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Did We Just Get A Game Changer?

Thursday, April 9th, 2020

Fed Junk

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Just when you think you have a plan set in the game of life, someone changes the rules.

Today, the Federal Reserve announced that they were going to start buying Junk Bonds.  Yes, you read that right.  They are going to buy the bonds of companies whose ability to repay the debt is in doubt.  What does that mean for the Investment Strategy I outlined for you yesterday?  In short, A LOT.

You likely recall the graph above from yesterday’s post.  Yesterday’s graph showed that I assigned a 75% that the stock market has put in a low and that we would move up to the Relief Rally Recovery Zone, then move back down to test the low before we head back to new highs; a W shaped recovery..  I also showed that I assigned a 25% chance that the coming (or more correctly the current) recession would not be a short term cyclical event and instead turn into a longer term secular event, meaning it would be a longer time for the to return to previous highs; a U shaped recovery.

I have amended the graph to show a 70% chance of a W shaped recovery and a 15% chance of a U shaped recovery, but added a 15% chance of a V shaped recovery that does not test the lows.  The fact that the fed is putting a safety net under the weakest corporations means we anticipate fewer (maybe significantly fewer) corporate bankruptcies due to the recession, which lower the inherent economic risk that the recession cause a feedback loop of corporate bankruptcies that extends the recession for a longer period.  You will see that I have added some solid green arrows to represent a potential path for the market to new highs which could be reach sooner than in the W shaped recovery’s dashed arrows.

If the terms I am using seem foreign, the past three blog posts define them for you and if you are interested you can give them a read.  The investment strategy I outlined in yesterday’s blog post remains the same as I still anticipate that the W shaped recovery will be the reality, but the Fed’s buying junk bonds really is a game changer in terms of investment and credit risk.  The only thing I am curious about is whether we should be looking at adding a position in a high yield bond fund to our fixed income portfolios – they have been rising in price over the past week or so as many investors have been anticipating this (I honestly didn’t believe this would ever occur – I figured when the Fed stated two weeks ago that they would never buy junk bonds, they meant it, but that’s just the way it is).  This will take some pondering so no action is anticipated on it at this time as the easy money has been made.



Relief Rally Recovery – Will It Last?

Wednesday, April 8th, 2020


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Even though we started the quarter on a positive note, three major items hit the news that drove stock prices down by the largest and fastest amount on record.  We all know that the corona virus has shut down much of the country and it has been one of the primary catalysts of the pullback in the stock market.  Many of us have heard about the oil production dispute between Russia and Saudi Arabia that drove down the price of oil to levels not seen since the early 2000’s – energy companies now make up just 3% of the market capitalization of the S&P 500, the smallest percentage ever.  Fewer of us have heard about the financial system liquidity crisis in Europe that has driven the value of the dollar to near record levels versus the euro and has caused our Federal Reserve to provide collateralized loans to European banks and even European Central Banks.  If you haven’t read the two previous blog posts, a few things written here are discussed more in-depth in those plog posts.

From the market’s peak on February 19th to its crash low on March 23rd, the S&P 500 was down 34%.  It has since moved 20% higher as of this writing, but it remains down 20% from the top.  In the previous blog post of March 23rd, I provided you with a graph showing that the market had sold off to five standard deviations from the 10-month moving average – move in the markets that is nearly unprecedented.  Given the dept of the crash, we should not wonder that the market has moved up as fast and furious as it has.  As you can see in the graph below, we are currently within two standard deviations of the 10 month moving average, a normal trading range.


The question that everyone is asking is whether the worst is over and will the market return to its previous highs.  Bear markets in stocks rarely go straight down then straight up.  Howard Marks, a well-known investment manager, recently wrote: “In 15 bear markets since 1950, only one did not see the initial low tested within three months.  In all other cases, the bottom has been tested once or twice.”   To illustrate this statement, he provides a grid of returns for the last two bear markets as they tried to move from crash to recovery:

2000 DotCom & 9/11 Attack Crash                              2007 Subprime Mortgage Loan Crash

09/01/2000 to 04/04/2001:     -27%                            10/09/2007 to 03/10/2008:      -18%

04/04/2001 to 05/21/2001:      +19%                           03/10/2008 to 05/19/2008:      +12%

05/21/2001 to 09/21/2001:      -26%                             05/19/2008 to 11/20/2008:      -47%

09/21/2001 to 03/19/2002:      +22%                           11/20/2008 to 01/06/2009:      +25%

03/19/2002 to 10/09/2002:      -33%                           01/06/2009 to 03/09/2009:      -27%

As you can see, the typical pattern is to experience the first leg of the crash, then recover part of the loss, then make successive ups and downs as the buyers struggle with the sellers to gain ground.  Knowing this, we must be ready for the current upward move in the markets to top out and another down leg to commence.  As such, we are keeping an eye on the various indicators we follow that help us get a feel for which way the market is headed, things like valuation, breadth, momentum and trend.

If you review the graph at the top of the page, you will see a depiction of the current market.  I have annotated it to show you the depth of the loss and the current recovery, but I’ve also included various levels and a potential pathway for the stock market that is our game plan on how to play the potential ups and downs by raising and reinvesting cash to manage risk and to maximize returns.

You can see that our first level to watch for a Relief Rally Recovery is in the 2800 to 3000 area of the S&P 500 – this is a move off the lows that I’ve assigned a 75% chance of happening.  I have also assigned a 25% chance that things economically and virus-wise could get worse from here and you can see the lower level of that trading range noted on the graph.

I have three zones marked on the graph, the first of which is the Relief Rally Recovery Zone where I expect us to rally to in this first leg up off the bottom.  The two bottom levels of each are given a 75% chance and a 25% chance of a bottom in this bear market.  Each range is denoted by their likelihood of either a short-term cyclical bear market or a more extended secular bear market (see previous blog post for more in depth discussion).  Right now we have assigned a 75% chance of a short-term cyclical bear market that will lead to new highs – but if we are locked down in the stay at home policy for a longer time than currently anticipated, the recession we move into would be longer and deeper than expected currently and a longer-term secular bear market would ensue that could take a longer time to move back to new highs.

We are fast approaching the area of the graph I have noted as Relief Rally Target Zone, with the market currently at 2750 as I write this.  Our assessment is that once we get into or near this area, we will pull back a bit then head higher in a series of up and downs that will eventually lead to a test of the February low ultimately followed by a move to new market highs – but the moves up and down will likely look much like the bear market gains and losses detailed above in the two most recent bear market crashes.

Obviously, no one knows were the market will go – in fact, despite the overwhelming historic precedent for the market testing the crash low, we could have a market that does go straight back up to the old highs.  We must be prepared for any scenario that the market throws at us.  By watching the various indicators, we follow, we have a good idea what to do based upon the behavior of other investors.  The indicators are just a graphic representation of investor sentiment and the actions they take in the market which help us determine when they move from a herd of buyers to a herd of sellers and back again.

These indicators are why we have been writing to you about our risk management process that raises money as the market gets over-valued.  It allows us to have cash on-hand to invest when the market goes down and be a buyer when everyone else is a seller.

As the market turned the corner at year-end, we started adding stop loss orders on many of our holdings.  We had accumulated such nice gains that we didn’t want to give them up in case of a market correction.  Those started to hit as the market went down, automatically raising cash for us that allowed us to be a buyer of equities at levels lower than we had seen just weeks prior.  Did we catch the absolute low?  Yes and no – yes we were a buyer on March 23rd, the day of the low, but we were also a buyer on other days after the market crash began.

Our stock market risk management process of raising cash then reinvesting it when the market goes down allowed us to out-perform our benchmarks by over two percent in many of our strategies.  It also gave us the opportunity to employ a new investment strategy that repositions our clients’ stock portfolios to areas of the market that should prosper if the current stay at home policy to confront the Corona Virus drives the economy into recession.

That stock portfolio strategy we have implemented focuses on high growth companies that should continue to make money during economic downturns – things like technology companies focusing on cloud related products and biotech companies focusing on critical disease prevention and treatment – as well as defensive companies that provide products and services that we all use no matter what the economy does – staples like food and beverages plus utilities like water and electricity.  The strategy reduces exposure to energy, industrials, and materials (except gold) and it repositions financials from banks into companies that have little interest rate risk exposure.

The three causes of the crash detailed above didn’t just impact the stock market – the bond market was also impacted.  Bond yields crashed to historic lows as bond prices soared higher.  Bonds are viewed as a safe space to hide from volatility in the stock market, so as the stock market correction started to gain steam, the money that came out of stocks went into bonds.  Couple that with money coming out of Europe that was fleeing negative interest rates there turned into a tidal wave of cash coming at the bond market.   This led us to employ a new bond market strategy.

The bond market strategy we have implemented focuses on short-term high-quality bonds and adjustable rate bonds.  This strategy is driven by rates being at all-time lows yielding significant interest rate risk.  To manage this risk, bonds need to be positioned so that potentially rising rates do not cause losses to principal value of the bonds.  Short-term bonds and adjustable rate bonds have lower interest rate risk for investors and as such are the preferred choice when rates really have only one direction to go – up.


Nearing A Turning Point

Monday, March 23rd, 2020

S&P Bollinger Band Std Dev

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Just a quick update on the market.

I put together a Volatility Comparison that goes back to early 1987 to determine if we have ever seen a stock market this volatile.

In the graph above, I’ve charted the S&P 500 since March, 1987.  I’ve added bands around the price line that represent how many standard deviations from the 10-month moving average has the market been at the various material low points over the years.  Standard deviation is a statistical term that measures the amount of variability or dispersion around an average. Standard deviation is also a measure of volatility. Generally speaking, dispersion is the difference between the actual value and the average value. The larger this dispersion or variability is, the higher the standard deviation (i.e., higher volatility).  The smaller this dispersion or variability is, the lower the standard deviation (i.e., lower volatility).

What do we take away from this chart?  The current crash is five standard deviations away from the 10-month moving average.  In the past 33 years, we have only been four standard deviations away three times – we have never been five standard deviations away from the 10-month moving average.  That type of reading tells you that we are nearing or past the point of a Relief Rally beginning.

Remember from our graph that we discussed in last week’s blog post, the price range for this to be considered a secular bear market is  from 2350 to 2116 on the S&P 500 Index.  Today we are at 2285, right in the middle of this range and in prime position for a rally to begin any day now.

Don’t lose hope and feel that the market will go down forever – all of the technical signs point to this crash moving into a relief rally phase soon.  That is when we will execute the next phase of our investment strategy (see last week’s post for that detailed discussion).  That is the best news we’ve seen on the charts in quite awhile!


How To Manage A Stock Market Crash

Thursday, March 19th, 2020

S&P Downtrend Line Graph

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We have seen unprecedented volatility in the stock and bond markets over the past several weeks.  The stock market has fallen faster and more violently than at any time since 1987.   Given that, I thought it would be instructive to take a visual look at the markets, so here are some graphs to help illustrate what has been happening.   The graph above shows the dramatic crash in prices – I’ve drawn in a downtrend line that needs to be broken so that we can get on the road to recovery with a Relief Rally.

After that, we will discuss the three major issues happening that are impacting the markets:  (1) European Financial System Liquidity that has led to an unreasonably strong US Dollar, (2) the Corona Virus and (3) the Oil War between Saudi Arabia and Russia.


S&P 500 Index

Let’s start with a review of a graph we last saw in a blog post from November.

S&P Forecast Graph Original

In a post from earlier in the year, I debuted an initial version of the above graph, and explained the primary pattern the market was taking (hat tip to Sven Henrich who used a very similar chart to identify the pattern).   This chart pattern is called a Megaphone and defines the outer boundaries of the potential stock market action.  You can either have a move up that breaks above the upper boundary at 3100 on the index or a move down that breaks the lower boundary at 2200 on the index.

In an August post, I added the two possible paths that the market could take:  (1) an orange dotted line that I called the Path to 3300, and (2) a pink dotted line that I called the Path to 2100.

In a November post I included the graph above that shows that we did break above upper boundary at 3100. I mentioned that the target I had was a measured target of 3300.  I also said that if we can break above 3300 and sustain that with a 3% move higher to 3400 we could see a major move higher into 2021 (3% is important as it is my investing Rule of 3 for breaking support and resistance).  As of November, we were well on our way to 3300.

On the graph below, we have an updated version of this chart with further annotations that shows:

  1. The market topped out at 3393 early this year, but not breaking above the 3400 resistance level established by the Rule of 3.  It has since crashed to the 2250 level, just above the bottom of the Megaphone and 2200 lower boundary and 2100 measured target.
  2. You will see that I’ve annotated in peach color an area of the chart between 2150 and 2350 that I call the Cyclical Bear Market Target Zone. I estimate that there is a 75% chance the correction/crash will bottom out somewhere in this zone and begin a move higher to the green color area Relief Rally Target Zone between 2850 and 3050 on the index.
  3. Once we get the relief rally, we should see a trading range develop between the two zones, but with an ultimate retest of the low before the market finally takes off to new All Time Highs in 2022.  I’ve drawn in some black and red arrows showing a hypothetical path the market could take.
  4. The stock market has a mind of its own, so I never like to say that it MUST do one thing or another. But I’m firmly in the camp of this being a cyclical bear market, rather than a secular bear market. Historically, cyclical bear markets within secular bull markets tend to be devastating, but very short-term in duration. Most last 3-6 months and average falling in the 20%-30% range. Q4 2018 was a perfect example of a cyclical bear market. Two of the three catalysts for this crash are more cyclical in nature (Corona Virus and Oil War) so I am giving the cyclical bear the 75% chance of being where we land.

S&P Forecast Graph 5yr

But what if the third of the three catalysts (European Financial System Liquidity) cannot be contained by the Fed’s Repo action?  Then we have a chance for a Secular Bear Market which takes much longer to resolve.  I am giving it a 25% chance of happening if this turns out to be a secular bear market.

But what if I am wrong and all three are more secular in nature and cannot be resolved in coming months?  Then we have the chance of either a Generational Bear Market (like the malaise between 1967 and 1981 where it took 14 years for the market to make a new high), or even worse a Centennial Bear Market (like 1929 to 1956 where the market took 27 years to make a new high).  You will find those in the next graph in gray colored areas.

The graph below is tough to read because it is so stretched out (you will most likely want to double click on it for a readable version), but it covers the past 12 years back to the 2008 Subprime Loan Crash.  The two zones to watch for are the Generational Bear Market Zone between 1250 and 1050 on the index and the Centennial Bear Market between 666 and 869 on the index.  It was important to stretch the graph back in time so we could determine the origin of the historic areas of support and resistance that form these two gray zones.

S&P Forecast Graph

I have rated both of these as unlikely because:  (1) I believe that the Corona Virus will run its course given that so many pharma companies are working on a cure and vaccine, one or more will be brought to market in an expedited time frame to beat this disease, and (2) Russia’s economy cannot sustain oil prices at $20 per barrel so they will be forced to play nice with Saudi Arabia and the Oil War will end.

Unfortunately, I do not believe the European Financial System Liquidity problem can be fixed in the short-term.  Their use of Keynesian Economics to justify:  (1) forcing the European Banks to buy the sovereign debt of the lesser financially solvent European nations with the artificial designation of Zero Risk Weight in their capital calculations – there is no market to liquidate that debt when liquidity problems arise because buyers will not touch it, and (2) negative interest rates that have wreaked havoc on European Banks’ net interest margins has led to a huge liquidity crisis because investors moved much of their investment capital into US Treasuries, thereby sending our own rates to historic lows in this flight to safety, instead of depositing cash into the banks.

Our Federal Reserve stepped in to fill the void left by the big US Banks when they shut off the European Banks’ access to overnight lending in the Repo market.  Our banks determined that the European Banks represented an unreasonable risk of default and ended their overnight loan program even though it was secured under the Repo contract.  Unfortunately, this issue has turned from a short-term fix as described by the Fed in October 2019 to an intermediate to potentially permanent problem as the issues in Europe have worsened.  Certain of the European countries have ended negative rates on their debts but it does not look like the market has responded to that action and there is a general feeling that the European Central Bank has lost control of the European economies.

Ultimately, the cash moving out of Europe will move into US stocks and drive our market back to new highs, much like happened in the fourth quarter of 2019 and January 2020.


US Treasuries

The problems in Europe have significantly impacted our treasury market, driving yields down to record low levels.  Here is a graph of the 10 year US Treasury Note Yield for the past two years:

Treasury Yield Graph

You can see that 10-year Treasury yields were fairly flat until August 2018.  Then money started to move out of Europe into treasuries, driving the yield down from 3.2% to the 1.5% area where they plateaued until January 2020.  The Fed’s Repo action stabilized things and provided the liquidity the European Banks needed for that four-month plateau, then it proved to be inadequate.   Money again began to flow out of Europe driving the yield down to 0.34%.

We have since rebounded to the 1.1% area based upon the Fed’s multi-trillion dollar intervention in both the Repo market and the Commercial Paper market (which had also started to freeze up), as well as their interest rate cuts returning to their ZIRP levels of pre-2018.


Our Strategy

Stock Market Strategy

I have written on the blog in previous posts that as the market moved higher in 2019, we got increasingly more conservative with our clients’ investment portfolios.   Valuations continued to expand, driving the market higher, while corporate earnings fell compared to 2018.  That is not a sustainable market situation and prudent investment management dictated that we raise cash and buy bonds.

When the crash began in February, we started investing those funds in both index ETF’s and individual company stocks.  We have been buying all the way down and still have some liquid cash that we continue to add to the market at these low levels.  Our plan is to be fully invested prior to the Relief Rally starting.

Based upon the most likely scenario for the market discussed above, we anticipate a bounce higher to the Relief Rally Zone (2850 to 3050 on the index) before a retest of the lows.  As we near that Relief Rally Zone, we will again get more conservative by raising cash ahead of the potential retest of the lows.  If the retest does not happen and the V shaped recovery moves the market above the zone, we will reinvest the cash we raised in anticipation of a move back to the 3300 level on the index.

Bond Market Strategy

In the time frame between September 2019 and January 2020, as the drop in treasury yields began to plateau, we reduced bond portfolio duration by selling our longer duration bond funds and adding to short-term and floating rate bond funds.

When we moved below 0.5% on the US Treasury, we liquidated all the longer duration bond funds in favor of short-term treasury bond funds.  The exception to this is the allocation to two actively managed fixed income mutual funds that have a good history of managing interest rate risk and holding onto any other short-term bond funds in client accounts.  We also maintained exposure to a few longer duration holdings in accounts where we have income beneficiaries that live off the income distributions from their trusts.  Finally, we did not change anyone’s ladder of individual bonds, other than to reinvest maturities as appropriate.



As the stock market tries to find a bottom in our cyclical bear market zone and the bond market tries to find appropriate yield levels across the yield curve, we believe we have positioned client portfolios to take advantage of what we see coming in the most likely scenario.  If that does not happen, we will adjust portfolios according to what is happening in the market.  As I have written multiple times in the past in blog posts, invest what you see, not what you believe.

We don’t invest our politics or our fears of the unknown.  We work to quantify the known data and the observable chart patterns so that our clients profit to the greatest extent possible.  No one is ever right 100% of the time in the investment business, but we strive to be right more often than our competition and consistently accomplish that.

Check back on this blog as we will be posting updates to our strategy as the situation develops.


For those of you who like scary movies, the second video below comes from the book adaptation of Stephen King’s The Stand.  For those of you who do not like scary movies, here is a concert video from 1977 of the same song.



Financial Market Update

Monday, March 16th, 2020

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I wanted to update everyone on what has been happening and what we have been doing in the face of this unprecedented drop in the stock market.

We have officially entered bear market territory after an 11 year bull market.  Even though this has been very painful to go through – I personally have gotten very little sleep as I have been getting up in the night to watch the close of the Asian markets and opening of the European markets – its become apparent that the trading algorithms employed on Wall Street that drove the market to historic valuations over the past couple of years have turned against us and driven stock prices down to 2017 levels.

As I write this on Monday evening, the Futures are pointing higher.  This may persist until morning and give us a positive day or something in news may change things.  Either way, I thought it important to give you the three stages of a bear market.  The following was published by Tony Dwyer and I saw no reason to not just quote him.  In the discussion of the three stages, he compares the current market to both 2008’s Subprime Loan Crash and the 1987 Portfolio Insurance Crash:

1. “Panic – This happens toward the end of the initial crash, like what happened in 10/1987, 08/2011, and currently. The SPX was down 33% and 18% at the panic lows in 1987 and 2011, respectively. At last week’s low, the SPX was down 26.9%. You only know where the initial panic low is AFTER you have seen the multi-week rally.

2. “Relief – This develops after the crash with a violent multi-week reflex rally as investors are simply glad it stopped crashing. The relief rally in 1987 and 2011 recouped 30% and 40% of the losses from peak to panic low, respectively. This would suggest a bounce-back range in the SPX of 2750-2850 over coming weeks.

3. “Demoralization – This occurs when the market tests the panic low as the realization of weaker economic and corporate news is released, similar to what took place leading into the 12/1987 and 10/2011 test of the lows in those two market crashes, respectively.”

Managing an investment portfolio is a process.  When the market reaches all time highs, you reduce your market exposure and raise cash so you can invest lower when a correction occurs.  As I’ve written on the blog in past articles, we were very prudent to have cash on hand over the past couple of years when fundamentals (like earnings growth) were ignored by the algorithms and stock valuations pushed ever higher.  Fortunately, as the market has been falling, we have invested in some of our favorite companies, funds, and index funds at cheaper prices than we saw at the top of the market.

We continue to make purchases in our managed accounts, but we are anticipating that we are nearing the end of the Panic stage as discussed above and should be moving into the Relief stage soon.  As the market nears the 2750 level (and hopefully the 2850 level) we will be raising cash again so that we have resources on hand to buy our favorite investments for client portfolios.

Corrections and crashes are part of the investment process, but long-term success with your investment means that you need to not panic when the market goes down, even if it goes down significantly.  The Corona Virus will negatively impact corporate earnings for two to four quarters of 2020 and possibly 2021.  Stock prices are a function of corporate earnings, and mathematically from a discounted cash flow valuation, two quarters of earnings is only 5% of the total calculation while four quarters of earnings is only 10% of the total calculation.  A stock market correction of 30% like 1987 or 40% like 2008 undervalues company’s future earnings in a material way.

Warren Buffet, one of the greatest stock investors of all time, has said repeatedly over the years that the best time to buy is when there is blood in the streets and stock prices have been slashed to a fraction of their real value based upon future earnings.  This is one of those times that “uncle” Warren looks forward to in order to buy quality companies at a significantly discounted value.  That is exactly what we have been doing on behalf of our clients by raising cash when the stock market was making new highs and reinvesting it as the market has fallen.

There is no way to specifically say when the bottom of the correction might occur, but when stocks are valued downward significantly and you can buy a quality company whose earnings will return to a normalize growth rate at 17.95 price to earnings ratio (the current P/E for the S&P 500) from a 24 P/E just a month ago, this is a buying opportunity even if the market goes down some more.

Screen Shot 2020-03-16 at 8.14.01 PM

To give us some perspective, this graph shows you the S&P 500 since 1986.  I’ve annotated the major market disruptions so that you can see that sitting tight has always been the right decision.  Selling at the bottom of a correction or crash means you miss out on the recovery stage and lock in a permanent loss of capital.    To stress this point even more, below is a graph of the S&P 500 since 1922.

Screen Shot 2020-03-16 at 8.18.45 PM

Managing the volatility in the stock market is part of the process of investing.  If you are fortunate to have cash on hand, whether you are Warren Buffet or one of our clients, you can buy shares of stock, mutual funds, or ETF’s at discounted prices and over the long term benefit from the growth of corporate earnings and the stock valuations associated with it.

One of the hardest things to do is to remain calm and seeing clearly in the face of a stock market showing you paper losses.  However history shows that buying during corrections as we have been doing for clients produces very positive results over the long term.

Stay calm and let us do the worrying for you.

A Technical Look At the Stock Market

Tuesday, December 3rd, 2019


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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.


Bizarro World – When Did It Start?

Friday, 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.


Third Quarter Update & Fourth Quarter Strategy

Monday, October 7th, 2019


Double Click on Image for Full Size View

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.