Archives for February 2017

Charts of the Week

Posted on 02.27.17 |

This week we offer several charts concerning inflation, interest rates, U.S. economic recoveries, equity market performance and equity mutual fund flows.

This chart plots U.S. economic recoveries. Note the blue line. Debt’s a major drag:

Source: Crestmont Research

Keep an eye on inflation (rising):

Year-over-year change in CPI – look at the January numbers in the far right of the chart. The most recent BLS – Bureau of Labor Statistics Annualized Inflation Rate year-over-year equals 2.5%. The Fed’s target has been reached:

Source: Advisor Perspectives

And if you were wondering what inflation looks like by category:

Source: dshort.com

Here is the current probability of a Fed March interest rate hike:

Switching to equities, Ned Davis Research has something they call “Top Watch Indicators”… meaning indicators that help them spot a probable market top.

Here’s how you view the next chart:

When the green bars in the lower section rise above the horizontal dotted line (50), a market top is indicated.
The vertical dotted lines and shaded area indicates the times that more than 50% of their top watch indicators signaled a market top.
Percentage declines are indicated.
Green bar on the far right shows where we are as of 2-14-17.

Source: Ned Davis Research

Chalk one little dot up for the active fund managers. All the money has been flowing into passive index funds and ETFs:

And all that money that chased into “high dividend papers?” In a few short months, they’ve given up six years of excess returns. I continue to be cautious on high dividend stocks due to over popularity, low interest rates and the risk of rising rates.

Diversification has been under pressure the last few years. The average university endowment lost 1.90% in 2016. However, it is best viewed over the long term and designed to achieve a certain return relative to an acceptable amount of risk. 100% allocation to stocks is for a different investor risk profile. Not wise to compare one asset class to a diversified investment plan. With that said, in case you were wondering… this is how the 10 richest universities invested their money in 2016:

“Don’t Fight the Tape or the Fed”

Posted on 02.21.17 |

The number one rule many of us were taught is “Don’t Fight the Fed.” I like to add “trend” into that equation and, as you’ll see in the next chart, the math is compelling.

When the Fed raises rates (don’t fight them) and the trend turns negative, equities underperform. Focus on the red arrows. Two different time periods are measured, however, the message is the same. The big corrections come when both the Fed and trend turn negative. I wrote some time ago in On My Radar to “watch out for minus 2.” We currently sit at -1. I’ll share this chart from time to time – especially if -2 is triggered.

Here is how you read the chart:

The top section plots the S&P 500 Index but focus on the middle section.
NDR has a Multi-Cap Tape Composite Model to measure the technical health of the broad equity market. That model aggregates the signals of over 100 component indicators and generates a signal based on the percentage of the component indicators that are giving a bullish signal for the S&P 500. It measures momentum and trend.
The Fed component is really an interest rate component, which measures the trend in rates by looking at the yield on the 10-year Treasury note. When the 10-week trend in yields are lower than their 70-week trend in yields, the S&P 500 has produced larger gains. When it is higher, the S&P 500 has performed poorly. It’s that simple.
The combined indicator can produce a score of -2 (both indicators are bearish) to +2 (both bullish) and overall have done a good job historically as a risk-on/risk-off indicator.
The current reading is -1 (data shows we need to watch out for -2): refer to the red arrows.

Source: Ned Davis Research

Beware: Rising Rate Environment

Posted on 02.21.17 |

Reminder for bond investors: When interest rates rise, bonds lose value. I shared the following chart in July 2016 (interestingly just two days from the 1.37% low in yields). It shows how much money is lost for every 1% increase in rates. The top section is the 10-year Treasury bond and the bottom section is the 30-year Treasury. (I know I’ve shared this chart with you several times, but I believe it is worth revisiting. I just don’t believe the average investor knows just how much risk they are taking on with their so called “safe” investments.)

1.37% was the low yield back on July 13, 2016. The 10-year Treasury is currently yielding 2.42% and the 30-year is yielding 3.02%. That adds up to a -8.84% loss in value for the 10-year and call it a -16% for the 30-year. Maybe rates move back down, but I’m not so sure. I’m a bit more worried about what those losses will look like when yields rise to 3.4%, 4.4% and 5.4% (similar to where they were in 2007). -30% is a real risk.

A Look at U.S. Domestic Debt

Posted on 02.13.17 |

Total Credit Market Debt in the U.S. is 352.4% of GDP. Post the peak in 2008 at north of 380%, this chart shows deleveraging has begun.

Recall the Reinhart/Rogoff study that debt greater than 90% of GDP slows growth. We’ve certainly witnessed slow growth in the 2% range for the last 16 years. Debt’s a drag on growth.

0210-06

Source: Ned Davis Research

College Endowment Returns Were Negative in 2016 and Negative Since 2007

Posted on 02.06.17 |

U.S. stocks have worked well since the 2008/09 financial crisis. Modern Portfolio Theory – broad asset class diversification has not. But I didn’t know it was this challenging. I was somewhat surprised to see this from Bloomberg:

Endowments were hampered by investments in non-U.S. equities, which declined 7.8 percent, energy and natural resources, which lost 7.5 percent, and commodities and managed futures, which were down 7.7 percent.

Wealthier schools’ performance was dragged down by their larger allocations to riskier alternatives such as hedge funds. Hedge funds were among the worst performers for endowments of all sizes, with a 4.0 percent loss.

Endowments with more than $1 billion declined 1.9 percent, the same as the average. The blue line tracks the performance. Reflected are negative returns for 2016 and negative overall returns from 2007 – 2016:

More from Bloomberg: Endowments were hampered by investments in non-U.S. equities, which declined 7.8 percent, energy and natural resources, which lost 7.5 percent, and commodities and managed futures, which were down 7.7 percent.

It causes one to think – who needs diversification anymore? We likely need it most when the risk feels the least (like today) and need it least when the risk feels the most (like early 2000 and 2008/09).

Things just don’t smell right to me. It feels like it is 1999 all over again. This time we are witnessing a massive shift into low-fee passive (non-managed) index products. Active money managers are taking it on the chin.

However, like all that money that raced to technology funds at the market peak in the late 1990’s. The -75% tech wreck followed. That same bad behavioral trend is alive and well today. Stay risk minded. It took 15 years and a 300% recovery gain to overcome that loss and get back to even. Just saying…

Rising Inflation Pressures and What it Means to Your Bond Allocations

Posted on 02.06.17 |

Below is my “go to” inflation chart. The Ned Davis Research Inflation Timing Model consists of 22 indicators that primarily measure the various rates of change of such indicators as commodity prices, consumer prices, producer prices, and industrial production. The model totals all the indicator readings and provides a score ranging from +22 (strong inflationary pressures) to -22 (strong disinflationary pressures). High inflationary pressures are signaled when the model rises to +6 or above. Low inflationary pressures are indicated when the model falls to zero or less.

0203-13

Source: Ned Davis Research

Bonds, bond funds and bond ETFs lose money when rates rise. I posted this next chart just a few days before Treasury yields hit a 35-year yield low of 1.37%. What it shows is how much money is lost when rates rise.

If your starting point was a yield of 1.40% (top half of chart), as it was on 7/11/2016, and rates rose to 2.40% (which they did) your loss would be -8.84% if you were invested in 10-year Treasury Notes and -19.07% (bottom section of chart) if yields on the 30-year Treasury Bond rose to 3.25% (which it nearly did). Further, note the risk of loss if the 10-year rises to 5.40%. Note the -53.90% loss on the 30-year if yields rise to 6.25%.

A number of pundits are calling for a 5% yield in the 10-year within a few short years. I’m not in that camp but really… I don’t know. I’m more in the “one more big recession” camp that will properly reset equity valuations and if so then rates should gap lower.

What I do believe is most important, is that investors should see this chart and size up the potential risk-reward for themselves. With rates just coming off 5,000-year lows, my best advice is to think about your bond exposure as if your retirement wealth is dependent on it… and it is.

2.45% Treasury yields suck (as a good friend reminds me is a technical term) and rising inflation will eat into the net real yield and further cause interest rates to spike higher. Treasury yields were north of 5% in 2007.

Be tactical with your bond exposure. Don’t look at the last 35 years, as many people do, and project it forward. The great bond bull market yield low is likely in. Think differently about how you position that 40% of the traditional 60% equity / 40% bond portfolio.