March 6, 2020
By Steve Blumenthal
“It will take considerable time — perhaps several quarters —
before we can be confident that the virus has been contained.
It will take even longer for the global economy to recover its footing.”
– Letter from Sequoia Capital to Founders and CEOs of its Portfolio Companies
(March 5, 2020)
The current movement in the markets is unprecedented. It took just five days for the market to drop 11%—the largest decline in the shortest amount of time on record. If your head is spinning, it should be. One-day moves of 5% have happened just a few times since 1928. We’ve had two in the last week. Rare indeed.
The Fed’s intra-meeting rate cut of 50 bps on Tuesday was the sixth time in the past two decades they’ve made such a rescue move. An emergency response? Yes. Expect more.
I’m writing from beautiful Park City this week where I am attending the WallachBeth Winter Symposium. Among the ranks are market makers, traders, investment managers, institutional money managers, banks, insurance companies, investment advisors, and ETF issuers. I share a few of my high-level takeaways with you today. Let’s go…
The 10-year Treasury note yield was at 1.22% when I wrote last week’s On My Radar: John Ray – I’m Calling the Bond Market Top (Low in Yields); It’s Got to Be Over. It’s yielding 0.93% as I write. Wow!!!
Samantha Azzarello of JP Morgan Asset Management shared the firm’s thoughts on “What’s Ahead in 2020,” suggesting we zoom out and focus on the mega-trends over the coming years versus being hyper-focused on the short run. I enjoyed her candid, honest way. Following are several high-level bullet points from her presentation:
Theme one: Looking at the forward P/E ratio (JPM’s preferred valuation measure) vs. its 25-year average P/E of 16, the market is richly priced.
- Thus, at the beginning of 2020, JPM was not excited about stocks. The market was expensive at a P/E ratio of 18.
- She said you can make the argument that when rates are lower, a higher P/E can be justified.
- JPM expects rates to stay low for a long time so “overvalued” can remain in place for a while, but equity returns should be low.
Here is a look at JPM’s February month-end forward P/E chart. Note they believe P/E has moved back to its long-term forward P/E trend line. [SB here: I’ll share my February month-end valuation dashboard with you next week. I don’t prefer forward P/E but certainly worth taking JPM’s viewpoint in.]
Theme two: We are all living longer, working longer, and the demand for equities will go up.
- Fixed income is not doing what it should do for a portfolio (yields are too low).
- We’ve seen a decline in the number of outstanding shares of stocks. Companies are staying private longer or deciding never to go public. As such, there are not enough shares of stocks in the market. This is something that isn’t being talked about enough.
- The SEC has put together a task force to study why companies are not going public. They think it is a real problem. The reality is it is punitive to go public (companies have to focus on the short term and earnings every single quarter, etc.)
- In addition, as people live longer, the demand for stock—which is in limited supply—is extending much farther into retirement than it was previously.
- Marry all this in your mind—bond yields not helping, limited supply of public shares, and people living longer—and you can see how elevated valuations can remain elevated for some time. Samantha believes forward P/E could pop above 20 without eliciting much stress. [SB here: By the way, this is why private investments could be an important, yet small, portion of your portfolio – only if it’s suitable depending upon your circumstances and you’re qualified.]
Theme three: The idea around a secular bull. First, the chart, then the notes.
- She said some of the JPM asset managers believe we entered a secular bull market in 2015. A secular bull is a long-term uptrend that lasts about 13 years. You can definitely have more than one 20% correction in secular bulls. The last secular bull market was in the 1980s. She cautioned that they are growth managers, so they are generally bullish-biased, but that is their case. [SB here: Note in the chart that it took 15 years to get to the new high, 2000-2015, or the beginning of the next secular bull. By the way, I don’t share this view and I don’t like forward P/E as a base valuation metric because of Wall Street’s history of over-estimating future earnings… but I could be wrong and Samantha could be right.]
- She says much of this comes down to demographics—the number of working younger people versus working older people. Peak earning years begin in your 40s and the millennials are getting there. The oldest turn 39 this year. A big support for equities. [SB here: 75% of investable funds is in the hands of pre-retirees and retirees. I agree with future demographic wave but not until money transfers as boomers graduate, so to say.]
- Samantha is really bullish on equities. They are still the biggest wealth generators.
- Coronavirus is not even stressing her out; it is the 10-year at 1% that’s keeping her up at night.
The last big mega-theme she is focused on: Inequality is a big risk to markets and growth.
- This is the biggest risk facing markets—and it’s one that no one is talking about.
- About two months ago, the Fed put out a study on inequality in the U.S. It’s important because they are actually a trusted source on this. When the Fed comes out and says we want to start paying attention to this data, we should…
- Why does this matter? Simply, wealthy people don’t spend money. They save it and they are all about capital preservation. She said she can speak to that, not because she is personally wealthy, but because she works with JPM’s private bank and all of their wealthy clients.
- Their portfolios are all about capital preservation. She said, “If I have to be honest,” they are in muni bonds, they are interested in paying as little tax as possible, and they are not really interested in risk assets.
- From a purchasing power/consumption standpoint there’s this:
- The top 10% are really not spending. If you are in the top 10% and you are given a dollar, you are only spending 69 cents. And she’s seen estimates that are lower.
- If you give a dollar to someone in the bottom 90%—basically everyone else— they are spending $1.01.
- If you go lower down the earnings curve, for every dollar they are given, they are spending $1.37.
[SB here: This may just be our greatest challenge and we’ll need to solve it. And we will. We just don’t yet know how. I’ve written about this before: the challenges between the haves and the have-nots. It is showing up in our economy locally and globally. It is showing up in our politics. It is driving us apart. A good resource on the subject and possible solutions? Institutional Investor’s article titled, “Dalio Says Capitalism Is ‘Not Working.’ Here’s How He Thinks the U.S. Should Fix It.” To read it, click here.]
Samantha added that inequality is the highest it’s been since the 1910s, and what got us out of it then was the rise in unions. Unions were very powerful and you don’t have that force right now. She said, “Expect higher taxes.” I think she’s right.
One of the attendees asked Samantha for her view on the 10-year yield. As you know, I went out on the limb last week suggesting we are at a secular low in bond yields. My long-stated target on the 10-year has been 1%. My number was breached this week.
Sam’s view (some very interesting insights here):
- The general trend of rates coming down remains. Nothing stops a big wave. We do think the 10-year yield could go to zero; it is in the realm of possibility. [SB here – I’m in the John Ray camp. I think the bottom is now but that’s a guess. Watch the trend in price. The move since last week has been epic.]
- The U.S. yield curve is not the U.S. yield curve anymore. It is a worldwide hodge-podge of global interest rates.
- It is not representative of U.S. rates. JPM has a “fair value” model that looks at U.S. growth, U.S. inflation, sentiment and inflation information—all that stuff. The 10-year Treasury yield should be above 3%, period.
- Clearly, it’s not, so the fair value model is not working. That’s because this is a global model now. We are linked to international rates. Foreign inflows and the fact that rates are basically negative in much of the world are like a big anchor hanging around our neck. The Fed has no control over this—it controls the short end but not the long end. The long end is controlled by the anchor.
- So, there is no way our yield curve will move higher unless rates around the world go up. And guess what? That is not happening. So, we are in this weird catch-22.
- The yield curve could invert again, but it does not mean a recession is coming; it just means the yield curve is massaged and manipulated.
- Sam used a funny analogy. She said it’s like a false fire alarm. Her apartment fire alarm is always going off. It’s not a fire; she’s just making toast. An inverted yield curve today is like a broken fire alarm. With that in mind, let’s not view it as a recession-is-coming signal.
- She said she doesn’t want to fear-monger, but Tuesday felt very bizarre (the 10-year diving below 1%). The Fed cut rates, they wanted yields on the 10-year and 30-year to go up. Technically, they should have gone up. They sent a message of “Don’t worry, we are here…” but instead, rates fell. So, this feels quite broken.
Bottom line: We have to reposition fixed income for everyone we talk to because we are not getting yield. Other asset classes are required. This whole dynamic is not changing anytime soon. It’s time to get out of your longer-dated bond funds and ETFs. I just finished a paper called The Case for High and Growing Dividends. Shoot me a note if you’d like a copy.
I really have no idea what this means in terms of the market over the next several days or weeks. Sitting in Park City with some of the major liquidity providers in the business, I can tell you what they are saying: In times of crisis, liquidity dries up. Market makers step away from risk. Therefore, it is easy for hedge funds or a handful of traders to push the market in either direction. Meaning, it doesn’t take a gigantic sell order to send the market lower. Same on the buy side.
My friend Dave A shared the next chart with me – suggesting the large recovery move is a bull trap. He could be right.
I’ve written a great deal about how fully invested retail investors are in stocks, how high margin account balances are today, how corporate share buybacks (which fueled much of the market gains in 2019) are late in the game (just look at the record level of corporate debt, much of it fueled by share buybacks). Perhaps global flows increase, yet I’m not sure—outside of the Fed themselves—who might be the next marginal buyer. Most investors are all in and leveraged up. Fixed income flows to equities? Don’t know.
What to do? I’m sticking to our trend-following rules and will let price dictate risk management. What I do know is the chips are not stacked in our favor. We sit late cycle and well above the long-term trend (updated in Trade Signals). I’d be far less concerned if the current market price was below the long-term trend growth. Then, the chips would be stacked in our favor. In the Trade Signals section below, you’ll find the trend signals are weakening, but not yet in risk-management sell mode for U.S. equities. Lights on!
When you click through, you’ll also find a thoughtful piece from my friend Dr. Jonathan D.T. Ward. I met Jonathan at the Bangor, Maine, airport last August. We spent several hours together on the drive to Grand Lake Stream and the annual Camp Kotok (Shadow Fed conference) where we fish, debate, and share knowledge. Jonathan opened my eyes to the challenges we face with China. He wrote a must-read book entitled China’s Vision of Victory, and he is founder of Atlas Organization, a think tank and consultant to the U.S. government, U.S military, and corporations. Earlier this week, one of our fishing friends shared an article by Dr. Ward with the Camp Kotok group and I share it with you. Hint: watch India. The conference concludes today. There was an excellent presentation on leadership that I’ll share with you next week and meeting and learning from old and new friends… priceless. I finish today’s piece with a few photos from the Park City event. It’s been great fun.
Grab that coffee, find your favorite chair, and keep washing your hands!
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:
- “Why a U.S.-India Partnership Must Succeed” – Jonathan D.T. Ward and Jagannath Panda
- Trade Signals – Supply and Demand Jaws Closing, and a Look at Long-Term Trend
- Personal Note – Park City (photos), Snowbird, NYC, San Antonio, and Phoenix
Here’s Dr. Jonathan D.T. Ward and Dr. Jagannath Panda’s take on the importance of the U.S.-India partnership, published in The National Interest:
The strategic momentum in the U.S.-India relationship has been a long time in the making. Now is the time for both sides to think big.
President Donald Trump’s visit to India is the latest in a tradition of summits between U.S. presidents and Indian prime ministers. Dwight D. Eisenhower had a personal fascination with the subcontinent and always wished to travel there, becoming the first U.S. president to do so. John F. Kennedy, who hosted Jawaharlal Nehru in America, believed that India would be the key to unlocking the potential of U.S. relations with the emerging world. Kennedy dreamed that India could be a treasured American partner in the fight against Communist totalitarianism.
However, the meetings between twentieth-century American and Indian leaders were overshadowed by ruined hopes and frustrated ambitions. India’s policy of nonalignment, its need to balance its relations with Russia and China against the overtures of America, and its desire to chart its own course post-Independence, all forestalled America’s aspirations for the relationship. Close U.S.-Pakistan relations also created a barrier for engagement with New Delhi.
This time, Trump finds himself on ground that was carefully prepared by post-Cold War administrations. He will arrive in India to find not the frostiness and frustration of last century’s relations but the prospect of building the most important partnership of this century.
Building the U.S.-India relationship is a strategic necessity for both nations. Both India and America face the economic and military rise of an unreformed, totalitarian China and the ambitions that its leaders hold for a new world order with China at its center.
America faces the prospect of the defeat and destruction of the U.S.-led order at the hands of the Chinese Communist Party. What was once called the “free world” or the Pax Americana is today called the “rules-based order,” an international system in which free nations are the ultimate arbiters of power. China’s leaders mean to end this system and to bring the American era to a close.
India faces the prospect of overwhelming Chinese power on its Himalayan borders and throughout the Indian Ocean region where India should be a natural defender of global trade, security, and prosperity. The flood of Chinese companies, technology, and capital into the lands and continents marked out by the “Belt and Road Initiative” threatens to strangle India’s own economic ascendancy, leaving a Chinese Raj in the Indo-Pacific region where the British once held sway. With China’s dominance in the Indo-Pacific region, India’s rise as a free and independent world power, in control of its national destiny, would be severely challenged.
India and America must come together to build and lead a twenty-first-century coalition of developed and developing nations that can counter China’s goals of dominance. In order to do this, the U.S.-India relationship must evolve even further. Great gains have been made on military cooperation and national security. The relationship must now focus on trade, technology, and commerce. This can create an economic beacon for other democracies and emerging nations that will be pressed to make hard choices by America and China.
The global economy needs a new growth center in order to create alternatives to an ascending authoritarian China. A fully realized U.S.-India economic relationship would create a new center of gravity in the global economy where innovation, growth, and business can thrive while also safeguarding and strengthening democratic values and security among democratic nations.
As the problems of doing business in China continue to take their toll on American corporations, from intellectual property theft to rising labor costs, India presents an important alternative. India offers the prospect of growth and opportunity without sacrificing U.S. national security interests. For India, deeper economic engagement with the United States offers a shot in the arm for economic growth, manufacturing, development, and innovation, all of which will be necessary to realize India’s ambitions as an emerging world power.
If the United States and India are able to build a dynamic economic partnership, then the result will be a counterweight to China and a rallying point that can reinvigorate the democratic world. Today, the United States struggles to engage European Allies on the problem of China. America struggles equally to influence emerging nations in Asia that are increasingly reliant on trade and finance from China. India faces the possibility of a full economic and military eclipse in its own region if China’s Communist Party realizes its ambitions.
A vigorous U.S.-India partnership, based on commercial and security ties, can enable democracies and emerging economies to make a hard but necessary choice: do we turn to China for economic opportunity or can we find that dynamism amongst each other? This may be the question on which the future of the free world turns. India and America can provide the answer by working together.
Dr. Jonathan D. T. Ward is the author of China’s Vision of Victory and Founder of Atlas Organization (Washington DC). Dr. Jagannath Panda is a fellow and heads the East Asia Center at Manohar Parrikar Institute for Defence Studies and Analyses (New Delhi). Both are specialists in Chinese strategy.
March 4, 2020
S&P 500 Index — 3,003
Notable this week:
We sit at a point in the long-term investment cycle where rewards are low. Accordingly, risk is high. We can quantify the risk. Let’s first take a look at why risk is so high. It has everything to do with just how far the market, as measured by the S&P 500 Index, sits above its long-term growth trend. The dotted line in the middle section of the following chart plots the long-term growth trend since 1928. Over time, the popular cap-weighted S&P 500 Index has gained about 10% per year. However, sometimes investors bid prices up above the long-term growth trend. Sometimes, selling panic and the unwind of leverage drives prices below the long-term growth trend. The bottom section of the chart plots just how far above or below the growth trend line the market is at any given time. Ned Davis Research grouped the deviation from trend and grouped the data into quintiles. They then looked at the subsequent returns over 5- and 10-years. The red arrow in the upper left-hand section shows what returns were when our starting position was in the Top Quintile (where we find ourselves today) vs. the Bottom Quintile (where the subsequent returns are best). Note: the returns are the average percent change in the S&P 500, not the annualized change. So, $100,000 invested would grow to be just $109,640 in five years. A compounded annualized return of less than 2%. This versus your $100,000 growing to $224,000 in five years when are starting point is the Bottom Quintile (below the dotted black line in the bottom section). The last time we had a shot at that buying opportunity was in 2009.
The jaws are closing. One of the indicators I check each week measures buying demand vs. selling supply. More buyers than sellers or more sellers than buyers. Note the “We are here” annotation and how close the jaws are to closing (crossing). I’ve added a few red and green arrows to mark other turning points. (Note too that there are a number of false signals so there will be some false trades).
The reason this is meaningful is that returns are strongest when Volume Demand is greater than Volume Supply.
Factor this into your weight-of-evidence calculus. The market is overpriced (Top Quintile) and the supply demand dynamics are changing. 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.
“It ain’t what you don’t know that gets you into trouble,
It’s what you know for sure that just ain’t so.”
– Mark Twain
It’s what you know for sure that just ain’t so. Amen to that. The WallachBeth Winter Symposium has been fantastic. Wishing it not to end, one attendee volunteered to inject himself with COVID-19 so that we could all get quarantined in skiing paradise. I awoke this morning with a small cold. I might need to claim COVID-19 and park myself here for a while. On a more serious note, the risk of recession is rising and COVID-19 might be the shock to the global system that trips to switch. We are not yet seeing pending recession in our recession charts. You’ll find most of them updated in Trade Signals (the balance will be updated next week.) Do take the opportunity to think differently about your bond allocations. 1% won’t cut it. It’s been a great trade. Perhaps JPM is right and the 10-year goes to 0%. God help us if we do. One can never be sure but I think it’s time.
Following are a few photos from Park City:
Day 1 – Back Country Park City, Utah – “Tierra Del Garf”
If you’ve never skied powder, the following video is what it is like. Click on the image below to play. One of the day’s best powder runs. Like floating on air. (I come down at the 3:15 mark.)
Old and new friends:
An evening event at the High West Distillery.
The Old Fashioned hiding on the right in next shot was pretty good (a first for me.) Attending a conference with daughter Brie (loved it).
The annual poker tournament is professionally staffed. Chips are for fun, though I can’t confirm or deny a side bet or two. 120 attendees with six tables filled with players. Winners advance. I enjoyed watching from the sidelines. The game finishes a bit too late for my blood. Pictured is CMG’s newest independent advisor rep, Taylor Ames (he’s also the one wearing the patriotic USA ski onesie in photos above – the man is upbeat, positive and full of fun):
This year’s conference marks the 10th anniversary for the WallachBeth Winter Symposium. A special thank you to David Beth and your WB team. Congratulations – another excellent conference.
The WB team had us all wear pinnies so we could easily find each other on the mountain. And we did:
Snowbird is up next. Poor Steve… I know, I know… I’m really excited. Three of my sons are flying out this evening. We are heading to Snowbird for a long weekend of skiing. Brianna is in Park City at the conference and the five of us will be smiling from ear to ear. The weather news is advising of a big snowstorm on Saturday. So, I’m checking in happy and hope this note finds you doing something really fun for you. Life’s too short. Get out and dance!
Saturday is daylight saving time and the clocks spring ahead one hour. An extra evening hour of daylight—put that in the plus column. Spring is near.
I’m looking forward to sharing the leadership presentation notes with you next week. Until then, 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.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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