January 28, 2021
By Steve Blumenthal

“A two sigma is the kind of deviation that should occur every 44 years.
Because we’re a little wilder and less efficient than we should be,
it happens every 35 years. Every 35 years feels about right…
one event in a career and twice in a lifetime.

Three sigma events should occur once every 100 years.
Now we, as I like to say, do crazy pretty well as a species.
Therefore, three sigma events occur much more often than they should,
and they are out of kilter much more than two sigma events.

With two sigma events, you can have some reasonably standard bubbles.
They give you a certain amount of pain in the minus 30, 40 to 50% area.

Super bubbles can pretty much wipe you out like 1929. And that’s where we are now.”

– Jeremy Grantham,
Co-founder and Chief Investment Strategist of Grantham, Mayo, & van Otterloo (GMO)

Three Sigma? Hang with me for a moment as I set the stage. I promise you; today’s story is about to get interesting, real fast. It is a story about something that has happened in the markets only three prior times in the last 100 years. Dire? Yes. What Jeremy is expressing may or may not prove true. However, the risk is real. Spending a little bit of capital to hedge against it makes sense. I see opportunity. I hope you do too. Others may not.

Three-Sigma is a mathematical rule that states that almost all returns fall between three standard deviations of the mean in a normal return distribution. Think of the mean as the average of a set of a series of numbers. If you add up a set of five numbers: 1+3+12+9+15 and then divide the total by five, you get 8 (40 divided by 5). In the following chart, the mean is the tall centerline. One-Sigma moves above and below the mean happen frequently (~68.2% of the time), Two-Sigma moves happen less frequently (about ~27.2% of the time), and Three-Sigma moves rarely occur, as Jeremy explains in the opening quote and in greater detail in the discussion below.

In the investment world, you can add up the price series of the S&P 500 Index (or any asset) over a period of time to determine the average trend. And using Sigma (a/k/a standard deviation), we can see just how far above or below we are from the average price trend (mean) at any given point in time. Let’s take a look.

I’ve been sharing the following chart with you over the years. Focus on the middle section. The up-trending dotted light blue line is the average price trend line or “mean” in the data series from 1928 to the present. The orange line plots the price of the S&P 500 Index. Note how the orange line has always reverted to and below the long-term trend line. I’ve noted the years of extreme deviation from the trend in red. Next, take a look at the bottom section of the chart. Here, Ned Davis Research (NDR) plots the deviation from the trend. Each of the prior secular bull market peaks occurred when the deviation from the trend was above 1.5. Today, using NDR’s math, the S&P 500 is at Two-Sigma. (Grantham has the math at Three-Sigma. I trust he has a sound process. I believe he is factoring more than just the S&P into his equation. Don’t get hung up in the difference. Let’s focus on the big picture.)

From an investment perspective, the picture to me is clear. Hedge long-biased equity exposure and/or raise cash. When the market reverts to the mean (the dotted blue line), that is a point in time when we can expect average nominal returns in the +/- 10% range. If you are sitting on a lot of cash, remain patient. The average trend line is around 2,500 in the S&P. That’s a pretty good target.

Grantham says we are at Three-Sigma

With this basic picture painted, let’s dive into today’s story. Famed investor Jeremy Grantham says U.S. stocks are in a “super bubble,” a Three-Sigma extreme. He says this is the fourth time in the last 100 years this has occurred, and the markets and poised to collapse. Adding,

All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five superbubbles corrected back to trend with much greater and longer pain than average.

Today in the U.S., we are in the fourth superbubble of the last hundred years.

Previous equity superbubbles had distinct features that individually are rare and collectively unique to these events. In each case, these shared characteristics have already occurred in this cycle. The checklist for a superbubble running through its phases is now complete, and the wild rumpus can begin at any time.

Yikes, yes. If your investment mandate is long-only equities, risk is high. Can you find a way to hedge? But can you see the opportunity? It’s simply a question of investment positioning and game plan.

Grab a coffee and find your favorite chair. This week’s OMR is broken down into four sections. Read a section, reheat the coffee, read some more…

• Calling a Super Bubble: Front Row With Jeremy Grantham
• “This Time is Different” – By Robert Eisenbeis, Ph.D., Cumberland Advisors
• Trade Signals – Downside Risks Remain
• Personal Section – The Star of the Show

Grantham is up next. I conclude this week’s post with a great picture of Shiloh on the theater stage at Penn State. The Star of the Show.

---

Calling a Super Bubble: Front Row with Jeremy Grantham

For almost a half-century, value-investing icon Jeremy Grantham has been calling market bubbles. In this interview, Grantham, co-founder of Boston’s GMO, goes further, explaining his bubble analysis and discussing what he sees as multiple threats to the economy and the planet, including persistent inflation and climate change. He spoke exclusively with Erik Schatzker on Bloomberg’s “Front Row.”

From Schatzker: A year ago, Jeremy predicted the pandemic rally would end with a historic crash. Here’s what he told me.

• When you have reached this level of obvious super enthusiasts, the bubble has always without exception, broken in the next few months, not a few years.
• Things didn’t play out that way.
• In fact, the S&P 500 gained almost 27%.
• So I had to check in with Jeremy again and see if he changed his mind. Not one bit.
• Jeremy says, US stocks are in a super bubble, only the fourth of the past century. Super bubbles can really wipe you out like 1920. He said, that’s where we are now.

The interview began and Schatzker hit Jeremy right from the start. Jeremy, a year ago, you predicted an epic collapse and stock prices and you told me it would rival the 1929 crash in the.com bust of 2000 2001. Are you wrong?

• Grantham: No, I don’t think so. I noticed in reviewing that interview last night that there was one little element of contradiction. At one stage I said you can’t call these events to within a few months. And at another point I said history says that when you reach this level of craziness, the market tends to break within a few months. Rather than a few years. And I think with hindsight, the market started to get distinctly weaker about 10 months after we talked.

Schatzker said, “2021 was a great year for stocks if I’m not mistaken, the seventh best in a half century.”

• Grantham: And this has been exactly how the great bubbles have broken. The blue chips the S&P 500 have kept strong right up to the last second, and wave after wave of the stocks that had made the real running.
• If you look at the drop in 1929, the flakes (speculative stocks) were down for the year before the market broke. They were down 30%. The year before they’d been up 85%. They had crushed the S&P.
• The really classic example of this is the Russell 2000. They’re multibillion dollar companies with serious enterprises. They are down. They have not made any money at all while the S&P 500 made 23%.
• The Russell 2000 is meant to go up about 1.2 times the market in a bull market like you’re saying we are having. The Russell 2000 should have been up about 30%. It wasn’t even up recently.
• So this is a huge divergence of a kind that has never happened other than preceding the super bubbles of 1929 and 2000. You may remember that growth stocks peeled off and went down 50%. The S&P was flat which meant the remaining 70% had risen 20%.
• This is an enormous divergence and it happens on the upside for the blue chips.
• So this is absolute. It’s almost eerily classic. It’s a pattern. It’s a pattern. It’s a very rare path. And we have been checking off this list all year.

Schatzker: At the risk of putting words in your mouth. You are as certain as you were then if not more.

• Grantham: I would say clearly more.
• I think the peak of crazy behavior is behind me. I really do.
• I think we’re now in the by the dip mode which the super bubbles specialize in. You don’t have two years of buying frenzy, dying overnight, typically so even in 1929 you had some magnificent rattles.
• And by the dip is the watchword of practically every brokerage house out there.
• It always is you never almost never have a major brokerage house. Say the game’s over, guys. Duck.

Schatzker: If you’re right, and stocks are in a multi sigma deviation from the statistical trend, tell me what happens. The S&P 500 peaked that almost 4800 points or does it bottom

• Grantham: The trend line being slightly generous is 2500. Most of the great bubbles, the super bubbles go below trend and stay there for quite a while.
• In the Greenspan era. That tendency to stay below trend stopped in 2000. Yes, the NASDAQ came down at 82% which was fairly brutal. Amazon came down 92%.
• But the Federal Reserve came to the rescue so loudly and strongly that they stopped the decline in the S&P at the long-term trendline. It only declined 50%.
• 50% is a hell of a big decline. But it was only enough to get it back then to trend.
• This time trend is at about 2500.
• I would expect even if the Federal Reserve tries to do the same, it will be hard to prevent the market from declining to that level.

Schatzker: So we’re talking about a decline of certainly from the peak of almost 40%.

• Grantham: And of course, it declined very quickly by 50% in 1929. It declined 50% in three years in 2000. And the housing market, which was another great American super bubble, went all the way back to trend in three years.

Schatzker: Asked what does an investor do?

• Grantham: I’m sympathetic to how difficult it is to get out entirely out of equities. And I would point out, as I did last year that there are less overpriced parts of the equity market around the world.
• In fact, everywhere is less overpriced than in the US. The US is the peak of this bubble as it was in 2000. And what it meant then is what it will mean today… that is the US will decline a whole lot more than the rest.
• It’s also true that the value end of the spectrum as opposed to the growth end is about as cheap as it gets.
• So if you can combine buying value stocks outside the US, I would say particularly emerging markets, but there’s quite a few countries – Japan, the UK, they’re only moderately overpriced.
• The US is not moderately overpriced. It is shocking.

Schatzker: What’s the difference between a standard bubble and a Super Bubble?

• We define a standard bubble as a two sigma statistical event. It is just a measure of how much of an outlier you have in terms of a historical variation from trend.
• If you have a price series of the S&P you can calculate the trend. Statistics 101 is not difficult, and you can work out how far away from trend you are.
• A two sigma is the kind of deviation that should occur every 44 years. Because we’re a little wilder and less efficient than we should be. It occurs every 35 years. Every 35 years feels about right one event in a career and twice in a lifetime.
• Three sigma events should occur every 100 years. Now we, as I like to say, do crazy pretty well as a species. Therefore, three sigma events occur much more often than they should, and they are out of kilter much more than two sigma events. With two sigma events, you can have some fairly standard bubbles. They give you a certain amount of pain in the minus 30, 40 to 50% area. Super bubbles can pretty much wipe you out like 1929.
• And that’s where we are now.

There is more in the interview. He sees great opportunity in venture capital (a focus area of mine I thoroughly enjoy). Turning ideas into things that will make our world a better place. Really fun. Jeremy says there are specialty managers that have trading niches that may do fine. You get the general theme. The general stock market is in an epic bubble.

Jeremy’s quarterly letter that sparked all the media excitement is titled “Let The Wild Rumpus Begin.” Click on the photo to link to the letter.

And here is the link to the Bloomberg interview. Put your ear buds in, grab your sneakers and take a 30-minute walk. Remain patient and think opportunity. Another 2009 like buying opportunity likely presents.

---

“This Time is Different” – By Robert Eisenbeis, Vice Chairman & Chief Monetary Economist, Cumberland Advisors

Jerome Powell’s post meeting press conference comments made it clear just how hawkish he and the Fed have become. We are in a different state of play.

Long time readers know I’m a big fan of David Kotok and his work and the commentary he and his team openly share. I’ve watched David on CNBC and Bloomberg over the years and really got to know him attending his annual “Shadow Fed” fishing known as Camp Kotok. Hosted every year at Grand Lake Stream in Maine. David is smart, sharp has a great heart.

David’s partner, Robert Eisenbeis, Ph.D. is a former Fed insider. Before joining Cumberland Advisors in January 2008, Bob was Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta, where he advised the bank’s president on monetary policy for FOMC deliberations and oversaw basic research and policy analysis.

At fishing camp, we drink, eat and spend time together debating and learning. We operate under Chatham House Rules so that all feel they are in a safe place where they can openly share their views. Robert is humble, balanced and certainly well connected. Following is from his post late this week post the Fed’s meeting.

As we at Cumberland expected, the FOMC left its target rate unchanged at 0%–0.25% and made only a small adjustment to its asset purchase program, cutting its purchases of Treasuries to $20 billion and purchases of mortgage-backed securities to $10 billion per month. The Committee also reaffirmed its previous “Statement on Longer-Run Goals and Monetary Policy Strategy” and put forward a bland set of principles to follow in reducing its balance sheet, affirming its intention to hold only Treasury securities in the System Open Market Portfolio. In contrast, the press conference was notable for three clear themes that went farther on several policy dimensions than previous press conferences did, if one listened carefully.

The first theme emerged when Chairman Powell was queried about the timing and pace of policy moves. He clearly indicated that policy considerations this time were substantially different from those in play when the FOMC embarked upon a tightening in December 2016. Then, real GDP growth was under 2%; PCE inflation was 1.3%; and the unemployment rate was 4.6%. But this time, Powell noted, inflation is at 7%; unemployment is arguably at potential at 3.9%; and economic growth forecasts for Q4 of 2021 are in the 5–6% range. Labor markets are extremely tight, but Powell did see inflation moderating in the second half of the year as supply chain disruptions are moderated. This set of facts makes one wonder why, as some have argued, the Committee has waited to change policy, and helps to explain why one reporter asked whether the Committee was already significantly behind the curve, which Powell denied.

For the second theme, Powell provided much more detail on how the FOMC will approach the policy problem in 2022 and how it will adjust its policy tools. He indicated that the FOMC is likely to both raise rates sooner rather than later, and more than once, but he declined to indicate that this process would start in March, as some are now claiming with happen then. In fact, he said that there was little discussion of the likely paths and that by March there would be a new Summary of Economic Projections to provide better focus on that issue. He did indicate that asset purchases will cease in March and that the Fed will begin to shrink its portfolio later in the year, but also that no firm decision has been made on the latter.

A third theme, or rather policy issue, arose when a reporter asked whether, since inflation is significantly above target now, the Committee will keep rates high to drive inflation below its 2% target for a period of time. Powell indicated that there is no intent to drive inflation below 2%; but, rather, the goal as he sees it is to keep inflation expectations well anchored at 2%. He seemed to have forgotten that the FOMC is targeting average inflation, which would require rates to be below target for some time if the average is to be held at 2%. Does this mean that the average target has been abandoned by the Committee, or at least by Powell? None of the reporters picked up on this nuance.

Finally, the press conference was notable this time for what did not come up. There were no questions about Powell’s confirmation hearings. There were no questions about the three Biden nominees for seats on the Federal Reserve Board. There were no questions about whether international political uncertainties concerning Russia and Ukraine entered into the FOMC’s policy discussions or how they might have conditioned decisions at this meeting.

---

Trade Signals – Downside Risks Remain

January 26, 2022

Posted each Wednesday, Trade Signals looks at several of my favorite equity markets, investor sentiment, fixed income, economic, recession, and gold market indicators.

For new readers – Trade Signals is organized into three sections:

• Market Commentary
• Trade Signals — Dashboard of Indicators
• Charts with Explanations

Market Commentary

Notable this week: 

“The downside risk remains wide open until central banks
terminate their tightening process.”

– Felix Zulauf,
Founder, Zulauf Consulting

“With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,” the Fed said in a statement that concluded its two-day meeting today. Chair Jerome H. Powell said asset purchases also are likely to halt in March. It is a different state of play. Downside risk remains. More defense than offense.

The equity markets are under pressure. Approximately 175 of the 500 S&P 500 Index stocks are down more than 20%. The 10-year Treasury closed near its January high today (1-26-2022) a 1.84%. The Vanguard Extended Duration bond ETF is down more than 11% since mid-December.

The Trade Signals Dashboard follows next. Clear deterioration in the equity models. The short-term technical signal remains negative. The intermediate-term technical models are weakening and nearing sell signals. The bond indicators remain bearish. Gold is in a buy signal.

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.

---

Personal Note – The Star of the Show 

Son Kyle is a senior theatre major at Penn State. He’s a great aficionado of all pets, particularly the family dogs, Milo and Shiloh. Given the saying that “a dog is a man’s best friend,” Kyle asked if Shiloh could go back to school with him. We were slightly unsure how Shiloh would be in the new surroundings. However, that hesitation was quickly dismissed and, as you can see from the picture, Shiloh is loving his new life. A star is born! We have no idea how Kyle got Shiloh to pose, but it makes for a good laugh!

I’ll be traveling to Penn State to watch Kyle’s show on February 5 and 6. He wrote a play called “GRAFF.” GRAFF is an original hip hop theater piece about graffiti, ambition, and selling out versus staying true to the people who have always had your back. When prodigal graffiti artist Elliot receives the offer of a lifetime, he is forced to confront his immaturity and decide what is truly important to him.

The show is 90 minutes and will be live streamed Friday night, February 4, at 7:30 pm ET. Here’s a link to the show.

At the end of the month, I’m flying to Vancouver for business and then heading to four days of powder skiing at a resort called Chatter Creek in British Columbia. A conference on March 1-4 immediately follows in Park City. Some fun events on the calendar have me really excited. Especially Kyle’s show.

Hope this note finds you with fun plans to look forward to.

With kind regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

Consider buying my newly published Forbes Book, described as follows:

With On My Radar, 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.

If you are interested in the book, 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.

Click here to receive his free weekly e-letter.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.

---

IMPORTANT DISCLOSURE INFORMATION

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 Capital Management Group, Inc. [“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, 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. 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 a 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 purpose.

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.