This blog is intended to keep clients and friends current on my investment management activities. In no way is this intended to be investment advice that anyone reading this blog should act upon in their personal investment accounts. There are other significant factors involved in my investment management activities that may not be written about in this blog that are equally as important as the things that are written about that materially impact investment results. Neither is this blog to be construed in any way to be an offer to buy or sell securities. To be notified via e-mail when new posts are made, CLICK HERE TO SUBSCRIBE. To view previous investment strategies, click strategy downloads.


Don’t Marry Your Stocks

November 20th, 2020

I recently performed a major rebalancing of client portfolios who have a Growth, Core or Fully Diversified investment objective, buying and selling a number of holdings so that portfolios would be in line with our views on the market (I will get to that in a bit).  Selling a stock holding can be difficult, but as an investor you have to remember that you don’t make any money when you buy a stock – you make it when you sell it.  It is very easy to buy a stock at the right price, ride the price up to new highs, then watch as you turn you big winner into a loss.  It’s why I tell people that you don’t marry your stocks – its OK to make a change when circumstances say it’s time.  

This got me thinking about what stocks were in client portfolios when I started this business in 1991.  Unfortunately we changed our computer system sometime in 1998 so I selected 12/31/1998 to look as some accounts and see what sorts of things we owned and what has happened to them since.  I chose a performance chart format so we can see how the stock price has done in all these years.

Walmart:

I thought we’d start with one of the survivors (or winners, if you will) of the passage of time

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You can see that if you were a patient owner of this stock, you would have done very well over all this time.  However, if we were looking at the performance at the end of a decade, you would not have been a happy investor at the end of 2009:

1For 10 years, you earned a whopping 34% return – I’m not sure any investor would be pleased with that return as it basically kept pace with inflation.

GE, Citigroup, AT&T, Xerox, Del Monte:

Many of the stocks owned in 1998 do not exist today, either because they were merged into another company (e.g., Compaq Computers, Sun Microsystems, Lucent) or because they have gone out of business (Sears, National City Bank).  These five companies still exist and I can guarantee you that there are folks that have owned them all of this time.

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Yes, there have been some companies that we owned in 1998 that have been huge winners for people, some of them are listed in the merged company list above.  But the idea here is that there is no reason to hold onto a stock if you see a catalyst that will likely cause it to flatline in return like the decade-long Walmart chart or to go down in price like GE above.

Why am I telling you this and what does it have to do with the major rebalancing of client portfolios?  Excellent question!

We are at an investment fulcrum where I believe the stocks of many of the market leaders since 2008 will likely flatline in price for a period of time (Two years? Ten years?  No way to know until you reach another fulcrum).

The cause of this investment fulcrum?  Covid, or rather the end of the Covid Recession.   This virus will work its way through the population and eventually we will achieve the herd immunity required for it to die out because you will either be vaccinated against it, you will have already had it (like me – it’s one of the reasons you haven’t heard from me on the blog in the past few weeks), or you have a natural immunity to it.  As we approach that point, the stock market will look forward and start to revalue the stocks of companies that prosper during economic expansions.

I expect that our economy will move from being stimulated by monetary policy to being stimulated by an infrastructure bill.  That infrastructure bill (as long as it goes to actual construction projects – in the past, we have seen state governments take Federal money and spend it elsewhere) will juice the natural growth that comes from an economy opening up again after a recession.  The stocks of companies that prosper coming out of a recession are the cyclical value stocks and the domestic-focused small cap stocks.

Over the past several years, I have focused client portfolios on large cap growth stocks and largely avoided value and small cap stocks based upon the economic policies our country adopted coming out of the 2008/2009 recession.  The massive monetary stimulus pushed down interest rates to zero and made investing in companies with ever-increasing valuations (i.e., expanding Price to Earnings ratios) make sense.  These were the only companies with consistently growing earnings and investors were willing to pay up to own companies with growing businesses.

However, investor face two major problems investing in highly valued large cap growth stocks in an expanding economy, when economic momentum is gaining speed: (1) even if the large cap growth stocks still have expanding earnings, they new have competition of other significantly lower valued companies with significantly lower P/E Ratios whose earnings are growing at the same or higher rates.  This means there is less demand from buyers of their stocks at the high valuations so when the supply of people wanting to sell their shares outpaces the demand of buyers, the stock price has to come down; and (2) as interest rates begin to rise those higher rates put pressure on valuation levels.  The valuations of companies go down as interest rates go up, even if their earnings continue to grow.

Now, I know you are going to say that interest rates will be low for a long time – you’ve heard it on the news, on internet, just about everywhere – you have even watched the Federal Reserve Chairman on TV telling you so.   However, I mean the rates material to corporations that occur in the bond market, not the overnight Fed Funds rate controlled by the Federal Reserve – that rate has been and will likely continue to be held artificially at the zero level for years to come.  However the bond market is totally independent of the rates set by the Fed.  If demand for capital increases because economic activity increases, and corporate America needs to borrow money to fund its growing business, they will go to the bond market and borrow it from investors.  The more demand, the higher the bond market can charge for the borrowing (yet again, supply and demand matter).

Also, as economic activity increases, prices can increase – think of all the businesses that have been nearly shut down or have had to lower their prices just to exist through this recession – once the demand is back for their goods and services and the covid restrictions are eased up, prices will rise.  As prices rise at the same time as demand increases for borrowing money, the lenders (in this case the people who buy the corporate bonds) will keep demanding higher and higher yields on the borrowed money so that they achieve purchasing power parity (or more simply, keep the buying power of their money stable despite the inflation).

All of this means that I expect (1) cyclical value stocks whose fates are tied to the economy to outperform growth stocks, and (2) domestically focused small cap stocks to outperform their internationally-focused large cap brethren who are doing business in places that will not likely have a domestic recovery until well after ours is underway.  Those growth stocks steady earnings and large cap stocks with an international focus will be valued less by investors because they can buy cheaper value stocks with the same or better earnings growth and small cap stocks with better earnings growth than large cap stocks that are less tied to our economic recovery.

Have I sold all of our large cap growth holdings? Absolutely not – however everything I own for clients has some catalyst or story that gives investors a reason to own them, even if their P/E’s are higher than normal.  For the bulk of the large cap growth companies, they will have to grow into their valuations, and that will take time.  It is much like what happened to Walmart all those years ago – it went from its high growth stage where investors drove its stock price up faster than its earnings so that its P/E Ratio was well above the median valuation for retail industry.  Their price didn’t need to fall, and in fact could increase a bit, but to drive down their P/E Ratio and get the resulting valuation of the company in line with the retail industry, their earnings growth had to far outpace their stock price growth.

Since 2008, the prices of large cap growth stocks grew faster than the earnings grew.  When Price was divided by Earnings, the valuation went up as the P got larger relative to the E.  Now, we will likely be watching the E grow faster than the P so that the valuation comes down to a level that will once again entice investors.  It’s sort of math that you have to pay attention to as an investor, otherwise you get stuck with companies in your portfolio that will cause your returns to suffer.

Investment Strategy

>I have rebalanced client portfolios to reduce economic risk, adding a significant allocation of Value and Small Cap stocks and reduced our allocation of Large Cap Growth stocks so that portfolios are in line with the coming economic expansion.

>Portfolios have a strong domestic bias over foreign to reduce the timing risk of foreign economies not recovering as quickly (or ever) as the US economy.

>Every stock I own in client portfolios has some sort of catalyst that I believe will cause investors to want to own their shares as that catalyst helps to drive their earnings higher.

>To reduce the individual company risk of owning stocks based upon projected earnings growth once the economy starts to recover, I have reduced the position size and increased the number of positions in portfolios.

>To make me sleep better at night owning such a large allocation to value and small cap, the projected earnings growth for the portfolio is > 15% and the projected Return on Equity is 25% (just remember that there is not a direct correlation between these numbers and stock price increases – lots of outside factors influence stock price growth, like whether the supply and demand for the company’s stock is favorable or not, whether the discount rate for corporate earnings is rising or falling, etc.  However, as long as earnings and returns are rising at these levels, one major factor in stock price movement is taken care of).

>I have also significantly reduced bond portfolio durations (for clients that are not invested 100% in equities) to protect against interest rate risk, keeping individual bond holdings short-term and bond mutual fund holdings short duration or floating rate.

Note:  In coming blog posts I will discuss the catalysts mentioned earlier in this post.  To give you preview, though, one of those is the Humanization of Pets.  One of the unexpected things to come out of the covid restrictions is an increase in the number of households that own pets.  Our society has moved to the point where pets are members of the family who get good food and medical care.  With the increase in the number of pets, comes increased demand for quality pet food and medical care.  As such, client portfolios own two leaders in the pet pharmaceutical field in client portfolios because of the increased demand for pet medical care.

Have a great weekend!

—Mark

Head and Shoulders Above The Rest

October 15th, 2020

2020-10-15

 

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This blog post is a copy of the Investment Discussion I presented to my board Investment Committee today.  It was written for them, so please read it as such…Thanks!

Since we last met, the market has drawn out a inverse head and shoulders pattern (see graph above).

I’ve annotated the graph so you can see the three inverse head and shoulders moves.  You can also see the neckline of this pattern at 3429 (the horizontal green line I drew).

Typically this pattern is a bullish set up for a move higher in stocks.  Generally, your target higher is the distance of the neckline to the bottom of the head, or in our graph above its roughly 200 points on the S&P 500 Index.  That would give us a target of 3629 +/- (remember, it’s a target not a commandment that it will happen).

However, in the case where the pattern does not turn out to be bullish, then you have to measure your risk as well as your upside potential reward.  Here is how that works:

If we break below the neckline, then you have three targets that are easily seen on the graph:

  1. 33 points down you have the 50 day simple moving average at 3396
  2. 200 points down you have the bottom of the head at 3229
  3. 307 points down you have the 200 day simple moving average at 3122

We should not be surprised that the market pulled back after the fast and furious run higher from the late-September correction low (the bottom of the head).  You can see it ran straight up to resistance zone (highlighted pink) between the All Time High in the market and the beginning of the correction.

The chaotic nature of the news is driving the market right now.  We came off the bottom of the September low based upon news of an almost deal on stimulus and we have pulled back with news that it may be dead until after the election.

Right now?  We are trading in no-mans land – the blue shaded area between the neckline and the broken uptrend line off the bottom of the head.  Ideally, we want to see the neckline hold and the market move back above the uptrend line while heading toward the 3629 measured target of this pattern.  If it doesn’t, then we need to watch for a move to the 50 dma – fortunately, it is less than 1% below the neckline.  Holding that level will be key.

As far as strategy is concerned, remaining opportunistic is key for this market.  When the market bottomed in September, I put some of our cash to work in the growth, core and fully diversified strategies in small cap and value stocks which have underperformed the overall market.  If the neckline doesn’t hold, I will likely sell some growth stocks exposure in anticipation of a move down to the bottom of the pattern or even the 200 dma. I expect we will see increased volatility over coming weeks until the election is decided, so that could very well be the catalyst for a downdraft to the 200 dma that we were looking for prior to this pattern forming.

In terms of the shift into some small cap and value stock exposure in these three strategies, we will discuss that more in depth next month.  The markets have been primarily driven by beta allocations to the top weighted growth stocks in the indices – that appears to be changing, even if for a short period of time – and the lagging areas of the market will start to perform better.

Rising bond yields and a rising dollar both should result from the economy beginning to pull out of the covid shutdown recession which should favor the cyclicals and domestically focused small caps over the large cap growth stocks that outperform during falling interest rates and a slowing economy.

Note:  after I finished my meetings today I checked the market and the S&P ended nearly flat for the day after opening down > 1%.  Most notable, small cap value stocks ended up nearly 2% on the day, which makes me feel positive about the shifts we’ve been making to add value and small cap to portfolios. /msb/

S&P 500 Roars Higher

October 1st, 2020

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Just a quick update as its been a long day and I’m ready for work to stop.

We have very quickly retraced 50% of the recent correction – I’ve drawn a green horizontal line at 3393 which is half way between the high and low.

Over the past few days, we have broken above both the 20 day moving average and the 50 day moving average.  Very strong moves and both buy signals for us to add to stock market exposure in client accounts.  However, you can see that today all of the action took place between the 50dma line and the 3393 horizontal line (see the black candlestick on the far right side of the graph.  Notice it looks like a spinning top – that is a special candle shape and typically represents some indecision on the part of investors which makes sense as the bulls could not push above the 50% retracement level and the bears couldn’t push below the 50dma.

Friday’s action may give us a clue, but the big consideration is the 50dma – if we can close above it for three days in a row then the 3419 level discussed in the last post is the target to watch for – but it also because the flashing yellow caution light because it represents a level of 10% above the 200dma, a level that has always sent markets back down toward the 200dma (see the blog post from immediately prior to the correction for more on this concept).

However, we have had two consecutive buy signals so that means we are buyer and not sellers until the market tells us differently.  As the old saying goes:  “yell and roar and buy some more.”

Many thanks to reader Nan for the hat tip that Ms Ready passed away this week and that this song might work for a blog post – many thanks!

—Mark

Market Moves Up on Stimulus News

September 28th, 2020

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News of the House of Representatives and Treasury Secretary Mnuchin being close to a new stimulus package allowed the market to gap up and run through the resistance at 3353 (the 50 day moving average line) and stop just shy of 3363 resistance (the thick black horizontal line on the graph above).  You might recognize this graph from previous blog posts, so I’ve updated it for today’s action because I wanted you to see a couple of important things:

1.  First, I’ve annotated in orange the low volume on this two day recovery – for us to say definitively that last weeks low is THE low for this correction (yup, we did have a 10% correction as measured by intraday price action) we’d want to see increasing volume along with rising prices.

2.  Second, today’s action closed right at resistance and above the 50 day moving average.  Moving above the 50dma is a buy signal, and I am treating it as such, putting some money to work in new holdings.  However, the weak volume and not breaking through the next level of resistance means caution is warranted, so we still have plenty of cash available in client accounts to add new holdings if we can sustain the move above the 50dma (we need to close above it for three consecutive market days) and break above 3363 resistance.

3.  Third, I annotated in orange the new target for the market, the rising red 200 day moving average 10% envelope line (remember that rising above that line was the beginning of our cautions market outlook).  That line is at 3419 today, but it is rising and will change everyday as the 200dma changes.  It will take a lot of work for the market to get there as the downward sloping 20 day moving average lies just overhead at 3373.

4.  Finally, the downward sloping 20dma will likely present formidable resistance.  Twice before during this correction, the market has tried to break above the 20dma and was turned back down.  A typical pattern is for three failed attempts at a strong resistance level before finally breaking above it on the fourth attempt.  The odds are we could see that again as we have today’s gap higher (the yellow highlight) to fill at some point in the future.

Below is an annotated graph we’ve looked at before with the black dashed line detailing a typical path to the 200dma – I’ve updated it to show you a new potential path in pink that bounces off the 200dma resistance and then falls to fill the gap:

spx 09-28 2

If it follows this path, then it puts the original path to the 200dma back in play, likely driven by news flow much as today’s move higher was driven by news of more stimulus.  But we will have to wait to see how things play out – right now we have the buy signal detailed above but we are not at the point where there is an all clear to be 100% invested in the stock market.

—Mark

The Path of Least Resistance

September 23rd, 2020

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In the image above I’ve drawn in a dashed black line.  This is the graph that I presented to our investment committee last week to show what I believe to be the path to the 200 day simple moving average – so far, it has followed the path of least resistance:  down.

If you recall from recent blog posts, I wrote that we were headed for the 200dma based upon various indicators that I discussed.  I haven’t added those to this graph as I didn’t want to make the graph any more confusing.  However, this focus on the S&P 500 seems to be misplaced and we should be watching the NASDAQ.

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This is the chart of the NASDAQ that covers the same timeframe.  I have drawn a blue box around where the NASDAQ appears to have taken over dominance in the market.  You can see how the past several days have had all of the action under the red 50 day simple moving average line.  This is key – the index broke below the line in a pretty standard 3 down days followed by two up days followed by a resumption of following the primary trend, down.

What we need to watch for is:

1.  will there be follow through with another down day tomorrow?

2.  will we see another attempt to break above the 50dma? or

3.  Will we trade sideways in a consolidation range, build a base as we wait for valuations to come down and/or earnings to firm up, then move back toward the all time highs.

If we have another down day, we will be watching to see how the pattern develops – most likely it will follow the same path down that the S&P is following to the 200dma.

A break above the 50dma would mean we may have put in the low for the correction – no guarantees – all trading would need to take place above the 50dma for three days for it to be considered support.  But if that were to occur it would give us a buy signal to increase our equity allocation back toward previous levels.

If we trade sideways in a consolidation pattern, we could be in it for some time.  Maybe not as long as Walmart and Microsoft were as discussed in the prior blog post, but certainly long enough for another area of the stock market to take off.  Banks and Oils are both significantly oversold and trading at near-historic low valuations – its possible that the deep value area of the market that has been left behind for so long starts to be the leader while technology experiences a reversion to the mean.

Stay tuned as we work our way through this correction and look for an investable bottom to put cash to work.

—Mark

Resistance Is Not Futile

September 16th, 2020

2020-09-16

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Following up yesterday’s post about the strength of the 20 day moving average line as resistance against the stock market moving higher, yesterday I noted that 3429 was the reading for the 20 dma and today we managed to move up to 3428.92 before the market fell back to close below yesterday’s low.

So far, I am sticking with the original reading of this market – that we have a date with the 200 day moving average line around 3100 (its not shown on this graph), or roughly 10% lower than current readings.  But first the 50 day moving average line will act as support and may allow the market to bounce higher.  We have plenty of cash ready to put to work when the market bottoms.

I have been reviewing a number of companies as purchase candidates, but we need to determine if growth companies with little debt and growing earnings will continue to lead the market in spite of their record high P/E ratios, or will deep value companies rotate back into focus, with huge discounts to book value and shareholder friendly dividends take over.

There is no way to know the answer to that question right now, but at some point the high growth companies stock prices will start to follow the path Walmart took as it transitioned from high growth company to mature sustainable growth company:

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This graph is the stock price of Walmart from 1980 to today.  You can see the box I drew where the stock price flattened out after the long period of strong growth.  That box represents over 13 years with no increase in stock price!  It took work for Walmart to shift to a sustainable growth mode (it added groceries and became THE shopping destination for a huge swath of the country) and it is now a mature company with a respectable and sustainable growth rate.

Another example?  Microsoft with 15 years of flat stock price:

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Looks pretty similar, right?  Microsoft also found a way to shift to a sustainable growth mode (it added cloud computing and is the go to source for companies who want to outsource their data to the cloud, second only to Amazon and its Amazon Web Services subsidiary).

What are the new growth stocks that we can catch on that long trajectory higher to capture their early stock price growth?  What companies  do we own now that we should be selling prior to their settling  into a flat stock price for a decade?   What stocks have had flat stock price performance over the past several years that now have a catalyst to move them to a sustainable growth mode that we should consider adding to portfolios?  Even if we find those high growth stocks and sustainable growth stocks, will they be the stock price performance leaders like they have been the past few years or will the deep value stocks take the lead as they have in many prior time periods?

These are all questions I am working on so that clients have the best possible holdings in their portfolios.  The market will tell us what is going to be the top performer and what is going to lag; it’s our job to listen and act accordingly.  Just keep checking here on the blog to find out what we are doing in this crazy market and why!

—Mark

PS – thanks to reader Nan for the heads up on adding some Patsy Cline to our music video presentation – very good call!

Return To Resistance

September 15th, 2020

2020-09-15

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Just a quick update – when we last chatted here on the blog, I noted that we were set to test the 50 day moving average (the red line on the graph above).  We did that and predictably bounced back to the underside of the 20 day moving average (the blue line on the graph above) where we were rejected and pushed back to the 50dma where we broke through it intraday, closing above.  Today, if the market closes at or below the high we put in earlier today, we have formed a pattern of lower highs and lower lows.  Tomorrow is key to knowing what will happen on a going forward basis.

1.  If we can put in a positive day and close above the 20dma, then the market is telling us that this was just a blip of a correction and that we will probably be heading back toward the previous highs.

2.  If we have a down day, we could be working on a third lower low and potentially a close below the 50dma.

My gut feeling is that based upon the movement of the price action, we are going to break below the 50dma and head toward the 200 day moving average (I mentioned this on the blog last week one day).

So what is the strategy?  If we close above the 20dma and can sustain it for three trading days (our Rule of Three for breaking above or below support), then you get a signal that a return the previous highs are likely.  It is relatively safe to commit some liquidity and put some of your money to work.  However, we still have the same issues present from two weeks ago when I wrote that we were due for a correction:  high valuations and the distance from the 200dma.  Today, intraday we popped above the 10% envelope discussed on the blog a couple weeks ago.

More than anything else, this psychologically important level which shows how stretched the market has gotten should keep us in the correction with a falling market headed toward the 200dma which is around 3100 on the S&P 500.

—Mark

Stormy Markets

September 8th, 2020

2020-09-08

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I’ve annotated a graph of the S&P 500 to give you an idea of what I see happening to the market.

If you’ve been reading the blog and the recent posts since I warned that we were getting ready for a pullback, you will recall the solid blue trendline that I said was important.  You will recall that I posted when we broke below that line last week.  Today, we have decisively dropped beneath it (making it now overhead resistance to a recovery to previous highs) and we have an intraday break of major support (horizontal black line) at 3363 on the index based upon previous trading activity.

What you want to watch for today is:

(1) whether we can stage a rally and close above 3363 ( that would be positive and an indication that buyers have begun to emerge from the sidelines and put money to work).  This could set the stage for an assault on the blue trend line and a return to previous highs; or

(2) whether we continue to deteriorate and close below 3363 (that would be negative and an indication that the sellers are still in charge and further downside is likely).  This will set the stage for a move to test the 50 day moving average and further weakness to the 200 day moving average line at 3093.

I’ve also added two key items that indicate number two above is possible:  (1) rising volume on down days in the index; and (2) volatility is rising toward highs seen in May.

We continue to pick our spots to book profits in holdings so we have cash to reinvest once we see a market turn.

Before ending I wanted to provide some color commentary.   I had an email from a reader wanting to know why we don’t just sell everything when the market looks like it is headed lower.  It’s a good question.  The answer is that even if the indicators say that market is headed lower, we are dealing with human emotions and psychology.  I’ve written on this blog in the past that the graphs are really just visual ways to understand the human psychology of the markets.  You can see the emotional turns when the markets move up and down and the indicators we follow are measures of those emotions in the form of price and volume.  Because we are dealing with emotions, plus the added impact of a 24 hour news cycle, the indicators tell us where we are where we are most likely to go subject to nothing being reported in the news that investors find surprising.  Because of this, it is not prudent to make a big bet like selling everything, particularly when our news is so full of surprising things at the current time.  The better move is to incrementally buy and sell, building or deploying cash over time, in order to outperform the market.

—Mark

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