C2 Top Trader Radio Podcast

I will be interviewed by Charley Wright of Strategic Investor Radio for their Top Trader series on Wednesday.   I hope to have a link to the podcast as soon as possible.

Brad

“Money, Markets and Murder” July update

Stocks remain in an uptrend. For the first half of the year Tech stocks were the dominant sector.   Since the Fed shift in June Healthcare and Finance have joined Tech in leadership.  June witnessed a pullback in prices for the market leaders of which we owned many.   This short pullback bottomed on the last day of June.  Since June 30^th most accounts are up at least 3%

No major economic risks at the moment for at least a year or two. While I expect some economic slowing in the second half of the year due to Fed rate hikes, slow growth doesn’t equate to Recession.   The ingredients for a major business cycle top are still absent.

Last week I spoke with Bob Dieli of Nospinforecast.com  regarding the present status of the economy within the larger business cycle.   My concerns were due to the rate hikes and low unemployment and might these be signs of final “boom phase” of the economy.  His answer surprised me:

Me: “If this was a baseball game what inning do you think we’re in regarding the economic expansion, the 7th or 8th?”

Bob: “I would say more like the 6^th.  The reason is that I don’t think the early stages of this expansion used up resources at the same pace as other long-lived episodes.  We have yet to see any serious adjustment in interest rates, and we have yet to see even the slightest hint of wage pressures.  Both of those are 7^th and 8^th inning types of events.”

“Of course, the one thing that you did not mention is the weather.  A cloud burst, say in the form a failure to pass a debt ceiling bill, or some strange action by the FOMC with the balance sheet, or the Europeans getting their shorts in a knot yet again, could bring an end to the game before the 9^th inning.”

Interest Rates Rising:  For 9 years the Federal Reserve has been pushing down long term interest rates by being heavy buyers of long term Treasury bonds.  In May, based on the price trends in Treasury bonds I began to take some of our losing/lagging stocks and shift the proceeds to long term Treasuries.   This was based on the price action trend and the potentially serious implication of the Yield Curve narrowing – see chart below.   But, Janet Yellen at the Fed admitted she pays close attention to the Yield Curve too and announced the Fed will no longer be buying bonds but in fact selling bonds which put an end to the rally in Treasuries. This caused a sharp pullback in bond prices which triggered our sales which are always present to keep losses to a minimum.

So are at the end of a nine year cycle of continual downward pressure on interest rates?   If you’re looking to lock in a rate on a mortgage this may be a good time to do so.

With the Fed selling bonds in the open market they will probably cause interest rates to gradually rise while reducing the money supply.  (They sell the bond and the buyer gives them cash taking the cash out of the system) This does represent a potential headwind for stocks.   However, central bankers will try to balance the sale of debt and interest rate hikes to keep growth and inflation neither too hot nor too cold.  But eventually they’ll go too far and then we’ll have our next economic downturn.   But according to Bob Dieli, don’t look for the downturn anytime soon.

Money, Markets and Murder

From the title you may think this months newsletter has more to do with Agatha Christie than markets will be disappointed.  While I’m more of a Philip Kerr fan this letter will make reference to a case of repeating cycles and the serial murder of economic expansions.

The two biggest questions I receive revolve between “How can the keep rallying with the chaos and ineptitude in the White House?” and “How much longer till the next recession?”

The last letter I wrote analyzed the US stock market from a Technical view point in which I used various moving averages to identify major turning points in the market indices.   The technical view of the markets is really the latter half of the “cause and effect” duo.   Market reactions are the effect and in this letter I’d like to address the “cause”.

Markets and economies don’t roll over randomly.   To quote the German economist Rudiger Dornbusch: “US economic expansions don’t die of old age.  Every one of them was murdered by the Federal Reserve.”
Well now……….That may seem to be just colorful language but the continual coincidental circumstances of should dispel anyone thinking its just a mere coincidence.

The tightening of credit or raising short term interest rates is on the short list of weapons of choice for the Federal Reserve.  Perhaps the evidence is strictly coincidental but we have a repeating circumstance that just so happens to be at the scene of every “murder”.

One does not have to be Hercule Poirot to see that a rising Fed Funds rate is seen before every major recession since 1954.  Short term interest rates do not rise on their own accord.  The Fed’s Open Market Committee pegs the rate in accordance with how they view employment and future growth.   No magnifying glass is needed to see that sharp rises in short term interest rates are closely followed by economic slumps.

While investors have no control over short term interest rates investors do have control in the open market via supply and demand with long term interest rates.   Normally long term interest rates are higher than short term rates.   If a 30 year Treasury bond yields 4% and the one year Treasury bill is 1% we would say it has a positive spread and slope of 3%.   The actual numbers change on a daily basis but the Trend is the most important factor to consider.

The chart below from Ned Davis shows the performance of US stocks based on the yield curve.  They use a threshold of .6%.   For example if a T-Bill rate is 1% the yield on the 10-year Treasury bond would have to be equal or below 1.6% to create a spread of .6%

According to the chart above when the spread is above .6% the gain per annum for stocks is 9.8% annually.  Below .6% reveals a loss of -3.3% annualized.  This doesn’t even take into effect the severe draw downs in account values or the increased volatility and risk, sleepless nights, higher blood pressure and visits to the Astrologer.

This is one of the biggest cons played on regular retail investors by mutual fund companies (especially Index funds and Robo’s) and financial professionals who tell investors that “markets can’t be timed” “you should buy and hold” or “you’re in this for the long haul” when they’re down 30%.   This is because the fund companies get paid more to have you invested in their mutual funds rather than in cash or a money market account.   I also know a several financial planners who’s “specialty” is reducing taxes on a portfolio.   While that may sound good, at the same time their “buy and hold” philosophy means major losses in principal.

While it’s next to impossible to consistently “time” the market in the short term it’s very possible and wise to construct your investments in accordance with US monetary policy which is long term oriented.

I hope everyone has a great Summer.

Cheers,
Brad Pappas
970-222-2592 direct
720-310-8056 Skype

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone.  Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Past performance is no guarantee of future results.

Website changes: “Model Data Access”

Years ago when we created the Model Data Access page on this website we only had back tested data to draw upon for our model portfolio.  Now years later, we will have 5 years of live data come this November.  Hence we will no longer update hypothetical back tested data and only focus on live data of our model portfolio (The Vegan Growth Portfolio) collected by third party Collective2.com

The changes to the Model Data Access page will happen soon.  In the meantime we’ll post historical live data on our blog here.

Vegan Investing Not only possible but profitable

When is a good time to sell?

When is a good time to sell?
(Answer: not now)
March 2017

Summary: US equity markets remain in a strong uptrend which shows no signs of abating. Markets that have broken out from multi-years of trendless behavior can last for quite a while and deliver significant returns. So at this point we need to sit tight and let the rally continue and grow our equity. I will continue to allow our good performing stocks run as far as they’re trends remain intact. Almost all the activity in your accounts is related to the laggards and losers as I have minimal patience when better options present themselves. Our focus remains on the two best performing industries: Semiconductors and Finance.

In addition, I’m seeing a change in character in two industries thought to be in the dumpster: Solar and phones companies (Specifically, Canadian Solar -CSIQ, America Movil -AMX and Nokia -NOK). If any of these stocks are genuinely in a new upward long term trend they would likely be home run stocks, but time will tell.

Treasury bonds and interest rate related securities continue to act poorly and are to be avoided. This poor action is a positive sign for stocks as they’re a sign of a healthy economy.

_________________________

Markets and economies are cyclical and you can add recessions/bear markets to the death and taxes mantra of sure things we’ll experience. In these letters in the past I’ve generally focused on the economy or interest rates as a tool to identify high risk environments. So, in this letter I want to spend a little time on what I call our “Primary Trend Filter”.

The primary purpose of having a Primary Trend Filter is to eliminate emotions and avoid the big loss from the investment process. It’s too easy to fall prey to emotions in a rising or falling market where you lose objectivity to the prevailing trend. In addition if you’re over 50 years old time becomes an issue as you have fewer years to recoup the loss.

Just about every study I read regarding losses assumes the investor is “buy and hold” with the silent assumption that it’s impossible to “time” the market. Not only is this wrong but it’s highly biased based on the compensation plans of the mutual fund industry. Funds are paid top dollar when you’re invested in equity mutual funds and receive minimal compensation when you’re in cash or Treasury funds.

Investors are bombarded with subjective media. Today, 3.13.2017 I received an email from the investor service Zacks titled “The S&P will double in 5 years.” To quote; “Sounds like a Herculean task on the surface, but it’s really not. In fact, the market only needs to gain on average of 14.9% per year in order to do so. That’s not such a stretch given the market has been averaging 14.9% per year since the bull market began in early 2009”……..

“My 5 year doubling thesis also means that we won’t see another recession until stocks double again,nor will we see another bear market until stocks double again. Got it?”

At no point his article does he even mention interest rates, the effect of past Quantitative Easing on the “14.9%” returns or the Federal Reserve. Why interrupt a good story with the thought of higher interest rates.

Predictions like the market will double in five years have no basis in a serious investment conversation and are meant to sell memberships and generate publicity. And, there is no accountability if the author is wrong.

On the flip side of the markets is this generations Dr. Doom, Mark Faber. He sells his version of fear with almost an annual prediction of a crash. He’s right about once a decade and he never changes his tune but how objective can he be with https://www.gloomboomdoom.com/ as his domain?

Will either be right, who knows? But these kinds of calls are common and best ignored. Prediction odds are always a coin toss although some are 50-50 and some are 1 in 10. But they’re all guesses and nothing more.

Rather than basing a strategy on someone’s subjective opinion, I’ve found that objective mathematical systems are far more accurate and profitable. They make far fewer mistakes and can prevent an investor prematurely buying or selling. Many pundits can only wish their calls were as accurate. These
systems will never get you out at the absolute top or bottom but they will have you correctly positioned for the bulk of a new trend.

These types of systems are especially valuable to those of us who can’t afford a 30% decline (as if anyone can) but still need the returns generated by stocks. Unfortunately for most investors these tools are generally not utilized by most financial planners, brokers and absolutely not used by the mutual fund
and robo-advisory industry. These outfits rely on “buy and hold” with the inevitable risk of big downdrafts.

But they are in various forms utilized by some of the best independent advisory firms, independent and institutional proprietary traders.

The following two graphs are my primary exposure filters for stocks. I also use several monetary and leading economic data for confirmation. When they give a green buy signal we know the odds are heavily in our favor. I only want to have stock exposure for my clients when the odds are in their favor
otherwise cash or Treasury bonds are a better alternative.

Primary Trend Filter #1 

This is a system I created with Cesar Alvarez of Alvarez Quant Trading. It’s a simple (simple is good) moving average crossover system that in testing since 1986 delivered a higher annualized rate of return than buy and hold. Using this system the CAR (compounded annualized return) was 9.7% versus 7.9%
for buy and hold since 1986. Best of all, it lowered the maximum downside risk significantly.

The worst calendar year for this system was 2008 when followed strictly generated a loss of -9.39% but compared to buy and hold the loss was -38.49%.

In reality I don’t often wait for a system like this to trigger if the downside momentum is too great as was the case in late 2015 and 2016. The rapidly falling momentum in those instances told me that a break of the 200 day moving average was inevitable and the poor economic data backed up the sell
signal. So I didn’t wait for the formal signal to keep any losses to a minimum.

I’m not interested in market timing systems that increase return, what I’m primarily interested in is reducing downside risk. The by-product of reduced downside risk is a higher rate of return. Profits will take care of themselves but big losses are to be avoided.

Primary Trend Filter #2

The MACD indicator shown was developed by Gerald Appel of the old Systems and Forecasts in the late 1970’s. In most cases this indicator is used for short term time periods but I think it’s of special value when looked at on a monthly basis. It’s a very slow moving indicator whereby the buy and sell periods
tend to last for at least a year. It also caught the tumultuous 2015-2016 period and flipped to a Buy last summer.

One might ask when looking at the Sell signals whether it’s a good time to short stocks in anticipation for a prolonged bear market. I’d say yes but for only a small percentage of capital since bear market volatility can be huge. Better yet, the sell signals happen to be great signals for buying long term
Treasury bonds. The price appreciation of long term Treasuries tend to move into their own bull market as a “flight to safety” from stocks to bonds emerges.

Lastly, as you can see in both charts now is not the time to sell. Market tops take time to develop frequently a year or more in the making. Considering that we just broke out from a 2 year sideways trend our current rally could last quite a while. Eventually it will end and that will likely coincide with
peaks in employment and an aggressive Federal Reserve and the behavior of the stock market will be reflected in the charts above.

In the meantime market pullbacks will likely be shallow in the 5% to 8% range before prices launch the next leg higher.

Cheers,
Brad Pappas