At which point do rising interest rates spark the fire? Rates are key to the equation of risk. In Friday’s On My Radar, Steve surveys what the current equity market valuations tell us about risk… and likely forward returns. Should you be playing more offense than defense or more defense than offense? Valuations can help.READ MORE
In Friday’s On My Radar, Steve provides his much-anticipated market outlook for 2018.
Steve says, “The weight of market trend evidence remains bullish. I remain focused on both market momentum and trend evidence. Despite the aged, overvalued and over-bullish environment, as evidenced in Trade Signals each week, I remain moderately bullish on both equities and fixed income.”READ MORE
In past valuation posts, I’ve occasionally shared the following two charts. Ned Davis Research (NDR) charts the Federal Reserve’s “U.S. Household Asset Allocation” data. Below is the charted history of stock, bond and cash percentages. Stock ownership is currently 55.83% of a “Household’s” asset allocation (upper section of next chart).
NDR looks at that stock allocation number (55.83% today) and they then do something really cool. They analyze the history of the percentage in stocks and plot the returns an investor received 10 years later.NEXT CHART
Several weeks ago, I shared an interview with behavioral economist and recent winner of the Nobel Memorial Prize in Economic Sciences, Professor Richard Thaler (here). So when I read Martello Investments’ monthly commentary this week, I thought it perfect to share their piece with you. Below is an excerpt from Artie and Charlie.
Earlier this month, Richard Thaler received the Nobel Prize in Economics, and his recognition was long overdue. In a world where conventional economics is driven by simplifying assumptions — assumptions like “markets are efficient” and “investors are rational” — Thaler’s contributions to the field as one of the founding fathers of behavioral finance bring a realistic perspective. The underlying principles of behavioral finance, blending financial theory with psychology, accept the emotional and cognitive biases of most investors. Instead of assuming investors are rational, Thaler and others acknowledge that, on the contrary, most investors are irrational, emotional creatures that are driven by a combination of greed, fear, and fallacy, and that it is these behavioral issues that can cause bubbles and overreactions.
Despite tidy econometric models that peg investors as rational creatures, we value the contributions of the behavioral camp; we believe that emotions and irrational decision-making tend to govern investor behavior, oftentimes to the detriment of the investor. There are numerous behavioral biases prevalent in investing; some of the more notable include loss aversion (losses are generally 2-3X more painful than the positive feelings associated with similarly sized gains), confirmation bias (only pay attention to opinions that agree with you), and endowment bias (what we own is more valuable than what we don’t). Ultimately, these behavioral fallacies can result in investors buying high (chasing) and selling low (out of frustration and fear), the consequences of which are long-term wealth destruction.
In the “what can you do about it” category, here are a couple ideas to think about.
Let’s look at two very simple trend following ideas.
Most of us are familiar with the 200-day moving average (MA). It is simply a smoothing of the average price of, for example, the S&P 500 Index over the last 200 days. Take all the daily closing prices, add them up and divide by 200. It creates a smooth trend line that enables you to see if the trend is moving up or moving down.
In an uptrending period, the average price is moving higher. In a downtrend, it is moving lower. Investors can use the trend as an indicator as to when to be invested and when to hedge or get out of the market. But one needs to have a rule to trigger a signal. It’s one thing to see the trend line moving higher or lower, but it is another to know when to act.
One of the more popular trading indicators is called the “golden cross.” It is when the 50-day MA price line (the shorter-term trend) crosses above or below the 200-day MA price line (the longer-term price trend). A buy signal when it crosses above. A sell signal when it crosses below.
Click below for the models and charts…READ MORE
August and September are the two worst performing months for stocks each year. You wouldn’t know it from the relative calm in the market. From Bloomberg’s David Wilson, “This month’s pattern of calm for U.S. stocks persisted even after Federal Reserve officials laid out plans to begin selling some of the central bank’s bond holdings. The CBOE Volatility Index, or VIX, is headed for its lowest daily average in any September since calculations began in 1990. Wednesday’s 0.4-point decline in the VIX, to 9.78, as the Fed announced the monetary-policy shift.” The all-time low was in early 2007 at 9.39. Readings below 10 are rare.
Here is a look at the VIX Volatility Index since 1999. Imagine the calm confidence that set over the market in 2007. VIX measures perceived risk. We should get worried when everyone is comfortable and see opportunity when others are in fear.READ MORE
Take a look at the recession data in the next chart. Since 1930, there have been at least one or two recessions every decade. Three of the post-1930 decades had just one recession and five of the decades had two recessions. There have been zero recessions so far this current decade.
Will this be the first without recession? I doubt it very much. Often I share with you my favorite recession indicator signal charts. There is no current sign of recession within the next six months. I’ll keep you posted. Here are the recessions by decade chart:
Let’s continue to keep our eye on leading recession indicators. The best is an inverted yield curve. The equity market is also a good leading indicator. No need to cover this today.
Every month, Steve reviews several market valuation metrics in an effort to provide visibility into forward 7-, 10-, and 12-year returns. In this week’s On My Radar, Steve looks at Median P/E and also shares GMO’s 7-Year Asset Class Real Return Forecasts. It’s a must-read!READ MORE
James Montier from GMO along with his colleague, Matt Kadnar, put out an excellent piece last week. They explained how GMO gets to the -4.2% annualized real return forecast for U.S. Large Cap stocks.
With everyone herding into passive index funds, James and Matt begin by addressing what you are probably hearing from your clients. “U.S. stocks have outperformed for the last number of years, so I see no reason why that should not continue.”
Yes, but not likely. Here is a look at their forward return estimates for various asset classes.
Click below to read more about GMO’s methodology and forward estimates for the S&P 500.READ MORE
Every month, Steve reviews several market valuation metrics in an effort to provide visibility into forward 7- and 10-year returns. In this week’s On My Radar, Steve looks at Median P/E and Warren Buffett’s favorite measure, Total Stock Market Cap to Gross Domestic Product. Additionally, Steve shares GMO’s 7-Year Asset Class Real Return Forecasts. It’s a must-read!READ MORE