July 24, 2020
By Steve Blumenthal
“For those clinging to the recovery narrative, I just don’t see it.”
– David Rosenberg,
President and Chief Economist & Strategist, Rosenberg Research
Last week we took a look at coming return probabilities, which showed the expected 10-year future return for the S&P 500 Index to be a painfully low -0.18% per year before inflation. You can find that data here. With the 30-year Treasury Bond yielding 1.30%, there is little oomph in bond yields to help the traditional asset allocation stock-bond mix.
What can you expect from stocks and bonds over the coming 12 years? I do like John Hussman’s work on valuations and what they tell us about coming returns. The process is sound, yet wonk-ish, so let’s save that analysis that for a later date (or you can learn more here). The idea for now is to see the big picture.
In the following chart, Hussman plots the estimated return vs. the actual achieved return of a 60% stocks, 30% bond, and 10% Treasury bill portfolio allocation. Simply notice how closely the maroon line (which represents actual achieved 12-year returns) followed the blue (estimated coming 12-year annual returns).
No one wanted to buy stocks in 1982. The same was true after the tech bubble burst and the Great Financial Crisis (green arrows). The red arrow shows where we are today. The current 12-year coming return outlook is below 0 percent per year. If this is your portfolio mix, it’s highly probable that your $100,000 today will be worth slightly less than $100,000 in July 2032. Not good.
Of course, there are ways to invest that differ from the traditional mix above. A carefully selected portfolio of high and growing dividend stocks yields more than 3.5%, and the yields likely grow at about a quarter of a percent per year—maybe more. That certainly makes more sense than government bonds yielding 1.30% and a 10-year Treasury yielding 0.60%.
And what if you patiently wait for better re-entry opportunities? Data like the above can serve as a guide of sorts to let you know when you might overweight or underweight your equity allocations.
Now, let’s consider a slightly different view on equity market valuations.
Regression to Trend
If you are not following Jill Mislinski at Advisor Perspectives, I recommend you do. I want to share with you her work on Regression to Trend. The idea here is to understand how markets cycle from bull to bear and back to bull again over time.
The blue line is the inflation-adjusted “real” return of the S&P 500 Index with data going back to 1870. The red line is the long-term growth trend line. Bull market peaks are noted above the red line. Bear market bottoms are noted below the red line. Jill wrote, “The light blue graphic plots how far above or below the market was at any time from its long-term trend. The peak in 2000 marked an unprecedented 129% overshooting of the trend — substantially above the overshoot in 1929. The index had been above trend for two decades, with one exception: it dipped about 15% below trend briefly in March of 2009. At the beginning of July 2020, it is 119% above trend.”
There is another way to evaluate the same data. We quant geeks like to look at standard deviation. Think of it as a measurement of how far something is from its long-term norm. A 1-standard deviation (SD) move from the trend is somewhat normal, both in bull and bear market cycles. 2SD moves are less frequent, having occurred in 1900, 1929, 2000, and today. 3SD moves are very rare. Note 2000 and today (almost).
Jill added, “The major troughs of the past saw declines in excess of 50% below the trend. If the current S&P 500 were sitting squarely on the regression, it would be at the 1418 level.”
I could be wrong, but I don’t think 1,418 is going to happen. Fair value based on median price-to-earnings (P/E) is around 2,200. If I bought in at fair value, I would expect my coming 10-year returns to be in the 10% range and not the 0% range, so I would be more comfortable holding through a crash-like event that could drive the market to 1,418. Fair value is far better than the overvalued level of the market today.
One last thought on all of this. Here’s an interesting set of charts from Jill that show how markets cycle. Imagine that five years ago you invested $10,000 in the S&P 500. How much would it be worth today, with dividends reinvested but adjusted for inflation?
The purchasing power of your investment has increased to $15,442 for an annualized real return of 8.72%.
If you had asked the same question in March 2009, returns from April 2004 to March 2009 would have turned your $10,000 into $6,654. The -8.12% annualized real return would have cut the purchasing power of your initial investment by a third.
Let’s increase the time frame to 10 years. The annualized return is considerably smaller than the 5-year time frame. As of the end of last month, your $10K invested 10 years ago has grown to about $31.4K, adjusted for inflation, for an annualized real return of 11.50%.
The 15-year time frame is only slightly more profitable. Your one-and-a-half decade investment of $10K has grown to about $27.3K adjusted for inflation, for an annualized real return of 6.72%.
If we extend our investment horizon to 20 years, the roller coaster is less volatile with higher lows and lower highs.
The volatility decreases further with a 30-year timeline. But even for that three-decade investment, the annualized returns since 1901 have ranged from less than 2% to over 11%. But can your client remain on plan for 15, 20, or 30 years?
Instead of coffee, grab the tequila (it is National Tequila Day)—it’s a party in just a handful of the largest technology companies. But do put two Advil on your nightstand. Below you will find a visual of U.S. total government debt-to-GDP. More tequila… more Advil.
You’ll also find the link to this past Wednesday’s Trade Signals post, in which I show the NASDAQ 100 Index’s relative outperformance to the S&P 500 Index. It just eclipsed the 1999 tech bubble peak. However, the good news is the weight of trend evidence continues to signal “risk on” for both bonds and stocks.
I hope the above charts help you in your work with your clients. At the very least, they should enable you to set reasonable return expectations and to emphasize the importance of risk management. We have been here before. In my opinion, I would put stop-loss processes in place on most holdings. Doing so would give an investor optionality to shift when the getting gets good again. A special hat tip to Jill Mislinski and the team at Advisor Perspectives. Great stuff.
Thanks for reading. Wishing you a great week.
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:
- U.S. Government Debt-to-GDP
- Trade Signals – NASDAQ 100 Index Relative to S&P 500 Index (1999 Tech Bubble)
- Personal Note – Smile, You’ve Got This
Where might we go from here? I have to say, this is what concerns me the most.
The above does not include Social Security and Medicare-Medicaid promises made, also known as debt.
We sit at the end of a long-term debt supercycle. If you have some extra time, Ray Dalio has written more on debt and its implications for the dollar in “The Big Cycle of the United States and the Dollar, Part 2.” More on this in a future letter. Click on the picture to read the full article. Worth the read.
July 22, 2020
S&P 500 Index — 3,254 (open)
Notable this week:
The following chart shows the relative performance of the NASDAQ 100 Index relative to the S&P 500 Index. As of 7-21-2020, the NASDAQ 100 has gained 3.3 times more than the S&P 500. In 1998, prior to the tech bubble peak in March 2000, the relative performance was about the same. Then it spiked in favor of the NASDAQ to 3.3 in March 2000, followed by a decline back to 1 at the bear market bottom in October 2002. It touched 3.4x a few days ago and sits at 3.3 as of 7-21-2020 (yesterday).
Today’s Robinhooders were about ten years old back then. We are witnessing mass speculation of grand proportion. Boomers to Roberinhooders, “you go hooders…” Advance with caution. My advice: Trade with risk processes in place. In my opinion, this will not end well.
I like to follow investor sentiment and I share two sentiment charts each week. One is focused on daily data while the other looks at weekly data. You’ll find them below. The daily data now indicates “Extreme Optimism,” which is short-term bearish for U.S. equities. The weekly data reading remains “Neutral Optimism.”
Today, let’s take a look at another sentiment indicator: the CBOE’s Put-to-Call Ratio. Think of it as the number of put buyers versus call buyers. This one tells you what people are actually doing with their money. When more people are buying calls than puts, it’s a clear sign of investor optimism the number is low (bearish for equities). When more people are buying puts than calls, it’s a clear sign of investor pessimism the number is high (bullish for equities).
- The lower section of the following chart plots the put/call ratio (orange line).
- Why 1999? It’s because the put/call ratio recorded its lowest reading since March 2000 (not a typo).
- This is an extremely bearish warning for U.S. equities.
- One last note, take a look at how high the reading was in 2002 and again in 2008-09. Everyone was buying puts (they were bearish on the market at the time they should have been bullish). Today, investors are the most bullish in 20 years. If this isn’t a Sir John Templeton “sell when everyone else is buying moment,” I don’t know what is. Lights on!
You’ll also find the gold trend chart below. Take a look. We’ve been bullish on gold since late 2019. Since then, GLD has moved from approximately $120 per share to $172 per share yesterday. That’s a gain of $52 per share (up 43%). The positive price trend in gold remains bullish.
The balance of the Trade Signal‘s Dashboard and charts follow. The equity and fixed income bull market trends remain in place. However, as my friend Art Cashin says, “Stay alert and very, very nimble.”
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.
The weekend weather forecast is looking pretty good. Golf is in the plans. And I have to admit: golf has provided an uplifting escape from the COVID-19 mess and escalating geopolitical tensions with China.
I sometimes turn to Jon Gordon, author of the book Stay Positive: Encouraging Quotes and Messages to Fuel Your Life with Positive Energy, when I need a little positivity. I follow him on Instagram and liked this post:
Tell yourself (and someone else) these 5 things today:
- You are loved!
- You matter.
- It’s OK to fail. Everyone does.
- Fear is normal. Don’t worry about the outcome.
- Smile. You’ve got this.
Stepson Tyler is home for a few days and then off to California for four months of military training before heading to what will be his home base in South Carolina. It sure is good to see him. Ty’s a Marine, and his job is to support air and other military missions through advanced logistical planning. A big dinner celebration is planned for next week. And with a hug, we’ll send him off saying, “Smile, you’ve got this.”
Hope you are doing something uplifting for yourself. My best to you and your family.
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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