August 7, 2020
By Steve Blumenthal
“The intelligent investor is a realist who sells to
optimists and buys from pessimists.”
“In the short run, the market is a voting machine but in the long run,
it is a weighing machine.”
– Benjamin Graham, “the Father of Value Investing”
and Author of The Intelligent Investor
If you’ve been reading for a while, you know that at the beginning of each month, I like to review my favorite valuation charts. I do it to maintain my footing on what coming 7-, 10- and 12-year returns are likely to be. Today, valuations are high, and—given the liquidity from the Fed—they’re likely to remain that way.
Since little has changed, let’s pass on taking a look at my dashboard of valuation indicators and focus in on just two: Research Affiliates’ 10-year Asset Class Expected Returns and GMO’s 7-Year Asset Class Real Return. Also this week, you’ll find my bullet-point notes from the second half of the Shilling-Rosenberg client call.
Let’s start with Research Affiliates. Rob Arnott and his team plot the expected real 10-year return for many different assets. What I like about this chart is that it gives us a sense of coming 10-year returns, relative to expected risk.
Below, you’ll see various colored dots. The higher the dot is on the page and the further to the left, the better. We’d all love a 10% annual real return with less than 5% volatility. Think of it as a smooth, low risk, high return ten-year experience. Unfortunately, the current 10-year real return forecast is the opposite. For example, in the center of the chart, you will find a red dot representing US Large (Cap). If you look to the left, you’ll see that the real expected return is approximately 0.5%. And if you look to the bottom, you can see that the expected volatility is about 14%. The bond asset classes plot worst.
Source: Research Affiliates
GMO shares its 7-year real (“real” means after inflation is factored in) return forecast each month. In the late 1990’s, friend Mark Yusko took the forecast to his UNC investment board. Then, like today, the return outlook was negative (though then we were looking at a -2.50% seven-year US equity market forecast, and not the -4.70% we see today). Mark tells a great story about how one of the board members exploded with anger when he shared it, saying he never wanted to see that chart again. It was hard to convince anyone in 1999 to shift out of stocks. Talk about pressure and career risk!
Before we go on, place any sharp objects out of reach…
Here is GMO’s latest as of June 30, 2020. Note the negative annualized return outlook for U.S. equities and the equally awful return forecast for bonds. If you are a buy-and-hold investor, this is not good news.
This Time Is Different? There Is No Alternative (TINA)
“But hang on there, Steve… not so fast,” you say. “Fed Chairman Jerome Powell just told us, ‘There’s no monthly cap, no weekly cap… that language is open ended, and it’s meant to send a signal to the market that we’re not going to be bound by, for example, $60 billion a month or anything like that. We’re going to go in strong…’”
Well, let me share an excellent note from my Camp Kotok fishing friend Philippa Dunne and her partner Doug Henwood from TLR Analytics. It’s insight for you to keep on your radar:
FISCAL POLICY TO THE RESCUE
From Philippa Dunne and Doug Henwood
According to the Brookings Institution’s Fiscal Impact Measure, which shows the effect of federal, state, and local spending on GDP, government added 14.6 points to second-quarter GDP growth. As the graph shows, this is by far the biggest stimulus since 2000. It’s also bigger than anything in Brookings’s fuller history dating back to 1973 (which it doesn’t share on its website).
More than all of the lift came from federal spending; state and local government shed workers, subtracting 6.8 points. So the federal kick—and this measure doesn’t include Federal Reserve actions, whose effects are very hard to quantify—was an incredible 21.4 points. That saved us from a 47% decline in GDP.
If fiscal stimulus is not renewed, policy will turn neutral and then contractionary as 2020 turns into 2021. Given pressure on state and local government budgets that drag may intensify, even though Brookings assumes it will stay mildly simulative through the projection period. It’s not clear Congress will be able to cobble together a package any time soon, so this is a matter of great urgency.
JPMorgan’s Jamie Dimon put it this way: “The range of outcomes for the economy in the second half is incredibly wide. Nobody knows what comes next.”
The bank sees unemployment in its default “base” scenario hitting nearly 11% by the end of the year. That’s 4.3% worse than it forecasted in April. If the virus surges further in the fall, forcing another round of widespread shutdowns, JPMorgan believes unemployment could rise to 23%.
We wait on the news from Washington. This just in around lunch time today, “Coronavirus relief talks grind to a near halt, dimming chances of a deal.” (Source: CNBC.) We are far from out of the COVID-19 woods.
What’s NOT Different This Time?
I remember the dot.com bubble. It was a bad time to be an active manager. It was an even worse time to be a value investor. Then, like today, Benjamin Graham might whisper to the Robinhood newbie, “The intelligent investor is a realist who sells to optimists and buys from pessimists.” Newbie would probably think the old guy had lost his mind.
Jesse Felder, founder, editor, and publisher of The Felder Report, puts out some great work. You can follow him @jessefelder. This, from Felder:
Just three stocks, Apple, Amazon and Microsoft, make up more than 16% of the S&P 500 Index and over a third of the Nasdaq 100 Index. Together they are now valued at nearly $5 trillion. That’s larger than the entire economy of Germany and roughly the size of the Japanese economy. What is really most astounding, though, is the aggregate valuation of these three behemoths relative to their free cash flow. Only at the peak of the Dotcom Mania have we see anything like it – which begs the question: ‘If that was a bubble, what’s this?’
My personal view is that growth plays will continue to outperform value plays. Central bank liquidity is finding its way from bond markets and into the equity markets. No one knows when the music stops. But it will stop. And then we reset.
Valuations do matter. Not this month, not next and maybe not next year but don’t bite on the ‘this time is different’ head fake. In the short run, the market is a voting machine but in the long run, it is a weighing machine.
Sage words from the Father of Value Investing.
Grab that coffee and find your favorite chair. There are a number of things you can do to make it through. Consider high and growing dividend-paying stocks. Risk-managed trading strategies may provide stability, and simple trend-following rules can help you get from here to the other side of what my partner John Mauldin calls “The Great Reset.” The virus, in my view, is accelerating that time line. Don’t avoid risk… Manage it. You’ll find the link to Wednesday’s Trade Signals post below.
If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.
Included in this week’s On My Radar:
- Trade Signals – Gold’s Hot, Recession Conditions and Sentiment Updates
- Personal Note – Love Will Prevail
A. Gary Shilling and David Rosenberg – Notes from the Research Call (Part II)
I’ve been kindly asked to remove my bullet-point notes from the second half of the July 27, 2020, research call.
Trade Signals – Gold’s Hot, Recession Conditions and Sentiment Updates
August 6, 2020
S&P 500 Index — 3,327
Notable this week:
“The word unprecedented is rarely used properly, this time, it’s being used properly.
It is unprecedented what’s going on around the world, obviously Covid itself is the main attribute.”
– Jamie Dimon, Chairman & CEO, JPMorgan Chase & Co.
Sorry about the delayed post. Six to eight inches of rain in a few short hours followed by high winds took out power and flooded my basement. Poor Steve… I know. Ever forward. Here’s this week’s commentary followed by the Dashboard of Indicators and Trade Signal charts.
Several of the recession signals have improved. Though given the pandemic and the economic shock, no one knows the depth of the problem. Based on the rising number of defaults (already matching the 2009 default highs) and the shock to hotels, in-person retail and restaurants, I’m looking at the improving conditions with a healthy degree of skepticism. JPMorgan’s Jamie Dimon put it this way, “The range of outcomes for the economy in the second half is incredibly wide. Nobody knows what comes next.”
The bank sees unemployment in its default “base” scenario hitting nearly 11% by the end of the year. 4.3% worse than it forecasted in April. If the virus surges further in the fall, forcing another round of widespread shutdowns, JPMorgan believes unemployment could rise to 23%.
Many years ago, I was a president of a trade organization of active investment managers called NAAIM. I enjoyed the members and my time with the organization. Many are still close friends. While I rarely share this next sentiment chart with you, I do scan it weekly. I’m a big investor sentiment fan as you probably know by now. Be wary of the market at points of extreme bullish optimism and get very interested to buy at points of extreme bearish pessimism. My two go-to investment sentiment charts are are showing “Neutral Optimism,” which supports a moderately bullish view on equities (you’ll find them further below). However, the NAAIM survey is signaling warnings or Extreme Optimism.
Here is how the process works: NAAIM surveys their members each week and asks them what percentage of their active management portfolio is allocated to equities. Data is shared with Ned Davis Research (NDR) and NDR sorts it plots how the market did based on data.
Here’s how to read the chart:
- NDR tracks the data and you will find that when the NAAIM members have a high allocation (overly optimistic), the market does worse and when they have a low allocation to equities, the market does best.
- The data box at the bottom of the chart shows the return that occured when readings where the NAAIM survey average is above 73, between 25.5 and 73, and below 25.5. You can see that the best returns happened when the pros were most bearish.
- Also note several other dates, such as January and February 2020 (bullish just prior the the COVID-19 crash), September 2018 (prior to the hard Q4 selloff), and October 2007 (at the peak of the market prior to the Great Financial Crisis).
- Note too, the buying opportunities when the NAAIM members were overly bearish (low equity market exposure) – 2008-09, October 2011, December 2018, and March 2020.
- Bottom line: We are back into the nosebleed “Optimistic” zone once again. The data suggests it is prudent to de-risk and/or hedge.
As for the other Trade Signal indicators, there are no major changes this week. Fixed income and equity signals remain bullish. Gold remains bullish, as well. BTW, we’ve been running a gold trend-following strategy for a number of years. We use it for our private clients and recently made it available for independent advisors on our E*TRADE Advisors TAMP platform. It will be coming soon on the Orion Portfolios Solution platform. It is a little more responsive vs. the 13-week EMA vs. 34-week EMA I post each week (below). If you’d like to learn more, email our Head of Sales, Avi Rutstein, at avi@cmgwealth.com. Put “GOLD” in the subject line.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
Personal Note – Love Will Prevail
Tropical Storm Isaias hit the East Coast on Tuesday. Close to eight inches of rain in less than four hours overwhelmed the Blumenthal basement. But it was the 70 mph winds that followed at the storm’s tail end that delivered the knockout punch, taking electricity with it. Our power was restored yesterday evening, but more than a million people are still without it. Another line of strong thunderstorms are forecasted today.
As I was heading home to bail out the basement, a good friend called. He was driving home from Connecticut to NYC on a major road when a large tree suddenly fell across it. He quickly ducked, just barely making it under as the branches crushed his windshield. Two seconds later and it would have been a different story. That shook him. It shook me. A wet basement is really no big deal. A life certainly is.
Speaking of life, I got a really nice card from my daughter. It was a needed pick-me-up. I stopped to think, Now who’s now teaching whom?
Did you ever read the poem titled, “The Race: Life’s Greatest Lesson,” by Dee Groberg? I read it to my kids when they were young. It’s an inspirational poem about perseverance. It tells the story of a young boy who falls repeatedly in a footrace and dreads his father’s disappointment throughout. But he somehow finds the courage to get back up and finish the race.
The Race: Life’s Greatest Lesson
By Dee Groberg
Whenever I start to hang my head in front of failure’s face,
my downward fall is broken by the memory of a race.
A children’s race, young boys, young men; how I remember well,
excitement sure, but also fear, it wasn’t hard to tell.
They all lined up so full of hope, each thought to win that race
or tie for first, or if not that, at least take second place.
Their parents watched from off the side, each cheering for their son,
and each boy hoped to show his folks that he would be the one.
The whistle blew and off they flew, like chariots of fire,
to win, to be the hero there, was each young boy’s desire.
One boy in particular, whose dad was in the crowd,
was running in the lead and thought “My dad will be so proud.”
But as he speeded down the field and crossed a shallow dip,
the little boy who thought he’d win, lost his step and slipped.
Trying hard to catch himself, his arms flew everyplace,
and midst the laughter of the crowd he fell flat on his face.
As he fell, his hope fell too; he couldn’t win it now.
Humiliated, he just wished to disappear somehow.
But as he fell his dad stood up and showed his anxious face,
which to the boy so clearly said, “Get up and win that race!”
He quickly rose, no damage done, behind a bit that’s all,
and ran with all his mind and might to make up for his fall.
So anxious to restore himself, to catch up and to win,
his mind went faster than his legs. He slipped and fell again.
He wished that he had quit before with only one disgrace.
“I’m hopeless as a runner now, I shouldn’t try to race.”
But through the laughing crowd he searched and found his father’s face
with a steady look that said again, “Get up and win that race!”
So he jumped up to try again, ten yards behind the last.
“If I’m to gain those yards,” he thought, “I’ve got to run real fast!”
Exceeding everything he had, he regained eight, then ten…
but trying hard to catch the lead, he slipped and fell again.
Defeat! He lay there silently. A tear dropped from his eye.
“There’s no sense running anymore! Three strikes I’m out! Why try?
I’ve lost, so what’s the use?” he thought. “I’ll live with my disgrace.”
But then he thought about his dad, who soon he’d have to face.
“Get up,” an echo sounded low, “you haven’t lost at all,
for all you have to do to win is rise each time you fall.
Get up!” the echo urged him on, “Get up and take your place!
You were not meant for failure here! Get up and win that race!”
So, up he rose to run once more, refusing to forfeit,
and he resolved that win or lose, at least he wouldn’t quit.
So far behind the others now, the most he’d ever been,
still he gave it all he had and ran like he could win.
Three times he’d fallen stumbling, three times he rose again.
Too far behind to hope to win, he still ran to the end.
They cheered another boy who crossed the line and won first place,
head high and proud and happy — no falling, no disgrace.
But, when the fallen youngster crossed the line, in last place,
the crowd gave him a greater cheer for finishing the race.
And even though he came in last with head bowed low, unproud,
you would have thought he’d won the race, to listen to the crowd.
And to his dad he sadly said, “I didn’t do so well.”
“To me, you won,” his father said. “You rose each time you fell.”
And now when things seem dark and bleak and difficult to face,
the memory of that little boy helps me in my own race.
For all of life is like that race, with ups and downs and all.
And all you have to do to win is rise each time you fall.
And when depression and despair shout loudly in my face,
another voice within me says, “Get up and win that race!”
I’m convinced we will win the COVID-19 race. I know it has many people feeling down. The economy is a mess and many businesses are in trouble. And we humans need humans. If you are older and unable to be with your children and grandchildren, it’s an especially hard time.
Brianna’s note said, “I love you. Ever forward.” And next to an arrow pointing to a clipping of the poem, she wrote, “Here’s a little reminder when things get tough—love will prevail.”
Get up and win the race! Love will prevail.
Best to you and your family.
Warm regards,
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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