August 22, 2014
By Steve Blumenthal
To me, the next cyclical market down trend is linked to Fed Policy and the timing of their change in interest rate policy. For now, I remain in the Don’t Fight the Fed or The Trend camp (constructive on equities).
So what happens when the Fed raises interest rates? Do you have a plan in place to deal with the risk? Important questions as you’ll see the equity markets do not do well when the Fed raises interest rates.
One can argue that this time might be different but that is a tough bet as noted in the following chart. It shows the number of times the Fed has hiked rates without a negative equity market consequence. The data goes all the way back to July 1, 1954 and tells us we should stand on guard. Out of the 15 times the Fed has raised rates, there were ZERO times when the market gained. Not once did it avoided a negative outcome. The average decline was -23% (note the Subsequent % Decline in Market column – red arrow).
So it is pretty clear that the market does not do well when the Fed raises interest rates though I’ll add that, historically, it is typically after the second rate hike that market indigestion begins. Further, I believe that given the unprecedented six years of Fed zero interest rate policy, this time could be even more challenging. Don’t know – we’ll see.
When your clients tell you that the economy is doing better thinking that it will justify an even stronger stock market, show them this chart. The time to buy is when everyone is selling and a business cycle is at a low (2002, 2009). The best times to buy is when the economy and the market is in crisis. A perverse business we are in. The logic is seemingly backward. As Bullard mentions in the interview link provided below, Fed policy is “very far from normal”. That means normalization (raising rates and selling acquired financial assets) may take a very long time this time.
It is Fed week in Jackson Hole. Given the importance of the timing of Fed rate hikes, let’s focus in on what the guys steering the great big ship are saying.
I share the following in this week’s On My Radar:
- Fed Officials Said Job Gains May Bring Faster Rate Increase
- The Current State of Inflation
- Trade Signals – Cyclical Bullish Trend for Stocks Remains – 08-20-2014
Fed Officials Said Job Gains May Bring Faster Rate Increase
Bullard Says Better Labor Market Causing FOMC ‘Rethink’ (16 minute audio link)
Some selected quotes from the interview:
- Monetary policy is a long, long way from normal.
- We have a long way to go on normalization.
- The economy is improving and the interest rate rise will come sooner and quicker.
- Dramatic improvement in labor markets.
- Economy looking like it is finally taking hold. 3% second half GDP.
- With inflation coming up this year and employment coming down, we are much closer to our goals.
- Combine this with the funds rate some 350 bps from normal and a balance sheet north of $4 trillion, how are we going to get that on a path to getting back to normal.
In short, some Fed officials are forecasting the first rate hike in March 2015. Consensus seems to be June 2015. Following are a few more links if you are interested:
- http://www.bloomberg.com/news/2014-08-20/fed-officials-said-job-gains-may-bring-faster-interest-rate-rise.html
- http://washingtonexaminer.com/more-federal-reserve-officials-show-support-for-ending-stimulus-earlier/article/2552245
- http://www.bloomberg.com/video/fed-s-john-williams-fed-rate-rise-may-occur-near-mid-2015-HRHRIkqBTEG6WGqt4S9F~A.html
I strongly recommend listening to the Bullard audio podcast. It will give you a peak into what the guys behind the curtain are thinking and how they interact with each other. As for timing of the coming interest rate increase, my best guess is a June 2015 rate increase followed by a September 2015 additional rate increase (but this is really just a guess).
I favor a disciplined risk management process following the cyclical trend of the market (currently bullish) and a bias towards “don’t fight the Fed or the tape”. See Trade Signals below.
The Current State of Inflation
Given that inflation is one of the Fed’s objectives, following are several of my favorite inflation related charts. In looking at the bottom sections of the below three charts, inflationary pressures appear to be low to moderate. Low as measured by the Institute for Supply Management Price Index and moderate inflationary pressures as measured by the NDR Inflation Timing Model.
Trade Signals – Cyclical Bullish Trend for Stocks Remains – 08-20-2014
Despite my personal feelings that:
- the cyclical bull market is aged,
- profit margins have likely peaked (and will likely mean revert),
- the market is meaningfully overvalued and over-owned, and
- margin debt is high and cash low
… price momentum (as measured by Big Mo) remains bullish and don’t fight the Fed or the Tape remains the important theme.
Big Mo remains in a cyclically bullish buy signal for equities. The last buy signal was October 14, 2011 when the S&P 500 Index was at 1224.58. As for the bond market, the Zweig Bond Model remains in a cyclically bullish buy signal for bonds and our 20-plus year old high yield tactical bond strategy moved back to a “buy” signal early last week.
Note too, after the recent correction, that short-term Daily Investor Sentiment is now reading extremely pessimistic – which suggests a “buy”. While risk remains high, the weight of technical evidence supports a continuation of the current cyclical bull market in both stocks and bonds.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains (as measured by Big Mo and 13/34-Week EMA S&P 500 Index chart)
- Weekly Investor Sentiment Indicator – NDR Crowd Sentiment Poll: Neutral (Not Yet Bullish)
- The Zweig Bond Model: Cyclical Bullish Trend for Bonds (supporting bond investment exposure)
Click here for the link to the full piece.
Conclusion
What we know today is that valuations are high and the markets are highly leveraged. Similar to mountain snow, we can measure the stability but we can’t predict which snowflake will cause the snow to fracture and slide nor when. Today, risk is high and the system unstable. The markets can continue higher. Thirty plus years and some hard knocks has taught me that nobody can forecast the future perfectly every day. It is simply not humanly possible. What can be measured is the degree of risk and today risk is high. The tools to manage risk are abundantly available and are highly liquid but risk measures should be taken prior to the slide; for when it does slide again, it will be too late to protect your investments.
The U-Haul is rented and it’s time to load the stored couch, bean bag chair and other miscellaneous pieces of old stuff. I’m heading to Penn State early tomorrow morning to move my beautiful daughter into her rented house for her senior year. She left yesterday – my job, of course, is the heavy stuff.
Do you remember back then (32 years ago for me – ugh) how you and your friends would fight for the best room positioning, figure out groceries and surely not tell mom and dad about the beer budget. It has been a great three years and Brianna is already wishing for time to slow down. It has gone by too fast, she said.
I hope to really be present in my time ahead. Sometimes that is hard to do… and I hope for you too for time to slow down.
Wishing you a wonderful “slowed down” weekend!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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 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).