Five Ways to Prepare for the New Normal
I am sorry I have not put up a new blog post in the last 45 days or so, obviously the world changed with the Coronavirus shutdown and it has affected everyone.
In our case, market volatility rose, client needs ramped up, and investor nervousness was heightened. This led to a very busy quarter for us and our distributed workforce.
Additionally, some of the work we usually do during the summer was pushed forward. Things are finally stabilizing. Just like Punxustawney Phil, we are finally sticking our heads out of our burrows and wondering what happened to the world!
I was reading a article sent to me by one of my support staff recently called Leading Beyond the Blizzard: Why Every Organization Is Now a Startup where they used the terms Blizzard to describe the virus shutdown and Winter to describe the period we are now entering over the short to intermediate term. They used the term Ice Age as the place we may be heading. It was a somber piece with some great ideas for businesses of all sizes in the “New Normal.”
As a financial guy, I must point out that we were headed towards Winter with or without the virus. Sequential quarter over quarter earnings and GDP were starting to slow and we were already in unprecedented territory with regards to the length of the economic expansion. The pandemic just expedited the process and accelerated the pain for many unsuspecting individuals and businesses.
What was a key take away from the article is that everyone is now a start-up! The point being that every business must now adapt, reinvent itself or die, even the large multi-national firms. As I look out of our burrows, I see a new environment with new challenges in term and new opportunities. In other words, a New Normal.
Here is a recent example, I went to the eye doctor recently and had to phone to get let in, wear a mask my entire visit and then have my hands sanitized on multiple occasions by the staff just to keep germs at bay. This is not the world I used to know!
Something else we see are disruptions in supply chains. We see tremendous government spending and interest rates that are now approaching zero (and being forecast to be negative by November). This is not the old normal!
Internally, we are already a distributed workforce utilizing technology to stay lean. However, we will be looking for ways to serve our clients with lower even costs and man hours while still delivering world class service. In my mind, technology is again the answer!
Enough of me rambling. Where am I going with this?
I think simply that the world has changed, and we all need to be prepared to think outside the box and be proactive, not reactive, to this New Normal. Those businesses/families that see the new environment as a positive and adapt, will thrive. Those businesses/families that attempt to stay the same will likely struggle.
The Leading Beyond the Blizzard article does a pretty good job of providing some basics for leaders as we move forward in “Winter.” I want to give you five specific ideas or take aways that you can use in either your business or in managing your family wealth.
1. Nothing is free in life – right now the global governments are passing out funds and bailing out businesses like there is no tomorrow. Unfortunately, those funds have a cost and ultimately, these same governments will be forced to raise taxes to pay the carry on those funds. Now is the time to look for ways to reduce your taxable footprint. Some ideas that come to mind quickly are utilizing private placement insurance or annuity products to reduce taxes on messy, tax inefficient investments. Maybe looking at places like Puerto Rico, where there is a 4% tax on foreign business income, for back office operations to lower overall tax rates.
2. Digital currency is a place to be – My belief is that when global governments are debasing their currencies in unison (as they are now), a new financial pact and currency agreement is on the horizon. Don’t be surprised if that next currency is digital. Now is the time to take advantage of that possible change by being an earlier adaptor/investor in digital currencies. The digital currency that the global governments will likely issue will be different, but it is coming as the world becomes more interconnected.
3. Debt is not your friend – some of you are discovering this right now. Debt is not your friend; it is your enemy unless used prudently and judiciously. A great deleveraging could be part of the future Ice Age. Now is the time to seek to restructure your liabilities so they are more easily manageable in a world where revenues may be harder to grow or return to pre-crisis levels.
4. Deflation and inflation – In a recent post, A Possible Next Move for the Markets, I spoke about the possibility of deflation and then inflation thereafter. I now believe there is a chance we will see both inflation and deflation at the same time until a future date where inflation likely overwhelms deflation. Just look around, prices of many things like energy are falling but prices for things that you really need like paper products and food are continuing to increase. In the past gold has served as an effect hedge against both deflation and inflation. Given the wave of government money printing, it could increase in value dramatically as one of the only forms of sound money.
5. Reexamine/Question Everything – now is the time to turn everything from your business to your personal life upside down and sideways. Look at it from every angle. Is what you are currently doing working? Will it work in the New Normal environment? Does it meet your personal goals and objectives? Be prepared to try new things as Leading Beyond the Blizzard suggests and to possibly fail. However, whatever you do, do not rest on your laurels!
So, what are your thoughts or comments? I would love to hear them in the comments below.
In our prior post, we talked about a possible Minsky Melt Up if the monthly Relative Strength Index (RSI) closed the month above 70. A late February sell off doomed that possible indicator signal and the outbreak of the Coronavirus quickly pushed us into an unexpected Bear market in March. Not exactly what we were hoping for when we made the post!
In fact in the midst of the panic selling, I echoed the words of Ray Dalio of Bridgewater Associates L.P. (manager of the world's largest hedge fund) when describing this decline “we did not know how to navigate the virus and chose not to because we didn’t think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk.”
In our case, we cut risk, but not enough nor fast enough. We also did not expect the decline to be so sharp and deep. As we noted on many occasions through out the month, we expected a market bounce and told clients we would adjust exposure at that time.
It took massive new interventions from the Fed and other Central Banks and unprecedented fiscal policy to finally bring some stability to markets in the largest collection of aid packages ever.
Where we stand now is that the market is still in the aforementioned bounce. We call these rallies affectionately “dead cat” bounces. They feel good but do not last (usually)!
In fact, since the 1950, there have been 15 such bounces and all but one retested the lows of the initial decline. This one could defy the odds, but the betting man would wager for a retest of the market lows.
The current bounce is within a pattern that we call a bearish rising wedge. This pattern typically breaks to the downside as it reaches the top of the pattern, which is where we are right now.
Also note that we have currently recaptured about 50% of the decline in March. A typical bear market bounce will recapture between 38.2% and 61.8% of the market decline.
What Is Next?
As I mentioned the next move in the bearish wedge pattern is to the downside. According to thepatternsite.com, once the bounce completes, price resumes declining, averaging 30% from the bounce high to post bounce low in 49 days. This places price an average of 18% below the event low 67% of the time.
We expect a scenario could unfold much like what occurred in 1987 where a market bounce led to a retest of the lows (or possibly new lows this time around).
Like 1987, we expect that this retest will start soon with it culminating around the same time the “Stay in Place” restrictions are lifted for most or all Americans.
It is possible the market then starts to feel better about Americans getting back to work and we enter a period, like above or the green box below, where we rally for a number of months.
The problem we believe is that the economy will not come back as fast or get back to the levels previously experienced, which will lead to further possible market declines as shown in this chart from 1930-1932. This is the classic Bear market!
Now this is just a guess, but this could be how it unfolds.
We think the challenge will be that initially, the decline, the virus and the global standstill for business are all deflationary. This means citizens will be hoarding cash and not spending, which will exacerbate already low levels of monetary velocity (i.e. exchange of monies from one person to the next and the next) here in the U.S.
You can see below that the velocity of money has already been declining for most of the past twenty plus years.
To counteract this low level of spending and declining velocity of money, the Central Banks will continue to buy every asset not tied down, global governments will continue to implement generous fiscal programs and even more Modern Monetary Theory practices, like the $1,200 per adult that is being distributed to taxpayers under the Cares Act currently in the U.S.
However, its possible that when the dust settles and global citizens start to feel better their situation including spending again, the huge amounts of currency and deficit spending that have been pumped into the system will spur a bout of hyperinflation the likes of which we have never seen. This will be the time when the velocity of money turns up from its current downward trend.
We feel that the last ten years were the period of the passive buy and hold manager and the next ten years could easily see the return of the active manager given the volatility we could see and the bouts of deflation and then inflation we could experience.
What are your thoughts? How about leaving us a comment below?
Just like the weather in Florida tends to be sunny most days, so the markets have gone up most days recently. Can you remember a day where you woke up to falling stock futures? Let me tell you that there have not been many such days in the past six months.
How can this be with all the global problems including slowing growth, the Coronavirus, conflict in the Middle East, impeach proceedings here in the U.S. and more?
The simple answer is liquidity.
Central banks keep printing and that money needs to go somewhere and right now that place is into assets, including stocks and bonds.
We all know this little global experiment in Keynesian Economics is going to end badly, but somehow the Central Banks continue to win the tug-a-war matches with the global economic cycles.
This is hard for more experienced managers to fathom as bubbles are everywhere and risk levels continue to rise, but here we are fully invested as if these signs of systematic risk do not exist.
I told a client just the other day “I think you have two choices as an investor. One, take advantage of what the market is giving you and then trade out or hedge when it finally does move into a bear phase; or Two, start taking positions off now and raising cash if you are not confident that someone is watching the store and will reduce exposure for you at the appropriate time.”
I also told that same client that “if he does the latter, he may miss out on one heck of a move over the balance of 2020 and into 2021.”
How can I make that latter statement?
First, the charts are showing that long-term strength in the markets is still possible based on an important historical chart pattern (i.e., real historical precedent).
If you look at the chart (below), you will see that the top window, 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. In other words, it is a momentum indicator.
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 15 months, based on 1997 - 2020 historical data.
Notice that we crossed the 70 level in February. We would have crossed last month if not for the end of month Coronavirus swoon.
What happens when the RSI indicator is above 70?
Usually the largest and most steep part of the stock market move occurs or as we call it the "melt up." This is the point that the most money is made in the market's move.
If we look at the past 6 times the market has risen above this level and stayed above 70 for more than 3 months, we find the following moves are possible:
When this occurs, historically the market has added 24.0% on average in return for the 15 months (on average) it stayed above 70 on the RSI.
Based on this alone, I think the stock markets could be headed higher, possibly much higher. History would say we could look for a price target in the range of 4090 for the S&P 500 come 2021.
Additionally, we believe the markets have further to go based simply for physiological reasons.
No bull market ends without excess enthusiasm for stocks!
In my experience, this is still one of the most hated bull markets that I have participated in to date.
In fact, I have almost daily discussions with long-time market participants who are raising cash, getting out or concerned about the markets. Does that sound like euphoria?
Now obviously, no one knows for sure what might happen, but I think there is a pretty good chance we could see an average move of 15 months and 24%. If it "melts up" all the better for our clients and investors.
That melt up may be the "Minsky Melt Up" we have been predicting. Hyman Minsky warned that capitalist economies created debts. Crises are born out of debt financed speculation on asset prices (private equity, levered loans, etc.) He theorized that eventually asset prices pop and then prices collapse. Conflicted governments then devalue, re-lever and set things up for the next fall. Sounds like the environment we are in today doesn’t it?
Could it be that this next move for the markets is a melt up to end all melt ups? Could it be that this move is the final move in this cycle?
Again, no one knows for sure, but this bubble must pop sometime!
When you pop a balloon what does it do? It shoots higher and then just as quickly runs out of gas and drops.
Sound scary? Well yes it could be. However, also it could be the greatest opportunity to profit with eyes wide open, constantly looking for the right opportunity to exit stage left, that we may see in our lifetimes!
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 Index 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.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. The DJIA was invented by Charles Dow back in 1896.
Nikkei is short for Japan's Nikkei 225 Stock Average, the leading and most-respected index of Japanese stocks. It is a price-weighted index comprised of Japan's top 225 blue-chip companies traded on the Tokyo Stock Exchange. The Nikkei is equivalent to the Dow Jones Industrial Average Index in the United States.