May 20, 2022
By Steve Blumenthal
“I can complain because rose bushes have thorns or rejoice because thorn bushes have roses.”
There were a lot of thorns in the stock market this week. To put the recent performance into perspective, YCharts put out an excellent summary of popular stocks. And this was before Wednesday’s 4% decline. Peloton -91%! I have to admit that I enjoyed my Peloton membership through Covid. I’m thankful I don’t own the stock. I spend more time focused on private equity and generally don’t trade individual stocks, but I have to believe there are a few roses in the thorn bush you see next.
Not a recommendation to buy or sell any stock.
Today, I planned to highlight the exceptional conversation Henry Kissinger had with Neil Ferguson; however, after rewatching the session, I turned to the conference summary notes that forbid sharing information publicly from that session. I can say that Kissinger, at age 99, was sharp and, as my good friend Kevin Malone put it, “a privilege to watch.”
If you subscribed to the conference, it’s worth a rewatch, and if you have not, you can click here to get your pass. All of the sessions were recorded, and you can watch the full presentations and download the audio files. I’m sorry, I was so looking forward to sharing my Kissinger notes with you.
Overall, the Mauldin Economics 2022 Strategic Investment Conference increased my conviction on the markets, inflation, and the Fed. We are in a different investment regime, with inflation on one side and recession on the other. The bottom line is that the Fed is trapped.
Jim is active on Twitter and fun to follow. John gave a brief summary of several of the presentions in his recent Mauldin Economic letter, Thoughts From the Front Line, last week. From John,
As we saw in the April CPI data released this week, inflationary pressures may be stabilizing but they are not reversing yet. This has a cumulative effect the longer it continues. The pain is adding up.
Bianco, Boockvar, and Inflation
Jim Bianco and Peter Boockvar have been among my most valuable sources for many years, but especially so since 2020. Both have been doggedly following the economic data and, more important, pointing to where it will go. And doing it pretty accurately, I must say. I put them together for SIC just to kind of see what would happen.
Peter went first. Back in late 2020, he was expecting serious inflation while many others were still on the transitory bandwagon. One reason for that is he is a bottom-up money manager and listens to so many corporate executives on their quarterly earnings calls. He has a good sense for how they think and react to changing conditions. Here’s a bit from the transcript.
“If I’m a company making widgets and my transportation costs spike, my labor costs jump, the cost of my raw materials jump by 30% all of a sudden, I’m not calling up Walmart and saying, ‘Hey guys, I need to raise your prices by 30%.’ You’re going to spread out those price increases over time to regain that lost profit margin. Now you will cut costs as much as you can, you will set your labor force to where you think it should be right.
“But those price increases, even if your cost pressures stop going up, you want to get back to where you were pre-inflation in terms of profit margin, you are going to continue to raise prices…. Pass on as much as you can. Mitigate it as much as you can via faster productivity and cost cuts and what fully can’t be priced or recovered is obviously lost profit margins.
“And then at some point, the question is, and I’m going to go through that in this presentation too, when does the consumer say no more? Where is that breaking point where price increases to the consumer, or to that business, stops because it can’t be absorbed anymore and there’s pushback? And that’s what we’re about to find out.”
That’s an ominous note for inflation. It means consumer prices could stay higher for longer as companies try to recover their own higher costs and lost profits.
Jim Bianco then had one of his magnificent slide presentations. He has a screen where he can actually draw on the slides as he speaks, a bit like John Madden doing football analysis. (I can’t reproduce that here, obviously, but you’ll see it on the video).
In Jim’s view, the US has more inflation than other countries because we stimulated more than other countries, through both fiscal spending and monetary policy. This showed up in home values. Here’s one of his slides, with the accompanying comments below.
Source: Bianco Research (Click to enlarge)
“As of March, the typical home value was $338,000. As the middle panel shows, the 12-month change on that was $58,000 or a 20.9% increase. So let me restate that for emphasis. The median home in the United States went up $58,000 last year. As was pointed out by the chief economist of Zillow right here, the median income in the United States, it’s $50,295. Sitting in your house, your house made you more money than you earned on your job. That has never been the case, anything close to that. Not even in 2006. Median income then was $47,000. And we peaked out at $22,000 of the average home price gain in October of 2005. Massive stimulus in the housing market.”
That’s just a staggering data point. And if Barry Habib is right, those home prices may hold up for quite some time.
Gavekal Times Three
We were extraordinarily privileged to have a panel of Gavekal’s three co-founders: Charles Gave, Louis Gave, and Anatole Kaletsky. All three are brilliant and still active in the business, but they rarely appear together this way. The interaction among them is fun to watch, on top of everything you learn.
Another point about Gavekal: They freely and frequently disagree with each other. Unlike many research groups, they don’t have a “company line.” I find this extremely valuable. It’s a bit like the adversary process in a criminal trial. Vigorously arguing different viewpoints is a great way to reveal the facts.
What they are uncovering now isn’t great news. Ahead of the Ukraine war, they still held out hope the pre-COVID trends would resume. Those trends were going to bring big changes, but in a slow, manageable way. Now they have a different outlook with a bearish bent.
Remember, inflation was already a growing problem by late 2021, long before Russia moved into Ukraine. Anatole called that the result of COVID-driven monetary expansion, and previous policies dating back to 2008. The additional war-driven increases in food and energy prices turned preexisting inflation into a hard-to-control bonfire. Anatole has been an enormous bull since 2009. He turned bearish less than a month ago which was quite a shock to some of us.
Charles Gave emphasized how passive management is dying. Decades of generally (though not always) positive market conditions trained generations of money managers in a certain worldview that is now gone. Managers will have to adapt, and some will adapt slowly. You could get by without tactical asset allocation in the non-inflationary times. Not anymore.
Another problem is globalization’s reversal. This was already underway, but the pace is increasing. While we usually think of it in terms of physical supply chains, Louis stressed it includes financial flows, too. Trade policies, sanctions, and security concerns are all constraining capital into regional boxes. US money increasingly stays in the US instead of going to China, for instance. There may be good reason for those policies, but they will have side effects. Charles said we are in the beginning stages of a major liquidity crisis. He thinks the panic stage is getting closer.
There is so much to share with you, so please stay tuned—for more notes from the conference next week.
Correction from last week’s OMR – re: Felix Zulauf Consulting. If you were trying to reach out to Zulauf Consulting, the correct email address is firstname.lastname@example.org, not bluegoxadvisors.com. I subscribe to Felix’s institutional service. I find it to be outstanding. Clients are typically large family offices, fund managers, institutions, and governments. You can imagine that the research service is priced for institutions, not retail. If you’d like to learn more, email my friend Jennifer Mendel at email@example.com. She runs the business side of things for Felix. I’m not compensated to promote it; I’m just a big fan of the work.
Grab your coffee and find your favorite chair. A short post this week. Thank you for reading.
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Wall Street Earnings Estimates and Forward PE
Even though it has fallen 16% to start 2022, the S&P 500 traded late last week at 16.8 times its projected (forward) earnings over the next 12 months, according to FactSet. That is still above the average multiple of 15.7 over the past 20 years but down from a recent peak of 24.1 in September 2020. Source: WSJ 5-16-22
If Wall Street analyst forward earnings estimates are your metric, at 16.8 price-to-earnings, we are now out of the red zone and in the middle of the pink zone. Buying in the white zone makes more sense than buying in the red zone. However, PE-based on forward estimates is not the best metric in my view. I show why in the second chart.
History of Earnings Forecasts
The lines in the next chart track the history of Wall Street’s earnings estimates – from the first estimate to when the companies actually reported the data. We don’t yet know the 2022 and 2023 last earnings, but we will be able to track the ongoing revisions until we do. Most years start with optimistic numbers that are lowered over the period until the actual final numbers are known. 2001 being the exception (it looks like Wall Street analysts started low with the uncertainty of economic impact from Covid).
I like Median PE based on actual reported earnings best. It points to Fair Value in the S&P 500 Index at ~ 3,033. We’d be better off at the green arrow.
As you will see in the next chart, that level lines up nicely with the green zone (green triangle).
What is happening to the markets isn’t a surprise. Thorn bushes have roses. I’m excited about the opportunity that is taking shape. You’ll see in trade signals that conditions remain CODE RED. No one knows what the Fed is going to do. Not even the Fed knows what the Fed is going to do. At Median Fair Value, my best guess is investors can expect an approximate 10% per year from the standard cap-weighted indices. I think we can all do better with non-cap weighted indices. So Fair Value, to me, is a good “risk-on” target. For now, more defense than offense. Please know this is not a recommendation for buying or selling any security.
Trade Signals: The One Positive is Extreme Pessimism
May 18, 2022
Notable this week:
“To buy when others are despondently selling and to sell when others are avidly buying requires
the greatest fortitude.”
– Sir John Templeton
Using Investor Sentiment Indicators is More Art than Science
Last week’s Trade Signals was titled, “CODE RED.” Seemed appropriate. Still seems appropriate. It was red across the board for the stock market with the S&P 500 and NASDAQ indices down more than 4% today (Wednesday, May 18, 2022). The Dashboard of Indicators follows below. All red arrows, no green arrows.
In the direction of Sir John, the one positive is the level of extreme pessimism. We’ve tested investor sentiment over the years seeking a viable buy/sell indicator and came to the conclusion there was not enough statistical evidence to create a short-term systematic trading strategy. We believe using investor sentiment is more art than science.
In a cyclical bull up-trending stock market, one might use investor sentiment to “buy the dips.” It’s never a straight path but in general, you don’t want to fight the bullish trend. The best opportunities are present when “others are despondently selling.”
In a picture, the horizontal green box in the lower section of the following chart highlights prior periods of the most Extreme Pessimism. Think of that as “dependently selling.”
First, note that there were not many instances of Extreme Pessimism that saw a reading below 20. Just prior to the Powell Pivot in December 2018, the stock market was down 20%. Extreme Pessimism dipped to its lowest reading (data back to 2006). When the reality of Covid hit the stock market in Feb/March 2020, Extreme Pessimism reached a reading below 10. Then came the support from the government and from the Fed.
This week, the NDR Daily Trading Sentiment Composite is at 25.56. What is different today vs. December 2018 and pretty much anything we’ve experienced in the last 35-years is inflation. What this means to me, and I could be wrong, is that the Fed will not come to the rescue as quickly as it has since the Great Financial Crisis (2008/09). My view is that QE is sidelined until we reach a greater pain point.
My guess is that when the S&P 500 is down 30% or more, the economy is slowing (which it currently is) and inflation eases downs towards 3% or 4%. Mathematically, the year-over-year inflation rate will come down by the fall and may provide cover for the Fed to print again.
Bottom line: Investor sentiment is a measure of investors’ fear and greed. Given the equity market downtrend (red arrows across the board), we are more likely in a sell-the-rallies cyclical bear market environment (Excessive Optimism) than we are in buy-the-dips cyclical bull market environment (Excessive Pessimism).
The Dashboard of Indicators follows next. More red than green. Yellow arrows indicate a nearing change in signal.
Click HERE to see the Dashboard of Indicators and all the updated charts in 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.
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Personal Note – Joy!
Running late, and the edit team is looking to begin their weekends. Let’s conclude this week’s letter with a toast to Joy!
I see an ice-cold IPA in my near future! Grab your favorite beverage and hold it high with me – “To Joy.”
Wishing you a great week.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
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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