January 12, 2024
By Steve Blumenthal
“The art of investment is the discipline of inaction in the absence of a good opportunity, but aggressive action when one is identified.”
– Li Lu
Consumer Price Index (CPI) inflation data came in just above consensus estimates earlier this week at 3.4% year-over-year. Expectations had pegged it at 3.2%.
And today, the Labor Department reported that Producer Price Inflation (PPI) unexpectedly fell in December due to lower fuel and food costs. Prices for services, however, were unchanged. The combined CPI and PPI data continue to support the consensus view that the Federal Reserve will start cutting interest rates later this year.
The yield on the 10-year Treasury Note rose a few bps after the CPI data release but declined slightly in today’s PPI print, ending just below 4%.
As of now, Fed officials are dot-plotting three rate cuts in 2024, while investors are expecting six. No one can know for sure what will ultimately happen, but investors should know that a recession has followed almost all prior Fed rate-cycle peaks (see the following chart—hat tip to David Rosenberg @EconGuyRosie at Rosenberg Research). Jobs have also plunged, with an approximate 12- to 18-month lag, and the S&P 500 Index has declined approximately 32%, on average, from cyclical peaks to recession lows.
Here’s what Dr. Lacy Hunt had to say on this in the latest newsletter from Hoisington Investment Management Company:
“The long history of business cycles illustrates that rising inflation precedes recessions. Inflation accelerations don’t just happen, they are caused. Accordingly, a more complete description of these aggregate fluctuations is that monetary accelerations precede rising inflation, which then requires monetary decelerations that inevitably lead to recessions. Thus, monetary policy actions are pro- rather than counter-cyclical and the financial cycle will continue to lead the GDP and price/labor cycle.
The process of the monetary policy reversal from the 2020-22 inflation is presently at an advanced stage, suggesting a repeat of the standard business cycle process. To be sure, the quick spread of inflation in this cycle was abetted by massive fiscal stimulus via transfer payments along with the central bank’s dramatic balance sheet expansion. These combined monetary and fiscal actions have resulted in negative net national saving, a condition that will impair economic growth well after the Fed reverses the severe monetary restraint currently in place.
On the horizon, Lacy sees a recession and lower Treasury bond yields. The 10-year Treasury Weekly MACD and the Zweig Bond Model technical indicators support his bullish bond market view.
Recession Watch
As for recession timing, keep your eye on the high-yield bond and small-cap stock markets. Historically, they have turned negative prior to recessions. I shared three key bond indicators to watch in last week’s OMR post: (1) the 10-year Treasury yield, (2) the Zweig Bond Model, and (3) the high-yield junk bond market and small-cap stocks. The indicators in #3 are sensitive to economic activity, and yesterday, January 11, they had a signal change, moving from bullish to neutral. Historically, high-yield bonds and small-cap stocks have served as an excellent early-warning recession indicator. Keep watching. When both orange and blue lines (below) drop below their respective moving average, the alarm bells will go off.
Grab that coffee and find your favorite chair. Investors, who are betting that the Fed can accomplish its “soft landing” for the economy, believe the coming rate cuts will be bullish for stocks. Yet, history tells us the odds are low.
Below, you’ll find a few more interesting charts that speak to equity market valuations as of year-end 2023. With escalating geopolitical challenges and the negative drumbeat of war—China v. Taiwan, Iran and the Middle East, Russia v. NATO—the risk of an event is high.
My friend Renè Javier Aninao had this to say in his email update to clients today,
Team CORBU Advisory Clients — ahead of the Taiwan election tomorrow, developments on the security and geopolitics front have materially escalated with: Iran now directly involved in the regional conflict — with the successful repatriation (aka seizure) of an oil tanker just outside the Strait of Hormuz.
There is more on the intelligence front. It’s concerning. Channel your inner Warren Buffett and remember, as he says, “Anything can happen in stock markets, and you ought to conduct your affairs so that if the most extraordinary events happen, that you’re still around to play the next day.”
Taiwan’s election is tomorrow. Lights on.
On My Radar:
- Valuations Remain High
- Warren Buffett – 71% of Berkshire Hathaway’s Portfolio is in Four Stocks
- Random Tweet’s
- Personal Note: Habits That Make A Champion
- Trade Signals: Weekly Update, January 10, 2024
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Valuations Remain High
Reflecting back on today’s intro quote, “the discipline of inaction in the absence of a good opportunity,” valuations can help us set parameters to see opportunities better. I’m looking for the silver lining in the general equity market regarding buying and holding passive equity index-based funds, but I don’t see one (yet). Nevertheless, the majority of investors are overweight cap-weighted index equity funds and ETFs.
A better opportunity remains ahead. We’re looking for a “fair market value” level on the S&P 500. What’s that target? Current calculations put it at 3,224. To get that value, we take a look at the median price-to-earnings (PE) ratio over the last 59.8 years, which is 17.6. Multiply the current earnings of the S&P 500 Index by the median PE ratio, 17.6, and you get 3,224. Our “good opportunity” will come when the PE ratio returns to 17.6. It is currently 26.1. Keep holding your horses.
Dashboard of Valuation Indicators
- Bottom line: Extremely overvalued across multiple valuation metrics
The Buffett Indicator
The Buffett Indicator, also known as the market capitalization–to–GDP ratio, is a long-term valuation indicator for stocks measuring the total market value of all publicly traded stocks in a country, divided by that country’s GDP (gross domestic product). Popularized by Warren Buffett (and his success), it’s a way to assess whether a country’s stock market is undervalued, fairly valued, or overvalued and has become popular in recent years. Back in 2001, Buffett remarked in a Fortune Magazine interview that the Buffett Indicator “is probably the best single measure of where valuations stand at any given moment.” Source: AdvisorPerspectives
What does it show us now?
Bottom line: Valuations are lower than the crazy high level reached in 2021, but still higher than they’ve been during any other period dating back to the early 1950s, including the Tech Bubble peak in 2000.
Historical Returns Based on Stock Market Cap as a Percentage of Gross Domestic Income (GDI)
How to read it:
- The middle section shows the orange line well above its long-term linear regression trend line.
- The bottom section blue line shows the current distance the orange line is above its trend line is in the “Top Quintile” or most overvalued. It’s better than in 2021 but still in the most overvalued quintile.
- Focus on the data box in the bottom right-hand section. When in the “Top Quintile” (most overvalued of all readings dating back to 1925), the arrow points to the returns that followed 1-, 3-, 5-. 7-, 9- and 11-years later. Effectively, after 11 years, the average percentage change in the S&P 500 was -2.05%.
Equal Weight Trend – Bear Trend Signal
I was reviewing my dashboard of indicators this morning and thought I’d share this next chart to note the risk-off signal that was triggered yesterday (1-11-24). This data looks at an equal weighting of the U.S. stock market (in contrast to a cap-weighted approach, which finds the top ten stocks at 30% of the entire S&P 500 index). It’s not a perfect indicator (there is no perfect indicator), but it’s done a pretty good job. The grey highlight in the data box indicates the current signal-a bear trend signal.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Warren Buffett – 71% of Berkshire Hathaway’s Portfolio is in Four Stocks
“Both Warren Buffett and his late right-hand man Charlie Munger firmly believed that their top investment ideas should have added weighting in Berkshire’s investment portfolio. As of the end of the first week of the new year, a whopping 71% ($254 billion) of Warren Buffett’s $358 billion portfolio was invested in only four stocks. of the end of the first week of the new year, a whopping 71% ($254 billion) of Warren Buffett’s $358 billion portfolio was invested in only four stocks.” Source: YahooFinance
- Apple: $165,881,230,011 (46.3% of invested assets
- Bank of America: $35,561,094,567 (9.9% of invested assets)
- American Express: $28,663,518,942 (8% of invested assets)
- Coca-Cola: $23,868,000,000 (6.7% of invested assets)
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
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Random Tweet’s
RRP’s – Reverse Repo’s
US National Debt
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Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
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Personal Note: Habits That Make A Champion
One of the really fun things about being married to a youth soccer coach is having frequent discussions about what she’s reading, and how she works what she’s learning into her coaching. Great coaches—Susan among them—have an insatiable appetite to improve, and our den at home (where my favorite chair is located) is lined with many books she bought. The lessons she takes with her from these books almost always play out in small moments—sometimes with one player at a time, and sometimes with the broader team.
As it turns out, sometimes I’m one of the players she coaches. She’s been reading Habits That Make a Champion, by Allistair McCaw, about how champions plan, prepare, think, behave, and compete, and she shared an excerpt from it (above) with me recently when I was getting offside, so to speak, during a business challenge and needed to find balance. It couldn’t have come at a more perfect time.
The excerpt really made me reflect on some of the people I work most closely with and new people with whom I would be willing to share my time and energy. Reminds me of what Mama always said: “When you get on the school bus, choose carefully who you sit with.”
McCaw has consulted and worked closely with some of the best athletes and people in the world, and he believes that the difference between the good performers and the great ones lies in their discipline and daily habits. Tennis great Roger Federer’s coach, Ivan Ljubicic, calls the book “an athlete’s bible.”
In addition to writing about how past and current champions do what they do, McCaw also shares how we can each build the beliefs, habits, and traits to make us high performers. One tip? Focus on the yellow, and avoid complainers, blamers, and excuse-makers—especially those who believe they’re never at fault.
It’s a motivational book; you certainly don’t have to be an athlete to gain value from it. I’m going to encourage my children to read it and focus on the yellow, too.
Books aside, I have some travel coming up. I’ll be in Tampa on the 25th for a due diligence meeting, then on to Snowbird, Utah, in early February for a week of skiing with my family. A trip to San Fransisco for an investment banking meeting is in the works, and I’ve promised my son Matthew that I’d visit him in Denver. We have hopes of sneaking up into the mountains to ski Copper Mountain or Winter Park. The golf clubs are in storage, and the skis are coming out. I’m checking in happy.
My Utah friend just sent me an Instagram. Snowbird has had four feet of snow in the last few weeks, and another 70-80 inches is expected to fall in the next four days.
January and February are not the best months in the Northeast US, so having the ability to travel and work remotely from anywhere really is the one great uptick from the pandemic. Yellow is better than Orange, and warm is better than cold…unless you are atop 11,000 feet looking down at fresh, deep powder snow. However, 70-80 inches of new snow on top of 48 inches of recent snow is insane and dangerous. No one is going to be let out of the lodges.
I hope you are doing something fun!!!
Kindest regards,
Steve
Trade Signals: Weekly Update – January 10, 2024
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Notable this week:
The big surprise for me and others in 2023 was the liquidity the Fed and the Treasury injected into the system after the SVB banking crisis last spring. Capital raced out of bank accounts to other larger (perceived to be safer banks) and into money market funds via brokerage accounts, mutual funds, and ETFs.
The massive amount of capital running from those 0% interest-paying bank accounts into the much higher-paying money market funds left the money market funds needing more Treasury bills to buy. The Treasury created new Treasury bills, and money exited the reverse repo market to lock in higher yields Janet Yellen was issuing via new T-bills. Effectively injected the idle cash into the financial system—a back door stealth QE.
The remaining liquidity will likely be gone by the end of March or early April 2024. Some think sooner. This liquidity helped support risk assets and the economy in 2023. We are looking for a peak in the markets by quarter end tied to the end of the liquidity injection. While the Fed raised interest rates to tighten financial conditions, they back-doored liquidity into the system, muting the impact. I missed this.
Bullish conditions remain regarding most equity market indicators you’ll find below.
What didn’t miss this move was the weekly MACD trend indicator for the S&P 500 Index. I’m closely monitoring all trend indicators, primarily the weekly MACD. Here’s a quick look: Green arrows are bullish intermediate-term trend signals, and red arrows are bearish.
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