December 5, 2014
By Steve Blumenthal
“Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do work you believe is great work. And the only way to do great work is to love what you do. If you haven’t found it yet, keep looking. Don’t settle. As with all matters of the heart, you’ll know when you find it.”
– Steve Jobs, co-founder of Apple
I love the above quote and shared it with my oldest daughter, Brianna. She is deciding between two job offers. Four years at Penn State has flown by quickly and for a happy dad, the final tuition bill is paid. Her choice is between large and structured or small with great promise. We spoke last night for about an hour and I hung up with a happy heart.
“The only way to do great work is to love what you do.”
Life stepped in with a heavy hand this morning. The sales team gathered for their weekly meeting and Jason shared that his father passed yesterday. Emotional, warm, sad, there is not a dry eye in the shop today. He’d been sick but, as you know, it really hurts.
Your firm, as mine, is a family of sorts. The culture matters. How we treat people matters. One of my favorite interview questions is to ask, if they could do anything in the world, what would they do. I ask, what does your heart tell you to do? Not the head, the heart. Maybe it’s a bit corny but what I’m looking for is passion. Put me with smart, driven and passionate people who love what they do. It is nice to create with people you really admire and it is even nicer to be with people that genuinely care about each other.
This week, Bill Gross is out advising investors to lighten up on stocks as is former co-CIO Mohmand El-Erian. You may agree with me that these are certainly two people with passion that are doing what they love to do. To that end, we all benefit.
Today, I link to a few thought pieces, share several market valuation charts and take a look at how you might consider portfolio construction through the lens of risk. As El-Erian said, “Be ready for greater volatility and be ready for picking up good companies at cheap prices.”
Included in this week’s On My Radar:
- The Bond King on 2015 – Bill Gross’s December letter
- El-Erian – You Want To Have Dry Powder at This Point
- Quintile 5 – Predicting Forward Return Over the Next Ten Years: Just 4.28%
- So What Does This Mean to You and What Can You Do?
- Trade Signals – Trend Positive, Sentiment Remains Too Optimistic 12-3-14
The Bond King on 2015 – Bill Gross’s December letter
Following is the heart of the piece:
“But each of these central bankers is trying to achieve the same basic objective: Solve a debt crisis by creating more debt. Can it be done? A few years ago, I wrote that this uncommonsensical feat could be accomplished, but with a number of caveats: 1) Initial conditions must not be onerous; 2) Both monetary and fiscal policies must be coordinated and lead to acceptable structural growth rates; and 3) Private investors must continue to participate in the capital market charade that such policies produced.
Let me explain each of these three caveats in turn.
1) By initial conditions, I am referring to existing structural headwinds that would thwart the successful rejuvenation of old normal, nominal growth rates. Certainly a country’s current debt/GDP ratio factors enormously into the odds making for success. It is difficult, for instance, to imagine Japan getting out of its quagmire of debt by simply creating more of it and buying 100% or more of the new and current supply. Similarly, Greece (which has already suffered several restructurings) as well as neighboring Euroland peripherals begin the healing process well behind the debt/GDP eight ball. But there are other significant initial conditions – structural headwinds – that my version of the “New Normal” envisioned as early as 2009: aging demographics, technology/the race (rage) against the machine, and the ongoing reversal of globalization, are all growth-stunting factors to consider. Economist and former Treasury Secretary Larry Summers has labeled this “Secular Stagnation” and rightly so, but it is just another way to describe the New Normal and its deleterious effect on future growth.
2) Monetary and fiscal policies must work side by side; they must be stimulative as opposed to being counterproductive. It makes little sense, for instance, for Euroland to be running a tight fiscal policy resembling the balanced budget mandate of Germany, while at the same time initiating quantitative easing and negative interest rate monetary policies. The same holds true for the Bank of Japan’s massive monetary stimulus on the one hand, and Japan’s raising of its consumption tax on the other. One could even apply that complaint to the U.S. with its fiscally restrictive rebalancing of its budget deficit from 10% to 3% over the past five years. If not for fracking, Uncle Sam might be labeled the Old Man in the Shoe for not knowing what to do. In fact, in the U.S., as elsewhere, there has been little focus on public investment and infrastructure spending. It’s been all monetary policy, all of the time, with most of the positives flowing over to markets as opposed to the real economy. The debt currently being created is not promoting real growth and solving a debt crisis – it is being used by corporations to repurchase shares and accentuate the growing inequality between the very rich and the middle class.
3) Keeping private investors playing the “game” in our financial markets even though they smack of a pyramid scheme might seem like a no-brainer. “Where else can they go” has been and continues to be the commonsensical refrain. Not sure, but perhaps Google Maps can show the way. But on the fringe and at the margin, there are alternatives to negative interest rates or artificially low cap rates, or escalating P/E ratios based on historically high profit margins. And even if investors must buy something, they don’t necessarily have to buy it in their own or any specific country. If 3-year German government bonds yield -.05%, then how about a 3-year Brazilian government bond at 12.5%? At the moment the negative yielding German bond gets the market’s vote, but you must see the point. Creating more debt with artificially low yields leads to currency wars and exchange rate volatilities that distort global capitalism. Solving a debt crisis by creating more debt cannot cure the disease if higher volatility distorts the historical flow of markets and associated commerce.
And of course economic theory might suggest that artificially low interest rates gradually but inevitably lead not to more consumption and real growth, but to more savings in order to meet future liabilities such as education, health care, and eventual retirement. If a household needs $250,000 for any or all of these future commitments, it will be twice as hard to meet them with 5-year Treasury’s at 1.5% instead of 3%.
With each of my three primary caveats coming up short in an answer to my earlier question: “Can a debt crisis be cured with more debt?” It is difficult to envision a return to normalcy within my lifetime (shorter than it is for most of you). I suspect future generations will be asking current policymakers the same thing that many of us now ask about public smoking, or discrimination against gays, or any other wrong turn in the process of being righted.
How could they? How could policymakers have allowed so much debt to be created in the first place, and then failed to regulate their own system accordingly? How could they have thought that money printing and debt creation could create wealth instead of just more and more debt? How could fiscal authorities have stood by and attempted to balance budgets as opposed to borrowing cheaply and investing the proceeds in infrastructure and innovation? It has been a nursery rhyme experience for sure, but more than likely without a fairytale ending.”
Bill concludes:
“Markets are reaching the point of low return and diminishing liquidity. Investors may want to begin to take some chips off the table: raise asset quality, reduce duration, and prepare for at least a halt of asset appreciation engineered upon a false central bank premise of artificial yields, QE and the trickling down of faux wealth to the working class. If the nursery rhyme theme is apropos to the future, as well as the past, investors should remember that while “Jack and Jill went up the hill,” that “Jack fell down, broke his crown, and Jill came tumbling after.””
Here is the link to the full letter.
El-Erian – You Want To Have Dry Powder at This Point
Following are my quick takeaways:
- “Because correlations are changing. Look at commodities — commodities have been coming down while equities have been going up. That is a very strange correlation historically. It reflects the fact that we have the interference of central banks with the functioning of markets.” (emphasis mine)
- This interference, along with weak growth in China, Japan and Europe, means the United States — while doing better than the rest of the world — “is facing headwinds,” the economist notes.
- “I would say given the very strong rally we’ve had, take some money off the table here — have some optionality. There will be bumps down the road. There will be lots of volatility.”
- “You want to have dry powder at this point…”
- “Be ready for greater volatility, and be ready for picking up good companies at cheap prices,” he added.
Source: El-Erian appearance on “Sunday Morning Futures with Maria Bartiromo.”
Quintile 5 – Predicting Forward Return Over the Next Ten Years: Just 4.28%
The following chart looks at historical data and ranks PE into five quintiles. Quintile 1 (blue line) shows an annual gain of 15.66% in the S&P 500 index over the 10 years following periods when PEs where low. Quintile 5 (yellow line) shows an annual gain of just 4.28% following periods when PEs were high.
Think of it this way. The study looked at what happened ten years after PE was at a certain point. NDR grouped PEs into 5 quintiles ranging from low to high. They then took the median total returns of the ten years that followed. It is based on what actually happened. Not surprisingly, when PE valuations were low, the subsequent 10-year returns were the highest.
The market is richly priced by other measures as well; however, I still expect a positive surge in 2015 through Q2.
Source: NDR Data through December 1, 2014
Source: Advisor Perspectives
In the 1973 edition of The Intelligent Investor, Benjamin Graham commented:
“It always seemed, and still seems, ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the applicable net current assets alone — after deducting all prior claims, and counting as zero the fixed and other assets— the results should be quite satisfactory.”
According to Graham, investors will benefit greatly if they invest in companies where the stock prices are no more than 67% of their NCAV per share. A study done by the State University of New York to prove the effectiveness of this strategy showed that from the period of 1970 to 1983 (overall, a particular challenging period for stocks) an investor could have earned an average return of 29.4%, by purchasing stocks that fulfilled Graham’s requirement and holding them for one year.
However, Graham did make it clear that not all stocks chosen in this manner will have excessive returns and that investors should also diversify their holdings when using this strategy.
Net-Net Working Capital (NNWC) = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities
You won’t find many discounted shares today as QE has inflated most risk assets but as boom follows bust and bust follows boom, the market will fall again. Have some dry powder indeed.
As a quick aside, there are subscription based websites that can help you screen for stocks that meet Graham’s approach to value investing, though, as you can see in the above series of valuation charts, now is a time to be underweight stock market exposure. Just google ‘Benjamin Graham Net Working Capital’.
So What Does This Mean to You and What Can You Do?
I personally believe there is more run left in the equity market, yet risk is high and I certainly don’t want to be left sitting on the tracks in front of an oncoming train. Stay nimble and alert. And remember while risk can be measured (high today due to high valuations), it is more difficult to time.
Consider something like this:
30% Equity exposure:
Since valuations are in Quintile 5 (low forward expected return), weight just 30% of your portfolio to equities. Keep it hedged with a put option strategy. When valuations move lower (which will happen in a bear market), take that weighting back up to 70% and hold unhedged (risk is far less when valuations are low – i.e. Quintile 1).
30% Fixed Income exposure:
Rates are so low that the historical benefit to a balanced portfolio is significantly reduced. Allocate to flexible bond strategies and have a relative strength based process in place to know when to shorten and lengthen your bond maturity exposure. Tactical relative strength can help to keep you in line with the fixed income assets showing the strongest price leadership. Tactically trade high yield. Risk of a coming HY default wave is growing.
40% Tactical – Alternative – Other:
Tactical investing strategies can help enhance returns and increase overall stability within investors’ portfolios. They are different from managed futures, global macro and long/short equities. Over the years such strategies have done a good job at providing return and reducing downside risk. No guarantees in anything. Thus the principle of diversification.
One note on diversification. If your client calls up concerned that their well diversified portfolio didn’t do as well as the S&P 500 Index, remind them that there are no bonds held in that index and that there are two types of investment approaches. One is to speculate (target just a few aggressive risks). The other is to broadly diversify many diverse sets of risks.
I would love to have been all-in on Amgen (+47.33%) and Apple (+44.65%) this year (see below) but I would have also thought that small caps would have done much better. They have gained just 1.74% vs 12.56% in the S&P 500. Finally, look at the year-to-date performance of Amazon down 20.63% through December 3, 2014. Glad I didn’t own that.
The reason for diversification in one chart:
I could have included gold, oil, and other commodities. Commodities look to have entered a secular bear market period but that is a topic for another day.
I post several of my long-time favorite market “weight of evidence” indicators each week in Trade Signals. Currently, the evidence supports my view for a strong equity market into mid-2015. No guarantees, of course – I’ll continue to post those indicators each week. Right now they say “the party lives on”.
Trade Signals – Trend Positive, Sentiment Remains Too Optimistic 12-3-14
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish
- Volume Demand Continues to Better Volume Supply – This Too Remains Bullish
- Weekly Investor Sentiment Indicator:
o NDR Crowd Sentiment Poll: Extreme Optimism (Caution)
o Daily Trading Sentiment Composite: Extreme Optimism (Caution) - The Zweig Bond Model: Cyclical Trend for Bonds Remains Bullish
Click here for the full link, including updated charts, to Wednesday’s Trade Signals post (trend and sentiment charts)
Conclusion
I’m heading to Arizona on Sunday for IMN’s Global Indexing and ETF Conference. There is a great lineup of speakers. Here is a link to the conference agenda. I present on Monday afternoon. Scottsdale certainly trumps Philly this time of year. Let me know if you are going to be there.
Also, if you’d like to learn more about tactical relative strength, I presented, along with Tom Dorsey, on a webinar hosted by Joe Cunningham of Horizon ETFs and MC’d by Tom Lydon of ETF Trends. Here is a link to the webinar. You may have to sign in and provide your email information.
Finally, I’d like to ask a favor. If you know Jason, keep him and his father in your prayers – great men with big hearts. Maybe send him a note – he could sure use a lift.
Our annual office holiday party is tonight. It will be nice to all be together.
Have a great weekend!
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
CMG Advisor Central and Other CMG Related Links
Please know that we here at CMG Capital Management Group are committed to bringing you the latest intelligence on the markets and tactical investing strategies.
We launched Advisor Central six months ago to offer advisors a quick read on trade signals in the fixed income and equity markets, commentary on economics and investing, and trends in the financial advisory business.
You can sign up here http://advisorcentral.cmgwealth.com for updates and you’ll get a weekly digest delivered to your in box.
We also created a LinkedIn Showcase Page devoted to tactical investing. Tactical investing has been our sole focus for 20+ years. We aim to give this investing style clear definition and scope as investor awareness of ‘tactical’ develops. Follow the LinkedIn Tactical Investing page here for periodic updates. https://linkedin.com/company/tactical-investing
Important Links
- CMG’s AdvisorCentral: http://advisorcentral.cmgwealth.com
- CMG’s Tactical Investing LinkedIn Page: https://linkedin.com/company/tactical-investing
- CMG on Twitter: @askcmg
- Steve Blumenthal on Twitter: @SBlumenthalCMG
- CMG Research and Insight: http://www.cmgwealth.com/research-insight
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).