January 17, 2020
By Steve Blumenthal
“The last five major global cyclical events were the early 1990s recession —
largely occasioned by the U.S. Savings & Loan crisis, the collapse of Japan Inc.
after the stock market crash of 1990, the Asian crisis of the mid-1990s,
the fabulous technology boom/bust cycle at the turn of the millennium
and the unprecedented rise and then collapse for U.S. residential real estate in 2007-2008.
All five episodes delivered recessions, either global or regional.
In no case was there as significant prior acceleration of wages and general prices.
In each case, an investment boom and an associated asset market ran to improbably heights
and then collapsed. From 1945 to 1985 there was no recession caused by the instability
of investment prompted by financial speculation — and since 1985 there has been
no recession that has not been caused by these factors.”
– Robert Barbera’s explanation of Hyman Minsky’s ideas, The Cost of Capitalism
(Featured in “It’s a Tidal Wave of Liquidity. And Waves Crash” by John Authers)
In a Bloomberg piece titled, “It’s a Tidal Wave of Liquidity. And Waves Crash,” John Authers writes about renowned economist Hyman Minsky, who “argued that the economic cycle is driven more by surges in the banking system and in the supply of credit than by the relationship which is traditionally thought more important, between companies and workers in the labor market.”
So much for the monthly employment report and pretty much every other economic data point that flashes across our screens. Focus on liquidity, investment booms, and market runs to improbable heights.
In the U.S., it’s the bubble in the credit markets that will, like bubbles past, pop. In Europe, it’s negative rates and what that has done to the banking and pension systems.
Focus on Liquidity
Move away from employment statistics and keep your eye on this next chart. It’s a great way to look at liquidity in the system. With 37% of the companies in the Russell 2000 Index failing to pull a profit, the availability of credit is crucial for their survival. The lights go out when they can no longer borrow more capital. As Warren Buffett said, “Only when the tide goes out do you discover who’s been swimming naked.”
When the lending dries up, defaults soon follow. Once a month, I update the Ned Davis Research Credit Conditions Index on my Trade Signals blog. Let’s call it our swimming naked indicator. It looks at mortgage rates, mortgage delinquency rates, delinquency rates on consumer loans, debt-to-net worth of the household sector, senior loan officer survey on lending standards for consumer credit cards, consumer and residential mortgage loans… all combined into one indicator to give us a sense for the available liquidity in the system. Yes, I hear you… What about the Fed, its balance sheet, the direction of interest rate policy? That information gets transmitted into lending conditions, too.
NDR plots the data monthly to measure if “Credit Conditions” are “Favorable” or “Unfavorable.” The red line in the following chart is the combined score, and a rise above or a drop below the 50 level (green dotted line) is the signal. Note how recessions (indicated by the vertical grey bars) followed shortly after a drop below 50 (three yellow circles). The most recent month-end reading is a relatively high 67.5 on December 31, 2019. The good news is that lending conditions remain favorable—there is no current sign of recession.
Here is a look at the above, plus its components:
We’ll be keeping a close eye on “Credit Conditions” as the year moves forward. And since I believe today’s largest bubble is in the fixed income market, especially high-yield and bank loan funds, let’s also keep a close eye on the trend in the high-yield junk bond market, as there are a lot of naked swimmers there. A simple 50-day moving average line can serve as an early warning indicator. When price moves above its 50-day smoothed moving average price trend line, the trend is favorable. When price declines below its 50-day moving average price trend line, the trend is unfavorable. Nothing bad happens when the trend is favorable. Combine an unfavorable trend with unfavorable lending conditions, though, and prices will plummet. Since the bubble is in the corporate credit markets, these two indicators together may be our most important gauges. Today, the price is above its 50-day trend line. Ride the wave, as the trend is favorable (arrows represent a few select buy and sell signals since 2008).
Manufacturing, consumer spending, employment, and wage information are important, but the credit cycle and speculation matter most to your financial well-being.
And, according to our friend Minsky, there’s a moment in time where everything goes awry, aptly named “The Minsky Moment.” It marks the beginning of a market collapse, spurred by the kind of reckless speculation on the part of investors that is emblematic of a bullish period—one that just isn’t sustainable. What happens next? Prices deflate rapidly and the market collapses.
We should heed the words of the great Sir John Templeton: “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”
A close and trusted friend is a managing director at a major Wall Street firm. He sits at the center of the market’s engine. He called me yesterday to get my thoughts and said, “This market is insane. It sure feels like a market blow-off top.” I agreed.
He asked me if I had any data on past blow-off tops. And I do… I shared the next chart with you a few weeks ago. Let’s look at it again.
NDR measured prior blow-off tops and found that since 1901, the Dow has posted a median gain of 13.4% over a median time frame of 61 days in blow-off tops. NDR shows 18 prior occurrences and said that the Dow was up 10.5% over the course of just 74 trading days from mid-August to late November. They added, “That kind of rally is similar to the ones that ended previous bull markets.” (Here’s a link to the previous post: On My Radar: A Euphoric Blow-Off Top?)
Since that OMR post, the Dow is now up 13.2% in 107 trading days.
Look at that chart again. It captures 18 prior data points similar to what has just occurred. Number 19 is the current run from mid-August to late November (now mid-January 2020).
We could go higher.
I was in Vail this week at a Market Structures event. Market makers, options traders, vol traders, hedge fund and investment managers. One large takeaway: the cost to put on portfolio protection is very inexpensive. No one sees risk right now. Think put options on ETFs, such as IWM (Russell 2000 Small Cap Index), HYG, or JNK (two popular high-yield junk bond ETFs). There are other ideas out there, too—and keep in mind, this is not a recommendation from me to you to buy or sell any security (I know nothing about your personal financial situation. But do talk to your advisor or call me if you’d like to learn more.)
Bottom line: Put options are inexpensively priced. Volatility is at a near-record low. That should make our risk goosebumps rise. For me, when the HY market turns down, I’m raising cash. And I’m thinking about shorting HY bonds via put options when the credit conditions index drops below 50…maybe sooner. The above remain my two most important indicators.
Grab a coffee and find your favorite chair. David Rosenberg allowed me to share his 2020 Outlook piece with you. And you’ll also find the link to the most recent Trade Signals post. The trend signals remains favorable, but boy am I really getting concerned. As Yoda might say, “When you look forward careful you must be.”
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:
- David Rosenberg — 2020 Outlook: “Year of the Rat”
- Trade Signals – Despite Domestic and Global Issues, Bullish Market Trends Continue
- Personal Note – Hollywood, Florida
You’ve probably seen David Rosenberg on CNBC, Bloomberg, and Fox Business. He just launched his new business, Rosenberg Research. Prior to founding his firm, he worked at Gluskin Sheff for a decade. Prior to that, David was Chief North American Economist at Merrill Lynch in New York for seven years, during which he was consistently ranked among Institutional Investor’s All-Star analysts. Please click here if you’re interested in a free 30-day trial of his service.
David graciously allowed me to share his outlook piece with you. Following is a short summary. The link to the entire piece is below.
Here are a few important comments:
Right now, it is critically important to get as close to the truth of clients’ risk tolerance. There have probably never been as many characteristics of a top as we are experiencing today. At some point, as unpopular as contrarianism can be, we all need to ponder deeply about Bob Farrell’s Rule #4: “Exponentially rapidly rising or falling markets usually go further than you think but they do not correct by going sideways.
No one really knows how far up the top is, but what happens after the top does not fit into very many people’s risk tolerance. In the meantime, another year of double-digit returns on the highest quality, long duration bonds is our expectation and the interest rate risk associated with them is entirely manageable from our perspective as market economists. While I cannot pick the date, I can tell you that this turbocharged debt cycle will end miserably, not unlike 2008 and 2001. Don’t try to time the inevitable mean reversion trade. Just heed this first Bob Farrell rule of investing on ‘mean reversion’ and know that it’s out there.
In nearly eleven years the S&P 500 has soared nearly five-fold to multiples (on earnings, sales and book value ─ take your pick) we have only seen twice in recent history. Corporate bond spreads off Treasuries squeezed to levels that fall well short of compensating for imminent default risks, and there really is no reason to wait for the herd to head for the exits. That time will come sooner rather than later because Mother Nature will not tolerate leverage and multiple-expansion supplanting corporate earnings and productivity growth indefinitely (emphasis mine).
Click here to access the full piece. I hope you find the information helpful, and I believe you’ll love his wit and blunt way. I sure do…
If you’d like to subscribe to Rosenberg Research, send me an email at email@example.com. I’ll forward it to David and his team. Note: I don’t earn any compensation from David – I’m just a big fan of his work.
Also, in case you missed it in last week’s OMR post, Gundlach’s firm, DoubleLine Capital, recorded a global outlook video with David Rosenberg, James Bianco, Danielle DiMartino Booth, Ed Hyman, and Steven Romick. It’s outstanding. You can find it here.
January 15, 2020
S&P 500 Index — 3,282
Notable this week:
Like it or not, we live in interesting times. Two weeks ago, it appeared that the United States and Iran were headed toward a serious armed conflict (some calling it “World War III”) that could envelope the Middle East. However, in response to the killing of Iranian Major General Qasem Soleimani, Iran conducted a relatively mild attack on Iraqi-U.S. installations, and the markets shrugged off the retaliatory strike. Today, China and the U.S. will sign a phase-one trade agreement intended to ease trade tensions, but many unresolved issues remain. For example, China has not committed to stop hacking American companies, particularly to steal intellectual property. The Chinese contend it’s not a trade issue. Also, many Chinese promises in the agreement appear to be broad and vague and, in some cases, overlap with other changes it has been pursuing anyway. Of course, the optics of a U.S.-China trade deal, even a “phase-one” agreement, are positive, and many business leaders, politicians and economists are breathing a little easier today. The path forward remains uncertain.
Defying fundamentals, equities and fixed income continue their record-breaking runs. As shown below, gold also continues to perform strongly.
Among many indicators that we vigilantly monitor, investor sentiment continues to be “Extremely Optimistic,” which is generally a short-term bearish indicator. See chart below. Note the annual percentage gain of the S&P 500 Index when the crowd sentiment poll exceeds a reading of 66 (it’s -2.36%).
Additionally, since 1995, overall debt has been increasing rapidly and high debt levels negatively affects growth. Current Total Credit Market All Sectors Debt as a percentage of GDP is 347.5%. Recall that, in mid-2009, debt-to-GDP was 382%.
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.
“You are never too old to set another goal or to dream a NEW DREAM.”
– C.S. Lewis
Looking out the window on the final approach to the Eagle Vail Airport, there was zero visibility. The pilot announced that we would be circling for 20 minutes in hopes that conditions would improve. He said we needed three miles of visibility and we had two. About ten minutes later, he took his first shot. No go, as he pointed the nose of the plane up and accelerated out of the fog. We circled some more and took another shot at the approach. This time we could see the mountains and houses. The wheels were lowered and all looked good. Suddenly, he pulled the wheels up, accelerated, and aborted attempt number two.
“Gas and go,” he said. “We are going to fly to Denver and gas and go.” With a wait of up to three hours, gas and go sounded like a maybe to me. Fortunately, the car service we were using had a driver in the Denver area. Andrew (CMG’s COO) and I hit that trade.
The good news was the snowstorm was dumping about a foot of fresh powder. Several hours later, we arrived in Vail. Dinner, wine, more wine, and all was well. We skied Sunday, Monday, and Tuesday. The first two days were deep powder days as the storm persisted. The new snow and strong wind kept refilling the bowls. “Free refills,” they call it. Tuesday was a “blue sky powder day.” The dialogue on the chair lifts, at dinner, and during down time was great. The friendships… priceless.
The Inside ETFs annual conference is up next in Hollywood, Florida. There is now $6.5 trillion in global ETFs. Name the exposure you wish to gain. Amazing the tools you and I have at our fingertips. A far cry from the 6% commission-based mutual funds in the mid-1980s. I remember my Merrill Lynch manager telling me to sell the Merrill Lynch Basic Value Fund. I remember the lunch with Sir John Templeton. I put clients in his mutual funds as well. You guessed it… 6% commission.
And if you wanted to buy a stock, commissions for large institution accounts were six cents a share. Today it’s a very small fraction of a penny per share. And supposedly commission-free at Charles Schwab, TD, E*TRADE, and Fidelity. But pick your custodian carefully, as “free” is not always free. Some firms sell their order flow. Anyway, you get the point. We’ve come a long way and there are many tools that can help you both grow and defend your wealth.
I’m looking forward to learning more at the Inside ETFs conference January 26-29. Please do let me know if you are going to be there. I’d love to grab a coffee with you. You can learn more about the conference here. More dinners, red wine, and some valuable insights are guaranteed. Former New York Yankees captain Derek Jeter is the official keynote for 2020—a bonus, even though I’m a Phillies fan.
I was praying to the powder gods for snow and my prayers were answered.
Here’s a toast to “… dreaming a NEW DREAM.”
Have 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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