December 22, 2023
By Steve Blumenthal
“The four most expensive words in the English language are “this time it’s different.”
– Sir John Templeton
Last week, we looked at the Fed, inflation, recessions, and stock market valuations. If you didn’t get a chance to read it, I shared some exciting charts (well, exciting is relative in the macro-economic world) and discussed two big takeaways:
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- There have been 14 recessions since 1950. Three of them were soft, and 11 were hard. Today, everyone is betting on “soft.”
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- Valuation levels have improved but are still far too high. Periods of high valuations have typically been followed by periods of low annualized returns, whereas periods of low valuations have typically been followed by periods of high annualized returns. There’s a reason why Warren Buffett is sitting on so much cash.
Today, let’s view the equity market from a different perspective: the household equity percentage. The chart further below, which I have shared with you a handful of times over the years, shows the percentage of money households have allocated to equities as a percentage of their total money allocated to stocks, bonds, and cash. This is different from the standard valuation measurements overall, but it’s similar in that it gives us a way to handicap what potential future returns may be. It’s also tied to standard valuations from the perspective that all the investors buying stocks push up prices and, thus, valuations.
Historically, when the percentage was high, the subsequent 10-year returns were low. The reverse was also true, and the logic makes perfect sense. It’s a supply-and-demand game. When the percentage of your wealth allocated to equities is high, do you feel comfortable allocating more? When we reach the extremes, future buying demand goes down. A crisis prompts people to sell and drives equity ownership down and cash ownership up. When the system resets, the amount of available cash to buy stocks becomes the fuel to drive prices up again.
The chart paints the picture. Here’s how to read it:
- The blue line plots the “Equity as a Percentage of Total Household Equities”.
- The orange dotted line plots the actual rolling 10-year S&P 500 Index Total Returns. Notice that the dotted line stopped 10 years ago, in 2013. That’s because we don’t yet know the number for the 2014 to 2024 return.
- Overall, the lines track each other very well. There is a high (a.k.a. statistically meaningful) correlation of 0.85 (1.00 is a perfect correlation). It’s not 1-to-1, but we can’t ignore it.
A little more to explain…
- The numbers on the right-hand side of the chart are the Total Return numbers.
- The numbers on the left-hand side of the chart are the “Equity as a Percentage of Total Household Assets (equities, bonds, and cash)”.
- A record high of 62.5% was achieved in 2021. Some of the extra lunch money handed out by the government evidently found its way into stocks.
- At 62.5% Equity as a Percentage of Total Household Assets, Vegas odds-makers put the 2021–2031 return forecast at -3% annualized return.
- If you bought in at the high in 2021, and lose 3% per year over 10 years, your $100,000 investment would turn into $73,742 by 2031. That’s some wasted lunch money.
- Alternatively, if you bought into the stock market when the blue line was below 45% Equity as a Percentage of Total Household Assets, you are looking at a probable 8% annualized return. At 8% compounded yearly, $100,000 grows to $215,892.
- Today, based on the current (as of 9-30-2023) 58% Equity as a Percentage of Total Household assets, the 10-year S&P 500 Index Total Return forecast is in the 0% to -1% range (see the orange circle right side in the chart).
You’ll note the two large, red arrows showing a departure from the historically high correlation. What happened there? My first thoughts point to the unprecedented period of stimulus money and the twelve years of near-zero interest rate policy—or, more simply stated, the massive amount of liquidity injected into the system since the great financial crisis in 2008. Is this time different? One could argue, yes, maybe, I think so. Yet I can’t help but reflect back on Sir John Templeton’s sage advice: “The four most expensive words in the English language are ‘This time it’s different.’” So, set me next to Sir John. The macro challenges loom large. Is the potential reward worth the risk?
The WSJ picked up on this theme this week:
It’s important to remember that valuation levels can tell us a great deal about potential future returns, but they tell us nothing about timing. Markets can remain irrational for long periods of time.
If you have enjoyed reading Charlie Munger over the years, the following quote is one of my favorites of his, and it seems apropos to the data we are seeing: “Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.” Perhaps it’s easy for Charlie Munger and Warren Buffett to execute that way—it’s in their DNA. It’s much harder for most of the rest of us.
Grab your coffee and find your favorite chair. Last week, we looked at various equity market valuation metrics. This week, let’s take a look at the investment return outlook for gold, commodities, and oil.
Additionally, I found a series of tweets from my friend Jim Bianco that I wanted to share with you as his view differs from mine. As you know, I sit firmly in the hard-landing, recession in the 2024 camp. Jim, however, sees no recession in 2024 but believes the 85% majority calling for a “soft” landing will be proven wrong. He believes the economy will give us a surprise toward the upside, noting something very important for investors. He believes that since the soft-landing view has now translated into higher stock prices and lower bond yields, getting a soft landing does nothing for stock prices from here. “How it misses will move the markets in 2024,” he says. On that, we totally agree.
Finally, I share a beautiful sports story in the personal section. Hat tip to my wife, Coach Sue. She is always sending me great teaching clips, and I love them. I hope you enjoy it too.
Scroll down if you are reading online. Click the large blue “On My Radar” button if you are reading this week’s post in your email. There are a lot of charts so the piece prints long.
Here are the sections in this week’s On My Radar:
- Gold, Commodities, Oil, and Real Estate
- No Landing – Jim Bianco
- Random Tweet’s
- Personal Note: Merry Christmas and Happy New Year
- Trade Signals: Weekly Update, December 20, 2023
(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.)
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Gold, Commodities, Oil and Real Estate
Chart 1: Gold Vs. Long-term Trend
How to read the chart:
- It is best to buy an asset when its price is below its long-term trend and be cautious when the price is above its long-term trend.
- The upper section plots the price of Gold (blue line) vs. its long-term trend (dotted orange line).
- The lower section plots the divination of the price of gold above and below its long-term trend line. Data is posted monthly. Ned Davis Research sorts each month-end deviation from trend into five quintiles that range from the Top 20% of Readings (most overpriced relative to long-term trends) to the Bottom 20% of Readings (most underpriced relative to long-term trends).
- Now, take a look at the data box in the upper left corner. I’ve highlighted in yellow the “Average Annualized Return in Gold” 1-, 3-, 5-, and 10-years.
- Bottom line: The price of gold is sitting right on top of its long-term trend line. Historically, the “Bottom 20% of Readings” where subsequent returns were best. Gold looks to be fairly priced. I remain fundamentally bullish on gold due to Central Bankers gone wild and my expectations for even greater debt monitization in the coming years.
Chart 2: Gold Miners
Gold miners look to be particularly attractive. Currently in the “Bottom 20% of Readings:”
Chart 3: Commodities Vs. Long-term Trend
Commodity prices are near a record high in terms of current prices relative to long-term trends. Think – recent spike in inflation.
The components that make up a commodity index are the underlying commodities, such as wheat, oil, gold, or soybeans. A commodity index picks a basket of commodities to track, and that index’s performance depends on the underlying commodities’ price movements.
Here’s how to read the chart:
- The bottom section shows the deviation in the price relative to its long-term trend line. Data back to 12-31-1800 (not a typo). Note the spike in the green bar in the lower right-hand section of the chart.
- Expect some reversion back towards the trend line, but can stay above or below the trend for very long periods of time.
- Bottom line: I wanted to point out the record-high spike in price relative to a long-term look at history. You already know this each time you swipe your card at the grocery store.
Chart 4: Oil Vs. Long-term Trend
How to read the chart:
- It is best to buy an asset when its price is below its long-term trend and be cautious when the price is above its long-term trend.
- The upper section plots the price of WTI (blue line) vs. it’s long-term trend (dotted orange line).
- The lower section shows the Top 20% of Readings (most overpriced relative to long-term trends) and the Bottom 20% of Readings (most underpriced relative to long-term trends).
- Based on the readings, the data box in the upper left compares the “Average Annualized Return in West Texas Crude” 1-, 3-, 5-, and 10-years later.
- Bottom line: The price of oil is not in the “Bottom 20% of Readings” where subsequent returns were best, but the price is close to that threshold. Oil looks to be attractively priced.
Chart 5: Real Estate Vs. Long-term Trend
Housing prices, adjusted for inflation, remain high relative to long-term price trends.
Here’s how to read the chart:
- The middle section in the chart (orange line) plots the S&P/Case-Shiller Home Price Index vs. its long-term trend (dotted blue line).
- The lower section shows the deviation of the price index from its long-term trend.
- The data box in the upper left shows the “Average Annualized Return in Home Prices” 1-, 3-, 5- and 10-years later. Plotted is the subsequent annual average return.
- Compare the “Top 20% of Readings” (most overpriced relative to trend) to the “Bottom 20% of Readings” (most underpriced relative to long-term trend).
- Side note: I’m bullish on real estate due to the mismatch between the supply of houses on the market and the demand for houses due to important age demographics (the large number of individuals in their early 30s)—hat tip to Barry Habib.
- Bottom line: The most attractive price points are when the orange line is near or below its long-term trend line (center section in chart).
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
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Transcript to Zulauf – Blumenthal Podcast
I received several requests for a transcript of the podcast. You can find a printout of the discussion by clicking here.
And, if you are like me and learn best by reading along while listening to the audio, open the print version and then click on the picture to link to the full audio discussion posted on Spotify.
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
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No Landing – Jim Bianco
Camp Kotok fishing friend Jim Bianco is smart, sharp, and quick to the point. He is arguing that a “soft landing” is priced into the market. This means that the recent rally to near-record highs in stock indices and a more than 1% drop in long-term bond yields is due to the belief the economy will slow but not enter a recession. And that means the Fed will pause (or maybe even cut) interest rates. Thus, the move in stocks (higher) and bond yields (lower). Priced in means the move has already happened.
Quoting the great Bob Farrell. One of his top ten investment rules states, “When all the experts and forecasts agree – something else is going to happen.”
If this is true, we need to turn our lights on to what happens should “something else is going to happen.”
Few are in the recession camp, which is where I sit. Bianco is in the no-recession camp. In Jim’s view, continued growth, inflation, and rising interest rates are likely.
The market isn’t pricing in his view or mine. I think that if either he or I are correct, the market gets hit on the head. It won’t like recession, and it won’t like a more aggressive Fed.
No Landing – Jim Bianco
If you are not following him on Twitter, you can follow him @biancoresearch. Click on the first photo to go to Jim’s X page and access the 9 thread post.
Beware of the Most Crowded Trade on Wall Street: Next Year’s Soft Landing (Click on the next clip to go to the full Wall Street Journal article).
The cynic in me wonders what the Fed officials were looking at that caused them to flip their dot plot to expecting three rate cuts in 2024. What are they seeing in the early data they get to see that the rest of us might be missing? Either way, no-landing or hard-landing is not the consensus view, and getting one or the other is not bullish for overvalued stocks. The big bet is in the bond market. Hard-landing will see rates go lower and bond prices higher. No-landing and rising inflation mean rising interest rates. If so bond prices will move lower.
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
Random Tweet’s
More from Jim:
Every year Byron Wein publishes his top 10 surprise list. Here is the link:
We’ll actually there are three ways – a combination of A and B:
Current Top 5 stocks make up approximately 26% of the S&P 500 Index:
Red circle bottom right in the chart:
Follow me on X (formerly Twitter) @SBlumenthalCMG.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
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Personal Note: Merry Chrismas and Happy New Year
“I love snow for the same reason I love Christmas. It brings people together while time stands still.”
– Rachel Coh
Coach Sue (my wife Susan) sent me an article she read in The Athletic by Dan Pompei, dated October 3, 2023. It narrates a story that intertwines the themes of sports, life lessons, and family through the experiences of Steve Young, a former NFL MVP and Super Bowl MVP.
The story begins with a flag football game involving Young’s daughters, Laila and Summer, who play for a high school team in Atherton, California. Despite being their first game, both girls exhibit natural talent, with Laila playing a critical position, wide receiver.
The narrative highlights a pivotal moment where Laila misses a crucial catch, leading to the team’s defeat. This moment sets the stage for Steve Young, also an assistant coach for the team, to share his own experiences of failure and the learning he gained from his failures with his daughter.
Young recounts a game from 1991 where he, as a replacement quarterback for Joe Montana, missed a crucial pass, that would have won the game for the 49ers. “It was 1991, and we were in the L.A. Coliseum playing the Raiders,” he begins. The 49ers went 14-2 in each of the previous two seasons. Joe Montana, their quarterback, was mythical in 49ers lore by then. But during the
1991 preseason, Montana, the reigning MVP, injured his elbow, forcing Young into the lineup. Then they began the season 2-2. “The 49ers needed to win this game,” Young continued, “but I needed to win this game — me. We trailed 12-6 and we were driving to win. Time was running out. It was fourth-and-7 on the Raider 19. I was running around trying to find somebody to throw the football to and Jerry (Rice) was open in the end zone, almost like waving his arms. But I didn’t see him until I watched the tape the next day. I threw an incompletion. We lost.”
It was, Young remembers, one of the most bitter feelings of his life. “The regret you are feeling, Laila, is the same kind of regret I was feeling at the Coliseum,” he tells his daughter. “Part of the reason you go out there is to learn from that, to find a way to make it a positive. There is great potential in not catching that pass. You have to find it.” (Bold emphasis of mine – love that part).
After the loss to the Raiders that Steve told Laila about, volatile 49ers defensive end Charles Haley raged at Young in the locker room, blaming and threatening. He put his fist through a glass door and wouldn’t calm down until former 49er Ronnie Lott, who had joined the Raiders as a free agent, was summoned to mollify him. A Montana loyalist, Haley had bullied Young for years by then, so much so that Young often asked team employees where Haley was so he could try to avoid him, even if it meant skipping treatment he needed in the trainer’s room.
The climb (to success) was grueling, though. Young experienced anxiety and found joy elusive. On the night before home games, he watched from the team hotel as planes took off from the airport, wishing he were on one of them. And the next morning, he didn’t want to get out of bed.
After that loss to the Raiders, Young flew to Salt Lake City to spend a day with his brother Mike. As he took a seat on the plane back to San Francisco, he questioned if he could make it through the season. Next to him was Stephen Covey, author of “The 7 Habits of Highly Effective People.” Young bared his soul to Covey, telling him he wished he were a golfer or tennis player without teammates to concern himself with. Young writes about it in his inspirational book, “The Law of Love.”
Covey made him think about how 49ers owner Eddie DeBartolo saw players as partners, how Walsh looked at players holistically, how offensive coordinator Mike Holmgren understood quarterbacks like few others, and how Montana set an example to follow. “I don’t know of anyone that I’ve ever met, anywhere in the world, who is in a better place with a better platform to go see how good he can be,” Covey told him.
On that plane ride, Young’s outlook changed.
Eventually, the 49ers traded Haley and Montana. The rest of the players who were invested in Montana moved on. The 49ers became Young’s team. He won everything a quarterback can win and transitioned from runner/thrower to passer — pure passer — better than anyone ever, leading the NFL in passer rating for six out of seven seasons.
Remember the great potential in failure that he told Laila about? This was it.
Haley continued to torment Young as a member of the Cowboys, but it was different coming from an opponent.
During the 1998 season, 49ers coach Steve Mariucci brought up the idea of bringing back Haley. He asked his player leaders who was in favor of signing the free agent.
Young was the first to raise his hand.
These days, Young looks forward to seeing Montana. He and Rice live near one another and are closer than ever. Rice frequently gives of himself to the Forever Young Foundation, the charity Steve and his wife, Barb, oversee.
Young’s football journey is celebrated with a ring nearly the size of a golf ball, but it was about so much more. It was about reconciliation and resourcefulness, subjugation of self and survival, determination and vindication.
Young retired in 2000 after 17 seasons of professional football.
The story concludes by emphasizing the importance Young places on coaching, which he sees as a sacred responsibility akin to being a parent or a guardian. It’s a role that allows him to influence not just his player’s athletic skills but also their personal growth and character development.
One of the things I like most about sports, no matter the physical talent, is sports are a wonderful medium to teach valuable life lessons.
No wonder Coach Sue likes this story.
Here is a link to the full article. I hope you enjoy the story as much as I did.
Merry Christmas and Happy New Year!
From my family to yours, please raise a glass of fine red wine (or your favorite drink) high in the air and toast with me, “To love! The greatest present of all.”
May time stand still for you and yours!
Trade Signals: Weekly Update – December 20, 2023
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Notable this week:
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