January 3, 2012
By Steve Blumenthal
As I dive through a broad range of independent research each week, following are several bullet points I found interesting:
John Mauldin – Somewhere Over the Rainbow
- Since U.S. GDP (Gross Domestic Product) has tended to grow (at least until recently) at 3% per year, predicting long-term returns and secular bull and bear markets has been pretty straightforward. But recently, several noteworthy analysts have presented research suggesting that GDP will not grow anywhere close to 3% over the coming decades. In Mauldin’s letter he looks at the ramifications of slower GDP growth on equity returns. For most investors this is a very important topic as the stock market tends to be the main driver of their investment returns.
- Bill Gross (PIMCO) forecasts economic growth at just 1.5%. Jeremy Grantham (GMO) predicts just 1.4%. Chris Brightman (Research Affiliates) sees just 1%.
- Mauldin and I have partnered together for more than ten years. I enjoy reading him today more than ever. He has a unique way at making sense of what is happening in the economy and focusing on what matters most. In his most recent piece, co-authored with Ed Easterling of Crestmont Research, the two look at the impact lower GDP growth will have on market valuations as measured by Price/Earnings (P/E). Hint: A slower growth economy would certainly help bring about lower valuations. Here is the link to the article: CLICK HERE
P/E – S&P 500 Price/Earnings Ratio (Normalized GAAP Earnings)
Given the above, I include the next chart on P/E to help get some footing on where we are in regards to current P/E. This is one of my favorite charts on P/E as it is based on reported earnings and not some future, hoped for, over optimized Wall Street earnings estimation. Note that when your starting point is a high P/E, your forward returns are low and visa versa.
Trade Signals – the late December sell-off left sentiment in the Neutral zone. Sentiment continues to support “RISK ON”. Be prepared to hedge on a move into the Extreme Optimism zone. The last two Fiscal Cliff-based up days should move sentiment higher.
- For years I have found investor sentiment to be one of the most effective tools to help manage long directional equity risk exposure. My very simple approach is to go against the crowd at points of behavioral extreme. Given current high P/E valuation levels and the likely low growth environment I believe remains ahead, I believe we are in a period of time that favors more active risk management of long equity portfolio positions. There are many ways to actively hedge long equity positions: inverse ETFs, leveraged inverse ETFs, put options, covered call options and more.
- Here is the link to today’s investor sentiment charts and short commentary on the current “Risk On” trade.
Wishing you an outstanding 2013!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
steve@cmgwealth.com
610-989-9090 Phone
PS: When I look at the world, I try my best to view it from a probability perspective. I read endlessly and have access to some outstanding hedge fund and independent investment research. Fortunately, if you dig deep enough, you have access to a great deal of information on the internet. This certainly wasn’t the way it was in 1984 when I started in the business.
I believe we are in a challenging low return environment and that most individual investors hold higher return expectations; those expectations will not be met and investors will seek a better solution. I see an unprecedented opportunity for you to grow your advisory business.
With this piece I try to share some information that I have found to be important. To me the evidence is clear, but I most certainly could be wrong.
Whether I am correct or incorrect in my thinking, my overriding belief is that you can create and manage successful portfolios for the period ahead. This environment requires more work (mixing a diverse set of risk drivers and more active beta hedging) than exists in a secular bull market cycle, but also offers you the ability to separate yourself from the 98+% of your competition that is heavily weighted in the old 60/40 stock/bond construction model.
The good news is that the investment opportunity has been greatly expanded and solutions exist. While risk is an inescapable companion in the investment process, I believe it can be quantified and minimized by expanding the asset classes you include in your portfolios.
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