May 13, 2022
By Steve Blumenthal
“We are in pre-recession, we are going into recession, and where the Fed goes from there I’m not sure.”
– Dr. Lacy Hunt, Executive Vice President, Hoisington Investment Management
The 2022 Strategic Investment Conference concludes today. In this missive, I’ll be providing a brief recap of day four. Grant Williams interviewed Albert Edwards and then Felix Zulauf. Mark Yusko followed and didn’t disappoint. Ben Hunt shared his thoughts on how social media (and media in general) is in attempting to control the narrative to shape our perspective. John Mauldin interviewed Howard Marks. Ed D’Agostino interviewed Cathie Wood, and the day concluded with Neil Ferguson interviewing the great Henry Kissinger. Yes, that Henry Kissinger. The Kissinger interview, as my friend Kevin Malone, put it, “was an absolute privilege to watch.”
Wow! What a day it was.
There was so much information to take in. It really requires further review and reflection on my part, but I do want to give you a feel, so here goes. Following are a few high-level takeaways shared in bullet-point form.
Day 4 Recap:
Albert Edwards, Global Strategist for Société Générale
- Edwards blamed central bankers for inflating an asset bubble. The Fed insisted that inflation was transitory, and got called out on it (they were wrong). A bit of a wage-price spiral is unfolding in the U.S., and central bankers are now “beating their chests” about how far they will go in raising rates.
- The Fed will be aggressive in its rate hikes to curb demand and reduce inflation.
- When the S&P is down 30–35%, the Fed will capitulate. That translates to a level of 3,000, which Edwards said will happen. The “Fed put” is lower because of inflation.
- But, he said, within two to four months of reaching that level, the Fed will reverse course and we will see a big rally.
- The last 19 bear markets have had an average decline of 39%. But we could go “way below that,” he said. Technology will lead the way down.
- Bond yields will go to “higher lows and higher highs…when the recession unfolds, the 10-year yield could go back to 50 basis points.”
- “We are approaching a secular bear market for bonds. But the cyclical recession will temporarily derail that.”
Felix Zulauf, Zulauf Consulting
- Nothing is linear. Things progress cyclically, as determined by greed and fear.
- There is a business cycle up-wave, then a bear market down-cycle.
- Government fiscal stimulus has caused supply-side distortions. Because of the inability to meet the quick increase in demand, we got inflation.
- Money printing by the Fed only postpones our problems.
- The Fed is attempting to regain its credibility. There is a big risk that inflationary psychology becomes embedded.
- The Fed must bring down demand, yet that will damage the economy. Jay Powell is not Paul Volcker.
- QT is the reduction of liquidity and we will get a liquidity crisis at some point. Will the blow-up this time be in Turkey or Hong Kong? We don’t know.
- He believes there is more room on the downside.
- We will see a big bull run in equities if the Fed U-turns.
- He sees a peak for now in commodities, and he’s bullish on commodities and agriculture commodities longer-term.
- On gold: He’s bullish long-term, while he believes the short-term trend is lower. He thinks gold will rise when faith is lost in authorities and the system itself, which will start in 2024.
- He sees more upside in yields and the dollar, and expects inflation to continue into the mid-2020s.
- He expects a rollercoaster ride in the markets over the next 10 years.
- In reference to bonds and equities, he said you must be aligned with the main trend and the trend is bearish.
BTW, I subscribe to Felix’s institutional service. I find it to be outstanding. Clients are typically large family offices, fund managers, institutions, and governments. You can imagine that the research service is priced for institutions, not retail. If you’d like to learn more, email my friend Jennifer Mendel at email@example.com. She runs the business side of things for Felix. I’m not compensated to promote it; I’m just a big fan of the work.
Mark Yusko’s 10 Potential Surprises for 2022
In Mark’s early years, he was CIO of the University of North Carolina’s endowment. Today he runs his own firm, Morgan Creek. He still loves UNC and refuses to verbally name the Blue Devil team located just 12 miles up the road from the Tar Heels campus. Each year, Mark publishes his list of 10 potential surprises. He presented his 2022 surprises and noted these are not predictions; they are the opposite of consensus. He believes each has a 50/50 chance of happening.
- #1: The CPI spike is merely base effects resulting from the lockdowns and re-openings, and the inflation trend reverts back toward deflation due to big demographic headwinds.
- #2: The market panics that occur even from the threat of rising rates cause the party train to stall and QE forever will return.
- #3: The music finally stops and there clearly aren’t enough deck chairs to go around. Serious hangovers ensue.
- #4: Equity market turmoil will shoo away the hawk. When the dove returns, the U.S. dollar falls.
- #5: Powell slips and falls, bumps his head, forgets about tapering and raising rates, and the bubbles get even bigger.
- #6: Politics magically result in OPEC pumping, or the SPR gets tapped and oil prices head back to $60.
- #7: Global investors see the strong growth and cheap prices of Japanese stocks and the Nikkei surges to 33,000.
- #8: The three dead dogs of higher rates, lower growth, and high valuations sink European equities and Mario’s campaign.
- #9: The PBOC stimulates again, stocks surge and China is the best-performing global equity market.
- #10: Crypto winter is back. Bitcoin prices struggle, but there are myriad opportunities to profit in emerging areas like P2E, social tokens, NFTs, and the metaverse.
Mark is lightning-quick and his chart deck is fun and entertaining, as is his great personality. He is famous for his bitcoin socks and has long been big believer in Crypto. He did a great job zeroing in on areas for us to focus.
- The last 13‒14 years have been unusual in that we have not had a substantial number of defaults in distressed debt. His fund is 80% invested. He sees the likelihood of more bankruptcies over the next two years and noted that cheap money has kept zombie companies alive.
- The Fed game is basically over. He does not see another round of stimulus in the years ahead.
- He believes the Fed should ignore the markets and focus on inflation. He noted that Powell doesn’t want inflation and will take strong measures to lower it. But, is the Fed willing to take higher unemployment rates to achieve that outcome? How much the Fed is willing to accept is hard to know.
- Raising rates and reducing the Fed balance sheet… making a soft landing happen will be hard to achieve.
- He sees the Fed Funds rate at 3% to 4% within 18 to 24 months.
- If the Fed capitulates at a 4% unemployment rate, it will tell us the Fed is not serious about fighting inflation.
- On market psychology, Howard noted that the “pendulum always swings too much, typically from flawless to hopeless.”
- He noted several examples:
- 1) Offshoring to save on costs; now supply chain security is most important.
- 2) In Europe, from energy cost savings to energy security (distancing from Russia).
- 3) The U.S political pendulum swung too far toward division… extremism in the pursuit of democracy is not advisable. He noted that “unfortunately, there is no reward for moderation, while there is for extremism.” Congress has become undemocratic due to voting strictly along party lines and is abdicating its responsibility as a result.
- He said we must have political cooperation to solve coming problems like Social Security, Medicare, and immigration. “Good ideas are not confined to a single party,” he said.
- He was asked what he thought Powell is going to do and answered, “Powell doesn’t know what he is going to do so why should we?”
- When asked about Bitcoin, he said he doesn’t have an opinion, noting that it is hard to assign a valuation to something without cash flow. He said his son, told him not to opine on something he knows nothing about and told him he should learn more. Marks did say, “As I understand it, Bitcoin is a record-keeping system. It’s a computing system that has great potential. Bitcoin is something that is monitored using the blockchain. And they’re two different things. He said his son and others tell him that blockchain has a bright future that may or may not be the same as Bitcoin.
There was a lot covered and with all the performance pressure Cathie is under, she has not wavered in her conviction for her process. We run a portfolio of her highest conviction ideas on our platform and given my overbought, overvalued, overleveraged views on the market in general, I’ve been waiting for a better entry. Seems it is nearer. Following are a few select highlights.
- Innovation solves problems. Today, inflation, energy, and supply chains are problems that technology is ready to solve. The costs are low enough that they can be scaled to reach a solution.
- Technology will enable deglobalization, self-sufficiency, and resilience. Innovation is deflationary.
- She continues to like Tesla and she believes 3D printing, or additive manufacturing, is ready for primetime and will help solve our supply chain issues.
- She sees manufacturing returning to the US.
- I found this interesting: Rare-earth minerals are crucial for technology, so how do we get more resilience in that area. Finding substitutes is one way. Technological ingenuity will pull us away from dependence on these minerals.
- Regarding food security, look at precision agriculture—Deere is at the forefront of this. It will improve yields, conserve fuel, and reduce herbicide use.
- Agriculture solutions will accelerate over the next few years.
- Gene editing will enable crops to use less water.
- Liquidity is drying up for technology. Yet, the need for technology has never been greater. Companies with real growth will continue to do well.
- Would not be surprised if we are in a recession now, with forces to the downside that will lower inflation.
- She remains steadfast in her 5-year outlook on companies. If she is right on the fundamentals, she believes her portfolio will show spectacular returns.
- Expecting the growth of the companies, even during a recession to be far greater than the economy. Adding that truly disruptive innovation companies will make up nearly 50% of the benchmarks cap weighting by 2030.
- She is not worried about battery issues and the EV sector.
Henry Kissinger and Neil Ferguson
My intention today was to highlight the exceptional conversation Henry Kissinger had with Neil Ferguson. Neil was the author of Henry’s biography. But my writing is nowhere near where it needs to be and I think it may be more interesting if I do an OMR combining my Kissinger session review with my notes from Richard Shirreff, who was Deputy Supreme Allied Commander Europe from 2010 to 2014, and high-level takeaways from George Freidman at Geopolitical Futures discussion. I’ll start with Shirref and Friedman and conclude with Kissinger/Ferguson. Stay tuned.
What I find most valuable about the conference is the way in which the various experts’ views are stress-tested by their peers.
Earlier this afternoon, I was interviewed by Mauldin Economics’ Ed D’Agostino. My job was to share what I gained from the conference; my firms multi-family office perspective on what Felix calls “a rollercoaster ride in the markets the next 10 years;” and more specifically, what an investor should do. Three percent-yielding 10-year bonds won’t work.
I shared a few general investment ideas, along with our 80% CORE, and 20% EXPLORE approach to wealth. I’m hoping to get a copy of today’s interview so that I can share it with you in a future OMR post.
Grab your coffee and find your favorite chair. A quick note on this month’s sticky inflation data is next, followed by this week’s Trade Signals, titled “CODE RED.” In the Trade Signals post, I included several valuation charts. You’ll see that the valuations are improving, but remain elevated.
I also show a few logical “risk-on” opportunity targets that I’m keeping my eye on. Stay safe and risk-protected. When fear is high and there is blood in the streets, we’ll have a very good “buy when everyone else is selling” risk-on opportunity. I have my high and growing dividend stocks and Cathie Wood’s top ideas in mind. In my view, we are not yet at risk-on.
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Sticky Inflation Data
U.S. inflation edged down to an 8.3% annual rate in April but remained close to the fastest pace in four decades as the economy continued to face upward price pressures. The Labor Department’s consumer-price index reading last month marked the first drop for inflation in eight months, down from an 8.5% annual rate in March. The decline came primarily from a slight easing in April gasoline prices, which have since reached a new high. Broadly, the report offered little evidence that inflation was cooling, Gwynn Guilford reports.
Prices rose for groceries as well as dining out, airline travel and other services that consumers are turning to as they shift from spending heavily on goods from earlier in the pandemic. Airline fares surged 18.6% in April from a month earlier, the fastest rise on record. The cost of full-service restaurant dining rose 0.9% from March, the biggest gain since last October.
A steady pickup in housing costs, which account for nearly one-third of the CPI, is also adding to inflationary pressure. Both tenant rent and so-called owners’ equivalent rent, which estimates what homeowners would pay each month to rent their own home, rose 4.8% from a year earlier, a pace last seen in the late 1980s and early 1990s.
“Inflation is no longer just contained to the supply chain—these pressures are actually becoming more broad-based,” said Aneta Markowska, chief financial economist at Jefferies LLC, referring to disruptions in goods supplies that initially drove the run-up in prices.
My two cents: An inflation regime is upon us. Inflation regimes are different. I do believe it will ebb and flow, much like it did in the 1970s. The traditional 60-40 approach is done for now. It’s worked for the last 10-years and much of the last 30-years. It didn’t work in the 1970’s. It is how most portfolios are positioned today.
I like 80% CORE and 20% EXPLORE. It is an “Endowment” like investment approach. There are simple ways to hedge equity exposure, there are ETFs that give you market exposure with options hedging built-in, and there are alternatives to traditional short-term fixed-income investments that are well collateralized and yield in the high single digits. There is much you can do but it requires more active money management. If you have $500,000 or more to invest, send me a note if you’d like to learn more.
Trade Signals: CODE RED
May 11, 2022
Notable this week:
“We are in pre-recession, we are going into recession and where the Fed goes from there I’m not sure.”
– Dr. Lacy Hunt, Hoisington (2022SIC)
You’ll see below (or when you click through to the entire Trade Signals piece if you are reading this in On My Radar) that the indicators are RED across the stock and the bond market dashboard. There is no green. The Don’t Fight the Tape and Fed indicator is back at -2 (“Watch Out For Minus 2”), and this week the NDR CMG Large Cap Long Flat Indicator moved to a sell. You’ll find the dashboard of indicators further below. The investor sentiment indicators are “Extremely Pessimistic,” a short-term bullish indicator. The recession indicators aligned with Dr. Lacy Hunt’s recession warning. Buckle up and keep hedges in place. Let’s look at some tactical investment opportunity targets in this week’s Trade Signals.
Typically, I share my favorite valuation charts with you each month in On My Radar. This week I’ve been glued to the Mauldin 2022SIC, and as I write this week’s Trade Signals, I’m listening to a great conversation with Joe Lonsdale, Neil Ferguson, and now it’s William White and Lacy Hunt. I’ll share much more with you over the coming weeks in my OMR notes. Let’s just say the current conditions = CODE RED:
- Valuations? Valuations are better but remain overvalued
- Leverage? Declining off of record highs. Leverage in the system remains too high
- Recession? We are in pre-recession; we are going into recession.
- The Fed? The Fed is fighting inflation and can’t support the markets – yet.
Let’s take a look at valuations and set some opportunistic targets. Red is bad, green is good.
Valuations: The Buffett Indicator
Note the red “We are here” arrow. Off the record valuation high, but it still has a way to go to get back to its long-term “linear regression trendline.” A much better investment opportunity will present at and below the dotted black line. Note the “We’d be better off here” green arrow.
Valuations: Median PE
The same line of thinking is reflected in this next chart. Focus on the green “We’d be better off here” arrow. Consider the Median Fair Value estimate of 3,033 a mental risk-on opportunity target. At this point, annualized returns of 10% or so are a reasonable expectation.
Valuations: Stock Market Capitalization to Gross Domestic Income
Here’s how to read the chart:
- Focus on the orange line in the middle of the chart. It tracks the stock market’s value as a percentage of nominal gross domestic income.
- The bottom section of the chart (the light blue line) plots how far above or below the orange valuation level is from its long-term trend.
- We can look at history for handicapping future return probabilities. Focus on the data box in the upper left-hand section of the chart. The average percentage changes in the S&P 500 Index returns that occurred 1-, 3-, 5-, 7-, 9- and 11 years later based on whether the valuations (as measured in terms of total stock market cap to gross domestic income).
Valuations: Based on US Household Stock Ownership
The last valuation chart to share with you today looks at US Household Stock Ownership. Think of it this way, when investors are overweight stocks in their portfolios, as they are today, they are fully invested with little additional buying power to buy more stocks.
Here’s how to read the chart:
- The top red circle identifies a high level of allocation to stocks. The bottom red circle shows low subsequent annualized returns 10-year laters: note 1966, 2000, 2008, and the recent record high of 62.47%.
- The small green circle identifies the low level of allocation to stocks. The wider/larger green circle shows the high subsequent annualized returns 10-years later. Note 1975 to 1990 and again in 2009.
- The large red arrow indicates where we are today and the actual 10-year subsequent returns that followed when stock ownership was high. We’d be better off at the big green arrow; however, it wouldn’t be so bad at the 3rd or 4th Highest 10% (data box at the bottom of the chart).
Where might we go from here?
If I can take a shot at translating the above data into an actionable game plan, this next chart sets a target between 3,000 and 3,500 in the S&P 500 Index. Median PE “Fair Value” is at 3,033. That will be a correction of ~ 37% from the December 2021 high. At that level, I believe it is reasonable to expect a 10-year annualized compounded return of 10%. Note the green box in the chart.
As we witnessed in prior periods of excess, the majority get run over when it reverses. This time around, investors are highly concentrated in the same few stocks – primarily US large-cap growth stocks, funds, and ETFs. We are in CODE RED.
See the opportunity. It will present when it doesn’t feel like an opportunity. It will present in an emotional state of fear.
The Dashboard of Indicators follows next. More red than green. Yellow arrows indicate a nearing change in signal.
Click HERE to see the Dashboard of Indicators and all the updated charts in Wednesday’s Trade Signals post.
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.
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Personal Note – An Old Dear Friend and Golf
Many years ago, I attended a soccer try-out in the Philadelphia area. It was part of U.S. Soccer’s then national plan to identify talent by creating regional tournaments. The goal was to identify the country’s top talent invite them to regional try-outs, and from there select the best of the best to try out for the national team.
Standing behind me in the registration line for the Pennsylvania team try-outs was a young man from Fleetwood, PA named Doug M. He led his team to a state championship in 1979 and scored 59 goals in his senior season. Sports Illustrated had just named Doug in their “Faces to Watch” section. He led the nation in scoring that year.
“Hey, do you have a roommate yet?” he asked. I knew all about Doug. What I didn’t know was that was the beginning of a life-long friendship. We both made the state team which made for a fun summer. We were teammates at Penn State and later we joined the same fraternity. Somehow, we were able to sneak a cooler of beer on the team bus to be opened only after a win. Someone would whisper 1, 2, 3 and following 3 there would be a loud collective cough. Most times we thought we were able to provide cover for the sound you know when a beer can is opened. The rides were long, the celebrations were fun and it wasn’t long before the team was fast asleep. Young and dumb!
Years later, Coach Bahr would joke with us. Of course, he knew.
When I married at age 30, Doug was the best man at my wedding. We keep in touch, reaching out to one another from time to time, and when we connect it’s like no time has passed—we picked up right where we left off. Tomorrow, we are going to play golf together at Stonewall and share an IPA or two afterward. I’m really looking forward to being with my old dear friend. He’s asking for way too many strokes and I’ve agreed. Adding, “you’re going down.” Regardless of who comes out on top, the win will be our time together. I can’t wait.
Wishing you a great week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Forbes Book – On My Radar, Navigating Stock Market Cycles. 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. 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.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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