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What Powerball, Stocks, And Contrarianism Have In Common

“You’ve got to kick fear to the side, because the payoff is huge.” – Mariska Hargitay We all know that the lottery is random, and that the odds are one in 292 million. Maybe you’ll get lucky and win it all, or maybe you’ll split the payout because multiple people luckily choose the same winning numbers. But keep in mind that the higher the lottery jackpot goes, the more likely you are to split the pot with others. Lottery participation is not linear. Every new dollar increase in the jackpot game after game does not bring with it a set new number of people who play. Rather, the larger the jackpot, the more exponential the number of people who play becomes. That means the more attention the lottery gets, the odds of splitting the payout with others actually increases. Meaning if you really want to play the lottery, the best way to do so given the same odds of choosing the right numbers is actually to bet on a jackpot that is high, but not high enough to attract a large number of new players. And this relates to the stock market how? The more an investment is talked up (largely because that investment has already moved and made a boat load of money), the more likely you are to split the payout among others listening to the same reasons to buy that particular investment. The more people know about a big payout, the more likely you are to split the pot and not make as much as you hoped. There is a high correlation to the amount of attention the Powerball and stock market gains receive from the media and the jump in the number of new entrants who come in afterwards This is where contrarianism comes into play. Few people pay attention to losing investments. Those who do will often be too scared to buy in after a large drawdown, even though the very definition of “buy low, sell high” is based on those depressed prices that happen peak to trough. Some will argue that if a stock, asset class, or strategy is down, it must be down for a good reason. As we know from several quantitative studies of markets, however, that “good reason” may be either 1) legitimate, 2) random, or 3) based on a cycle that simply doesn’t favor that investment. We show the latter point as being a major one in our award winning papers related to predicting stock market volatility. Being a contrarian isn’t about going against the crowd. It’s about betting on a jackpot which few other players are betting on, so the odds of you splitting the payout are much lower. Let’s apply this to today’s market. Ask yourself very simply – where have most people overweighted their portfolios? What is the overarching narrative? Where are most people betting? Likely on the “cleanest dirty shirt” on the global landscape, which is the US stock market. Why? Because Fed policy and the Age of QE, combined with ever faster information flow from the internet has resulted in a similar Powerball mentality among a large portion of the investor landscape. Make no mistake about it – though we may hear stories about investors “selling” US stocks (NYSEARCA: SPY ) in this volatility, you can’t unwind 5+ years of divergence from the rest of the world in 5+ trading days. Where does the contrarian look to now? Reflation through a bounce in commodities (NYSEARCA: DBC ) and emerging markets (NYSEARCA: EEM ), both of which no one seems to want to buy a ticket on. Of course that doesn’t mean you buy that ticket right here, right now. But that also doesn’t mean you should ignore what on the surface looks like a low payout right now. 6 11 19 48 54 06 QP

Strategies For Coping With A Volatile Market

It’s easy for stock investors to be lulled into a false sense of security when everything is going their way. The past year, however, has brought reality back to the table and is evidence of the fact that stocks don’t always grow unfettered into the sky. Whether the bump in the road that stock investors are experiencing proves transient or longer term in nature, it does serve as a reminder that various risks abound in the global economic marketplace, and that nothing should be taken for granted. Manage Expectations During a Volatile Market While many investors get into the market expecting to make huge sums of money over a relatively short period of time, history would indicate that that is an overly optimistic frame of mind. Backward looking market returns over the past century have collectively averaged in the upper-single-digits per annum. Investors taking a passive index approach who are expecting to double their money every five years, like they may have post financial crisis, may have found the 2015 market as somewhat of a rude awakening. Of course, if you have a portfolio loaded with FANG stocks (Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and the like), you may have done exponentially better than average near term. Chasing returns, however, rarely ends well. In the late 90s, sell-side stock analysts creatively encouraged investors to buy into weak stories they felt held promise simply because of their relation to the Internet. Some abandoned “old economy” stocks and embraced every “dot com” or technology infrastructure enterprise they could get their hands on. There were survivors, but as we know, many succumbed to their flimsy business models. Further, stock prices became so out of whack in many cases that it has taken more than a decade for survivors to build back capital sacrificed during speculative times. Concentrated portfolios may provide more upside potential, but the counterpoint is that much can be lost and never regained if one becomes too speculative. Today, with the market trading on the high end of an expected valuation spectrum, even more conservative expectations may prove optimistic. Newer investors or those with short-term memories should refer to index performance during the so-called “Lost Decade” from 2000-2010 for evidence on how price can stagnate. Asset Allocation Given recent volatility, investors with overly aggressive equity allocations – either by merit of stock type or sheer amount – may be losing a bit of sleep or feeling a knee jerk reaction to sell. While that may be somewhat normal, it might mean that the portfolio is in need of some housecleaning. Decreasing allocation to equities and increasing it to fixed income, cash, or potentially some other hard asset may be just what the doctor ordered. More balanced allocations help smooth the volatility of a mostly equity portfolio and may help to decrease a knee-jerk reaction to sell assets potentially at the worst of times. While this may decrease your total return potential over the long term, it will promote less personal angst when the market decides to turn against your portfolio. Conventional wisdom says that investors should stick to a plan and ride out the rough times – no matter how severe. The problem is that conventional wisdom is not a guarantee. Each and every dime you expose to equities is a dime that you are putting up as risk capital. Though it may stand to reason that shares of Microsoft will be higher in one decade, Microsoft will not be guaranteeing that fact, nor will the party that you are buying shares from. While it probably isn’t realistic to assume that Microsoft will go out of business in 10 years – rendering its equity worthless, no investor should be willing to bet their life that profits will necessarily be leaps and bounds higher either. In times past, companies like Bethlehem Steel, Eastman Kodak (NYSE: KODK ), and other household names were considered “widows and orphans” stocks, the kinds of investments that were bulletproof, set it and forget it ideas. As we know times change, economic conditions fluctuate, and an organization that can’t compete effectively can end up in the bankruptcy bin. The investment space isn’t as foolproof as it once was. Market volatility is not always easy to get through. Arguably, the financial crisis was the scariest episode of economic history since the market crash of 1929 and the pursuant Great Depression. Though we were able to sidestep a potential catastrophe there, the sheer experience should serve as a reminder that stocks present an economic vulnerability beyond the individual investor’s control. Though the downside potential can be easy to forget amidst a bull run, it should not be forgotten or ignored. Understanding the realities behind fluctuating-value assets, maintaining reasonable expectations with that which you are investing in, and allocating assets in balanced fashion commensurate with life stage and risk tolerance are all free ways to get you sanely through volatility. With today’s economic uncertainties and rapidly moving markets, volatility should not be just anticipated, it should be expected. Original Post

1704 On The S&P 500 In 2016? Less Far-Fetched Than Investors Want To Believe

How does a favorable bullish uptrend become an unfavorable bearish downtrend? Does the transition happen overnight? Do commentators, analysts, money managers and market participants simultaneously concur that the environment for risk-taking is exceptionally poor? The transition from “good times” to “bad times” is far more gradual than many realize. Granted, prices on the Dow or the S&P 500 may fall apart in a matter of days, changing the narrative from “no reason to worry” to “don’t panic.” That said, there are a wide variety of indications that forewarn mindful investors six to twelve months in advance , including consecutive quarters of corporate profitability declines, economic deceleration, and waning participation in price gains across the majority of assets and asset types. 1. Corporate Profits Have Been Breaking Down For Quite Some Time . Peak profitability for the S&P 500 occurred with the third quarter results of 2014 (9/30). Operating earnings that exclude “non-recurring” charges like one-time losses and loan write-downs came in $114.5; reported, or actual earnings, came in near $106. Not only will operating earnings decline for two consecutive quarters on a year-over-year basis for 12/31/2015, but reported earnings will decline for three consecutive quarters on a year-over-year basis (i.e. Q2, Q3 and Q4 in 2015). An earnings recession – two consecutive quarters of year-over-year declines is a bad omen regardless of the earnings type that one looks at. According to one researcher, Keith McCullough, two consecutive quarters of declining profits always result in bearish price depreciation for the S&P 500 in the subsequent year. Similarly, I have pointed out in past articles that a relationship between a manufacturing recession via erosion of the Institute for Supply Management’s PMI strongly correlates with declining earnings per share (EPS). In other words, as much as cheerleaders look to play up ex-energy (EPS) or the 65%-70% service-oriented (ex-manufacturing, ex industrials, ex transports) economy, overall S&P 500 profitability weakness goes hand-in-hand with overall economic weakness. The last two bear markets tell the tale. Back in 2000, bulls continued to push the idea that consumers were resilient and forward earnings projections (ex tech) looked phenomenal. They missed the bearish turn of events entirely. Back in 2008, bulls opined that forward earnings estimates (ex financials) were attractive, and that manufacturer health was irrelevant. They missed the housing bubble as well as its subsequent bursting. Here in 2016, bulls are confident that the U.S. can shake off $30 oil, energy company stock/bond woes, a manufacturing recession and a sharp global economic slowdown without a 20% drop for the Dow or S&P 500. Unfortunately, there’s more to the story. 2. The U.S. Economy Continues To Slow And The Global Economy Is Getting Worse . In 2014, I talked about the best way to participate in a late-stage bull market. In June of 2015, I advocated lowering one’s overall allocation to riskier assets . Bearish? Cautious would be a more appropriate description for downshifting from 70% equity exposure to 50% equity exposure. One of the key reasons for reducing risk had been the consistency of the downtrend in the global manufacturing. Here is a chart of JP Morgan’s Global Manufacturing PMI that I described in numerous pieces in the summer of 2015. It should not come as a surprise that U.S. corporate earnings peaked near the top of the PMI Index level in September of 2014. Since that time, a super-strong dollar strangled profits as well as U.S. exports. Meanwhile, Fed “de facto” tightening via tapering asset purchases throughout 2014 coupled with its direction shift in overnight lending rates in late 2015 have strained gross domestic product (GDP) growth. Even worse, Russia and Brazil are fighting off nasty recessions. Japan is there as well. China’s slowdown may be accelerating. Oil producing nations are close to falling apart on $30 oil. And expectations for Europe continue to sink, as debts pile up and international trade diminishes. Indeed, it’s not difficult to spot the pattern on global nominal year-over-year GDP. When it’s negative, market-based asset prices, including those in the U.S., are more likely to deteriorate. What about the constant drumbeat that sensational U.S. job growth proves that the domestic economy is healthy? Not only are the majority of new jobs low-paying, part-time positions, but the erosion of 25-54 year-old workers from the labor force – from 83.5% in 2008 to 81% in 2016 – represents millions of non-retirees who are not being counted. What about the notion that the U.S. consumer is resilient? According to a wide range of resources, including data at Federal Reserve web sites, personal consumption expenditures (PCE) is the primary measure of consumer spending on goods and services in the U.S. economy. Some would say that PCE accounts for nearly two-thirds of domestic spending, which would make it a significant driver of economic growth. Here’s the problem. Year-over-year percent growth in PCE has been declining steadily since May-June on 2014, which is roughly in line with more significant reductions in the Federal Reserve’s asset buying program (QE3). 3. Weakness in Breadth Of U.S. Stock Market As Well As Majority Of Asset Types . By May of 2015, when the S&P 500 hit its all-time record (2130), investors had learned that reported profits had declined on a year-over-year basis – 3/31/2015 ($99.25) versus 3/31/2014 ($100.85). In the same vein, by May of 2015, investors were privy to significant deceleration in Global PMI, U.S. manufacturer woes as well as dissipating personal consumer expenditures (PCE). Yet there was more. The NYSE Advance/Decline (A/D) Line seemed to have peaked in late April. From late April through the August-September correction, the number of declining stocks outpaced the number of advancing stocks. In fact, in late July, market breadth had grown so weak, the A/D Line fell below its 200-day moving average for the first time since the euro-zone crisis – four years earlier. What’s more, less than 50% of S&P 500 stocks could claim bullish uptrends. Equally disturbing, the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ), the iShares Transportation Average ETF (NYSEARCA: IYT ) as well as small caps via the iShares Russell 2000 ETF (NYSEARCA: IWM ) had already entered corrections; all had dropped below respective long-term trendlines. In other words, market breadth was extraordinarily weak. Obviously, a great many folks believed that an October snap-back rally had terminated the volatile 12% correction that occurred in the summertime. Not only did the S&P 500 fail to recover the highs from May of 2015, but virtually all asset types never made it back. And now, most of those assets are actually lower than they were at the August/September lows . Take a look at the widespread carnage that extends far beyond the S&P 500 or the Dow. U.S. small caps in the Russell 2000 (IWM) reside near 52-week lows. The same holds true for commodities via the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ), Europe via the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) and emerging markets via the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). Still choose to believe that rapid deterioration across asset types as well as within U.S. stocks themselves is irrelevant? Perhaps some data from the wildly popular Bespoke Research team might provide additional perspective. Internally, the average stock in every U.S. stock classification has already fallen more than 20% from a 52-week high (through 1/11/2016), meaning the average stock is in a bear market. Think this is a mathematical slight of hand because of energy stock depreciation? Wrong again. Every stock sector with the exception of consumer stables and utilities – safer haven assets less tied to economic cycles – is down more than the 20% bear market demarcation line. Is it possible for Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOG ), Facebook (NASDAQ: FB ), Microsoft (NASDAQ: MSFT ), Home Depot (NYSE: HD ) and a host of influential companies to keep market-cap weighted S&P 500 ETFs like the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) from sinking 20%? It’s possible. Is it likely? Not unless the Fed has a change of heart on the direction of its monetary policy and not without unanticipated improvements in both corporate profits and the global economic backdrop. For Gary’s latest podcast, click here . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. 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