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A Technical Look At the Stock Market

December 3rd, 2019

2019-12-03

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I thought it would be instructive to look at the technical picture for the S&P 500 since we are at a crucial point in determining whether there will be a new bull market leg in our future or something less positive.

The graph above is one I shared last month with our investment committee but updated for recent market action.  I have been keeping track of this technical pattern since the summer and have been updating this graph accordingly.  The chart depicts two different patterns, a megaphone pattern and a rising wedge pattern.  You can see that the megaphone pattern had been in existence since the beginning of the January, 2018 correction and the rising wedge pattern began with the end of the December 2019 correction.

What I was watching for was a break above the top of the megaphone when we got to the July 2019 all-time high on the S&P 500 Index.  What we got instead was a break below the bottom of the rising wedge and several weeks of the market moving higher but not with a move strong enough to return to the wedge.

During the August pullback, I drew in two potential paths for the market: (1) the Path to 3300 (orange lines), and (2) the path to 2100 (pink lines) since both were possibilities at the time given the uncertainty of the economy.  Note that I have added some commentary on the graph that might be useful in helping to understand my reading of the market action.

Since August, the Fed has cut rates and started to expand its balance sheet.  Those two sources of easy money and liquidity have driven stock prices higher, to new all-time highs on the S&P 500 Index.  Despite not being able to move back above the bottom of the rising wedge, the Fed’s intervention has powered the market higher to follow the orange path to 3,300.  There is an entirely separate discussion to be had on the reason for the increase in liquidity (problems in the Repo market being one) that could ultimately move the market to the 2100 level on the index, but that is dependent upon many factors that are not quite in play yet (e.g., possible negative resolution of the trade wars, impact of negative interest rates in Europe, a recession, election of a president that could scare investors, unforeseen geopolitical issues, etc.).   Remember what I’ve written on the blog many times – invest what you see, not what you believe.  Today we see that the Fed’s liquidity program is good for the stock market in the intermediate term so it is critical to have a plan to profit from it.

On 11/20/2019, I wrote this to our investment committee:  “we have now reached a critical technical level for the index.  Yesterday, we closed above the black horizontal line I drew at 3,118.82 (a 3120.46 close) however today we are trading below it.  This horizontal line represents a level of 3% above the July closing high and for a new bull market leg higher to 3,300, we need to either close above it for three consecutive market days or to pullback to the July high of 3,027.98 and then break above the 3,118.82 level in a move toward 3,300.”   You can see on graph above that since then the index has fallen back to the top of the megaphone pattern (the rising green line) and we are most likely headed toward the July all-time high – we may not make it all the way back there since the expansion of the Fed’s balance sheet is a powerful tool, pushing money into the stock market, but this should give us a chance to put some funds to work a prices a bit cheaper than we have seen the past several weeks.

It looks like the odds are on the market continuing to move higher after a brief pullback, with a subsequent move to 3,300-ish on the index.  How did I get 3300 as a target?  I am old school – we learned to do measured targets in the days before all of the technology brought technical analysis to the masses.   We get our measured target from the graph above by finding the point difference from December 2018 low on the index, 2400-ish on the index, and the low from the breakdown of the rising wedge lower boundary, 3000-ish on the index, and adding half the difference to 3000-ish.  In other words, it is:

Measured Target =((3,000 – 2,400) x 0.5) + 3000 = 3300

Yes, it is old school but it has served me well over the years in managing clients’ portfolios, so no reason to give up on the process.

The break above the July high led to increasing equity exposure to banks, tech, biotech, and cyclicals which should all benefit from a liquidity driven market risk increase while reducing cash and fixed income investments.

Additionally, with the Federal Reserve now saying that their 2% inflation target is being set aside and that they will allow inflation to move above 2% should also be good for gold, commodities (Energy extraction, refining and transporting;  Agricultural growing and processing;  and Metals – mining and production), in addition to banks.

Our current strategy has been to reduce consumer staples and defensive stocks as the market has been juiced higher by Fed liquidity.  We have slowly been adding to the industries that should benefit from Fed liquidity.  We will take advantage of the sell-off to the July highs by adding to current positions or starting new ones in targeted companies that we want to own but did not previously want to pay the valuations seen at the top of the market.

I’ll be back on the blog with updates as the current change in the market picture plays out.

–Mark

Bizarro World – When Did It Start?

October 11th, 2019

Negative DebtDouble Click on Image for a Full Size View

In my opinion, we have officially moved into Bizarro World.  What is that?  If you are a fan of Seinfeld, you will recall that Elaine breaks up with her boyfriend Kevin but they decide to “just be friends.” Much to Elaine’s surprise, Kevin is thrilled at the idea, and starts becoming a much more reliable friend than Jerry. Jerry suggests to Elaine that Kevin is “Bizarro Jerry”, and explains the comic book concept of Bizarro World.  In popular culture, “Bizarro World” has come to mean a situation or setting which is weirdly inverted or opposite to expectations.

This week, we entered Bizzaro World when Greece, the least credit worthy country in Europe and one that continually teeters on the edge of bankruptcy, started issuing negative yielding bonds.

What does that mean?  Someone (in this case most likely the European Central Bank, the “ECB”) loans Greece money when they buy their bonds – but instead of earning interest on the loan, they agree to negative interest which means that instead of getting all of their money back at the end of the loan term, the get back less than they invested.

For a number of years, various European countries and corporations have been issuing negative yielding bonds.  It is definitely a concept foreign to us here in the states, but the European Central Bank came up with this scheme as a way to stimulate the economy in Europe.  Over time, the negative interest rates have worked their way into the banking system, with European banks issuing loans with negative rates and charging people interest to deposit money with them.

The banks in Europe are by and large in terrible shape, not able to make enough money to maintain or grow their capital base.  Yet, the ECB continues to double down on their negative interest rate policy in spite of its failure to stimulate the economy.  In the chart above, you can see that Switzerland has negative yielding debt that they are issuing for 30 years.  Would any sensible investor lock up their money for 30 years knowing that in 30 years they will receive back less than they invested and they will have not received any cash flow from it during all those years.

In calculating what a $1,000 30-year Swiss Bond with a negative yield of -0.058% would give you in 30 years, the formula is:  $1,000*(1-0.058)^30 = -$166.54.  Now, I may just be a poor country banker, but even I can see that receiving a -$164.54 reduction to my original capital in 30 years in return for my $1,000 loan to them today is a bad deal for whomever buys this bond.  So why are people buying them, let alone the less credit worthy European countries like Greece?

The ECB is buying the bonds to inject liquidity into its constituent countries to try to stimulate growth.  This policy has failed since they started it a decade ago, but they are now trapped and cannot resume a normalized rate policy for fear of causing a world-wide economic depression.  Oh, and in case that news is not bad enough, in June our own Federal Reserve announced through much government double-talk that they had adopted new rules for the “lower band” of interest rates – which means they are now prepared to take rates negative here in the states if they deem it to be advisable.  God forbid they close their failed Keynesian Economics textbooks and actually look at the damage that policy has done to Europe.

From the bond traders I’ve talked to, they tell me that the investment houses and mutual funds focused on European fixed income investments buy these to trade them, hoping that yields will get more negative which will drive the price higher.  Over the 35+ years that I’ve managed money for clients, I’ve always called this the “greater fool” theory of investing:  buying an investment that has no fundamental way to make you money just because you believe you can sell it to some sucker for more than you paid.

It is very similar to how the big investment houses operate when they manage your money.  In June they were planning to sell to their clients an IPO of a company named We Work which they had valued at $50 billion.  Since then, and credit to the independent investment analysts out there who exposed the company’s problems – it is not a technology company as the company and the Wall Street banks were marketing it as but rather a real estate company that owns no tangible real estate and has long term leases at top of market pricing across the world.  As of last week, We Work was selling its corporate jet, firing its CEO and founder, and trying to secure lines of credit to avoid bankruptcy.

We are economically in a very difficult position.  Our Fed continues to pump liquidity into the US economy, but we continue to see economic reports of slowing in both the manufacturing and service sectors of the economy.  Third quarter corporate earnings reports start hitting the wire next week, and all forecasts are for continued softness in earnings which are being called by many an earnings recession.  There is a very good chance that the Fed will lower rates once again at its meeting later this month, yet the stock market remains close to its all time high.

Every move to add liquidity to the US economy is cheered by Wall Street yet the market peaked in July prior to the initial rate cut and has not been able to move above that level.  The trade war with China which is definitely having a negative impact on corporate earnings for companies that export a significant portion of their product to China.  However, with every tweet out of the White House announcing an end to the trade war or that a deal is imminent – believable or not – the market seems to rally and keep us near the July high.

In a world that has turned into the opposite of logical, with Bizarro economic policies and Bizarro investment decisions by many institutions, we will continue to play defense with cash equivalents, bonds, and precious metals.  Hard assets and longer dated treasury bonds have consistently over time been the best insurance with the best investment returns as asset classes during times of crisis.  Cash Equivalents have provided outsized returns when viewed as your opportunity to buy undervalued assets when everyone else is forced to sell.

Until we return to a more normalized economic and investment environment, playing defense is the wise move and following the herd by buying stocks at all time highs is being the greater fool.

—Mark

Third Quarter Update & Fourth Quarter Strategy

October 7th, 2019

2019-10-07

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After a difficult summer for equity investments, investors returned from their summer holidays in a bullish mood and drove stock prices higher in September.  The quarter was marked by a continued slowdown in the global economic data, offset by further monetary easing from the US and Europe.

In the US, the Federal Reserve (Fed) cut interest rates in July and September in an attempt to prolong the economic expansion in the face of an economic.  While the economy continued to add jobs, the pace of growth of aggregate hours worked in the economy has slowed meaningfully.  Consumer confidence also declined from elevated levels.  US equities delivered 1.7% over the quarter but have been unable to break above the July all-time-high.

Many economists are calling for a recession in coming months due to the continued weak economic data – the manufacturing sector has been contracting for a few months, but until last week the services sector of the economy has remained in expansion mode.  Last week, the services sector reported contraction as well.  If the combination of a weak manufacturing sector combined with a weak services sector turns GDP negative for two consecutive months, we will indeed be in an economic recession.

We have seen the bond market act accordingly – the yield on the 30-year treasury bond today has again dropped below 2%.  The yield curve is inverted from 3 months to 10 years while roughly flat from 2 years to 10 years.  The inverted yield curve is considered historically to be a leading indicator of a potential recession – its track record is not 100% accurate, but at roughly 80% it is something we definitely need to be watching.

In spite of the slowing economy, the stock market continues to trade near its all-time-high.  In the graph above you will see that since the July high of 3,027 on the S&P 500 Index, we have moved up and down within a tight price range, but there has been no significant move either up or down – price rallies are sold and price dips are bought.

Investors are clearly confused – the ones with a positive view see the Fed lowering interest rates and buy the dips while the ones with a negative view see the weak economic data which causes the lowering of rates and sell when prices move higher.    Who will win this tug of war?  That is the question we are all waiting to see – will the bearish minded investors get their recession, or will the Fed rate cuts strengthen the economy and move the stock market higher?  There is no way to know until the economic data is reported.

However, with the market near all-time-high, the risk is clearly to the downside.  Given that, we continue to be cautious and maintain above average allocations to cash and fixed income.   One issue that we are watching closely is the lack of liquidity in the markets – the Federal Reserve has recently increased its activity in the overnight lending markets that the big financial institutions participate in when they need access to significant liquidity to balance their books.  Right now, the Fed has it under control, but a liquidity driven market correction is something we want to avoid as they are fast and brutal.  By being suspicious of the stock market at these levels we are remaining cautious, overweighting precious metals, bonds, and cash equivalents, we are protecting our clients’ investment capital while the current uncertainty plays out.

–Mark

Stocks and Bonds and Gold, Oh My!

August 12th, 2019

2019-08-12

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I thought it would be instructive to look at the performance of stocks, bonds and gold since the stock market peak in January, 2018, or 20 months ago.

2019-08-12 B

The line graph above shows the performance of the S&P 500 Index from the peak until today.  You can see that the total return is 2.86%, roughly 2% of which is from dividends.  The stock market has gone virtually nowhere in over a year and a half.

The bar graph at the top of the page compares the S&P 500 Index to the ETF for Gold and Long Term Treasury Bonds.  It is clear that the treasuries have won the performance race, with gold putting in a very good showing as well.

Investment Strategy Summary

Last year, I told you that we were getting more conservative in our asset allocation in client accounts, reducing the allocation to stocks and increasing the allocation to gold and bonds.  I wrote our reasons why – in a nutshell, gold and bonds are a hedge against stock market volatility, and given the over-valued levels of the stock market, we were expecting volatility. Over the past 20 months, our clients with an investment objective of 100% Stock Allocation have experienced returns more than double (and more than triple in certain of our strategies) the stock market return simply by diversifying and hedging with other asset classes at the right time – when the stock market was overvalued and the economy was beginning to slow.

At the present time, I see no need to lower our allocation to bonds and gold in favor of stocks until we see equity valuations more in-line with historical averages.

 Economy

The economic numbers continue to be mixed, with the bond market pricing in three rate cuts in 2019.   The Fed cut rates on July 31st by 0.25% and the fed fund future market is expecting another in September and in December with additional cuts in 2020.

There are a number of recession indicators that point to a possible recession within the next year – many of those indicators coming from the Federal Reserve itself.

Bond Market

Over the past several weeks, the trend in yields at the middle and longer end of the yield curve has been down, inverting the yield curve below short-term rates.  After a brief un-inverting of the curve, we are back to the most sizeable inversion since 2007.  The ten-year bond yield is at 1.63% and the thirty-year bond yield is at 2.11%.  The Federal Reserve Chairman made a speech with his rate cut announcement and indicated it might be a “one-and-done” rate cut to just reverse the one from the Fall of 2018.  The bond market reacted by strengthening at the longer-end of the yield curve, driving down rates to where we are today.  It clearly does not buy the one lonely rate cut scenario and anticipates further.

Stock Market

Even though the stock market rallied to new all-time highs prior to the rate cut announcement, a “sell the news” reaction to the one-and-done statement has sent the market down in early August.  The S&P 500 is down 3.28%, the NASDAQ is down 3.86% and the Russell 2000 Small Cap Index is down 5.09%.  The relative strength index for the S&P 500 is approaching over-sold readings, at which point we will probably get a bounce higher.  But the severe reaction of the bond market indicates it will be short-lived.

Macroeconomic Issues

The macroeconomic  issues discussed in the previous Market Outlook continue to be of concern in their current and potential impact to the economy and financial markets.  They are, in short:

  • Tariffs hindering economic activity and increasing inflation
  • Earnings estimates are being cut
  • Personal, corporate, and government debt bubble
  • Government Debt Ceiling on September
  • Fiscal Policy limited due to high levels of deficit and debt plus the tax cut has already been implemented
  • Growing acceptance of Modern Monetary Theory, negative Fed Fund rates, and pegging of bond market yields
  • Illegal Immigration putting pressure on viability of social safety net
  • Legal Immigration system needs overhaul to focus on increasing the number of visa going to skilled workers
  • Demographics in the western world are deteriorating, with few than required young people than needed to sustain social programs and economic growth
  • A Solar Minimum Cycle of Sunspot activity leading to cooler and wetter weather, brief extreme heat waves, reduced crop productivity, volcanic and earthquake activity
  • Leading economic indicators flashing warning signs of recession
  • Negative Interest Rates in USA

As recently as this Spring, no one was seriously discussing negative interest rates in the USA.  However, in early July, the Fed Chair gave a speech indicating that they were a possibility to ward off recession.  I’ve added it to my list of Macroeconomic Issues because in my opinion negative rates would be a financial disaster.

More on all of this in the next blog post!

–Mark

Market Outlook: July 12, 2019

July 12th, 2019

 

2019-07-12

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Economy

The economic numbers continue to be mixed, with the bond market pricing in three rate cuts in 2019.  The most recently released numbers show an increase in employment as well as hotter than expected consumer and producer inflation.  The market is pricing in a 100% chance of a rate cut in July, a 65% chance of a cut in September, and a 45% chance in December.  Fed Chair Powell’s recent statements indicate that the July cut is likely despite the stronger employment and inflation readings.

There are many signs that a recession could happen in the next six to twelve months based upon continued slowing of leading economic indicators.  However, with the Fed beginning a monetary easing cycle while lagging indicators (like employment) are still strong, we certainly could avoid a recession.  Manufacturing is already in recession territory, contracting based upon PMI readings, but given that the services sector is still expanding (and a significantly larger portion of GDP) the overall economy could keep GDP positive.

Bond Market

Over the past several weeks, the trend in yields at the middle and longer end of the yield curve has been down, inverting the yield curve below short-term rates.  However, with the Fed likely cutting rates at the short end, yields have been ticking up in the middle and longer end of the yield curve.  This is leading to a potential un-inverting of the yield curve as bond investors grow slightly more bullish on the economy.

Negative bond yields in Europe have grown slightly less negative in recent days.  Economic numbers for Germany, France and Italy have all come in stronger than expected in recent days, giving bond investors there hope that the stagnating socialist economies might show some life.

Stock Market

After the big sell-off in May where the market was down 6.5%, the market recovered 6.8% in June.  So far in July, we have seen the market move 2.1% higher to new all-time highs as investors are viewing the anticipated rate cut as a fix to the slowing leading indicators.

This may be a temporary thing since second quarter earnings begin being reported next week and there have been a significant number of companies pre-announce that their second quarter and balance of the year likely would not meet earnings expectations.  It will be a struggle for investors to continue to push the market higher on the hopes that a rate cut will stimulate the economy adequately to change the trajectory of corporate earnings versus what they companies are seeing in actual financial results and sales trends.

Trends and Technical Analysis

The S&P closed yesterday at 2,999.91, trading up about 19% for the year.  It has continued to make new historical highs over the course of the rally from 2016 to date.  We are in a sustained bull market from the 2009 lows of 666 to the todays high of 3,006 (as of this writing), with the long-term (yearly) bullish trend intact.

The monthly bullish trend came into question in May, with the month ending lower than the preceding month.  However, the June month-end was higher than May as well as April, meaning that if July closes higher than June our monthly bullish trend is intact.

We have two levels of technical resistance that we need to get through to confirm that this move higher can be sustained and that it would be safe for investors to add equity exposure.  There is a key Fibonacci Retracement level at 3043 and an upper trend channel line at 3067 on the S&P 500 Index, that if both are broken signals that a move higher to the 3,113 pivot point resistance level is possible.

If we see market weakness based upon corporate earnings disappointments, there is lower trend channel line technical support at 2,832 as well as 2,792 pivot point support level.  Additionally, the 50dma is sitting at 2,891 and the 200dma is at 2,780, both of which are strong support levels.  As long as these levels of support hold any downside price movement, the market will be in technically neutral territory until we see if July closes above or below June.

Macroeconomic Issues

The macroeconomic  issues discussed in the previous Market Outlook continue to be of concern in their current and potential impact to the economy and financial markets.  They are, in short:

  • Tariffs hindering economic activity and increasing inflation
  • Earnings estimates are being cut
  • Personal, corporate, and government debt bubble
  • Government Debt Ceiling on September
  • Fiscal Policy limited due to high levels of deficit and debt plus the tax cut has already been implemented
  • Growing acceptance of Modern Monetary Theory, negative Fed Fund rates, and pegging of bond market yields
  • Illegal Immigration putting pressure on viability of social safety net
  • Legal Immigration system needs overhaul to focus on increasing the number of visa going to skilled workers
  • Demographics in the western world are deteriorating, with few than required young people than needed to sustain social programs and economic growth
  • A Solar Minimum Cycle of Sunspot activity leading to cooler and wetter weather, brief extreme heat waves, reduced crop productivity, volcanic and earthquake activity
  • Leading economic indicators flashing warning signs of recession

Strategy Summary

With the stock market at its all-time high, and the various technical indicators we follow telling us that the market is over-valued, caution is warranted.  However, stock markets can continue to move higher for longer than makes sense.

In recent weeks, we have raised cash by booking profits on holdings that our analysis showed were over-valued compared to their discounted cash flow fair value.  We invested that cash in bonds and in gold miners to hedge against a prolonged downturn in the market, along with cash equivalents.  This allowed us to outperform our benchmarks in May as the market corrected as we anticipated and again in June as the market recovered.

In early June, the Federal Reserve announced additional monetary stimulus was back on the table and that they would be ending their policy of Quantitative Tightening in the Fall.  This caused the correction to reverse and stocks to go higher.  We have reduced the duration in our bond hedges and have marginally increased our equity exposure by adding to defensive stock names as well as higher growth names that sold off in May.

Now that we are back at all-time highs, we need to examine our cash/gold/bond hedges.

  • If the market can close above the resistance levels discussed earlier and sustain those levels for at least three trading days, we will add additional equity exposure in client accounts
  • We will keep a normalize amount of cash equivalents on hand along with our bond and gold positions.
  • We added to our precious metals hedge by adding some silver to client accounts via the SLV ETF. Silver has not participated to the same extent in the move higher by gold prices and has the added benefit of industrial uses in case the fed rate cuts start to stimulate the cyclical areas of the market

With the stock market signaling that recession is off the table and the bond market giving trying to un-invert, we are in a difficult investment environment given the deteriorating fundamentals in the economic leading indicators.   The Fed’s anticipated rate cuts may in fact positively impact these fundamentals, but until they do we have to stick with what is known.  Based upon this, caution is still warranted in equity portfolios at the present time, but taking out overhead resistance would be a good start to a sustained move higher.

Stocks, Bonds and Gold Soar Higher – Which Is Correct?

June 20th, 2019

NY Fed

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Investment Strategy Executive Summary

With the stock market at its all-time high, and the various technical indicators we follow telling us that the market is over-valued, caution is warranted.  However, stock markets can continue to move higher for longer than makes sense.

In recent weeks, we have raised cash by booking profits on holdings that our analysis showed were over-valued compared to their discounted cash flow fair value.  We invested that cash in bonds, some longer duration, and in gold miners to hedge against a prolonged downturn in the market, along with cash equivalents.  This allowed us to outperform our benchmarks in May as the market corrected as we anticipated.

The graphic above (courtesy of the Zero Hedge Blog and Real Investment Advice) shows the NY Federal Reserve Bank’s Recession indicator.  The current reading is where we were exactly 12 years ago prior to the 2008 recession and stock market crash induced by the sub-prime bond market disaster.  It graphically illustrates why we need to be cautious at the current time.

In early June, the Federal Reserve announced additional monetary stimulus was back on the table and that they would be ending their policy of Quantitative Tightening in the Fall.  This cause the correction to reverse and stocks to go higher.  Even though we were at Max levels of Equity underinvestment, the bonds and gold both continued to move higher in anticipation of lower Fed Fund rates.

Now that we are back at all-time highs, we need to examine our cash/gold/bond hedges.

  • If the market can close at a new all-time high and sustain it for three trading days, we will invest some of the cash we have on hand in a beta driven strategy of buying the SPY. We will set stop losses for that position and raise them as the SPY moves higher in order to capture what could potentially be a blow-off top prior to a recessionary bear market.
  • We will keep a normalize amount of cash equivalents on hand along with our bond and gold positions.
  • If gold moves above its long-term resistance level as represented by 130 on the GLD and sustains it for three trading days, we will add to our gold miners positions, buying the GDX with a similar trailing stop strategy as the SPY.
  • If we see any corrections in defensive equity companies, we will likely swap some higher beta holdings in tech and biotech – particularly if they are overvalued compared to DCF FV – in anticipation of a potential recession but without increasing overall equity exposure.

With the stock market and the bond market giving us two different forecasts of the future, we are in a difficult investment environment.  Historically, the bond market has won the forecasting contest, but you cannot use it as a timing mechanism.  We will continue to be cautious, but with the strategy outlined above, act opportunistically based upon sound investment management techniques.

______________________________________________________________________________________________

Market Outlook   –   June 20, 2019

Economy

The economic numbers continue to be mixed, with the bond market pricing in two rate cuts in 2019 and a third in 1Q2020.  The most recently released numbers show a major drop in the manufacturing index but stronger than expected retail sales numbers.  I am writing this prior to the Fed meeting on Wednesday where many anticipate the first rate cut, but my best guess is they will not cut but say some soothing words to make people believe they will cut in July.

Bond Market

Over the past several weeks, yields at the middle and longer end of the yield curve have dropped materially.  Investors are looking at the weak economic data and driving down rates; many are also predicting recession odds are rising.

The bond market is pricing in two rate cuts in 2019 and a third in 1Q2020.  I am writing this prior to the Fed meeting on Wednesday where many anticipate the first rate cut, but my best guess is they will not cut but say some soothing words to make people believe they will cut in July.

Post-Fed Meeting, the 10-year treasury yield dropped below 2% for the first time in three years and the Yield Curve inverted even further with the Fed not cutting rates but indicating there will be cuts in July.  The Fed Fund Futures are now pricing in a 100% chance of a cut in July with another 65% chance in September and another 45% chance in December.

Stock Market

After the big sell-off in May, the market fell further in June before rebounding by 180 S&P 500 points, or 6.5% from the June low.

In May, the market peaked at 2,954.13, up 25% from the Christmas Eve low of 2,346.58.  Unfortunately, we closed May at 2,752.06 below the 12-month moving average and down 6.7% from the high and below the previous three months closing lows.  This indicates a potential change in trend that would need to be confirmed by a June close below the May close.

In June so far, we saw the market trade at 2,728.81, below the May low and below the 12-month moving average, but it has since rebounded by 6.5% and is now trading above the May close.

There are three possible outcomes to the month of June:

  • If we can close June above the May low but below the May high, this could just be a consolidation of the December to May rally, with potentially higher prices ahead.
  • If we can close June above the May high, then the rally from the December lows is still in place and May was just part of the ebb and flow of the markets.
  • If we close June below the May close and below the 12-month moving average, then we are looking at a change in trend with lower prices likely ahead.

The first level of resistance at 2,849.65 was broken above and the market has stayed above it, which is quite bullish.  The second level of resistance is at 3,192.44, well above the May high.  If we can break above the second resistance level and close June there, then the rally is certainly back on.

Post-Fed Meeting, the market rallied, and as of this morning we are threatening to close the day at a new all-time high.

Given our defensive stance, I have a plan to deal with this intermediate move higher in the markets – see the summary at the end for details.

Macro Issues

Tariffs: Tariffs are by their nature negatively impact corporate profits, are ultimately inflationary as companies raise prices to maintain profits, and generally disruptive to global growth.   While it is positive that the potential punishment tariffs on Mexico have been sidelined, the tariff war with China continues.

Earnings Estimates:  Corporate earnings before tax (Operating Earnings) have been flat since 2011, with EPS showing growth due to the financial engineering of stock buybacks.  However, 2019 has seen Operating Earnings fall even while valuation multiples have expanded.   Since the December low in the stock market, P/E multiples have expanded by 300 bps.  Investors are now paying very expensive prices for earnings that are at risk of falling further if the current economic weakness expands.

Debt:  Personal, corporate, and government debt is exploding worldwide.  It is a very worrisome situation, particularly if we are headed into a weakening economy.  If unemployment begins to increase materially, a larger than reserved percentage of personal debt becomes uncollectable.  If corporate profits continue to weaken, the corporate bond market and other lenders will experience write-offs greater than anticipated.  If unemployment increases and corporate profits fall, government tax revenues will suffer and additional debt will need to be issued to sustain our government’s unsustainable level of spending.

Government Debt Ceiling:  September 30th marks yet another opportunity for a government shutdown over the corporate debt ceiling.  We will be facing a $4 trillion continuing resolution to fund the coming year’s expenditures along with a $1.5 trillion anticipated deficit.  At some point, the global debt bubble will explode.  The fight over our debt ceiling could be a catalyst for that or it could be a non-event as the politicians try to kick the can down the road for future elected officials to deal with.

Fiscal Policy:  There do not appear to be any fiscal stimuli on the horizon to give the stock market and the economy a boost.  Tax cuts are behind us and the unacceptably huge budget deficit does not really allow for aggressive government spending.  There appear to be no tailwinds that will push us higher, if only temporarily.

Is the Fed Changing the Game:  There is a movement out there to accept that Modern Monetary Theory, negative Fed Fund rates, and pegging of bond market yields will allow the economy to go on into the future with no major economic disasters.  Modern Monetary Theory says that the government can continue to spend without regard to debt levels because the Fed will buy up all the debt, much like has happened in Japan.   In this way, we can spend the $92 trillion required to implement the Green New Deal and other socialist ideas.  In order to keep the debt service on all the new debt reasonable, both negative Fed Fund rates and setting fixed bond yields for government debt will ensure a low and positive yield curve.

Many economists are arguing strenuously against this, but many politicians and liberal economists are promoting it.   With the budget deficit at nearly 5% of GDP, I do not see how bond investors will stand for these actions without crashing the bond market first.

Immigration and Demographics:  As the G20 continues to age demographically with a birth rate below the replacement rate, their economic dominance declines over time.  To combat this, a country needs a sound immigration policy to bring their population growth back to the level where economic growth can be sustained at a reasonable level.

 

Weather:   We are currently in a Solar Minimum cycle of Sunspot activity.  These cycles last several years and impact the weather patterns on Earth in a few key ways:  the climate gets cooler and wetter, winters are longer and summers are shorter.

We can see this playing out right now with its impact on our Agriculture in terms of the reduced growing season from late planting due to the wet weather.

From a historic standpoint, insects, bacteria, and fungus that normally do not live at various climate zones are seen and attack crops, much as China is seeing today.  Here is an excerpt of the news report:  “A crop-eating pest first detected in China about five months ago is spreading rapidly and could hurt production of key crops critical to the populous nation’s food supply, according to the U.S. Department of Agriculture.  Damage from the so-called fall armyworm, which gorges on corn, soybeans, cotton, rice, and dozens of other crops, could force China to import more corn, rice or soy to makeup for the shortfall..as authorities expect it to expand to all provinces in coming months.”

From a historic standpoint, diseases that you thought we under control begin to proliferate.  The black plague came about during a solar minimum, while we have ebola once again proliferating out of control in Africa and measles gaining traction in the states even though a small minority of children have not been vaccinated against it.

From a historic standpoint, earthquakes and volcanic activity also increase.  It was during a Solar Minimum in 1465 that a volcano erupted in the tropics spewing so much ash into the air that the skies in Europe were darkened for years, leading to the mini Ice Age.  The impact of the mini Ice Age was reduced agricultural activity, increased disease, and European exploration of foreign lands and migrations of Europeans leaving Europe in search of land to farm and exploit natural resources.

Recession:  Many of the recession indicators published by the Regional Fed Banks and other entities are showing an increasing likelihood of recession in a range of six months (or sooner?) to two years.

Based upon this, lets look at the components of GDP to see what we believe.  Here is the normal calculation of GDP:   GDP = Personal Consumption + Investment + Government Spending (not including transfer payments) + Exports – Imports.

  • Personal Consumption (69% of calculation): this is typically the last item to turn down (ignore government spending which never turns down); at the moment it is in a debt-fueled growth move higher
  • Investment (18% of calculation): Housing and Business Investment in Capital Equipment are the two big factors here.  Housing has turned down at the national level (although lower rates are helping to stem the drop).  We need to watch Business Investment which usually trails Housing in movement.  If Business Investment drops then we have a problem.
  • Government Spending (17% of calculation): always growing and currently accelerating in a debt-fueled rage.
  • Exports – Imports (-4% of calculation): Tariffs are negatively impacting this at the present, even though the theory is that they will fix the imbalance over time through fairer trade deals, the short term impact is negative.

Personal consumption is by far the biggest component of GDP, and it continue to move higher as consumers continue to buy on credit and increase balances.  As long as employment stays relatively strong, and consumers can service their debt, this component should be solid.  However, if businesses lose money on tariffs and start to downsize, employment could suffer.

Business Investment as measured by Core Capital Goods Orders has been sluggish for a year.  It has neither grown nor shrunk markedly, meaning corporate CEO’s are cautious about the future.

Government Spending always increases, even net of transfer payments.  However, if we begin to see weakness in employment and corporate earnings, that spending will have to be funded by even more debt issuance.

Net Exports have been negatively impacted by the tariffs as China has curtailed its purchases of our goods in response to tariffs.

Based upon these issues, keeping an eye our for a potential recession is a necessary and prudent thing at this time in the battle.

Here Is What The Indicators Say

April 1st, 2019

2019-03-31

Double Click on Any Image for a Full Size View

The graph above shows the percentage performance of the S&P 500 over the past year.   If you were someone that did not panic in the November/
December sell-off, and held onto your investments, you are up about 8% over the past 12 months.

However, I like to analyze various factors that go into the markets movements to give me a feel for where we are going and what the investment strategy should be to best address where it is going.  So, I thought I would share with you some of those factors and what they are telling me:

 Momentum

  • 7-Day Relative Strength Index (70/30): nearing over-bought levels and rising (67.92)
  • 14-Day Relative Strength Index (80/20): rising (63.95)
  • Volume-Weighted Relative Strength Index (80/20) – shown as MFI below: rising (65.63)

2018-03-31 2

Breadth

  • McClellan Oscillator (50/-50): rising out of negative territory (7.92)
  • McClellan Summation Index (500/-500): weakening but still overbought (874.59)

2018-03-31 3

Note:  The top green and red graph is the Summation Index

Investor Sentiment

  • VIX Volatility Index (12/22): low volatility (13.74) equating to investor over-confidence

2018-03-31 4

Trends

  • Moving Average Convergence/Divergence: positive trend but weakening, with black indicator line below red trend line
  • Price/Momentum Oscillator: positive trend but weakening, with black indicator line below red trend line

2018-03-31 5

Participation

  • Percentage of S&P 500 Stocks Above 50-Day Moving Average (70/30): over-bought (71.80)
  • Percentage of S&P 500 Stocks Above 200-Day Moving Average (70/30): Positive (58.60)

2018-03-31 6

Based upon the indicators above, I expect that we are nearing a top in the market and should be rolling over.  We may have some continued upside as the computerized trading systems try to break through the all-time high, but the resistance is strong overhead and the indicators are mostly pointing to a weakening market.  Figuring out the indicators is never just a black and white decision, there are always nuances to it, plus they are just indicators and not commandments.  However, by and large they provide information that is critical to staying on the profitable side of the stock market.

As a result, we have been raising cash and will likely continue to do so as the market rallies toward the all-time high (if it does).  Risk Management is a key part of active investment management, and right now the risk is to the downside.

–Mark

Signs Of A Slowing Economy

March 22nd, 2019

Sentiment

Graph above courtesy of sentiment.com

Double Click on Any Image for a Full Size View

 

I wanted to share with you the current investment strategy activity as its been presented to our board of directors.  It includes some strategic changes based upon the technical indicators we follow and changing fundamentals of the economy.  The graph above shows you how investor sentiment has moved into the zone where we normally see stock prices pull back.

‘With the stock market approaching its all-time high, and the various technical indicators we follow telling us that the market is over-valued, breadth is weakening, momentum is waning, sentiment has gotten complacent, and the near-term trend appears to be rolling over to the downside, we have begun to book profits in positions that have moved above their calculated Intrinsic Value and/or positions that have significant gains since the January lows.  We have moved client portfolios up to maximum cash levels as outlined by their individual investment policies.  This is consistent with our view that the economy has begun to slow over the past three months and that corporate earnings growth has slowed significantly now that the impact of lower taxes is built into quarter-over-year-ago-quarter estimates.

 

With the Federal Reserve on hold with further interest rate increases questionable, plus the flattening of the yield curve with the spread between 2’s and 10’s at just 14bps, we have lengthened durations in bond portfolios and moved client portfolios up to maximum fixed income allocation as outlined by their individual investment policies. We have closed our positions in adjustable rate and floating rate government bonds, reduced our allocation to short-term fixed income corporate and government bonds, and increased our intermediate term holdings.  Additionally, we have moved a small percentage of the bond portfolio to long-term treasury holdings as a hedge against the downside risk in the stock market.  In accounts that allow both mutual fund and individual securities, we re converting mutual funds to individual bonds to lock in current rates for income clients.  This is consistent with our view that the economy has begun to slow over the past three months and that we risk an inversion of the yield curve that often presages a recession.”

10-2

The graph above shows the spread between the 2 year treasury yield and the 10-year treasury yield.   It has moved below the 14 basis points discussed above down to 13 basis points.  That means if you are a treasury investor, you are only paid 13/100’s of one percent more to tie up your money for 10 years than 2 years.  Because the yields are being crushed at the longer end of the maturity offerings, you are paid virtually the same amount of money on either maturity.

When the longer term maturities really fall like we have seen with the 10 year treasury yield, that is indicative of a slowing economy where investors a driving the yield down with demand for that maturity in spite of the shorter term paying the same return.  They are willing to do that because of the safety factor of being in a US Treasury Note and the opportunity to make capital gains on the principal because they believe yields will continue to fall (as yields fall, other investors are willing to pay you more than you paid for your note thereby providing you with capital gain income if you sell to them, which is a strategy the big bond investors like mutual funds and pensions use to enhance their returns).

Now is a time for caution, and we are positioning client portfolios accordingly so that when we get a correction we have cash on-hand to reinvest at lower prices.

–Mark

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