Surprise: Long Term Equity Trends Intact

“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.” – William Feather, Author of: Business of Life (1889-1981).

While chatting with a friend, who works at a large wealth management firm in San Francisco, I wanted to hear his take on whether we have seen a market top in stocks. He answered “…how many times have we asked this question in the last five years?”

This truly has been one of the most hated bull runs in history, and a stubborn question has been stuck in investors mind about whether we’ve reached a top. This skepticism coincides with all major US stock indexes being at all-time highs. The last time this condition was seen back in 1999, we all know what followed: the tech bubble crash.

In addition to stocks, real estate and fixed income markets have been in an extended uptrend as well. The only major asset class that hasn’t joined this party has been commodities.

By some valuation factors, stocks, along with real estate and fixed income securities, are too expensive to invest. For some market participants, global economy is losing steam if not approaching a recession. This sentiment is supported by data flowing from countries in Europe like Germany, which is at borderline recession and fighting negative interest rates. A similar situation can be seen in Japan. The situation is even sketchier in the United Kingdom as the Brexit boat is undocking to leave the European Union, and this surely hasn’t helped the economic projections of the island’s economy for the near future.

We have been in a growth cycle since 2009, which makes 2016 the eighth year in the current one. On average every six years a recession knocks on the US economy’s door. To add insult to injury, presidential election is fast approaching and the FED is getting ready for a rate hike. Who in his or her right mind would have a bullish view in the midst of all this?

Well, I guess I will cautiously be one of those crazies arguing for further growth in stocks and the US economy.

By no means do I dare to suggest that a 5- 15% pull back in stocks is inconceivable. On the contrary, now that we are in the last third or the second half section of a secular (long term) stock market up trend cycle, I do believe short and shallow corrections will be more frequent and volatility will rise.

The legendary economist John Maynard Keynes famously said “When information changes, I alter my conclusions. What do you do, sir?”. I try not to fight the FED, the trend, and facts, so I will change my mind when presented by information that suggests otherwise, but currently, I conclude a longer-term equity price appreciation hasn’t reached a capitulation phase – just yet.

Why is this? Please read on.

Accommodative Monetary Policy

In addition to the US Federal Reserve Bank, the European Central Bank, the Bank of Japan, and Central Banks of the UK, Switzerland and Canada, have been implementing their own versions of accommodative monetary policies. Add to this, Chinese interventions to stimulate growth and similar tactics implemented by governments and/or central banks around the world, and it is easy to determine that we are in an era of global accommodative monetary policies.

Even though the effectiveness of these policies has been diminishing, and going forward, fiscal policies will be needed to replace them, a dovish central bank still creates a stock friendly environment.

It would be stating the obvious to say that the US Federal Reserve is getting ready to increase interest rates, which scares many investors as this, in theory, is not only bad for stocks, but also fixed income securities, real estate and business in general. But it is important to note that neither inflation nor the economy is heating up to a level that would back the Fed in to a corner. In fact, the current sluggish growth environment allows for plenty of patience.  There is more than a 50% probability for a December rate hike, but a speedy increase is a low probability event, and this is more important than the timing. Since the current starting point is close to zero, there is some room before new levels start hurting the stock market strongly enough to push it to the next bear cycle, though the reception of information will surely result in volatility.

Another important point is that a rate hike would suggest that the economy is strong enough for such an action on FED’s part, which would justify expectations for further earnings growth and valuation expansion.

The US Economy

Another reason why the existing uptrend may have further legs, is that the economic data currently doesn’t suggest a recession. As long as the leading indicators and coincident economic figures point to a non-recessionary period, the chances of being stuck in a deep bear market is, historically speaking, low. Plus, being a leading indicator, the stock market would see a recession approaching and kick start a correction, well before the recession is officially announced. Once again, based on leading indicators, even though growth may tend to stay below average levels, the probability of a recession seems low, which supports the uptrend.

Length of Previous Cycles

As indicated above, a typical business cycle lasts anywhere between 5 to 7 years. With 2016 being the eighth year in this current business cycle, it raises eyebrows. I, myself, am a believer of studying historical trends (aka technical analysis) but the devil is always in the details. Not only the duration of a cycle, but also the level of growth in the cycle is a factor to consider.

Wages have started going up only recently and we still haven’t recovered in aggregate terms matching past recoveries. My point here: current below average growth creates a potential for an elongated business cycle. To reach historical averages, at current growth rates, the economy needs another three or four years to catch up.

Relative Valuations

Having said this, good reasons to be skeptical of continued growth are high valuations and how expensive investments have become. There is more than one way to look at this, and by some absolute calculations, stocks are in a bubble territory. However, when you look at relative valuation measures (stock returns in relation to returns from other asset classes), one gets a different result. In other words, when investing in Treasuries become cost prohibitive in a rising rate environment, and the sweet deals in real estate are harder to come by, a high dividend paying stock may appear more attractive. To gain some perspective, operating price/earnings ratio of Standard & Poor’s index is now around 20, which was around 50 in 2000, before the tech bubble burst.

Past Market Cycles

Last two long-term (secular) stock market periods were between 1942-1966 (24 years) and 1982-2000 (18 years). Current bull cycle, which started in 2009, is in year eight, and it could very well be in the second half or two thirds of a secular cycle. In other words, based on historical periods, the current cycle might very well have more time to run.

 Emerging Markets

Overseas markets such as China, India, South America and Japan, may start seeing reversal of their past downtrends, which will most likely help US markets. This view has already been supported by recent traction seen in these markets. It may also be important to note that more than 50% of Standard & Poor’s company earnings come from overseas. Recent stabilization of the US dollar has created a tailwind for these markets. This is good news for globally diversified investors.


Leaving best for last, full employment, increasing participation rates, wage increases, spillover effects of the price appreciation in stocks and housing, low commodity prices, low inflation, and low interest rates, all contribute to the relatively decent shape the US consumer is in. The US economy is 80% consumer driven. The state of the sentiment in this area is extremely important. The reasons I have listed above may go back and forth in mild rates, but a major change doesn’t appear likely in the near term, which supports the consumer theme being intact, as well as the economy and the stock market.


In summary, I am still cautiously optimistic about the US economy and its stock market, and I believe that the uptrend is intact. At all-time highs, markets are exposed to shocks and higher volatility. These shocks will probably be shallow and short-term, which should be seen as buying opportunities until proven otherwise and data points to a different direction.

Thanks for reading my commentary and as always, you can reach me at for questions and comments.



The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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First Half Report, Brexit and More

“Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.” Hyman Minsky

At first glance, the US stock market performance in the first half of 2016 can be summarized as a “all hat no cattle” type of action.

Put in other words, a sideway trend has been the name of the game, with a lot of volatility, only to end back to square one for large US stock indexes such as S&P 500 and Dow Jones.

The S&P 500 is almost flat with a 2.69% gain and an 11% drawdown, while Nasdaq finished down by 3.29% with a 16% draw down during the first half.

The story is quite different in European and Emerging Market stocks, and most importantly, in bonds.

Europe closed the first half (Symbol EZU) down 7.91% and Emerging Markets (Symbol EEM) up 6.74%…meanwhile we saw significant bond returns, a 20 Year Treasury Bond ETF (Symbol TLT) gained 15.19% in market value.

For those who are new to my market letters: bond values are inversely correlated with interest rates. As the interests (yields) drop, outstanding bonds with relatively higher interest payments become more attractive investors, and gain value.

During the first half of 2016, interest rates and bond yields have come down in historic ways with no precedence. First time in its history, 10 year German treasury bonds hit negative interest rate territory. US mortgage rates are at historic lows. All this signal a tremendous amount of worry in the market, waiting for a big drop in stock values, or risky assets in general.

Bill Gross, aka the Bond King, came out in the past few weeks and said (paraphrased) “…and so the returns of the last 40 years, may only be found in Mars in the upcoming 40-year period.”

Why so?

Why is there so much fear in the market?

Why do the investment returns of the past 40 years seem a difficult target to reach?

Stretched Valuations

Well, let’s start with stretched valuations. Albeit in varying degrees and timelines, the FED and all other major central banks around the world have been throwing money at the slow economic growth problem, and help push the global debt of all types to $199 trillion, a $57 trillion increase between 2007 and 2014 (Source:  Mc Kinsey Global Institute Report 2015).

The approximate $60 trillion increase in global debt since 2007 has been translated in to inflated asset prices, hence the reason for stretched valuations, especially in stocks and real estate.

Are stock valuations in bubble territory? Measured by major US indexes’ price to earnings ratios, no but definitely at the upper end of the range, eerily close to the bubble territory. For stock values to go further up, one of two things need to happen: a) valuations to stretch in to bubble territory, or b) corporate earnings to improve.

For earnings to improve, ultimately the economy has to grow, and 2016 estimates have been lowered to around 2% in 2016 US Gross Domestic Product.

So, with high valuations and slow growth, it is hard to be a champion of robust equity returns, at least on a risk adjusted basis.

There is some good news from the rising or stabilizing energy prices, which many investors use as an indicator of growth and bring new funds to investments as a result.

Other Macro Trends

In macro trends, I see mixed messages in almost everywhere I look.

Take dollar for instance. The 2016 Gross Domestic Product estimates are slashed by major institutions such as the IMF, World Bank and large research firms. One culprit is the strong dollar, which hurts exports. Usually strong dollar lowers inflation and is good for the consumer but input prices being under deflationary pressures, a strong dollar’s current negatives outweigh the positives.

FED action is another area of concern and also full of mixed messages. A sluggish economy is bad news, but allows the FED to move slowly towards its higher interest rate policy. The market is confused on how to read this…an accommodative FED is good, but a slow economy is bad…so…what a man to do?

At the end of the day, albeit slowly, the economy is growing and supports the mildly and cautious bullish outlook in stocks for those who can stomach the volatility that comes with it, as 2016 first half performance being a case in point.

This outlook is probably good for another 6 months, and to be revised after election results…(more on the US elections below).


During a client portfolio review, I found myself saying “…it is not so much the economic risks that worry me, but the political uncertainties.”

Brexit is a case in point.

British establishment politicians, led by Cameron, challenged the Brexiters by offering a simple “yes” or “no” referendum…most likely with a lot of assurances of a “remain” vote.

I speculate this assurance was so convincing, that even the Brexiters themselves thought a “leave” vote would never happen, at least in the short term.

A referendum would just earn good political credits for Nigel Farage and Boris Johnson.

Now, it feels like, the unpredicted result of a “leave” vote is so shocking, and the price tag of its consequences are so high, that it is followed by PM Cameron’s resignation, and winners’ hesitation from declaring victory. Nigel Farage has stepped down from his party and Boris Johnson announced that he wouldn’t run for the PM position.

Now why on earth would a politician do that?

I speculate because they don’t want to go down in the history books as the people who broke the UK, exited the EU and paved the way to an economic and political crisis in their country.

How does all this news affect us?

Other than the immediate shock, the political uncertainty and economic slowdown it will bring to the UK during the drawn out exit process of 2 may be 3 years…not much.

UK contributes only 3% to global economic growth…so a 2-3% drop in their Gross Domestic Product would make financial news for sure, but wouldn’t trigger a global recession.

Scotland and Ireland may leave the UK as they voted to stay in the EU, and that possibility alone may weigh on economic and market performance. But still, it wouldn’t trigger a domino effect leading to a 2008 type of scenario for the same reasons listed above; too small when put in global scale.

Brexit did one thing that might be contrary to some’s intuition; it brought pessimism and weakness, enough to create value and potentially set the stage for the next bull run.

Bad news, followed by panic selling sometimes create the best opportunities…as long as the news doesn’t linger like a bad tooth ache.

The US Presidential Elections

This year’s big whale in the pool is the US presidential elections. Historically, Dow Industrials do significantly better when the incumbent wins. So far, the market has been pricing a Democratic Party (incumbent) victory. So as we approach the election date, the potential for a Republican Party win may trigger a correction to the downside…something to watch for.

Thanks for reading my commentary and as always, you can reach me at for questions and comments.



The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

Leave a comment

The Key Question Is…

“If you can’t explain it simply, you don’t understand it well enough.” Albert Einstein

Hello tax season survivors. In this commentary, I will do my best to explain the current state of capital markets as simply as it would please Einstein, and dive deeper as I move along.

To gain a big picture perspective, let’s look at the sentiment towards the end of last year:

  • With their easy money policies, the central banks around the globe, especially the FED, have pushed all asset prices higher, punished savings account owners by turning “cash to trash”, gave investors no option but to take risk…and as a result major stock indexes in the US have seen all-time highs.
  • These high prices resulted with stretched valuations and it had become harder and harder to find good value in stock investing.
  • Earnings growth slowed down, corporate profits started to decline.
  • Driven by Chinese slow down, global demand softened, which pushed energy and commodity prices, along with capital expenditures, down.
  • FED was going to begin the tightening cycle and increase FED funds rate four times in 2016, adding up to a 1-1.5% increase. This was going put a tighter leash on both stock and bond markets.

So in short, along with high prices and weaker demand and earnings, the market was set for a correction…and that’s precisely what had happened.

Between November highs and February lows, the SP 500 index lost over 13%. If you date back to July highs, the loss is more like 15%. Other indexes have been struggling and waiving the red flag since the summer of 2014. For example between the beginning of July 2014 and Feb 11 2016, energy lost -69%, emerging markets -32%, Eurozone -24%, Japan -18%. In other words, a global correction has been under way since the summer of 2014 and the US stock markets had caught up with this trend by late 2015.

Since mid-February though, a rebound has been underway. Oil prices have bounced from 30 to 40 dollars range, major US indexes have recovered almost all of their losses, many US companies have been posting positive earnings surprises, market breadth has improved (the rate of total number of rising stocks to total number of falling stocks) and the fear of a global economic recession has been put to rest, at least for now.

Here comes the key question: is the recent bounce a dead cat bounce, a bull trap, or the beginnings of the next bull cycle?

Depending on one’s answer to this question, he/she should move to cash right now, or increase stock exposure.

Here is one big picture aspect of the markets, which I’ve talked about many times in the past. Markets, whether it’s currency, commodity, stock, bond or real estate market, tend to have a longer term trend, with shorter term counter trends within it. To define long and short term, this view determines roughly 5 to 20 years as long, and 1- 3 years as short.

No long term trend, also known as secular trend, is immune to shorter term, also known as cyclical counter trends. In other words, a 15 year bear market may have cyclical bull periods of a year or two within it. Naturally, these counter trends tend to leave a lesser of a mark than the longer term, or secular trend.

To revise our key question, if one believes that the longer term stock bull market that has started in March of 2009 is intact and the recent drawback is temporary, than the next cyclical bull market within a secular bull market may have started. If conversely, the longer term bull market is broken, and what we have seen since February is a bull trap, than we might be at the earlier stages of the next longer term bear cycle.

Clearly, we can call these dates and trends always after the fact …but managing investments require positioning assets based on probabilities and making changes as needed. Unfortunately we don’t have the luxury to wait until answers to these questions are abundantly clear. In the world of investments, there is no value in information known to all participants, except for their contribution to the historical perspective.

So if you go to cash, you might miss the next bull run. Conversely if you increase stock exposure now, you might lose some or all of your gains since 2009.

I think this much can be said with some confidence: the easy money has been made, and going forward one has to accept volatility as part of being in the game. If that’s not your cup of tea, this might be the time to consider a risk off strategy for your portfolios.

Moments like these remind me the scene from the musical Fiddler on the Roof, in which Tevye, the main character, talking about tradition, says “For instance, we always keep our heads covered  and always wear a little prayer shawl. This shows our constant devotion to God. You may ask, how did this tradition get started? Let me tell you. I don’t know…”.

Well, I am paid to have an opinion and turn those opinions in to action. So unlike Tevye, I don’t have the luxury to say I don’t know…but I do recognize that both sides of the argument have valid reasons to stick to their guns.

I believe we have a few more years in this stock bull market. After that, I have concerns.

The main reason why I believe there is still room for price appreciation is that attractive valuations in different pockets of the market, and willing investors to exploit those opportunities are bountiful.

On the other hand, the reason why I am concerned is the lack of ammunition left in central bankers’ arsenal in case of an economic recession.

Speaking of which, let me share this with you: the longest period in the US economic history with no recession is during the 1991-2001 period. In every other case, on average, the US economy has experienced a recession every 5-7 years. Since we’ve been in an economic growth period for 8 years now, by the end of 2018, anticipating a recession wouldn’t be unreasonable.

In such incidents, governments have two resources available to them: monetary and fiscal policies. Monetary policies are driven by the central banks, mainly by managing the amount of liquidity through interest rates, reserve requirement etc. Fiscal policies are driven by the congress through tax policies, regulations, subsidies etc…

Currently, there is almost nothing left for central bankers to do in case of a recession. Rates are as low as they can get. The speed of a reaction is as important, if not more, as the reaction itself. That’s why the central banks, being able to make decisions faster than the congress, are critical in these circumstances.

Finalizing fiscal policies by congress may take months of negotiations and the damage may be done by then.

That’s why, I want to say that the long term/secular bull market is intact, have more legs in this rally and so one should increase stock exposure.

But I am being cautious because the underlying economic strength isn’t there and even though slow economic growth may be enough for the markets to move higher by further stretching valuations, any headwind could cause a fast reversal.

In terms of where to increase exposure to, look for better valuations in the emerging markets, Europe and recently beaten down sectors in the US. Previous winners may be too late to look for gains in the next 6 months or so.

Also bear in mind that we are in an election year and post elections, uncertainty may subside and leave room for another wave of tailwinds for the risk on trade. It also can rock the boat a bit till November.

Thanks for reading my commentary and as always, you can reach me at for questions and comments.


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

Leave a comment

Looking Ahead to 2016


“Chaos isn’t a pit. Chaos is a ladder. Many who try to climb it fail and never get to try again. The fall breaks them. And some are given a chance to climb, they cling to the realm or the gods or love. Only the ladder is real. The climb is all there is.” – Littlefinger, Game of Thrones

On May 21st, the S&P 500 index hit an all-time high, 3.5% above December 31st close, only to drop 12.35% in the following three months.

A similar and even deeper fall occurred during the summer of 2011, a loss of 17.6% in the same index.

But between these two incidents, 2011 and 2015, there hasn’t been a correction over 10%. This uptrend with no breaks had brought valuations to a stretched territory and susceptible to a correction.

Looking at other major indexes and Exchange Traded Funds, the recent 12.35% drop in the S&P 500, was 14.44% in Dow Jones, 13.65% in Nasdaq, 28.98% in Emerging Markets ETF (EEM), 17% in Gold ETF (GLD), 17.78% International Developed Markets ETF (EFA).

In bonds, the loss was 3.4% in 20 Year Treasury Bonds ETF (TLT) and 3.7% in Aggregate Bond ETF (AGG).

Commodities have been in a straight downtrend since June 2014 and the drop is 53.65% from top to bottom.

It has been a difficult market to find positive returns…as stocks, bonds, precious metals and commodities all have been hit hard lately.


The main culprits have been widely viewed as: the FED fears, global and more so Chinese economic slowdown, oil glut, stretched valuations and strong US dollar.

So looking ahead globally and in the US, what to expect and what should be one’s investment strategy in 2016?


The recent drop in equity prices cooled off valuations a bit. Absolute valuation (stand-alone) matrices have been showing stocks as mostly expensive, relatively (to bond yields) fairly valued and cash adjusted within historical averages.

Cash adjusted valuation adjusts the valuation of your stock investment for the cash the company has at its disposal. US large corporations have piled 2.5 trillion dollars of cash and when you invest in them, you get to own a portion of this asset as a shareholder, hence the reason why cash adjusted valuation makes equity prices seem more reasonable.

Where will this cash be spent in 2016? Most likely the past trend will be repeated and it will be allocated to stock buy backs and dividends.

When a company buys its own stock, it lowers the number of available shares. This improves earnings per share without increasing earnings. So even though company earnings don’t improve, its stock valuation gets a boost.

In aggregate, when these funds aren’t invested in capital expenditures or research and development, the economy doesn’t reap their benefits, but investors are rewarded through dividends and buy backs.

Global Stock Markets

The weakness we’ve been seeing in the US equities is a global phenomenon, in some cases even more seriously. But more recently, breadth (percentage of the world stock indices with rising moving averages) is improving and signs of a recovery may already be here.

Japan and Emerging Markets, specifically India and China has more room to the upside as unlike the US stock market with shallow corrections, they have been hit hard. But again, they also carry higher risk, so think twice before you overweight.

US Dollar

A strong US dollar is one of the reasons for headwinds, as it makes US exports more expensive and puts pressure on foreign earnings. Has dollar reached a peak? I doubt it.

Knowing that we are probably only about a month or two away from the next FED rate hike, historical US dollar movement around past rate hikes can be a guide here. Considering the weakness in the global economy, European and Asian central bankers’ rate hike decision is a low probability event. So relatively, the dollar may seem more attractive and continue its strength. Given that the rate hike pace is expected to be slow; the trend in dollar strength may be sustained.


If you’re wondering whether or not the bear market since 2014 has created a buying opportunity in commodities, think again. Technical support levels have been broken and there is no reason to think the reversal is near. This is good news for consumers, but bad news for commodity driven industries.

Bubble Economy?

Are we in a bubble, closer to the end of the growth cycle?

It is understandable to look at historical averages and wonder if a recession is here, knowing that historically about every 5-7 years, the US economy finds itself in one.

According to this approach since the growth cycle started in 2009, next year we should start feeling the heat. According to National Bureau of Economic Research, since the Great Depression in 1929-1933, the longest growth cycle was for 10 years (1991-2001) and the shortest was for 1 year (1980-1981). So it may still take a few more years for the US economy to reach that point.

There is also the camp that argues FED’s next to zero interest rate policy has been artificially boosting asset values and once the tightening cycle starts, the bubble will burst.

Before I get to FED, I will say this: growth cycles don’t die because of old age and bubbles form mainly as a result of excessive debt. We live in a fiat currency and debt driven economy. In a usual business cycle, the borrowing goes to the roof and the debt payments become a burden on spending. As one’s spending is another’s income, falling incomes put pressure on growth and the economy goes in to a recession.

So the better question here is the level of debt, especially consumer debt. The answer is, nowhere near peak, in fact consumer debt to consumer financial assets ratio has been falling since 2009.

Also, other signs of an end of a growth cycle usually include high inflation, high interest rates and extreme optimism, none of which are present at current time. In short, a recession in 2016 is a low probability.


Leaving the best to last, let’s talk about the FED. The most important player and its actions have been so closely followed; that it is hard to report news here. Most likely in December or January the rate hike will be resumed, and will continue through 2016. How will this affect the markets?

As mentioned previously, it really depends on the pace of the rate hike and most likely a slow pace is in the cards in which case, based on historical records, the market may actually continue the uptrend with some volatility for adjustment.

I hope you find this summary of global capital markets and my projections as helpful. Please feel free to send your questions or comments to

Also, have a pleasant Thanks Giving!


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What is Wrong with the US Stock Market?

“Life is pleasant. Death is peaceful. It is the transition that is troublesome.” Isaac Asimov


A client and friend asked why the current US stock market was having a hard time finding a path and if I saw this lack of a path as a threat to the global financial stability.

I started my reply with “In short…”, only to realize I had promised in my last newsletter, to share reasons to be bearish in my next newsletter and Eureka! Without further adieu: “6 reasons why US stock markets are having difficulty forming an uptrend.”

Reason 1: Transition from the Industrial Revolution to Information Age

We are at a juncture where multiple trends are ending and are in transition to the next. The biggest one of these is the end of the Industrial Revolution, which started in the late 1800s in England and probably lasted until the end of the 20th century. I use caution here as trends and cycles are difficult if not impossible to define while in them. Most of the political and economic concepts we live in or with, were either born or have grown strength as a result of this mega step in human history. The world’s governmental and economic systems are built to support this industrial life style based on production, transportation and consumption of goods, while supported by the banking system whose function is to turn profits into investments for businesses and lending for consumers.

And then, there came the technological revolution and globalization. In this new world, information and ideas may have become more important than having access to capital, as money is easily and readily available to invest in marketable ideas. Labor markets are global and therefore more competitive. National borders are less meaningful, as resources move faster than ever. Education systems, at least here in the US, fail to prepare the youth for the skills needed in this new economy. Automation is taking over human participation in production. Productivity growth no longer equals income growth. Since 1970’s incomes haven’t been able to keep up with productivity growth and the gap has been widening (except in the last few years because of falling productivity). With the use of computerized trading systems and financial engineering, risks and returns have grown exponentially. The level of welfare and the income distribution policies are a discussion for a heated debate, as haves can reach resources globally, while have nots end up competing against poorer parts of the world who are willing to work for much less.

As a result of this mega shift, there are 5.5 million job openings in the U.S. that can’t be filled, which was 3.5 million only two years ago. The capital markets and investors are trying to adapt to this new wave of technologies, business models and get a better sense of the present and projected valuations, while seeking balance in risk/return relationships. This tug of war between the past and the future is forcing the global economic machine and its capital markets to give errors in the forms of global financial crisis, massive computerized trading errors, discrepancies in valuations and increased volatility. Are these new challenges? No. But their magnitude brings us to an uncharted territory and at times, the capital markets act like a deer in the headlights. This long period with a sideway trend we have been in since November, could be one example.

Reason 2: Global Economic Slowdown

Are we in a global economic recession? No. According to the Organization of Economic Co-operation and Development (OECD), there have been 13 global downturns since 1960, last one being in 2011, with average length of 22 months. It looks like every 4-7 years, we go through a global recession and it wouldn’t be outside of historical averages if we experience a slowdown in the next 3 years. According to IMF calculations, global economic growth rate was 3.4% in 2014, estimated to be 3.5% in 2015 and 3.8% in 2016. So there is no global downturn currently or in the projected near future. However, it is not robust growth by any means and so it’s vulnerable to shocks. The strongest headwind for growth is the debt hangover. Governments and consumers are trying to pay down their debt as opposed to investing and spending, a minus effect on growth.

In most cases, when the US joins the international community and contributes to negative growth, markets react with a sharp decline. However, when the US is in growth mode while the rest of the world slows down, US stock markets typically go sideways. Given the problems in the EU zone and Japan, the slowdown in the Emerging Markets and US growth rate at around 2.5%, the sideway trend can at least partially be explained by the state of the global economy as a whole.

Reason 3: The Federal Reserve (FED)

We are in a central bank driven, multiple expansion based bull market. (Multiple expansion is paying a higher price for given earnings). Once the FED starts the tightening phase, we will be in a different zone and the US stock market’s reaction will depend on the speed of the rate increase.

Usually market tightening cycles start during an uptrend. Going back to all tightening cycles since 1946, the S&P continues the uptrend for another 4 months after the tightening begins (average of 5 cases). In the case of a fast tightening cycle though (7 cases) a sharp decline immediately starts with the tightening, lasts for 3 months to fully recover in 6

months (Source: NDR). So the speed of the hike is more relevant than the hike itself. Will the FED push rates up at a fast or slower pace? Most likely at a slower pace because the economy is growing at an annual rate of 2.3%, and the inflation rate that FED considers is at 1.8%. Slow growth, no inflation and lackluster income growth doesn’t give FED enough room to push the paddle to the metal. Even so, the markets are trying to adjust to the fact that probably the tightening cycle is only a few months away and as Isaac Asimov noted: “Transition is troublesome.”

Reason 4: Strong Dollar

It is usually a good sign when a currency strengthens. It shows that a country’s stability, the value given to its promises and its credibility are rising. It is however a headwind in the short term for the exporters as it makes the exported goods more expensive. About half of all revenues generated by the S&P 500 companies come from overseas. A strong dollar shrinks those revenues and makes it harder to increase market share. It is however also making imports cheaper, lowers input prices and so mutes the inflation. Since the US doesn’t have an inflation problem, the dollar strength isn’t helping. In time, a better and more efficient allocation of resources can and will usually fix this problem (which is good to have), but it does hurt growth while adjusting to it.

Reason 5: Low Energy Prices

Similar to a strengthening dollar, lower energy prices can be a good thing only if those savings were allocated efficiently elsewhere. The reason why it is a negative for now is that the energy companies are the largest contributors to capital expenditures (capex). Low oil prices mean low revenues for energy companies and low revenues mean low capex. Since one’s expense is another’s income, lower spending subtracts from growth. Also, their profit decline lowers their stock prices, adding more pressure to the market indexes.

Reason 6: Stretched Valuations

Valuation is how much one pays to a security for expected returns (capital gains and income) at the risk level of that return to materialize.

Currently, the stock valuations are a bit stretched. Not so much that major indexes are in a bubble territory, but they certainly are not fairly or underpriced. One area that is in bubble territory is the dividend paying stocks. Those seeking yield have been discouraged by the bond market and have found refuge in dividend payers, which made that space a bit crowded.

The market is more vulnerable to shocks with stretched valuations. There is still upside potential…but the volatility in prices is harder to handle for many investors.


The bottom line is that the bull market doesn’t end because it gets tired or it expires. It usually ends because of a recession, bubble type extreme valuations or extreme investor optimism. Currently, we are experiencing none of the above.

I have shared with you the reasons to be bullish and bearish in two market updates. Hope you have enjoyed – see you next time.


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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Markets Comfortably Numb, or Confused?

“It is easier to find man who will volunteer to die, than to find those who are willing to endure pain with patience.” Julius Caesar

If you think the stock market was down 5% since November, then up 8%, then down 2%…and it’s been on a trade mill during which time the end result performance has been flat for the last 8 months – you’d be correct (you’d get a very similar result with Dow Jones). In more detail:

On November 26th 2014, S&P 500 closed at 2072.83. Lowest we’ve seen this large cap US equity index that we call “market” hit since then, was on December 16th at 1972.74. The highest point was on May 21st 2015 at 2130.82. The drop from November to December was 4.8%, and the increase from December to May was 8%. On Friday June 12th, this index closed at 2,094.11, 1% above November 26th high!

Well, then bonds must have done relatively well, right? No…20 year treasury (Symbol TLT) index is down 2.9% in the same period (Nov 26 – June 12) and in fact down 6.3% year to date…

How about commodities (Symbol DBC)? Down 17.8% since Nov 26th and down 4.7% year to date.

US small cap equity index (Symbol IJR) is up 5.6% since Nov 26th and up 4.9% year to date.

Lastly, a safer bet in stocks, utilities is down 6.9% (Symbol IDU) since November.

Emerging markets (EEM) is down 4.98% since November 26th and developed internationals (EFA) is up 2.6% (Please note that I look at investable ETFs instead of an index as they are better indicators of money flow.)

So what does this picture tell us about the present and the future of capital markets? Short answer: it’s a mixed message. Volatile and yet flat, not knowing which direction to take. Let’s dive deeper.

The U.S. Economy

The good and bad news about the US economy is that it’s growing at a moderate paste, or one can call it a “sluggish growth”. This is good because we are far from recessionary pressures as some fear mongers would like to argue, bad news because it is below the historical averages and expectations.

Every period has phrases that become short term clichés and sometimes for good reasons. Last quarter’s cliché reward goes to “Extreme Weather Conditions and Port Disruptions”, which was seen as the main root of the negative real annualized GDP growth of 0.7% during the first quarter. (Notice how I used negative growth as opposed to contraction…it should say something about our addiction with growth). Market reaction to this news was a “meh”…for two reasons 1 – The cliché accurately described the main reasons behind the contraction and both conditions dissipated, which signaled an expected stronger second quarter as a result. 2 – By some measures, there was no contraction. For instance if you look at Gross Domestic Income (GDI), which in theory should be the same with Gross Domestic Product (GDP), as one’s spending is another person’s income. GDI grew 3.6% year over year versus 2.7% growth in year over year increase in GDP. The difference arises due to different data sources and these two figures converge in the long run. The gap suggests that GDP is not accurately capturing all the output in the economy and understating growth (Source: Ned Davis Research).

So first quarter contraction should largely be ignored and deservedly it was. The economy did slow down because of a shrinking shale gas industry, stronger dollar and the cliché mentioned above but there is a big question mark on contraction.

Second quarter and second half of this year is expected to bring stronger economic growth. I base this conclusion on forward looking indicators such as Purchasing Managers Index and most current data on revised retail sales to the upside, exceptional strength in auto sales, strong employment trends and rising incomes.

Stocks, Bonds and Commodities 

The mixed message from the main asset classes is probably the following: the longer term uptrend in stocks is likely to continue. Shallow declines should be seen as buying opportunities. Long term bull markets in bonds and commodities are likely to be over.

When the stock market goes sideways for 3-4 months let alone 8, unless a catalyst for a deep correction is on its way, it usually builds up for the next up trend. Why? Because this period frustrates the investor, bullish sentiment quickly fades, patience is replaced by pessimism and negative sentiment is bullish for stocks (just like extreme optimism is bearish). Negative sentiment is bearish because it signals a built up of potential buyers if and when the tide turns.

Along with an improving US economy, negative investor sentiment is likely to turn into a tailwind for the stock market during the second half of the year.

Those who have been waiting for a correction may not be aware but one form of a correction is a long side-way trend. Is 8 months long enough? We shall see.


A few take-aways from the market action during the first half of the year are:

  • Long term bull market in bonds and commodities might be over.
  • Second quarter US economy and second half stock market may perform better than the prior period.
  • Small cap out performance gives hope for a sustained uptrend.
  • Utilities under performance confirms the possibility of an uptrend. Why? Because as the market matures, the defensive sectors outperform growth oriented sectors (a rotation towards lower beta). Defensive sectors’ under performance keeps the bulls in the game.
  • International opportunities may out shine US investments, but for only those with patience and longer time horizon, as the timing of this switch is impossible to guess.

The contrary view to the market building for the next uptrend argues that the valuations based on price/earnings ratios are stretched, margin debt (to borrow and invest) is at extreme highs, we are coming close to the end of the business cycle, cash ratios are at extreme lows (everybody who is to be invested already is) and we haven’t had a meaningful correction (over 15%) since 2011.

In my next newsletter, I will expand on these bearish opinions because they are noteworthy. For now, the bull is still running, a little confused and tired may be, and so taking it’s needed rest, but until proven otherwise, a benefit of the doubt should be granted.

How to counter the bears and what to say about FED’s next move? That’s for the next commentary.


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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Macro Factors In Play

“It is better to be vaguely right than precisely wrong.” –   Wildon Carr, 1942


My last market commentary’s title was “Dollar Is Up, Oil Is Down, Stocks Get Confused”. If you’re wondering why I haven’t written a newsletter for the last few months, that’s because this analysis has been as valid as it was a few months ago. Since November 2014, stocks have been in a sideway trend, dollar has been climbing up and oil looking for a bottom at around $40-$50 per barrel.

Some investment strategists argue that at this stage of the bull market, the name of the game is picking individual investments instead of indexing. They put this forward by looking at breaking correlations among asset classes and securities. In the early stages of a bull or a bear market, correlations rise, related asset classes move in tandem. As the trend starts to mature, correlations break and stock/bond pickers become popular again.

Though there is some truth in this, correlations haven’t shown a sustainable divergence pattern, meaning, just when they seem to be on their own, a heavy hitter gets a seat at the table and a brand new set of cards are dealt. The US dollar, oil, cold weather, port disruptions, Janet Yellen and foreign tensions are the most noteworthy examples.

I’ll argue, macro factors such as mentioned above are still the dominant players and paying attention to them would be wise. British Philosopher Wildon Carr’s quote makes so much sense when applied to capital markets. A diversified portfolio by definition will have less than perfectly correlated securities and some of them will zig while others zag. If you call this being vaguely right, it surely beats being precisely wrong on a stock holding that is 100% of your portfolio. So please remember this before you get too comfortable with your individual stock selections and don’t dismiss your diversified portfolios entirely, but rather supplement your allocation with individual holdings to get the best of both worlds.


Oil has been, and probably will for a while be, a headline topic for market followers. It has lately settled in $40-$50 per barrel range with significant daily price fluctuations. I have recently seen a report on future oil contracts, an estimate of the future price traders are willing to pay, and it points to $30/barrel oil. I personally think $40 dollar is the near term floor simply because below those levels, there aren’t many producers that can survive without making money.

This is a double edge sword. Cheaper oil pushes prices down and as a result helps improve savings rate along with consumer confidence. On the other hand, troubled refineries and depressed levels of oil production put a cap on capital spending. This has already been seen in shrinking durable goods orders, which is a big red flag for the markets. In the long run however, once the savings come back to the system as investments or pent up demand, the lost production can be re-gained. So in the short term, lower oil prices may hurt production and capital spending, but increased savings can translate into investments and higher consumption in the coming months.


 Can you have too much of a good thing? Too strong of a dollar can surely be an example. The timing of the dollar strength has taken care of two interrelated worries for some: An overheating economy and inflation. If you remember, the 3rd quarter growth rate was 5%, which is high enough to cause inflation and push FED to move with their rate hike sooner rather than later. A stronger dollar lowered import costs and subdued inflation, while making exports more expensive and lowering large exporters’ profits. 4th quarter economic growth rate was 2.2%, clearly nowhere near overheating territory, accompanied by a 1.8% inflation rate. The strong dollar is not solely responsible, but surely had a role in it. In the short term, we may observe a reversal of this trend as there has been an excessive momentum behind the dollar. In the long term however, especially against the currencies where the central banks are implementing their own version of monetary easing, it is hard to see how the dollar can lose significant ground. If you’ve read about the Euro/Dollar parity, this projection refers to Euro and the US Dollar being equally valued, which would require the Euro to lose about 7%. That’s Goldman Sachs’ projections by the year end.


 Six years since the beginning of the recovery and the bull market, the biggest gorilla in the room has been the FED. There are two unstoppable forces I’d never knowingly (can’t say I haven’t made mistakes) stay in front of: the market trend, and the FED. I take pride in writing my commentary as an easy read in everyday language, but if the FED is the most important player and the timing of the rate increase is extremely important, then let’s make an exception and dive deeper into the statements of their last meeting.

In the US, the FED has two mandates, to keep the inflation at or around 2% and sustain full employment, which is 5.5% unemployment rate. So, since the current inflation rate is at 1.8% and the unemployment rate is at 5.5%, are we right at the doorsteps of a rate increase? No, not for another 6 months or so it seems, and here is why: NAIRU.

Not to be confused by Nibiru, the Babylonian god Marduk’s home planet, NAIRU stands for non-accelerating inflation rate of unemployment, meaning the unemployment rate below which inflation rises. In other words, once the unemployment rate goes below NAIRU, the FED would see this as an inflation warning and start sharpening their pencils to increase interest rates to fight inflation.

This unemployment rate, the rate below inflation rises, has historically been 5.2%-5.5%. The most recent FED statement lowered it to 5.1%. This is significant because it simply means the FED will not use unemployment as an excuse to raise rates until it reaches to 5.1%, not the previous estimate of 5.5%.

Also, if you add the part time employed to the unemployed number (U6), it is 11%, and all the more reason for the FED to delay the rate hike from June to September.

Extreme Weather Conditions and Port Disruptions

 While here in California we are dealing with a drought in historic proportions, the East Coast and Mid-West has gotten hit hard with extreme cold weather conditions this year and especially the latter has significant short term effects on the economy. When it is freezing cold, people shop less, certainly delay purchasing big ticket items such as cars, home appliances and real estate. To add insult to injury, strikes in major ports, especially on the West Coast, has slowed down or stopped all together the shipment of goods.

In aggregate, the US economy has slowed down more than anticipated and the markets have noticed. Like any other short term headwinds, these conditions have for the most part passed (except the drought) and the pent up demand will likely start adding to the economy in the coming months.

All these macro factors are affecting your investments in one way or another. With some exceptions, no individual holding is immune to macro regimes. A strong dollar lowers large US companies’ overseas profits, cheap oil makes it more difficult to profit from energy related industries, these two trends tie  in to interest rate and inflation expectations, and Janet Yellen’s statements are carefully watched by the markets.

The bottom line is that the uptrend in US stocks is still intact. So use the dips as buying opportunities, have a globally diversified portfolio, look for companies with wider access to domestic markets and rebalance periodically.

Hope you’ve enjoyed my market update. For questions or comments, please feel free to reach me at


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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