June 25, 2021
By Steve Blumenthal
“I fear not the man who has practiced 10,000 kicks once,
but I fear the man who has practiced one kick 10,000 times.”
– Bruce Lee,
Martial Artist, Actor, Director, Instructor, and Philosopher
A few days into my first job, Norman Tonkin pulled me into his office. Norman ran the Philadelphia Institutional office for Merrill Lynch. He slid a copy of Investor’s Business Daily across his desk. “This is the best newspaper in the business,” he said. “It’s better than the Wall Street Journal. Read it every day.”
Founded in 1984, Investor’s Business Daily (or IBD) is a leading financial news and research organization, recognized for proprietary stock screens, comparative performance ratings, and its record of identifying stock leaders as they emerge.
In How to Make Money in Stocks: A Winning System in Good Times and Bad, author, entrepreneur, stockbroker, and IBD founder William J. O’Neil wrote, “The moral of the story is: never argue with the market….The whole secret to winning big in the stock market is not to be right all the time, but to lose the least amount possible when you’re wrong.” He developed a system called “CANSLIM” that uses a set of rules and his daily newspaper, IBD, provides the data.
The paper has been helping individual and professional investors find more success for many years. Norman was right: best investment paper in the business. Pick it up the next time you are in the airport. Warning: quant geeks will love it; others’ eyes may glaze over.
The CANSLIM method filters for the characteristics evident in stocks that went on to be great companies and applies a trading strategy approach to limit downside loss. A new newspaper filled with incredible data that was accessible to all. Successful now–36 years later, if you have the time required to manage the process, you too can implement the strategy.
On the shelf in what we call the CMG Mauldin Kitchen, which is stocked with select strategies, is a manager who follows the CANSLIM method with a focus on small-cap stocks. I have to admit, I enjoy getting his daily position reports and studying the stocks he is buying. If you are a client, ask the team to walk you through the strategy and tell you about the stock picks.
Buy-and-hold investing sits on the other side of the investment strategy seesaw. Compared to a trading strategy, it really requires little time and attention. And frankly, that is what makes it so popular. After all, few have the time to sit in front of a computer screen managing their investments all day, every day.
I was on a call this week with an old friend. He presented a new stock strategy that has promise. In his pitch deck, he shared a chart that shows the average time it takes to recover your money after a 20% stock market correction. It’s 1,500 days or approximately three years. I share it with you as a reminder that markets cycle from bull to bear and back to bull. At times it’s easy, at times it tests everything you’ve got (2000, 2008, etc.). Note: it didn’t take three years to get back to even after the great tech crash; the S&P 500 declined by -1.5% per year from 2000–10. It took more than 10 years to get back to even. If you’re 30 years old, average in. You’ve got time. If you a pre-retiree or retired, it’s a different situation.
Here’s the overall data since 1960:
(Hat tip to my good friend Robert S.)
Your starting conditions matter. Last week, I shared with you a few of my favorite valuation charts (On My Radar: Valuations, Trend, and Debt) that showed U.S. stocks to be extremely overvalued. The star in the line-up is the “median P/E” data from 1964 to present. Click on the link to see the chart.
- Bottom line: A 48.6% decline to get stocks back to what is considered “fair value.”
- As a target, that’s 2,160.91 in the S&P 500 Index. That’s a decline of more than 2,000 points from where the S&P 500 sits today (north of 4,275). Will that shake a few investors out of the buy-and-hold tree?
- A 32% correction gets us back to “overvalued,” or the 2,858.78 level on the S&P 500 Index. Both offer better entry points vs. today’s level. In the end, fundamentals will win out.
The other half of the problem is the bond market. If you take corporate bond yields and factor in inflation, the current yield is below 0%. Negative safe money returns are not safe money.
That pretty much sums up the state of our current investment starting conditions for the traditional 60-40 stock/bond buy-and-hold portfolio. Yet, great investment ideas remain. I just don’t believe you’ll find them in cap-weighted index fund/ETF methodologies and negative yielding bond funds/ETFs.
“I believe the only edge in investing is innovation,” said my dear friend Mark Finn on a client call a few weeks ago. Sage advice. This from a guy has practiced “one kick 10,000 times.” Smartest investor I know. Bio here.
If you can’t afford three years (or longer) of waiting to get back to even, channel your inner William O’Neil and use stop-loss orders to limit your downside risk of loss. And don’t put all your chips on one strategy.
Grab a coffee and find that favorite chair. This week’s post is a quick read. Do take a look at the margin debt section (yikes) and the latest GMO 7-Year Real Return Forecast in the Trade Signals section. And please reach out to me if you have any questions. Thanks for reading!
- Record High Margin Debt
- More Links to Prior SIC2021 Notes
- Trade Signals – Households Near Record High Stock Ownership; GMO 7-Year Real Return Forecast Near Record Low
- Personal Section – Teammates Forever
Record High Margin Debt
Margin Debt to GDP
Total margin debt at the end of May 2021 reached a record high of $861.63 billion.
Here is how to read the next chart:
- Plotted are investor credit balances. Think of it as cash in brokerage accounts minus margin debt. The red bars show periods when credit balances are negative. The yellow text boxes call out various dates. The red bar in the lower right-hand side of the chart labeled “current level” represents current negative credit balances.
- Compare the current level to prior periods like the Tech Bubble, June 2007, and May 2021.
- Focus on how investors behaved when prior bubbles popped. The green bars show positive credit balances. The blue line plots the S&P 500 Index.
- Bottom line: When margin calls kick in, panic rules reason and all the leverage unwinds. We want to be in a position––with capital in good shape––to take advantage of the buying opportunity that panic will create.
From Advisor Perspectives:
Margin debt data is several weeks old when it is published. Thus, even though it may, in theory, be a leading indicator, a major shift in margin debt isn’t immediately evident. Nevertheless, we see that the troughs in the monthly net credit balance preceded peaks in the monthly S&P 500 closes by six months in 2000 and four months in 2007.
We are potentially now past the longest bull market in history. The peak in margin debt preceded the peak in the monthly S&P closes (the December 2019 peak) by 19 months, much longer than the previous shifts prior to corrections. Margin debt is currently at its peak, as is the S&P… could this mean that the S&P will continue to rise for at least another four months?
There are too few peak/trough episodes in this overlay series to take the latest credit balance data as a leading indicator of a major selloff in U.S. equities. This has been an interesting indicator to watch and will certainly continue to bear close watching in the future.
SB here again:
One timing signal I keep my eye on looks at margin debt as a percentage of GDP in comparison to a 15-month smoothed moving average line. It’s market debt unwinding (and forced selling by brokerage firms) that causes crashes.
Bottom line: Margin debt is very high. Investors are leveraged up. This means risk is high. Keep an eye out for a change in trend. In the end, leverage is always what blows things up.
More Links to Prior SIC2021 Notes
I concluded my SIC2021 conference notes a few weeks ago, but I’m sharing with you some links to pieces I feel are worth your time. SIC is hosted by my friend and partner John Mauldin. This year, nearly 5,000 virtual attendees watched and listened to six days of presentations, including insights from Howard Marks, Felix Zulauf, William White, Richard Fisher, Karen Harris, Ian Bremmer, Jim Bianco, Dr. Lacy Hunt, Peter Boockvar, Barry Habib, David Rosenberg, David Rubenstein, Liz Ann Sonders, Ron Baron, Catherine Wood, Louis-Vincent Gave, Constance Hunter, and more.
Here are a handful of links if you’d like to track some of the writings from SIC2020.
- On My Radar: Howard Marks’s “A Bowl Full of Tickets,” and William White on Inflation
- Deflation Talk, by John Mauldin – Thoughts from the Frontline (May 28, 2021)
- Expecting Inflation, by John Mauldin – Thoughts from the Frontline (May 21, 2021)
- Cold War or Not – China Panel, by John Mauldin (May 14, 2021)
- On My Radar: Stan Druckenmiller at His Best
- On My Radar: SIC2021 – Deflation? Inflation? Transitory? Define It?
- Politics with No Labels, by John Mauldin (June 11, 2021)
- Strategic Investment Potpourri, by John Mauldin (June 18, 2021)
Trade Signals – Households Near Record High Stock Ownership; GMO 7-Year Real Return Forecast Near Record Low
June 23, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
No signal changes since last week. We’re currently seeing buy signals across the board – equities, fixed income, and gold.
In 1985, I was fortunate to meet the great Sir John Templeton at the Union League in Philadelphia. He said to me then, “The secret to my success is that I buy when everyone else is selling and I sell when everyone else is buying. It sounds easy but it will be one of the hardest things for you to do.” Perhaps the most important piece of advice ever shared with me.
“Bull markets are born on pessimism, grow on skepticism,
mature on optimism and die on euphoria.”
– Sir John Templeton
He is also famous for the above quote. There are now many ways to measure market euphoria. One of my favorites looks at how much U.S. households have allocated to stocks. At bull market tops, ownership is high. At bear market bottoms, ownership is low. Think about this in terms of supply and demand. If investors are fully invested in stocks, there is less extra money available to buy more. If under-allocated to stocks, there is more money available to buy stocks… pushing prices higher. Thus, sell when everyone is buying and buy when everyone is selling. It’s not perfect but, in the long run, it’s about how math compounds.
What I like about the following chart is it quantifies to some extent what Sir John was preaching.
Here is how to read the chart:
- The orange line plots the each quarter-end U.S. Household Stock Allocation. I’ve added the yellow highlights to mark prior secular bull market peaks (1966, 2000, 2007, and today)
- The light blue line plots the subsequent 10-year actual annualized returns. The last 10-year period is 3-31-2011 to 3-31-2021. The annualized return for that period was 13.78%. Note too where the orange line was in 2011.
- When stock ownership was high, subsequent 10-year returns were low. When ownership was low, subsequent 10-year returns were high.
- The bottom data box plots the actual lowest, highest and average annualized returns 10 years later. I’ve marked in red the ownership zones for you to zero in on. I’ve circled the worst 10-year actual return but the “average GPA%” is more probable than the one worst or one best 10-year occurrence.
- Bottom line: U.S. Households could buy even more stocks, but as of March 2021, we are challenging the highest level of stock ownership in the last 70 years. Downside risk management is as important as it was in 1966, 2000, and 2007.
Lastly, GMO’s latest 7-Year Real Return Forecast is out and it is concerning. Pretty much self-explanatory. I’ve been following it for more than 20 years. I’ve never seen it more negative. “Warning Will Rogers, Warning Will.” (From the TV show “Lost In Space.”)
Here’s how to read the chart:
- Real means after inflation is factored in.
- Returns are annual returns. For example, U.S. Large Cap stocks (like the S&P 500 Index cap-weighted ETFs) are forecast to return -7.8% compounded per year for seven years.
- $1,000,000 will be worth $566,391.14 under this scenario or a loss of 43.36%.
- GMO plots various stock and bond asset classes.
- Not a guarantee. Process is sound. Could be wrong. Worth our attention.
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
With all this said, the overall trend remains bullish. Trade Signals – Dashboard of Indicators follows next. Green continues to dominate the dashboard.
Click HERE to go to the balance of 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.
Personal Note – Teammates Forever
“When you start your day with gratitude you create a fertile mind
and heart that is ready for great things to happen. When you feel blessed you
can’t be stressed. Don’t worry about the day. Take it on with power and positivity!
– Jon Gordon, Author and Speaker
(Find him on Instagram: @JonGordon)
Brianna is home for a few days, and it is so nice to see her. COVID opened a window of opportunity to work remotely from pretty much anywhere. After bunking with a friend in Denver (and skiing on weekends) for a while, she traded in her ski pass for a few months in Newport Beach, California. Oh, to be young and free.
Brie, Matthew, and I played nine holes of golf Wednesday night and had dinner afterward. Basil Hayden’s 10 Year on the rocks is really pretty tasty. Susan and I hope to have a beach day this Sunday—“down the shore” as they say here in Philadelphia. Next week, Susan is taking her team to Tampa, Florida, for nationals. Our anniversary is next week on June 30. She’ll be flying down that day, and I’ll catch up with her July 3 or 4. I’ll attend a game or two and hope to share the sideline with Susan’s mother, Pat, and then head to dinner.
I lost a dear friend a few weeks ago. He was tragically hit while riding his bike in Florida. When I moved to Philadelphia in 1984, a fraternity brother introduced me to Carl Cutler. Carl and I both played soccer, and he invited me to a post-work pickup game. By the weekend, I had joined his club team (Allegro). We played together for years. Some of my closest friends are from that team.
The memorial service was on Tuesday. The church was filled with family, colleagues, friends, and teammates. I hung up my soccer cleats after my last donation to the orthopedist’s country club fund (ACL, two hips, and an Achilles tendon) in 2016. I had lost touch with my friends. I miss them.
Carl was a college all-American athlete at Denison University and went on to have an excellent career. He retired as a partner from Brown Brothers Harriman a few years ago. A great competitive spirit and wonderful teammate, he was fast and scored a lot of goals. Always positive and a loving father to his three children. When I came across the Jon Gordon quote above, I thought of Carl. Power and positivity!
He, Doug Deitch, and I were the three forwards up top. We won an over 40 national championship together. “If it’s going to be, it’s up to us,” we said before every game. Of course, it was far more than just us. After reconnecting with Doug at the service, we promised to stay in touch. And that promise begins tomorrow morning at Stonewall for some golf and, more importantly, time together. I can’t wait.
Call an old friend or two this weekend. Better yet, make an effort to go see them and hug them as often as you can.
Wishing you the very best,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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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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