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As of this writing, August 2019, the US and global equity markets have made substantial gains and hit all-time highs year-to-date. However, the yield curve inversion earlier this year and other leading indicators are flashing warning signals of possible recession within the next few months to a year. Based on these indicators, the Fed recently cut rates. We know that recessions are always accompanied by equity drawdowns. Is now the time to sell?
Let’s look at some data. After making new all-time highs, do markets tend to revert to the mean or continue to grow? From Dimensional:
Average Annualized Returns After New Market Highs
S&P 500, January 1926–December 2018
In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.
This chart strongly suggests that selling following all-time highs may not be the best strategy or timing tool.
Can we glean any useful market timing information from the Fed rate cut? Data is mixed. From DailyFX.com:
Although the average and median returns are all positive for every time period studied here, there is a great deal of variation. Most troubling, the 2 recent Fed rate cut cycles show the only negative returns, and they each exhibit a very different pattern from the older data. Has something changed over more recent history? Or will our current cycle revert to previous patterns?
Dimensional recently studied the performance of actively managed mutual funds and found that even these teams of money managers are not beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs. Although market timing is not likely the entire explanation for this, it is certainly a component.
When considering technical or quantitative analysis methods, we can look at many rules-based ETFs. ETFDB.com lists 83 ETFs as momentum- or quant-based. Of these, only 19 (23%) lag their Yahoo Finance category returns YTD. However, if we look at one-year returns, which include the drawdown in December 2018, a whopping 73 of 83 ETFs (88%) are underperforming their category (data from Yahoo finance).
What about valuations, such as the Shiller CAPE/10 or other similar growth/value metrics? John Hussman has studied these extensively. His current hypothesis is that valuation metrics cannot be used as a timing tool. He is studying other market metrics to combine with value, hoping to find the market timing holy grail. Here is the latest market commentary which details these thoughts: https://www.hussmanfunds.com/comment/observations/obs190714/
Once you successfully sell at or near a market top, what are the indicators that it is time to buy back into the equity market (presumably at a lower level)? It’s important to remember that market timing success requires that the timing is correct on two successive transactions, not just one. It is not safe to assume that the market low point is somehow identified by just the reverse, or inverse, of whatever timing tool is used at the top. In other words, your model needs to be proven at both extremes to be successful.
For many advisors and clients, the simplest and most time-proven method of success in owning equities is simply to hold through the downturns, small and large. Regardless of any other metric, more time in the market is associated with a greater likelihood of positive returns. Again, from Dimensional:
Frequency of Positive Returns in the S&P 500 Index
Overlapping Periods: 1926–2018
In US dollars. From January 1926–December 2018, there are 997 overlapping 10-year periods, 1,057 overlapping 5-year periods, and 1,105 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.
The above is from Dan Martin via FPA blog.
1.) Write Like You Speak
2.) Read It Out Loud
- First, it can help you practice and ultimately, master Tip #1 (writing like you speak).
- Second, it can help you identify the areas where you need to add some qualifiers to simplify and clarify certain thoughts.
- Third, it’s the best way I’ve found to ensure that content is conversational enough for your audience, and for the objective of the piece. Reading aloud will help you identify the areas of your work that really lend themselves to a conversational style (i.e., something that you, or at least some human being, might actually say), and those that need some adjusting.
3.) Edit, Don’t Sterilize
My last piece of advice on engaging writing is to remember that the small imperfections and quirks in your writing style are not necessarily bad things. I think some of these quirks make up an important part of anyone’s writing style, and not all of them should be eradicated through the editing process.
Following the pullback at the end of 2018 and subsequent recovery, most analysts agree that we are likely near the end of the bull market. The 10 year – 2 year yield curve nearly inverted in December, and the 10 year – 3 month yield curve inverted in March. Other leading indicators have been mixed, as well.
Over the last several years, the best performing asset, by a lot, has been US large cap stocks. For those investing with a home bias, this has been a winning strategy. For those investing with global diversification, it’s been a long hard road.
Looking at valuations, it appears that emerging markets have the best opportunity for higher forward-looking returns, followed by international developed, with US equities coming in last (see https://mebfaber.com/2019/01/25/the-biggest-valuation-spread-in-40-years/). P/B, CAPE, and cyclically-adjusted CAPE values all suggest that the S&P 500 is due for a rough 10 years ahead. However, this has been true for at least the last 3 years. John Hussman has been predicting low returns for far longer. If you examine his analyses (at http://www.hussmanfunds.com), they are clearly well researched and make sense. But they haven’t worked.
One unaccounted-for variable has been central bank interventions. This includes not only our Federal Reserve, but actions of the central banks of Europe and Japan as well. You can find a monthly update showing the close correlation of the S&P 500 to the total of these balance sheets at yardeni.com. Since October 2017, the Fed has been reducing its balance sheet. Will this cause the US markets to decline? It appears that instead, the other central banks will increase their holdings to make up for at least part of it. The correction in December 2018 has been variously credited oil prices, revisions to 2019 earnings estimates and/or Fed balance sheet reduction. Of those three options, we have many years experience with two of them, and zero experience with the third.
One way to determine a sensible action plan is to think through possible outcomes and consider their likelihoods. Start with some assumptions: Economic conditions are likely to either stay stable for the foreseeable future or weaken. Although it is possible for conditions to further improve, it seems unlikely based on most forecasts. Central bank interventions will likely be contingent on economic conditions, which may include market conditions.
What are the possible outcomes of stable conditions vs. weakening conditions? We know that economic recessions are nearly always accompanied by market corrections. We also know that the US market is more richly valued than other markets, which may result in a larger over-correction in the next bear market. OR NOT! In Meb Faber’s article referenced above, notice that the US has been over-valued now for about 7 years. How long can this continue? Is it related to the Fed or to something else?
Many market observers, myself included, believed that this massive Fed balance sheet would cause sustained inflation above the Fed’s target 2%. We have been wrong. Before responding with, “CPI is measuring inflation wrong,” take a look at this article from Cullen Roche: https://seekingalpha.com/article/4255137-hard-truths-inflation-truthers. His arguments debunking the idea are compelling. We have not experienced excessive inflation so far, but that doesn’t mean we can’t. Moderate inflation is possible, although hyperinflation in the global reserve currency remains unlikely. How to protect clients from inflation? The traditional answer has been real assets and commodities, with a newer option being TIPS.
Will the US dollar remain the primary global reserve currency through the next recession? Despite the ongoing buzz about how China and the yuan are taking over the world, the answer is almost certainly yes. This article explains why: https://www.thebalance.com/world-currency-3305931. What does that mean for our analysis? It means the dollar, and US Treasuries, are special compared to any other currency and any other security.
Conclusions for asset allocation:
- If you hold US government securities for diversification and stability, there appears to be a strong argument that they will continue to function well in this role.
- If you hold most of your equity allocation in US securities, this might be a good time to consider some diversification to a more global allocation, international developed and/or emerging markets. Please note, this involves home-bias risk, because clients will certainly see the underperformance of their portfolios if the current outperformance of the US market continues.
- If you have concern about possible inflation, consider a position in one of the traditional hedges, keeping in mind that while these positions have provided effective diversification over the past 10 years, this mainly means that they have been performing poorly compared to US equities and other investments.
To help pet owners make decisions about end-of-life care, Dr. Villalobos developed a decision tool based on seven indicators. The scale is often called the HHHHHMM scale, based on the first letter of each indicator. On a scale of zero to 10, with zero being very poor and 10 being best, a pet owner is asked to rate the following:
Hurt: Is the pet’s pain successfully managed? Is it breathing with ease or distress?
Hunger: Is the pet eating enough? Does hand-feeding help?
Hydration: Is the patient dehydrated?
Hygiene: Is the pet able to stay clean? Is it suffering from bed sores?
Happiness: Does the pet express joy and interest?
Mobility: Can the patient get up without assistance? Is it stumbling?
More: Does your pet have more good days than bad? Is a healthy human-animal bond still possible?
Dr. Villalobos says pet owners should talk to their vet about the ways they can improve a pet’s life in each category. When pet owners approach end of life this way, they often are surprised at how much they can do to improve a pet’s quality of life, she said.
[Try Dr. Villalobos’s scale: Assess Your Pet: Is It Time to Say Goodbye?]
By revisiting the scale frequently, pet owners can better assess the quality of the pet’s hospice care and gauge an animal’s decline. The goal should be to keep the total at 35 or higher. And as the numbers begin to decline below 35, the scale can be used to help a pet owner make a final decision about euthanasia.
Here’s a great podcast from Dr. Mike Roizen of the Cleveland Clinic, and the transcript is there too:
It is focused on supplements, but includes this important detail about diet:
…food with carnitine, that is red meat and, yes, pork is a red meat, and lecithin, and choline such as egg yolks and cheese, in specific configurations seems to, and does, change the bacteria inside you over a period of as short as one week. And the good news is if you get rid of those foods totally, within one week, your bacteria changes back to healthy bacteria inside you. But when you have, for example, two six ounce steaks in a week, the bacteria that love that steak predominate, and those bacteria produce as their waste product from the carnitine—so it doesn’t matter whether it’s grass fed or not—but they produce from the carnitine an inflammatory substance that is called butyl butane and trimethylamine. The trimethylamine goes to the liver and creates trimethylamine oxide, which ends up causing inflammation and is a more powerful inflammatory agent and cause of heart disease, stroke, and memory loss than is in fact the LDL cholesterol 260. So there isn’t a physician who wouldn’t treat that. You probably should avoid more than four ounces of red meat or an egg yolk or cheese a week.
Michael Lebowitz has written an interesting piece on yield curve inversion, posted at RealInvestmentAdvice.com
His thesis is that although the 2-10 has not inverted, it’s close enough, and maybe won’t, and if you look at all the comparisons, maybe you’re missing an even better signal.
2 charts tell the story: