December 31, 2021
By Steve Blumenthal

“In my view, modern monetary theory (“MMT”) has been tried, tested, and failed.”

– Dr. Lacy Hunt,
Executive Vice President, Hoisington Investment Management Company

Let me begin by wishing you a Happy New Year. Today, I share an outstanding discussion. Camp Kotok fishing friend Danielle DiMartino Booth interviews the great Dr. Lacy Hunt. Danielle is CEO & Chief Strategist for Quill Intelligence LLC, a research and analytics firm, and former Advisor to Federal Reserve Bank of Dallas President Richard W. Fisher, author of the book FED UP: An Insider’s Take on Why the Federal Reserve is Bad for America (Portfolio, Feb. 2017), and one of the far too few important voices for sound money policy.

In Danielle’s words, “Well, it’s hard to recap what I just experienced. There is no greater teacher of economics than Dr. Lacy Hunt. So what an amazing privilege. You’re probably going to have to watch this one a few times. I’m going to go back and take notes of everything he talked about and all that rich history of the Federal Reserve he shared. If for some reason you haven’t seen a recent episode of “Down the Middle” where I interviewed former Philadelphia Fed President Charles Plosser, go back and watch that because he is also somebody who is an advocate for independence. The independence of the Federal Reserve and how critical it is and how far astray the Fed has gone.”

In the Trade Signals section below, I share with you my personal views on what’s happening in the markets, the economy, inflation, the Fed, and what the road ahead may look like. Of course, I could be wrong. There are things that are known, such as current market valuations, margin debt, interest rates, and there are unknowns we simply cannot yet know (Covid, inflation, Fed policy, infrastructure stimulus, tax legislation, Russia/Ukraine, China/Taiwan, Iran, etc.)

I watched the Danielle-Lacy video interview after I wrote my 2022 Investment Outlook piece. If anything has changed in my fundamental view, I may be underestimating the pace of economic decline we are heading into in 2022. Let’s keep a close eye on the economic indicators section in Trade Signals over the coming months.

Stock market tops occur when complacency is high, the news is good, and there are many divergences (fewer stocks carrying the indices higher). Market bottoms occur when panic is high, volatility is high, and correlations are high. As we head into 2022, we’ll continue to keep a close eye on the Trade Signals – Dashboard of Indicators. They continue to flash green for both stocks and bonds. More below. Grab that coffee and find your favorite chair and don’t worry about the markets. There is always opportunity found in all kinds of environments.

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Danielle DiMartino Booth Interviews Dr. Lacy Hunt

For investors, what we are after is to understand the impact of debt on growth. The greater the level of debt, the weaker the growth. If growth weakens, corporate earnings weaken. Lower earnings make it difficult to justify high stock prices.

Lacy is a bond investor. If he believes interest rates are heading lower, he positions his clients into long-duration Treasury bonds. Bond prices move up when interest rates move down. Lacy says, “We have reached a phase where the overuse of debt-financed spending is detrimental to economic growth.” Slower growth means lower bond yields. In the interview, Lacy explains why he believes bond yields will continue to move lower.

On inflation, Lacy said, “People are upset, inflation’s in the headlines. And we know that if inflation were to be sustained over long periods of time, it would take the bond yield up with it. So the critical issue is whether inflation is going to be sustained. And it’s not a question of when inflation occurs. It’s the question of whether it’s going to be sustained and I’m in the camp that it will not be sustained.” Lacy believes the current bout of inflation will choke off economic growth, and along with the debt mess we are in, the economy will slow. That the long-term bull market in bonds is not over just yet.  The Zweig Bond Model in the Trade Signals section is signaling agreement.

This is the arena we investors find ourselves in. Purely from an investment perspective, how we position ourselves to profit is the game. Click on the photo to access the interview.

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Trade Signals – 2022 Investment Outlook

December 29, 2021

Posted each Wednesday, Trade Signals looks at several of my favorite equity markets, investor sentiment, fixed income, economic, recession, and gold market indicators.

For new readers – Trade Signals is organized into three sections:

• Market Commentary
• Trade Signals — Dashboard of Indicators
• Charts with Explanations

Market Commentary

Notable this week: 2022 Investment Outlook

The investment picture going into 2022 is the relatively high probability the global economy will slow dramatically from the stimulative-driven pace we are now exiting. Equity market valuations are at record highs, U.S. household ownership is at an all-time high, foreign ownership of U.S. equities is at an all-time high, and never before has so much money been concentrated into the same few names (FAANG stocks). Most concerning is the high level of leverage in the system: margin debt has exceeded the insane levels reached at the prior two bubble peaks (see the orange line in the center section below) in 2000 and 2007.

The challenge with margin debt is not when it is going up, it’s when it is going down. Ned Davis Research has a great chart that looks at Margin Debt relative to a 15-week Rate of Change. Technical sell signals are triggered when margin debt reverses from a high (“Excessive Speculation”) level. Buy signals are the opposite. Note the “S” sell signal in the chart below that fired at the end of last month. The last time this indicator generated a sell signal was in 2007.

Get your mind around this piece of data: In the last 12 months, in-flows to U.S. equities total $1.1 trillion. That compares to in-flows over the last 19 years totaling $1.1 trillion combined. More buyers than sellers and prices go up. (Source: BofA Global Investment Strategy, EPFR.)

Corporate Share Buybacks

And where is a good portion of that money coming from? Corporate share buybacks. We’ll be talking about this someday in the future and shaking our heads. A consequence of the Fed’s zero-interest-rate policy and the structure of executive stock option incentive packages. Courtesy of Lance Roberts at RIA Advice, “The surge in the repurchase of shares over the last decade remains one of the more significant supports to the financial markets. (Such is because it is mostly the major market-cap-weighted names that can afford multi-billion share buybacks.)

The chart below via Pavilion Global Markets shows the impact of buybacks on the market over the last decade. The decomposition of returns for the S&P 500 breaks down as follows:

• 21% from multiple expansion,
• 31.4% from earnings,
• 7.1% from dividends, and
• 40.5% from share buybacks.

In other words, in the absence of share repurchases, the stock market would not be pushing record highs of 4700 but instead levels closer to 2800. The risk to stocks is a reversal of that support from the Fed.”

This helps explain some of the record inflows into U.S. equities. With individuals, foreigners, and corporations all in, one has to wonder where the future buying demand will come from.

The salient point is the market is priced to perfection, euphoria is at an epic high, leverage has never been greater, and too few see the risks. Following are my fundamental views on the year ahead. No guarantees, I could be wrong.

2022 Outlook

• A difficult first half of 2022 with the potential for a 30 percent or greater market decline.
• Fed responds aggressively and the equity market bottoms. Strong second half 2022.
• Similar to inflation cycles of the past, some moderation in inflation into mid-year. Inflation picks back up in the second half with the return of Fed Quantitative Easing (QE).
• Bullish outlook for 10-year and 30-year Treasury bonds. The 10-year yield may decline from 1.5% to 1% in the first half of 2022.

As we enter 2022, inflation is calling the Fed’s hand. The Fed is pulling liquidity from the system and anticipates raising rates three times next year. If I’m correct in my view that inflation, rising rates, and debt will lead to a meaningful economic slowdown (“stagflation”), then the first half of 2022 will surprise investors. A -30% market decline into mid-year is a real threat. If correct, I suspect the Fed will reinstate QE, we’ll bottom and we’ll be off to the races again.

• Bullish dollar first half of 2022, as the global slowdown and market turmoil, favors a strong dollar. Longer-term, bearish view on the dollar but I wonder relative to what other currency. The developed world is collectively debasing its currencies.
• The outlook for gold is the opposite of the dollar. Long-term very bullish on gold with a target of greater than $5,000.
• Bullish on commodities, agriculture, uranium (nuclear fuel), and oil for the foreseeable future.

This is all a big “if” because there are many unknowable pieces. We don’t know what role the Covid virus will play or what inflation will look like. You and I can’t control the geopolitical risks: China/Taiwan, Russia/Ukraine, Iran’s apparent pursuit of nuclear weapons.  And we can never know for sure what big liquidity guns the Fed may fire next. The risk-on party may have more euphoria left in its run.

Time to Hedge

But just in case, buying at-the-money put options three months out is not a bad idea. Think of it like homeowners insurance. There is a cost, but it is small relative to the potential savings. Of course, this is not a recommendation for you to engage in any securities transaction. Talk to your advisor.

I see “fair value” in the S&P 500 Index around 2,800. Forward returns from that entry point should be close to the historical long-term returns for equities. Give or take 10% per year before inflation is factored in (no guarantees). My downside target on the S&P 500 is 3,000.  Much depends on the degree of leverage unwinding and the reaction from the Fed. I suspect the Fed will aggressively come back into play.

Finally, with all that said, the technical picture remains moderately bullish as you’ll see in the Trade Signals – Dashboard of Indicators next. I’ve added “Dr. Copper” to the Economic Indicators section. Historically, it has been a useful early indicator warning of a downturn in the economy. Dr. Copper is insider lingo used in the commodities markets to explain price trends in copper’s ability to predict the overall health of the economy. When copper prices decline, it may indicate sluggish demand and an imminent economic slowdown. You’ll also see overall liquidity in the system remains positive, the risk of recession is currently low and the economy in general looks to be in good shape. We are exiting 2021 on a high note and I hope you are as well.

Trade Signals zeros in on the equity and fixed income markets. If you are most invested in cap-weighted index funds (unhedged) and bonds, my view is you are in for a bumpy ride over the coming years. However, there are so many ways to find a good return. In our multi-family office business, we are investing in well collateralized short-term private credit funds yielding in the mid-to-high single digits. Because of the network Mauldin and I and our team have built over the years, we have access to certain select opportunities that others may not. We believe in defending our CORE wealth in a way that enables us to position very risk-on (we call it EXPLORE) with select late-stage private credit investments. If you are a qualified investor with a net worth of more than $5 million, email me at blumenthal@cmgwealth.com if you’d like to learn more.  If your net worth is smaller, and you’d like some ideas about how to hedge we’d be happy to speak with you.

Wishing you a successful 2022!

Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon, and risk tolerances.

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Personal Note – Happy New Year

“There are only two ways to live life. One is as though nothing is a miracle.
The other is as though everything is a miracle.”

– Albert Einstein

It is 50 degrees with little wind in Philadelphia today. All the kids are home. We are heading to Stonewall this afternoon for a nine-hole scramble. Brianna and her boyfriend Kyle and my step-son Tyler are on my team. Our mission is to beat sons Matthew and Kyle. The way a scramble works is everyone tees off. The best drive is picked and everyone hits from that position. Then the best shot is picked and everyone then putts from that position. It’s a hole-by-hole match. Win the first hole and you go one up. The winning team gets bragging rights and maybe a little cash.

Tonight we are home. A fire is planned for outside and the red wine is ready and waiting. I’ll be holding a glass high and from my family to yours, Happy New Year!  To life, love, and miracles.

With kinds regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

Consider buying my newly published Forbes Book, described as follows:

With On My Radar, Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth.

If you are interested in the book, you can learn more here.

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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.

Click here to receive his free weekly e-letter.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.

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