July 2, 2020
By Steve Blumenthal
“I don’t see us wanting to run through the bond market like an elephant,
you know, doing things and snuffing out price signals or things like that.
We just want to be there if things turn bad in the economy or if things
go in a negative direction, we want to make sure that, you know, we are there.”
– Jerome Powell, Chair, Federal Reserve Board of Governors
“To emphasize, ‘Just want to be there if things turn bad.’ Doesn’t this translate into an ‘investors will not lose’ market which retail understands and is why they are killing themselves to get in?”
– Jim Bianco, President and Macro Strategist, Bianco Research, via Twitter.
The weight of the trend evidence continues to be bullish for stocks. More stocks are making new highs and fewer are making new lows. Early in the year, there were a lot of new highs, but also a lot of new lows (otherwise known as “bad breadth”). Generally, the absence of new low leadership is bullish for equities (“good breadth”). It’s the Fed vs. Fundamentals, and for now, the Fed is winning.
From ETF.com: “To date, the Fed has only expended $6.8 billion of the $250 billion the agency is authorized to use in its bond buying program, but the bond market has largely restabilized. In fact, Fed Chairman Jerome Powell announced last week that the agency will ultimately move away from bond ETFs altogether in favor of individual issues.
So if the Fed tapers its buying program, or even begins to unwind its positions, that could potentially lead to a sell-off in some of these bond ETFs—especially the ones for which the Fed represents a majority of new net cash.”
Let’s Get Our Footing Here
The Fed is in control; however, it is important to have some perspective on just how much the Fed can print and buy. Perspective? Truth is, we don’t know. But the authorized $250 billion pales in comparison to the global fixed-income market’s $300 trillion and that number does not include global government debts.
While yield curve control on government debt is probable in our near future (my stomach turns at the thought), the ability to manipulate rates in the corporate bond markets will be lost. The global debt market is too big for the central bankers to control. As credit risk and default rates rise, so will the yields on corporate bonds, mortgages, and any other debt not guaranteed by the government.
Bond yields for the weaker borrowers will rise because investors will demand a higher return for the risk they are taking on. This is being played out in every country – the debt problem is everywhere. When the ECB, JCB, China, and the US print more money to buy more and more debt via ETFs or direct purchases, the currency in the weakest countries decline first. When and where that happens, inflation happens.
The global authorities are relentless in their desire to create liquidity. For every push there is a pull—and in this case, inflation is the pull. Inflation will be their kryptonite. Since the U.S. is the cleanest shirt in the dirty laundry pile, and sits with privilege as the world’s reserve currency, it will likely be the last to fall. In my view, probabilities favor deflation now and inflation later (1-3 years from now). At least in the US. We’ll keep watch.
The worst outcome, a collapse of the monetary system as we know it, will occur if confidence in central bankers and government leadership is lost. While extreme, that outcome is unlikely—but the risk remains. It’s why gold is in a bull market and why bitcoin and blockchain technologies are gaining momentum. To which, gold has played a great role in our core portfolios. I remain bullish on gold.
What Is the Fed Buying?
The following chart is courtesy of WallachBeth’s Director of ETF Trading Solutions, Mohit Bajaj. R.I.P. Capitalism? The Fed now owns 26.32% of LQD. With just $6.8 billion of the $250 billion spent, they’ve got more ammo – locked and loaded. This is what the Fed is buying:
The hard truth is we are on the path to some form of debt forgiveness and we really have no idea how this is going to end. Much depends on who’s pulling the levers at any given time along the way. Next elections? Appointments? Trade frictions? Policies? The debt and pension crisis mess requires fiscal spending programs and Fed support. Make America’s Pension System Great Again – coming soon to a theater near you. And we will see similar challenges around the globe. What happens in the U.S. will intersect with the struggles and yet-to-be-known policy responses in other parts of the world.
My two cents: Play more defense than offense today. Then, adapt and play more offense when the odds are more abundantly stacked in your favor. Below you’ll find an interesting section titled, “Market Returns Relative to Long-Term Growth Trends.” Think of it as a road map of sorts to know when the return/risk odds are more or less in your favor.
I believe in a well-thought-out investment game plan. At CMG, our investment mindset is simple—we call it “Core and Explore.” Objective number one is to defend your core wealth. Let’s say that represents around 80 percent of your investable assets. The goal is to seek growth and protect the downside in such a way that your 80 percent core grows back to 100 percent, ideally in four to six years (though, of course, there’s never a guarantee). This isn’t about beating the market; it’s about preserving what you have worked so hard to acquire. With your core wealth defended, this enables the ability to “explore” with the remaining 20 percent of your wealth.
The “explore” portion of your portfolio is the fun stuff. Here, you may consider transformational investment ideas in technology, biotech, bio-agriculture, healthcare, and more. “Explore” doesn’t mean you’re taking a gamble; this is about positioning in a handful of strategically-sourced and intelligently-researched investment opportunities. “Core and Explore” is about having a game plan. A plan designed to defend your core wealth, reduce emotion and keep you on course.
Everyone is different, so know you can dial up or dial down the risk/reward ratios to meet your needs, risk level, and time horizon. Maybe your ratio is 70-30, 60-40, or 90-10. If you are an independent advisor or accredited investor and would like to learn more about the approved strategies on the CMG Mauldin Portfolios platform, how to create your own custom core portfolio(s), and learn about explore opportunities, send me a note at firstname.lastname@example.org.
You’ll also find the most recent Trade Signals post (summary and link) along with a short personal story. Happy Independence Day to you and your family and thanks for reading!
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:
- Market Returns Relative to Long-term Growth Trends
- Trade Signals – If Things Turn Bad (Jerome Powell)
- Personal Note – Alexander Hamilton
Keep the following on your radar and monitor as time progresses. I have no idea what the market will do over the coming months. Over the last year, the market is up 5.03%.
That’s in the ballpark for the low returns I’ve been forecasting. And the outlook hasn’t changed. As you’ll see next, the equity market remains overvalued and above trend.
I love the Advisor Perspectives website and I’m a big fan of Jill Mislinski, their research director. She posts some fantastic charts every day. From a wealth management perspective, I think it is important to have clear footing on when the odds are most with us or against us in terms of coming returns and relative risks. On Wednesday, Jill shared her insights in “A Perspective on Secular Bull and Bear Markets.”
Was the March 2009 low the end of a secular bear market and the beginning of a secular bull? Are we in the beginning stages of another secular bear?
Let’s examine the past to broaden our understanding of the range of historical trends in market performance. An obvious feature of this inflation-adjusted series is the pattern of long-term alternations between uptrends and downtrends. Market historians call these “secular” bull and bear markets from the Latin word saeculum “long period of time” (in contrast to aeternus “eternal” — the type of bull market we fantasize about).
We’ve added the recent major downturn as a potential new secular bear and the February S&P 500 market top. Time will tell if this is in fact a secular bull, but note that the market is still at very high levels.
The key word on the chart above is secular. The implicit rule we’re following is that blue shows secular trends that lead to new all-time real highs. Periods in between are secular bear markets, regardless of their cyclical rallies. For example, the rally from 1932 to 1937, despite its strength, remains a cycle in a secular bear market. At its peak in 1937, the index was 29% below the real all-time high of 1929. For a scholarly study of secular bear markets, which highlights the same key turning points, see Russell Napier’s Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms.”
From a portfolio management perspective, the idea here is simple: There are times when the odds favor broad-based market exposure and times when they don’t.
Take a look at this next chart:
- The red upsloping line is a long-term regression line reflecting growth, after inflation, of 1.87%. But don’t focus on that number.
- Note how the market trades above and below that long-term growth line.
- At the market peak in early 2000, the S&P 500 was 127% above its long-term growth trend. More recently, it was 131% above. In 1929, it was 79% above. In 2009, it was 21% below.
- The best buys come at or below the red trend line in the middle of the chart.
Game plan: more hedging and risk management when above the red line. Overweight to equities and un-hedge when below.
Similar to Jill’s regression channels, this next chart looks at where we are relative to the long-term growth trend, sorts the data, and plots the average returns that followed. Think of the orange line as fair value. Below it are the best return outcomes and above it the low return outcomes. NDR considers how far above or below the market is from its long-term trend and sorts that data into quintiles. The top quintile captures the highest 20% (expensive) of month-end readings since 1928 above the trend line and the bottom quintile are the 20% (inexpensive) below the trend.
- Focus in on the data box in the upper right. When in the top quintile, the market was up just 9.86% on average five years later and just 38.96% ten years later. $100,000 turned into $109,860 five years later and $138,960 ten years later. Annualized compounded returns of approximately 2% and 3%.
- Compare that to the best buys that occur when below trend, in the bottom quintile. The market was up 123.68% on average five years later and 358.53% ten years later. $100,000 turned into 223,680 five years later and $458,530 ten years later. Annualized compounded returns of greater than 16% per year.
We find ourselves in the top quintile today. We’d be better off in the bottom quintile.
One last look through a slightly different valuation lens that brings us to a similar conclusion—Stock Market Capitalization as a Percentage of Nominal Gross Domestic Income:
- This data looks at valuations vs. our collective incomes. Just think of it as another way to measure if things are overpriced or underpriced. Here, too, the idea is to see if the chips are more or less in our favor in terms of probable future returns.
- The middle orange section plots each month-end comparison of the total value of the stock market vs. our collective incomes. The blue dotted line is the long-term trend line. Above it the market is expensive, below it the market is attractively priced.
- The bottom section shows where we are today in terms of how far we are above or below the long-term trend line. And it sorts the data into quintiles.
- NDR then looks at the average percentage change in the S&P 500 index 1, 3, 5, 7, 9, and 11 years later when valuations were in the top quintile vs. the bottom quintile. Clearly, the best subsequent returns come when the orange line is below the blue dotted long-term trend line.
July 1, 2020
S&P 500 Index — 3,115
Notable this week:
It’s a Fed-driven market (for now). The market technicals support the move. The weight of trend evidence in the equity market remains bullish. High yield moved to a sell signal this week. I could be wrong but suspect the signal will be short-lived. Stick to the process. The Zweig Bond Model continues to signal a bull market trend in bonds. Gold gained 13.5% for the quarter and remains is a buy signal.
A look at two indicators that have done an excellent job:
1) My favorite equity market indicator for large-cap equity market exposure is the Ned Davis Research CMG U.S. Large Cap Long/Flat Index. The NDR CMG L/F indicator looks at the collective trend evidence across 24 market sectors and never reached the zone where historically markets turn to bear. The speed of the COVID Crash (16 days) was too fast to affect the intermediate and long-term trend processes.
2) The decline in the NASDAQ Index from February into March was not enough to turn the 200-day moving average trendline down. The NASDAQ Index 200-day moving average trend signal has also remained in a buy signal all year.
I’m keeping a close eye on investor sentiment. It’s done a good job identifying turning points of extreme optimism and extreme pessimism. Current readings are neutral.
We really are in uncharted waters. It’s the Fed vs. Fundamentals. Fed Chairman Jerome Powell said last week, “We just want to be there if things turn bad in the economy or if things go in a negative direction, we want to make sure that, you know, we are there.” For now, the Fed is winning. Stay nimble with a diversified risk management game plan in place. No single process is perfect. The idea is to grow and protect core wealth is a relatively predictable way.
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.
We met on a soccer field a little more than ten years ago and this past Tuesday marked our 8th wedding anniversary. I’m as crazy about my Susan today as I was when I first fell in love with her.
I left work early on Tuesday and we drove into the city. Some of the windows along Market Street were still boarded up from the recent protests. We went to Jeweler’s Row. While the shops were open—unbeknownst to us—appointments were required, as we are still far from what we know as “normal.” Fortunately, we found success with a good friend, who let us into his store just prior to closing. He, like everyone in retail, is managing. The PPP has helped, but business is far below where it once was. He owns his building and is debt-free. He’ll be fine, he told me.
We left his store, walked a block to 6th and Walnut Street, and enjoyed a cold IPA on the balcony of a bar located in the historic Curtis Publishing Building, right across the street from Independence Hall. Curtis bought the Saturday Evening Post for $1,000 in 1897 and developed it into one of the nation’s most popular periodicals. The magazine had its roots in Ben Franklin’s Pennsylvania Gazette and went as far back as 1728. Pretty cool.
Independence Hall, of course, is the birthplace of America. The Declaration of Independence and U.S. Constitution were both debated and signed inside the building, which originally housed all three branches of Pennsylvania’s colonial government.
We finished our beers and headed a few blocks south to an Italian restaurant. I dropped Susan off in front of the restaurant and rushed to park. We ate outside, along the street in the heart of historic Philadelphia. After dinner, we walked along the river and then headed back to the car. As I was about to get in, I looked to the left and saw the following sign (next photo). Alexander Hamilton was born January 11, 1755 or 1757, and passed July 12, 1804. He was one of the most important individuals in the history of our nation—an American statesman, politician, legal scholar, military commander, lawyer, banker, and economist. And, of course, he was one of the Founding Fathers of the United States.
He was an influential interpreter and promoter of the U.S. Constitution, as well as the founder of the polity’s financial system, the Federalist Party, the United States Coast Guard, and the New York Post newspaper. As the first Secretary of the Treasury, Hamilton was the main author of the economic policies of George Washington’s administration. Wow.
I’ve driven past that spot many times. Sad to admit, this was the first time I noticed the sign. We sure do sit in an uncomfortable place as a country and as a world. I trust our roots and believe we’ll rise to a better place. We must. Ever forward…
Wishing you a happy and fun-filled Independence Day celebration.
Grab a cold beer, a fine white or red wine or your favorite adult beverage – hold your glass high and envision a bright and healthy future. All the very best to you and your family!
Enjoy the long 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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