July 28, 2017
By Steve Blumenthal
“Over the years I have seen scores of very bright investment advisors turn into
hugely successful gurus who blaze into the investment business with spectacular forecasts.
Yet, I’ve watched each and every one of them crash back to earth when a big subsequent forecast inevitably proved wrong.”
– Ned Davis
Founder of Ned Davis Research
In 1965, Gordon Moore, co-founder of Intel, predicted that the number of transistors on integrated circuits would double every two years. This is the basis of “Moore’s law,” and it’s why we currently have pocket-sized devices that are more powerful than 1980s supercomputers that took up entire rooms.
Computer chips continued to increase performance while decreasing in size, allowing for innovations that engineers never thought possible. Forty years ago, most people wouldn’t believe that we would soon have access to limitless information from the palm of your hand.
Most people are familiar with the word megabytes, but terabytes, gigabytes and petabytes? It’s easy to forget just how far we have come.
I was in New York City this past Monday. Ned Davis Research (NDR) and CMG have co-licensed the Ned Davis Research CMG U.S. Large Cap Long/Flat Index to VanEck. We were doing a video interview to explain the Index and process. You can find it explained in Trade Signals below. Anyway, Jan van Eck asked me, “What percentage of time has the market been in a bull market cycle versus a bear market cycle?” I answered, best guess, two-thirds of the time. But, frankly, I was unsure and a bit embarrassed I didn’t nail the answer.
Back in my office and a few quick clicks later, this is what I leaned:
Since January 31, 1900, the stock market was in a secular bull market just 54% of the time and in a secular bear market 46% of the time.
Following is a visual look at the data set. Here is how you read the chart:
- The chart shows the secular trends in U.S. stocks, bonds, and commodities.
- The top clip plots the monthly average of the S&P 500 along with a mode box that shows returns during secular bulls and bears.
- The middle clip plots the yields of long-term government bonds, which (for data geeks) are defined as prime corporate bonds prior to 1919 and Treasury bonds with a maturity of 10 years or more thereafter.
- The bottom clip plots the NDR Commodity Composite, which is constructed using prices provided by George F. Warren & Frank A. Pearson, Bureau of Labor Statistics and the Commodity Research Bureau.
- Shaded regions in each clip represent a secular bull period for that particular asset.
Notice the gain per annum of 13.8% during secular bull trends and -4.0% loss per annum during secular bear trends. Secular simply means long-term cycle vs. cyclical, which means short-term cycle. Note too, the gains and losses for bonds and commodities.
The next chart takes a look at the Dow Jones Industrial Average bull and bear market secular trends. This time, the return stats are sorted by cycle. I started my career at Merrill Lynch in February 1984. After the long 1966-1982 bear period, I can tell you nobody was interested in buying and holding stocks. Conventional wisdom was that you had to trade stocks to make money. My manager wanted me to sell the Merrill Lynch Basic Value Fund. It was a tough sell. Making 200 cold calls a day, I can tell you everyone I spoke with told me that “buy-and-hold” doesn’t work.
Few saw the bull market to come. Valuations were so low and forward return opportunity so high and with Treasury bonds yielding in the mid-teens, it was a beautiful set up for the 60-40 “buy-and-hold” mix. We are creatures of recent experience. Something the smart guys call “Recency Bias.”
As you can see in the next chart, the 1982-2000 equity bull market was pretty great. And the move since 2009 has been nothing short of spectacular; yet, who do you honestly know that was buying back then? It was pure panic.
Here’s the data:
One of the things that is easy for investors to lose sight of is the reality that both bull and bear markets exist. We know, behaviorally, it gets challenging for many investors after strong market periods and it is equally challenging after bear market corrections.
Kevin Malone from Greenrock Research visited me and my team this week. His firm partners with advisors and wealth managers, providing advice and an array of investment solutions. Before Kevin left he gave me a copy of a paper he wrote, “Think Twice.”
In 1998, the top 12 stocks contributed all the return of the S&P 500 Index. In other words, the S&P 500 was up 28.6% while the S&P 488 was flat. We thought that performance couldn’t be sustained until we saw what happened in 1999 when the total return of the S&P 500 came from the top 7 stocks.
Unfortunately, this is normal behavior after long rises in stock prices. The same phenomenon existed in the later 1960s and early 1970s with a group of stocks called the Nifty Fifty. These were supposed to be one-decision investments: one could safely hold them for decades. The problem was that 1973 and 1974 saw the Nifty Fifty fall more than the market, just as the top 12 and 7 stocks from 1998 and 1999 fell in the 2000-2002 period.
The poster child for this one-decision investing phenomenon in the 1998-1999 period was Microsoft, a great company. Our job, though, is not to identify great companies but great investments. If one bought Microsoft on the first trading day of 1998, the price was $16 per share and by the end of the next year, 1999, the price was $48. Investors were euphoric, but here is the problem. Microsoft peaked at the end of 1999 at $48 and one had to wait until September 30, 2015 to reach $48 again. That was 15 years and 9 months of no appreciation.
Today, the craze is FANG (Facebook, Amazon, Netflix and Google) stocks. And it looks like this:
Is it any wonder investors are crowding into these four stocks? Seems like periods past.
Ned Davis said, “Over the years I have seen scores of very bright investment advisors turn into hugely successful gurus who blaze into the investment business with spectacular forecasts. Yet, I’ve watched each and every one of them crash back to earth when a big subsequent forecast inevitably proved wrong.”
The reason I shared that intro quote is that all too often I see investors jump from one hot hand to another. My point is that I don’t believe that works in the long run.
Be mindful of risk… at all times. This is not a game of perfect. Everyone makes mistakes but you have to avoid the really big mistakes. If you are young and have many investment years and little need to touch your savings, then dollar-cost average and simply buy and hold. Your additional savings and ongoing rebalancing will get you to a very good place. Save more… borrow less.
But if you are a pre-retiree or retiree, like me, unfortunately you don’t have the time required to overcome significant loss. Like Microsoft in the late 1990s, resist the urge to herd. As Kevin suggests – Think Twice.
Below you’ll find a great chart on long-term buy-and-hold. I think about my daughter, Brianna, and see this as a good investment plan for her. And you’ll also see that the weight of evidence, as posted in this week’s Trade Signals (link below), remains bullish.
FANG stocks, gigabytes and terabytes. The amount of data that is available at our fingertips is simply amazing. We can be really thankful for that. Read on and have a great weekend!
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Included in this week’s On My Radar:
- S&P 500 Total Return Index With and Without Contributions — 1926 to May 31, 2017
- “Think Twice,” by Greenrock Research
- Trade Signals — Trend Trumps Sentiment
- Personal Note
S&P 500 Total Return Index With and Without Contributions — 1926 to May 31, 2017
Here is how to read the chart:
- Start date: 12-31-1925
- $500 monthly contribution
- Black line shows the results of dollar-cost averaging starting with $500 in 1926 (in today’s dollars adjusted for inflation or the equivilent of $37 in 1926) and adding the inflation adjusted equivalent of $500 per month
- The dollar-cost averaging took the return up to 13.2% from 10% (blue line). That’s really good.
The problem is in one’s ability to stick to the plan. If you can dollar-cost average the indices, reinvest the dividends over the long run and stay the course during the big declines, then this type of investment process is a really good plan. One that is more suitable to the young and ultra-wealthy.
Here is a look since August 2000 to give you a feel of what this investment strategy looked like through two bear market declines of 50%.
But real life experience tells me to question just how many people can continue to buy when prices are crashing. I believe few can truly stick to the process. And that’s the point, find a process that suits your psyche.
“Think Twice” by Greenrock Research
Here is the link to a thoughtful piece from Greenrock Research. A special thank you to Kevin Malone for allowing me to share it with you. Kevin and his firm work with hundreds of individual investment advisors.
“If you go to the dictionary to get an understanding of the term ‘Think Twice’, you will find theses definitions,
- To consider carefully whether one should do something.
- To be cautious about doing something.
- To weigh something carefully.
- To review one’s options.”
Kevin believes, “Thinking twice and considering reasonable timeframes are critical to investment success. So why do investors get caught up in the wrong timeframe?”
It may be the amount of information or investment sound bites. When investors hear that the market is up 8%, but EAFE is up 14% for the first half of 2017, they feel they missed out. It becomes too easy to stray from a long-term game plan.
Your job is not an easy one. Hope material such as this helps you keep your clients focused on 10 years and not eight months. And post-Trump’s election, what an eight months it has been.
Click here for the full piece. It is short and well worth the read.
Trade Signals — Trend Trumps Sentiment
S&P 500 Index — 2,477 (7-26-2017)
Notable this week:
It’s Fed day [last Wednesday], so let’s take a look at one of my favorite indicators: Ned Davis Research’s Don’t Fight the Tape or the Fed. The indicator looks at the NDR’s Big Mo Multi-Cap Composite and the 10-year Treasury yield percentage. Big Mo measures the overall breadth of the marketing across many sectors. The Treasury yield looks at where the current yield is relative to its recent trend to define periods of rising rates, flat rates or declining rates.
Each indicator can score +1, 0 or -1. A +2 (bullish) score is given if both the composite and 10-year yield are bullish. A -2 when both indicators are bearish. The current reading is +1. The composite reading is neutral and the 10-year Treasury yield is bullish. When used together they can be a historically strong indicator as indicated by the model results reflected in the following chart. We want to “watch out for minus 2.”
Overall, the balance of evidence remains bullish for both equities and fixed income. Both the short-term and intermediate-term gold indicators are bullish. Investor sentiment has been excessively optimistic suggesting short-term caution. Trend trumps sentiment in my view.
You’ll find more information, charts and explanations here.
Long-time readers know that I am a big fan of Ned Davis Research. I’ve been a client for years and value their service. If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at (617) 279-4876. John’s email address is firstname.lastname@example.org. I am not compensated in any way by NDR. I’m just a fan of their work.
Some vacation is in my near future and I hope yours as well. Susan and I, along with our children, are heading to Lake George to visit family this weekend. Everyone is really excited. It’s going to be tough to surpass last year’s wine-induced Karaoke session where we passed the pepper shaker (microphone prop). Only later to discover, thanks to video recording captured on our kids’ iPhones, we just didn’t sound as good as we thought we did in the moment. Oh, but what fun.
John Mauldin is flying to Philadelphia next Wednesday and we head out the following morning to Maine for an economic and investment brainstorming session of sorts at the annual Camp Kotok “Shadow Fed” get-together. I’m not sure what I’ll be able to share but I’m really looking forward to those few days.
If you missed John’s recent post titled, “Three Black Swans” you can find it here. John writes,
I am concerned that another major crisis will ensue by the end of 2018 – though it is possible that a salutary combination of events, aided by complacency, could let us muddle through for another few years. But there is another recession in our future (there is always another recession), and it’s going to be at least as bad as the last one was, in terms of the global pain it causes. The recovery is going to take much longer than the current one has, because our massive debt build-up is a huge drag on growth. I hope I’m wrong. But I would rather write these words now and risk eating them in my 2020 year-end letter than leave you unwarned and unprepared.
Black Swan #1: Yellen Overshoots
Black Swan #2: ECB Runs Out of Bullets
Black Swan #3: Chinese Debt Meltdown
I look forward to stress testing his thinking on a lake in Maine with fishing rod in hand. I then fly home on August 6 and head straight, as they say here in Philadelphia, “down the shore.” Susan and I have rented a house in Stone Harbor, New Jersey for the week. Kyle will be coming home from camp and five of our six kids will be with us. Can’t wait.
If you have any great book recommendations, please let me know. Something non-financial. I don’t think I can stuff any more terabytes in my hard drive.
Thanks for reading. Have a wonderful weekend!
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With kind regards,
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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A Note on Investment Process:
From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.
My objective is to position in line with the equity and fixed income market’s primary trends. I believe risk management is paramount in a long-term investment process. When to hedge, when to become more aggressive, etc.
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