Author Archive for Lance Roberts

5 Things Things Bulls Should Consider

By Lance Roberts, STA Wealth

This past week I wrote two articles discussing Shiller’s CAPE ratio (see here and here) and why valuations are still an important metric when it comes to making long term investments.  However, during the research process of writing that article I could not help but notice the extreme amount of optimism about the financial markets. Despite weak economic data and geopolitical intrigue the complacency and “bullishness” are at extreme levels.

My Californian money manager friend sent me the following note yesterday from Wolf Richter:

“And so we have a series of geniuses: Greenspan who said that the very concept of a national housing bubble in the US was impossible just as the national housing bubble was inflating to monstrous proportions; Bernanke who said that the consequences of sub-prime lending were ‘contained’ just as the consequences of subprime lending were eating up the banks from the inside out; and Yellen who now told us that complacency is nothing to worry about.

So we sally deeper into the Yellen era, which is the same as the Bernanke era, in that the Fed – and other central banks, for that matter – is the only thing worth looking at. Central banks rule. Practically nothing else matters. Metrics and ratios are just for decoration. Markets as a means of price discovery no longer exist.”

Wolf is correct, the markets have now come to believe that the Federal Reserve is the omnipotent controller of the financial markets.  Such beliefs have always ended badly. This is why I discussed one of the biggest traps that investors fall into during times like these“Confirmation Bias:”

“As human beings, we hate being told that we are wrong, so we tend to seek out sources that tell us we are ‘right.'”

 This week’s “Things To Ponder” is dedicated to things that “market bulls” should consider to keep from falling prey to the psychological biases that lead to poor investment returns over time.

1) Who Is Selling Stocks? by Sigmund via

“According to Reuters, 1st quarter share weighted earnings amounted to $258.8 billion. So companies in the S&P 500 spent 93% of their earnings on buybacks and dividends. It’s been all the rage in this cycle to look at “shareholder yield” which is a combination of buybacks and dividends, something I find too clever by half considering the past track record of management led buybacks. But if you think that is a useful metric, you have to ask yourself, is a 93% payout ratio sustainable? I guess we do have the answer to one question though. We know why capital spending has been so punk.”

2) BuyBacks Grow 50% YoY – Near Pre-Recession Highs via FactSet

Aggregate share buybacks for the S&P 500 grew 50% in Q1 to $154.2 billion, and amounted to the third largest quarterly total since 2005. The biggest contributor to the Q1 total was Apple’s record $18.6 billion in repurchases, but IBM also had an uncharacteristically active quarter with $8.3 billion in buybacks. In addition, five of the top ten companies by dollar-value buybacks in Q1 are traditionally not big spenders, and each spent more money on buybacks in Q1 than in any quarter in at least ten years.”


“But the increase in buybacks has outpaced cash inflows for the highest growth sectors. The Materials sector spent 195.5% of adjusted free cash flows on share repurchases in the trailing twelve months ending Q1. This compares to a median of 82.9%. In addition, the Information Technology and Industrials sectors are also significantly above their median (83.7% versus 68.7%, and 104.6% versus 79.4%).”

3) Volatility Is Disconnected From Fundamentals by JP Morgan via ZeroHedge

To further understand the current low volatility levels and compare it to the 2004-2007 time period, we looked at levels of market activity and structural drivers of volatility. Firstly, there is much less trading activity now as compared to the 2004-2007 time period. [The data] shows a nearly 50% decline of equity share volumes since 2007. Volume and volatility are highly correlated. Volatility and volumes are linked by a positive feedback loop (lower volumes lead to lower volatility and vice versa).

In summary, we see the current market environment as different from 2004-2007. Volatility appears to be too low and disconnected from fundamentals.However, the low yield environment and support from central banks is currently keeping volatility low not just in equities but across asset classes.

Additionally, equity volatility has been held down by low trading activity and option hedging pressure. As we will discuss below, some of the option-related pressure on volatility will abate after the June expiry, which could result in higher realized volatility.


READ ALSO:  It’s Not The VIX That’s Vexing The Market by Michael Kahn via Barron’s

“I won’t debate whether indicators measuring investor sentiment are different from those measuring professional sentiment. But from what I see in many sentiment gauges, the weight of the evidence leans toward the market being too sanguine for its own good right now.

Jason Goepfert, who runs the Website, offered a third view, saying that the low levels of volatility expectations across asset classes have forced traders to make bolder bets.

It is the same concept. Traders and investors are taking risks without worrying about the consequences. That should be a warning for everyone.”

4) Food Stamp Usage Is Cratering by Cullen Roche via Pragmatic Capitalist

The rate of participation in the food stamps program has now declined on a year over year basis for six straight months. And the cost of benefits has declined at a near double-digit pace for each of the last 5 months.  After reaching peak participation of 47.6 million last August the number of participants has declined to 46.1 million.

This might seem like good news, but it’s more likely a sign of a late cycle recovery trend.  You see, food stamps are a countercyclical event.  They’re part of what economists refer to as ‘automatic stabilizers’.  That is, when corporations fire employees they often sign up for government benefits so they can try to make ends meet while they look for work.  And those benefits are most in demand when the economy is at its worst.  So programs like food stamps ‘automatically’ kick into high gear when the economy goes into recession.  You can see this clearly in the following chart:”



“The fact that this trend is now sharply improving means that the economy is on the mend.  But it also means that the economy is late in the cycle of expansion.  And so what looks like a positive trend could actually be a sign of something negative developing.”

5) Does The Fed Really Know What Time It Is? by Vince Foster via MinyanVille

“Fed officials keep talking about when they will raise rates, and media focus is on whether it will be sooner than the market expects. More significant questions are not being discussed.

JPMorgan CFO Marianne Lake outlined the exit process the bank was preparing for, raising some risk management hurdles…

‘In terms of sequencing, what we expect is that the Fed will seize asset purchases by the end of this year. The likely next step would be to drain liquidity from the systems, potentially as much as $1 trillion or so using the reverse repo facility with non-banks. This is likely to happen over a short period of time, maybe a quarter or two and probably in the second or maybe in the second-half of 2015. After which the Fed funds rate will start to raise and lastly reinvestment in order to shrink the remaining balance sheet, but over time.

The second important assumption we’re making is that as rates continue to normalize over time, we’re all likely to also see a migration of stickier high quality retail deposits in favor of more attractive rates in money funds. We think ultimately those deposits will likely find their way back to bank balance sheet in the form of wholesale deposits, which of course is very important particularly in light of regulatory liquidity standards, when notably, if you take a retail deposit that has a low outflow assumptions and ultimately replaced with a wholesale deposit that has a high outflow assumption, it could substantially reduce your liquidity…”

Think about that last bit for a minute.  The Federal Reserve will drain liquidity from the system at the same time they begin to raise the overnight lending rateswhile looking for rates “normalize” at higher levels.  Considering that the markets have been primarily advancing on the back of continued flows of liquidity from the Federal Reserve combined with artificially suppressed interest rates; what do you think the impact on the financial markets will be?  The chart below shows the history of the Fed’s ability to control the economy.



 “Success breeds complacency. Complacency breeds failure. Only the paranoid survive.”  –  Andy Grove

Shiller’s CAPE – Is It Really Just B.S.?

By Lance Roberts, CEO, STA Wealth

In late stage bull market cycles, the inevitable bashing of long term valuation metrics comes to full fruition. In the late 90’s if you were buying shares of Berkshire Hathaway stock it was mocked as “driving Dad’s old Pontiac.”  In 2007, valuation metrics were being dismissed because the markets were flush with liquidity and interest rates were low.  Today, we once again see repeated arguments as to why “this time is different.”

There has been an ongoing debate about Dr. Robert Shiller’s Cyclically Adjusted Price Earnings (CAPE) ratio and its current validity. Critics argue that the earnings component of CAPE is just too low, changes to accounting rules have suppressed earnings, and the financial crisis changed everything.  The latest was by Wade Slome:

“If something sounds like BS, looks like BS, and smells like BS, there’s a good chance you’re probably eyeball-deep in BS. In the investment world, I encounter a lot of very intelligent analysis, but at the same time I also continually step into piles of investment BS. One of those piles of BS I repeatedly step into is the CAPE ratio (Cyclically Adjusted Price-to-Earnings) created by Robert Shiller.”

Let’s break down Wade’s arguments against Dr. Shiller’s CAPE P/E individually.

Shiller’s Ratio Is Useless?

Wade states:

“The short answer…not very. For example, if investors followed the implicit recommendation of the CAPE for the periods when Shiller’s model showed stocks as expensive they would have missed a more than quintupling (+469% ex-dividends) in the S&P 500 index. Over a shorter timeframe (2009 – 2014) the S&P 500 is up +114% ex-dividends (+190% since March 2009).”

Wade’s analysis is correct.  However, the problem is that valuation models are not, and were never meant to be, “market timing indicators.”  The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level it means that:

  1. The market is about to crash, and;
  2. Investors should be in 100% cash.

This is incorrect. Valuation measures are simply just that – a measure of current valuation. If you “overpay” for something today, the future net return will be lower than if you had paid a discount for it.  Think about housing prices for a moment as shown in the chart below.


There are two things to take away from the chart above in relation to valuation models.  The first is that if a home was purchased at any time (and not sold) when the average 12-month price was above the long term linear trend, the forward annualized returns were significantly worse than if the home was purchased below that trend. Secondly, if a home was purchased near the peak in valuations, forward returns are likely to be extremely low, if not negative, for a very long time.

This is the same with the financial markets. When investors “pay” too much for an investment, future returns will suffer. “Buy cheap and sell dear” is not just some Wall Street slogan printed on a coffee mug, but a reality of virtually all of the great investors in our time in some form or another.

Cliff Asness discussed this issue in particular stating:

“Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations.”


Asness continues:

“It [Shiller's CAPE] has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view the critics have not provided a good reason this time around — I think you are making a mistake.”

While, Wade is correct that investors who got out of the market using Shiller’s P/E ratio would have missed the run in the markets from 2009 to present, those same individuals most likely sold at the bottom of the market in 2008 and only recently began to return as shown by net equity inflows below. In other words, they missed the “run” anyway. As I discussed yesterday, investor psychology has more to do with long term investment outcomes than just about anything else.


Peaches for $.25 Post-Bubble?

Wade’s second argument is also important which discusses the price of peaches falling to $.25 per pound where he concludes:

“This complete neglect of current market prices in the calculation of CAPE makes absolutely no sense, but this same dynamic of ignoring current pricing reality is happening today in the stock market. Effectively what’s occurring is the higher P/E ratios experienced over the last 10 years are distorting the Shiller CAPE ratio, thereby masking the true current value of stocks. In other words the current CAPE of 26x vastly exaggerates the pricey-ness of the actual S&P 500 P/E ratio of 16x for 2014 and 14x for 2015.”

Let’s break that statement down into its two basic arguments:  1) Higher P/E ratios over the last 10 years are distorting CAPE, and: 2) the problem with forward P/E ratios.

First, it is true that P/E’s have been higher over the last decade due to the aberration in prices versus earnings leading up to the 2000 peak.  However, as shown in the chart below, the “reversion” process of that excessive overvaluation is still underway.


Clff Asness directly addressed this concern:

“Some outright hucksters still use the trick of comparing current P/E’s based on ‘forecast’ ‘operating’ earnings with historical average P/E’s based on total trailing earnings. In addition, some critics say you can’t compare today to the past because accounting standards have changed, and the long-term past contains things like World Wars and Depressions. While I don’t buy it, this argument applies equally to the one-year P/E which many are still somehow willing to use. Also it’s ironic that the chief argument of the critics, their big gun that I address exhaustively above [from the earlier post], is that the last 10 years are just too disastrous to be meaningful (recall they are actually mildly above average).”

Secondly, I specifically addressed this issue of forward P/E’s recently in “The Problem With Forward P/E’s:”

“As a reminder, it is important to remember that when discussing valuations, particularly regarding historic over/under valuation, it is ALWAYS based on trailing REPORTED earnings.  This is what is actually sitting on the bottom line of corporate income statements versus operating earnings, which is “what I would have earned if XYZ hadn’t happened.”  

Beginning in the late 90’s, as the Wall Street casino opened its doors to the mass retail public, use of forward operating earning estimates to justify extremely overvalued markets came into vogue.  However, the problem with forward operating earning estimates is that they are historically wrong by an average of 33%.”

The consistent error rate in forward earnings projections makes using such data dangerous when making long term investments. This is why trailing reported earnings is the only “honest” way to approach valuing financial markets. Importantly, long term investors should be abundantly aware of what the future expected returns will be when buying into overvalued markets. Bill Hester recently wrote a very good note in this regard in response to critics of Shiller’s CAPE ratio and future annualized returns:

“More recently the ratio has undergone an attack from some widely-followed analysts, questioning its validity and offering up attempts to adjust the ratio. This may be a reaction to its new-found notoriety, but more likely it’s because the CAPE is suggesting that US stocks are significantly overvalued.  All of the adjustments analysts have made so far imply that stocks are less overvalued than the traditional CAPE would suggest.”

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns. But we decided to come to the aid of the CAPE ratio in this case because a few errors have slipped into the debate, and it’s important for investors who have previously relied on this ratio to understand these errors so they can judge the valuation metric fairly.  Importantly, the primary error that is being made is not even the fault of those making the arguments against the CAPE ratio. The fault lies at the feet of a misleading data series.


As clearly stated thoughout this missive, fundamental valuation metrics are not, and were never meant to be, market timing indicators. This was a point made by Dr. Robert Shiller himself in an interview with Henry Blodgett:

“John Campbell, who’s now a professor at Harvard, and I presented our findings first to the Federal Reserve Board in 1996, and we had a regression, showing how the P/E ratio predicts returns. And we had scatter diagrams, showing 10-year subsequent returns against the CAPE, what we call the cyclically adjusted price earnings ratio. And that had a pretty good fit. So I think the bottom line that we were giving – and maybe we didn’t stress or emphasize it enough – was that it’s continual. It’s not a timing mechanism, it doesn’t tell you – and I had the same mistake in my mind, to some extent — wait until it goes all the way down to a P/E of 7, or something.”

Currently, there is clear evidence that future expectations should be significantly lower than the long term historical averages. Does the current valuation levels mean that you should be all in cash? No. However, it does suggest that a more cautious stance to equity allocations and increased risk management will likely offset much of the next“reversion” when it occurs.

While I disagree with Wade’s assessment, it does not mean that I do not value his opinion. My job is to protect investment capital from major market reversions and meet investment returns anchored to retirement planning projections. Not paying attention to rising investment risks, or adjusting for lower expected future returns, are detrimental to both of those objectives.

Tomorrow, I will introduce a modified version of the Shiller CAPE ratio that is currently flashing a very important warning sign that you should be paying attention too.

Yield Spreads & Market Reversions

By Lance Roberts. STA Wealth

Over the last few days, I have been discussing the very wide deviations in price from long term moving averages and other signs of bullish excess.  As of late, even the“bullishly biased” mainstream media has begun to at least question the eerie calm that has overcome the financial markets as volume and volatility have all but disappeared.

I found it very interesting that several market commentators all made similar statements when asked about the “market calm.” 

“Where else are investors going to go to get yield.”

The “chase for yield” was the desired result by the Federal Reserve when they dropped rates to record lows and announced, in 2010, that supporting asset prices to boost consumer confidence had become a “third mandate.” However, they may have gotten more than they bargained for as several Fed officials have now voiced concerns over potential financial instability.  To wit:

Fed’s Kocherlakota Urges 5 More Years Of Low Interest Rates via Reuters

Kocherlakota acknowledged that keeping rates low for so long can lead to conditions that signal financial instability, including high asset prices, volatile returns on assets, and frantic levels of merger activity as businesses and individuals strive to take advantage of low interest rates.

But that is a risk, he suggested, the Fed should be willing to take.

Fed’s Williams Says Central Banks Need To Realize Investor’s Aren’t Rational via The Wall Street Journal

“In a world of rational expectations, asset prices adjust and that’s it, but if one allows for limited information, the resulting bull market may cause investors to get ‘carried away’ over time and confuse what is a one-time, perhaps transitory, shift in fundamentals for a new paradigm of rising asset prices.

This “exuberance” can be clearly seen in bond yields. In normal times, the interest rate paid on a loan is driven by the potential for a default on repayment of the principal. For example, a person with a credit score of 500 is going to pay a substantially higher interest rate on a loan than an individual with a 700+ credit score. The “risk” of a potential repayment default is offset to some degree by a higher interest rate.  If a loan of $100,000 is made with an interest rate of 10% for 30 years, the principal is recouped after the first 10 years.  The real risk is that the loan defaults within the first 1/3 of its term.

Currently, investors are assigning only 1/2% difference in interest rates between loaning money to a highly credit worthy borrower and one that is only marginally so.  This is shown in the chart below which is the spread between AAA and BAA rated bonds from 1919-present.


There have been precious few times in history that the spread between interest rates have been so low. Importantly, extremely low yield spreads are not a precursor to an extended economic recovery but rather a sign of a mature economic cycle.

The Federal Reserve officials have very good reason to be concerned about the potential for “financial instability” as extremely low thin yield spreads have also been indicative of both minor and major financial market corrections and crashes.


I have zoomed into the chart above to show just 1960-present in order to provide a bit more clarity.


What investors need to be watching for is a “widening” of the spread between yields. The decline in the yield spread shows the rise of investor “complacency.” However, the“lack of fear” is a late-cycle development and not one seen at the beginning of economic upswings. Importantly, when the yield spread begins to rise, it tends to do so rapidly leading to a reversion in asset prices.

Currently, the ongoing “chase for yield” has led investors to take on much more “credit risk” in portfolios than they most likely realize. When “fear” is introduced into the financial markets, the subsequent “instability” will lead to far greater losses than most individuals are prepared for.

The chart below is a comparison between “junk bond” yields, the least credit worth borrowers, versus the S&P 500.



Currently, loans are being made to the highest risk borrowers at an effective interest rate of just 5% as compared to the “risk free” rate of 2.6% for a 10-year Government bond.

We have seen this exuberance before.  In 1999, the old valuation metrics no longer mattered as it was “clicks per page.”  In 2007, there was NO concern over subprime mortgages as the housing boom fostered a new era of financial stability.  Today, it is the Federal Reserve “put” which is unanimously believed to be the backstop to any potential shock that may occur.

I always have to qualify these missives by stating that my portfolios are still biased to the long side of the markets. When I discuss rising risks in the markets, which is what leads to catastrophic and irreversible destruction of capital, it is always assumed that I am sitting in cash.  This is not the case. I must remain invested while markets are rising or suffer career risk, however knowing when to “fold’em” is what makes the difference to long term investment returns.

However, having qualified my position, it is important to understand that it is not the DECLINE in interest rates and yield spread that is important, but it is the REVERSAL that must be watched for.  I point out these issues of risk only to make you aware of them as the always bullishly biased media tends to ignore “risks” until it is far too late to matter. It is likely that it will be no different this time.

“Once more unto the breach, dear friends, once more” – William Shakespeare

Is This The Mania Phase of the Bull Market?

By Lance Roberts, STA Wealth

During the course of the past two months, I have been regularly discussing the market consolidation that began in early February.  (Here for latest and archives) In that weekly analysis, I posted the following chart which showed the two most probable outcomes of the current consolidation process.



The breakout above 1900 yesterday brings into focus the potential for a continuation of the current bull market cycle.  However, with the market very overbought in both the short and intermediate term, it is unclear how far the advance will go considering the drag from reduced liquidity inflows by the Federal Reserve.  This concern is not unfounded as we have seen this particular set up (overbought conditions with reduced liquidity) previously in 2011 as QE 2 came to its conclusion.


I am NOT suggesting that the current market cycle will exactly replicate the 2011 experience as there have been enough market period chart comparisons as of late. However, what I am suggesting is that a similar “set up” had a negative consequence and the current market cycle should not be taken for granted. Markets don’t repeat, but they do rhyme quite often.

With the current bull market now stretching into its sixth year; it seems appropriate to review the three very distinct phases of historical bull market cycles.

Phase 1) “What bull market? The fall is right around the corner”

Following a massive, mean reverting, correction – markets tend to bottom and begin an initial recovery. Most individuals have been crushed by the previous market decline and only recently “panicked sold” into cash.

There are many signs during the initial phase that a new bullish uptrend has started.  Money flows from defensive names in order to chase higher yield, market breadth is improving, and volatility declines substantially.

However, despite those indications, many individuals do not believe that the rally is real.  They use the rally to sell into cash and angrily leave the markets or continue to stay in cash expecting another failure.

Note: The fastest price appreciation in the market happens during the first and third stages of the bull market.

2) Acceptance stage

During the second phase individuals gradually warm up to the idea that the markets have indeed bottomed the psychology changes to one of acceptance.  At this point, the market is generally considered “innocent until proven guilty.“

The overall psychology remains very cautionary during this second phase.  Investors react very negatively any short term market correction believing the bull market just ended.  They continue to remain underweight equities and overweight defensive positions and cash.

During the second phase stocks continue to climb higher and market corrections are short-lived.  It is between second and third phases that a deeper market pullback occurs.  This pullback tests the resilience of the rally, shakes weak hands out of the market, and allows for new bases to be formed.  This deeper pullback is used as a buying opportunity by institutions, which missed the initial stages of the rally, and their buying continues to push the markets to new highs.

3) Everything will go up forever

During the first phase, most individuals remain skeptical of a market that has just gone through a high-correlation, mean-reverting correction.  It is at this point that most investors are unwilling to see the positive change in market dynamics.

In phase two, however, investors gradually turn bullish for the simple reason that prices have been steadily rising for some time. Analysts and strategists are also turning universally “bullish” in an attempt to manage their career risk and attract investor dollars.

In the final phase of the bull market, market participants become ecstatic.  This euphoria is driven by continually rising prices and a belief that the markets have become a “no risk opportunity.”  Fundamental arguments are generally dismissed as “this time is different.”  The media chastises anyone who contradicts the bullish view, bad news is ignored, and everything seems easy. The future looks “rosy” and complacency takes over proper due diligence.  During the third phase, there is a near complete rotation out of “safety” and into “risk.”  Previously cautious investors dump conservative advice, and holdings, for last year’s hot “hand”  and picks.

The chart below shows these three phases of the bull market over the past three market cycles.


Note:  I have highlighted with blue vertical lines the deviation between current prices and the linear trend of the index. The current extreme price divergence is not indefinitely sustainable.

While the current bull market remains “bulletproof” at the moment to geopolitical events, technical deterioration, overbought conditions and extremely complacent conditions; it is worth remembering what was being said during the third phase of the previous two bull markets:

  • Low inflation supports higher valuations
  • Valuation based on forward estimates shows stocks are cheap.
  • Low interest rates suggest that stocks can go higher.
  • Nothing can stop this market from going higher.
  • There is no risk of a recession on the horizon.
  • Markets always climb a wall of worry.
  • “This time is different than last time.”
  • This market is not anything like (name your previous correction year.)

Well, you get the idea.

Are we in the third phase of a bull market?  Most who read this article will immediately say “no.”  But isn’t that what was always believed during the “mania” phase of every previous bull market cycle?


Survey Explains Why Investors Remain “Side Lined”

By Lance Roberts. STA Wealth

Each quarter I run a survey of investor attitudes, allocations and economic expectations to get a sense of actual “investor” behavior. In the financial markets it is easy to become“detached” from reality and assume that “everyone” is acting in a similar manner. The survey shows that this is far from being the case. What was not surprising was the makeup of survey participants.

I have often stated that the average investor has about 15 years to save for retirement. This is due to ability much more than desire. During the younger years of life there is little ability to save as wage scales tend to be lower as marriage, family and debt consume most of their income. As shown by the survey the majority of individuals are between the ages of 46-65. Furthermore, as would be expected, the majority of investors surveyed also have higher levels of education which tends to lead to higher incomes later in life.


Of course, when it comes to “saving for retirement” the most important question is whether an individual is saving enough? The survey shows that roughly half of those surveyed “think” they are saving enough for retirement with on 15% feeling as though they have more than enough.


However, much of the current “confidence” in savings has been the result of a surging stock market over the last few years. It is highly likely that when the next mean reverting event occurs that confidence will shift rather markedly.

The reason I suggest that will be the case is because of “where” the majority of investors are receiving their investment advice. As shown in the chart below the majority of investment “advice” is coming from newsletters and the internet.


This too is not surprising given the surge in the markets which tends to make individuals believe that they are “smarter than the average bear.” Success breeds overconfidence in the markets which has a long history of poor outcomes.

One interesting sidenote is that television only made up 2% of the vote which confirms the plunge in ratings that CNBC has experienced in recent years.

Not So Forgetfull

It has often been stated by the media and Wall Street analysts that the current “bull market” cycle is “the most hated in history.” The survey shows that this may indeed be the case as two nasty bear markets over the last 13 years have left an indelible stain on individuals memories and retirement accounts.

When asked what is most important to them the survey showed that, by a wide margin, the majority are more focused on loss avoidance rather than chasing stock market returns.


That mentality is reflected in their asset allocation models with the roughly on 44% invested in stocks and 48% in bonds and cash.


While the media and Wall Street chants that the markets have hit new nominal highs, the reality is far different for individuals who panic sold near the last market bottom and are only now wading back into the markets again. The loss of capital, due to both declines and inflation, combined with the loss of “available time” to save for retirement has crippled investor psychology on many levels.

The problem is that investors today have “seen this film” before and are fairly confident in how it ends.  When asked about stocks the vast majority believe that stocks are current overvalued.


Conversely, most investors see bonds as part of their long term investment strategy to protect capital and create income.


It is interesting that most mainstream analysis is confused as to why individuals remain cautious despite the surge in asset prices. However, in addition to the massive beatings that investors took over the last decade, much of their caution is likely rooted in the massive divergence between Main Street and Wall Street.

“It’s The Economy, Stupid”

Following the very weak economic performance in the first quarter of the year, most economists blamed the weakness on “cold weather.” However, since we often experience “cold weather” during the winter, it is likely that the economic drag was more deeply rooted in consumer outlooks.  When asked about their outlook for the second quarter of this year the response was decidedly negative with over 80% expecting the economy to perform the same or worse.


What has not been lost on individuals is that the Federal Reserve’s monetary interventions have done little to improve the quality of their lives but have vastly benefitted Wall Street.  This is why despite wanting her to focus on improving economic growth, they also want her to continue tapering the current Q.E. program.

Not Surprised

If you have been paying attention at all, what is happening in the world outside of “Wall Street” leaves little surprise in these survey results. For most, the recovery of wealth over the last few years has certainly made many individuals feel more secure about their current financial position. However, they also realize that they have only recovered most of what they lost and are unwilling, and many unable, to live through such an event again.

With the majority of individuals surveyed facing retirement in the very near future, the need to conserve principal has overtaken the desire to accumulate wealth.

As I have continually reminded you, the “real economy” is far different from the“statistical economy” as reported in government data. While the costs of living continue to increase incomes have remained stagnant. With 1-3 Americans on some sort of government assistance, and nearly as many sitting outside the labor force, it is really on a handful of individuals that are actually invested in the financial markets to begin with.

As I stated recently in “Expect Low Returns:”

“Despite the media’s commentary that “if an investor had ‘bought’ the bottom of the market…” the reality is that few, if any, actually did.  The biggest drag on investor performance over time is allowing ‘emotions’ to dictate investment decisions.  This is shown in the 2013 Dalbar Investor Study which showed ‘psychological factors’ accounted for between 45-55% of underperformance.  From the study:

‘Analysis of investor fund flows compared to market performance further supports the argument that investors are unsuccessful at timing the market. Market upswings rarely coincide with mutual fund inflows while market downturns do not coincide with mutual fund outflows.’

In other words, investors consistently bought the ‘tops’ and sold the ‘bottoms.’  The other two primary reasons of underperformance from the study related to a lack of capital to invest.  This is also not surprising given the current economic environment.”

While many dismiss the impact of the “baby boomer” generation moving into retirement, the reality is likely to be far different. If the current survey is representative of that particular group, the drag on the financial markets and economy over the next decade could be quite substantial.

Historical Market Comparisons Are Meaningless

By Lance Roberts, STA Wealth

As Chief Strategist for STA Wealth Management I start each and every day by consuming copious amounts of a heavily caffeinated beverage and a data feed from a litany of web and blog sites. Over the last couple of days in particular, they have been numerous articles on whether the market is currently in a bubble.   Here are a few as an example that I just grabbed from

Is This a Bubble Market? There’s One Way to Tell

Is Financial Media Warding Off Stock ‘Bubble’?

The Upside of Speculative Market ‘Bubbles’

Yellen: Bubbles? What Bubbles?

Well, you get the idea. First of all, bubbles only occur when no one is looking for them. Bubbles form when greed runs rampant and there is a mass hypnotic state that the current ride will never end. The shear fact that multitudes of articles are being written about “market bubbles” is a sign that we are likely not there, yet. (Read: Too Much Bubble Talk)

However, as a shot of caffeine hits my brain, I read with interest a recent piece on Bloomberg entitled 5 Reasons We’re Not In a 2000 Bubble Redux.” which I have summarized for you:

1) Volume of IPO’s is less than half of the first quarter of 2000

2) First-day returns of IPO’s are just 1/5th of the first 1st quarter of 2000.

3) Speculative companies carried a 43% higher valuation to dividend paying companies in 2000 versus just 26% today.

4) Cash derived from equity issuance was 20% in 2000 versus just 11% today.

5) Share turnover in 2000 was an annualized 89% rate versus 58% today.

While these are certainly some interesting arguments, the comparison between now and the turn of the century peak is virtually meaningless. Why? Because no two major market peaks (speculative bubble or otherwise) have ever been the same. Let me explain.

In late October of 2007, I gave a seminar to about 300 investors discussing why I believed that we were rapidly approaching the end of the bull market and that 2008 would likely be bad, really bad. Part of that discussion focused on market bubbles and what caused them.  The following two slides are from that presentation:

001-Is-This-Time-Different 001-All-Bubbles-Revolved-Around-Something


Every major market peak, and subsequent devastating mean reverting correction, has ever been the result of the exact ingredients seen previously. Only the ignorance of its existence has been a common theme.

As I discussed yesterday, the reason that investors ALWAYS fail to recognize the major turning points in the markets is because they allow emotional “greed” to keep them looking backward rather than forward.

Of course, the media foster’s much of this “willful” blindness by dismissing, and chastising, opposing views generally until it is too late for their acknowledgement to be of any real use.

The next chart shows every major bubble and bust in the U.S. financial markets since 1871 (Source: Robert Shiller)



At the peak of each one of these markets, there was no one claiming that a crash was imminent. It was always the contrary with market pundits waging war against those nagging naysayers of the bullish mantra. Yet, in the end, it was something that was unexpected, unknown or simply dismissed that yanked the proverbial rug from beneath investors.

What will spark the next mean reverting event? No one knows for sure but the catalysts are present from:

  • Excess leverage,
  • IPO’s of negligible companies,
  • Companies using cheap debt to complete stock buybacks and pay dividends, or
  • High levels of investor complacency.

Either individually, or in combination, these issues are all inert. Much like pouring gasoline on a pile of wood, the fire will not start without a proper catalyst. What we do know is that an event WILL occur, it is only a function of “when.” 

The discussion of why “this time is not like the last time” is largely irrelevant. Whatever gains that investors garner in the between now and the next correction by chasing the“bullish thesis” will be wiped away in a swift and brutal downdraft. Of course, this is the sad history of individual investors in the financial markets as they are always “told to buy” but never “when to sell.”

For now, the “bullish case” remains alive and well. The media will go on berating those heretics who dare to point out the risks that prevail. However, the one simple truth is“this time is indeed different.”  When the crash ultimately comes the reasons will be different than they were in the past – only the outcome will remain same.

No One Will Ring The Bell At The Top

By Lance Roberts, STA Wealth

The market has had a rough start of the year flipping between positive and negative year-to-date returns. However, despite all of the recent turmoil from an emerging markets scare, concerns over how soon the Fed will start to hike interest rates and signs of deterioration in the underlying technical foundations of the market, investors remain extremely optimistic about their investments. It is, of course, at these times that investors should start to become more cautious about the risk they undertake. Unfortunately, the“greed factor,” combined with the ever bullish Wall Street “buy and hold so I can charge you a fee” advice, often deafens the voice of common sense.

One of my favorite quotes of all time is from Howard Marks who stated:

“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That’s why it’s essential to remember that ‘being too far ahead of your time is indistinguishable from being wrong.’)

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”

That quote is truest at extremes as markets can remain “irrational” far longer than would otherwise seem logical. This is particularly the case when, despite clear signs of overvaluation and excess, central banks worldwide are dumping liquidity into economies in a desperate attempt to “resolve a debt bubble with more debt.”

It is interesting that when you ask most people if they would bet heavily on a “pair of deuces” in a game of poker, they will quickly tell you “no.” When asked why, they clearly understand that the “risk to reward” ratio is clearly not in their favor. However, when it comes to the investing the greater the risk of loss, the more they want to invest. It is a curious thing particularly when considering that the bets in poker are miniscule as compared to an individual’s “life savings” in the investment game.

However, that is where we clearly find ourselves today. There was never a clearer sign of excessive bullish optimism than what is currently found within the levels of margin debt. Even as the markets sold off sharply in February, investors sharply levered up portfolios and increasing overall portfolio risk.

MarginDebt-NetCredit-040814-2Even professional investors, who are supposed to be the “smart money,” are currently at the highest levels of bullishness seen since 1990.  (The chart below is the 4-month moving average of the net-difference between bullish and bearish sentiment.)


Franklin Roosevelt, during his first inaugural address, made one of his most famous statements:

“So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself…”

However, when it comes to the stock market it is the “lack of fear” that we should be most fearful of.  Throughout human history, the emotions of “fear” and “greed” have influenced market dynamics.  From soaring bull markets to crashing bear markets, tulip bubbles to the South Sea, railroads to technology; the emotions of greed, fear, panic, hope and despair have remained a constant driver of investor behavior.  The chart below, which I have discussed previously, shows the investor psychology cycle overlaid against the S&P 500 and the 3-month average of net equity fund inflows by investors. The longer that an advance occurs in the market, the more complacent that investors tend to become.

Investor-Psychology-Cycle-040814Complacency is like a “warm blanket on a freezing day.”  No matter how badly you want something, you are likely to defer action because it will require leaving the “cozy comfort” the blanket affords you. When it comes to the markets, that complacency can be detrimental to your long term financial health. The chart below shows the 6-month average of the volatility index (VIX) which represents the level of “fear” by investors of a potential market correction.


The current levels of investor complacency are more usually associated with late stage bull markets rather than the beginning of new ones. Of course, if you think about it, this only makes sense if you refer back to the investor psychology chart above.

The point here is simple. The combined levels of bullish optimism, lack of concern about a possible market correction (don’t worry the Fed has the markets back), and rising levels of leverage in markets provide the “ingredients” for a more severe market correction. However,  it is important to understand that these ingredients by themselves are inert. It is because they are inert that they are quickly dismissed under the guise that“this time is different.”

Like a thermite reaction, when these relatively inert ingredients are ignited by a catalyst they will burn extremely hot. Unfortunately, there is no way to know exactly what that catalyst will be or when it will occur. The problem for individuals is that they are trapped by the combustion an unable to extract themselves in time.

I recently wrote an article entitled “OMG! Not Another Comparison Chart” because there have been too many of these types of charts lately. The reason I make that distinction is that the next chart is NOT a comparison for the purposes of stating this market is like a previous one. Rather, it is an analysis of what a market topping pattern looks like.


As you can see, during the initial phases of a topping process complacency as shown by the 3-month volatility index at the bottom remains low. As the markets rise, investor confidence builds leading to a “willful” blindness of the inherent risks. This confidence remains during the topping process which can take months to complete. With individuals focused on the extremely short term market movements (the tree) they miss the fact that the forest is on fire around them. However, as shown, by the time investors realize the markets have broken it is generally too late.

As Seth Klarman recently wrote:

“The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.

But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.

Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

It is in that statement that we find the unfortunate truth. Individuals are once again told that this time will be different. Anyone who dares speak against the clergy of bullishness is immediately chastised for heresy. Yet, in the end, no one will ring the bell at the top and ask everyone to please exit the building in an orderly fashion. Rather, it will be a “Constanza moment as the adults (professionals) trample the children (retail) to flee the building in a moment of panic.

It is only then that anyone will ask the question of “why?”  Why didn’t anyone warn me? Why did this happen? Why didn’t we see it coming? Why didn’t someone do something about it?




The Problem With Forward P/E’s

By Lance Roberts, STA Wealth

In a recent note by Jeff Saut at Raymond James, he noted that valuations are cheap based on forward earnings estimates.  He is what he says:

“That said, valuations are not particularly onerous with the P/E ratio for the S&P 500 (SPX/1841.13) currently trading around 15.2x this year’s bottom-up estimate of roughly $121 per share. Moreover, if next year’s estimates are anywhere near the mark of $137, the SPX is being valued at a mere 13.4x earnings.”

As a reminder, it is important to remember that when discussing valuations, particularly regarding historic over/under valuation, it is ALWAYS based on trailing REPORTED earnings.  This is what is actually sitting on the bottom line of corporate income statements versus operating earnings, which is “what I would have earned if XYZ hadn’t happened.” 

Beginning in the late 90’s, as the Wall Street casino opened its doors to the mass retail public, use of forward operating earning estimates to justify extremely overvalued markets came into vogue.  However, the problem with forward operating earning estimates is that they are historically wrong by an average of 33%.  The chart below, courtesy of Ed Yardeni, shows this clearly.



Let me give you a real time example of what I mean.  At the beginning of the year, the value of the S&P 500 was roughly 1850, which is about where at the end of last week.  In January, forward operating earnings for 2014 was expected to be $121.45 per share.  This gave the S&P 500 a P/FE (forward earnings) ratio of 15.23x.

Already forward operating earnings estimates have been reduced to $120.34 for 2014.  If we use the same price level as in January – the P/FE ratio has already climbed 15.37x.

Let’s take this exercise one step further and consider the historical overstatement average of 33%.  However, let’s be generous and assume that estimates are only overstated by just 15%.  Currently, S&P is estimating that earnings for the broad market index will be, as stated above, $120.34 per share in 2014 but will rise by 14% in 2015 to $137.36 per share.  If we reduce both of these numbers by just 15% to account for overly optimistic assumptions, then the undervaluation story becomes much less evident.  Assuming that the price of the market remains constant the current P/FE ratios rise to 18.08x for 2014 and 15.84x for 2015.

Of course, it is all just fun with numbers and, as I stated yesterday, this there are only three types of lies:

“Lies, Damned Lies and Statistics.”

With the continued changes to accounting rules, repeal of FASB rule 157, and the ongoing torturing of income statements by corporations over the last 25 years in particular, the truth between real and artificial earnings per share has grown ever wider.  As I stated recently in“50% Profit Growth:”

“The sustainability of corporate profits is dependent on two primary factors; sustained revenue growth and cost controls.  From each dollar of sales is subtracted the operating costs of the business to achieve net profitability.  The chart below shows the percentage change of sales, what happens at the top line of the income statement, as compared to actual earnings (reported and operating) growth.”


“Since 2000, each dollar of gross sales has been increased into more than $1 in operating and reported profits through financial engineering and cost suppression.  The next chart shows that the surge in corporate profitability in recent years is a result of a consistent reduction of both employment and wage growth.  This has been achieved by increases in productivity, technology and offshoring of labor.  However, it is important to note that benefits from such actions are finite.”

This is why trailing reported earnings is the only “honest” way to approach valuing the markets.  Bill Hester recently wrote a very good note in this regard in response to critics of Shiller’s CAPE (cyclically-adjusted price/earnings) ratio which smoothes trailing reported earnings.

“More recently the ratio has undergone an attack from some widely-followed analysts, questioning its validity and offering up attempts to adjust the ratio.This may be a reaction to its new-found notoriety, but more likely it’s because the CAPE is suggesting that US stocks are significantly overvalued.  All of the adjustments analysts have made so far imply that stocks are less overvalued than the traditional CAPE would suggest.”

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns. But we decided to come to the aid of the CAPE ratio in this case because a few errors have slipped into the debate, and it’s important for investors who have previously relied on this ratio to understand these errors so they can judge the valuation metric fairly.  Importantly, the primary error that is being made is not even the fault of those making the arguments against the CAPE ratio. The fault lies at the feet of a misleading data series.


If I want to justify selling you an overvalued mutual fund or equity, then I certainly would try to find ways to discount measures which suggest investments made at current levels will likely have low to negative future returns.  However, as a money manager for individuals in retirement, my bigger concern is protecting investment capital first.  (Note: that statement does not mean that I am currently in cash, we are fully invested at the current time.  However, we are not naive about the risks to our holdings.)

The following chart shows Tobin’s “Q” ratio and Robert Shillers “Cyclically Adjusted P/E (CAPE)” ratio versus the S&P 500. James Tobin of Yale University, Nobel laureate in economics, hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm’s assets.  Currently, the CAPE is at 25.41x, and the Q-ratio is at 1.01.


Both of these measures are currently at levels that suggest that forward stock market returns are likely to be in the low to single digits over the next decade.  However, it is always at the point of peak valuations where the search for creative justification begins. Unfortunately, it has never “been different this time.”

Lastly, with corporate profits at record levels relative to economic growth, it is likely that the current robust expectations for continued double digit margin expansions will likely turn out to be somewhat disappointing.



As we know repeatedly from history, extrapolated projections rarely happen.  Therefore, when analysts value the market as if current profits are representative of an indefinite future, they have likely insured investors will receive a very rude awakening at some point in the future.

There is mounting evidence, from valuations being paid in M&A deals, junk bond yields, margin debt and price extensions from long term means, “exuberance” is once again returning to the financial markets.  Again, as I stated previously, my firm remains fully invested in the markets at the current time.  I write this article, not from a position of being“bearish” as all such commentary tends to be classified, but from a position of being aware of the “risk” that could potentially damage long term returns to my clients.  It is always interesting that, following two major bear markets, investors have forgotten that it was these very same analysts that had them buying into the market peaks previously.

OMG! Not Another Comparison Chart

By Lance Roberts, STA Wealth

Enough with the comparison charts already. The current stock market cycle has been compared to everything from the 1920’s, 70’s, 90’s, you name it.  I will readily agree that, in all the comparisons, the price patterns are similar, however, correlation is not causation.  What is ALWAYS left out of the conversation are the fundamental underpinnings that either supported or impeded those previous market cycles as compared to today.

Today, Business Insider produced the following chart and commentary by Jeff Saut:

In his new weekly Investment Strategy comment, Saut notes that these things work in both directions. Here’s Saut:

“Accordingly, the alleged pundits that called for a “crash” four weeks ago have, at least so far, also been proven wrong, which I discussed when dissecting their comparison chart to 1929 showing that when comparing apples-to-apples the correlation totally breaks down (see chart 1 and 2). In fact, as proof that you can make ratio charts do just about anything you want, take a look at chart 3 that suggests this secular bull market has another 300% to 400% left on the upside.”


There are two major issues with that statement.  First, Business Insider extracted selected verbiage which makes it seem as though Jeff Saut is suggesting that the markets have 300-400% more upside to go.  That is not exactly the case.  Below is actually what Jeff Saut wrote:

“A few weeks ago it was the correlation to the 1929 stock market rally that led to the ’29 crash that made the rounds. I wrote about that, noting that the folks making said comparison were using ratio-adjusted charts, which can make the charts show just about anything you want them to. The same thing happened with Japan’s Nikkei Index in the early 1990s and that also proved to be wrong. Accordingly, the alleged pundits that called for a ‘crash’ four weeks ago have, at least so far, also been proven wrong, which I discussed when dissecting their comparison chart to 1929 showing that when comparing apples-to-apples the correlation totally breaks down. In fact, as proof that you can make ratio charts do just about anything you want, take a look at that suggests this secular bull market has another 300% to 400% left on the upside.”

The point Jeff was trying to make is that you can take any multiple of data series, and with the right manipulation, you can torture the data into saying whatever you want.  As the old saying goes:

“There are three types of lies:  Lies, Damned Lies and Statistics.”

Secondly, and much more important, is that while it is true that history does “rhyme”, it does not repeat.  As I stated in the opening, there are specific fundamental underpinnings that supported the rampant secular bull markets that followed the major secular bear market lows of 1942 and 1974 which simply do not exist, as of yet, today.

One of the primary drivers that assisted in ending the “Great Depression” was the massive Government spending ramp, roughly 125% of GDP that was used to support WWII.  The surges in industrial production to support the war led to increased employment as women entered the work force while husbands, brothers and fathers were deployed overseas.  However, what drove the secular bull market of the 50’s and 60’s was “Johnny” returning home from war.  For years, everything had been rationed for the war effort, now the focus turned back to building families, homes and lives which lead to increased consumption as “pent up demand” was met.  However, more importantly, the United States became the industrial manufacturing powerhouse of the world.  With Europe, Japan and Russia in ruins following the war, the U.S. produced and shipped goods and products overseas for the rebuilding of war torn countries.  Government debt fell to historically low levels, household debt remained modest relative to incomes and personal savings rates were high which led to productive investment.  Even as interest rates rose, economic growth continued to rise giving a broad lift to prosperity.

This is something that I discussed at length in “Correcting Some Misconceptions Of A New Secular Bull Market:”

“The United States became the manufacturing center of the industrialized world as we assisted in the rebuilding of Germany, Britain, France and Japan.  That is no longer the case today as much of our industrial manufacturing has been outsourced to other countries for lower costs.  The chart below shows interest rates overlaid against the annual changes in economic growth.”

Interest-Rates-Economy-123013 (1)

The secular bull market of 80’s and 90’s is also something that we are unlikely to witness again in our lifetimes.  Unlike the secular boom of the 50’s which was driven by “healthy”consumption, the boom of the 80’s and 90’s was an unhealthy “debt driven” demand cycle which was fostered by an era of falling interest rates, inflation and financial deregulation.   As I stated in “Past Is Prologue:”

“The next chart shows the much beloved and hoped for, secular bull market of the 1980’s and 90’s.”


“There were several contributing factors that drove that particular secular bull market:

1) Inflation and interest rates were high and falling which boosted corporate profitability.

2) The extreme negative sentiment of the late 70’s was finally undone by the early 90’s.  (At the turn of the century, roughly 80% of all individual investors in the market began investing after 1990. 80% of that total started after 1995 due to the investing innovations created by the internet.  The majority of these were “boomers.”)

3) Large foreign net inflows to chase the “tech boom” drove prices to extreme levels.

4) The mirage of consumer wealth, driven by declining inflation and interest rates and easy access to credit, inflated consumption, corporate profits and economic growth.

5) Corporate profits were boosted by deregulation of industries, wage suppression, outsourcing and productivity increases. 

6) Pension funding requirements and accounting standards were eased which increased corporate profits. 

7) Stock based executive compensation was grossly expanded which led to more “accounting gimmickry” to sustain stock price levels.

The dual panel chart below shows the economic fundamentals versus the S&P 500 and the change that occurred beginning in 1983.  (Red dividing line)”


“I have also noted the expanding “megaphone” pattern in the current market as compared to that of the 60’s and 70’s.”


Despite much hope that the current breakout of the markets is the beginning of a new secular“bull” market – the economic and fundamental variables suggest otherwise.  Valuations and sentiment are at very elevated levels while interest rates, inflation, wages and savings rates are all at historically low levels.  This set of fundamental variables are normally seen at the end of secular bull market periods.

Lastly, the consumer, which comprises roughly 70% of economic growth is unable significantly increase their consumption, as a percent of the economy, as the capacity to releverage to their balance sheet is no longer available.  This “deleveraging” of balance sheets by the aging baby boomers, as they move through retirement, will further exacerbate the consumption side of the economic equation.

As I have said many times in the past I am currently maintaining fully allocated portfolio models.  As a money manager, I must participate with rising markets or suffer career risk.  However, while being a “stark raving bull” going into 2014 is certainly fashionable currently; as investors, we should place our faith, and hard earned savings, into the reality of the underlying fundamentals.  As I said at the beginning of the missive, it is disingenuous to manipulate the data to support a bullish thesis.

In my opinion, this is the wrong way to view the markets.  Participating with rising markets is the easy part. As investors, we should focus our analysis on what can go wrong.  The “glass is always half full” commentary leads investors into taking on substantially more investment risk than they realize as markets are rising.  It is the unwinding of that “risk” that leads the majority of investors to unrecoverable losses.  Most importantly, one absolutely unrecoverable commodity that is lost during mean reverting events is our most precious form of investment capital – “time.”  The reality is that we will not live forever.  By allowing “greed” to drive investment decisions the eventual “mean reversion” destroys our singularly most precious form of investment capital.

On that note, it is entirely conceivable that stock prices can be driven higher through the Federal Reserve’s ongoing interventions, current momentum, and excessive optimism.  However, the current economic variables, demographic trends and underlying fundamentals make it currently impossible to “replay the tape” of the 80’s and 90’s.  These dynamics increase the potential of a rather nasty mean reversion at some point in the future.  The good news is that it is precisely that reversion that will likely create the “set up” necessary to launch the next great secular bull market.  However, as was seen at the bottom of the market in 1974, there were few individual investors left to enjoy the beginning of that ride.  

5 Things To Ponder: Macro Investing Thoughts

By Lance Roberts of STA Wealth Management

This past week has seen the market struggle due to continued weak economic data, rising tensions between Russia and the Ukraine and an extended bull market run.  As I discussed in yesterday’s missive, the market internals are showing some early signs of deterioration even though the longer term bullish trajectory remains intact.  Therefore, this week’s “Things To Ponder” wades through some broader macro investment thoughts from the safety of your investments to how market tops are made.

1) The Delusions Of Real Returns by Brett Arends, WSJ

This is a topic that I discuss very often with clients.  Past performance is no guarantee of future results, and making investment decisions based on such is likely going to leave you very disappointed.  Extrapolating 110 year historical average returns going forward is extremely dangerous.  First, you won’t live 110 years from the time you start saving to achieve those results, and starting valuation levels are critical to your expected returns.  Brett does an excellent job discussing this issue.

“Money managers point to historical data going back to the 1920s to show that in the past stocks have produced total returns of about 10% a year over the long term and bonds, about 5%—meaning a standard “balanced” portfolio of 60% stocks and 40% bonds would earn just over 8% a year. (Naturally, their legal departments quickly add that the past is no guide to the future.)

Are these forecasts realistic? Are they sensible? Are they even based on actual logic or a correct reading of the past data?

A close look at the data reveals a number of disturbing errors and logical flaws. There is a serious danger that investors are deluding themselves and that returns from here on may prove far more disappointing than many hope or believe.

This has happened before. Money invested in a balanced fund of stocks and bonds at certain points in the past—such as in the late 1930s, or during the 1960s and 1970s—ended up losing money for many years, after accounting for inflation.

Far from making an annual profit, investors went backward in real, purchasing-power terms. And those losses were even before deducting costs or taxes.”

2) Lessons From The Bull Market by Jason Zweig, Joe Light and Liam Pleven

If you do nothing else this weekend - read this article.  There are simply too many nuggets of wisdom for me to summarize, but here are a couple of my favorite points.

“Every day, in the newspapers, on financial-news shows and online, dozens of market strategists make bold predictions about the direction stocks are heading. Take their forecasts with a mound of salt. After all, current prices already reflect the sum of stock-market buyers’ and sellers’ opinions. If one investor is bullish, there must be another investor on the other side at the current price.”

“In a speech about intellectual honesty 40 years ago, Nobel Prize-winning physicist Richard Feynman said, ‘The first principle is that you must not fool yourself—and you are the easiest person to fool.’

What they should be asking is this: Am I fooling myself into remembering my losses as less painful than they were? Am I itching to take risks that my own history should warn me I will end up regretting? Am I counting on willpower alone to enable me to stay invested and to rebalance through another crash?”

“Investors who hear the phrase ‘bull market’ might decide it is time to get in on the rally. On the other hand, investors who hear the current bull market in stocks has been running for five years might worry it will soon end. In either case, investors would do better to tune out the chatter. The definition of a bull market is arbitrary, and the term tells investors little about what will happen next.”

3) How Market Tops Are Made by Barry Ritholtz via Bloomberg

This is a great follow up to my articles this past week on “10 Signs Of Exuberance” and “Market Internals.”  Barry interviews Paul Desmond, the Chief Strategist and President of Lowry’s Research, who has spent the past five decades analyzing markets.  From Barry:

“I spoke with him [Paul Desmond] recently, chatting about his work in identifying market tops. Rather than focus on the usual noise, Desmond suggests anyone concerned about a top should be watching for very specific warning signs. He notes the health of a bull market can be observed by watching internal indicators that provide insight into the overall appetite for equity accumulation.

These four include:

1. New 52-Week Highs

2. Market Breadth (Advanced/Decline Line)

3. Capitalization: Small Cap, Mid Cap, Large Cap

4. Percentage of Stocks at 20 percent or greater from their recent highs”

4) New All Time Highs = Secular Bull Market? by Cam Hui via Humble Student Of The Markets Blog

I wrote an article recently entitled Correcting Some Misconceptions About A New Secular Bull Market” as the markets pushed toward new highs at the end of 2013.  At that time, there was a flurry of articles suggesting that the markets had entered into a new secular bull market.  However, my argument against this thesis revolved around the fact the no secular bull market in the history of the known universe has ever started from peak market valuations.  Cam Hui brings forward an excellent point:

“Here is a difficult question for those in the secular bull camp. What’s the upside from here? Ramsey of Leuthold Weeden Capital Management projects limited upside under a secular bull scenario, even assuming that everything goes right:

If the current cyclical bull unfolds into a secular one that is perfectly average in duration and magnitude (a very tall achievement, in our book), the annualized total return over the next ten years will still be a bit below the long-term average return of 10%. Frankly, we don’t find this all that compelling, considering all that must go according to plan for the market to achieve it (i.e. sustained EPS growth at a healthy 6% and an inflated terminal P/E multiple).

He added some of these gains depends on assuming the resumption of a stock market bubble:

Based on the relative positions of these time-tested measures, secular bulls seem to be implicitly betting on the reflation of a multi-generational stock bubble less than 15 years after it popped. The pathology of ‘busted bubbles’—which we’ve detailed at length in the past—doesn’t support that bet.

When he puts it all together, my inner investor thinks that, if we are indeed seeing a new secular bull market, the extraordinary measures undertaken by global central banks in the wake of the Lehman Crisis has front-end loaded many of the gains to be realized in this bull.

5) Does Shiller’s CAPE Still Work? by Bill Hester, Hussman Funds

It is becoming more difficult for more mainstream commentators, analysts and managers to justify their arguments for a continued bull market when having to contend with rising valuation levels.  However, as would be expected, at the peak of every major bull market in history there have always been those that have suggested “this time is different.”  In 1929, stocks had reached a new permanent plateau.  In 1999, old valuation measures didn’t matter as it was about “clicks per page.”   In 2007, subprime credit was “contained” and it was a “goldilocks economy.”  In 2014, old valuation metrics simply don’t account for the new economy.  We have always heard the same “sirens song” during every major bull market cycle and, as the sailors of the past, we are ultimately lured toward our demise.  Bill Hester does an excellent job breaking down the arguments against Shiller’s CAPE valuation metrics.

“More recently the ratio has undergone an attack from some widely-followed analysts, questioning its validity and offering up attempts to adjust the ratio. This may be a reaction to its new-found notoriety, but more likely it’s because the CAPE is suggesting that US stocks are significantly overvalued. All of the adjustments analysts have made so far imply that stocks are less overvalued than the traditional CAPE would suggest.

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns. But we decided to come to the aid of the CAPE ratio in this case because a few errors have slipped into the debate, and it’s important for investors who have previously relied on this ratio to understand these errors so they can judge the valuation metric fairly.


Importantly, the primary error that is being made is not even the fault of those making the arguments against the CAPE ratio. The fault lies at the feet of a misleading data series.

EXTRA:  Just Good Stuff To Know

I use Google for just about everything.  Email, picture uploads, all of my spreadsheets that I use for blogging, analysis, newsletters, etc.  From my phone to my computer, Google has just about all of my data.

That makes me a little more than uncomfortable. If you are like me, then you will find the following links very useful in adjusting things from what Google knows about you to archiving the stuff you put on the site.

Here are 10 important links that every Google user should know.

Have a fabulous week.

10 Warnings Signs Of Stock Market Exuberance

By Lance Roberts, STA Wealth

Imagine that you are speeding down one of those long and lonesome stretches of highway that seems to fall off the edge of the horizon.  As the painted white lines become a blur, you notice a sign that says “Warning.”  You look ahead for what seems to be miles of endless highway, but see nothing.  You assume the sign must be old therefore you disregard it, slipping back into complacency.

A few miles down the road you see another sign that reads “Warning: Danger Ahead.”  Yet, you see nothing in distance.  Again, a few miles later you see another sign that reads “No, Really, There IS Danger Ahead.”  Still, it is clear for miles ahead as the road disappears over the next hill.

You ponder whether you should slow down a bit just in case.  However, you know that if you do it will make you late for your appointment.  The road remains completely clear ahead, and there are no imminent sings of danger.  So, you press ahead.  As you crest the next hill there is a large pothole directly in your path.  Given your current speed there is simply nothing that can be done to change the following course of events.  With your car now totalled, you tell yourself that there was simply “no way to have seen that coming.”

It is interesting that, as humans, we fail to pay attention to the warnings signs as long as we see no immediate danger.  Yet, when the inevitable occurs, we refuse to accept responsibility for the consequences.

I was recently discussing the market, current sentiment and other investing related issues with a money manager friend of mine in California. (Normally, I would include a credit for the following work but since he works for a major firm he asked me not to identify him directly.) However, in one of our many email exchanges he sent me the following note detailing the 10 typical warning signs of stock market exuberance.

(1) Expected strong OR acceleration of GDP and EPS  (40% of 2013’s EPS increase occurred in the 4th quarter)

(2) Large number of IPOs of unprofitable AND speculative companies

(3) Parabolic move up in stock prices of hot industries (not just individual stocks)

(4) High valuations (many metrics are at near-record highs, a few at record highs)

(5) Fantastic high valuation of some large mergers (e.g., Facebook & WhatsApp)

(6) High NYSE margin debt

Margin debt/gdp (March 2000: 2.7%, July 2007: 2.6%, Jan 2014: 2.6%)

Margin debt/market cap (March 2000: 1.8%, July 2007: 2.3%, Jan 2014: 2.0%)

(7) Household direct holdings of equities as % of total financial assets at 24%, second-highest level (data back to 1953, highest was 1998-2000)

(8) Highly bullish sentiment (down slightly from year-end peaks; still high or near record high, depending on the source)

(9) Unusually high ratio of selling to buying by corporate senior managers (the buy/sell ratio of senior corporate officers is now at the record post-1990 lows seen in Summer 2007 and Spring 2011)

(10) Stock prices rise following speculative press releases (e.g., Tesla will dominate battery business after they get partner who knows how to build batteries and they build a big factory.  This also assumes that NO ONE else will enter into that business such as GM, Ford or GE.)

All are true today, and it is the third time in the last 15 years these factors have occurred simultaneously which is the most remarkable aspect of the situation.

The following evidence is presented to support the above claim.

Exhibit #1: Parabolic Price Movements



Exhibit #2: Valuation



Excerpt from a recent report by David J. Kostin, Chief US Equity Strategist for Goldman Sachs, 11 January 2014

The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock:

(1) The P/E ratio;

(2) the current P/E expansion cycle;

(3) EV/Sales;


(5) Free Cash Flow yield;

(6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of inflation; nominal 10-year Treasury yields; and real interest rates.


Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of Operating EPS and about 45% overvalued using As Reported earnings.

Reflecting on our recent client visits and conversations, the biggest surprise is how many investors expect the forward P/E multiple to expand to 17x or 18x. For some reason, many market participants believe the P/E multiple has a long-term average of 15x and therefore expansion to 17-18x seems reasonable.But the common perception is wrong. The forward P/E ratio for the S&P 500 during the past 5-year, 10-year, and 35- year periods has averaged 13.2x, 14.1x, and 13.0x, respectively. At 15.9x, the current aggregate forward P/E multiple is high by historical standards.

Most investors are surprised to learn that since 1976 the S&P 500 P/E multiple has only exceeded 17x during the 1997-2000 Tech Bubble and a brief four-month period in 2003-04. Other than those two episodes, the US stock market has never traded at a P/E of 17x or above.

A graph of the historical distribution of P/E ratios clearly highlights that outside of the Tech Bubble, the market has only rarely (5% of the time) traded at the current forward multiple of 16x.


The elevated market multiple is even more apparent when viewed on a median basis. At 16.8x, the current multiple is at the high end of its historical distribution.

The multiple expansion cycle provides another lens through which we view equity valuation. There have been nine multiple expansion cycles during the past 30 years. The P/E troughed at a median value of 10.5x and peaked at a median value of 15.0x, an increase of roughly 50%. The current expansion cycle began in September 2011 when the market traded at 10.6x forward EPS and it currently trades at 15.9x, an expansion of 50%. However, during most (7 of the 9) of the cycles the backdrop included falling bond yields and declining inflation. In contrast, bond yields are now increasing and inflation is low but expected to rise.

Incorporating inflation into our valuation analysis suggests S&P 500 is slightly overvalued. When real interest rates have been in the 1%-2% band, the P/E has averaged 15.0x. Nominal rates of 3%-4% have been associated with P/E multiples averaging 14.2x, nearly two points below today. As noted earlier, S&P 500 is overvalued on both an aggregate and median basis on many classic metrics, including EV/EBITDA, FCF, and P/B.”

Exhibit #3: Selling Of Company Stock By Senior Managers

Excerpt from a recent article by Mark Hulbert

“Prof. Seyhun – who is one of the leading experts on interpreting the behavior of corporate insiders – has found that when the transactions of the largest shareholders are stripped out, insiders do have impressive forecasting abilities. In the summer of 2007, for example, his adjusted insider sell-to-buy ratio was more bearish than at any time since 1990, which is how far back his analyses extended.

Ominously, that degree of bearish sentiment is where the insider ratio stands today, Prof. Seyhun said in an interview.

Note carefully that even if the insiders turn out to be right and the bull market is coming to an end, this doesn’t have to mean that the U.S. market averages are about to fall as much as they did in 2008 and early 2009. The one other time since that bear market when Prof. Seyhun’s adjusted sell-buy ratio sunk as low as it was in 2007 and is today, the market subsequently fell by ‘just’ 20%.

That other occasion was in early 2011. Stocks’ drop at that time did satisfy the unofficial definition of a bear market, and the insiders’ pessimism was vindicated.”

Exhibit #4: Investor’s Confidence

AAII-Bull-Bear-030714 AAII-INVI-Bearish-13wk-030714


Exhibit #5: Ownership Of Stocks As % Total Financial Assets



The point my money managing friend wishes to make is simply that the “”warning signs” are all there. However, since the road ahead seems clear, it is human nature that we keep our foot pressed on the accelerator.

As the Federal Reserve extracts liquidity from the markets, the “Bernanke Put” is being removed which leaves the markets vulnerable to a “mean reverting event” at some point in the future.  The mistake that many investors are currently making is believing that since it hasn’t happened yet, it won’t.   This time is only “different” from the perspective of the “why” and“when” the next major event occurs.

Of course, despite the repeated warning signs, the next correction will leave investors devastated looking to point blame at everyone other than themselves.  The question will simply be “why no one saw it coming?”

5 Things to Ponder: Serious Stuff

By Lance Roberts, STA Wealth

There were so many good things to read this past week that it was hard to narrow it down to a topic group.  After a brief respite early this year, the markets are hitting new highs confirming the current bullish trend.  As a money manager, this requires me to increase equity exposure back to full target weightings.  After such an extended run in the markets, this seems somewhat counter-intuitive.  It is, but as Bill Clinton once famously stated; “What is….is.” 

However, while the current market “IS” within a bullish trend currently, it doesn’t mean that this will always be the case.  This is why, as investors, we must modify Clinton’s line to:“What is…is…until it isn’t.”  That thought is the foundation of this weekend’s “Things To Ponder.”  In order to recognize when market dynamics have changed for the worse, we must be aware of the risks that are currently mounting.

1) Fisher Warns Fed’s Bond Buying Could Be Distorting Markets via Reuters

While this article falls in the “no s***” category, Dallas Fed President Richard Fisher points out areas that we should be paying closer attention to for signs of change.

“There are increasing signs quantitative easing has overstayed its welcome: Market distortions and acting on bad incentives are becoming more pervasive,” he said of the asset purchases, which are sometimes called QE.

“I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis.”

Here are his main points:

1) QE was wasted over the last 5 years with the Government failing to use “easy money” to restructure debt, reform entitlements and regulations.

2) QE has driven investors to take risks that could destabilize financial markets.

3) Soaring margin debt is a problem.

4) Narrow spreads between corporate and Treasury debt are a concern.

5) Price-To-Projected Earnings, Price-To-Sales and Market Cap-To-GDP are all at “eye popping levels not seen since the dot-com boom.”

“We must monitor these indicators very carefully so as to ensure that the ghost of ‘irrational exuberance’ does not haunt us again,”

In order to make it in professional sports, you have to be an elite athlete.  What is amazing, is that among all of the elite athletes, there are always one or two that rise above all others.  Players like Michael Jordon, Tiger Woods, Nolan Ryan and many others have elevated their game to inexplicable levels.  In the investment game, there are a few individuals that have done the same.  The follow three pieces are views from some of these men Howard Marks, Jeff Gundlach and Seth Klarman.

2) Howard Marks: In The End The Devil Usually Wins via Finanz Und Wirtschaft

“Our mantra at Oaktree Capital for the last few years has been: «move forward, but with caution». Although a lot has changed since then I think it’s still appropriate to keep the same mantra. Today, things are not cheap anymore.  Rather I would describe the price of most assets as being on the high side of fair. We’re not in the low of the crisis like five years ago.”

“Let’s think about a pendulum: It swings from too rich to too cheap, but it never swings halfway and stops. And it never swings halfway and goes back to where it came from. As stocks do better, more people jump on board.  And every year that stocks do well wins a few more converts until eventually the last person jumps on board. And that’s the top of the upswing.”

“But there actually are two risks in investing: One is to lose money and the other is to miss opportunity. You can eliminate either one, but you can’t eliminate both at the same time.”

“There are two main things to watch: valuation and behavior.”

3) Seth Klarman: Downplaying Risk Never Turns Out Well via Value Walk

““In the face of mixed economic data and at a critical inflection point in Federal Reserve policy, the stock market, heading into 2014, resembles a Rorschach test,” he wrote. “What investors see in the inkblots says considerably more about them than it does about the market.”

“If you’re more focused on downside than upside, if you’re more interested in return of capital than return on capital, if you have any sense of market history, then there’s more than enough to be concerned about.”

“We can draw no legitimate conclusions about the Fed’s ability to end QE without severe consequences.”

“Fiscal stimulus, in the form of sizable deficits, has propped up the consumer, thereby inflating corporate revenues and earnings. But what is the right multiple to pay on juiced corporate earnings?”

“There is a growing gap between the financial markets and the real economy,”

“Our assessment is that the Fed’s continuing stimulus and suppression of volatility has triggered a resurgence of speculative froth.”

“In an ominous sign, a recent survey of U.S. investment newsletters by Investors Intelligence found the lowest proportion of bears since the ill-fated year of 1987,” he wrote. “A paucity of bears is one of the most reliable reverse indicators of market psychology. In the financial world, things are hunky dory; in the real world, not so much. Is the feel-good upward march of people’s 401(k)s, mutual fund balances, CNBC hype, and hedge fund bonuses eroding the objectivity of their assessments of the real world? We can say with some conviction that it almost always does. Frankly, wouldn’t it be easier if the Fed would just announce the proper level for the S&P, and spare us all the policy announcements and market gyrations?”

4) Jeff Gundlach & Howard Marks: Beware Of Junk Bonds via Pragmatic Capitalist

 “There’s been some cautionary commentary in recent months from some bond market heavyweights.  Most notably, Howards Marks and Jeff Gundlach. In a Bloomberg interview today, Marks said you need to be cautious about low quality issuers:

‘When things are rollicking and the market is permitting low-quality issuers to issue debt, that’s when you need a lot of caution,’

And just a few weeks before that Jeff Gundlach referred to junk bonds as the most overvalued they’ve ever been relative to Treasury Bonds.”

5) Bernanke Unleashed: What He Can Say Now That He Couldn’t Say Before via Zero Hedge

Now that Ben Bernanke is no longer the head of the Fed, he can finally tell the truth about what caused the financial crash. At least that’s what a packed auditorium of over 1000 people as part of the financial conference staged by National Bank of Abu Dhabi, the UAE’s largest bank, was hoping for earlier today when they paid an exorbitant amount of money to hear the former chairman talk.

“The United States became ‘overconfident’, he said of the period before the September 2008 collapse of U.S. investment bank Lehman Brothers. That triggered a crash from which parts of the world, including the U.S. economy, have not fully recovered.

‘This is going to sound very obvious but the first thing we learned is that the U.S. is not invulnerable to financial crises,’ Bernanke said.

“He also said he found it hard to find the right way to communicate with investors when every word was closely scrutinised. ‘That was actually very hard for me to get adjusted to that situation where your words have such effect. I came from the academic background and I was used to making hypothetical examples and … I learned I can’t do that because the markets do not understand hypotheticals.

The complexity though arises because in order to help the average person, you have to do things — very distasteful things — like try to prevent some large financial companies from collapsing.  The result was there are still many people after the crisis who still feel that it was unfair that some companies got helped and small banks and small business and average families didn’t get direct help.  It’s a hard perception to break.”

I guess the real question is now that the markets are once again over confident, over extended and excessively bullish – have we actually learned anything?

Have a great weekend.

Revisiting Why Benchmarking Is A Bad Strategy

By Lance Roberts, STA Wealth

Just recently my friend Cullen Roche wrote a great piece entitled “Can we All Agree to Stop Comparing Everything to the S&P 500″ in which he stated:

“Benchmarking is a pernicious thing in financial circles.  Not only because it disconnects the way the client and a fund manager understand the concept of ‘risk’, but also because the concept of benchmarking seems to be misunderstood.”

Risk is rarely understood by investors until it is generally too late.  Take, for example, a call I received the other night during a broadcast of the “Lance Roberts Show.”   The caller didn’t understand why people didn’t just buy an S&P 500 index and then just leave it alone.  When I asked him when he started investing he proudly stated that he had been investing for the almost 5 years and had more than doubled his money.  The problem is that this particular individual has no functional idea of what “risk” entails.

The chart below is an inflation adjusted return of $100,000 investment in the S&P 500 from 1990 to present.  The reason that 1990 is important is because that is when roughly 80% of all investors today begin investing.  Roughly 80% of those began after 1995.  If you don’t believe me, go ask 10 random people when they started investing in the financial markets and you will likely be surprised by what you find.



As shown, there is certainly a case to be made for buying and holding an index.  However, it is quite clear that “buying low” and “selling high” would have been much more beneficial from 2000 until present.

Unfortunately, the reality is that investors rarely do what is “logical” but react “emotionally” to makret swings.  When stock prices are rising instead of questioning when to “sell” they lured in near market peaks.  The reverse happens as prices fall leading first to “paralysis” and“hope” that losses will soon be recovered.  Eventually, near market bottoms the emotional strain is too great and investors “dump” shares at any price to preserve what capital they have left.  Despite the media’s commentary that “if an investor had ‘bought’ the bottom of the market…” the reality is that few, if any, actually did.   The biggest drag on investor performance over time is allowing “emotions” to dictate investment decisions.  This is shown in the 2013 Dalbar Investor Study which showed “psychological factors” accounted for between 45-55% of underperformance.  From the study:

“Analysis of investor fund flows compared to market performance further supports the argument that investors are unsuccessful at timing the market. Market upswings rarely coincide with mutual fund inflows while market downturns do not coincide with mutual fund outflows.”

In other words, investors consistently bought the “tops” and sold the “bottoms.”  The other two primary reasons of underperformance from the study related to a lack of capital to invest.  This is also not surprising given the current economic environment.

There are many reasons why you can’t really beat the S&P 500 index over time and why you see statistics such as “80% of all fund underperform the S&P 500.”   The impact of share buybacks, substitutions, lack of taxes and trading expenses all lead to outperformance by the index over everyone else that is actually investing and doesn’t receive those benefits.  Furthermore, any portfolio that is allocated to to lower volatility, create income or provide for long term financial planning and capital preservation will underperform the index so comparing your portfolio to the S&P 500 is “apples to oranges.”   Cullen makes this point very clearly:

“But it gets worse.  Often times, these comparisons are made without even considering the right way to quantify “risk”.  That is, we don’t even see measurements of risk adjusted returns in these “performance” reviews.  Of course, that misses the whole point of implementing a strategy that is different than a long only index.

It’s fine to compare things to a benchmark.  In fact, it’s helpful in a lot of cases.  But we need to careful about how we go about doing it.”

recently wrote a fairly deep study on the perils of benchmarking and why, despite your best intentions, it was highly unlikely that you will ever “beat the market” over the long term.

“While Wall Street wants you to compare your portfolio to the “index” so that you will continue to keep money in motion, which creates fees for Wall Street, the reality is that you can NEVER beat a “benchmark index” over a long period.  This is due to the following reasons:

1) The index contains no cash

2) It has no life expectancy requirements – but you do.

3) It does not have to compensate for distributions to meet living requirements – but you do.

4) It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance – this is fine on the way up, but not on the way down.

5) It has no taxes, costs or other expenses associated with it – but you do.

6) It has the ability to substitute at no penalty – but you don’t.

7) It benefits from share buybacks – but you don’t.”

For all of these reasons, and more, the act of comparing your portfolio to that of a“benchmark index” will ultimately lead you to taking on too much risk and ultimately making emotionally based investment decision making.  The index is a mythical creature, like the Unicorn, and chasing it takes your focus off of what is most important – your money and your specific goals.  Investing is not a competition and, as history shows, there are horrid consequences for treating it as such.  So, do yourself a favor and forget about what the benchmark index does from one day to the next.  Focus instead on matching your portfolio to your own personal goals, objectives, and time frames.  In the long run you may not beat the index, but you are likely to achieve your own personal investment goals which is why you invested in the first place.

Chart Of The Day: S&P Tracing A Top?

By Lance Roberts, STA Wealth

Chart comparisons predicting the next major market crash have abounded as of late.  Is this a repeat of 1929, 1974 or 1994?  The truth is that we are all guessing at what will happen next in the markets as no one really knows what will happen tomorrow much less six months from now.  I say that to qualify today’s chart because the market is behaving very similarly to what we witnessed beginning in late 2010.



What is interesting about the chart above is that in late 2010 the markets were rising strongly as the Fed’s second quantitative easing program was fully engaged.  Complacency among investors was high as the economy plugged along.  Much the same as we are witnessing currently.  Then, in March of 2011, the Japanese trifecta of economic disaster struck as an earthquake caused a tsunami which led to a nuclear plant chain reaction.  The only thing missing was a 90 foot tall lizard sending citizens fleeing from the city.

The domestic economy was quickly impacted by the shutdown of Japanese manufacturing.  Economic data began to wane at the same time as the Fed’s liquidity program approached its early summer expiration.  As the market anticipated the reduction in liquidity flows from the Federal Reserve, stock prices began to struggle. However, for a while they managed to hold above important support.  Then, in the middle of summer, President Obama squared off with Congress over a heated debt-ceiling debate.  Threats of a government default filled media headlines while market participants watched helplessly from the sidelines.  While there was never any real threat of a default, as witnessed by the plunge in U.S. interest rates to record lows at the time, the markets plunged sharply over just a few short weeks causing investors to flee for safety.

That was then.  Interestingly, we are currently witnessing similar events.

The Fed is once again tapering their current liquidity program.  The most recent commentary from the Federal Reserve suggests that the current path of reduction in bond purchases will continue which suggests the program will end by October, 2014.

While the U.S. has not yet witnessed an “abominable snowman” threatening Manhatten, the series of “polar vortexes” are exacerbating already weaker trending economic data.  As Idiscussed previously, the pop in economic data in Q3 of 2013 was an inventory restocking cycle.

“It has been a ‘Summer of Recovery’ for the U.S. economy with GDP growth rising from 1.1% in the first quarter to 2.5% in the second and manufacturing surveys showed sharp jumps in new orders and outlooks.  The same occurred in the Eurozone with Markit’s PMI reports showing sharp bounces higher and hopes that the recession that has plagued the region was finally coming to an end.  The question of sustainability remains.

I have noted several times as of late, most recently here, that the recent bumps in economic activity, particularly in the survey and sentiment data, is most likely due to short term restocking activity rather than actual economic improvement.”

That point was reaffirmed by the NFIB’s Chief Economist, Bill Dunkleberg, just recently:

 “Last year finished with a fair uptick in economic activity, but probably not as strong as the ‘headline’ GDP numbers made it look. Overall, GDP was up only 1.9 percent in 2013, down from 2.8 percent in 2012. But the second half of the year posted above trend growth numbers, a rare showing in our 5 year recovery. Exports were strong, that’s good for manufacturing output, but less so for jobs – productivity looking good. A huge share of the growth was in inventory building, nice while it is happening, but usually followed by sub-normal production later as excess stocks are worked off. That will depress activity in the first half of 2014 and keep some prices down.”

With that restocking cycle now complete, the economic data was already showing signs of weakness.  However, the exogenous shock of the extraordinarily cold winter has sent utility costs surging, slowed production and reduced incomes.  While not as economically damaging as the “Japan shutdown,” when the effect of the winter impact is combined with the rising costs, taxes and uncertainty created by the Affordable Care Act, the economic drag will likely be exacerbated.

Lastly, we are in a mid-term election year which typically does not bode well for markets just prior to the November election.  This is an issue I discussed previously stating:

“Midterm election years are also notoriously weaker when Democrats are in control, but in the last 13 quadrennial cycles since 1961, 9 of the 16 bear markets bottomed in the midterm year.

As stated, on average all midterm years have returned 4.16%. However, when the midterm year followed a strongly positive post-election year, as in 2013, that return fell to just 2.4% on average.  The chart below, from Stock Trader’s Almanac, shows the mid-year correction that generally accompanies a mid-term election year.”

DJIA-Midterm-Election Years

While mid-term election years have typically finished on a positive note, it is important to note the corrections that tend to occur prior to the election in the chart above.

So, while there have been plenty of charts comparing this year to that, the current combination of both the technical setup and economic backdrop should raise a cautious view.  Since no two periods are ever alike, it leaves us guessing at the future when making investment decisions.  Unfortunately, while psychics and fortune tellers have the “crystal ball”market cornered, the rest of us are forced to take our ques from what has happened in the past.

5 Things To Ponder: Cash, QE, Investing & 1929

By Lance Roberts, STA Wealth

The market correction that begin in January appears to be subsiding, at least for the moment, as Yellen’s recent testimony gave markets the promise of the continuation of Bernanke’s legacy.  A synopsis of her “accommodation supportive” comments (courtesy of Bill King) is below:

* The recovery in the labor market is far from complete.

* The hope is that by stimulating more borrowing and spending, lower interest rates can jumpstart the economy.  [Of course, we are still waiting for that to actually happen]

* QE tapering is “not on a preset course. The Committee’s decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.”

* Asset prices are not at “worrisome levels.” [This statement caused the midday surge.]

* The Fed will have to keep rates near zero “well past the time” that unemployment crosses below the 6.5 percent threshold; and the Fed will be an active participant in increased bank regulation, specifically focusing on avoiding the too-big-to-fail problems

With the markets back into rally mode, for the moment, this week’s “Things To Ponder” focuses on some of the bigger issues concerning the effectiveness of QE, investing and that chart of 1929 that has been making the rounds.

1) QE Is A Mistake – A Big One by Allan Meltzer of E21

If you review the Yellen’s comments above, she stated that the “hope” of QE was to stimulate more borrowing and spending.  Unfortunately, as shown in the chart of M2V below, it has simply not been the case.



Allan Metzer wrote a terrific article for E21 driving home this point:

“The Fed deserves high praise for the first round of QE in 2008. However, the benefits ended long ago. More than 95 percent of the reserves that the Fed supplied under QE 2 and 3 sit idle on bank balance sheets. M2 money growth for the year to the end of January 2014 is less than 5.5 percent. There is no mystery about why inflation remains low.

The mistaken results of QE policy include Federal Reserve financing of outsize budget deficits. No one should require a tutorial about the longer-term consequences of using central banks to finance government deficits. Sooner or later the results are inflation, always and everywhere.”

2) The Cash On The Sidelines Myth by Pater Tenebrarum via Zero Hedge

In a recent interview by JP Morgan’s Tom Lee, he asserted that:

“This could be only the middle innings of what could be one of the longest bull markets in history,” Lee said in a “Squawk Box” interview.“There is a lot of firepower to fuel this rally. There is a lot of cash on the sidelines, consumers have delevered.”

Pater dismantles this very ill-founded argument, a pet peeve of Cliff Asness as well, in great detail.

“Let us think about this statement for a moment. What is ‘cash on the sidelines’ even supposed to mean? We submit that it is a meaningless concept. All stocks are owned by someone at all times, and all cash is held by someone at all times. When people trade stocks, all that happens is that the ownership of stocks and cash changes hands. There is as much ‘cash on the sidelines’ after a trade concludes than there was before. There are no owner-less orphan stocks flying about in the Wall Street Aether, waiting to suck up cash.

In other words, the ‘cash on the sidelines’ argument is a really bad argument, or rather, it’s not an argument at all.”

3) Can Earnings Get Better Than This? by Tom McClellan via Pragmatic Capitalist

“The conventional stock market analysis world revolves around earnings.  ‘Earnings drive the stock market,’ they say.  This myopic view is akin to the belief that carbon dioxide is the driving force behind the greenhouse effect(water vapor actually accounts for 90-95% of it, but you don’t hear that).  People believe that earnings are everything because they have been told that it is so, and everyone thinks so,  therefore it must be so.  Circularity of logic and contradictory evidence do not seem to be significant impediments to the acceptance of this belief system.

This week’s chart looks at the BEA’s data on corporate profits.


Why doesn’t everyone look at earnings this way? My answer is that Wall Street has a fascination with its own forecasts of earnings, and with the reported earnings of listed companies stocks. But those are a pair biases which excluded private company earnings, and which also accept earnings estimates which are notoriously subject to revision. I prefer to deal in hard data. The next BEA report on earnings is not due out until Feb. 28, so using these data means accepting the inherent reporting lag.

What we see now is an indication that the reading for overall corporate profits as a percentage of GDP is at one of the highest levels of recent years. And when it cannot get higher, it can only get lower. It is true that this measure has been higher in the distant past, but that was back in the 1960s and earlier, when GDP was a bit different than it is now, and when accounting standards for measuring profits were also different. The current high reading has only been exceeded once in the past 46 years, and that was at the real estate bubble top for earnings back in 2006. And we all know how that ended.


4) Everything I Know About Investing I Learned From Drivers Ed by Jason Zweig

Jason’s articles are always a must read as he has a brilliant ability to very complex issues into an understandable, and enjoyable, format.  His recent piece on investing is no exception and well worth your time to read.

“Only recently did I realize that his messages apply at least as much to investing as they do to driving. Here are the pithy expressions Mr. Terry taught us about driving – and how I think they apply to investing as well.

Put Your Head on a Swivel – Risk is all around you, and the likeliest places to look for it are the places that appear to be the safest. That’s where the next danger will come from – just where and when nobody is looking.

Edge On, Edge OffMaking a sudden change in your plan is usually a mistake. Making a sudden, big change in your plan almost always is.

Get in the Ground-Viewing Habit – It’s what is beneath eye-level that matters

Give Him Room and Let Him Zoom – People who try to get rich quick don’t end up any farther along – and take a lot more risk, and incur a lot more cost, to get there. You don’t get bonus points in investing for arriving at your destination ahead of time. The only thing that matters is getting there in one piece.”

5) The 1929 Scary Chart via Bill King, The King Report

The chart below, which compares the 1929 stock market to today, has been making the rounds stirring up quite a bit of angst.  I thought Bill did a good job of dispelling some of these concerns.

“There is another factor that drove stocks higher on Tuesday – some of the 1928-1930 algorithm followers are now covering their shorts. [Especially after the S&P 500 blew threw 1800]“


“In our missive on Monday we stated: We believe that the current stock market will now diverge from the 1928-1930 algorithm. For the near future we cannot see or fathom a catalyst for a stock market crash. Plus, it’s the wrong time of the year for a dramatic decline in stock prices.

PS- Several people voiced irritation with our forecast that stocks would not tank in coming days.

Apparently a critical mass of traders now realize that stocks are diverging from the 1928-1930 algorithm. This unleashed massive short covering on Tuesday.

This story by Mark Hulbert appeared yesterday on Drudge: Scary 1929 market chart gains traction

There are eerie parallels between the stock market’s recent behavior and how it behaved right before the 1929 crash…

Tom Demark [has a huge hedge fund and institutional following] added in interview that he first drew parallels with the 1928-1929 period well before last November. ‘Originally, I drew it for entertainment purposes only,’ he said—but no longer: ‘Now it’s evolved into something more serious.'”

I agree with Bill.  Statistically speaking, the odds are high that the markets will diverge from the pattern.   While history does indeed rhyme, it often does not repeat exactly.  Do I think that eventually the markets will have another major reversion?  Absolutely.  The natural ebb and flow of market dynamics tells us this will be the case.  Unfortunately, we just don’t know when or what will cause it.

Bonus Reading:  77 Reasons You Suck At Managing Money by Morgan Housel

“People usually get better at things over time. We’re better farmers, faster runners, safer pilots, and more accurate weather forecasters than we were 50 years ago.

But there’s something about money that gets the better of us. If you look at the rate of personal bankruptcies, financial crises, bubbles, student loans, debt defaults, and savings rates, I wonder whether people are just as bad at managing money today as they were in previous generations, maybe even worse. It’s one of the only areas in life we seem to get progressively dumber at.”

Yes, there are indeed 77 charming nuggets of wisdom contained within the article, all of which are worth every minute you spending reading them.  They are funny, enlightening and humbling with insights like:

“You get upset when you hear on TV that the government is running a deficit. It doesn’t bother you that you heard this on a TV you bought on a credit card in a home you purchased with a no-money-down mortgage.”

He concludes with the most salient point:

“You nodded along to all 77 of these points without realizing I’m talking aboutyou. That goes for me, too.”