CMG AdvisorCentral

Tactical investing news, views and resources for financial advisors

Recessions by Decades – Will This be the First Without One?

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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:

Source: Crestmont Research

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.

Blumenthal Appears on Fox Business News

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On March 20, 2017, CMG CEO and CIO Steve Blumenthal appeared on Fox Business News’ “Countdown to the Closing Bell with Liz Claman.”  Ashley Webster filled in for Liz Claman.  Ashley pointed to Amazon and Google and the great moves they’ve had – a recent proof statement that all is well.  We humans are herd beings.  Steve’s suggestion was if you do nothing else, put a 200-day moving average stop-loss on everything you own.  Here’s the clip:

The Trump rally has been amazing.  The equity market trend remains bullish.  Risk remains elevated as we sit at the second most expensively priced market in history and the Fed is raising, not lowering, interest rates.  We’re cautious.

Charts of the Week

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I personally believe that recessions can be forecast in advance.  While no indicator is perfect, there are a few processes that have had a high correct signal rate in the past.

The reason that getting in front of recession is important is that it is during recessions that all the bad corrections tend to happen.  Bad as in -40% bad.

The other problem with recessions is that they are only known in hindsight.  It takes two quarters of negative GDP growth for the chief recession czars at the National Bureau of Economic Research to tell us when the recession actually started.

Following are three of my favorite leading “recession watch” indicator charts:

Chart 1: The Economy (no current sign of recession)

Here is how you read this chart:

  • Believe it or not, the stock market is a great leading indicator for the economy. It tends to turn down in advance of recession.
  • This process (bottom section of the chart) plots the S&P 500 Index (red line) and also a five-month smoothed moving average of the S&P 500.
  • The smoothed dotted line (green in lower section) represents the trend of the market’s prices.
  • When the red line (S&P 500 Index) drops below its smoothed moving average trend line (dotted green line) by 4.8% or more, a recession signal is generated.
  • When the red line rises above the dotted green line by 3.6% or more, a bullish signal is triggered for the economy.
  • The down arrows are the recession signals, up arrows are the expansion signals.
  • The gray vertical shaded lines mark the beginning and end of all the recessions since 1948.
  • In total, 79% of the signals have been correct though some have been a little early or just a little late. There were a few false signals but they didn’t keep you offsides for long.  All in all, in my opinion, pretty darn good.

0317.00

Chart 2: The Economy vs. the Employment Trends Index

Here is how you read the chart:

  • 100% correct signals
  • Down arrow – recession signal is generated when the Employment Trends Index drops by 4.8% from the most recent high watermark.
  • Up arrow – expansion signal is generated when the Employment Trends Index rises from its most recent low watermark by just 0.4%.
  • Data 1979 through 2/28/2017

0317.01

Chart 3: Global Recession Probability Model

Here is how you read the chart:

  • High global recession probability when the blue line is above the dotted red line.
  • Low global recession probability when the blue line is below the dotted green line (like today).
  • The box at the bottom right shows what happened. When above the dotted red line (the 70 level on the chart), recession occurred 81.46% of the time.  54% of the time (including the most recent high recession risk reading in 2016), a recession did not occur.  This is a probability game, folks… but pretty good accurate history.

0317.06

Conclusion: Low current risk of a U.S. recession.  Low current risk of a global recession.

Charts of the Week

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My favorite trend following indicator is something we co-created with Ned Davis Research.  It looks at the underlying trends in 22 industry sectors and scores the weight of evidence on a 0 to 100 scale.  Here is the chart if you haven’t seen it before (note: I post it every Wednesday afternoon in Trade Signals).  The trend for equities is currently bullish.

What about bond exposure?  We monitor the Zweig Bond Model.

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Please refer to the March 10, 2017 post of On My Radar for an explanation of how it works.

Finally, I believe the key to investing and perhaps the most important lesson to learn is how money compounds over time.  To that end, I wrote a piece called the “Merciless Mathematics of Loss.”  Next is the chart and you can find the full piece here.

Rising Inflation Pressures and What it Means to Your Bond Allocations

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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%.

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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.

The Bond Market is Facing a “Perfect Storm”

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I’ve been saying for some time that the biggest bubble of all bubbles is in the bond market. European sovereign debt might just be the first to crisis. Further, global debt has reached 325% of GDP. Academic studies show that economies get into trouble when debt-to-GDP exceeds 90%. Expand that to the U.S. and you’ll find a 105% debt-to-GDP number. (The number is actually much higher — 250% — if you include Social Security and Medicare debts.)

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According to Paul Schmelzing, “The current bond market is facing the “perfect storm” of potential steepening of the bond yield curve, monetary policy tightening and a multi-year period of sustained losses due to a “structural” return of inflation resembling that of 1967.”

Don’t despair… click below for ideas about what you can do with the fixed income portion of your portfolio.

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Update: CalPERS Expected to Formally Reduce Return Forecasts

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From The Sacramento Bee (December 20, 2016)

CalPERS moved to slash its official investment forecast Tuesday, a dramatic step that will translate into billions of dollars in higher annual pension contributions from the state, local governments and school districts.

CalPERS’ Finance and Administration Committee voted 6-1 to lower the forecast from 7.5 percent to 7 percent in phases over three years, starting next July. Although the committee’s vote must be ratified by the entire board Wednesday, most other board members indicated they support the move as well.

It would be the first adjustment to the forecast in four years.

The move is a recognition that investment returns are falling and that the California Public Employees’ Retirement System, which is just 68 percent funded, needs higher contributions from government agencies to solve its long-term problems.

“We’re in a low-growth (investment) environment, and it’s expected to remain that way the next five to 10 years,” board member Henry Jones said.

Paul Tudor Jones’ 200-Day Moving Average Rule

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Paul Tudor Jones is one of the greatest traders of all time.  Jones’ firm, Tudor Investment Corporation, manages about $13 billion across multiple strategies.

Jones says, “The whole trick in investing is: ‘How do I keep from losing everything?’”  To which, he said he would advise investors to “to get out of anything that falls below the 200-day moving average.”  Visually, it looks something like this:

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Source: dshort.com.

Here’s a trend following idea for you to consider.  In the next chart, the black line is the simple 200-day moving average line.  The red dotted line is the 50-day shorter-term moving average line.  Both are a way of showing us the current price trend.  When the 50-day trend line moves above the longer 200-day trend line, the overall trend is bullish.  When below, it is bearish.

Since 1929, 65.98% of the time, the market trend was bullish and returns highest.  Likewise, the data since 2006 shows similar results.  The return figures are the percentage annualized gain per year.  The yellow highlight shows the regime we are in today.  The trend by this measure is currently bullish.

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The Quest for Yield

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Yields are at 5,000-year lows.

71% of the world’s government bonds are yielding less than 1%.  33% yield less than 0%.  In a picture it looks like this:

10-07-12

Source: Bloomberg; JPMorgan Asset Management, BofA Merrill Lynch

Risk is being overlooked in HY bonds.  Yields on high yield debt are close to the same yields on less risky loans.  The chase for yield has driven investors to riskier asset classes.

I am anticipating a once-in-a-generation buying opportunity in HY bonds.  While the trend this week is up, continue to invest with the trend.  Move to the safety of cash or Treasury Bills when the trend crosses down.

Click below for a great chart showing what a 1% increase in interest rates does to bond prices.  Show it to your clients!

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