April 16, 2021
By Steve Blumenthal
“Earnings don’t move the overall market; it’s the Federal Reserve Board….
Focus on the central banks and focus on the movement of liquidity….
Most people in the market are looking for earnings and conventional measures.
It’s liquidity that moves markets.”
– Stan Druckenmiller,
Former Chairman & President, Duquesne Capital
“When the end comes, it is because the US Federal Reserve has hit the brakes,
or at least it has been for almost every cycle over the last century.
The Fed raised interest rates by 400 basis points before the Lehman crisis,
350 points before the dotcom bust in 2000, 1,300 points during Paul Volcker’s
war on inflation, and 800 points to rein in (belatedly) the ‘guns and butter’
stimulus of the 1960s.”
– Ambrose Evans-Pritchard and Jeremy Warner, The Telegraph
“Big money is made in the stock market by being on the right side of the major moves.
The idea is to get in harmony with the market. It’s suicidal to fight trends.
They have a higher probability of continuing than not.”
– Martin Zweig,
Late Investor, Advisor, and Financial Analyst
In the mid-1980s, the great Marty Zweig wrote a book titled Winning on Wall Street. In the book, Zweig shared a rule that was important back then and remains important today: “three steps and a stumble.” When the Fed raises interest rates three times, the markets stumble. Here’s a look at the track record since 1915:
The takeaway is simple: the Fed has enormous influence on stock prices. As Zweig explained, “The monetary climate–primarily the trend in interest rates and Federal Reserve policy–is the dominant factor in determining the stock market’s major direction.”
The Fed and the trend are bullish. Risk level is high. Seabreeze Partners Management president Douglas A. Kass noted this week, “With market valuations, investor sentiment, and prices well above long-term averages, trading volume low and with allocations to equities historically elevated––stocks remain vulnerable and ‘the margin of safety’ is nearly invisible to my eye today.”
It’s liquidity that moves the markets, and the Fed and the Treasury (and other central banks) have their hands on the spigots.
And Marty’s three steps don’t appear to be in our immediate future. Probable lift-off in 2022.
The risk is the Fed reacts too late and inflation gets out of the bag. But it’s not a question of whether they are going to be late; it’s a question of how late they’ll be. This time, three steps and a stumble may also be late.
While driving to the office Tuesday morning, I listened to Bloomberg’s Tom Keene and Jon Ferro interview William Dudley, former president of the New York Federal Reserve. The interview was telling… It will give you a peek into the mind of the Fed.
I share highlights in bullet-point form below and encourage you to put your sneakers on, plug in, and go for a walk while listening to the full podcast.
Here are my key takeaways:
Keene asked Dudley if he is concerned about the banks today. Quick answer was no. He then asked about the leverage building up in the shadow banking industry and the lack of regulation in that particular area. “Do you see a pressing concern?” he asked.
- Dudley: I think it’s pretty pressing. I mean, when you think about what happened last March, a year ago, basically the federal government had to rescue the money market, mutual fund industry again, we had problems for mortgage read space, we have problems in the corporate bond space, we have dysfunction, the US Treasury market, so and then more recently, we had the articles issue. So it seems to me like the non-bank financial sector is still rife with a lot of issues that need to be dealt with sooner rather than later.
Then, Dudley was asked about the transitory nature of inflation.
- Dudley: While the Fed is being patient for a couple of very obvious reasons. Number one, they’re not really sure where full employment is. Number two, they’re not sure how fast inflation will rise once they get to full employment. And so they’re willing, and number three, they’re worried about inflation, expectations, becoming unanchored to the downside because the Fed hasn’t been able to keep its 2% inflation objective for a long time. So that change in policy is well motivated.
- The risk is that the Fed will be late. Before, the Fed basically tried to tighten monetary policy to arrive at a 2% inflation rate, full employment, the neutral monetary policy all at the same time. Now, they’re not even going to start to tighten monetary policy until they’re at full employment [and] inflation’s at 2%. And they expect inflation to move higher. So the Fed [will] be much slower to tighten this regime than in prior regimes, and that does create some risks for the economy.
Dudley was asked, “But we say it’s a risk that they’ll be late. Isn’t it a commitment that they’re going to be late? Well, the question is, how late?”
- Dudley: I think they are making commitments that they’re going to be late. The question is really how late and then how high will they have to raise short-term rates, to basically keep inflation from continuing to accelerate?
- And the risk is that recession will be more likely, at that point, because the Fed is going to have to move not to a neutral monetary policy quick with tight monetary policy, but they’re following this new framework.
“So this is a huge issue, and I think the most important question we can ask right now [of] Fed officials and we asked it of Vice Chair Clarida on Friday is how will they know if they’re wrong? On this transitory issue? If you run the FOMC, back on the FOMC, Bill, how would you know if you were wrong?”
- Dudley: Well, at the end of the day, I mean, I think they they’re going to look at the bubble that we’re going to see in inflation this year is mostly due to base effects and some frictional cost issues or reopen the economy.
- They’re going to be really focusing more on the labor market, how many people are still unemployed, compared to where we were in March of 2020.
- Right now, we have a shortfall of employment of about 8.5 to 9 million people. And the feds could be tracking that very carefully. As soon as people get employed, then the Fed will start to focus on the transitory factors of inflation. And really, one that they are most concerned about is what point you get to such a tight labor market that generates wage pressures that drive up prices.
“And Fed officials have said that they have the tools to combat inflation that’s higher than expected. Do they have the tools to deal with financial disruption after with this incredible surge in risk taking that has been on the heels of Fed policy? What happens if that stopped in its tracks as a result of Fed tightening policy?”
- Dudley: I think you’re raising an important question that when the Fed goes from very, very friendly to unfriendly financial markets are going to have an adjustment and the adjustment could be quite severe after such a long period of low interest rates.
- I don’t think the Fed cares about the stock market level per se, but they do care if the stock market were to collapse, then that would potentially hurt the U.S. economy. So the Fed does care about financial conditions in terms of how they feed into the performance of the economy.
- The Fed is not going to run to the rescue, just because the stock market goes down.
“But it raises a question about whether the Fed is going to tighten in the near term because they see that things are getting a little bit ahead of their skis or if they tried to take actions to combat inflation could they torpedo markets that are already at heady levels. Do you feel like your colleagues are actively considering that or is that sort of, not as significant as just getting the market and the economy back up to speed?”
- Dudley: I think Chair Powell, repeatedly has made it very clear that the Fed is not going to be preemptive, and they’re not that concerned about financial stability risk. What they’re concerned about is getting that 8 to 9 million people back to work as soon as possible. That’s the focus of policy right now. (Emphasis mine.)
- What that does do though creates a risk for markets, when the Fed has to shift gears and start to worry about inflation. That’s probably several years off.
“In our great debate here, do we still underestimate that wage inflation doesn’t move because of the new technological impulses that we see in our economy?”
- Dudley: Well that could be a factor.
- We are running an experiment basically and we’re going to see how this experiment goes.
- There is more uncertainty than usual because we’ve never had to recover from a pandemic like this, going back for more than 100 years.
- So anybody who tells you that they know how the economy is going to perform over the next year or two, I think is not being truly honest with you because we’ve never had an economic recovery like this one, fueled by massive monetary and fiscal policy stimulus.
- So I think it’s going to be very hard to know for sure how fast this is all going to unfold.
And finally, this question: “Mohammed el Erian said on Bloomberg Opinion this morning. Did the Fed shift policy lanes at the wrong time? Do you think they made this framework shift a little bit prematurely because I wonder if they had known what was about to happen on the fiscal side whether they would have made this change?”
- Dudley: I think they would have made the change in any case because they weren’t really worried about inflation expectation becoming an anchor to the downside, and because they had such a poor record of forecasting what level of employment is full employment.
- So I think they would have made that shift, no matter what. But I think Mohamed El Erian piece is a good one because I think he points out the fact that there are some risks of this new strategy, the Fed could be late and if the Fed is late, they’ll have to slam on the brakes and have consequences not just for the economy but also for the financial markets. (Emphasis mine.)
That concludes my bullet point notes. That’s about as straightforward and clear as it gets. My two cents: The Fed will be late. Three steps and a big stumble remain ahead. My other takeaway is that the Fed will give the markets room to breathe before rescue. That likely means more stumble in the stumble. Keep wealth preservation top of mind and for now; the trend remains our friend.
Here’s the link again or click on the image below: https://www.bloomberg.com/news/audio/2021-04-12/surveillance-fed-policy-with-dudley-podcast
Trade Signals – Rule #9
April 14, 2021
S&P 500 Index — 4,074 (open)
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators. Market trends persist over time and stem from changes in risk premiums or the amount of return investors demand to compensate them for the risks they take.
Risk premiums vary a great deal over time in response to new market information or changes in the economic environment or even changes in investor sentiment. When risk premiums increase or decrease, stocks, bonds, and other assets have to be priced again. Investors react to the changes gradually and this creates trends.
Rules-based trend following strategies don’t predict, they react to what prices are telling us about supply and demand. More buyers than sellers, price moves higher and more sellers than buyers, price moves lower. Trend-following strategies seek growth opportunities while maintaining a level of protection in down markets.
Notable this week:
Bob Farrell’s Rule #9:
“When all the experts and forecasts agree,
something else is going to happen.”
– Courtesy of David Rosenberg
Overvalued, Overbought, Over-believed: Each week, since the late-1990’s, I look at the weekly Ned Davis Research (NDR) Crowd Sentiment Poll. The indicators look at the percentage of investors who are bullish and the percentage who are bearish among different categories of investors. Investor polls from Investors Intelligence — surveys of stock market newsletter writers, the American Association of Individual Investors surveys of market expectations among individual investors, CBOE Put/Call ratios — ratio of the volume of call options to total options traded (calls plus puts) on Chicago Board Option Exchange, Rydex fund assets (the ratio of assets invested in bullish market timing Rydex funds to total assets in bullish plus bearish Rydex funds) and MBH Commodity Advisors Daily Sentiment Index for the S&P 500 (surveys of non-professional retail traders) and others.
The collective reading is compiled weekly and you can see the plotted history (1995 to present) reflected in the orange line in the following chart. The data in the lower two data boxes track the performance of the S&P 500 Index based on the degree of investor optimism and returns that occurred based on the readings.
The reason I’m sharing this with you today is since 1999, there we just two readings that were higher than this week’s “Extreme Optimism” reading of 74.8 (75.7 in 2004 and 78.9 in early 2018). If you were ever looking for an entry point to hedge your equity market exposure, now is that time. Put options are inexpensive because everyone is bullish. Here is a look at the history.
Of course, there is no perfect timing measure and with the Fed and the extra stimulus from Washington now in play, my best guess is that the gig is up when inflation gets out of its box. Too early to say but clearing its showing its teeth.
You’ll see below that NDR CMG Long/Flat Indicator remains firmly bullish as does the majority of our indicators. However, we believe now is a good time to hedge.
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.
Trade Signals — Dashboard of Indicators
(Green is Bullish, Orange is Neutral and Red is Bearish)
Equity Trade Signals
- Ned Davis Research CMG U.S. Large Cap Long/Flat Index: Buy Signal – 100% U.S. Large Cap Equity Exposure
- Long-term Trend (13/34-Week EMA) on the S&P 500 Index: Buy Signal – Bullish for Equities
- Volume Demand (buyers) vs. Volume Supply (sellers): Buy Signal – Bullish for Equities
- S&P 500 Index 200-day Moving Average Trend: Buy Signal – Bullish for U.S. Large Cap Equities
- S&P 500 Index 50-day vs. 200-day Moving Average Cross: Buy Signal – Bullish for US Large Cap Equities
- NASDAQ Index 200-day Moving Average Trend: Buy Signal – Bullish for U.S. Large Cap Technology Equities
- Don’t Fight the Tape or the Fed: Indicator Reading = -1 (Bearish Signal for Equities)
- Value vs. Growth Factor Model: The Model favors Value
Investor Sentiment Indicators
- NDR Crowd Sentiment Poll: Excessive Optimism (S/T Bearish for Equities)
- NDR Daily Trading Sentiment Composite: Excessive Optimism (S/T Bearish for Equities)
Fixed Income Trade Signals
- CMG Managed High Yield Bond Program: Buy Signal – Bullish for High Yield Corporate Bonds
- Zweig Bond Model: Buy Signal – Bullish on High Grade Corporate and Long-Term Treasury Bonds
- Global Recession: Low Global Recession Risk
- U.S. Recession: Low U.S. Recession Risk
- Inflation Timing Indicator: High Inflationary Pressures
- U.S. Dollar Price Trend – Short-term (Daily MACD) Sell Signal
- U.S. Dollar Price Trend – Intermediate-term (Weekly MACD) Buy Signal
Select Recession Watch Indicators
- Global Recession Probability Indicator: Low Global Recession Risk
- The Economy Based on the Stock Market Indicator: Low U.S. Recession Risk
- Recession Probability Based on Employment Trends: Low U.S. Recession Risk
- Credit Conditions – Favorable, Low U.S. Recession Risk
- U.S. Economy vs. Yield Curve: Low U.S. Recession Risk
- Trend Indicator – 13-week EMA vs. 34-week EMA: Sell Signal
Click here for this week’s Trade Signals.
Personal Note – 2021 Mauldin Strategic Investment Conference
That sure was an exciting finish to the Masters. Japan’s Hideki Matsuyama finished one shot over par on the final day, but it was enough to win it all. What Tiger did for the popularity of golf for young people in the U.S., Hideki has done for golf in Asia. Carrying the weight of his country on his shoulders, he stood strong and finished 10 under par. American Will Zalatoris finished at -9. It was fun to watch.
The 2021 Mauldin Strategic Investment Conference begins in a few weeks, on May 5. The theme to this year’s virtual conference is “Navigating the New Normal.”
Speakers include Bryon Wien, vice chairman of Private Wealth Solutions, Blackstone Group; Richard Fisher, former president and CEO, Federal Reserve Bank of Dallas; Doug Kass, president of Seabreeze Partners; famed investor Howard Marks, co-founder and co-chairman of Oaktree Capital Management; and OMR regulars Felix Zulauf; Bill White; Dr. Lacy Hunt; David Rosenberg; and Mark Yusko to name a handful.
Mauldin’s conferences are like no other conference I attend. Usually a big name presents, then exits stage left. Nothing out of the ordinary there. But then Mauldin does something unique.
After several sessions, he puts the presenters on stage together (or on one screen) and a thoughtful debate ensues. Imagine Lacy Hunt challenging Richard Fisher on Fed policy, or Zulauf, Marks, and Kass debating markets. Hard questions are asked and convictions are tested. Each presentation is carefully documented, and attendees are provided with audio recordings, presenter slides, and transcriptions.
I touched on inflation above today. Phosphates, steel, organic chemicals, plywood, plastics, and lumber are up 10% to 23%–the most since 1974. It’s hard to say inflation is not a risk, and the Fed is saying they are going to be purposefully late to raise rates (to put out an inflation fire). But I want to add that we don’t yet know what the outcome will be.
This morning, I read Dr. Lacy Hunt’s latest quarterly. He believes the level of debt and aged demographics mean any inflation will be transitory. Hard to argue with his math. Deflation is the major headwind and rates are likely headed lower. Transitory? Hope so. Don’t know. And this is exactly what I want to see challenged on Mauldin’s virtual stage. My global-macro geek excitement meter is rising and I’m really looking forward to the conference.
If you are attending and are an accredited investor, Kevin Malone, John Mauldin, and I will be presenting on short-term private credit (to replace traditional bond holdings) and late-stage venture capital. We’ll share a few of our top ideas.
Note: Mauldin Economics has no affiliation with CMG and CMG receives no compensation from Mauldin Economics.
You can learn more by clicking on the image that follows:
Some golf is in the weekend plans, as well as overdue yard work. A few more pieces of outside furniture sit in storage and I’ll grab the boys to help lift and carry. Flowers are up, trees are greening, and it’s always nice to spend more time outside.
Wishing you the best…
Have a great week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Consider buying my newly published Forbes Book, described as follows:
With On My Radar, Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth.
If you are interested in the book, you can learn more here.
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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