reversion, it does suggest there is likely more risk to the markets currently than many expect.


Question:  Does the technical backdrop currently support the resumption of a bull market?


There are reasons to be optimistic on the markets in the very short-term. However, we are continuing to extend the amount of time the economy will be “shut down,” which will exacerbate the decline in the unemployment and personal consumption data. The feedback loop from that data into corporate profits and earnings is going to make valuations more problematic even with low interest rates currently. 

While Central Banks have rushed into a “burning building with a fire hose” of liquidity, there is the risk that after a decade of excess debt, leverage, and misallocation of assets, the “fire” may be too hot for them to put out.

Assuming that the “bear market” is over already may be a bit premature, and chasing what seems like a “raging bull market” is likely going to disappoint you.

Bear markets have a way of “suckering” investors back into the market to inflict the most pain possible. This is why “bear markets” never end with optimism, but in despair.

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.  

How COVID-19 May Move Markets

As the pandemic drives markets to the 2018 lows, certain relationships in trends between the markets and the COVID-19 virus are evident.  As social distancing increases, markets continue to fall. So, by looking at the expected breakout levels of the virus, we can assess possible market reactions. The chart below shows the inverse correlation between the expected peaks of the virus and potential lows in the markets: 

Source: FIPhysician – & Patrick Hill  – 3/18/20

In the COVID-19 – SPX model above, the steep red line is a forecast of new cases if social distancing were not in place.  The green line shows how social distancing will flatten the curve of new cases. The blue curve shows how growth in the pandemic may unfold doubling every 4 – 7 days.  The lower chart shows how social distancing correlates to movements in the SPX. As the number of cases peak, there is a related trough in the SPX. Looking at present levels, we are likely to see more selling as the number of cases increases to a possible low of 2000 in the May-June time frame.

Epidemiologists currently forecast the COVID -19 pandemic will unfold in two waves, with the current breakout and remission during the summer followed by a possible second breakout in the fall and winter of this year.  Researchers think the closest analog to the COVID -19 pandemic is the Spanish Flu in 1918, which came roaring back the following winter resulting in a second wave of even greater infections and death. 

The first blue dot shows where the SPX is today at this early stage in the pandemic.  The SPX index may continue to fall as the economic damage increases and GDP declines in the first and second quarters. Two consecutive declines will officially put the economy in a recession.  

The SPX may fall to 2030 in this first wave, which represents a Fibonacci retracement of 50 % from the 2008 low to the 2020 peak.  From there, markets may rebound back up to 2350, a Fibonacci retracement of 61% as the virus breakout fades, relief rally emerges, and economic activity picks up.  However, as this occurs, higher interest rates from massive stimulus spending may weigh on financial markets, as seen in the spike of bond yields, the decline in gold prices and other safe haven assets. 

Consumers who are already financially stretched are being furloughed or laid off, which will trigger loan defaults.  Finally, corporations are now at the highest level of debt since 2008 and are experiencing a steep decline in sales, causing a cash squeeze leading to layoffs.  The most important consideration is that the virus is exposing the heavy reliance on debt on major institutions and consumers in our economic system.

The slide into a recession is evident in announced layoffs by significant corporations. Marriott and other hotels have announced thousands of layoffs. Other hospitality industry companies will follow. Harley-Davidson, GM, Ford, Fiat Chrysler, Nissan, and Tesla have all suspended manufacturing for several weeks in the U.S. Thousands of workers are on furlough until manufacturing resumes. There is a growing risk consumer demand may not return to pre coronavirus levels forcing permanent layoffs.

While manufacturing is 30% of GDP, services contribute 70% of GDP.  Many services can be offered online or via web conferencing.  The present social distancing experiment will provide significant insights into how well the economy can perform when many knowledge workers are working from home.  If working from home is successful, we expect to see more companies permanently move employees to their homes to reduce office space and cut expenses. This has grave implications for the commercial real estate industry and investors of those properties. 

The diverse U.S. economy is likely to recover quicker than the world economy.  However, an earnings recovery may stall due to the fact most S&P 100 companies derive 55% of their sales from overseas and 60% of their profits from international markets.  

Looking at a possible second virus wave in the fall, it is likely that economic damage will grow worse due to increasing unemployment, declining corporate spending, falling consumer spending, and a resumption of social distancing. The second wave fits a decline model seen in 2000 from the Y2K software bug scare.  That crisis was an external event, causing a demand shock, though little supply shock.  The bottom for the NDX did not happen until 18 months after the market peak. The virus seems to be compressing the market drop period as there have been three trading halts of 7% in the markets in just eight days of trading.  SPX support is near 1810 – 1867 in 2016, just above the Fibonacci 38% level of 1708.

In our post of February 14th about the coronavirus triggering a downturn, we saw the strong possibility of the economy sliding into a recession.  In the post we noted that Allianz Chief Economic Advisor, Mohammed El-Arian observed that we are likely headed into a U or L shaped recession:

“…analysts and modelers should respect the degree of uncertainty in play, including the inconvenient realization that the possibility of a U or, worse, an L for 2020 is still too high for comfort.”

Hope is not a strategy. Of course, we hope the virus is contained, lives saved, and the economy can weather the stress on corporations and consumers.  However, as long term investors, we need to look at the reality of what may happen based on research and plan our strategic investments accordingly. Plan for the worst, and hope for the best.


Patrick Hill is the Editor of The Progressive Ensign, writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677.

America: WILL WE FINALLY LEARN A LESSON?

Much of what passes for orthodoxy in economics and finance proves, on closer examination, to be shaky business.” The Misbehavior of Markets – by Benoit Mandelbrot & Richard L. Hudson.

If as households we do crumble financially yet another time, will this ‘outlier’ event finally teach us a valuable lesson? One we’ll never forget (again)? I mean, how many Black Swans or events that create wholesale economic and financial devastation must we endure to work diligently, effortlessly, to shore up our family’s finances?

Unfortunately, as humans, we focus on risk and financial stability too late. Always. Too. Late. We are creatures of complacency and mainstream financial advice does nothing but fuel our overconfidence bias. Only when a storm is upon us, wreaking havoc, do we seek to board the windows and secure what’s important to us. 

We’re cajoled by ‘experts’ during good times. We’re taught how outlier events occur every 1,000 years. Strange how rare occurrences aren’t so rare. They seem to happen every decade. So, let me ask you – How many times do these so-called ‘rare’ events need to occur before fiscal discipline becomes a priority for all of us?

Over the last three years, at RIA we have created several financial tenets to guard against financial vulnerability. I don’t mean to preach; I mean to teach.

I hope over the next few years, once this pandemic is past and we rummage through the economic rubble, we’ll take it upon ourselves to remain vigilant through the complacency and take the following rules to heart.

1. A painful reminder about the ‘buy and hold’ investment philosophy or whatever horrid expletive you’re probably calling it right now.

Never forget that convincing words, piles of academic studies and mined data from big-box financial retailers in pretty packages make it easy to share convincing stories to push stocks. Hopefully, investors who spent most of their time and money getting back to even remain comforted by the narratives. They’ll now do it again.

I’ll admit – I’m nonplussed by the appeal of buy-and-hold to the purists. I truly envy them.

It seems to be a “What Me Worry?” kind of existence. There seems to be an eerie comfort to throwing money into a black hole of overvalued investments and hoping that it transforms into a white light of wealth 20 years down the road (even if it’s a very dim bulb). I truly wish I could be convinced that a blind buy-and-hold fable is truth.

I so passionately want investors to achieve returns and exceed their financial life benchmarks or goals; it’s good for me too. I also would like to minimize the damage from bears. Is that too much to ask?

At Real Investment Advice we think it’s one of a money manager’s primary responsibilities.

Buy-and-hold at the core wrapped in rules of risk management is a healthy, long-term strategy to build and protect wealth. That’s what we’re doing at this juncture.

If you’re completely out of the market for an extended period, I mean zilch, zero, then stock investing may not be appropriate for you. Hey, it isn’t for everyone, especially today when the flood of central bank liquidity (I’ve never witnessed anything like it), algos (the robots), probably $4 trillion in fiscal stimulus coming, tries to stem the devastation. The bull market is dead, a bear is tricky to navigate. I am grateful to be a partner at a firm where all members understand the devastation of bear markets and are not ‘deer in headlights’ as this crisis is upon us. Take heart – the bear will die; the bull will run again. As investors we will bleed. The key is not to hemorrhage. There is a difference.

It’s not too late to undertake a quick gut check – Realize that an allocation of 10-20% to domestic and international stocks can drop 40% on average in bear markets. Investors fail to realize that diversifying between foreign and U.S. stocks doesn’t manage the risk they care about most – risk of principal loss. We are witnessing this now – one more time on the disaster hit parade. The world has become increasingly an Irwin Allen (The Poseidon Adventure; The Towering Inferno), film and we are the actors.

Let’s say your retirement plan balance is $90,000. In a conservative allocation, $18,000 (20%), may be allocated to stocks. If a bear cycle takes the stock balance down to $10,800 and makes you a bit queasy, then certainly the market doesn’t fit into your overall investment philosophy.

If you do have the intestinal fortitude to maintain an allocation to stocks, your financial partner is a buy-and-hold zealot (highly likely), and you haven’t taken profits (a tenet of risk management) or rebalanced this year, then there’s still an opportunity to do so on rallies. It’s acceptable to maintain additional cash as much as buy-and-hold purists abhor cash.   

You’re not the ‘idiot’ who sells at the bottom just because you adhere to rules of risk management.

Granted, investors can be their worst emotional enemies. If risk management rules are employed as an integration to an overall investment process, then selling at the very bottom may be avoided. From my experience, the dumbest actions of those who did sell at the bottom in March 2009, rest almost solely on their brokers.

You see, if financial professionals would have empathized with their clients and took enough (any) action to preserve capital as clients were calling with concern in late 2007, maybe, just maybe, those distressed investors wouldn’t have sold out of everything pretty much at the bottom.

The advice “not to worry, markets always come back,” regurgitated repeatedly did nothing to allay concerns; frankly hollow words made brokers appear as if they employed market blinders or were in a state of denial. They appeared ignorant, not aware of the severity of the crisis.

I listened enough to begin surgically trimming positions (I explained to clients we sought to take a scalpel, not a machete to reducing stock exposure in portfolios), and was proactive to sell clients out of a Charles Schwab bond fund described as “stable in price,” an “alternative to cash,” in November 2007 when the mutual fund share price was doing nothing but faltering.

Although Schwab portfolio management assured us in the field repeatedly that there was “nothing wrong with the fund,” and it wasn’t suffering mass redemptions, it did eventually go bust and Schwab was held accountable for lack of oversight.

Unfortunately, the company got off easy as the settlement with the SEC was nothing but a financial slap on the wrist when the fund held $13.5 billion at its peak.

You tell me this stuff isn’t rigged against retail investors? I believe differently. I always will.

Proactive behavior allowed me to maintain a semblance of stock ownership and then begin to increase exposure through the summer of 2009.  I deemed it buy-and-hold with a “protective twist.”

If your broker isn’t actively listening and is discounting concerns, it’s time to replace him or her. Answers received should be thorough and backed by analysis.

If you must invest today, consider dollar-cost averaging.

Usually, dollar-cost averaging where you add a fixed dollar amount to variable investments on a regular schedule, underperforms value or lump-sum investing. Unless the cyclically adjusted price-to-earnings ratio or CAPE exceeds 18.6 (today, it exceeds 25).

An impressive analysis and paper by Jon M. Luskin, CFP® for the Journal of Financial Planning titled “Dollar-Cost Averaging Using the CAPE Ratio: An Identifiable Trend Influencing Outperformance,” outlines how investment periods with a CAPE greater than 18.6 is beneficial to dollar-cost averaging with investment returns .45% greater than lump-sum investing.

The other side of the coin of buy-and-hold isn’t active trading.

Cop out. Lame excuse. I can’t be clearer. Not only are you branded a ‘bear’ if you employ a sell discipline, it appears that the buy-and-hold purists can’t think outside of extremes. They tend to associate selling with active trading. It’s a clever ploy designed to avoid the conversation or even the thought of a sell process. It’s just impossible.

Not it isn’t. And it isn’t active trading either. Active trading isn’t going to generate returns, just activity. Plus, if you consider that trades cost ZERO at most big-box financial retailers, transaction costs aren’t a concern anymore.

For years, the investment industry has tried to scare clients into staying fully invested in the stock market, no matter how high stocks go or what’s going on in the economy. Investors are repeatedly warned that doing anything otherwise is simply foolish because “you can’t time the market.” 

Here’s why per Lance Roberts:

“Wall Street firms, despite what the media advertising tells you, are businesses. As a business, their job is to develop and deliver products to investors in whatever form investor appetites demand…Wall Street is always happy to provide ‘products’ to the consumers they serve.

As Wall Street quickly figured out that it was far more lucrative to collect ongoing fees rather than a one-time trading commission…The mutual fund business was booming, and business was ‘brisk’ on Wall Street as profits surged.”

I’ll add:

Frankly, it’s too much work. Financial experts are primarily peddlers of managed products. They’re hired to regurgitate sell-side biased data mined from their employer’s research department. What they’re implying is they’re too busy meeting sales goals to consider risk management (the way you define it as an investor), important.

With that being said, consider other rules to protect your household for when the next ‘outlier’ event occurs (I mean, after this one).

 2. The FVC – The Financial Vulnerability Cushion.

The main purpose of the Financial Vulnerability Cushion is to fortify the foundation of a financial house. You’ve heard about maintaining three to six months of living expenses in cash for emergencies. Well, define an emergency. The car breaks down, sure. The A/C goes out? Right. Expenses such as these fit well into a three to six-month cash cushion. However, Black Swan events remind us this cushion isn’t enough.  We must finally learn to separate emergency from crisis.

Over the last six months we’ve been discussing on the radio how important it is to build a cash war chest of one to two years’ worth of living expenses and maintain it above everything else. These reserves are for crisis. A sudden job loss; major illness. Unfortunately, millions will be out of work here. Some, long term. I’m increasingly concerned about those who work in the energy sector. Never forget. Don’t listen to mainstream financial media again. Remember this time and work diligently to build a FVC.

3. Create financial rules around debt control and savings. Then stick to them. No matter what. Good times or bad.

Consider strict debt management and savings habits as the blend of robust soil which allows opportunities to be realized. Excessive debt and limited ability to buffer against financial emergencies and crisis can limit a person’s ability to take on riskier but rewarding ventures like career change, entrepreneurial endeavors and risks that may lead to significant, long-term wealth.

Mortgage debt: Primary residence mortgage = 2X gross salary.

Student loan debt:  Limited to one year’s worth of total expense, tuition, room & board, expenses.

Personal, unsecured debt (credit card, auto): No more than 25% of gross monthly household income.

4. Be smarter with credit.

Today, credit cards are used for various reasons – convenience, cash back, travel reward points and the most unfortunate, to meet ongoing living expenses in the face of structural wage stagnation. So, consider the following.

Credit Card Debt = No greater than 4% of monthly gross income.

If your household gross income is $50,000 then credit card debt shouldn’t exceed $2,000. Per WalletHub, Texas ranks 46 with $2,848 in average credit card debt.

Survival tip: Take control of your money. Contact your credit card provider today and request a lower interest rate, perhaps the favorable balance transfer rate along with delayed payments. We are in this catastrophe together and it’s the least they can do for at least the rest of the year.

Car Loan Debt-to-Income Ratio:

Cars are required like breathing here in Houston and Texas, overall. However, they are not investments. Their values do not appreciate. If anything, auto values decrease as soon as you drive away from the dealership.

Car Loan Obligation = No greater than 25% of monthly gross income.

For example, a household bringing in $60,000 a year shouldn’t have more than $15,000 in outstanding auto loan debt. In my household, the ratio is less than 10%. I drive a Toyota RAV4. Put your ego aside; consider reliability first.

As I complete interviews with media and news outlets in Houston and across the country, my heart is overwhelmed with sorrow for those who are suffering through this, yet another ‘rare’ historical episode.

Please reach out to our team with questions and for guidance.

Every question is a good question.

Never be afraid to ask.

 

“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.   

Shedlock: Fed Trying To Save The Bond Market As Unemployment Explodes

Bond market volatility remains a sight to behold, even at the low end of the curve.

Bond Market Dislocations Remain

The yield on a 3-month T-Bill fell to 1.3 basis points then surged to 16.8 basis points in a matter of hours. The yield then quickly crashed to 3 basis points and now sits at 5.1 basis points.

The Fed is struggling even with the low end of the Treasury curve.

$IRX 3-Month Yield

Stockcharts shows the 3-month yield ($IRX) dipping below zero but Investing.Com does not show the yield went below zero.

Regardless, these swings are not normal.

Cash Crunch

Bloomberg reports All the Signs a Cash Crunch Is Gripping Markets and the Economy

In a crisis, it is said, all correlations go to one. Threats get so overwhelming that everything reacts in unison. And the common thread running through all facets of financial markets and the real economy right now is simple: a global cash crunch of epic proportions.

Investors piled $137 billion into cash-like assets in the five days ending March 11, according to a Bank of America report citing EPFR Global data. Its monthly fund manager survey showed the fourth-largest monthly jump in allocations to cash ever, from 4% to 5.1%.

“Cash has become the king as the short-term government funds have had massive deposits, with ~$13 billion inflows last week (a 10-standard deviation move),” adds Maneesh Dehspande, head of equity derivatives strategy at Barclays.

4th Largest Jump in History

It’s quite telling that a jump of a mere 1.1 percentage point to 5.1% cash is the 4th largest cash jump in history.

Margin and Short Covering

“In aggregate, the market saw a large outflow, with $9 billion of long liquidation and $6 billion of short covering,” said Michael Haigh, global head of commodity research at Societe Generale. “This general and non-directional closure of money manager positions could be explained by a need for cash to pay margin calls on other derivatives contracts.

The comment is somewhat inaccurate. Sideline cash did not change “in aggregate” although cash balances t various fund managers did.

This is what happens when leveraged longs get a trillion dollar derivatives margin call or whatever the heck it was.

Need a Better Hedge

With the S&P 500 down more than 12% in the five sessions ending March 17, the Japanese yen is weaker against the greenback, the 10-year Treasury future is down, and gold is too.

That’s another sign dollars are top of mind, and investors are selling not only what they want to, but also what they have to.

Dash to Cash

It’s one thing to see exchange-traded products stuffed full of relatively illiquid corporate bonds trade below the purported sum of the value of their holdings. It’s quite another to see such a massive discount develop in a more plain-vanilla product like the Vanguard Total Bond Market ETF (BND) as investors ditched the product to raise cash despite not quite getting their money’s worth.

The fund closed Tuesday at a discount of nearly 2% to its net asset value, which blew out to above 6% last week amid accelerating, record outflows. That exceeded its prior record discount from 2008.

It is impossible for everyone to go to cash at the same time.

Someone must hold every stock, every bond and every dollar.

Fed Opens More Dollar Swap Lines

Moments ago Reuters reported Fed Opens Dollar Swap Lines for Nine Additional Foreign Central Banks.

The Fed said the swaps, in which the Fed accepts other currencies in exchange for dollars, will for at least the next six months allow the central banks of Australia, Brazil, South Korea, Mexico, Singapore, Sweden, Denmark, Norway and New Zealand to tap up to a combined total of $450 billion, money to ensure the world’s dollar-dependent financial system continues to function.

The new swap lines “like those already established between the Federal Reserve and other central banks, are designed to help lessen strains in global U.S. dollar funding markets, thereby mitigating the effects of these strains on the supply of credit to households and businesses, both domestically and abroad,” the Fed said in a statement.

The central banks of South Korea, Singapore, Mexico and Sweden all said in separate statements they intended to use them.

Fed Does Another Emergency Repo and Relaunches Commercial Paper Facility

Yesterday I commented Fed Does Another Emergency Repo and Relaunches Commercial Paper Facility

Very Deflationary Outcome Has Begun: Blame the Fed

The Fed is struggling mightily to alleviate the mess it is largely responsible for.

I previously commented a Very Deflationary Outcome Has Begun: Blame the Fed

The Fed blew three economic bubbles in succession. A deflationary bust has started. They blew bubbles trying to prevent “deflation” defined as falling consumer prices.


BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

For a discussion of the study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

Blowing bubbles in absurd attempts to arrest “price deflation” is crazy. The bigger the bubbles the bigger the resultant “asset bubble deflation”. Falling consumer prices do not have severe negative repercussions. Asset bubble deflations are another matter.

Assessing the Blame

Central banks are not responsible for the coronavirus. But they are responsible for blowing economic bubbles prone to crash.

The equities bubbles before the coronavirus hit were the largest on record.

Dollar Irony

The irony in this madness is the US will be printing the most currency and have the biggest budget deficits as a result. Yet central banks can’t seem to get enough dollars. In that aspect, the dollar ought to be sinking.

But given the US 10-year Treasury yield at 1.126% is among the highest in the world, why not exchange everything one can for dollars earning positive yield.

This is all such circular madness, it’s hard to say when or how it ends.

Unemployment Set To Explode

A SurveyUSA poll reveals 9% of the US is out of a job due to the coronavirus.

Please consider the Results of SurveyUSA Coronavirus News Poll.

Key Findings

  1. 9% of Working Americans (14 Million) So Far Have Been Laid Off As Result of Coronavirus; 1 in 4 Workers Have Had Their Hours Reduced;
  2. 2% Have Been Fired; 20% Have Postponed a Business Trip; Shock Waves Just Now Beginning to Ripple Through Once-Roaring US Economy:
  3. Early markers on the road from recession to depression as the Coronavirus threatens to stop the world from spinning on its axis show that 1 in 4 working Americans have had their hours reduced as a result of COVID-19, according to SurveyUSA’s latest time-series tracking poll conducted 03/18/20 and 03/19/20.
  4. Approximately 160 million Americans were employed in the robust Trump economy 2 months ago. If 26% have had their hours reduced, that translates to 41 million Americans who this week will take home less money than last, twice as many as SurveyUSA found in an identical poll 1 week ago. Time-series tracking graphs available here.
  5. 9% of working Americans, or 14 million of your friends and neighbors, will take home no paycheck this week, because they were laid off, up from 1% in an identical SurveyUSA poll 1 week ago. Time-series tracking graphs available here.
  6. Unlike those laid-off workers who have some hope of being recalled once the worst of the virus has past, 2% of Americans say they have lost their jobs altogether as a result of the virus, up from 1% last week.
  7. Of working Americans, 26% are working from home either some days or every day, up from 17% last week. A majority, 56%, no longer go to their place of employment, which means they are not spending money on gasoline or transit tokens.

About: SurveyUSA interviewed 1,000 USA adults nationwide 03/18/20 through 03/19/20. Of the adults, approximately 60% were, before the virus, employed full-time or part-time outside of the home and were asked the layoff and reduced-hours questions. Approximately half of the interviews for this survey were completed before the Big 3 Detroit automakers announced they were shutting down their Michigan assembly lines. For most Americans, events continue to unfold faster than a human mind is able to process the consequences.

Grim Survey of Reduced Hours

Current Unemployment Stats

Data from latest BLS Jobs Report.

If we assume the SurveyUSA numbers are accurate and will not get worse, we can arrive at some U3 and U6 unemployment estimates.

Baseline Unemployment Estimate (U3)

  • Unemployed: 5.787 million + 14 million = 19.787 million unemployed
  • Civilian Labor Force: 164.546 million (unchanged)
  • Unemployment Rate: 19.787 / 164.546 = 12.0%

That puts my off the top of the head 15.0% estimate a few days in the ballpark.

Underemployment Estimate (U6)

  • Employed: 158.759 million.
  • 26% have hours reduced = 41.277 million
  • Part Time for Economic Reasons: 4.318 million + 41.277 million = 45.595 million underemployed
  • 45.595 million underemployed + 19.787 million unemployed = 65.382 million
  • Civilian Labor Force: 164.546 million (unchanged)
  • U6 Unemployment Rate: 65.382 / 164.546 = 39.7%

Whoa Nellie

Wow, that’s not a recession. A depression is the only word.

Note that economists coined a new word “recession” after the 1929 crash and stopped using the word depression assuming it would never happen again.

Prior to 1929 every economic slowdown was called a depression. So if you give credit to the Fed for halting depressions, they haven’t. Ity’s just a matter of semantics.

Depression is a very fitting word if those numbers are even close to what’s going to happen.

Meanwhile, It’s no wonder the Fed Still Struggles to Get a Grip on the Bond Market and there is a struggled “Dash to Cash”.

Very Deflationary Outcome Has Begun: Blame the Fed

The Fed is struggling mightily to alleviate the mess it is largely responsible for.

I previously commented a Very Deflationary Outcome Has Begun: Blame the Fed

The Fed blew three economic bubbles in succession. A deflationary bust has started. They blew bubbles trying to prevent “deflation” defined as falling consumer prices.

BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

For a discussion of the study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

Blowing bubbles in absurd attempts to arrest “price deflation” is crazy. The bigger the bubbles the bigger the resultant “asset bubble deflation”. Falling consumer prices do not have severe negative repercussions. Asset bubble deflations are another matter.

Assessing the Blame

Central banks are not responsible for the coronavirus. But they are responsible for blowing economic bubbles prone to crash.

The equities bubbles before the coronavirus hit were the largest on record.

Dollar Irony

The irony in this madness is the US will be printing the most currency and have the biggest budget deficits as a result. Yet central banks can’t seem to get enough dollars. In that aspect, the dollar ought to be sinking.

But given the US 10-year Treasury yield at 1.126% is among the highest in the world, why not exchange everything one can for dollars earning positive yield.

This is all such circular madness, it’s hard to say when or how it ends.

Margin Call: You Were Warned Of The Risk

I have been slammed with emails over the last couple of days asking the following questions:

“What just happened to my bonds?”

“What happened to my gold position, shouldn’t it be going up?”

“Why are all my stocks being flushed at the same time?”

As noted by Zerohedge:

“Stocks down, Bonds down, credit down, gold down, oil down, copper down, crypto down, global systemically important banks down, and liquidity down

Today was the worst day for a combined equity/bond portfolio… ever…”

This Is What A “Margin Call,” Looks Like.

In December 2018, we warned of the risk. At that time, the market was dropping sharply, and Mark Hulbert wrote an article dismissing the risk of margin debt. To wit:

“Plunging margin debt may not doom the bull market after all, reports to the contrary notwithstanding.

According to research conducted in the 1970s by Norman Fosback, then the president of the Institute for Econometric Research, there is an 85% probability that a bull market is in progress when margin debt is above its 12-month moving average, in contrast to just a 41% probability when it’s below.

Why, then, do I suggest not becoming overly pessimistic? For several reasons:

1) The margin debt indicator issues many false signals

2) There is insufficient data

3) Margin debt is a strong coincident indicator.”

I disagreed with Mark on several points at the time. But fortunately the Federal Reserve’s reversal on monetary policy kept the stock market from sinking to levels that would trigger “margin calls.”

As I noted then, margin debt is not a technical indicator that can be used to trade markets. 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 and is what is currently happening in the market.

The issue with margin debt, in terms of the biggest risk, is 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.

When an “event” occurs that causes lenders to “panic” and call in margin loans, things progress very quickly as the “math” becomes a problem. Here is a simple example.

“If you buy $100,000 of stock on margin, you only need to pay $50,000. Seems like a great deal, especially if the stock price goes up. But what if your stock drops to $60,000? Suddenly, you’ve lost $40,000, leaving you with only $10,000 in your margin account. The rules state that you need to have at least 25 percent of the $60,000 stock value in your account, which is $15,000. So not only do you lose $40,000, but you have to deposit an additional $5,000 in your margin account to stay in business.

However, when margin calls occur, and equity is sold to meet the call, the equity in the portfolio is reduced further. Any subsequent price decline requires additional coverage leading to a “death spiral” until the margin line is covered.

Example:

  • $100,000 portfolio declines to $60,000. Requiring a margin call of $5000.
  • You have to deposit $5000, or sell to cover. 
  • However, if you don’t have the cash, then a problem arises. The sell of equity reduces the collateral requirement requiring a larger transaction: $5000/.25% requirement = $20,000
  • With the margin requirement met, a balance of $40,000 remains in the account with a $10,000 margin requirement. 
  • The next morning, the market declines again, triggering another margin call. 
  • Wash, rinse, repeat until broke.

This is why you should NEVER invest on margin unless you always have the cash to cover.

Just 20% 

As I discussed previously, the level we suspected would trigger a margin event was roughly a 20% decline from the peak.

“If such a decline triggers a 20% fall from the peak, which is around 2340 currently, broker-dealers are likely going to start tightening up margin requirements and requiring coverage of outstanding margin lines.

This is just a guess…it could be at any point at which “credit-risk” becomes a concern. The important point is that ‘when’ it occurs, it will start a ‘liquidation cycle’ as ‘margin calls’ trigger more selling which leads to more margin calls. This cycle will continue until the liquidation process is complete.

The Dow Jones provided the clearest picture of the acceleration in selling as “margin calls” kicked in.

The last time we saw such an event was in 2008.

How Much More Is There To Go?

Unfortunately, FINRA only updates margin debt with about a 2-month lag.

Mark’s second point was a lack of data. This isn’t actually the case as margin debt has been tracked back to 1959. However, for clarity, let’s just start with data back to 1980. The chart below tracks two things:

  1. The actual level of margin debt, and;
  2. The level of “free cash” balances which is the difference between cash and borrowed funds (net cash).

As I stated above, since the data has not been updated since January, the current level of margin, and negative cash balances, has obviously been reduced, and likely sharply so.

However, previous “market bottoms,” have occurred when those negative cash balances are reverted. Given the extreme magnitude of the leverage that was outstanding, I highly suspect the “reversion” is yet complete. 

The relationship between cash balances and the market is better illustrated in the next chart. I have inverted free cash balances, to show the relationship between reversals in margin debt and the market. Given the market has only declined by roughly 30% to date, there is likely more to go. This doesn’t mean a fairly sharp reflexive bounce can’t occur before a further liquidation ensues.

If we invert margin debt to the S&P 500, you can see the magnitude of both previous market declines and margin liquidation cycles. As stated, this data is as of January, and margin balances will be substantially lower following the recent rout. I am just not sure we have “squeezed” the last bit of blood out of investors just yet. 

You Were Warned

I warned previously, the idea that margin debt levels are simply a function of market activity, and have no bearing on the outcome of the market, was heavily flawed.

“By itself, margin debt is inert.

Investors can leverage their existing portfolios and increase buying power to participate in rising markets. While ‘this time could certainly be different,’ the reality is that leverage of this magnitude is ‘gasoline waiting on a match.’

When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point that 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, triggering further margin calls. Those margin calls will trigger more selling, forcing more margin calls, so forth and so on.

That event was the double-whammy of collapsing oil prices and the economic shutdown in response to the coronavirus.

While it is certainly hoped by many that we are closer to the end of the liquidation cycle, than the beginning, the dollar funding crisis, a blowout in debt yields, and forced selling of assets, suggests there is likely more pain to come before we are done.

It’s not too late to take actions to preserve capital now, so you have capital to invest later.

As I wrote in Tuesday’s missive “When Too Little Is Too Much:”

“With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

The good news is that a great ‘buying’ opportunity is coming. Just don’t be in a ‘rush’ to try and buy the bottom. 

I can assure you, when we ultimately see a clear ‘risk/reward’ set up to start taking on equity risk again, we will do so ‘with both hands.’ 

And we are sitting on a lot of cash just for that reason.”

You can’t “buy low,” if you don’t have anything to “buy with.”

Technically Speaking: Risk Limits Hit, When Too Little Is Too Much

For the last several months, we have been issuing repeated warnings about the market. While such comments are often mistaken for “being bearish,” we have often stated it is our process of managing “risk” which is most important.

Beginning in mid-January, we began taking profits out of our portfolios and reducing risk. To wit:

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels.”

Importantly, we did not “sell everything” and go to cash.

Since then, we took profits and rebalanced risk again in late January and early February as well.

Our clients, their families, their financial and emotional “well being,” rest in our hands. We take that responsibility very seriously, and work closely with our clients to ensure that not only are they financially successful, but they are emotionally stable in the process.

This is, and has been, our biggest argument against “buy and hold,” and “passive investing.” While there are plenty of case studies showing why individuals will eventually get back to even, the vast majority of individuals have a “pain point,” where they will sell.

So, we approach portfolio management from a perspective of “risk management,” but not just in terms of “portfolio risk,” but “emotional risk” as well. By reducing our holdings to raise cash to protect capital, we can reduce the risk of our clients hitting that “threashold” where they potentially make very poor decisions.

In investing, the worst decisions are always made at the moment of the most pain. Either at the bottom of the market or near the peaks. 

Investing is not always easy. Our portfolios are designed to have longer-term holding periods, but we also understand that things do not always go as planned.

This is why we have limits, and when things go wrong, we sell.

So, why do I tell you this?

On Friday/Monday, our “limits” were breached, which required us to sell more.

Two Things

Two things have now happened, which signaled us to reduce risk further in portfolios.

On Sunday, the Federal Reserve dropped a monetary “nuclear bomb,” on the markets. My colleague Caroline Baum noted the details:

“After an emergency 50-basis-point rate cut on March 3, the Federal Reserve doubled down Sunday evening, lowering its benchmark rate by an additional 100 basis points to a range of 0%-0.25% following another emergency meeting.

After ramping up its $60 billion of monthly Treasury bill purchases to include Treasuries of all maturities and offering $1.5 trillion of liquidity to the market via repurchase agreements on March 3, the Fed doubled down Sunday evening with announced purchases of at least $500 billion of Treasuries and at least $200 billion of agency mortgage-backed securities.

In addition, the Fed reduced reserve requirements to zero, encouraged banks to borrow from its discount window at a rate of 0.25%, and, in coordination with five other central banks, lowered the price of U.S. dollar swap arrangements to facilitate dollar liquidity abroad”

We had been anticipating the Federal Reserve to try and rescue the markets, which is why we didn’t sell even more aggressively previously. The lesson investors have been taught repeatedly over the last decade was “Don’t Fight The Fed.”

One of the reasons we reduced our exposure in the prior days was out of concern the Fed’s actions wouldn’t be successful. 

On Monday, we found out the answer. The Fed may be fighting a battle it can’t win as markets not only failed to respond to the Fed’s monetary interventions but also broke the “bullish trend line” from the 2009 lows.  (While the markets are oversold short-term, the long-term “sell signals” in the bottom panels are just being triggered from fairly high levels. This suggests more difficulty near-term for stocks. 

This was the “Red Line” we laid out in our Special Report for our RIAPro Subscribers (Risk-Free 30-Day Trial) last week:

“As you can see in the chart below, this is a massive surge of liquidity, hitting the market at a time the market is testing important long-term trend support.”

It is now, or never, for the markets.

With our portfolios already at very reduced equity levels, the break of this trendline will take our portfolios to our lowest levels of exposure.

What happened today was an event we have been worried about, but didn’t expect to see until after a break of the trendline – “margin calls.” This is why we saw outsized selling in “safe assets” such as REITs, utilities, bonds, and gold.

Cash was the only safe place to hide.

We aren’t anxious to “fight the Fed,” but the markets may have a different view this time.

Use rallies to raise cash, and rebalance portfolio risk accordingly.

We are looking to be heavy buyers of equities when the market forms a bottom, we just aren’t there as of yet.”

On Monday morning, with that important trendline broken, we took some action.

  • Did we sell everything? No. We still own 10% equity, bonds, and a short S&P 500 hedge. 
  • Did we sell the bottom? Maybe.

We will only know in hindsight for certain, and we are not willing to risk more of our client’s capital currently. 

There are too many non-quantifiable risks with a global recession looming, as noted by David Rosenberg:

“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 and equity portfolio managers sitting with record-low cash buffers. Hence the forced selling in other asset classes.

If you haven’t made recession a base-case scenario, you probably should. All four pandemics of the past century coincided with recession. This won’t be any different. It’s tough to generate growth when we’re busy “social distancing.” I am amazed that the latest WSJ poll of economists conducted between March 6-10th showed only 49% seeing a recession coming”.

The importance of his commentary is that from an “investment standpoint,” we can not quantify whether this “economic shock” has been priced into equities as of yet. However, we can do some math based on currently available data:

The chart below is the annual change in nominal GDP, and S&P 500 GAAP earnings.

I am sure you will not be shocked to learn that during “recessions,” corporate “earnings’ tend to fall. Historically, the average drawdown of earnings is about 20%; however, since the 1990’s, those drawdowns have risen to about 30%.

As of March 13th, Standard & Poors has earnings estimates for the first quarter of 2020 at $139.20 / share. This is down just $0.20 from the fourth quarter of 2019 estimates of $139.53.

In other words, Wall Street estimates are still in “fantasy land.” 

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.

With the S&P 500 closing yesterday at 2386, this equates to downside risk of:

  • 20x Earnings = -16% (Total decline from peak = – 40%)
  • 18x Earnings = 24.5% (Total decline from peak = – 46%)
  • 15x Earnings = -37.1% (Total decline from peak = – 55%)
  • 13x Earnings = 45.5% (Total decline from peak = – 61%)
  • 10x Earnings = 58.0% (Total decline from peak = – 70%)

NOTE: I am not suggesting the market is about to decline 60-70% from the recent peak. I am simply laying out various multiples based on assumed risk to earnings. However, 15-18x earnings is extremely reasonable and possible. 

When Too Little Is Too Much

With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

One concern, which weighed heavily into our decision process, was the rising talk of the “closing the markets” entirely for a week or two to allow the panic to pass. We have clients that depend on liquidity from their accounts to sustain their retirement lifestyle. In our view, a closure of the markets would lead to two outcomes which pose a real risk to our clients:

  1. They need access to liquidity, and with markets closed are unable to “sell” and raise cash; and,
  2. When you trap investors in markets, when they do open again, there is a potential “rush” of sellers to get of the market to protect themselves. 

That risk, combined with the issue that major moves in markets are happening outside of transaction hours, are outside of our ability to hedge, or control.

This is what we consider to be an unacceptable risk for the time being.

We will likely miss the ultimate “bottom” of the market.

Probably.

But that’s okay, we have done our job of protecting our client’s second most precious asset behind their family, the capital they have to support them.

The good news is that a great “buying” opportunity is coming. Just don’t be in a “rush” to try and buy the bottom.

I can assure you, when we see ultimately see a clear “risk/reward” set up to start taking on equity risk again, we will do so “with both hands.” 

And we are sitting on a lot of cash just for that reason.Save

RIA PRO: Risk Limits Hit

For the last several months we have been issuing repeated warnings about the market. While such comments are often mistaken for “being bearish,” we have often stated it is our process of managing “risk” which is most important.

Beginning in mid-January, we began taking profits out of our portfolios and reducing risk. To wit:

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels.”

Since then, as you know, we have taken profits, and rebalanced risk several times within the portfolios.

Importantly, we approach portfolio management from a perspective of “risk management,” but not just in terms of “portfolio risk,” but “emotional risk” as well. By reducing our holdings to raise cash to protect capital, we can reduce the risk of our clients hitting that “threshold” where they potentially make very poor decisions.

In investing, the worst decisions are always made at the moment of the most pain. Either at the bottom of the market or near the peaks. 

Investing is not always easy. Our portfolios are designed to have longer-term holding periods, but we also understand that things do not always go as planned.

This is why we have limits, and when things go wrong, we sell.

So, why do I tell you this?

On Friday/Monday, our “limits” were breached, which required us to sell more.

Two Things

Two things have now happened which signaled us to reduce risk further in portfolios.

On Sunday, the Federal Reserve dropped a monetary “nuclear bomb,” on the markets. My colleague Caroline Baum noted the details:

“After an emergency 50-basis-point rate cut on March 3, the Federal Reserve doubled down Sunday evening, lowering its benchmark rate by an additional 100 basis points to a range of 0%-0.25% following another emergency meeting.

After ramping up its $60 billion of monthly Treasury bill purchases to include Treasuries of all maturities and offering $1.5 trillion of liquidity to the market via repurchase agreements on March 3, the Fed doubled down Sunday evening with announced purchases of at least $500 billion of Treasuries and at least $200 billion of agency mortgage-backed securities.

In addition, the Fed reduced reserve requirements to zero, encouraged banks to borrow from its discount window at a rate of 0.25%, and, in coordination with five other central banks, lowered the price of U.S. dollar swap arrangements to facilitate dollar liquidity abroad”

We had been anticipating the Federal Reserve to try and rescue the markets, which is why we didn’t sell even more aggressively previously. The lesson investors have been taught repeatedly over the last decade was “Don’t Fight The Fed.”

One of the reasons we reduced our exposure in the prior days was out of concern we didn’t know if the Fed’s actions would be successful. 

On Monday, we found out the answer. The Fed may be fighting a battle it can’t win as markets not only failed to respond to the Fed’s monetary interventions, but also broke the “bullish trend line” from the 2009 lows.  (While the markets are oversold short-term, the long-term “sell signals” in the bottom panels are just being triggered from fairly high levels. This suggests more difficulty near-term for stocks. 

This was the “Red Line” we laid out in our last week, in the Special Report Red Line In The Sand:

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

It is now, or never, for the markets.

With our portfolios already at very reduced equity levels, the break of this trendline will take our portfolios to our lowest levels of exposure. However, given the extreme oversold condition, noted above, it is likely we are going to see a bounce, which we will use to reduce risk into.

What happened today was an event we have been worried about, but didn’t expect to see until after a break of the trendline – “margin calls.”

This is why we saw outsized selling in “safe assets” such as REITs, utilities, bonds, and gold.

Cash was the only safe place to hide.

This also explains why the market “failed to rally” when the Fed announced $500 billion today. There is another $500 billion coming tomorrow. We will see what happens.

We aren’t anxious to “fight the Fed,” but the markets may have a different view this time.

Use rallies to raise cash, and rebalance portfolio risk accordingly.

We are looking to be heavy buyers of equities when the market forms a bottom, we just aren’t there as of yet.”

On Monday morning, we took some action.

  • Did we sell everything? No. We still own 10% equity, bonds, and a short S&P 500 hedge. 
  • Did we sell the bottom? Maybe.

We will only know in hindsight for certain, and we are not willing to risk more of our client’s capital currently. 

There are too many non-quantifiable risks with a global recession looming, as noted by David Rosenberg:

“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 and equity portfolio managers sitting with record-low cash buffers. Hence the forced selling in other asset classes.

If you haven’t made recession a base-case scenario, you probably should. All four pandemics of the past century coincided with recession. This won’t be any different. It’s tough to generate growth when we’re busy “social distancing.” I am amazed that the latest WSJ poll of economists conducted between March 6-10th showed only 49% seeing a recession coming”.

The importance of his commentary is that from an “investment standpoint,” we can not quantify whether this “economic shock” has been priced into equities as of yet. However, we can do some math based on currently available data:

The chart below is annual nominal GDP, and S&P 500 GAAP earnings.

I am sure you will not be shocked to learn that during “recessions,” corporate “earnings’ tend to fall. Historically, the average drawdown of earnings is about 20%, however, since the 1990’s, those drawdowns have risen to about 30%.

As of March 13th, Standard & Poors has earnings estimates for the first quarter of 2020 at $139.20/share. This is down just $0.20 from the fourth quarter of 2019 estimates of $139.53.

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.

With the S&P 500 closing yesterday at 2386, this equates to downside risk of:

  • 20x Earnings = -16% (Total decline from peak = – 40%)
  • 18x Earnings = 24.5% (Total decline from peak = – 46%)
  • 15x Earnings = -37.1% (Total decline from peak = – 55%)
  • 13x Earnings = 45.5% (Total decline from peak = – 61%)
  • 10x Earnings = 58.0% (Total decline from peak = – 70%)

NOTE: I am not suggesting the market is about to decline 60-70% from the recent peak. I am simply laying out various multiples based on assumed risk to earnings. However, 15-18x earnings is extremely reasonable and possible. 

When Too Little Is Too Much

With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

One concern, which weighed heavily into our decision process, was the rising talk of the “closing the markets” entirely for a week or two to allow the panic to pass. We have clients that depend on liquidity from their accounts to sustain their retirement lifestyle. In our view, a closure of the markets would lead to two outcomes which pose a real risk to our clients:

  1. They need access to liquidity, and with markets closed are unable to “sell” and raise cash; and,
  2. When you trap investors in markets, when they do open again there is a potential “rush” of sellers to get of the market to protect themselves. 

That risk, combined with the issue that major moves in markets are happening outside of transaction hours, are outside of our ability to hedge, or control.

This is what we consider to be unacceptable risk for the time being.

We will likely miss the ultimate “bottom” of the market?

Probably.

But that’s okay, we have done our job of protecting our client’s second most precious asset behind their family, the capital they have to support them.

The good news is that a great “buying” opportunity is coming. Just don’t be in a “rush” to try and buy the bottom.

I can assure you that when we see ultimately see a clear “risk/reward” set up to start taking on equity risk again, we will do so “with both hands.” 

And we are sitting on a lot of cash just for that reason.Save

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.

Technically Speaking: On The Cusp Of A Bear Market

“Tops are a process, and bottoms are an event”

Over the last couple of years, we have discussed the ongoing litany of issues that plagued the underbelly of the financial markets.

  1. The “corporate credit” markets are at risk of a wave of defaults.
  2. Earnings estimates for 2019 fell sharply, and 2020 estimates are now on the decline.
  3. Stock market targets for 2020 are still too high, along with 2021.
  4. Rising geopolitical tensions between Russia, Saudi Arabia, China, Iran, etc. 
  5. The effect of the tax cut legislation has disappeared as year-over-year comparisons are reverting back to normalized growth rates.
  6. Economic growth is slowing.
  7. Chinese economic data has weakened further.
  8. The impact of the “coronavirus,” and the shutdown of the global supply chain, will impact exports (which make up 40-50% of corporate profits) and economic growth.
  9. The collapse in oil prices is deflationary and can spark a wave of credit defaults in the energy complex.
  10. European growth, already weak, continues to weaken, and most of the EU will likely be in recession in the next 2-quarters.
  11. Valuations remain at expensive levels.
  12. Long-term technical signals have become negative. 
  13. The collapse in equity prices, and coronavirus fears, will weigh on consumer confidence.
  14. Rising loan delinquency rates.
  15. Auto sales are signaling economic stress.
  16. The yield curve is sending a clear message that something is wrong with the economy.
  17. Rising stress on the consumption side of the equation from retail sales and personal consumption.

I could go on, but you get the idea.

In that time, these issues have gone unaddressed, and worse dismissed, because of the ongoing interventions of Central Banks.

However, as we have stated many times in the past, there would eventually be an unexpected, exogenous event, or rather a “Black Swan,” which would “light the fuse” of a bear market reversion.

Over the last few weeks, the market was hit with not one, but two, “black swans” as the “coronavirus” shutdown the global supply chain, and Saudi Arabia pulled the plug on oil price support. Amazingly, we went from “no recession in sight”, to full-blown “recession fears,” in less than month.

“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.”

On The Cusp Of A Bear Market

Let me start by making a point.

“Bull and bear markets are NOT defined by a 20% move. They are defined by a change of direction in the trend of prices.” 

There was a point in history where a 20% move was significant enough to achieve that change in overall price trends. However, today that is no longer the case.

Bull and bear markets today are better defined as:

“During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average.”

This is shown in the chart below, which compares the market to the 75-week moving average. During “bullish trends,” the market tends to trade above the long-term moving average and below it during “bearish trends.”

In the last decade, there have been three previous occasions where the long-term moving average was violated but did not lead to a longer-term change in the trend.

  • The first was in 2011, as the U.S. was dealing with a potential debt-ceiling and threat of a downgrade of the U.S. debt rating. Then Fed Chairman Ben Bernanke came to the rescue with the second round of quantitative easing (QE), which flooded the financial markets with liquidity.
  • The second came in late-2015 and early-2016 as the market dealt with a Federal Reserve, which had started lifting interest rates combined with the threat of the economic fallout from Britain leaving the European Union (Brexit). Given the U.S. Federal Reserve had already committed to hiking interest rates, and a process to begin unwinding their $4-Trillion balance sheet, the ECB stepped in with their own version of QE to pick up the slack.
  • The latest event was in December 2018 as the markets fell due to the Fed’s hiking of interest rates and reduction of their balance sheet. Of course, the decline was cut short by the Fed reversal of policy and subsequently, a reduction in interest rates and a re-expansion of their balance sheet.

Had it not been for these artificial influences, it is highly likely the markets would have experienced deeper corrections than what occurred.

On Monday, we have once again violated that long-term moving average. However, Central Banks globally have been mostly quiet. Yes, there have been promises of support, but as of yet, there have not been any substantive actions.

However, the good news is that the bullish trend support of the 3-Year moving average (orange line) remains intact for now. That line is the “last line of defense” of the bull market. The only two periods where that moving average was breached was during the “Dot.com Crash” and the “Financial Crisis.”

(One important note is that the “monthly sell trigger,” (lower panel) was initiated at the end of February which suggested there was more downside risk at the time.)

None of this should have been surprising, as I have written previously, prices can only move so far in one direction before the laws of physics take over. To wit”

Like a rubber band that has been stretched too far – it must be relaxed before it can be stretched again. This is exactly the same for stock prices that are anchored to their moving averages. Trends that get overextended in one direction, or another, always return to their long-term average. Even during a strong uptrend or strong downtrend, prices often move back (revert) to a long-term moving average.”

With the markets previously more than 20% of their long-term mean, the correction was inevitable, it just lacked the right catalyst.

The difference between a “bull market” and a “bear market” is when the deviations begin to occur BELOW the long-term moving average on a consistent basis. With the market already trading below the 75-week moving average, a failure to recover in a fairly short period, will most likely facilitate a break below the 3-year average.

If that occurs, the “bear market” will be official and will require substantially lower levels of equity risk exposure in portfolios until a reversal occurs.

Currently, it is still too early to know for sure whether this is just a “correction” or a “change in the trend” of the market. As I noted previously, there are substantial differences, which suggest a more cautious outlook. To wit:

  • Downside Risk Dwarfs Upside Reward. 
  • Global Growth Is Less Synchronized
  • Market Structure Is One-Sided and Worrisome. 
  • COVID-19 Impacts To The Global Supply Chain Are Intensifying
  • Any Semblance of Fiscal Responsibility Has Been Thrown Out the Window
  • Peak Buybacks
  • China, Europe, and the Emerging Market Economic Data All Signal a Slowdown
  • The Democrats Control The House Which Effectively Nullifies Fiscal Policy Agenda.
  • The Leadership Of The Market (FAANG) Has Faltered.

Most importantly, the collapse in interest rates, as well as the annual rate of change in rates, is screaming that something “has broken,” economically speaking.

Here is the important point.

Understanding that a change is occurring, and reacting to it, is what is important. The reason so many investors “get trapped” in bear markets is that by the time they realize what is happening, it has been far too late to do anything about it.

Let me leave you with some important points from the legendary Marty Zweig: (h/t Doug Kass.)

  • Patience is one of the most valuable attributes in investing.
  • Big money is made in the stock market by being on the right side of the major moves. The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not.
  • Success means making profits and avoiding losses.
  • Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major decision.
  • The trend is your friend.
  • The problem with most people who play the market is that they are not flexible.
  • Near the top of the market, investors are extraordinarily optimistic because they’ve seen mostly higher prices for a year or two. The sell-offs witnessed during that span were usually brief. Even when they were severe, the market bounced back quickly and always rose to loftier levels. At the top, optimism is king; speculation is running wild, stocks carry high price/earnings ratios, and liquidity has evaporated. 
  • I measure what’s going on, and I adapt to it. I try to get my ego out of the way. The market is smarter than I am, so I bend.
  • To me, the “tape” is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!
  • The idea is to buy when the probability is greatest that the market is going to advance.

Most importantly, and something that is most applicable to the current market:

“It’s okay to be wrong; it’s just unforgivable to stay wrong.” – Marty Zweig

There action this year is very reminiscent of previous market topping processes. Tops are hard to identify during the process as “change happens slowly.” The mainstream media, economists, and Wall Street will dismiss pickup in volatility as simply a corrective process. But when the topping process completes, it will seem as if the change occurred “all at once.”

The same media which told you “not to worry,” will now tell you, “no one could have seen it coming.”

The market may be telling you something important, if you will only listen.

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