March 28, 2014
By Steve Blumenthal
“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” Winston Churchill.
Last night I had the absolute pleasure of seeing NY Times columnist Adam Bryant, speak at my stepson’s school. Bryant interviews chief executives about leadership and management. His piece, The Corner Office, is featured in the NY Times each Friday and Sunday. If you have haven’t read it, I highly recommend it for its insightfulness on management best practices.
I have made many management blunders over the years and only realize in hindsight how much I didn’t know but thought I did, and how much more learning remains ahead for me. I do hope I’m growing and helping to lead my CMG team to make a material impact on the world.
As an investment advisor, I know it took great courage to create your business from zero to something significant. It’s certainly arduous to field the best team and stay innovative while maintaining stability in the workplace. There are so many challenges; yet I’m sure you, like me, relish and honor the responsibility you feel for your employees’ professional lives. You truly want to create an environment where they can grow, contribute and feel rewarded. It is no small task to create the energy and belief necessary to get the team over that next hill.
As Mr. Bryant captivated his audience with rich tidbits from CEOs, he shared his insights about common themes that they have experienced. The importance of taking risks and embracing failure were tantamount in the path to success.
Let’s take a quick look at the immediate market risks ahead and conclude with a few great Churchill quotes.
Today, I share the following in this month’s Blumenthal Viewpoint:
- Sell in May and Go Away
- Summer Sell-Off: Probable Correction Targets
- Major Market Peak in 2015? Sooner?
- Trade Signals – Extreme Optimism Remains and Don’t Fight the Fed
Sell in May and Go Away
Here is a look at the S&P 500 Cycle Composite for 2014. The blue line in the chart below shows the tendency for the market to correct in the May to October period.
Here is the same chart absent the sector information. The dotted red line shows actual S&P 500 composite performance year-to-date through 3-27-14.
Several things to note:
- The cycle composite charts are designed to provide perspective on how repetitive historical market patterns could indicate a potential pattern for the current year. These cycle charts are based on the idea that seasonality (tendency for stock prices to behave differently during different times within a calendar year) and multi-year cycles have patterns that tend to repeat over time in the stock market. In addition to seasonal cycles, the four-year cycle (reflecting the time frame of a U.S. presidential term) and ten-year (decennial) cycle have been found to have significant repetitive tendencies historically. The cycle composite chart attempts to combine these three patterns into a single representative pattern.
- The one-year seasonal cycle is calculated by finding the average percent change in the S&P 500 Index for each day of a calendar year, based on all years from 1928 to present. The average daily percent changes are accumulated to produce a representative “average year” pattern. The same process is used for the four-year and ten-year cycles, but instead of using all years, they use only every fourth or tenth year (e.g., all years ending in “4”) historically. Thus we have three representative “average years” based on different historical cycles (one-year, four-year and ten-year) and we average them together to get a single composite cycle pattern that represents the current year, plotted in the top section of the chart. The chart also includes a line in the lower section indicating the actual pattern of the S&P 500 for the current year-to-date (its cumulative year-to-date percent gain), in order to see how the actual market corresponds to the cycle pattern.
- As the chart label indicates, the actual values (level) of the lines plotted are not significant by themselves; rather the trend of the lines indicating the potential direction of the market is where the focus should be. As always, we do not rely on seasonal or cyclical patterns as primary timing tools, instead basing analysis on factors such as the tape, the Fed, crowd sentiment, etc. However, knowing the historical tendencies of the market can often provide useful perspective on potential turning points and trends, which gain added weight when confirmed by primary NDR timing models and indicators.
This from NDR’s Lance Stonecypher, CFA, Chief U.S. Equity Sector Strategist: “Last week’s underperformance by previous industry leaders, like Biotech and Internet, as well as outperformance by prior laggards, such as Telecom, Metals & Mining and Tobacco, suggests the momentum factor may be starting to tire.
After an extended run and optimistic sentiment, it’s not a good sign when the market’s leading industries see their valuations becoming stretched, and then start to lose momentum.
Given the continued excessive investor optimism, current market overvaluation, the winding down of QE, The Likely Path to Higher Interest Rates, insider selling, record high margin debt and the seasonal tendency of market corrections (May to October), now is a good time to hedge long-term focused equity portfolio exposure and/or position more defensively. I believe a highly probable “sell in May and go away” period is ahead.”
Summer Sell-Off: Probable Correction Targets
- The first and most likely correction target is 1750 on the S&P 500 Index. Note the “red” line that just sneaks into the “green” highlighted box in the next chart. 1737 marks the last correction low.
- Both chart 1 and chart 2 below suggest a correction to 1575 is highly probable. 1575 marks the 2007 market peak and also represents a 38.2% Fibonacci retracement of the rally from the 2011 low to the recent market high of 1883. Roughly a 16% correction. This is my best guess summer correction target.A quick note on Fibonacci Numbers: The Fibonacci number sequence (1,2,3,5,8,13,21,34,55,89,144,…) is constructed by adding the first two numbers to arrive at the third. The ratio of any number to the next number is 61.8 percent, which is a popular Fibonacci retracement number. The inverse of 61.8 percent is 38.2 percent, also used as a Fibonacci retracement number. It is the ratio of the Fibonacci sequence that is important and valuable, not the actual numbers in the sequence. (More on Fibonacci here)
This chart shows the 2007 market peak at 1576. The red boxes show the bear market periods, the solid blue lines the cyclical bull market periods and the dotted blue line the trend. The blue lines above and below the trend mark the standard deviation above and below the trend. A move below the dotted line changes the trend from bull to bear. Note the blue arrow shows the median price trend just above 1576. If we witness a correction within the trend, 1576 marks a strong technical support level.
Major Market Peak in 2015? Sooner?
This is clearly a guess on my part but guess I will. I think the next bear market cycle is tied to interest rate movement that is farther and faster than market participants expect; likely triggering a 2008-like crisis, yet of potentially greater proportion. $240 trillion in derivatives is simply too dangerous ($140 trillion in 2008).
Chicago Fed’s Charles Evans doesn’t expect the first rate hike until the second half of 2015 – somewhat later than Yellen’s “six-month” (from QE’s end) remark which suggested a boost as soon as April 2015. Speaking to reporters after his speech, Evans suggested holding off on hikes until 2016 could be appropriate given the state of the economy. Nevertheless, Evans sees a Fed Funds rate of 1.25% by the end of 2016 – the low end of FOMC guesses, but 25 basis points higher than his forecast three months ago. As for raising rates to cool “financial exuberance” – an idea seeming to gain a little traction with some Fed members in recent days – Evans says “monetary policy is not the best tool to mitigate this risk.”
Ultimately, it is best to follow a weight of evidence approach. In this regard, I favor the two cyclical trend charts you can find each week (and below) in Trade Signals – Big Mo and The 13/34 week EMA charts. Both continue to show that the cyclical bull market remains today’s dominant trend.
With the less favorable May to October seasonal period fast approaching, I believe it is prudent to proactively risk protect your long-term equity exposure. I continue to favor a 30% Equities (hedged from time to time), 30% Fixed Income (flexible bond and shorter term exposure) and 40% Tactical total portfolio allocation mix for a moderate growth investor.
60/40 remains challenged as the market is overvalued, overbought and over believed. Further, the 40% to Fixed Income faces a coming higher interest rate headwind. Traditional bond exposure may not help this time. Rates are simply too low and may just rise sooner and higher than many believe – a potential one-two punch that hasn’t hit the 60/40 portfolio in nearly 30 years.
If your client can take the hit and remain standing, then prepare him/her for a much more attractive buying opportunity that is coming (a buy when everyone else is selling opportunity). Unfortunately, we know all too well that most investors sold at the market lows in 2002 and 2008/09 and were eager buyers at the market peak in March 2000, June 2007 and again today. Emotion rules reason at points of sentiment extreme. Thus, I believe 30/30/40 is a better mix at this point in the market cycle.
Trade Signals – Extreme Optimism Remains and Don’t Fight the Fed
Click here for a link to Wednesday’s Trade Signals.
Trade Signals identifies the equity and fixed income markets’ cyclical trend and suggests ways to hedge your long-term focused equity exposure tied to periods of excessive investor optimism. Charts are posted weekly on Wednesdays.
Conclusion
Find a mentor and ask many questions. There exists a wealth of knowledge as it relates to management best practices. I am going to add Bryant’s book, The Corner Office, to my reading list this weekend. Oh, as I pen this, I hear the whisper of my mentor and good friend, Jim Ruff (retired Oppenheimer Funds’ President), ring in my ear “if you can’t measure it, you can’t manage it”. Why didn’t I put such metrics in place sooner? He has helped me open my eyes to what now seems like simple common sense. There is so much more to learn. I look forward to that.
Bryant concluded with a fascinating Q&A session from the audience. He shared quotes from many of today’s top business leaders. It really came down to listening, caring, motivating, setting goals and metrics and truly believing in the people on your team. Your great leadership leads to great things for you and everyone you touch. Here is a link to his NY Times page.
One person asked, of the hundreds of interviews he has conducted, is there someone he would most seek. He quickly responded “Winston Churchill”, stating Churchill had the ability to take the most complex of situations and simplify in clear statements of intent. So in the spirit of Churchill, one of the greatest leaders of all time, I leave you today with a few of his most famous quotes:
“Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.”
“To improve is to change; to be perfect is to change often.”
“Some people regard private enterprise as a predatory tiger to be shot. Others look on it as a cow they can milk. Not enough people see it as a healthy horse, pulling a sturdy wagon.” (SB – I hope too much regulation doesn’t shoot the horse)
“Criticism may not be agreeable, but it is necessary. It fulfills the same function as pain in the human body. It calls attention to an unhealthy state of things.”
And one of my favorites: “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” Winston Churchill.
Here is to the continued growth and outstanding success of you, your family and your team!
Have a great weekend!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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