December 6, 2019
By Steve Blumenthal
“Given the high valuations I see, plus these divergences between many different indices,
I am aware that many bull markets have ended with a rally similar to what we have seen since August.”
– Ned Davis
Founder, Ned Davis Research (CNBC)
A few years ago, my wife, Susan, asked me, “What’s the most important thing I should know about investing?” It was a great question. I reflected on it and gave her two answers, both of which surprised her.
“The first thing you have to understand is how magical compound interest is. The math doesn’t work the same on the way up as it does on the way down. And because of how merciless the math can be on the downside, it’s crucial to defend your wealth,” I told her.
The second was a piece of advice Sir John Templeton shared when I met him at a lunch in 1985, when I was just starting out in the business. Well, his advice is really for all of us, but I’ll forever remember our brief encounter. He said the secret to his success is that he buys when everyone is selling, and he sells when everyone is buying.
In Sir John’s day, investing was mostly about feeling. Yes, sound research mattered but how did he gauge when everyone was buying or selling? One could argue that it’s easier to do today. There is a massive amount of data available to assist us. Yet, our emotions still get in the way. In fact, they present one of the biggest challenges there is. Sir John went on to tell me in 1985 that as easy as his advice sounded, following it would be the most difficult thing to do. He was right.
My response to Susan sticks with me as I think about all that happened over the past month. What a November! Stocks gained, tied to a friendly Fed and the prospect of a U.S.-China trade deal. I’m still trying to get my head around the repo mess and the Fed’s $60-billion-per-month bailout. My intention was to write about that this week; however, you’ll have to stay tuned. I’ll be recording a podcast on December 20 with David Kotok, Sam Rines, and hopefully Jim Bianco on the subject. For now, let’s just say the patient’s current affliction requires a lot of medicine. The Fed is printing more and more to make it better, but we’re not sure it’s helping the patient heal. So, pump liquidity into the system – a.k.a. “this is not QE,” but really sorta-kinda is QE, and we get a big, Jim Cramer-like “Booyah” in the stock market.
And if that wasn’t enough to keep the party going, we got some positive vibes in the form of potential for a “Phase 1” U.S.-China trade agreement. The on-again/off-again, bi-polar phenomenon is curious to watch if you take a step back for a minute. It’s quite amazing how it impacts the market. Forget that we’ve had yet another quarter of negative earnings growth (the third in a row), the Fed and China trade are the narratives driving the markets. Thank you, Mr. Powell. Thank you, “Phase 1.” (Hat tip to David Rosenberg)
Perhaps the best Sir John Templeton quote of all time is what he said about the nature of markets: “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”
Bull markets die on euphoria. Is it time to channel our inner Sir John? I think so. It was feel back then, that is, more art than science. Today we have big data. Out this week, a CNBC article titled, “Bull markets often end with a euphoric rally called a ‘blow-off top.’ We may have just had one.” The article highlighted research from Ned Davis Research, which caught my eye.
NDR measured prior blow-off tops and found that since 1901, the Dow has posted a median gain of 13.4% over a median time frame of 61 days in blow-off tops. NDR shows 18 prior occurrences and said that the Dow was up 10.5% over the course of just 74 trading days from mid-August to late November. They added, “That kind of rally is similar to the ones that ended previous bull markets.”
Take a look at the following chart. It captures 18 prior data points similar to what has just occurred. Number 19 is the current run from mid-August to late November.
And as Ned noted, “Given the high valuations I see, plus these divergences between many different indices, I am aware that many bull markets have ended with a rally similar to what we have seen since August.” So buckle up and keep your risk management processes in place.
Every month, I like to review the updated valuation data. I do this because most of the data on my “valuation dashboard” is calculated at month’s end and, while I know the picture hasn’t changed (still near-record high valuations), I just find it helps me maintain my footing. When you click through below, you’ll find a series of valuation charts and what the latest month-end valuation data tells us about coming three-, five- and ten-year returns.
I’ve learned a lot over the years, and one thing I know for sure is investing is not a game of perfect. But let’s listen to the whispers of old sages and now may be one of those important moments to listen well. I hope what I share is helpful to you, too.
Lastly, with “blow-off tops” front of mind, you’ll find the latest Trade Signals post continues to lean bullish. Blow-offs can keep blowing as is the case today off a good employment number. I’m keeping a close eye on the signals with downside risk management top of mind. If you clicked directly on the Trade Signals post from earlier this week, do go back and take another look at the recession-watch charts. That data is refreshed monthly and I have updated in time for this post (direct link also provided below).
The balance of this week’s missive is a quick read. Heat up that coffee and find your favorite chair. Oh, on the personal front, the annual Black Friday Golf Scramble was cold but the home team left happy. More on that below. Thanks for reading!
If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.
Included in this week’s On My Radar:
- Valuations and Coming Returns — Just the Facts, Ma’am
- Trade Signals – Equity and Fixed Income Trends Continue; U.S. Manufacturing Concerns or Not?
- Personal Note – Five Under Par
Today’s current starting conditions are well summed up in a simple picture (next chart – courtesy of Howard Marks).
Here’s how to read the chart:
- The straight line from lower left to upper right are the returns equities give over time. Mathematically, large company equities return roughly 5% over what it costs the company to borrow. If a company issues a bond at 5%, the stock (over time) will grow at 10%. Generally, stocks return more for you than bonds.
- The problem is returns don’t come to us evenly. There are times when investors bid up prices well above the long-term return trend line and time when they panic and prices go below. The curved line shows the path how markets move over time from periods of undervaluation to overvaluation.
- Better entries come when prices revert back to the straight line but, because of human behavior, prices rarely stop at the line, they tend to drop below the line. So the best buys come when everyone is selling.
“Just the facts, Ma’am.”
This best-known quote from the TV series “Dragnet” was never actually said by Sgt. Joe Friday…or at least not quite. It was used in a pseudo-parody movie with Dan Aykroyd adapting the phrase from two similar statements: “All we want are the facts, ma’am” and “All we know are the facts, ma’am.” Let’s next look at a variety of valuation metric facts.
Chart 1: Valuation Dashboard
Here’s how to read the chart:
- Red is bad, green is good.
- Flashing red pretty much in every metric that matters.
Chart 2: NDR Total Stock Market Value vs. Money Market Funds
Here’s how to read the chart:
- Top section shows the Total Stock Market Value equals $32.54 trillion.
- The middle section shows the Total Money Market Fund Assets: $3.162 trillion.
- The bottom section shows that Total Money Market Fund Assets are 11% relative the $32.54 trillion Total Stock Market Value. It’s like if you have $1 million in the stock market and you have $110,000 in your money market account.
- The idea here is just how much money do you have sitting on the sidelines that might be used to buy stocks. Keeping in mind we all need some cash available for certain spending needs or emergencies. Thus, the balance rarely gets too low.
- The red arrows show when investors are aggressively invested in stocks (little money in reserves to buy and bid prices up). Note the dates and think about Sir John’s advice.
- The green arrows are the big buying opportunities. Again, note the dates. This chart is a good statistical visual of investors doing the wrong things at the wrong times. Look at all the cash in 2009. No wonder it was such a great buying opportunity.
Chart 3: Warren Buffett’s Favorite – Total Stock Market Capitalization as a Percentage of Gross Domestic Income
Here’s how to read the chart:
- The dotted red line in the middle section is a real-life equivalent to the above chart from Howard Marks.
- Note over time how the black line moves above and below the long-term up trending dotted red line.
- The yellow circle in the bottom right indicates we are in the most overvalued market environment, by this measure, since 2000. Higher than all other periods, including 2007’s market peak, with the exception of the great depression and the 2000 tech bubble period.
- Lastly, the light red arrow in the upper left of the chart points to the subsequent 1-, 3-, 5-, 7-, 9- and 11-year returns when the market was in the “Top Quintile Overvalued” zone.
- Bottom line: Play more defense than offense. Raise some cash.
Chart 4: Normal Valuation
Bottom line: Extremely Overvalued – Look at the return box when readings are above 20. Note the returns are the total returns years later… not annualized returns.
Chart 5: Median P/E
Bottom line: I like to look at the data in the bottom section of this chart. What it is saying is that the market is sitting up in rarified air. The 55.8-year median P/E mean is 16.8. NDR calls that “Fair Value.” A much better entry point would be at 2,212.08 on the S&P 500 Index. It will take a 29.6% market correction to get us to a better entry point. I believe we will see that level over the course of a full market cycle. That will be a good point to start getting excited again.
I could keep going but let’s not. If you’d like to see a favorite metric, please email me and let me know. Happy to send to you.
December 4, 2019
S&P 500 Index — 3,140
Notable this week:
No material changes since last week’s update: the weight of technical trend evidence remains bullish for equities, high-quality fixed income, and gold. High yield bond prices continue to trend higher. The CMG Managed High Yield Bond Program remains in a buy signal.
Recent concerns about an imminent U.S. recession have appeared to fade. At least for now, we’re not reading or hearing about economic growth concerns in the mass media or financial news. U.S. manufacturing data, released on Monday, December 2, conflicts and could indicate that the recession “all clear” signal could be premature. The ISM’s November U.S. manufacturing index shows a fourth straight reading indicating the industry in contraction. On the other hand, IHS Markit’s index indicates a solid recovery. Which is correct? And why is this information important?
“Manufacturing is a leading economic indicator and if ISM’s data is correct, the U.S. economy could be in peril,” writes Axios’ Dion Rabouin. “Alternatively, if IHS Markit data is correct, it appears the industry has found its bottom and has steadily been rebounding over the past few months.”
Both surveys are well respected by Wall Street and economists, but they follow different methodologies. Bottom line: we must remain vigilant, regularly checking our indicators for signs of weakness in the economy. On that note, we will be updating our select recession charts this week.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
With glove warmers in pockets and golf gloves on both hands, Team Blumenthal and good friend, Steve Oh, walked to the 16th tee at Stonewall in suburban Philadelphia. Thirty-six hearty foursomes – two golf courses. Our team was assigned hole 16 on the Old Course. In the old days, the club pro would fire a shotgun from just outside the clubhouse – the signal for all the teams to tee off at the same time. At 9:30 am and 36 degrees, the annual Black Friday golf tournament began.
The winners finished at 11 under par. A good score and, if you read my piece just prior to Thanksgiving, it was doable score. So I’m not going to report them to Santa … The prior year the winning team came in at 17 under par. Not sure how that was humanly possible. You could basketball bounce your golf ball on the putting green surface the first three holes and the pin placements are purposely placed in crazy places – like on the side of a sharp downslope. Anyway, I’ve complained enough. Congratulations to this year’s winners. We finished in third at five under par and won a little pro shop spending money. Mostly, it was fun to be with my kids and friends. Checking in happy!
Lastly, a favor to ask if you are an independent investment advisor. If you are an independent advisor, you are aware that our business is changing. In some way not too dissimilar to the impact Amazon brought to the retail consumer industry. That’s good from a pricing and product standpoint for all of us, yet more than ever our businesses are dependent on cutting-edge technology, the exchange of information and the quality of offerings to meet clients’ needs. We are looking to expand our advisor team. If you are an independent investment advisor managing more than $20 million in assets and you are interested in learning more about our TAMP, our open-source structure, our content and research, our technology, our valued network of relationships, and if you embrace my vision of the future, send me a short email at firstname.lastname@example.org. We have a short pitch deck we’d be happy to send to you. And please tell me a little bit about yourself.
Hope your December is off to a great start. Wishing you a great week.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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