This Time It Probably IS Different

      It’s been said that the four most dangerous words for investors are “this time it’s different.”  If you’re not familiar with the saying, let me provide an example.  In 1999, with the S&P 500 selling at 29x earnings, the bulls “reasoned” that stocks were still a buy because “this time it’s different. Yeah, stocks are very expensive, and it’s kind of reminiscent of the Nifty Fifty disaster of the late ‘60’s, but we’re in a 2nd Industrial Revolution.  Moore’s Law (the doubling of microchip processing power every two years) has changed everything.  The old metrics don’t apply.  There is no limit to how high this market can go!”

      Well, it wasn’t different.  A grossly overvalued stock market and a very mild recession in 2000 led to an almost 50% decline in the S&P 500.  The bulls got it right about Moore’s law and the expansion of earnings from digital age companies.  What they didn’t get right were stock prices.  Cisco’s business has done very well since 1999; sales and earnings have grown substantially.  But at its high in 2000, the stock changed hands at $82 per share.  Today it sells for $48. 

     With that history in mind, I’m going to go out on a limb and say that, with regards to the recession consequences of the current inversion of the yield curve (see last week’s blog post, The Whites of Their Eyes http://capitalistinvestment.com/2019/08/the-whites-of-their-eyes/ ), there is a very good chance that this time it IS different.  In that post, I pointed out that

 . . .every recession going back to 1969 was precipitated by the Fed raising rates to tamp down rising inflation.  We are in a very different situation right now.  Since mid-2011, the Core CPI has oscillated between 1.75-2.25%.  It has been very stable.  The Fed began raising rates in late 2015 to normalize rates after 7 years of its “zero-rate” policy, not in response to rising inflation.[1] 

Brian Wesbury this week echoed my analysis:

      The threat of a recession is on the minds of investors. Some traditional measures of the yield curve are inverted and, in the past, those have preceded recessions. The link between an inverted yield curve and a recession has so dominated recent financial news that for some investors it’s no longer a matter of whether we get a recession, but how long until it starts.

     What these investors are ignoring is how different recent circumstances are from the environment that preceded prior recessions.[2]

He goes on to list all the unarguable ways the situation today is different from that preceding the previous four recessions.  In 2008, we had a bubble in housing prices at a time when banks had significantly lower capital ratios than they have today, and were forced to use disastrous mark-to-market accounting rules for the valuation of their assets.   None of those conditions exist today.

       Most importantly, Brian details what I pointed out last week.  Preceding the 1990 recession, the Consumer Price Index was up 5.40% in May of 1989.  Prior to the 1981-1982 recession, inflation peaked at 14.8% in 1980.  The Fed had no recourse except to raise rates until inflation began to decline.  Today, inflation has been stable for the past 8 years and, if anything, is currently below the Fed’s target.  

The current worry is not that the Fed has raised rates so high that it has inverted the yield curve and choked credit.   Today’s fear is that the inverted curve is a portent of a U.S. recession because growth is slowing in Europe and China.  But as you can see below, the Eurozone recession of 2011-13 did not lead to a recession here.  In addition, 2-year Swap Spreads, a measure of credit stress, were severely elevated in Europe at the time, and that is not the case today. [3]

If slowing Chinese and European economies don’t fully explain the current state of our yield curve, what does?  I believe that negative interest rates in Europe are one of the main culprits.  If you’re not familiar with the term, here’s an explanation:

     Negative interest rates refer to a scenario in which cash deposits incur a charge for storage at a bank, rather than receiving interest income. Instead of receiving money on deposits in the form of interest, depositors must pay regularly to keep their money with the bank. This environment is intended to incentivize banks to lend money more freely.[4] 

Currently, rates in Germany are roughly (-.5%).  Jeff Saut, of Saut Strategy, concurs.  He believes

     . . . participants should not take the action in the bond market as a recession signal.  Rather we think it is all about capital flows from the rest of the world seeking a positive rate return in an environment where there is $16 trillion of paper with negative interest rates.[5]

If overseas buyers are flocking to U.S. Treasuries, they are driving prices up and yields down.  If you’re a German investor, the only reason you would not own U.S. fixed income is if you were worried about currency risk.  At the moment, that seems negligible; the dollar has been in a steady uptrend for the past year.
[6]

Bottom line – this time, the reason for our inverted yield curve may truly be different than the causes of this phenomena over the last fifty years, which could very well lessen the likelihood of a U.S. recession.         

                                                                                                            Don Harrison

                                                                                                            8/21/19

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Don Harrison, Scott Grannis , Brian Wesbury and Jeff Saut and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. All investments are subject to risk.  Leading Economic Indicators are selected economic statistics that have proven valuable as a group in estimating the direction and magnitude of economic change. Raymond James is not affiliated with and does not endorse the services of Scott Grannis, Brian Wesbury, and Jeff Saut.


[1] The Whites of Their Eyes, Capitalist Investment Blog, Don Harrison, 8/16/19 http://capitalistinvestment.com/2019/08/the-whites-of-their-eyes/

[2] This Is Not 2008, First Trust Monday Morning Outlook, 8/19/19  https://www.ftportfolios.com/retail/blogs/Economics/index.aspx


[3] Calfia Beach Pundit, Scott Grannis, “A Non-Fatal Fed Mistake,” 8/1/19 http://scottgrannis.blogspot.com/2019/08/a-non-fatal-fed-mistake.html

[4] Investopedia, https://www.investopedia.com/terms/n/negative-interest-rate.asp

[5] Tool Time, Saut Strategy, Jeffrey D. Saut, 8/9/19

[6] Chart from Trading Economics, https://tradingeconomics.com/united-states/currency


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The Whites of Their Eyes

      When I was a pre-schooler . . .  Actually, let me start over.  When I was around five years old (there were no “pre-schools” in those days, and my mother didn’t believe in kindergarten, but somehow I managed to learn to read well before I started first grade), my maternal grandmother, Helen Musterman, would take me on regular trips to the Annapolis Public Library.  At that time it was located on Church Circle, in what has now been rechristened “Reynold’s Tavern.”  It was a dilapidated colonial era building, with a dirt floor in the basement where the children’s books were shelved.  The steps were very steep and ladder-like, and since Nan was old and rickety (around my age now!), she would let me clamber down unaccompanied to explore and pick out my own books.  One of my favorites was a book about the Revolutionary War.  I took it out repeatedly, and still remember the pictures of the redcoats in their strange, tall hats, the damp mustiness of the basement, and how irritated I was when some stupid “baby” scribbled over some of the pages with a crayon.

      The reason I’m engaging in this bit of nostalgia is because the book contained an account of one of the opening battles of the war, The Battle of Bunker Hill.   Technically, the British won the battle because, after repeated assaults, they forced the Colonials to withdraw from the heights above Charlestown.  But it was a Pyrrhic victory; the redcoats took considerably more casualties, and the main reason the Colonials withdrew was because they ran out of ammunition.  Legend has it that as the British advanced up the hill, militia Colonel William Prescott, in order to conserve ammunition, commanded his men “don’t fire until you see the whites of their eyes!”

      Many clients are asking if the recession I have been discussing for the last year and a half is finally upon us.  Is it time to “fire” your stocks and retreat to the safety of cash and bonds?  And my answer is “I don’t believe so, because I can’t quite see the whites of this recession’s eyes!”

      At the moment, the ostensible reason for the current market decline is the “inverted yield curve.”  Normally, short term interest rates are lower than long term rates; investors have to be compensated with a higher rate of return in order to take on the extra interest rate risk associated with longer term bonds.  An inverted curve means  shorter term rates are now higher than longer term rates.  Specifically, the current consternation regards the two and ten year treasury notes.  Yesterday (8/15/19) the two year briefly rose above the ten year yield.  Here is a long term chart of this relationship.  The chart is as of 5/31/19.  Blue line would be at 0 if it was current.

      The yield curve for the 1-10 year Treasury Notes first inverted in March and has been bouncing in and out ever since.  

       Another monetary indicator I follow, the difference between the yield on 5-yr. TIPS (Treasury Inflation Protected Securities) and Real Fed Funds has also moved into negative territory.

     Of the four monetary indicators I follow, only the spread between the 10-30 yr. Treasury Bonds is still positive.  It currently stands at +.44%

What does all this mean? 

      Though these are all very good indicators, and have almost invariably presaged a recession when they turn negative, there is usually a significant time lag between their warning signal and the top of the market.  In the last recession, the average lag for the 4 indicators was 20 months, and for the 2001 recession it was 16 months.  And a recession did not begin until all four of these indicators turned negative.  The economy doesn’t surrender immediately when the yield curve inverts.

     The reason it doesn’t is that it takes time for interest rate issues to take effect.   At the moment, corporate credit spreads are still very healthy, and most of my real-world indicators – employment, vehicle sales, consumer and business confidence, housing, etc. – show little sign of deterioration.

     In addition, every recession going back to 1969 was precipitated by the Fed raising rates to tamp down rising inflation.  We are in a very different situation right now.  Since mid-2011, the Core CPI has oscillated between 1.75-2.25%.  It has been very stable.  The Fed began raising rates in late 2015 to normalize rates after 7 years of its “zero-rate” policy, not in response to rising inflation.  Because there is no current threat of inflation, there is room for them to lower rates, which they have already done by 25 basis points, and will probably do by 50 basis points in September, if not before.

     The current consternation centers around slowing overseas’ economies and the growth-threatening nature of the tariff battle with China.   I said “this about that” back in May, and my thoughts haven’t changed:

The “trade war” is today’s headline worry.  Trade conflicts have not caused a recession since Herbert Hoover signed the Smoot-Hawley Tariff in 1930. Even then, the Great Depression that followed might not have been so severe if interest rates and taxes had not been raised.  Though there are currently plenty of numbskulls in Washington on both sides of the aisle, I believe that there is still enough understanding of history in D.C. to prevent an all-out trade war.[6]

     Below is the current status of my Leading Indicators.

They now stand at 36, taking into account the recent inversions (0 is most positive, 100 most negative).  Before the 3 previous recessions their level was 97, 88 and 86.  Keep in mind that it has not always been a straight climb from current levels to recession territory.  We had a rise to a similar point in this cycle in the fall of 2015, only to see the indicators subsequently fall back to 0.  In the previous two cycles, there were also false alarms in 1998 and 2003.

     Bottom line – though the current yield inversions could be the first warning shots of a recession, at the moment the likelihood of an imminent recession is not strong enough to make me take cover in cash and bonds.  In my opinion, the “whites of its eyes” are still a ways off.

                                                                                                            Don Harrison

                                                                                                            8/16/19

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Don Harrison and Scott Grannis  and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. All investments are subject to risk.  Leading Economic Indicators are selected economic statistics that have proven valuable as a group in estimating the direction and magnitude of economic change.

[1] Cartoon is from The Far Side by Gary Larson, courtesy of Pondering Principles, “Assessing the Battle of Bunker Hill,” Alan Snyder, 1/5/17.  https://ponderingprinciples.com/2017/01/05/assessing-the-battle-of-bunker-hill/

[2] Calfia Beach Pundit, Scott Grannis, “Market to Fed: Two Rate Cuts Needed,” 5/31/19 http://scottgrannis.blogspot.com/2019/05/market-to-fed-two-rate-cuts-needed.html

[3] Calfia Beach Pundit, Scott Grannis, “Market to Fed: Two Rate Cuts Needed,” 5/31/19 http://scottgrannis.blogspot.com/2019/05/market-to-fed-two-rate-cuts-needed.html

[4] Calfia Beach Pundit, Scott Grannis, “Round Three of the Tariff Wars,” 8/5/19 http://scottgrannis.blogspot.com/2019/08/round-3-of-tariff-wars.html

[5] Calfia Beach Pundit, Scott Grannis, “Round Three of the Tariff Wars,” 8/5/19 http://scottgrannis.blogspot.com/2019/08/round-3-of-tariff-wars.html

[6] Capitalist Investment Blog, “Leading Indicators and the Trade “War,” Don Harrison, 5/30/19, http://capitalistinvestment.com/2019/05/leading-indicators-and-the-trade-war/

[7] Blue line – Leading Indicator level.  Red boxes – recessions.

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Leading Indicators and the Trade “War”

      With renewed talk in the financial press about the possibility that the trade “war” between the U.S. and China is leading to a recession, where do my Leading Indicators stand?  At the moment, they are at 14, with 0 being the best score and 100 the worst. As you can see from the chart below [1], before each of the last three recessions (red boxes), the score ranged from 84 to 96.

[1] Chart created by Don Harrison      

Current Negatives

 Monetary Policy — I don’t have an up-to-date chart of the 1-10 Yield Curve Slope (the difference between the yield on the 1 and 10 year Treasury Notes), but at the moment it is slightly negative at (-.05%).  Typically, an inversion like this occurs when the Federal Reserve, in an effort to stem rising inflation, raises short term rates.  Our current inversion, however, has been more the result of a decline in the 10 year yield.  I suspect this may be occurring because of negative interest rates in Europe and the strength of the dollar.  Why own Euro debt instruments that pay less than nothing, when you can buy Treasuries at 2%+ and benefit from a rising dollar? European demand has likely driven Treasury prices up and yields down.

The 2-10 year spreads and the 10-30 year spreads are still positive.  In addition, the Real Fed Funds rate does not indicate tight credit.  It has risen from roughly (-2%) in 2012 to 1% today, an increase of 3%.  In previous recessions, dating back to 1960, the increase has been anywhere from 4% to 7%.  Though the Fed will probably not cut rates anytime soon, current inflation is declining (Core PCE and Core CPI) and does not warrant any rate increases.

Even though most monetary indicators are still positive, I have given the 1-10 Yield Curve Slope a negative rating. 

Housing — As I mentioned at the beginning of November (Leading Indicators http://capitalistinvestment.com/2018/11/leading-indicators/), the housing market was showing signs of strain, and 4 of its 6 components had moved into negative territory.  Since then, New Home Sales and the NAHB Housing Market Index have righted themselves.  I am still giving New Home Supply (chart below) a negative score, but it has begun to decline (a good thing!) and I can see this indicator getting a green light in the next few months. 

Slightly Worrisome

       Light Vehicle Sales – As you can see from the chart below, a decline in Light Vehicle Sales preceded each of the past 6 recessions.  At the moment, sales have been in a trading range for the past 4 years, but it wouldn’t take much of a falloff to turn this component of my index negative.

Capacity Utilization – This has also turned down, but not enough for me to move it the the negative column.

Bottom line on my Leading Indicators – In spite of a few breakdowns, they are mostly still positive, and nowhere near the levels that preceded the last 3 recessions.

The Trade War

The “trade war” is today’s headline worry.  Trade conflicts have not caused a recession since Herbert Hoover signed the Smoot-Hawley Tariff in 1930. Even then, the Great Depression that followed might not have been so severe if interest rates and taxes had not been raised.  Though there are currently plenty of numbskulls in Washington on both sides of the aisle, I believe that there is still enough understanding of history in D.C. to prevent an all-out trade war.  

Brian Wesbury and Scott Grannis  have some thoughts on the subject that don’t jive with conventional wisdom.  Here are their conclusions.  Read the full reports here (https://www.ftportfolios.com/retail/blogs/economics/index.aspx) and here (http://scottgrannis.blogspot.com/2019/05/us-and-china-play-trade-chicken-and.html)

Don’t panic if, and when, you hear of slow growth abroad.  A large part of the reason is better policies in the US, which will help support growth here.[2] 

Anyone can invent a scenario where some sort of Smoot-Hawley-like global trade war happens.  Realistically, though, that appears very unlikely.  We’re not the only advanced country China’s piracy has victimized, and China may realize it’s more isolated than it thought.  In the end, China wants to trade with the West, not North Korea, Russia, and Venezuela.  China needs the West.  And all these trade war hysterics just aren’t warranted.[3]

Meanwhile, swap spreads and credit spreads remain relatively low. Liquidity conditions have not deteriorated, the Fed is not too tight, the dollar is not collapsing, and the US economy is likely to continue growing. What we see in the markets today is another panic attack which will likely be assuaged once the Chinese figure out a face-saving way of capitulating to Trump’s demands. That shouldn’t be too hard, since it ultimately will lead to a positive result for both the US and Chinese economies.[4]

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Don Harrison, Scott Grannis and Brian Wesbury and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involes risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. All investments are subject to risk.

International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Leading Economic Indicators are selected economic statistics that have proven valuable as a group in estimating the direction and magnitude of economic change. United States Nahb Housing Market Index.


[2] Foreign Slowness Is Not An Obstacle, Brian Wesbury, First Trust Economics Blog, 5/28/19, https://www.ftportfolios.com/retail/blogs/economics/index.aspx

[3] Trade War Hysterics, Brian Wesbury, First Economics Blog, 5/13/19, https://www.ftportfolios.com/retail/blogs/economics/index.aspx

[4] U.S. and China Play Trade Chicken, and Both Are Likely to Win, Scott Grannis, Calafia Beach Pundit, 5/13/2019 http://scottgrannis.blogspot.com/2019/05/us-and-china-play-trade-chicken-and.html

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Your Market Jeopardy! Winners

Thanks to everyone who participated in our Market Jeopardy! contest.  Since no one correctly guessed both of my answers to the question “what caused the large market decline at the end of last year?”, I’ve been forced to grade on a curve.  Prizes will be awarded to the two contestants who scored 50%, and to the two with the most entertaining answers.  I’ve got hats and tee-shirts to give away; they’re worthless sitting in a closet!  Names and comments of the winners revealed at the end of this post.  (Three of the four are St. Mary’s H.S. graduates.  The nuns must have got something right, other than to tell me in the 6th grade that I was going to hell for using “impure language!”)

First, the incorrect answers:

X) The Mueller Investigation – I probably should have phrased this “Russian collusion uncovered in the investigation,” since that is what I really meant.  Raymond James Chief Investment Strategist said in December that “this decline is all about Mueller and not about slowing economic metrics . . . .”[1]  I respectfully disagreed.  I have said from the beginning that there is very little likelihood that there was any collusion between Trump and the Russians re: the election.  Trump’s White House is certainly not the good ship Lollypop, but in order for a hull to become encrusted with barnacles, it has to spend more than a few minutes in the water.  At the time of the alleged collusion, Trump had simply not been in the political waters long enough for this to happen.  Crooked real estate deals?  Sex scandals?  Sure.  Russian collusion?  Not likely.

X) Slowing Overseas Economic Growth – I’m not aware of any U.S. recession starting with slower overseas growth.   Europe was essentially in a recession in 2012, and industrial production there has slowed markedly in the last year[2], but the U.S. of A. continues to chug along.

X) Chinese Trade Tiff – It’s a “trade tiff,” not the second coming of Smoot-Hawley.

X) Government Shutdown – This was not the first government shutdown, and as long as Congress abdicates its budgeting responsibilities though omnibus spending bills, it won’t be the last, but the market long ago learned to shrug these hiccups off.

X) Dow Theory Sell Signal – According to classic technical analysis, a “Dow Theory Sell Signal” occurs when a new low in either the Dow Industrial or Dow Transportation Average is confirmed by a new low in the other.  This occurred on 12/20/19, after the Fed raised the Fed Funds rate .25% and announced that further gradual increases would be warranted.  The DJIA dropped below its 23360 low of 2/9/18, confirming the breakdown in the Transports from earlier in the month.  But the Dow Theory Sell Signal didn’t cause the 4th quarter weakness; it was the result of other factors (see “Correct Answers” below.)

X) Housing Market Softness – This is some cause for concern, but as I said in my last post[3], housing stats are notoriously volatile, and it looks like some of the 4th quarter softness is starting to abate, so I don’t think that the housing market was a major contributor to the market’s decline.

X) Inverted Yield Curve – An inverted yield curve is when short term interest rates rise above long term rates.  It is always worrisome, as it indicates a tightening of credit.  But the hysterics have gotten ahead of themselves; by most generally accepted definitions of an inverted yield curve, we did not have one in the fourth quarter.  Though it is true the yield on the 1-year Treasury Note rose briefly above that of the 5-year Note, the 1-10, 2-10 and 3-30 spreads never went negative in the 4th quarter.

          And Now the Correct Answers!

  1. Hedge Fund Selling – I’ve never been a big believer in “they” explanations for market movements, as in “they’re” manipulating things, the “insiders” are getting out, etc.  But in this case, I think there is a high probability that hedge funds had a large influence on the decline.  If you are invested in a hedge fund, you can typically only redeem your holdings at the end of the year.  Because of poor performance, there were unusually heavy redemption requests for hedge funds in the 4th quarter. Jeff Saut had this to say in December:

        Speaking of ‘selling,’ we have written a number of times about the tax loss selling this time of year, mutual fund liquidation, and more importantly the wholesale liquidation going on in the hedge fund complex.  To that point, a portfolio manager sent us this yesterday: “At least 144 hedge funds closing and liquidating trillions of dollars.  All around the world, with very few buyers in equity markets, probably concentrates this sell off.”[4]

If 144 hedge funds were closing their doors, then hundreds more were forced into significant selling with no regard whatsoever for the prices being received.  This was a mini-version of the disastrous “market-to-market accounting” fire sale of 2008, when banks were forced into selling their mortgages, price be damned.

2. Federal Reserve Policy – The Federal Reserve has always been the 800-pound gorilla in the room when it comes to the stock market, and 2018 was no exception. 

Before the Fed made their rate increase announcement on 12/20, it looked as if the S&P 500 would make a stand around its February low, but the Fed’s words sent the market down another 8%.  Here are Scott Grannis’ thoughts from his post “The Fed Screwed Up Badly.”[5]

The interaction of the Fed and the market is a complicated dance, where one leads the other and vice versa. The bond market has been telling the Fed to back off on its plans for higher rates, and I think the Fed has been getting this message . . . .   

I would say I made the mistake of believing the Fed knew how to do this dance. Unfortunately, the Fed seems to be dancing with two left feet, and has in the process severely injured the feet of its dancing partner, the market. The Fed did not take the bond market’s advice to back off on its tightening agenda. The Fed ignored the obvious signs of angst that are playing out around the globe, and it ignored the evidence pointing to declining inflation and declining inflation expectations. A pause was called for and warranted; instead the Fed preferred to tighten and to project a further two tightenings next year . . . .  And on top of that, Powell said that the unwinding of the Fed’s balance sheet was on “auto-pilot,” as if nothing could go wrong in the interim.

In short, the Fed now has convinced the market that it is more likely than not to over-tighten policy, and that, in turn, raises the spectre of another Fed-induced recession. (Very tight monetary policy is directly responsible for every recession in modern times, as I’ve repeatedly noted in this blog.)

If the Fed does not reverse course or otherwise clarify its intent, soften its stance, or display more concern for the market’s angst, then the chances of a recession will increase significantly. It’s hard to believe that Powell would insist on snatching defeat from the jaws of victory, but that’s the message he has inadvertently sent the market.

There is still plenty of time for Powell to set things straight, because the key financial market and economic fundamentals are still intact. But in the meantime things are likely to get uglier.

The Fed, as it so often is, was way behind the curve.  As you can see from this chart[6] of oil prices and inflation expectations, by the time the Fed acted in December, inflation expectations had fallen way below the Fed’s stated inflation target. 

Of course, two weeks later, after Powell met with former Fed chiefs Bernanke and Yellen, the Fed took Scott’s advice and “apologized,” saying there were no more rate increases planned and the Fed would be “listening carefully to the markets.”[7]

And surprise! surprise!, as that noted economic theorist Gomer Pyle would say, the stock market has been rallying ever since.

The Winners

Both Joe and Charlie guessed “federal reserve policy.”   Gwenn and Beverly made no attempt to get the answer correct, but will be rewarded for the entertainment value of their efforts!

Gwenn — since most people in government are crazy, my guess is #1 fear that the Easter Bunny will not have enough jelly beans and #2 Climate change

Beverly – Market Jeopardy… so all answers have to do with a market.

  • Free range eggs– eggs produced by chickens that run around and are not in cages.
  • Grass fed beef – cows who are not given GMO grain
  • Organic vegetables – grown without the use of pesticides, synthetic fertilizers, sewage sludge, genetically modified organisms, or ionizing radiation

Hats and tee-shirts on the way!

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Don Harrison and Scott Grannis not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. All investments are subject to risk. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.

[1] Raymond James Investment Strategy, Morning Tack – Most Hated Groups, Jeffrey Saut, 12/18/18.  https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[2] Calafia Beach Pundit, Scott Grannis, U.S. vs. Eurozone Comparisons, 2/15/19 http://scottgrannis.blogspot.com/2019/

[3] Market Jeopardy!, Don Harrison, 3/7/19.  http://capitalistinvestment.com/2019/03/market-jeopardy/

[4] Raymond James Investment Strategy, Morning Tack – Fed Day, Jeffrey Saut, 12/19/18.  https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[5] Calafia Beach Pundit, Scott Grannis, The Fed Screwed Up Badly, 12/20/19,  http://scottgrannis.blogspot.com/2018/12/the-fed-screwed-up-badly.html

[6] Calafia Beach Pundit, Scott Grannis, The Fed Screwed Up Badly, 12/20/19,  http://scottgrannis.blogspot.com/2018/12/the-fed-screwed-up-badly.html

[7] Calafia Beach Pundit, Scott Grannis, The Fed Apologizes and the Outlook Improves, 01/04/19,  http://scottgrannis.blogspot.com/2019/01/the-fed-apologizes-and-outlook-improves.html

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Market Jeopardy!

       The 4th quarter saw the S&P 500 drop (20.2%) from its peak on 9/24 to the bottom on 12/26.  Though Raymond James Chief Investment Strategist Jeff Saut had expected some softness in the fall, a decline of this magnitude, which is usually associated with a recession, had not been anticipated.[1]  As you can see below, my Leading Indicators are not signaling a recession.  They currently stand at 12.5, with 0 being the best score and 100 the worst.[2]  All the negatives come from the housing industry, which is a volatile component, and which, at the moment, is giving signs of possibly moving back into positive territory.  Prior to each of the 3 previous recessions, the score was north of 80.

     If we don’t see a recession on the horizon, what could possibly have caused the large decline at the end of the last year?  The punditry was buzzing with possible causes during the decline, which included:

  • The Mueller investigation
  • Slowing overseas economic growth
  • Hedge fund selling
  • Chinese trade tiff and the arrest of Huawei CFO in Canada
  • Government shutdown
  • Dow Theory Sell Signal
  • Federal Reserve policy
  • Housing market softness
  • Inverted yield curve

     I’ll reveal what I believe to be the two best answers next week. In the meantime, email me at don.harrison@raymondjames.com with your 2 best guesses as to what my answers will be. First 5 correct answers get their choice of a Capitalist Investment hat, or a Harrison Country hat or t-shirt.  Unlike Jeopardy!, you won’t be penalized for not posting your answers in the form of a question!  Autographs on Harrison Country paraphernalia by request.


[1] Raymond James Investment Strategy, Being Wrong, Jeff Saut, 9/10/18 https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[2] This graph looks a bit different than the one I published in our previous blog, Leading Indicators (http://capitalistinvestment.com/2018/11/leading-indicators/).  That graph was updated yearly; this one is quarterly. In addition, I’ve tweaked some of the indicators which gives it slightly different scores.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Don Harrison and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involes risk and you may incur a profit or loss regardless of strategy selected. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. All investments are subject to risk.

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Leading Indicators

For the past few years, I’ve made many references, both in conversation and in print[1], to various “leading indicators” that I use to assess the probability of an impending recession and concurrent market downturn.  I’ve spotlighted charts on a number of these indicators such as The Fed Indicator, Small Business Confidence and Light Vehicle Sales.  I think it would be helpful, given the current uncertain state of the stock market, to review these and give you a more complete picture.

Before any of these trends and stats go into my “Leading Indicators’ Index,” they must first have a track record of flashing a warning sign not only before a recession starts, but in a timely enough fashion to allow you to profitably lighten up on your stock market exposure.  An indicator that always flashes red 6 months into a recession is wonderfully consistent, but no help at all.  Here are the twenty two indicators I am currently monitoring, grouped into five categories:

Monetary Policy
Real Fed Funds Rate
1-10 yr. Treasury Slope
Corporate Financial Health
2 yr Swap Spreads
 Corporate Credit Spreads
Corp Profits as a % of GDP
Business Trends
Institute for Supply Mgn PMI
Capacity Utilization
Chemical Activity
24 Month Payroll
Small Business Optimism
Small Business Hiring
General
Bloomberg Business Conditions
Consumer Confidence
Light Vehicle Sales
Unemployment Rate
Weekly Unemployment
Year/Year Change Employment

      Housing

Components of Residential Investment

Housing Starts

NAHB Housing Market Index

Year/Year New Home Starts

New Homes Month’s Supply

Housing, General, Business Trends and Corporate Financial Health each have an overall equal weighting, while Monetary Policy is weighted about 50% more than these other 4 categories.  Within each category, I weight each individual component according to its past reliability. If a component is not negative at any given time, it earns a “0.”  If it is negative, it earns a number based on its weighting.  For example, if New Home Starts are giving off a warning signal, I add 5 to the Index because that component makes up 5% of it.

Here is a history of the index since the recession of 1990. (red boxes are recessions).

The plot points were calculated:

  • At the market top just before the beginning of each recession
  • At the beginning of each year
  • On 10/30/18

Observations:

  • The index rose sharply before each recession – 1990 (87), 2000 (86), 2008 (98).
    • There is a good deal of “chatter” in the years before a recession starts. Indicators frequently give off false positives.  For example, Small Business Optimism was in a clear downtrend before each of the last 3 recessions.[2]  However, there was a great deal of waxing and waning during the interim years as the market advanced.

  • The key is the cumulative weight of each indicator. There is a very clear pattern that has proceeded the last 3 recessions.  First, monetary policy becomes restrictive.  Short term rates climb to where they exceed longer term rates (1-10 Slope).  The Federal Reserve increases the Fed Funds rate significantly above the inflation rate (Real Fed Funds).  This usually occurs at least a year before the onset of a recession.[3]

This restrictive monetary policy then works its way through the economy, leading to negative trends in most of the other indicators.  In the 1990 recession, the yield curve inverted at the beginning of 1989, but the downtrend in Year-over-Year Change in Employment did not become apparent for a year.[4]

Where Are We  Now?

As of 10/30/18, our Leading Indicator’s level stands at 10.  Year-over-Year New Home Sales and Months of New Home Supply have just turned negative.  But as you can see, these indicators can be very volatile.  In the most recent expansion, the New Home Sales have turned negative three times.

Bottom Line – We believe there is a low probability of the recent market downturn being a precursor to a recession.  However, we are watching the Monetary Policy indicators very closely.

[1] The Next Bear Market II http://capitalistinvestment.com/2018/10/the-next-bear-market-ii/, The Next Bear Market http://capitalistinvestment.com/2018/01/the-next-bear-market/, Stock and Bond Market Update http://capitalistinvestment.com/2017/11/stock-and-bond-market-update/

[2] Calculated Risk Blog https://www.calculatedriskblog.com/2015/09/bls-jobs-openings-increased-to-58.html

[3] Calafia Beach Pundit http://scottgrannis.blogspot.com/2018/

[4] Calculated Risk Blog https://www.calculatedriskblog.com/2015/09/bls-jobs-openings-increased-to-58.h

Opinions expressed in the attached article are those of Don Harrison, Scott Grannis and Bill Mcbride, and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. This information, developed by an independent third party, has been obtained from sources considered to be reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Links are being provided for information purposes only. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.  There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

 

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Martin Balsam Is Gone, but Allardyce T. Meriweather Lives On!

After my religion period, I took up with a swindler: Allardyce Meriweather.

Jack Crabbe, Little Big Man

I promise the immortal Meriweather may have something to do with the market.  Just have patience.

Allardyce Meriweather is a character in Thomas Berger’s novel Little Big Man, which centers around the adventures of Jack Crabbe, the only white survivor of The Little Big Horn.  In the film version, Jack is played by Dustin Hoffman, and Martin Balsam portrays Meriweather.

Allardyce is a con artist, a four-flushing, thimblerigging flim-flam man — a direct descendant of Mark Twain’s King and Duke.  He makes a living via his wits and the gullibility of his fellow man.  As he puts it:

Men will believe anything, the more preposterous the better: Whales speak French at the bottom of the sea.  The horses of Arabia have silver wings. Pygmies mate with elephants in darkest Africa.  I have sold all those propositions.

Crabbe encounters him from time to time, and can’t help but notice that there seems to be less of Meriweather each time they meet:

Meriweather was one of the smartest men I ever knowed, but he tended to lose parts of himself.  When I joined him, his left hand and his left ear were already gone. During my years with Meriweather, he lost an eye as a result of a fifth ace dropping out his sleeve in a poker game.

It didn’t faze him, though.  Deception was his life’s blood, even if it caused him to get whittled down kind of gradual like.

When their paths cross for the last time, Jack admonishes him: You don’t know when you’re licked!   To which Allardyce replies: Licked?  I’m not licked.  I’m tarred and feathered, that’s all.

On that note, I give you the graphic below:

It’s a chart of the S&P 500’s ascent since 2012, with predictions about its future course.   The quotes may not be legible, but here’s a sample[1]:

[1] www.tradernavigator.com

7/31/12The real crash is dead ahead. Paul B. Farrell

11/13/12Prepare for massive market meltdown. Marc Faber

1/10/13Crash in Q3 2013 and continuing for a year and a half.   Harry Dent

9/26/13Decent chance stocks will crash 30% in next year.  Henry Blodget

10/15/131929 parallel warns of crash, it’s preordained.  Tom DeMark

7/29/14Stocks are in a bubble and will crash.   Ron Paul

9/5/15100% risk of a 50% crash if Trump wins nomination.  Paul B. Farrel

1/11/16Sell everything, brace for a cataclysmic year.  RBS

8/9/16Can easily give back 5 yrs. of gains to 1100.   Marc Faber

11/9/16Very probably looking at a global recession, with no end in sight. Paul Krugman

6/24/17epic decline ahead, stocks to plummet 40%.  Marc Faber.

1/18/18The data is clear, 50% unemployment, a 90% stock market drop, and 100% annual inflation starting as soon as next year.  Robert Weidemer

10/25/18French-speaking whales have heard from the silver-winged horses of Arabia that a black swan is flying in from Armageddon.  Sell Everything! Dr. A. Meriweather

(Just checking to see if you’re paying attention)

It is remarkable that the business news will continue to quote these perpetually bearish broken watches no matter how preposterous their predictions.  It’s “preordained?”  When is anything in the market preordained?  “100% risk of a 50% crash?”  I guess that’s a more precisely convincing way of saying “preordained.”    “The data is clear, 50% unemployment, a 90% stock market drop, and 100% annual inflation starting as soon as next year?”  You better have some mighty powerful data to predict the mother of all Depressions!  On a positive note, at least Henry Blodget had the humility to say “decent chance.”

Now, I don’t mean to suggest that any of these talking heads engage in premediated swindling, a la the indefatigable Meriweather.   Reading their minds is beyond my mortal powers.  I also don’t mean to imply that our current market correction could absolutely not be the start of a major bear market.  But what I can say for sure is that, unlike Meriweather, they never seem to get a piece taken out of them.  Their reputations remain intact no matter how much harm their snake oil inflicts.  They are never licked, never tarred and feathered, never run out of town on a rail.  The news media knows that there will always be a market for their silver-winged Arabian horses.

Just make sure you don’t buy into that market!

Since there is always a possibility that we are on the cusp of a major bear market, I’ll post before the end of the week with an update on my leading indicators, and what they’re saying about the odds of a significant market decline.

 

Don Harrison

President, CIS Br Mgr,  RJFS

Opinions expressed in the attached article are those of Don Harrison, and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. There is no assurance any of the trends mentioned will continue or forecasts will occur.  The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.  Raymond James is not affiliated with and does not endorse the opinions or services of independent third parties named.  The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.  Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.  Individual investor’s results will vary.  This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Links are being provided for information purposes only. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.

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The Next Bear Market II

Back in January, I posted a piece entitled The Next Bear Market In it, I opined that we are in a “secular bull market,”[1] but that another recession is inevitable – though probably a few years away – and now is the time to start formulating a portfolio game plan to deal with it.

Well, yesterday “Roberto Rates” knocked “Sugar Ray Earnings”[2] for a loop, but that has not changed my, nor Raymond James Chief Investment Strategist Jeff Saut’s, opinion: we believe that we are in a long term bull market that still has a respectable amount of time to run.  As Jeff put it today[3] (10/11/18):

Our sense, after writing repeatedly last week that folks should sell trading positions, is that people should get ready to buy . . . .  Our sense is that things are approaching a totally “washed out” level similarly to the February undercut low of 2-9-18.

Jeff also quotes Leon Tuey:

Fear surged today globally. Few realize that the sell-off presents an outstanding buying opportunity as the market is grossly oversold and pessimism is at an extreme (conditions seen at market bottoms). As mentioned in my most recent report, investors should be buying into further weakness as further weakness will cause the market to reverse to the up side.   Earlier tonight, the Dow Future was down 228 points, but has recovered more than 50% at this writing. Clearly, the market is showing downside resistance. Hence, if the market drops further, redeploy cash. A more detailed illustrated report will be sent tomorrow. Remember what Warren Buffett said: “Be fearful when others are greedy and be greedy when others are fearful.” Refrain from joining the crowd.

Here’s an update of some of my favorite leading indicators:

1) The Fed Indicator[4] – Recessions are typically preceded by tight money.  One measure of the degree of Federal Reserve tightening is the Real Fed Funds rate, the difference between inflation and the Fed Funds rate.  The average rise preceding the last 6 recessions has been roughly 5%, with the smallest increase around 3%.  At the moment the RFF has risen 2%.  Another indicator of tight money is the 1-10 Slope, the difference between the yield on 1 and 10 year Treasury securities.  Usually, this goes negative 1-2 years before the onset of a recession.  At the moment it is not negative.  The 1 yr. yield is 2.67% and the 10 yr. is 3.22%.

2) Confidence[5] – Both Consumer and Small Business confidence usually begin declining before a recession. That is obviously not the case now.

3) New Home Sales – The chart below is Year over Year Change in New Home Sales vs. Recessions.  According to Bill McBride (Calculated Risk)[6], who has extensively researched this issue, “new home sales appear to be an excellent leading indicator” and “currently new home sales (and housing starts) are up year-over-year, and this suggests there is no recession in sight.”  The year-over-year increase in new home sales has turned negative and been at a minimum of -9% before each of the last 6 recessions.  It currently stands at +6%.

Bottom Line – Stay the course.  The end is not nigh.

[1] For a definition of a “secular bull market,” see my post of 11/16/17 http://capitalistinvestment.com/2017/11/stock-and-bond-market-update/

[2] For a recap of the contest between interest rates and earnings, see my post The Tale of the Tape and This Correction http://capitalistinvestment.com/2018/02/the-tale-of-the-tape-and-this-correction/

[3] The Earnings Picture Is Getting Complicated https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[4] Real Yields vs. Yield Curve Slope from Calafia Beach Pundit Interest rates are rising because the economy is strengthening http://scottgrannis.blogspot.com/2018/10/interest-rates-are-rising-because.html

[5] Both Confidence charts from Calafia Beach Pundit An emerging and important secular trend  http://scottgrannis.blogspot.com/2018/09/an-emerging-and-important-secular-trend.html

[6] New Home Sales from Calculated Risk Investment and Recessions 10/10/18 https://www.calculatedriskblog.com/

Opinions expressed in the attached article are those of Don Harrison, Scott Grannis and Bill McBride and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. This information, developed by an independent third party, has been obtained from sources considered to be reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Links are being provided for information purposes only. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.
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Thanks for the Bull Market, CNBC!

Thanks for the Bull Market, CNBC!

As many of you know, I have been a long-time critic of the various television business networks.  While they purport to provide viewers with usable information about business and investment markets, their true mission is to sell advertising, and what sells advertising is more eyeballs glued to the screen, and what drives those eyeballs is sensationalism – especially of the Armageddon variety.  We don’t tune in to hear that business conditions are pretty good and the stock market might go up 7% this year; we can’t help but tune in if we hear trumpets and see flashing graphics announcing the next black swan event that will drive the market down 50%.

But here’s the good news about all this seeming bad news: it’s helping to sustain this bull market.  What keeps a bull market going is the same thing that sells advertising – worry, and the more the better.   As the old saying goes, bull markets “climb a wall of worry.”

Raymond James Chief Investment Strategist Jeff Saut recently offered his friend Leon Tuey’s thoughts on this paradox. Leon is a retired Canadian technical analyst.

SENTIMENT FACTORS: Sir John Templeton accurately observed that “bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria”. Despite the longevity and power of this great bull market, investors are far from euphoric. In fact, in early February, investors panicked globally as fear skyrocketed, most unusual as this is the sentiment evident at major market bottoms, not at market tops.

 SUPPLY/DEMAND FACTORS: Typically, at important market tops, investors are heavily invested in equities and hold very little cash whereas at major market bottoms, investors hold little equities and sit on a mountain of cash.  What is unusual about this bull market is that despite the spectacular gains already achieved and the longevity of this bull market, investors are still sitting on a mountain of cash and very little equities.  In my more than 55 years of experience in this business, I have never seen such supply/demand imbalance, so much money chasing so few stocks.

 The supply/demand condition can’t be more bullish.  Note the following.  For years, stock listing on the NYSE has been plunging.  At one time, over 8,000 issues were traded and today, less than 4,000.  (Moreover) helped by the tax cut, share buybacks have skyrocketed.  The IPO market is quiet as a mouse as firms are flush with cash.  Investors, big and small, have been exiting the market.  In the first quarter of the year, BAML reported that “investors yanked $29.4 billion out of exchange traded funds and mutual funds, the most for a three-month stretch since 2016.”  While supply has contracted significantly, potential demand has surged.  Individual and institutional managers are sitting on a mountain of cash.  Amazing![1]

 I don’t see this “bad news manufacturing facility” – which is what the mainstream business media has become – being shut down any time soon.  It pays too well!

And in the hyper-politicized era in which we now live, at least 50% of the population will always be unhappy and inclined to pessimism because of the party affiliation of whoever might be occupying the White House.

My advice: encourage acquaintances you don’t really care about to watch the business news as much as possible and fill up on doom and gloom, while you keep a level head and refuse to be taken in.

Don Harrison

[1] Raymond James Morning Tack, 5/24/18, The Big Chill

Opinions expressed in the attached article are those of Don Harrison and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. This information, developed by an independent third party, has been obtained from sources considered to be reliable, but Raymond James Financial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Links are being provided for information purposes only. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.
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The Tale of the Tape and This Correction

I pay almost no attention to boxing anymore, but back in the day when I eagerly awaited every epic battle between Ali and Frazier or Leonard and Duran, there was always a pre-fight analysis called the “tale of the tape.”  This was exactly what the name implied.  It compared a boxer’s height, reach, weight and age – statistics that were easily measurable – to try to determine who might have an advantage.

One way to look at the behavior of the stock market over a full market cycle – from bull to bear and back again – is to think of it in terms of a boxing match.  In one corner we have “Sugar Ray Earnings” – the total earnings of all the stocks in the market.  In the other corner stands “Roberto Rates” – the level of interest rates and the relationship between short and long-term levels.

When the bell rings at the start of a bull market, “Earnings” looks a little tentative at first but soon he’s peppering “Rates” with left jabs and smacking him in the snoot with hard rights.  “Rates” is almost helpless as “Earnings” – younger, faster, taller –drives him around the ring at will.  But from time to time, the always tough and resilient “Rates” lands a left cross or a right to the gut that staggers “Earnings” but doesn’t quite knock him down.  Eventually, “Earnings” exhausts himself and one of those hard punches knocks him to canvas and ushers in a bear market.

But of course, unlike a real boxing match, this fight never ends.  “Earnings” gets up, goes to his corner for a whiff of smelling salts, and comes out swinging to start the next bull market.

Right now, “Earnings” is firing on all cylinders.  According to CNBC’s Bob Pisani:

      Half of the S&P will have reported by the end of the day today, and it is turning into an extraordinary quarter. Earnings are up nearly 15% from the same period a year ago, and keep rising, according to Thomson Reuters. That is a blended estimate, and includes companies that have not reported yet. If you just count the companies that have already reported, the actual earnings are up 17.3%. That would be the highest growth since the third quarter of 2011. Far more are beating estimates (nearly 80%) than the average (64%), and they are beating by a wider margin.

     Most importantly, revenue growth has returned. The earnings gains are no longer coming primarily from cost cutting: revenue growth, at 8.0 percent, is the highest since the third quarter of 2011, and 82% are beating the revenue estimates (also far higher than the 60% average). As with earnings, they are beating by a wider margin (6.1percent), more than twice the average of 3.1 percent.[1]

Even more impressive, we’re pretty far along in this current match.  The growth in 2011 was not too soon after the bell had rung to start this bull market, when “Sugar Ray Earnings” was fresh and energetic.  I think some of this second wind for “Earnings” comes from the fact that we had an oil-induced mini-recession in 2015, and the yield on the 10-year Treasury Note fell from 2.5% to 1.3%.

But “Roberto Rates” has now gathered himself enough to land a hard punch.  As I pointed out on January 19th,[2]  the direction in which key interest rates are moving means that a recession is closer than it was a few years ago.  I think the recent market correction was “Roberto” knocking the wind out of “Sugar Ray.”  This happens on a fairly regular basis during bull markets.  Since 1932, the S&P 500 has corrected 5%, on average, every 7.1 months and corrected 10%, on average, every 25.9 months.[3]  But I also believe that “Earnings” still has a number of rounds left before he ends up on the canvas.

[4]

Two Interesting Charts

I think there is decent chance that rising interest rates could take longer than normal to unbalance the economic ecosystem.  The chart below shows total U.S. household’s debt as a percentage of total assets.[5]  It is now lower than the level that preceded both of the last recessions.  This time around, increasing rates could have less effect on consumers.

This chart compares truck tonnage to the S&P 500.  It looks to me like it’s a pretty good leading indicator.  Before each of the last 4 recessions, it either declined sharply or flattened out.  Right now it looks like a rocket launch.[6]

The information contained in this report does not purport to be a complete description of the markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Don Harrison, and are not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.

Investing for the long-term does not ensure a profitable outcome. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members.

[1] Investment Strategy: “The 7% Solution”, Jeffrey Saut, Raymond James Investment Strategy, https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[2] The Next Bear Market, Don Harrison, Capitalist Investment Services Blog, 1/19/18 http://capitalistinvestment.com/2018/01/the-next-bear-market/

[3] Charts of the Week, Andrew Adams, Raymond James Investment Strategy, 2/7/18 https://myrjnet.rjf.com/ResearchandPlanning/InvestmentStrategy/MarketandEconomicCommentary/MarketStrategybyJeffSaut/Pages/default.aspx

[4] The Fed Is Not Yet a Problem, Scott Grannis, Calafia Beach Pundit, 12/14/17 http://scottgrannis.blogspot.com/2017/12/the-fed-is-not-yet-problem.html

[5] Wealthier and Wealthier, Scott Grannis, Calafia Beach Pundit, 12/7/17. http://scottgrannis.blogspot.com/2017/12/wealthier-and-wealthier.html

[6] Truck Tonnage Is Impressive, Scott Grannis, Calafia Beach Pundit, 12/21/17  http://scottgrannis.blogspot.com/2017/12/truck-tonnage-is-impressive.html

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