It was not my intention to write on the markets this month, but there have been so many poorly informed "negative naysayers" predicting a deep correction or a imminent 50% correction in the markets, that I wanted to set the record straight.
So for the record, we are due for a bit of a pullback and we have been doing a sideways to down pullback most of the month of March. So we are in the midst of that pullback now. It has just been mild so far, which is common at the start of pullbacks. Some indexes, such as the small cap indexes, have been hit harder than others.
Unless the wheels suddenly fall off the economy or some kind of unexpected shock comes from somewhere else around the globe, I expect markets to eventually move higher. Possibly much higher.
So you must be saying to yourselves, how come Jeff is now suddenly positive when he has been negative on the markets for much of the past few years?
The answer is what the charts and data are telling us to be positive. For much of 2015 and 2016 we were in a big range and moving sideways. In July 2016, we finally broke higher (not lower as I expected) out of this range and so far we have not looked back.
Here is what we are seeing:
First, the charts are showing that long-term strength in the markets is still possible based on historical chart patterns (real historical precedent).
If you look at the chart above, you will see that the top RSI indicator is now above 70 on this monthly chart of the S&P 500 index.
The RSI indicator, according to Wikipedia, is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period.
However, you don't really need to know anything about this indicator to see that when it moves above 70 (as highlighted in yellow), it usually stays there for an average of 13.4 months, based on 1997 - 2017 data.
Notice we crossed the 70 level in January. So based on the average, you could expect this indicator to stay above 70 till January or February of 2018.
So what happens when the RSI indicator is above 70?
Usually the largest and most steep part of the stock market move or as we call it the "melt up." This is the point that the most money is made in the market's move.
So if we look at the past 5 times the market has risen above this level and stayed above 70 for more than 3 months, we find the following moves are possible:
So historically the market has added 22.9% on average in return for the 13.4 months it stayed above 70 on the RSI.
So based on this alone, I think the stock markets are headed higher. History would say we could look for a price target in the range of 2766 for the S&P 500 come January/February 2018.
Secondly, the bureau of labor statistics published a paper by Yale Professor William Goetzmann. In it, he showed that booms are rarely followed by busts. His study of 42 different stock markets from 1900 to 2014 found that booms are more likely to be followed by more booms.
In fact, a stock market that’s doubled in the past year is almost twice as likely to double again as it is to get cut in half in the year that follows as you can see below.
My third and final reason that markets have further to go is a simple physiological one and that is no one is bragging about how much they earned on their investment portfolios yet.
No bull market ends without excess enthusiasm for stocks!
In my experience, including yours truly, this is the most hated bull market that I have participated in to date.
In fact, I have taken several calls over the past few weeks defending the markets from the alternative bubble, real estate and speculators that have been drawn into that bubble de jour. Somehow, in our boom or bust real estate market in Tampa, my average client is more excited about real estate than the stock markets. How this can be when list prices per square foot are already at 2007 bubble levels and interest rates are on the way up is mind boggling to me? Real estate is also not liquid so it is not like you can press a button and get out of your ill-timed investment overnight!
But I digress!
So no bull market ends without like enthusiasm for stock markets and we do not have that yet. In fact, far from it!
One last thought, Stansberry Research is suggesting that Central Banks around the world are dumping cash and funneling their cash into equities and bonds. This has already begun in Japan and Europe but they suggest that these actions could be followed by some 80% of Central Banks globally in 2017, including the U.S. Federal Reserve Bank (once their restriction against doing so is lifted).
They (Stansberry Research) further suggest that market "melt ups" like the one experienced in the Nikkei Stock Market in the 1980s (below left) or the one experienced in our own Dow Jones Industrial Average in the 1920s (below right) are possible.
Click here (http://lastbullmarket.com/bull_market_fb.html) to watch the entire Stansberry Research presentation.
Now obviously no one knows for sure what might happen, but I think there is a pretty good chance we will at least see an average move of 13.4 months and 22.9%. If it "melts up" all the better for our clients and investors.
Let me also point out that following the above "melt ups" there was also a "melt down" and this could also be a time of great opportunity and we are very excited about it.
So my advice is hang on tight because it looks like markets want to move higher and if the Central Banks around the world decide to increase their buying of securities due to global growth concerns, this thing could really take off!
Let me know your thoughts. Please leave a comment below.
We have been looking at real estate hard ever since we told our clients in September 2016 that we would be implementing a four pronged approach to expanding opportunities for them to profit. This new approach included looking harder for new opportunities, a continued focus on preservation and growth of capital, a renewed focus on planning and finally a increased desire to be an innovator for our clients.
We have consistently found the same things (in general) in our searches. This economic cycle is likely near an end and therefore investment risk has increased while corresponding return possibilities have declined. In other words, the incremental return for the risk being taken is just not there.
One area we have particularly looked hard at is residential real estate.
A Review of Residential Real Estate
I have to admit I am still learning all the numerous ways to approach residential real estate. My most significant experience in this space had been my 70+ year old house, that seems to monopolize a lot of my free time with constant maintenance projects.
In my quest to help clients look at this possible avenue for investment, I have read half a dozen books on subject. I joined the Tampa Bay Real Estate Investors Association (TBREIA) and started regularly attending their meetings. I have networked with investors in this space who owned hundreds or even thousands of residential properties.
I don't know if I am completely there yet and probably won't be until I personally own more residential units, but I have come a long ways!
So what did I learn?
First, its apparent that real estate in local. My analysis of the Tampa residential real estate market will likely not play in De Moines, Iowa or even New York City.
Second, real estate is cyclical. Many claim that real estate follows an eighteen year cycle of boom and bust like below.
Third, while there may be a bigger 18 year cycle to real estate, it also tends to follow the overall economic cycle. So within the larger 18 year cycle, we still have smaller boom and bust cycles (a cycle within a cycle) in that follow the economic cycle.
That market cycle tends to follow the same progression every time.
Fourth, I learned some geographic markets are more stable than others. My market, Tampa, is anything but stable. In fact, this market appears to be more of a boom, bust market than most!
When times are tough, the market drops like a rock. When times are good, prices rise to the moon. Much of this has to do with the growth this market experiences from people moving into the state when times are good. This trend seems to reverse when there is excess hurricane activity that effects the state or tough economic times as much of the workforce is service driven and transient.
So you may be asking how does this nice little lesson on real estate affects us?
The answer is that it may not, but I did want to share some of our insights on the Tampa market that may be applicable to other markets.
Let's start first with this chart of historical residential sales prices per square foot in the Tampa market taken from 100 random homes that are currently listed for sale. So that would mean the 2017 price per square foot data is based on list price, not a sale price. Price per square foot data before 2017 are based on actual sales prices.
So again this is price divided by the square footage of the unit sold. So we have attempted to compare apples with apples.
What you notice is that price per square foot in current listings is at bubble top levels. This does not in itself mean the top is in just that it's possible.
I also must disclaim that sales data prior to 2001 is very sparse and it could be misleading. If we just focus on 2001 through January 2017 that chart looks like this:
It doesn't really change the picture any but is does eliminate the less robust data that may be distorting the picture.
So next I wondered if we took three year smoothed price per square foot data from 1998 and then increased that data by the historical Consumer Price Index on an annual basis where should the price per square foot be based on that 1998 - 2000 smoothed data.
You see the results below.
So what can we conclude from this data?
I believe its quite possible that we are in another bubble and now well beyond where prices should be on a price per square foot basis. As I drove down a local street yesterday, I noticed For Sale signs every 8-10 houses. I can tell you that the shear number of such For Sale signs has literally multiplied in the last few weeks.
CNBC also reported that in some parts of the country homeowners were receiving 60 offers on one home (http://www.cnbc.com/2017/02/28/spring-housing-already-overheating-think-60-offers-on-one-house.html). This is crazy, if true.
I also believe the moral of the story is that you must either plan to buy and hold for a very long time or you must be very nimble at these levels.
Since the big money is real estate is made from buying low and selling higher and I don't want to be a flipper, I would believe the only play left is the public market play via real estate ETFs and funds where I can quickly press the SELL button when it appears the gig is finally up here.
Otherwise this is just a much larger, grown up version of musical chairs and we already know there are not enough chairs for everyone when the music finally stops.
Let me know your thoughts. Am I missing the mark? Leave your comments below.
Many of you have never heard of recency bias, but it all around us today. According to DaveManual.com, "Recency bias" is the phenomenon of a person most easily remembering something that has happened recently, compared to remembering something that may have occurred a while back.
In every day life we all experience recency bias! Just think for a moment about the best movie you have ever seen. I bet the mental process is affected by a recency bias because quite frankly it is simpler to remember the Star Wars Sequel you just saw (Rogue One) over the original Star Wars you may have seen in 1978, like me.
So how does recency bias affect investing and capital preservation?
Simple, as investors we tend to chase what has been working best in a search for higher returns. When we do this we inevitably rush to the same side of the boat as other investors as I talked about in my post entitled "Is the Market for Passive Strategies Really Just Load Shifting?" because this is the popular trade.
For many of us who, if not for bad luck, we would have no luck at all, we shift just at that moment in time that popular investment or trade is losing its advantage. What happens next is a reversion to the mean or average that then costs us money.
Today, I am going to share with you a number of graphs that clearly show both a recency bias by market participants and the growing possibility of a reversion to the mean.
Let's first start with a graph showing what investors are seeing today.
This is a graph of the S&P 500 Total Return Index versus both the SG CTA Trend Following Sub-Index (an active strategy index of commodity trading advisors) and a portfolio that is 50% active (the SG CTA Trend) and 50% passive (the S&P 500 Total Return Index on a cumulative return basis assuming a $10,000 initial investment for each.
Clearly, the S&P 500 Total Return has been the place to be over the past six years! As a result investors are piling into index based investments pulling investment dollars from active managers, like the trend followers that make up the SG CTA Trend Sub-Index.
However, let's now pull back a bit and get a greater perspective by looking at those same returns since 1990, below.
Now what do you see?
Here clearly the active managers are the historical winners, except for the last 6 years or so. Also note how well the 50% active / 50% passive portfolio did during this period both in terms of return and the smoothness of the return stream (more on this later).
So is it possible, assuming the world has not changed measurably, that investors have lost sight of what has worked historically to chase returns in the here and now?
I mentioned reversion to the mean earlier. Which charts below are the the most susceptible to a reversion to the mean (the mean is represented by the red linear trend line)?
If you answered the S&P 500 Total Return Index, you are correct.
Of the two charts, it appears the SG CTA Trend following index could be primed to rebound towards or even above its linear red line. The S&P 500 one would figure is most susceptible to a move towards or below the linear red line or mean.
Obviously, I have no idea on the timing and the S&P 500 could continue higher, but it stands to reason it will eventually have to turn lower and towards its mean.
So let's say the S&P 500 and markets in general do turn lower, how do you best position oneself for that eventuality?
We believe the answer is to have both passive (index) and active managers, specifically trend following managers.
Here is the why?
When that down market for the S&P 500 comes, trend followers generally do well (see boxes in red). Despite their reputation, the Equity Long/Short hedge funds (represented here by the HFRI Equity Hedged Index, still lose money but not as much as the pure, passive S&P 500 Total Return Index.
The trend followers are the only ones that have an almost zero correlation (i.e. the degree to which two securities move in relation to each other) with the S&P 500 index and they bring down the overall portfolio beta (or volatility vs. the benchmark S&P 500 Index). You can see this below in the chart of beta. Notice how the beta of the 50% active / 50% passive portfolio is lower than holding just the S&P 500 Total Return Index or for that matter the HFRI Equity Hedge Index.
So the moral of this whole story is simple! Don't throw out the active managers from your portfolio just because they have under performed.
In fact, it is probably time to allocate even more dollars in this direction as a contrarian play on the likely reversion to the mean that is sure to come. Remember this current bull market is already the 3rd longest advance on record. What are the odds it continues much longer?
If we can help you with portfolio construction or one of our many unique active or passive investment strategies, please feel free to reach out to us.
Past performance is not an indication of future performance and there can be no assurance that the above indexes will achieve results in line with historical results. This blog post is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
The S&P 500 Total Return is a capitalization weighted index of the 500 leading companies from leading industries of the U.S. economy. It represents a broad cross-section of the U.S. equity market, including stocks traded on the NYSE, Amex and Nasdaq. In this particular index dividends are reinvested and added to the index returns.
The SG CTA Trend Sub-Index is designed to track the largest trend following CTAs and be representative of the trend followers in the managed futures space. The index is comprised of the 10 largest managers in terms of assets under management, equally weighted, rebalanced and reconstituted annually. These managers must be open to new investment and report daily returns.
The HFRI Equity Hedge Index is an index of Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in, equities, both long and short.
A 50% active / 50% passive portfolio is just a simple portfolio that is 50% the historical returns of the SG CTA Trend Sub-Index and 50% the returns of the S&P 500 Total Return Index.