June 12, 2020
By Steve Blumenthal
“We are strongly committed to using our tools to do whatever we can and
for as long as it takes to provide some relief and stability.”
– Federal Reserve Chairman Jerome Powell (June 10, 2020)
Last week we took a look at valuations and what they tell us about coming 3-, 5-, and 10-year returns. Nearly every meaningful measurement taught in business school is blinking “Extremely Overvalued.” That was true just prior to the pandemic crisis, too. You can find last week’s post here.
Today, I share with you my bullet-point notes from Felix Zulauf’s discussion with Grant Williams at the SIC 2020. The Zulauf-Williams discussion covered COVID-19, world trade, debt, demographics, gold, the U.S. dollar, the Fed, ECB, JCB, China tensions, and thoughts on navigating the period ahead. I was also fortunate to listen in this week on a research call with Felix, Byron Wien, and Ed Hyman and I’ll share some thoughts from that too.
Let’s first take a look at earnings and then think about them in relationship to two very important and opposing thoughts: 1) Richly priced fundamentals, and 2) A very generous Fed (and other global central bankers).
In their conversation at the Virtual SIC, Grant did an excellent job leading Felix to address today’s pressing issues. Felix talked about the equity markets (a trading range within the structure of a cyclical bear market with the potential to retest the bottoms with a 30% to 40% potential downside before the bear market is over). He shared that he favors the U.S. dollar, sees the EU as a flawed structure with potential for bail-ins and capital controls, and sees deflation now and risk of inflation a few years away. He also talked about hyperinflation (specifically, the countries most at risk), and said that he remains bullish on U.S. Treasurys (though late in the game) and he is bullish on gold. Toward the end of their interview, he talked about the way he manages his own wealth.
During the research call, Byron Wien said, “COVID is a long way from over. Market recovery is mispricing the coming earnings challenges and reacting too positively to the end of the lockdown. This is true in the US and around the world.”
Felix said, “The first wave is over. We are flattening out. It has disappeared in most EU countries.” He added, “I expect a second round coming in flu season.”
Ed Hyman cited the late, great Marty Zweig, reminding us all that his motto was always, “Don’t fight the Fed.” And, Hyman added, “They are just killing it here.” He went on to put numbers to just how aggressive the Fed, the EU, Japan, and China have been with their money printing.
I think Felix has it right. More when you read on below.
My hope is that you will walk away with a much better understanding of the complexity of the global markets and economic systems, as we all attempt to figure this out.
A quick detour that has some relevance to these weekly macro On My Radar missives. My investment mindset is pretty simple: defend your core wealth—let’s say that’s around 80% of what you have—seeking growth and protecting downside in such a way that your 80% can get back to 100% in four to six years (never a guarantee and one can dial up or dial down the return-to-risk knob based on their individual circumstances). Why? Money is too hard to earn and too easy to lose. The math of loss kills the compounding process, so we must avoid big losses.
With the core defended, you can create what I call the “explore” side of the portfolio—the 20% in this example. Of course, everyone’s needs and interests are different. You could be 70-30, 90-10 or 100-0—it all depends on your goals/objectives/time frame. Regardless, the “explore” is the fun stuff. Think transformational investment ideas in technology, biotech, healthcare, etc. These are wealth-creating opportunities. It takes trust, experience, and— importantly—a deep network to source, research, and implement ideas like these. I also believe the core-explore approach reduces the emotional indigestion and better enhances an investor’s ability to stick to a game plan. If you’d like me to explain further, please feel free to email me (firstname.lastname@example.org).
As promised, let’s take a quick look at coming earnings, notes from the Byron Wien-Ed Hyman-Felix Zulauf call, and the Felix Zulauf-Grant Williams discussion at the Virtual SIC 2020.
I do hope you enjoy the notes as much as I enjoyed both listening to the presentation (several times) and then organizing them to share what I learned with you. It a bit of a process but it sure does help me better understand the most pressing issues of the day. I hope it helps you too. You’ll also find an interesting put/call ratio chart in Trade Signals – which inspired this week’s title, “Euphoria Déjà Vu.” Thanks for reading and please feel free to reach out to me with any questions.
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:
- A Look at Earnings
- Byron Wien – Ed Hyman – Felix Zulauf Research Call
- SIC 2020 Notes – Felix Zulauf Interview
- Trade Signals – Euphoria Déjà vu
- Personal Note – Be the Sunshine
Let’s keep this earnings section short. 2019 full-year GAAP earnings for the S&P 500 came in at $139.47 per share. That is down from 2018’s full-year earnings, which were $148.34 per share. As you can see, we went into the 2020 pandemic downturn with earnings already weakening.
Ned Davis Research’s (NDR’s) 2020 full-year earnings estimate is $92.06. You’ll see in the next section that Byron Wien estimates $100 in 2020, maybe $120 in 2021, and says perhaps we get back to $140 by 2022 at the earliest.
Following is a history of earnings. As you read through, keep the following in mind:
- NYU published the chart below on January 5, 2020. They were likely using Wall Street full-year earnings estimates. The numbers weren’t even close. Actual was $139.47 and not the $162.35 the forecast predicted.
- Over time, companies do grow and that’s a good thing.
Why do earnings matter? Put simply, when earnings are weak, returns for the market are poor. NDR has an outstanding earnings model (shared below). Just focus in on the lower data box.
Keep earnings top of mind as you read further.
Let’s next dive into my notes from Wednesday’s Wien-Hyman-Zulauf research call, followed by the awesome Zulauf-Williams discussion.
One of the perks of subscribing to Felix Zulauf’s research service is being able to listen in on these calls—and this was a great one. If you are unfamiliar with these three heavyweights, do a quick internet search. They’re all exceptional thinkers—I’ll leave it at that.
I mentioned above that Byron believes COVID is a long way from over, the market recovery is mispricing the coming earnings challenges, and reacting too positively to the end of the lockdown. He thinks that’s true in the U.S. and true around the world. He is expecting a gradual, slow recovery, rather than the fast one the market is pricing right now.
As I mentioned above, Byron said, “I think we are going to earn $100 on S&P 500 in 2020 and maybe $120 in 2021. Perhaps we get back to $140 at earliest in 2022.”
Since the price-to-earnings (P/E) ratio is at the core of our understanding of whether price is high or low relative to earnings (are we looking at a good bargain with high coming returns or a bad bargain with low coming returns?), the earnings component matters. What Byron is saying is that he believes the earnings will be driven lower, making the market way overvalued over the coming few years.
Felix believes the first phase of COVID is over or flattening out. It has mostly disappeared in most EU countries and he expects a second round to arrive during the flu season. Here are a few additional highlights from the call:
- The lockdown has pushed economies down everywhere, and we’ve hit an economic bottom.
- Optimism is ahead of itself as measured by the put-call ratio (I touched on that in this week’s Trade Signals section—you’ll find the chart below).
- He expects a market correction and sees the summer months as difficult.
- The Fed panicked and injected aggressively. They have now gone to neutral.
- He noted one big positive is that the Treasury account at the Fed is sitting on $1.5 trillion and they usually like to have a balance around $400 billion. When they pay their bills and spend, that is money that is injected into the economy. Think of it like a QE. So, there is a lot of firepower the Treasury has sitting around ready to be injected into the economy.
- He favors the U.S. (but says to trade with tight stops) and is generally bullish on the dollar and gold.
I’ll skip much of what he shared, as you’ll find a deeper dive into Felix’s thinking in the next section below.
Highlights from Ed Hyman:
Ed noted that the great Marty Zweig always said, “Don’t fight the Fed.” Ed’s bullish.
And the Fed is just killing it here:
- ECB balance sheet in just the last three months has at a 100% annual rate. It increased $1 trillion and we expect another $1 trillion bump. And Evercore ISI, Ed’s firm, sees it increasing another trillion dollars.
- He doesn’t see any let-up on that front.
- And the same is true for the Fed. The balance sheet has been growing like crazy and we expect it to continue to grow more in the second half of the year. It will be up 75% when it is all said and done.
- He sees $6 trillion more coming. We see another $1 trillion U.S. care package in July. The EU is proposing $2 trillion. Japan has two tranches at $1 trillion each. And their household disposable income just went up 15% in one quarter. Abe gave everyone a check just like we did. Our income in April went up 15%. China has earmarked another $1 trillion in fiscal stimulus—mainly targeted for the tech space.
- So $6 trillion in stimulus, balance sheet expansion like crazy. U.S. money supply was up 23% last week. China’s most recent was up 11% and is something like $30 trillion. U.S. money supply is something like $18 trillion.
- You’ve got a lot of stimulus out there. It works with one- and two-year lags on monetary policy.
- When it comes to the virus, we are getting more optimistic on a vaccine, maybe early 2021. The odds that we’ll have one during first part of next year are over 50%. And the economy is opening up everywhere. Employment is up. Vehicle sales are up 40% from April to May and vehicle production is expected to go from 4 million in the second quarter to 10 million in the third quarter.
- Apple mobility index for the U.S. is going up a point a day (people are moving about), Evercore’s surveys for airlines and home-building are going up, Korea’s employment is going up, Canada and U.S. are improving. It may peter out, but he thinks we have something going here.
- He expects a digestion period going into the election and potential increase in the virus in the fall.
- His earnings estimate for 2021 is $145. You still have to put a huge P/E on it to justify high prices.
Byron added the following, based on what he’s seen from businesses:
- In February, there were 160 million people working in the U.S.
- It dropped to 130 million, and now it’s 133 million.
- He realizes it is improving day by day, but it is still a long way from where we were in February.
- Looking at corporations, the first 40% of their business covers their fixed costs, the second 40% covers their variable costs for the all of their production and service provision. It’s in the last 20% that they make their real money. And that’s true in Europe as well as in the United States.
- We are a long way from full employment and we are a long way from the best level of profitability. And as a result of that, he is one of the people who see a square root recovery (vs. a V-bottom or W-bottom in the economy). He sees a gradual rise after the bottom.
Unfortunately, the call ended abruptly due to connectivity issues.
My two cents is that our bet is between fundamentals and the Fed. Sell euphoria and buy fear. I believe the Fed supports, sits back, assesses, and supports again in periods of great stress. That may be the path ahead, unfortunately—but I could be wrong.
If you need a break, put this piece down and grab another coffee, or come back when you’re feeling ready. But do not miss the next section—it’s fantastic. Again, I could be wrong, but I think Felix has it right.
Felix Zulauf is the founder and president of Zulauf Asset Management, based in Zug, Switzerland. On Thursday, May 19, 2020, Grant Williams, author of Things That Make You Go Hmmm…, interviewed Zulauf at the 2020 Virtual Strategic Investment Conference, hosted by John Mauldin, CMG’s Chief Economist and Portfolio Manager.
GRANT: …what I want to get into right away is the term depression, and you put a piece out today, in fact, which I eagerly read when it dropped into my box this morning. Talking about this idea of a new Great Depression, because it’s something that there’s been an awful lot of talk about, and I think people have a great deal of trouble framing what that means in long term, so I thought you did a great job in that piece this morning talking about why a depression is absolutely the right term to use, but how it might be different. So, could we start with your thoughts on this Great Depression of the 2020s.
FELIX: Well, a recession is the part of the business cycle that cleans the system from the excesses of the previous expansion. And a recession usually lasts only two to three quarters or less than a year, and it does not really change the thinking and behavior of economic subjects (like the corporate sector, managers, and the individuals/consumers).
June 10, 2020
S&P 500 Index — 3,080 (open)
Notable this week:
The Citi Panic/Euphoria Model of investor sentiment is at its most euphoric level since the Dotcom bubble in March 2000. The forward price-to-earnings (P/E) ratio is also at its highest level since the tech bust and the S&P 500 Index is the most overbought since late fourth quarter of 2019. It is even more overbought than when I wrote, On My Radar: This is EUPHORIA, Wait for PESSIMISM. I echo the same caution today.
The current rally has been mainly driven by Federal Reserve and global central bank stimulus. That’s the reason, period. My go-to large-cap indicator, Ned Davis Research CMG U.S. Large Cap Long/Flat Index has remained in a risk-on, buy signal all year. It measures the short-term, medium-term and long-term trend in prices across the 24 sub-industry sectors that make up the S&P 500 Index. You’ll find that model and others in the dashboard section below. Interestingly, the popular 200-day and 50-day vs. 200-day moving average signals remain in sells. The 13-week over 34-week moving average rule moved to a buy signal this week.
For short-term traders, I believe we are in a “buy the fear and sell the euphoria” trading environment. Two things to keep in mind: (1) the NDR Daily Sentiment Indicator (chart below) is back again in the Extreme Optimism zone. That signals caution. (2) The CBOE Equity Put/Call Ratio is at the lowest level since 2010. It too signals caution. That 2010 reading preceded a 20% decline in the stock market. FOMO or fear of missing out is palpable. I don’t like chasing rallies. I could be wrong but I don’t believe we will go back to the February lows around 2,200. We have a motivated Fed at our back with money on the sidelines to buy. A 20% decline is a drop to approximately 2,600 on the S&P 500 Index. That makes more sense to me than biting on euphoria.
The balance of the Trade Signals follow below. Notable is the Don’t Fight the Tape or the Fed indicator moved back to a neutral reading. Volume demand is greater than volume supply – more buyers than sellers. A bullish indicator for equities. The bond models remain in buy signals as does gold. It is clear we are in recession (updated recession charts below). Most of the bad stuff happens in recession. Risk is high.
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.
My daughter, Brianna, sent me a nice note this morning. I sure did need it—it picked me right up.
“When You Can’t Find the Sunshine, Be the Sunshine.”
What if 2020 isn’t cancelled?
What if 2020 is the year we’ve been waiting for?
A year of so uncomfortable, so painful, so scary, so raw that it finally forces us to grow.
A year that screams so loud, finally awakening us from our ignorant slumber.
A year we finally accept the need for change.
Declare change. Work for change. Become the change.
A year we finally band together, instead of pushing each other further apart.
2020 isn’t cancelled, but rather the most important year of them all.
– Leslie Dwight
It’s been a busy week. I’ve been working from our office in Malvern, Pennsylvania. We moved in last November and took on more space. With everyone else working remotely and a new world upon us, I’m scratching my head at taking on the extra cost. But I can say I love the feel of the office and I’m enjoying the quiet time. Plus, the weekend weather forecast is looking perfect.
There’s some golf in my immediate future. A tournament qualifier tomorrow for son Matt and me. Brianna is joining for the round and I’m really looking forward to that. Susan flew down to visit her mother in Florida. I can report that the check-in process was comical—crowded and absent masks and social distancing. Markets are selling off this week with the uptick in U.S. cases in certain cities. We humans are ready to go, me included, and there is both good and bad risk in that. With Florida being one of the growing hot spots, and businesses opening up, rates of travel increasing, etc., we are concerned about Grandma Pat and I’m glad Susan is visiting.
I do hope you are getting to visit your loved ones. Hang in, stay positive… ever forward.
Wishing you and your family a safe, healthy, and happy weekend.
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.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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