March 7, 2014
By Steve Blumenthal
On Thursday I spoke at the NWA Financial Fitness Forum sponsored by Mach-1 Financial Group in Northwest Arkansas. The keynote for the event was former Governor Mike Huckabee. He spoke about the mess in Washington (of course) and his deep belief that they have forgotten who they are working for.
Huckabee touched on the problems of excessive regulation and taxation and feels one of the real miss is that they are rewarding and incenting the wrong behavior. I thought he did a great job explaining to the audience the importance of savings and the healthy stewardship of money and how that investment translates into a strong economy and strong country.
My favorite part of his speech was a story about his bobsledding experience just prior to the 2002 winter Olympics in Utah. The governor of Utah had invited a few friends to preview the Olympic facilities. On the agenda was a run down the bobsled track. In steps a 16-year-old junior national bobsled team member. Huckabee’s coach and break man for the upcoming ride. They put on special shoes, spiked at the toe, and began the walk up the iced racecourse – from bottom to top. The idea was to give the sled’s new driver (Huckabee) a feel for the course.
The kid tells Huckabee how to enter turn 12, “you have to try to come into the turn about three quarters of the way up the curve.” They continue up the track through turns 11, 10, 9 – 1. Each curve has an optimal line he’s told. “What if I come in too high?” Huckabee asks. “Well, uh, well, uh, then we crash”, the kid answers. The image of the Swiss team crashing at last months Olympics pops into my head (heads ducked low banging against the iced sidewall).
Huckabee thinks he must be out of his mind to trust a 16-year-old when it comes to instructions on driving anything. Just before they are to take off, the kid simplifies the process and says, “Look, you are going to make some mistakes. We are going to be moving so fast you have to quickly put the bad ice (bobsledder speak for mistake) behind you. Just focus on the curve ahead”. They successfully arrived at the bottom.
Huckabee goes on to relate the story to the 2008 crisis, debt accumulation, gridlock in DC and said to the packed room, “what you can control is your savings, your debt, your investments and the stewardship of your money.” He said he learned something from the bobsled kid, “in order to be successful with your money, you must focus on the curve ahead.”
I have to say, I like Mike.
I was up next and presented on current market valuations and defined tactical investment strategies. Today, I share a new chart looking at five different valuation measures. Unfortunately, it too shows just how overvalued (32.48%) the market is and projects a forward cumulative return of -0.30% five years from now.
What you can do is find diverse ways to make money and add them to your portfolio(s).
Also, crossing my desk this week was the following quote on margin debt:
“The latest margin debt figures were released for January, showing another uptick in debt and decrease in the net worth of investors. The “available cash” for investors is now negative $159 billion, another new record low. As a percentage of the market cap of all U.S. equities, it amounts to -0.75%, tied with February 2000 for the most extreme figures since June 1987.”
Source: Jason Geopfert, SentimentTrader.com (emphasis mine)
So let’s take a look at margin debt, valuations and savings and “focus on the curve ahead”.
Today, I share the following in this week’s On My Radar:
- Margin Debt
- Another Look at Valuations – Dividends, Earnings, Cash Flow, Sales, PE and Trend
- A Quick Note on the Current Low Savings Rate
- Trade Signals – Extreme Optimism Once Again
Margin Debt – Highest Since February 2000
The above chart from Ned Davis Research shows Margin Debt at the highest level in history. Note the return when total margin debt is above the upper band (green dotted line) of just 2.05%. This data reflects Excessive Optimism (which is Bearish for the market).
Along with margin debt, it is concerning that the majority of investment newsletter writers are extremely optimistic (most since 1987). This has historically been a sign of a late phase of the bull market.
Another Look at Valuations – Dividends, Earnings, Cash Flow, Sales, PE and Trend
The problem is that this excessive margin and excessive optimism is coming at a time when the market is richly priced. The next chart shows the percentage gain of the S&P 500 Index at 6 months, 1 year, 2 years, 3 years and 5 years following periods of 20% market overvaluation, 20% market undervaluation and fairly priced. It is pretty clear to see that buying in and holding when the market is in an undervalued or fairly priced state provides you with the best returns.
Here is how to read the chart: Historical averages are used to calculate the “normal” valuation in five of the six measures. For example, the average of the monthly historical price to dividend ratio multiplied by the historical dividend per share gives the normal price for each month. The same goes for cash flow, sales, earnings and the CPI-adjusted P/E. The Trend component is a linear regression of the S&P 500 against time.
Each month’s data represents the median of the six normalized price lines – four until 1947 and five from there to 1954. What is important to note is the amount of history used in these calculations.
In the bottom section of the chart, NDR compares the S&P’s current price to its Normal Valuation Line, illustrating the number of percentage points by which the market is above or below its normal valuation. When the S&P 500 is 20% above its normal valuation, they consider it overvalued; at 20% below normal it is considered undervalued.
The table on the chart shows how the stock market has performed six months to five years after over or undervaluation is reached.
A Quick Note on the Current Low Savings Rate
Huckabee touched on the importance of savings to a free economy. My conclusion is that savings is improving but still at very low levels. Debt remains the primary drag. Great economies need savings and investments to drive growth. We remain in the slowest economic recovery since the Great Depression.
Trade Signals: Extreme Optimism Once Again
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.
In conclusion
I find myself circling back to interest rates and the potential and timing of higher rates. I fear it is the spark that lights the fuse. Debt remains unmanageable in a number of developed countries and those that can print are printing. There remains a debt and entitlement mess across the developed world. Japan and most of Europe are in far worse shape (debt to GDP). We are interconnected through a web of connectivity like never before (more than in 2007). The word “derivative” keeps me up at night.
It is the counterparty risk tied to the unimaginable amount of leveraged derivative exposure (supposedly used for hedging) that is the significant issue/risk we face. It is a tangled web of obligations. Counterparty risk that is so intertwined that, in short, if one fails, they all may fail. Dealers walk away, bids evaporate and a derivative market controlled by a small handful of Wall Street trading desks collapses.
I don’t believe the regulators fully comprehend the risk… weapons of mass destruction indeed.
The Fed may be nearing the end of the QE game yet that game can play forward. The economy is picking up but that is what may just close the QE door and begin to drive rates higher. With so much leveraged money tied to low interest rates, someone stretching for extra bases is going to get caught off sides. Add a pick up in inflation and rates may just surprise to the upside. The world and we are far too dependent on a low interest rate Fed and the global central banker’s money creation machines.
For now, the markets may go higher and I remain in the cyclical bull camp, but margin is high, optimism is high and valuations by all reasonable measures are high. My plan: I’m watching for our market models to change from cyclical bull to cyclical bear. I’m watching for our tactical strategies to show a price leadership shift away from equity exposure like they did in 2008.
Have a plan, be prepared to act and remain focused on the curve ahead.
A special thanks to David Lee and his partner Kyle Alexander of Mach1 Financial. David is a 1996 graduate of the United States Air Force Academy. He served nearly a decade in the US Air Force as an F-16 fighter pilot. Both are super bright and have a wonderfully honest and direct way. I attend many investment conferences – this was one of the best run advisor events I have attended. Well done guys.
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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