May 22, 2015
By Steve Blumenthal
“Ultimately, markets are the complex social action of human beings. Because of that they are driven by human emotions: fear and greed.”
-Mark Finn
CPI was reported this morning and there is a slight whiff of concern in the air. Fresh data showed consumer prices picking up for a third straight month. Core prices rose 1.8 percent, inching closer to the Fed’s inflation target of 2 percent.
This afternoon Fed Chair Janet Yellen predicted moderate growth this year and beyond, explaining that “economic headwinds are waning”. The market is expensively priced, investors are nearly “all in”, margin levels are higher than in 2000 and 2007. After six years of a zero interest rate policy and extraordinary QE, the market awaits the Fed’s next move. It will be tested. Markets perform best when inflation and interest rates are high and move lower. Unfortunately, the equity markets tend to get into trouble when inflation and rates are low and move higher.
As the Fed nears its tipping point, let’s take a look at investor tendencies and the risk to the market when investors are nearly “all in”. Can we safely ‘get off the Fed’s juice’? They are going to try and it’s going to get bumpy. Let’s keep the piece shorter this week. Have a great holiday weekend!
Included in this week’s On My Radar:
- Investment Behavior – We are Here
- Households Are Nearly “All In”
- Trade Signals – Big Mo Still Says Go, Sentiment Nearing Extreme Optimism, Zweig Bond Model Remains in a “Sell” Signal
Investor Behavior
I came across a great chart on investor behavior and post it for you next. My two cents, based upon many advisor calls (reflecting on their client conversations) as well as individual investor calls at our firm, we are somewhere north of “Excitement” and maybe just passing “Thrill”. After more than 30 years in the business, I’ve witnessed a few of the emotional roller coaster rides reflected in this chart.
There are a handful of individuals that seem to come into our lives at important times. Hopefully, our lights are turned on in those moments so that we can be open just enough to receive. One such moment for me happened in 1985.
As a young advisor at Merrill Lynch, my manager tapped me on the shoulder and told me I needed to go over to the Philadelphia Union League to listen to a presentation (actually it was more of an order). The room was filled with several hundred advisors and brokers. Just after lunch was served, famed Sir John Templeton took the stage. At age 23 and with one year notched in my career belt, I sat up in my seat – eager to learn.
What I walked away with was one of the most important insights that I carry with me every day. Sir John tells the crowd that “if you can follow my advice, you’ll be one of the best advisors in the business; however, while what I am going to tell you sounds easy, it will be one of the most difficult things for you to do.” He followed, “The secret to my success is that I buy when everyone is selling and I sell when everyone is buying.”
Ever since that day in 1985, those words still ring true. I was a guest on several radio programs this past week and both hosts told me that they are receiving more and more calls about account performance relative to the S&P 500 Index – similar to the late 1990s and again in 2007 and 2008 (prior to the peak). To me it is a warning. When investors go “all in” we are at a point of emotional euphoria or “maximum financial risk”.
Households are Nearly “All In”
Let’s take a second to study the next chart. The yellow circles mark the percentage of household financial assets that were invested in stocks. The yellow circle at the far right shows where we were at year end (more recent data not yet available but given the market’s relatively flat year, I suspect it is up marginally from 41.5%).
Also, take a look at the orange arrow and reflect on investor behavior. You can see that ownership of stocks dropped significantly after the 2000 market peak and similarly post all prior peaks.
Not only can the stock ownership chart tell us a lot about investor behavior, it can tell us a great deal about probable forward returns. I’m reposting the next chart (shared in last week’s On My Radar: Valuations and Forward Returns) because it is based off the data above and is quite telling. Note the low 2.25% probable 10-year forward return (yellow circle).
When investors are “all in”, there is less fuel available to drive prices higher. With margin debt at record levels, investor portfolios loaded into stocks and when investor selling overwhelms buying demand, margin calls kick in and the leverage unwinds – very quickly.
“Buy when everyone else is selling”… that day remains ahead of us. Until then, hedge your equity exposure, broadly allocate to other alternative sources of return (tactical, managed futures, etc.) and remain patient and prepared.
Margin Debt and the Merciless Mathematics of Loss
Here is a quick look at current margin debt. This is a chart I’m keeping an eye on. Essentially, we want to get concerned when the current level of margin debt drops below its six month smoothed moving average line. That may help us see when the tide begins to go out. (Note the return statistics in the upper left of the chart.)
We recently released a short paper titled, The Merciless Mathematics of Loss.
Our hope is that it proves a helpful tool for you to share with your clients. I sat with Susan one morning and we talked about how compound interest works its magic over time. Important in the equation is minimizing loss. She is extremely bright, yet like most individual investors, she is far from an expert on money.
I asked her the following question: If you have $100,000 invested in the market and you lose 50%, how much of a return do you need to get back to even? She quickly answered 50%. I explained that a loss of 50% would take her $100,000 down to $50,000 and she would need to make a 100% return on that $50,000 just to get back to even. A 50% return on $50,000 would be $25,000 and she would only get back up to $75,000. Her response, and many like it, was the motivation behind the Merciless Mathematics of Loss piece.
Shoot me an email if you’d like us to send you the PDF. Reply to this email saying – send me the Mathematics of Loss educational piece.
Trade Signals – Big Mo Still Says Go, Sentiment Nearing Extreme Optimism
I mentioned the following in Wednesday’s post:
The equity market trend remains positive as measured by Big Mo, 13/34-Week EMA and Volume Demand. Investor sentiment is neutral (neither excessively optimistic nor pessimistic). I continue to tilt bullish though the cyclical trend is aged and expensive.
Sentiment is inching back up to the excessive optimism level which will be short-term negative for equities – just not there yet. The Zweig Bond Model remains in a sell and our tactical fixed income ETF strategy is positioned defensively (let’s keep a close eye on the direction of interest rates). Our CMG Managed High Yield Bond Program remains in a buy signal (here is a link to the video webinar we hosted on high yield Opportunity of a Lifetime – Just Not Yet).
Click here for the charts.
Personal note
The intro quote is from Mark Finn. He is a good friend, mentor and, frankly, the most astute investor I know. Behavior matters and I believe his quote is apropos today. I’m sure you are getting more and more investor calls around performance relative to the S&P. It is just impossible for a broadly diversified portfolio (a collection of many types of risks including bonds, etc.) to beat a strong stock market. Investor or speculator – which one does your and my client want to be? He can’t be both. “…the complex social action of human beings. Fear and greed.” Indeed. Thanks Mark.
A long weekend is ahead and it’s time to relax. I’m wishing you a nice cold beer or perfect glass of wine, plenty of down time and joy with your family. I’m going to try to put the charts aside for a few days (btw – an addiction I have no desire to cure) and find a good book to get lost in.
I’m hoping Susan is planning a cookout. I love cookouts…
I hope you have something fun planned. Let’s slow down and celebrate life!
Have a wonderful holiday weekend!
With kind regards,
Steve
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
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