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Over the past few months, we have been writing a series of articles that highlight our concerns of increasing market risk. Here is a sampling of some of our more recent newsletters on the issue.

The common thread among these articles was to encourage our readers to use rallies to reduce risk as the “bull case” was being eroded by slower economic growth, weaker earnings, trade wars, and the end of the stimulus from tax cuts and natural disasters. To wit:

These “warning signs” are just that. None of them suggest the markets, or the economy, are immediately plunging into the next recession-driven market reversion.
However, The equity market stopped being a leading indicator, or an economic barometer, a long time ago. Central banks looked after that. This entire cycle saw the weakest economic growth of all time couple the mother of all bull markets.
There will be payback for that misalignment of funds.“

As I noted on Tuesday, the divergences between large-caps and almost every other equity index strongly suggest that something is not quite right. As shown in the chart below, that negative divergence is something we should not discount.

However, this is where it gets difficult for investors.

The “bulls” are hoping for a break to the upside which would logically lead to a retest of old highs.
The “bears” are concerned about a downside break which would likely lead to a retest of last December’s lows.
Which way will it break? Nobody really knows.

This is why we have been suggesting raising cash on rallies, and rebalancing risk until the path forward becomes clear. Importantly:

…click on the above link to read the rest of the article…

Whistling Past The $70 Trillion Debt Graveyard

July 28, 2019

Whistling Past The $70 Trillion Debt Graveyard

Review & Market Update
Whistling Past The $70 Trillion Debt Graveyard
The Real Crisis Is Coming
Sector & Market Analysis
401k Plan Manager

Last week, we discussed the setup for a near-term mean reversion because of the massive extension above the long-term mean. To wit:

“There is also just the simple issue that markets are very extended above their long-term trends, as shown in the chart below. A geopolitical event, a shift in expectations, or an acceleration in economic weakness in the U.S. could spark a mean-reverting event which would be quite the norm of what we have seen in recent years.”

This analysis is what led us to take action for our RIAPRO subscribers last week (30-Day Free Trial),as we added a 2x-short S&P 500 index fund to Equity Long-Short Account to hedge our longs (GOOG, CRM, NVDA, EMN, IVV, RSP) against a potential mean reversion.

“This morning, we are adding a small 2x S&P 500 short position to the trading portfolio to hedge our core long positions against a retracement over the next few weeks. We will remove the short if the market can regain its footing and move higher, or the market sells off and reaches oversold conditions.”

This is the purpose of hedging, as it reduces volatility over time, which inherently reduces the risk of emotionally based trading mistakes.

My friends at Polar Futures Group laid out the same concerns on Friday:

“The mean reversion trade: For the past few weeks I’ve been musing that the “irresistible force” that has moved all markets has been the aggressive repricing of future interest rate expectations since last November.

…click on the above link to read the rest of the article…

Economic Theories & Debt Driven Realities

March 11, 2019

Economic Theories & Debt Driven Realities

One of the most highly debated topics over the past few months has been the rise of Modern Monetary Theory (MMT). The economic theory has been around for quite some time but was shoved into prominence recently by Congressional Representative Alexandria Ocasio-Cortez’s “New Green Deal” which is heavily dependent on massive levels of Government funding.

There is much debate on both sides of the argument but, as is the case with all economic theories, supporters tend to latch onto the ideas they like, ignore the parts they don’t, and aggressively attack those who disagree with them. However, what we should all want is a robust set of fiscal and monetary policies which drive long-term economic prosperity for all.

Here is the problem with all economic theories – they sound great in theory, but in practice, it has been a vastly different outcome. For example, when it comes to deficits, John Maynard Keynes contended that:

“A general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”

In other words, when there is a lack of demand from consumers due to high unemployment, then the contraction in demand would force producers to take defensive actions to reduce output. Such a confluence of actions would lead to a recession.

In such a situation, Keynesian economics states that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment and deflation. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth.The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

…click on the above link to read the rest of the article…

Technically Speaking: Stuck In The Middle With You

February 12, 2019

Technically Speaking: Stuck In The Middle With You

In this past weekend’s missive, we discussed the market stalling at the 200-dma. To wit:

“We said then the most likely target for the rally was the 200-dma. It was essentially the level at which the ‘irresistible force would meet the immovable object.’”

“What will be critically important now is for the markets to retest and hold support at the Oct-Nov lows which will coincide with the 50-dma. A failure of that level will likely see a retest of the 2018 lows.”

“A retest of those lows, by the way, is not an “outside chance.” It is actually a fairly high possibility. A look back at the 2015-2016 correction makes the case for that fairly clearly.”

“But even if a retest of lows doesn’t happen, you should be aware that sharp market rallies are not uncommon, but almost always have a subsequent retracement.”

Importantly, as I expanded to our RIA PRO subscribers:

“We are likely going to have another couple of attempts next week as the bulls aren’t ready to give up the chase just yet. We are continuing to watch the risk carefully and have been working on repositioning portfolios over the last couple of weeks.
As noted, we lifted profits at the 200-dma and added hedges to the Equity and Equity Long/Short portfolios.”

On Monday, the markets rallied a bit out of the gate over continuing hopes of a “trade deal” between the U.S. and China but fell back to even by the end of the day. With earnings season now largely behind us, the “bulls”are going to need improving economic data and relief from Washington to provide continued support for the rally.

…click on the above link to read the rest of the article…

Why Another 50% Correction Is Possible

December 10, 2018

Why Another 50% Correction Is Possible

All of sudden….volatility.

Well, that is what it seems like anyway after several years of a steady grind higher in the markets. However, despite the pickup in volatility, the breaks of previous bullish trends, and a reversal in Central Bank policy, it is still widely believed that bear markets have become a relic of the past.

Now, I am not talking about a 20% correction type bear market. I am talking about a devastating, blood-letting, retirement crushing, “I am never investing again,” type decline of 40%, 50%, or more.

I know. I know.

It’s the “doom-and-gloom” speech to try to scare investors into hiding in cash.

But that is NOT the point of this missive.

While we have been carrying a much higher weighting in cash over the last several months, we also still have a healthy dose of equity related investments.

Why? Because the longer-term trends still remain bullish as shown below. (Note: The market did break the bullish trend with a near 20% correction in 2016, but was bailed out by massive interventions from the ECB, BOE, and BOJ.)

Now, you will note that I keep saying a 20% “correction.” Of course, Wall Street classifies a bear market as a decline of 20% or more. However, as I noted recently:

“During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average. This is shown in the chart below which compares the market to the 75-week moving average. During ‘bullish trends’ the market tends to trade above the long-term moving average and below it during ‘bearish trends.’”

In other words, at least for me, it is the overall TREND of the market which determines a bull or bear market. Currently, that trend is still rising. But such will not always be the case, and we may be in the process of the “trend change” now.

…click on the above link to read the rest of the article…

Oil Sends A “Crude Warning”

November 25, 2018

Oil Sends A “Crude Warning”

As with many Americans, I am on the road with the family making the traditional holiday rounds. Of course, my family is more “The Griswolds” than “The Waltons. but even with all of the antics, comedy, and occasional drama, it is always an enjoyable time of the year.

However, I did wake up from my tryptophan-induced coma long enough to pen a few thoughts on the crash in crude oil and the message it is sending.

On Monday, I am publishing an article on the fallacy that “falling energy prices are an economic boost.” It isn’t, and we dig into all the reasons why in that article.

However, the short version is that oil prices are a reflection of supply and demand. Global demand has already been falling for the last several months and oil prices are now waking up that reality. More importantly, falling oil prices are going to put the Fed in a very tough position in the next couple of months as the expected surge in inflationary pressures, in order to justify higher rates, once again fails to appear. The chart below shows breakeven 5-year and 10-year inflation rates versus oil prices.

Oil prices also tend to lead the broad economic cycle as well. The chart below is one of the broadest measures of economic activity and is comprised of leading economic indicators, Fed regional manufacturing surveys, NFIB small business survey, ISM, CFNAI, and Chicago PMI.

Since most of the economic data we look at is trailing, and subject to heavy negative revisions, the collapse in oil prices suggests that coming economic reports will likely be materially weaker than currently expected.

Can I Have A Side Of Debt

But there is another enormous problem currently for the oil and gas sector currently at risk – the debt.

…click on the above link to read the rest of the article…

Bear Market Growls As Market Remains Weak 11-16-18

November 18, 2018

Bear Market Growls As Market Remains Weak

Several months ago, I penned an article about the problems with “passive indexing” and specifically the problem of the “algorithms” that are driving roughly 80% of the trading in the markets. To wit:

“When the ‘robot trading algorithms’ begin to reverse (selling rallies rather than buying dips), it will not be a slow and methodical process, but rather a stampede with little regard to price, valuation, or fundamental measures as the exit will become very narrow.”

Fortunately, up to this point, there has not been a triggering of margin debt, as of yet, which remains the “gasoline”to fuel a rapid market decline. As we have discussed previously, margin debt (i.e. leverage) is a double-edged sword. It fuels the bull market higher as investors “leverage up” to buy more equities, but it also burns “white hot”on the way down as investors are forced to liquidate to cover margin calls. Despite the two sell-offs this year, leverage has only marginally been reduced.

If you overlay that the S&P 500 index you can see more clearly the magnitude of the reversions caused by a “leverage unwind.”

The reason I bring this up is that, so far, the market has not declined enough to “trigger” margin calls.

At least not yet.

But exactly where is that level?

There is no set rule, but there is a point at which the broker-dealers become worried about being able to collect on the “margin lines” they have extended. My best guess is that point lies somewhere around a 20% decline from the peak. The correction from intraday peak to trough in 2015-2016 was nearly 20%, but on a closing basis, the draft was about 13.5%. The corrections earlier this year, and currently, have both run close to 10% on a closing basis.

…click on the above link to read the rest of the article…

What The Oil Price Collapse Says About The Economy

November 18, 2018

What The Oil Price Collapse Says About The Economy

In Tuesday’s technical update, I discussed the breakdown in the major markets both internationally as well as domestically. Of note, was the massive bear market in China which is currently down nearly 50 percent from its peak.

(Click to enlarge)

What is important about China, besides being a major trading partner of the U.S., is that their economy has been a massive debt-driven experiment from building massive infrastructure projects that no one uses; to entire cities that no one lives in. However, the credit-driven impulse has maintained the illusion of economic growth over the last several years as China remained a major consumer of commodities. Yet despite the Government headlines of economic prosperity, the markets have been signaling a very different story.

In the U.S., the story is much the same. Near-term economic growth has been driven by artificial stimulus, government spending, and fiscal policy which provides an illusion of prosperity. For example, the chart below shows raw corporate profits (NIPA) both before, and after, tax.

(Click to enlarge)

Importantly, note that corporate profits, pre-tax, are at the same level as in 2012. In other words, corporate profits have not grown over the last 6-years, yet it was the decline in the effective tax rate which pushed after-tax corporate profits to a record in the second quarter. Since consumption makes up roughly 70 percent of the economy, then corporate profits pre-tax profits should be growing if the economy was indeed growing substantially above 2 percent.

Corporate profitability is a lagging indicator of the economy as it is reported “after the fact.” As discussed previously, given that economic data in particular is subject to heavy backward revisions, the stock market tends to be a strong leading indicator of recessionary downturns.

Prior to 1980, the NBER did not officially date recession starting and ending points, but the market turned lower prior to previous recessions.

…click on the above link to read the rest of the article…

The Economic Consequences Of Debt

November 12, 2018

The Economic Consequences Of Debt

Not surprisingly, my recent article on “The Important Role Of Recessions” led to more than just a bit of debate on why “this time is different.” The running theme in the debate was that debt really isn’t an issue as long as our neighbors are willing to support continued fiscal largesse.

As I have pointed out previously, the U.S. is currently running a nearly $1 Trillion dollar deficit during an economic expansion. This is completely contrary to the Keynesian economic theory.

“Keynes contended that ‘a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.’ In other words, when there is a lack of demand from consumers due to high unemployment, the contraction in demand would force producers to take defensive actions to reduce output.

In such a situation, Keynesian economics states that government policies could be used to increase aggregate demand, thus increasing economic activity, and reducing unemployment and deflation.

Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.”

Of course, with the government already running a massive deficit, and expected to issue another $1.5 Trillion in debt during the next fiscal year, the efficacy of “deficit spending” in terms of its impact to economic growth has been greatly marginalized.

…click on the above link to read the rest of the article…

Kass: High Anxiety In The Markets

October 31, 2018

Kass: High Anxiety In The Markets

“Brophy: I got it. I got it. I got it.

[thump]

Brophy: I ain’t got it.” – Mel Brooks, High Anxiety

Arriving at Los Angeles International Airport, Dr. Richard Thorndyke has several odd encounters (such as a flasher impersonating a police officer, and a passing bus with a full orchestra playing inside it). Dr. Thorndyke remarks:

“What a dramatic airport!”

He is taken by his driver, Brophy, to the Psycho-Neurotic Institute for the Very, Very Nervous, where he has been hired as a replacement for Dr. Ashley, who died mysteriously. Brophy has a condition of nervousness, and he takes pictures when he gets nervous. Upon his arrival, Thorndyke is greeted by the staff, Dr. Charles Montague, Dr. Philip Wentworth, and Nurse Charlotte Diesel. When he goes to his room, a large rock is thrown through the window, with a message of welcome from the violent ward.

During the movie, Thorndyke suffers from a neural disorder called “High Anxiety”, a mix of acrophobia and vertigo, and tries to overcome the infliction.

We Live In Mel Brook’s Crazy World Now

With an intraday move of almost 4% – the S&P futures fell by a remarkable 100 points from the day’s high to the day’s low. A large sell program at around 3:30 p.m. abruptly moved the market down by fifty handles in one of the largest sell programs I have ever seen hit the floor. (The day’s swing in the Dow Jones Industrial Average exceeded 900 points!)

The Spyders peaked at over $270 at around 10:10 a.m. and bottomed at under $260 (with 30 minutes left in the trading session). Spyders closed the day at $263.86.

Talk about High Anxiety!

As I write this morning’s missive the market volatility has continued. When I started writing this column, S&P futures were +18 and Nasdaq futures were +38 . They are now essentially flat, on no new news.

…click on the above link to read the rest of the article…

Markets Get Crash(ier)

October 28, 2018

Markets Get Crash(ier)

Over the last three weeks, as interest rates surged above 3%, we explored the question of whether something had “just broken” in the market.

As I stated last week:

“This past week has been a decidedly tough struggle for stocks to pick themselves up after last week’s drubbing. While we saw a sharp reflexive bounce earlier this week, that bounce quickly faded as stocks returned to retest support at critically important levels.”

While the market was oversold last week, there was no follow through on bounces which ultimately led to “crash”open on Friday morning.

Now, all this SOUNDS terrible. And, after having THE single longest uninterrupted bull run in the history of the market with record low volatility it FEELS even worse.

So, before we get into the not so good news, let’s keep this all in perspective for a minute.

For the year:

The S&P 500 index, not including dividends, is down 0.56%.
The S&P 500 Total Return index is still positive by 0.98%
A 60/40 model (60% Vanguard S&P 500 and 40% Vanguard Bond Fund) is down 1.72%

What has been different this year so far, is that bonds, while they have reduced the volatility of the recent decline in the S&P 500 index, have not contributed to portfolio returns this year so far. So, the only place to hide has been cash.

However, if we take a look at the market from 2009 to present, we can gain some better context.

The recent decline is very much like the previous corrections in the market. The red circles denote when both “sell signals” align (a correction of overbought conditions and a triggered sell signal). These corrections have specifically coincided with periods where the market was extremely deviated above the running bullish trend line (gold boxes.)

…click on the above link to read the rest of the article…

Yes, Something Broke

October 14, 2018

Yes, Something Broke

In this missive, we are just going to focus on the “WTF!” moment of this past week. In order to do this properly, I need to start with last week’s missive where we asked the question “Did Something Just Break?” In that article we addressed very specific concerns about interest rates and the problem they were going to cause.

“Speaking of rates, each time rates have climbed towards 3%, the market has stumbled.”

Chart updated through Friday.

“If you note in the chart above, a short-term ‘warning signal’ has been triggered which suggests that if rates remain above 3%, stocks are going to continue to struggle. The last time this occurred was in May when rates popped above 3%, stocks struggled and bonds outperformed.”

We also updated the pathway analysis for the highest probability outcomes over the next couple of months.

Chart updated through Friday – pathways remain unchanged

While the majority of the pathway’s accounted for a continued corrective, consolidation, process through the end of the year. It was Pathway #3 which came to fruition.

“Pathway #3: The issue of rising interest combines with a break in the economic data, or another credit-related event, and sends the market heading back to test supports at 2800 and 2750. This would likely coincide with a more severe contraction in the economic data which is not an immediate threat. Nonetheless, we should always consider the risk of an unexpected, exogenous, event. (10%)”

The recent sell-off coincides with the rising concerns of higher rates coupled with deterioration in economic growth heading into 2019. To wit:

“As such, our best initial take is that yesterday’s repricing of US growth was an overdue gut-check following last week’s monetary and oil supply shocks.”

…click on the above link to read the rest of the article…

The Next Crisis Will Be The Last

April 6, 2018

The Next Crisis Will Be The Last

It is an interesting thing.

Throughout the last four decades there is a direct link between the actions of the Federal Reserve and the eventual economic and market outcomes due to changes in monetary policy. In every case, that outcome has been negative.

The general consensus continues to be the markets have entered into a “permanently high plateau,” or an era in which asset price corrections have been effectively eliminated through fiscal and monetary policy. The lack of understanding of economic and market cycles was on full display Monday as Peter Navarro told investors to just “buy the dip.”

“I’m thinking the smart money is certainly going to buy on the dips here because the economy is as strong as an ox.”

I urge you not to fall prey to the “This Time Is Different” thought process.

Despite the consensus belief that global growth is gathering steam, there is mounting evidence of financial strain rising throughout the financial ecosystem, which as I addressed previously, is a direct result of the Fed’s monetary policy actions. Economic growth remains weak, wages are not growing, and job growth remains below the rate of working age population growth.

While the talking points of the economy being as “strong as an ox” is certainly “media friendly,” The yield curve, as shown below, is telling a different story. While the spread between 2-year and 10-year Treasury rates has not fallen into negative territory as of yet, they are certainly headed in that direction.

This is an important distinction. The mistake that most analysts make in an attempt to support a current view is to look at a specific data point. However, when analyzing data, it is not necessarily the current data point that is important, but the trend of the data that tells the story.

…click on the above link to read the rest of the article…

The Fed Will Ignite The Next “Financial Crisis”

January 31, 2018

The Fed Will Ignite The Next “Financial Crisis”

There seems to be a very large consensus the markets have entered into a “permanently high plateau,” or an era in which price corrections in asset prices have been effectively eliminated through fiscal and monetary policy.

Partnering with this fairytale like mindset is an overwhelming sense of complacency. Throughout the entire monetary ecosystem, there is a rising consensus that “debt doesn’t matter” as long as interest rates remain low. Of course, the ultra-low interest rate policy administered by the Federal Reserve is responsible for the “yield chase” which has fostered a massive surge in debt in the U.S. since the “financial crisis.”

As Ray Dalio, CEO of Bridgewater, recently noted:

“We’re in a perfect situation, inflation is not a problem, growth is good, but we have to keep in mind the part of the cycle we’re in.”

Yes, current economic growth is good, but not great. Inflation and interest rates currently remain low which creates an environment in which using debt remains opportunistic. But rising debt levels has a negative economic consequence. As shown, prior to the deregulation of the financial industry under Ronald Reagan, which led to an explosion in consumer credit issuance, it required just $1.25 of total system-wide debt to create $1.00 of economic growth. Today, it requires $3.83 to create the same $1 of economic growth. This shouldn’t be surprising, given that “debt” detracts from economic growth as the required “debt service” diverts income from savings and productive investment leading to a “diminishing rate of return” for each new dollar of debt.

However, debt levered economic cycles are a function of the ability to draw forward future consumption. But there is a finite limit to the “positive” effect of a debt-driven economic cycle.

Eventually, the “bill” must be paid.

…click on the above link to read the rest of the article…

Technically Speaking: This Is Nuts

December 5, 2017

Technically Speaking: This Is Nuts

Since the election, markets have accelerated the pace of the advance as shown in the chart below.

The advance has had two main story lines to support the bullish narrative.

It’s an earnings recovery story, and;
It’s all about tax cuts.

There is much to debate about the earnings recovery story but as I showed previously, and to steal a line from my friend Doug Kass, this “new meme increasingly resembles ‘Group Stink.’” To wit:

“Despite many who are suggesting this has been a ‘rational rise’ due to strong earnings growth, that is simply not the case as shown below. (I only use ‘reported earnings’ which includes all the ‘bad stuff.’ Any analysis using “operating earnings” is misleading.)”

“Since 2014, the stock market has risen (capital appreciation only) by 35% while reported earnings growth has risen by a whopping 2%. A 2% growth in earnings over the last 3-years hardly justifies a 33% premium over earnings.

Of course, even reported earnings is somewhat misleading due to the heavy use of share repurchases to artificially inflate reported earnings on a per share basis. However, corporate profits after tax give us a better idea of what profits actually were since that is the amount left over after those taxes were paid.”

“Again we see the same picture of a 32% premium over a 3% cumulative growth in corporate profits after tax. There is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.

We can also use the data above to construct a valuation measure of price divided by corporate profits after tax. As with all valuation measures we have discussed as of late, and forward return expectations from such levels, the P/CPATAX ratio just hit the second highest level in history.”

…click on the above link to read the rest of the article…

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Chart updated through Friday.

Chart updated through Friday – pathways remain unchanged

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