CMG AdvisorCentral

Tactical investing news, views and resources for financial advisors

“Three Steps and a Stumble”

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You may have heard the phrase, “three steps and a stumble.”  It means that when the Fed raises rates three times in a row, a market stumble is likely to follow.

Following is a visual look at that rule:

  • The S’s in the chart mark the third consecutive rate hike
  • Note how the hikes almost always precede a new recession
  • Note the current signal is a sell or “S” and
  • Note the DJIA has declined a median of 17.9% from sell signals to bear market bottoms

Source: Ned Davis Research

Minus 17.9% is not too tough to deal with.  We would need a return of approximately 20% to get back to even.  That may not take too long a period of time.  It’s the -40% and -50% that kills the compounding.  While I like the three steps and stumble rule, it’s not my go to.

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U.S. Household Asset Allocation (Ned Davis Research)

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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

“Greed, Fear, and Fallacy”

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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.

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Debt and Demographics – Two Powerful Ds

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From On My Radar (September 29, 2017):

The global economy continues to improve.  Recession probability for the U.S. remains minimal in the next six to nine months.  Europe’s economy is on better footing.  Risks persist, including North Korea, a sharp slowdown in China, fiscal dysfunction in the U.S. (e.g., tax cuts, fiscal spend), and growing protectionist risks to global trade.  Debt remains a significant headwind to growth as can be seen in this next chart.

Total Credit Market Debt-to-GDP

Here’s how to read the chart:

  • The chart looks at a number of growth factors.
  • For example, nominal GDP (before inflation is factored in) is lowest when Total Credit Market is above 318% Total Debt-to-GDP.
  • The blue line tracks the Total Debt-to-GDP ratio over time.
  • Note the upper dotted “high debt” line at 318%.
  • The yellow highlights show the growth when in the high debt zone.
  • Note how much better growth is when in the low debt zone. Also note that Total Debt-to-GDP peaked in late 2009 but remains high.

Source: Ned Davis Research

Also note the very last data box “Non-Financial Productivity.”  Overall GDP growth comes from the total number of workers multiplied by their collective productivity.  More workers producing more equals greater growth.  With aging demographics (typically people moving into their lower spending years… they have a lot of stuff and kids out of the house) and fewer workers… you can see the pressure it can put on growth.  And then with debt to be repaid, how much extra money is there to spend on things.  Growth suffers.

Two Ds: Debt and Demographics are headwinds to growth.  It is going to be hard for corporations to grow earnings much faster than GDP.  Some will, of course, but in the aggregate, it’s a headwind and we are seeing it consistently in the low growth GDP stats.  What we really need is Dedication, Determination, and Discipline.  Let’s tell that to our representatives in Washington.

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Trend Following – Two Actionable Ideas

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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…

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Volatility: Calm Before the Storm?

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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.

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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.

“The S&P 500: Just Say No”

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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.

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Monthly Valuation Review

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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!

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