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The Last Bull Standing

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January 29, 2016
By Steve Blumenthal, CMG

“Greenspan, Bernanke and Yellen – who are more like teenagers at a prom night. They are spiking the punch bowl and handing out free drinks and hoping to get lucky at the end of the night.”

James Montier, GMO

“Understanding the forces of Supply and Demand in the market is a critical component in evaluating the underlying process of bull markets and the gradual signs of erosion that appear in advance of bear markets.  As the major market price indexes continue to move to new highs, most investors are unaware of the actions of Buyers and Sellers as prices become extended and subtle signs of weakness begin to appear.”

Lowry Research

“Investors will find good managers and ETFs, but unfortunately they tend not to be able to stay the course.  It is the behavioral element where they leave too soon and at the wrong time.  A great advisor can help individuals avoid this common mistake.”

Ben Johnson, Director of Research at Morningstar

Speaking of spiking the punch bowl, the Japanese Central Bank surprised this morning announcing they are taking rates into negative territory.  The JCB is trying to rescue its struggling economy.  And the ECB.  And China.  In theory, negative rates encourage consumers to save less, borrow more and spend more.  It also weakens the home team’s currency with the hope to boost exports and thus domestic growth.  Beggar they neighbor – The global currency wars advance forward.

Debt is a drag man.  It is a massive drag on growth.  And for now, deflation is winning.  The global central bankers are in a fight to create inflation.  They need to inflate away the debt as best they can.  They are “hoping to get lucky.”

The JCB news is helping the equity markets around the world.  The U.S. market is up nicely, Europe closed up over 2%, Japan closed up about 3% and China was up over 3%.  You’ll see in a chart below that the S&P 500 needs to close today with a gain of 2.6% or more in order to avoid the likely start of recession (79% probability of 2015 recession).  I know – hang in there with me on this one and take a look at the data.

Today, I share with you some of my high-level notes from this week’s Inside ETFs Conference in Hollywood, Florida.  The forward return theme was consistent, from Vanguard to Wharton Professor Jeremy Siegel: expect low equity and fixed income returns.  Jeffrey Gundlach left the audience in a state of depression (well the audience, not Gundlach) and Mark Yusko spoke of likely recession citing poor ISM numbers.  This left Prof. Siegel to later say, “It appears I’m the only bull at the conference.”

Stay forward thinking, hedge that equity exposure and overweight liquid non-directionally dependent and tactical strategies.  Recession is probable and may just be starting (more below).  Equity markets decline more than 40% on average during recessions.  It is that we must defend our capital against.

Mauldin was the key-note speaker on Tuesday and shared what he believes to be the top five challenges immediately ahead.  There is a lot of content this week. Grab a coffee and jump on in (click on the orange On My Radar link).

? If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ?

Included in this week’s On My Radar:

  • Gundlach – The Outlook for the U.S. Economy
  • Siegel – The Last Bull Standing
  • S. Recession Watch Charts
  • So Yes – The Oil Crash Looks a lot Like Sub-Prime
  • GMO’s James Montier – A Quote Too Good Not to Include
  • Trade Signals –  Sell/Hedge the Rallies
  • Mauldin – Top Five Challenges

Gundlach – The Outlook for the U.S. Economy

My notes presented in bullet point format:

  • “What the heck is the Fed doing?”
  • Aftermath of Fed policies will haunt the markets.
  • Kaboom – Game. Pump up the balloon until it pops.  Metaphor for the Fed.
  • The Fed was supposed to raise rates in September. Since they said they would do in 2015 they backed themselves in corner for December.  Further, “idiotically” they said they would raise eight times in the next two years.  Fed must scale back its rhetoric!
  • Fed may have to reverse course and follow the path other central banks have taken since 2011.
  • Most central banks are cutting and we will be raising rates. What is difference between the US & ECB?  Why are we cutting?  Our growth is almost the same as theirs.
  • Average hourly earnings moving higher. The Fed is worried about wage inflation, but what’s wrong with the middle class getting a wage increase?
  • HY vs. Treasuries. Spread is bigger than during other rate hikes.  Average is 4% now 6% but was 8%.
  • The shadow rate was -3.5%. Now we are around 0%.  Market has tightened much more than 25 bps.
  • “Fed Frozen in Thinking.” US inflation rate is lower than rest of world.
  • “The Efficient Market hypothesis is dead wrong.”
  • As for GDP – Gundlach said the Fed dead wrong in its forecast.
  • “Trying for hope over experience like a second marriage.”
  • China 6.9% GDP is a joke. He thinks it’s negative, but will give them zero as benefit of the doubt.
  • Currency Wars increasing (SB here: indeed they are).
  • Noted the severe downgrade of forecast by Atlanta Fed.
  • The “Fed whistles through the graveyard.”
  • Nominal GDP does not support Fed raising.
  • Fed has never raised with GDP this low.
  • Gundlach doesn’t like stats that ignore the bad stuff. People like to take away energy and say that were up.  But there are many companies that benefit from lower energy prices.
  • Manufacturing still matters.
  • Long-term Treasuries are completely appropriate at 2%.
  • He will bet dollars to donuts that Junk Bond issuance will collapse.
  • Commodity Index. Thinks it is due to lack of demand not just supply.  Prices are symptom of growth not being there.
  • Emerging markets. More downside to come.  Could fall an additional 40%.
  • His “recommendation is to short them.”
  • Brazil in depression. -4.5% growth.
  • When blood in the streets in EM buy India. Massive labor force growth.
  • Shanghai looks like Dow in 1929. China might not bounce back.
  • Can’t create people… Similar to Japan in 1990. Chinese Yuan must depreciate.
  • When Yuan devalues, the markets throw a fit.
  • Sees yield curve flattening.
  • S&P 500 vs. HY Spreads bigger than 2008. Obvious sell signal.
  • More recession signs: S&P 500 profit margins are down. 1985 only period when 60 bp decline did not coincide with recession.
  • Thinks dollar has peaked and will fall.
  • Investment grade bonds haven’t rallied.
  • Downgrade ratio for bonds increasing. When bonds are downgraded they don’t rally.  Pensions and Endowments will need to sell if not A or better rating.
  • Leveraged loans continue to fall.
  • Clock ticking on HY energy.
  • Incredible drop in EBITDA.
  • Crude Oil inventories are very high. One of biggest gaps between supply and demand ever.

Ok – you get the picture.  Not good.  Go grab a stiff drink.

Siegel – The Last Bull Standing


His thoughts on the economy:

  • Deflation is an issue and oil is our number 1 threat (price declining from $126 to $26).
  • There is $2 trillion in infrastructure tied to $56 per barrel oil.
  • 30% of capital expenditures spent over the last five years was directly or indirectly tied to oil.
  • The threat is the debt tied to those companies.
  • He believes this is all part of the Saudi goal for market share (SB here: I think it is that and more).
  • He believes that $60 per barrel is a level we can live with and will get back to over the next several years.
  • On China – “we should never put a manipulated currency in a reserve basket” (SB: then that would eliminate every currency on the planet).
  • On the economy and risk: “it is the deflationary wave that is our biggest problem.”

His thoughts on market returns:

  • We are entering a period of low returns for all asset classes.
  • 6½% is the long-term U.S. equity market cap weighted real return (after adjusting for inflation).
  • It is about 5½% for the balance of the world.
  • We are not today way out of line with valuations – high but not bubble high.
  • A 15x trailing 12-month PE is the average for the long-run. Roughly 17.9x today.  S&P 500 was 30x and the NASDAQ was 600x in March 2000.  No bubble in stocks now (SB: I agree).
  • Earnings yield is the best predictor of real stock market returns over the long run.
  • 2015 estimated earnings are $106.43. That is 6% less than 2014.  Oil was an $8 hit and the strong dollar a $5 hit.
  • A PE of 18x forecasts a real return of 5.6% for stocks. He emphasized that is 5% better than bonds.  Adding, we are on the high side of normal.
  • This was a nice reminder from the professor: He said the only time we saw PEs below 10 was when interest rates were in the double-digits.
  • He added: Economic growth and risk aversion are the most important determinants of real returns.

On interest rates:

  • Interest rates are low for fundamental reasons – not the Fed.
  • He sees real bond yields of 1% to 1.5% and short-term yields at zero.
  • The Fed is slowly waking up to the new neutral and added that the Fed is “basically on hold going forward.”

His conclusion:

  • When people see that they won’t get the yield they are hoping for in bonds they will move to stocks.

Stocks for the long-run.  True to form.  The last bull standing.

So Yes – The Oil Crash Looks a lot Like Sub-Prime

One of the presenters discussed the size of the default risk tied to oil and my immediate thought went back to size of the $2 trillion sub-prime crisis in 2008.  Mentioned was that the size of the exposure could wipe out Credit Suisse and Deutsche Bank.  Think in terms of counterparty risk exposure.  So it caught my eye when PJ Grzywacz, President of CMG, sent me the following note:

“One year ago, analysts at Bank of America Merrill Lynch drew a parallel between the subprime mortgage crash and the disorderly fall in the price of oil.”

Led by Chris Flanagan, a veteran of the securitization space, the team drew attention to Markit’s ABX Index, better known as the mother of all synthetic subprime credit indexes.

Created in January 2006 and consisting of a basket of credit default swaps (CDS) tied to the welfare of subprime mortgages, it allowed a bevy of investors to bet on the future direction of riskier home loans and helped inflate the massive amounts of leverage tied to the U.S. housing bubble. More recently it played a starring role in the film version of Michael Lewis’s The Big Short—when protagonists Christian Bale, Steve Carell, et al. are tracking their bets against the U.S. housing market, they are tracking the ABX.

Here’s what they say:

The pattern of the decline in the price of oil that began in mid-2014 is remarkably similar to the 2007-2009 pattern of the price decline of ABX, the credit derivative index that referenced subprime mortgages and, ultimately, the U.S. housing market (Chart 1). The ABX history suggests that oil will see more declines in the next couple of months and find a floor somewhere in the low 20s in the March-April time frame. Both the duration of the decline (1.5+ years) and the scale of the decline (100 neighborhood starting price down to the sub-30 neighborhood) are similar. Given that both housing and oil prices were fueled to spectacular heights in the two periods by massive credit expansion, it’s probably more than just coincidence that the respective “bubble” bursting patterns are so similar.

Consider how things tend to work. Denial on what constitutes fair value is a big component of bubbles, on the part of both market participants and policymakers. When perceived “bubbles” burst, markets take their time in steadily shredding views of the perception of fundamental value, as prices move lower and lower. Along the way, many will cite “technical factors” as the cause of the decline, which in some way suggests the price decline may not be real when in fact it is all too real. In the end, the technicals drive the fundamentals, as credit flees and borrowers go bust, and a feedback loop lower kicks in. Lower prices beget accelerated selling, as asset owners need to raise cash. It could be margin calls or it could be producer selling needs, it doesn’t really matter: the selling becomes inevitable and turns into forced selling.

The point here is not that oil is necessarily the new subprime per se but that the recent action in the price of crude resembles nothing if not the bursting of a bubble and the sudden realization that the asset has been overvalued for too long. More worrying for oil investors will be BofAML’s idea of forced selling. As Flanagan notes: “The systemic margin call of 2008 seems to be back for now, albeit to a far lesser degree.”


The point is the amount of leverage and the related risk exposures.  Someone is going to get caught off-sides.  Keep an eye on this developing story.

U.S. Recession Watch Charts

Equities are a leading indicator on the economy.  As for recession, we only know them in hindsight.  Our job is to know them in advance and I think we can.  The charts in this section tell us that it is probable we are at the start of a new recession.  Let’s look at the data closely.

Re – ces – sion / ri-?se-sh?n:

“a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.”

We won’t know until sometime in the third quarter of 2016 whether the first two quarters of this year show a fall in GDP.  Once that happens, the start date is retroactively determined.  We need to know before and not after, if we are to avoid the very large declines.  This is where the equity market can help us, for equities are a leading economic indicator.  Many investors don’t know this.

This data released today: Fourth-quarter 2015 GDP growth slows to 0.7%.

Note the up and down arrows in the next chart.  Up arrows mark periods when this process generated an economic expansion signal.  Down arrows show economic contraction.  The rules to the process are in green (upper section).

What is important is that the process is based strictly on the price movement of the S&P 500 index.  You can see in the chart that 79% of the signals, based on this process, dating back to 1950 were correct.  This is a process we should pay attention to.


I’ll share with you the January month-end chart, based on today’s close, next week.  However, we can take an early peek, and it is not looking too promising.  It is likely we will close the month with the S&P 500 Index more than 3.6% below its five-month smoothing (I’m finishing this piece around noon so we’ll have to see how the market closes today).

Ok – this chart gets a little busy but I shared it with my mother-in-law (a pretty savvy investor I must add) and I think she gets it.  Here is how you read it:

  • The chart starts on the left in 2001. The red boxes represent the periods in time the market was in a cyclical bear market decline.  Blue lines represent cyclical bull advances.
  • The green line is the five-month smoothed moving average line. At the very far right of the chart (dark blue arrow), I measured the percentage decline from five-month smoothing to yesterday’s close.
  • Through yesterday, January 28, the S&P is 5.6% below its smoothing. According to research from NDR (chart above), if we close the month more than 3.6% below the five-month smoothing, we are likely in a new recession.
  • A decline of 11.6% from the high of 2134.72, is nothing compared to a decline of 42% (my most recent data on average declines in recessions). Yusko cited the average decline in recession to be 48%.  I’ll see if I can get that data from him.
  • Recession has likely started. It is probable that we’ll look back in six to seven months and see that the start date to be February 1, 2015.  Stay defensive.


Montier – A Quote Too Good Not to Include

“[Central banks] have generated an enormous bull market in complacency, more than anything else. Everyone seems to think that the central banks are capable of underwriting everything, like the famous Greenspan-Bernanke-Yellen “put.” Nobody can take on too much risk because ultimately the Fed will bail them out. That seems to me to be a complacency that is really driven by overconfidence in central bank behavior…. When people get overconfident they tend to overestimate return and underestimate risk. That is a very dangerous combination of events. That has led us to a world where we face very expensive assets everywhere. In that kind of world, the one thing we do know is that it doesn’t take a lot to lead to a valuation reassessment. Markets are essentially very fragile constructs and they are therefore subject to tipping-point outcomes where you can go from one day, when everybody’s saying everything is fine, to the next day, when everybody wakes up and says, “Oh my God, it’s the end of the world.” The world unravels on the back of that.”  Source

Trade Signals – Sell/Hedge the Rallies, Investor Pessimism Remains Extreme

By Steve Blumenthal
Posted Wednesday January 27, 2015

Pessimism remains extreme with the Weekly Sentiment at the lowest (most bearish) reading since 2011.  That supports a short-term bullish move.  I remain in the “hedge or sell the rallies” camp.

Our Zweig Bond model moved to a sell signal, suggesting shorter-term Treasury securities over longer-term maturities.  High-yield model is back in a buy signal.

My favorite “weight of evidence” indicator is our CMG NDR Large Cap Momentum index.  I moved our large cap exposure to treasury bills via “BIL” on June 30, 2015 when the S&P 500 index was at 2063.  It remains in a sell signal today (chart here).

Thus, sell/hedge the rallies and overweight non-directionally dependent liquid alt funds.

Email me if you want to know what I like in this category.  Many are up nicely in January.

Included in this week’s Trade Signals:

Equity Trade Signals:

  • CMG NDR Large Cap Momentum Index:  Sell Signal – Bearish for Equities
  • Long-term Trend (13/34-Week EMA) on the S&P 500 Index:  Sell Signal — Bearish for Equities
  • Volume Demand is greater than Volume Supply:  Sell Signal – Bearish for Equities
  • NDR Big Mo: See note below (btw, this process triggered a sell signal in mid-January 2016).

Investor Sentiment Indicators:

  • NDR Crowd Sentiment Poll:  Extreme Pessimism (short-term Bullish for Equities)
  • Daily Trading Sentiment Composite:  Extreme Pessimism (short-term Bullish for Equities)

Fixed Income Trade Signals:

  • The Zweig Bond Model:  Sell Signal
  • High-Yield Model:  Buy Signal

Economic Indicators:

  • Don’t Fight the Tape or the Fed: Indicator Reading = 0 (Neutral for Equities)
  • Global Recession Watch Indicator – High Global Recession Risk
  • S. Recession Watch Indicator –Low U.S. Recession Risk (NOTE – I’ll update this post January month-end.  Likely now High U.S. Recession Risk)

Tactical All Asset Model:

  • Relative Strength Leadership Trends: Utilities, Fixed Income, Muni Bonds, Gold and Cash are showing the strongest relative strength:

Click here for the link to the full Trade Signals (updated charts and commentary).

Mauldin – Top 5 Challenges


The room was packed with 2000 of the major players in the ETF industry.  Silverware was chattering plates as John stepped to the stage.  He was uncharacteristically nervous and didn’t disappoint.  Within a few short minutes, the noise grew quiet – the crowd totally engaged.  John shared the following top five challenges he sees ahead:

  • Challenge #1: Reality will catch up with Politics. We are coming to the end of the ability of government to keep its promises.

I’ve lost count of the Democratic and Republican debates. The seeming common theme, with a few notable exceptions, is the unwillingness of the candidates to confront the coming wave of deficits and debt that will stem from increased entitlement spending across the world. By 2023, entitlement spending, military spending and interest will consume 100% of tax revenues. Which means either trillions of dollars of cuts or tax increases or out of control debt.

Our so-called representatives have happily raised the debt limit over and over again, while doing little to rein in runaway spending.

This can’t go on forever—and it won’t. Nor will it go on forever in other countries, some of which are even deeper in debt than the US.  There are no easy solutions that won’t disrupt your life.

  • Challenge #2: Governments will hit their credit limits.

When you run out of money, you have to stop spending. This common sense is lost on politicians everywhere. They will find out soon that the law of gravity applies everywhere. Their lenders will stop subsidizing fantasy economics.

We’ll see consequences around the globe. Japan is ahead of the curve, for once, and no longer even tries to borrow money. It goes through the motions of issuing bonds, but the Bank of Japan is the only buyer. And today Japan followed Europe with negative interest rates. Europe is headed even further in the same direction.

Negative interest rates are increasingly normal in Europe and now Japan. Can the US resist the trend? What will the Fed do when the next recession hits—and it most certainly will hit.

If we go from ZIRP to NIRP, what will it mean for your retirement savings and investment returns?

A quick commercial on Mauldin’s May 2016 Strategic Investment Conference.

John is putting together a panel that includes an elite team of economists, bond market experts and central bankers, including: Richard Fisher, former Dallas Fed President, Grant’s Interest Rate Observer editor James Grant, Top investment analyst David Rosenberg and two of the smartest economists anywhere, Dr. Lacy Hunt and Dr. Gary Shilling.

I’ll be attending.  You can learn more about the conference and register here.  The early bird rate expires on January 31.  CMG will be a sponsor at the conference.

  • Challenge #3: Geopolitics will drive the global agenda.

Geography is destiny. Nations and economies develop within the constraints of their environments… and the constraints are getting tighter.

Landlocked Russia, for instance, is increasingly insular as Vladimir Putin wrestles with collapsing oil revenue. Europe is trying to deal with millions of Mideast refugees. China is asserting itself in Asian waters.

Who will lead the world as the US looks inward? Will something better—or worse—fill the void?

  • Challenge #4: The Currency Wars will intensify.

In the Decade of Disruption, money is more than a medium of exchange. It is a weapon, often wielded by leaders who have little to lose. That makes them even more dangerous.

We are going to see more competitive currency moves, including sudden devaluations and massive interventions. Smaller countries will have little choice. The result will be worldwide volatility and a minefield for emerging market stock investors.

  • Challenge #5: Technology will disrupt everyone.

Are the robots coming for your job? No, they’re not coming—they’re already here.

A quick example: new technologies have boosted cancer research to lightspeed. I feel very confident in predicting most cancers will be either cured or easily manageable in the next decade. It will go from a top killer to a nuisance.

That’s great news, but what will it do to the pharmaceutical industry? We could easily see half a trillion dollars in market cap erased, in the blink of an eye. Is your portfolio ready for that? If you work in the healthcare industry, are you ready for a career change?

We’ll see similar revolutions in other industries, too. Technology is racing ahead faster than ever and changing our lives more than ever. A decade ago no one had an iPhone in their pocket. Now they are everywhere.

What will be common in 2025 that we can’t even imagine today? More important, how will technology change us and change our lives?

Personal note 

Risk is high and it remains time to play defense.  A better investment opportunity is in front of us.  Let’s just not get run over by an oncoming train on the way to that opportunity.

The Inside ETFs Conference was well worth the time.  The content was stimulating and the networking invaluable.  One of the areas I’ve been looking into is energy infrastructure MLPs.  I owe a great deal to my friend, John Ray, who along with Steven Mittel (one of the founders of Montgomery Securities) put me under their wings and helped me land a job at Merrill Lynch on an options arbitrage desk in 1984.  I had no idea what I was doing and they helped to guide me over the years.

A month or so ago, John called me and shared his thoughts on the markets.  Now retired, he was a portfolio manager at a major mutual fund company.  He told me I am missing the boat if I’m not looking at the infrastructure MLPs.  So when a friend at the conference suggested I walk over to one of the vendor booths, an MLP ETF offering, my ears perked up.  I’m going to do more research with John, but I sense opportunity.  It has been run over in the oil sell-off, yet most of the companies own the underground pipelines and, like turnpike authorities, simply collect tolls.  A buy when everyone else is selling opportunity? Maybe.  I’ll share the idea with you after I do a deep research dive.  Stay tuned.

Next are a few photos from the conference:

Mauldin just post his presentation.  A sense of relief.


Here I am responding to an audience question on gold.  It was a “gold bug” question to which I found some humor.  Had to be careful with that one.


Friends Carly Arison and Jiggs Davis from Syntax.


Today, I’m writing from Susan’s parents’ house in Venice, Florida.  The sun is finally breaking out and the plan is to go to the beach and convince Grandpa he needs a scooter.  A surprise stop to the scooter store is up next.  Wish us luck – he’s not going to be happy.

Susan and I are heading back home early tomorrow with plans to ski on Sunday with the boys.  Looking forward to getting home.  Wishing you the very best.

Have a wonderful weekend!


With kind regards,


Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Chairman, CEO and CIO. Steve authors a free weekly e-letter entitled, On My Radar. The letter is designed to bring clarity on the economy, interest rates, valuations and market trend and what that all means in regards to investment opportunities and portfolio positioning. Click here to receive his free weekly e-letter.

Social Media Links:

CMG is committed to setting a high standard for ETF strategists. And we’re passionate about educating advisors and investors about tactical investing. We launched CMG AdvisorCentral a year ago to share our knowledge of tactical investing and managing a successful advisory practice.

You can sign up for weekly updates to AdvisorCentral here.  If you’re looking for the CMG White Paper Understanding Tactical Investment Strategies, you can find that here.

AdvisorCentral is being updated with new educational resources we look forward to sharing with you. You can always connect with CMG on Twitter at @askcmg and follow our LinkedIn Showcase page devoted to tactical investing.

A Note on Investment Process:

From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years.  I find that reviewing various sentiment, trend and other historically valuable rules based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.

My objective is to position in line with the equity and fixed income market’s primary trends.  I believe risk management is paramount in a long-term investment process.  When to hedge, when to become more aggressive, etc.

Trade Signals History: Trade Signals started after a colleague asked me if I could share my thoughts (Trade Signals) with him.  A number of years ago, I found that putting pen to paper has really helped me in my investment management process and I hope that this research is of value to you in your investment process.

Provided are several links to learn more about the use of options:

For hedging, I favor a collared option approach (writing out-of-the-money covered calls and buying out-of-the-money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure.  Also, consider buying deep out-of-the-money put options for risk protection.

Please note the comments at the bottom of this Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.CBOE.com to learn more.  Hire an experienced advisor to help you. Never write naked option positions.  We do not offer options strategies at CMG.

Several other links:



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