The advance estimate for first quarter GDP came in decidedly below expectations at a 2.5% annual rate, but even that rate belies the fact that real final sales slowed to just 1.5% growth, from 1.8% last quarter. The remaining 1% of the first-quarter growth figure – 40% of the total – represented the accumulation of unsold inventory. My view remains that the U.S. is unlikely to avoid joining the rest of the developed world in a global recession that is already underway, and may well be already underway in the U.S. once data revisions are reflected. The year-over-year growth rates of real GDP and real final sales have declined to just 1.80% and 1.87% respectively, which is the first time in this economic cycle that both have simultaneously declined from above 2.0% to below 1.9% - an occurrence that has been a hallmark of every post-war recession, with remarkably few false signals for such a simple measure. The Fed’s ability to kick-the-can in increments of a few months at a time may allow this time to be different, but investors should recognize that they are relying on that proposition.

It is certainly not the case that economic recessions precisely overlap with bear markets. Rather, bear markets are frequently underway before recessions are evident, and typically end several months before the recessions do. For that reason, market returns aren’t reliably abysmal when measured from the very start of a recession to its very end. Even so, note the shaded recessions in the chart below. Bear markets in equities occurred in 1956, 1961, 1970, 1973-74, 1981-82, 1990, 2000-02, and 2007-09. Of course, there are many less severe but still damaging market declines that occurred in the absence of recession.  Continue Reading »

Corporate profit margins are presently 70 percent above the historical mean going back to 1947, as I’ve discussed earlier (see, for example, Warren Buffett, Jeremy Grantham, and John Hussman on Profit, GDP and Competition). John Hussman attributes it to the record negative low in combined household and government savings:

[quote]The deficit of one sector must emerge as the surplus of another sector. Corporations benefit from deficit spending despite wages at record lows as a share of economy.  Continue Reading »

“The stock market isn't the only thing that has set records this spring. Barron's semiannual Big Money poll of professional investors also is setting a record -- for bullishness, that is. In our latest survey, 74% of money managers identify themselves as bullish or very bullish about the prospects for U.S. stocks -- an all-time high for Big Money, going back more than 20 years.” “Dow 16000!” – Barron’s Magazine Big Money Poll 4/20/2013

A few reminders…  Continue Reading »

Mark Twain wrote “Let me make the superstitions of a nation, and I care not who makes its laws.” In recent years, investors have somehow allowed themselves to be convinced that alchemy – exchanging outstanding government debt for zero-interest monetary liabilities despite what are already trillions in excess monetary liabilities – is capable having real, stimulative, and beneficial effects for the economy. Make no mistake – the faith that quantitative easing will produce anything other than temporary and ultimately calamitous financial distortion is superstition. Keep in mind that each dollar of monetary base must remain a dollar of monetary base until it is retired. It cannot “turn into” something else. The only two forms of monetary base are currency and bank reserves, and of the trillions of dollars of monetary base created since 2008, only $300 billion has taken the form of additional currency. All of the other trillions of dollars of base money that the Fed has created take the form of bits and bytes on some computer at one bank or another in the U.S. financial system. At every moment in time, someone in the economy must be the proud owner of those zero-interest bits and bytes. If they try to exchange their bits and bytes for stocks, or bonds, or gold, or real estate, the seller of that asset becomes the new owner of the bits and bytes.

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Overvalued, overbought, overbullish. When in history have we seen the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) above 23, the S&P 500 over 60% above its 4-year low and 10% above its 52-week average, with investment advisory bears below 20% for at least two weeks running? Three times: the April 2010 peak, the March-May 2011 peak – both followed by corrections approaching 20% – and today. Even if one ignores the historical evidence suggesting the potential for significant bear market losses over the next couple of years, speculators should be aware that present conditions have been hostile even in the context of the recent bull market advance.

I use the word “speculators” intentionally, as the historical evidence overwhelmingly indicates that there is little in the way of “investment” merit at present valuations. See Investment, Speculation, Valuation, and Tinker Bell for a review of the simplistic “forward earnings” measures universally touted by Wall Street here, compared with a range of distinct valuation approaches (including a far more effective use of forward earnings), all which reach nearly identical conclusions, and all which have a dramatically stronger relationship with subsequent market returns at every horizon. Our present estimate of prospective 10-year S&P 500 nominal total returns is now down to about 3.5% annually.  Continue Reading »

“The issue is no longer whether the current market resembles those preceding the 1929, 1969-70, 1973-74, and 1987 crashes. The issue is only – are conditions like October or 1929, or more like April? Like October of 1987, or more like July? If the latter, then over the short-term, arrogant imprudence will continue to be mistaken for enlightened genius, while studied restraint will be mistaken for stubborn foolishness. We can’t rule out further short-term gains, but those gains will turn bitter.”

February 2000 (S&P 1425)  Continue Reading »

In late-2008, with the S&P 500 down 40%, I noted that stocks had become reasonably valued (see Why Warren Buffett is Right, and Why Nobody Cares). The coupling of improved valuations with an early improvement in market action – at least on post-war measures – was a fairly standard combination of events warranting a constructive position, though I noted that our approach still indicated the need to maintain a “stop loss” a few percent below those market levels in the form of index put options. Valuations are a far cry from reasonable today.

On the policy front, I believed in 2008 that it was appropriate for the Treasury to provide capital to banks through the use of preferred stock (though I would have advised the use of Bagehot’s Rule – which would have provided that capital at much higher yields than the Treasury accepted). However, I did not believe that outright purchases of distressed assets were appropriate or ethical, and I railed against the notion of a Troubled Assets Relief Program (TARP), as well as Fed purchases of Fannie Mae and Freddie Mac’s liabilities, FASB accounting changes to reduce the transparency of financial reporting, and other interventions to defend bondholders and put bad private assets on the public balance sheet.  Continue Reading »

Government intervention in the U.S. economy is approaching the point where probable long-term costs exceed short-term benefits – straining to maintain the pace of extraordinary fiscal and monetary measures that have repeatedly nudged the U.S. economy from the border between new recession and tepid growth for three years. U.S. Treasury debt now exceeds 105% of GDP (publicly held debt approaching 75% of GDP). Meanwhile, the Federal Reserve has expanded the monetary base to more than 18% of GDP (18 cents per dollar of nominal GDP), where a century of U.S. economic history indicates that a normalization to Treasury bill yields of just 2% could not tolerate more than 9 cents of monetary base per dollar of GDP without inflation. The federal government continues to run a deficit of about 7% of GDP, which the $85 billion sequester would reduce to about 6.5% under the unlikely assumption that economic activity and revenues don’t contract somewhat. Current Federal Reserve policy absorbs about $45 billion per month in new government debt as part of QEternity, but even the Fed continues this policy indefinitely, U.S. publicly held debt is still likely to expand by several percent annually assuming no recession occurs. Any eventual normalization of Fed policy would dump Treasuries back into public hands (or require public purchases of new debt in the event the Fed decides to let the holdings “roll off” as they mature). Massive policy responses, directed toward ineffective ends, are scarcely better than no policy response at all.

Let’s take a look at the current monetary and fiscal policy environment, and then examine more effective policy initiatives and why they make sense.  Continue Reading »

Dear Shareholder,

For the year ended December 31, 2012, Strategic Growth Fund lost -12.62%, Strategic Total Return Fund achieved a total return of 1.14%, and Strategic International Fund lost -1.44%. From its inception on February 6, 2012 through December 31, 2012, Strategic Dividend Value achieved a total return of 1.01%. Notably, the decline in Strategic Growth Fund was primarily driven by a 7% shortfall between the performance of the Fund's stock holdings and the performance of the S&P 500 Index – the primary index used in the Fund to hedge market risk. While the Fund's stock selection approach has significantly outperformed the S&P 500 Index over time, a brief but similar performance lag in the Fund's stock holdings was also observed during the advance toward the 2007 stock market peak.  Continue Reading »

If there is one fatal siren’s song of investing, it is the belief that an unfinished half of the market cycle will remain unfinished. A typical, run-of-the-mill market cycle runs about 5 years in duration (though with a significant amount of individual variation). The typical bull market portion extends about 3.75 years, on average, during which time stocks advance at an annual rate of about 28%. The typical bear market portion extends about 1.25 years, on average, during which time stocks decline at an annual rate also about 28%. Historically, that puts the typical bull market gain at about 152% from trough-to-peak, followed by a bear market decline about 34% from peak-to-trough, for a cumulative full-cycle total return of about 67% (roughly 10.7% annualized). Taking the arithmetic average of past bull market declines (a slightly different calculation), the typical bear market comes in closer to a 32% decline. In any event, notice that even a run-of-the-mill bear market decline wipes out more than half of the preceding bull market advance. To put some perspective of where the market stands at present, and why the siren’s song of the half-cycle is so dangerous here, the chart below presents the S&P 500 since 1998. Notice in particular that the apparent performance of the market is strikingly different depending on the “lookback” that investors use. The 10-year lookback and the 4-year lookback are particularly misleading because each captures an unfinished half-cycle; essentially a trough-to-peak market move. Such lookbacks are useful only on the assumption that the preceding bear market periods were entirely avoided, and that the next one will be avoided as well. Otherwise, lookbacks with less heroic assumptions (e.g. peak-to-peak across market cycles) are more reasonable.

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“One ought to become concerned about risk when investors become convinced that it does not exist. There are certainly times when it appears easy, in hindsight, to make money in the stock market. The difficulty is in keeping it through the full cycle. The fact that over half of most bull market advances are surrendered in the subsequent bear doesn't sink in until after the fact. It's all fun and games until someone gets hurt.

“If the parents or the children of Wall Street analysts were to ask for wise investment advice, would the first thought of these analysts really be to encourage stock purchases at a multi-year market high, in a long-uncorrected and strenuously overbought advance, at a multiple of over 18 times earnings on unusually wide profit margins, with wages and unit labor costs rising faster than inflation, while interest rates are rising, bullish sentiment is unusually high, and corporate insiders are selling heavily? Would the potential for further gains in that environment exceed next inevitable correction by an amount that would make the net gains worth the risk? Would they encourage using trend-following systems in an overbought market, even though a decline to simple moving averages already implies substantial losses?  Continue Reading »

Present market conditions now match 6 other instances in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention). These conditions represent a syndrome of overvalued, overbought, overbullish, rising yield conditions that has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 22.6.
2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.
3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 54.3% vs. 22.3%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.
4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below identify historical points since 1970 corresponding to these conditions.

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“Even the intelligent investor is likely to need considerable will power to keep from following the crowd.”
- Benjamin Graham  Continue Reading »

Last week, the S&P 500 advanced the extra 1% required to re-establish virtually every “overvalued, overbought, overbullish, rising-yields” syndrome that we define – syndromes that have appeared at or close to the beginning of what investors can easily recall as the singularly worst set of market instances in history, including the 1973-74, 1987, 2000-2002, and 2007-2009 plunges. With some minor imputation (estimating bullish and bearish sentiment as a function of the extent and volatility of prior market movement), we can verify that these syndromes also emerged just prior to the 1929-1932 collapse. The S&P 500 is presently near or through its Bollinger band (2 standard deviations above its 20-period moving average) at daily, weekly and monthly resolutions, the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) is above 22, Investors Intelligence reports lopsided sentiment at 53.2% bulls versus 22.3% bears, the S&P 500 is well into a mature bull market and Treasury bond yields have advanced measurably.

The blue lines over the chart of the S&P 500 below are even sparser than our typical charts of "overvalued, overbought, overbullish, rising-yield" events, and identify the points where the S&P 500 was within 3% of its upper Bollinger bands, at least 7% above its 52-week smoothing, and over 50% above its 4-year low, with bulls above 52% and bears below 27%, a Shiller P/E above 18, and 10-year Treasury yields above their level of 6-months earlier. As I often note, there are numerous ways of defining syndromes like this. The conditions here are essentially a way of identifying what have normally been the most strenuously overvalued, overbought, overbullish, rising-yield points within already mature market advances. Investors who are willing to accept present, record profit margins (about 70% above historical norms) as permanent will reject the notion that stocks are overvalued, but I trust that the evidence we’ve presented over time underscores the deeper basis for that conclusion. See last week’s comment Declaring Victory at Halftime for the relationship between profits as a share of GDP and subsequent earnings growth, Too Little to Lock In for the link between deficit spending and corporate profits, and Overlooking Overvaluation for the relationship between various valuation metrics and subsequent market returns.  Continue Reading »

In the spirit of hope and optimism for the New Year, I’m going to depart a bit from my usual concerns (which are no less pressing at the moment), and instead discuss when to become bullish, why to become bullish, and how often to become bullish. Using the word “bullish” three times in a single sentence may be a record for me. Despite being a lonely raging bull for years coming out of the 1990 recession, and shifting positive in early 2003 after the 2000-2002 downturn, my defensiveness during the most recent cycle has lent far too much to my characterization as a “permabear.” Any previous bearishness I've had was validated by the 2000-2002 rout, and again by the 2007-2009 plunge, which wiped out the entire total return achieved by the S&P 500 - in excess of Treasury bill yields - all the way back to June 1995. While the S&P 500 - even with the recent advance - has underperformed Treasury bills for nearly 14 years, the stratospheric valuations of 2000 are well behind us. Valuations are still rich, but they are now in the range we've seen near more typical bull market highs, so I also expect a more typical frequency of bullish opportunities in the market cycles ahead. Looking over the full span of history, the return/risk estimates from our ensemble methods have been positive about 65% of the time, and would indeed have encouraged a leveraged position (unhedged, plus a few percent in call options) about 50% of the time. Present conditions will change, and bullish opportunities will emerge, as they always have in other complete market cycles. Understandably, if one expects nothing but a defensive position at all times, even a moderate drawdown makes no sense to endure. But if one is pursuing a risk-managed strategy that seeks to take significant exposure over the course of the market cycle, and to significantly outperform the market over time, the drawdowns should be considered in the context of what the market itself typically experiences over the course of an ordinary cycle.

The average bear market loss is about 32%, and about 39% for cyclical bears that occur during secular bear markets. Given the extreme valuations that we’ve experienced since the late-1990’s, the two most recent market plunges in 2000-2002 and 2007-2009 took the S&P 500 down to less than half of the preceding bull market peaks. A 50% drawdown requires a doubling to break even. An 85% drawdown, as the market experienced during the Depression, is even more intolerable because one needs to more than triple just to get back to a 50% drawdown.  Continue Reading »

Since 2009, both the stock market and the broad U.S. economy have been dependent on perpetual support from massive federal deficits and unprecedented money creation. Meanwhile, Wall Street is content to ignore the extent of this support, and looks on every movement of the economy as a sign of intrinsic health – which is a lot like admiring the graceful flight of a dead parrot swinging by a string from the ceiling fan.

To put some numbers on this, it’s worth noting that since 1940, the S&P 500 has achieved an average annual total return of 14.5% in weeks where it was above its 200-day moving average as of the prior week’s close, and just 4.4% when it was below its 200-day moving average (only slightly more than the 4.2% average Treasury bill yield during that time, and with deep drawdowns usually concentrated in this partition). By contrast, since 2009, the S&P 500 has achieved an average total return of just 5.4% annually when it has been above its 200-day average, versus 36.7% when it has been below. Put another way, advancing trends above the 200-day average have repeatedly failed, making limited net progress overall, but declines have been halted and often breathtakingly reversed with each intervention. This pattern also reflects an unfinished cycle, the completion of which is likely to significantly damage the appeal of reflexively “buying the dip.”  Continue Reading »

With industrial production, capacity utilization, real disposable income, real personal consumption, real sales retail and food service sales, and real manufacturing and trade sales uniformly declining in their latest reports, coincident economic indicators – having generally peaked in July – are now following through on the weakness that we’ve persistently observed in leading economic measures. We continue to believe that the U.S. economy joined a global economic downturn during the third quarter of this year.

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John Hussman has been very bearish. He thinks that the stock market is overvalued and positioned for dismal returns. At this point the potential risk is much higher than the returns. Especially he thinks that the economy is already in recession, although the GDP numbers indicates otherwise. Hussman sold a lot more stocks than bought during the third quarter. His equity positions are also full hedged, typically with index options. As of 09/30/2012, John Hussman’s firm, Hussman Economtrics Advisors, owns 205 stocks with a total value of $4.1 billion. These are the details of the buys and sells that have the impact to portfolio of more than 0.5%.

• New Purchases: CVS, WDC, CELG, LOW, UPS, USB, MA, QCOM, IBM, BMC, INTU, M, UTHR, NKE,
• Added Positions: MMM, DUK, GPS,
• Reduced Positions: BIIB, ABX, CSCO, NEM, VAR, CI, PG, CAKE, INTC, PNRA, AEM, AU, JNJ, MSFT, WAG, BBY, GG, TGT, EBAY,
• Sold Out: HUM, BRCM, DELL, WAT, LIFE, CSTR, ALTR, SYK,

For the details of John Hussman's stock buys and sells, go to http://www.gurufocus.com/StockBuy.php?GuruName=John+Hussman  Continue Reading »

Is the economy at an inflection point, or are we simply in the calm before the storm? Though economic reports have been relatively muted on balance, they have also come in somewhat above expectations in recent weeks – particularly the advance estimate of third quarter GDP at 2%, and October non-farm payrolls at 171,000. The lack of clear deterioration in recent reports begs the question of whether this is enough to dispose of any concern about recession, and instead look forward to continued positive – if slow – economic progress.

The answer to that question largely depends on how one draws inferences from economic data. The consensus of Wall Street economists, as well as the broader economic consensus, has never successfully identified a U.S. recession until well after it has begun. I believe that much of the reason is that economists tend to interpret reports one-by-one as what I’ve called a “stream of anecdotes.” From that perspective, a series of positive anecdotes, such as the reports we’ve recently seen on GDP and non-farm payrolls, encourages views that the economic landscape is all clear.  Continue Reading »

In recent weeks, market conditions have fallen into a cluster of historical instances that have been associated with average market losses approaching -50% at an annualized rate. Of course, such conditions don’t generally persist for more than several weeks – the general outcome is a hard initial decline and then a transition to a less severe average rate of market weakness (the word “average” is important as the individual outcomes certainly aren’t uniformly negative on a week-to-week basis). Last week, our estimates of prospective market return/risk improved slightly, to a level that has historically been associated with market losses at an annualized rate of about -30%. Though that improvement falls into the category of a distinction without a difference, at least we can say that conditions are not the most negative on record. Over the course of the coming cycle, I expect that we will easily observe conditions among the many favorable clusters in the historical record, where we will not face the syndromes of hostile conditions we’ve seen recently (e.g. overvalued, overbought, overbullish, yields rising). Valuations, though rich, are nowhere near where they were in 2000, and even the tepid valuations of early 2003 provided ample opportunity to accept market risk without the need for significant hedging. Unlike 2009, the next cycle will not unexpectedly present us with the need to capture Depression-era data in our approach (which we’ve addressed). Even without significant undervaluation, there are many combinations of market conditions that have historically been associated with strong subsequent market returns, on average.

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