February 3, 2023
By Steve Blumenthal
“Over the past year, the S&P 500 has retreated only modestly from its January 2022 speculative peak, yet interest rates have normalized to a much greater extent. That, in my view, is probably the most dangerous aspect of the current market environment. We continue to observe valuations that were created only as the result of a decade of reckless zero-interest rate policy, yet zero-interest rate policy is no longer present.”
– John Hussman
The Fed’s inflation fight continues. Powell’s comments were softer than expected, and the market loved what it heard. Last week, I shared this famous Stan Druckenmiller quote with you: “Earnings don’t move the market; it’s the Federal Reserve Board… focus on the Central Banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.” Today, let’s take a look at the current state of liquidity.
Ned Davis Research put together a composite model that measures the U.S. fiscal and monetary policy. It shows how it can be a helpful indicator for the stock market. In the following chart, the top clip plots the Dow Jones Industrial Average (DJIA), while the middle clip plots our Real Monetary, Fiscal, and Exchange Rate Policy Index, and the bottom clip plots the 12-month point change in the Policy Index’s readings.
The Real Monetary, Fiscal, and Exchange Rate Policy Index is derived by adding the year-to-year change of the real (inflation-adjusted) M2 money supply and the year-to-year change of the 12-month trailing total of federal expenditures. NDR then subtracts the year-to-year change of the 12-month total of federal receipts and the year-to-year change in the broad index of the foreign exchange value of the U.S. dollar. By combining these data series, NDR finds a composite measure of current federal fiscal policy (taxes and government spending), monetary policy (money supply growth), and exchange rates (change in the foreign exchange value of the U.S. dollar).
NDR believes these three factors (Fed policy, fiscal policy, and the exchange rate policy index) are critical when it comes to real-world dynamics. Money supply growth plays a vital role in determining economic growth. The correlation is too strong to ignore, as the government has historically been successful in stimulating the economy through its spending. Finally, there is a good correlation between changes in the dollar and exports. By combining the growth rates of the money supply, federal expenditures, and the dollar into a single measure, NDR believes we gain insight into the total stimulus being provided to the U.S. economy. Bottom line: It’s a good way for us to “focus on the Fed” and “ on the movement of liquidity.”
The results in the box in the chart’s lower right-hand corner show that when the policy index turns up and is materially higher than it was 12 months prior (the “Policy Easing = Bullish” zone), the market sees the expansionary policy and shows strong gains. Conversely, when the policy index falls well below the level it was at a year ago (the indicator is below the lower bracket – “Policy Tightening = Bearish” zone), the market sees contractionary policy coming and does poorly. This indicator thus reflects the importance—to both the economy and the stock market—of the U.S. government’s and central bank’s macro policies.
While the Fed is the big elephant in the room, looking at the world’s 10 largest central banks and the change in their balance sheets over the past two months, the following stats are notable:
- The Fed has drained approximately $151 billion from the system,
- The ECB has drained approximately $430 billion,
- The Bank of Japan has injected $631 billion,
- The Bank of England has drained $17 billion,
- The Peoples Bank of China has injected $581 billion,
- The Bank of Korea is flat,
- The Bank of Canada has drained $10.5 billion,
- The BCB has drained -$8.6 billion,
- The Swiss National Bank has injected $54.5 billion, and
- The CBC has injected $2.3 billion
- . . . for a net injection of approximately +$653 billion—most of which is from the Peoples Bank of China. A hat tip to@GordonJohnson19 for the central bank balance sheet data.
This may help explain some of the global rebound in equities in January. Some of those liquidity injections most certainly found their way into equities, and it’s likely that more than a few shorts were caught offside.
Dazed and Confused?
My good friend Peter Boockvar said it best with this excellent thread:
The Fed will not terminate monetary tightening in the face of high inflation. They need to push unemployment up, consumer demand down, and—YES—asset prices down until inflation abates. Powell will tighten until something breaks.
I do believe we are on the path to lower inflation, which will become more evident in the second half of 2023, or maybe sooner. If my thesis is correct—and it may not be—the stock market low has not yet happened. I’m still targeting 3,000 to 3,200 as the line in the sand for the Fed. Expect a bumpy few months ahead.
Our recession watch indicators still point to a recession. The average correction in a recession (from high to low) is approximately 38.5%. Thus, the 3,000–3,200 area. If correct, the recession will provide cover for the Fed to pivot. With a pivot, it’s “risk on” again into 2024-2025 before we get inflation wave #2. Then, more QT, plus recession. Wash, rinse, and repeat.
We’re not going back to high school, but it sure seems like we’re heading back to the mid-1970s. Rolling inflation, big hair, bell bottom jeans, tie-dyed shirts, peace-sign belts. . . How could my mom have let me walk out of the house with that big hair? By the way, watching Susan’s boys soccer team train last night, one big takeaway that I couldn’t miss: Big hair equals inflation, and big hair is back. Talk to mom, boys… For inflation’s sake and your chance for a date to the prom, please talk to mom!
I’d feel far less concerned about the stock and bond markets if valuations were attractive. They are better than a year ago but not yet anywhere near a point where we investors will get a fair return. It seems highly optimistic for investors to expect smooth sailing at current valuations that rival the 1929 and 2000 extremes (blue line – the right-hand side of Chart 1). Chart 2 plots the actual 10-year Total Return by decile. You’ll see that decile 1 has the worst subsequent 10-year annualized returns. Decile 10 is the best. We still sit in decile 1.
Chart 1: Shiller PE 30.08
Chart 2: The Shiller PE of 30.08 puts PE in “Declile 1,” the most expensive top 10% of all PE measurements since 1909. This tells us very little about what the market will do in the short term, but it tells us a great deal about the probable coming 10-year annualized returns. See the range of actual nominal 10-year annualized returns (before inflation) in the following chart (“We are here” red arrow).
With high valuations comes high risk. Stay patient with your equity exposure until we reach the “We’d be better off here” green arrow area. There are many different ways to make money. It’s just not the right time for the traditional cookie-cutter, buy-and-hold approach. Bonds don’t yield enough, and the “We are here” red arrow signals flat returns for the next 10 years. Mauldin and I recently updated our “How We Think About Wealth” white paper, which includes some unique investment examples. Email me at Blumenthal@cmgwealth.com if you’d like a copy.
Grab that coffee and find your favorite chair. Jeremy Grantham is out with his latest market update. It’s back to the meat grinder in his view. We’re not predicting as dire of an outcome as we believe the Fed and the government will come back in with guns blazing. If we’re wrong, then put us in Grantham’s camp. It’s worth the read. I have a few Random Tweets to share with you, and there are some positive market trend developments highlighted in Trade Signals.
(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.)
If you are not signed up to receive the free weekly On My Radar letter,
you can subscribe here.
Jeremy Grantham – After a Time Out, Back to the Meat Grinder
Ok, an all-world title to a market commentary piece. “After a Time Out, Back to the Meat Grinder.” Gotta love it… Click on the photo to link to Jeremy’s full piece.
Here’s a quick summary:
- The 2022 rout left the most speculative growth stocks that led the market on the way up “crushed, while a “large chunk of the total losses across markets that we expected to see a year ago have already occurred.”
- It gets trickier from here. While the downturn has wiped the most “extreme froth” off the market, valuations remain well above long-term averages, he said, noting that in the past, they have tended to overcorrect, falling below their long-term trend line as fundamentals deteriorate.
- Grantham estimated the trend line value of the S&P 500 index, adjusted upward for trend line growth and expected inflation, will be around 3,200 by the end of 2023.
- He said it’s a 3-to-1 bet the S&P 500 reaches that level and spends at least some time below it this year or next.
- A drop to 3,200 would mark a roughly 17% fall for the year and a drop of around 20% from the S&P 500 level of 4,100.
- “To spell it out, 3200 would be a decline of just 16.7% for 2023 and with 4% inflation assumed for the year would total a 20% real decline for 2023 — or 40% real from the beginning of 2022,” he said.
- “A modest overrun past 3200 would take this entire decline to, say, 45% to 50%, a little less bad than the usual decline of 50% or more from previous similarly extreme levels.”
He concluded, “not the end of the world but compared to the Goldilocks pattern of the last 20 years, pretty brutal.”
(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.)
If you are not signed up to receive the free weekly On My Radar letter,
you can subscribe here.
Random Tweets
Companies are not having a problem raising prices.
The following is from Campbell Soup’s earnings call. They increased their prices by 16%! Hat-tip to my fishing friend, Sam Rines.
Campbell Soup is not alone. We are seeing this across many industries. Inflation? Nothing to see here… just keep moving, just keep moving:
Reach out to @Samuel Rines. If you would like to be added to his free research distribution.
Earnings are starting to slow:
It was an excellent January for global financial assets:
Spot on Danielle:
A few more tweets:
More Random Tweets next week. Follow me @SBlumenthalCMG.
If you are not signed up to receive the free weekly On My Radar letter,
you can subscribe here.
Trade Signals: Extreme Optimism Ignors the Fed
February 1, 2023
S&P 500 Index — 4,119
Markets move in cycles, and cycles will always exist. Trade Signals provides a weekly snapshot of current stock, bond, currency, and gold market trends. Trade Signals is a summary of technical indicators to help you identify where we sit in short-term, intermediate-term, and long-term cycles. We track important valuation metrics as they can help us assess the probability of future returns (when investment opportunity is best/least). Trade Signals also tracks investor sentiment indicators and economic and select recession watch indicators.
Stay on top of the current trends with “Trade Signals.”
Market Commentary
I wanted to wait to see how the market responded to the rate decision prior to posting this week’s Trade Signals. Here’s some quick commentary on what you likely already know. The Fed raised rates for the eighth time in a row by +25 basis points, taking it to the 4.5%-4.75% range. Their post-meeting statement said that at least two more hikes are coming. The Fed emphasized the need for “ongoing increases.”
Further, the Fed is signaling another 50 basis points in the next few months — which will take the inverted yield curve even deeper into the inverted territory. Stepping forward on thin ice, the Fed is attempting to navigate a challenging inflation problem of its own making. The economy is contracting which is evident in the Leading Economic Indicator (LEI), GDP numbers, corporate earnings, and the broad money supply (M2).
The year-over-year rate of change in M2 has fallen off the cliff.
Inflation is the issue at hand. More tightening in interest rates and QT ahead. Pivot remains a hope. We’ll look closely at liquidity this coming Friday in On My Radar.
I have been writing about important global macroeconomic issues for more than 25 years. The On My Radar publication has grown from just a few hundred to tens of thousands. Trade Signals was created to provide a highly useful tool for investors to get a birds-eye view of the significant directional price trends of the markets. “The trend is your friend.”
- On My Radar is a global macroeconomic letter focused on market valuations, the Fed, inflation, deflation, debt, currencies, capital flows, and geopolitics.
- Trade Signals provides weekly market essentials focusing on what price tells us about the significant short-, intermediate-, and long-term trends in stock, bond, commodities, currency, and gold markets.
We hope our customers/readers/savvy investors have enjoyed these research tools to complement their own. CMG will continue to offer our flagship On My Radar letter, which comes out every Friday, for free. Starting Feb 15th, Trade Signals will become a low-cost subscription-based service at $9.99 monthly. Approximately the cost of two Starbucks extra hot lattes.
The Dashboard of Indicators follows next, which includes the equity market, bond market, economic, select recession watch, and gold indicators. Trend evidence continues to improve. However, the S&P 500 Index has reached a logical technical resistance, and our short-term investor sentiment indicator has reached an extremely high level of optimism. A level seldom reached. It’s been an excellent short-term trade. For short-term traders, I favor booking the gain.
Click HERE to see the Dashboard of Indicators and all the updated charts in this week’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizons, and risk tolerances.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
If you are not signed up to receive the free weekly On My Radar letter,
you can sign up here.
Personal Note: Eagles vs. Chiefs
The Philadelphia Eagles will face the Kansas City Chiefs in the 2023 Super Bowl. If your team has been in the Super Bowl, you know the excitement it brings to your city. I was angry when the Eagles fired Andy Reid in 2012. He now stands at number 5 on all time NFL wins list behind Don Shula, George Halles, Bill Belichick, and Tom Landry. He is one of the greatest coaches in NFL history, but he and his all-world quarterback Patrick Mahomes will need to bring their A-game because my Eagles are hungry dogs and “hungry dogs run faster.” Psssst Patrick, keep an eye on Haason Reddick. He’s a very hungry dog.
The last meeting between the Eagles vs. Chiefs didn’t disappoint. It was a dramatic late-game come-from-behind win. This game is looking to be a great one. The spread is 2.5 points in favor of the Eagles. Go birds!
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here. Follow me on Spotify, Twitter @SBlumenthalCMG, and LinkedIn.
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
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.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
IMPORTANT DISCLOSURE INFORMATION
This document is prepared by CMG Capital Management Group, Inc. (“CMG”) and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives, or tolerances of any of the recipients. Additionally, CMG’s actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing, and transaction costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This material is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors which are necessary considerations before making any investment decision. Investors should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, where appropriate, seek professional advice, including legal, tax, accounting, investment, or other advice.
Investing involves risk. Past performance does not guarantee or indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CMG), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CMG. Please remember to contact CMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CMG is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.
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.
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, has not been independently verified, and does 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. See in links provided citing limitations of hypothetical back-tested information. Past performance cannot predict or guarantee future performance. Not a recommendation to buy or sell. Please talk to your advisor.
Information herein has been obtained from sources believed to be reliable, but we do not warrant its accuracy. This document is general communication and is provided for informational and/or educational purposes only. None of the content should be viewed as a suggestion that you take or refrain from taking any action nor as a recommendation for any specific investment product, strategy, or other such purposes.
In a rising interest rate environment, the value of fixed-income securities generally declines, and conversely, in a falling interest rate environment, the value of fixed-income securities generally increases. High-yield securities may be subject to heightened market, interest rate, or credit risk and should not be purchased solely because of the stated yield. Ratings are measured on a scale that ranges from AAA or Aaa (highest) to D or C (lowest). Investment-grade investments are those rated from highest down to BBB- or Baa3.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Certain information contained herein has been obtained from third-party sources believed to be reliable, but we cannot guarantee its accuracy or completeness.
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 professional.
Written Disclosure Statement. CMG is an SEC-registered investment adviser located in Malvern, Pennsylvania. 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, or exclusively determines any internal strategy employed by CMG. 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 www.cmgwealth.com/disclosures. CMG is committed to protecting your personal information. Click here to review CMG’s privacy policies.