Data suggests more upside

Coming off a weekend of political disappointment, it’s easy to get caught up in the emotions of it all. As I pointed out, the market was due for a pullback, and it got a reason to. We can “beat a dead horse” and dissect all of the “what-if” scenarios and implications of the failure. But none of this will be fruitful for your investment decisions. We know that pullbacks and corrections are an inevitable part of investing. And once in awhile we get a major decline, usually due to a recession. The key question is does the data suggest a business cycle peak?

The short answer is no.

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Consumer confidence numbers just came out at a high not seen since November 2000.

Small business optimism

Scott Grannis points out that Small Business Optimism has soared post election and is near all time highs.

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Earnings growth is finally back and is projected to be around 9-11% for 2017. This would be the largest annual increase in earnings since 2011. And this doesn’t even factor in the potential for tax reform and repatriation.

And interest rates are still very low. The earnings yield on the S&P 500 is currently 5.59%, while the 10 year treasury bond yield sits at 2.38%. Even the Fed’s overly optimistic projection suggests the real Federal Funds rate won’t even turn positive until another two years or so. So, even though valuations are on the high side and interest rates have risen quite a bit post elections, stocks still present an attractive risk premium.

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An interesting chart to follow going forward is the ten year yield. Post election the 10 year yield has risen on the assumption of pro-growth policies of the new administration. Since then a trading range between 2.3% and 2.62% has been formed. An upside breakout suggests all is clear, while a breakdown suggests that more of the President’s agenda may be in jeopardy.

Time will tell. But for now, things are looking pretty good to me. But I parse this by saying we’re probably closer to the end of the bull market, than we are to the beginning. The stock market and the economy don’t always correlate. We’ve had great performance in stocks over the last 8 years, while the economy largely under-performed. I wouldn’t be surprised if, going forward, we experience a situation where the economy starts to outperform, while stock performance slows down to an eventual crawl.

The great thing about diversification and asset allocation is that we don’t have to be prophetic. We stick to our strategy and re-balance when necessary. It’s that simple, but certainly not easy.

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How low can the S+P go?…

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As I type this the S+P 500 is down about 11.50% from it’s highs. All four major market averages are below their 50 and 200 day moving averages. And the cumulative advance – decline line is also below its 50 and 200 day moving averages. A caution sign if there ever was one, as it has been about four years since we last saw this level of volatility. Let’s take a look at the technical scenarios to look for in the days and months ahead.

The chart above shows trading in the S+P 500 since the 2011 correction. That correction caused a drop in the S+P 500 of 295 points or 21%. After the smoke cleared, the S+P would increase 100% over the next four years.

On the way up there were six minor corrections that were all in the 120-150 point variety, with the exception of the fall 2014 correction that happened to be 199 points. That pattern has broken after the dismal August performance in equities. But there is reason to believe we may be nearing a bottom, at least in the short term.

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We talked about the potential of revisiting the August lows, and it appears that is what the market is attempting to do. However, there looks to be a confluence of support between 1820-1850. As there is a prior swing high at 1850, 1838 would match the size of the 2011 correction (295 points) and the fall 2014 swing low @ 1820.  I have no idea if the final low will come in this vicinity, but I am anticipating some buying reaction here. Given the macro environment, I believe this is the more probable outcome.


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However it’s always good to be prepared for multiple outcomes. So in the case that the market spends much time below 1820, I would have to conclude that a full 20% correction would then be the most likely scenario. This would equate to about 1700 on the S+P 500. We have a swing high in the 1680 area and the 2000 and 2008 bull market tops between 1550 – 1575 could be a likely target if this scenario were to play out.

I would say the majority of the concern is coming from lack of earnings growth. Earnings for the 3rd quarter are estimated to fall 4.5% amidst global growth concerns. If this were to occur, it would be the first time since 2009 that earnings declined in back to back quarters. Couple that with the concern of rising short term rates into a weak earnings cycle, and you have a recipe for volatility and contraction.

Since I also believe there is low risk of recession in the near term. I believe that this recent earnings losing streak will eventually dissipate. At the very least I think it’s unlikely that we see the high level of Earnings contraction that accompanies a recession. And if we are to believe that the Fed will take a very modest and gradual approach to raising rates, it is likely that equities will soon find solid footing once.

Without QE it’s possible we don’t see the level of equity market gains that we have seen in the past. But that doesn’t mean that investors won’t be rewarded either.

Want to learn how to trade and analyze the markets? Whether your a day/swing trader or investor wanting to learn how to analyze trends in the financial markets, there is something in The Trading Playbook for everyone. 

Financial Markets Week in Review: September 14-18

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Last week was a week full of economic data and central bank announcements. Gold came out as the biggest winner, sporting a gain of 2.81%, while stocks, bonds and the dollar eked out minor gains.

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Retail sales came out on Tuesday, showing a month over month increase of 0.2% while the street was expecting a gain of 0.3%.

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On Wednesday the Core Consumer Price Index (CPI) showing a month over month increase in line with expectations of 0.1%. This excludes food and energy and it’s the main indicator used by the Fed in gauging inflation in their mandate to promote price stability.

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The big letdown for the week was the Philly Fed Manufacturing index on Thursday. The expectations were for a reading of 6.1, while the actual number came in at a negative 6.0. We have seen worse readings in the last few years, nonetheless this wasn’t a good outcome.

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Without a doubt the biggest event last week was the Federal Open Market Committee (FOMC) meeting, press conference, and economic forecasts. There was much speculation around this event in terms of raising the short term rate. Before the August stock market sell off it was a 50/50 proposition. By Thursday it was priced in as only a 30% chance. As it turns out, the majority were correct. The Fed kept short term interest rate at 0%, were it has been for almost seven years. They cited global market concerns as a main reason.

It is my opinion that the Fed has no plans to raise the Fed Funds rate until March 2016 or later. The Fed has historically been reactive, not proactive, to policy changes in either direction (whether easing or tightening). By keeping the threat of a rate increase open since last year, I believe they are attempting to keep any potential bubbles in financial markets from getting too out of hand. Of course bubbles are usually hard to identify until it’s too late. I could be wrong (I hope I am wrong) but I believe the Fed will maintain status quo until next year.

As for the Fed’s economic projections, there wasn’t a lot of change in their long term forecasts that I could see. They maintain longer run GDP projections of 2.0%, Unemployment rate of 4.9% and PCE Inflation of 2.0%. 13 of 17 FOMC participants believe 2015 is still the appropriate time for the first increase in the Federal Funds rate.

Full text link here: FOMC economic projections

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The chart of the week is the US dollar; resistance has come in around the $100 mark. Support may come in around the prior highs between $89-90. Upside target remains $107 as long as support holds.

For Next Week…..

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There is a handful of important economic data.

Tuesday night is Flash Manufacturing PMI for China. With all of the attention to China’s market lately, this could be a key to Wednesday’s trading.

Wednesday there is German and French Flash Manufacturing PMI as well as European Central Bank President Mario Draghi.

Thursday the US Fed Chair Yellen will speak.

And Friday is the Final US GDP number. The expectations are for a quarter over quarter gain of 3.7%.

Want to learn how to trade and analyze the markets? Whether your a day/swing trader or investor wanting to learn how to analyze trends in the financial markets, there is something in The Trading Playbook for everyone. 

Simple ways to avoid fraud…

As an Investment Advisor there is a fiduciary responsibility to be honest and forthright in all matters. It’s increasingly frustrating to see so many examples of Advisors who neglect these responsibilities to their clients, in order to enrich themselves. Here we have yet another story:

InvestmentNews Article

According to the article, this advisor lied about the amount of assets under management and the returns those assets were achieving. With the proliferation of financial data these days, portfolio models are a dime a dozen. Anyone can backtest to find the correct portfolio that WOULD have done well during the previous full market cycles. This doesn’t mean it will work in the future, as no one knows what the future will bring with any consistency.

I guess if we are reaching for bright spots, the only one here is that it doesn’t appear to be an outright ponzi scheme and so investors are still able to access their money. Investing is a difficult endeavor by itself. Investors do not need the additional stress of wondering if their advisor is legit or the investments being pitched to them are legit. To combat this, here are three simple steps to help avoid most of the fraud that is occurring these days.

  1. Check the FINRA’s Broker Check web site.  http://brokercheck.finra.org/

The Financial Industry Regulatory Authority has developed a database that contains important information for you the investor. Anyone who is attempting to do business with you must be registered. So look up the name of the contact person and the firm he or she is representing first. If you can’t find them listed, it’s usually best to walk away. There are some instances where someone can sell certain securities without being registered, but these are few and far between. If you were to look through the disciplinary files at the SEC and State Securities Administration website, you would see that the majority of these fraud cases were because some unlicensed sales person sold some unregistered security that turned out never existed in the first place. Unfortunately a simple check on FINRA’s website could have negated many of these fraud cases.

Along with being registered, the database will alert you to any prior disciplinary actions as well as their background information. This will be helpful to you the investor to see if there are any further red flags to be aware of. At the very least you can use this information to ask further questions of your advisor or broker. Don’t be afraid to ask questions. Remember this is your hard earned money that is at stake.

2. Low risk and High reward just doesn’t exist. If it sounds too good to be true, it probably is.

Unfortunately there isn’t a holy grail in investing. If someone comes to you and claims to have a little to no risk investment that offers a high yield or rate of return, be very suspicious. First of all, if they had this “sure” thing, why would they tell you about it? Why wouldn’t they be borrowing as much money as they could and investing in it themselves? The answer is because it’s not real.

There are no certainties in the financial markets. And the trade off between risk and reward is always prevalent in real investments. In other words you can take little risk and keep money in a savings account or money market account. But the trade off would be to accept low rewards in the form of an almost 0% interest rate. On the other end of the spectrum, you could take an above average amount of risk by investing in a 100% stock portfolio, emerging markets, high yield junk bonds, etc. These investments would give the investor a chance to make above average returns. But the trade off would be a tremendous amount of volatility and risk of losing money.

There is simply no getting around this concept in and by itself. But an Advisor can create an investment plan to diversify your investments across a variety of different asset classes. This will help to ensure that your portfolio aligns with your personal goals, time horizon and risk tolerance.

It’s not always easy because it usually ensures that you will dislike part of your portfolio. But financial markets are cyclical, and what works now doesn’t always work in the future, and vice versa. So creating a diversified portfolio is really the best way of navigating the risk in the markets.

3. Keep it simple. If you can’t understand the investment, don’t be afraid to walk away.

There is a growing trend to promote complicated investment products that few can fully understand. The main reason is that fees are generated on these products, so the more sophisticated the product or strategy, the higher the fees generally are. This is not a one size fits all answer. There may be a place to these types of investments in certain portfolios. However you should not feel that your financial goals hinge on these products.

Ask your advisor or salesperson to explain the investment or strategy in simple terms. What does the investment do and how does it align with your personal goals and objectives? If after the explanation you still don’t comprehend it or feel uneasy about it, don’t be afraid to just walk away or decline the offer. The worst that can happen is that you miss out on an opportunity that might have made some more money. However if you maintain an Investment plan, this one decision alone should not deter you from meeting your goals. And the best case scenario is you avoid an outright fraud or an investment that crashes.

Following these three steps will go a long way to saving you from making a bad investment decision.

Some bright spots…

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2015 has so far been a trying year for investors patience. The financial media will be quick to highlight and emphasize all of the major pitfalls (Greece, Fed raising rates, etc.) that could derail the bull market. I, on the other hand, will take a look at a few bright spots in the data and price action.

The chart above shows the year to date return of the four major market averages. The tech heavy Nasdaq and the Russell 2000 (small caps) sport gains in the 5-6% range while the S+P 500 and the Dow struggle at the flat line. Not only is this another indication of how diversification can help your portfolio (especially in choppy markets), this also shows investors still willing to take some additional risk, at least for the moment.

2015-06-16_1051This next chart is of the financial sector ETF (Symbol: XLF), this fund holds all of the financial companies located within the S+P 500 index. This sector makes up about 16% of the S+P 500 and is the second largest sector, Information Technology being the largest.

In late 2014 and then again in early 2015 about $2.25 before finding support and making a new bull market high. If this pattern continues I would expect to see XLF trading above $26 in the not to distant future.

Last week the XLF briefly made a new bull market high before dipping back down with the broader market. However the overall outperformance of the sector itself bodes well for the overall market.