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2016 Forecast

January 6, 2016 by Angelo Gallo Leave a Comment

At the end of the year Barron’s Magazine gathers the opinions of well-known mutual fund managers to gather their economic/stock market forecast for the upcoming year. The forecast for 2015 called for the following: GDP growth of 3-3.5%, profit growth of 8-10%, a 10yr bond yield of 3%, and the S&P 500 at 2275. For 2015, GDP growth is actually tracking 1.5-2%, profit growth is tracking a negative 5-10%, the 10 year bond yield is 2.1%, and the S&P 500 is at 2010 as I write this.

What these forecasters missed and still don’t seem to understand is the combined risk of deflation and a late cycle slowdown as indicated by the following:

  1. Commodities (CRB Index) crashed to -24%
  2. Oil (WTI) crashed to -41%
  3. Nickel crashed to -44%
  4. Copper deflated to -25%
  5. Coffee prices crashed to -32%
  6. Natural gas prices crashed to -44%
  7. Emerging Market stocks (EEM) deflated -18%
  8. Latin American stocks (MSCI) deflated -29%
  9. Small cap stocks (Russell 2000) are -7%
  10. Energy stocks (XLE) are -23%
  11. Large company stocks (S&P 500) are -2.5%
  12. Dow Jones Transportation Index is -17%
  13. China stocks (Hang Seng) is -9%
  14. India stocks (EPI) is -14%

For 2016 the Barron’s Forecasts are calling for GDP growth of +2.5-2.75%, profit growth of +5%, a 10 yr. bond yield of 2.75%, and 2220 for the S&P 500. It’s not too much different from the 2015 forecast. What will the forecasters and the media get wrong this time? What you may not know is that if the data continues to trend bearish (and we believe it will) on both growth and inflation, we’ll see both the slowest year-over-year GDP and corporate profit growth of the cycle sometime in the first half of 2016. In fact, I believe a recession commencing by mid-2016 is increasingly probable.

Our negative view of stocks, commodities, and junk bonds is contrary to the view held by the overwhelming majority of investors, Wall Street, and policymakers. Our view is further reinforced when we analyze the expanding deterioration of stocks taking place beneath the surface. This deterioration is masked by the price performance of the S&P 500 which contains a select few large company names propping it up. They’re known as the “FANG” stocks: Facebook, Amazon, Netflix, and Google. These names and a handful of others have been giving investors a false sense of security. According to Lowry Research the percentage of S&P 500 stocks that are down 20% of more from their 52 week high is rising and is now at 26%. As of November 3rd it was 23%. The deterioration among small company stocks is even more worrisome at 57% being down 20% or more. Extreme caution is warranted.

There is an intimate relationship between corporate profit growth and the economic cycle and this relationship seems to have caused a major buyer of stocks to step aside in the third quarter of 2015. Profits of non-financial corporations declined 5% vs. the third quarter of 2014 however their debt level increased 7% vs. the third quarter of 2014. This large gap between debt growth and profit growth is the widest since 2007 and it caused less cash to be available for corporate share buyback programs. And as a reminder let me just say that bad things happen when debt grows faster than profits. And to confirm this information, the Federal Reserve released data showing that there was a 75% DECLINE in company share buybacks in the third quarter of 2015–no doubt a contributing factor in the stock market downdraft in the third quarter. If I had to guess, I’d say that in addition to deflation and growth slowing, another key theme for 2016 will also be that contracting corporate profits will equal weaker cash flows and therefore a much lower level of corporate share buybacks.

While I have not gotten every market move right, specifically the timing of our short positions, the factor exposures we did adopt as a result of our research and technical analysis has kept us away from all of the aforementioned asset groups that continue to crash or perform poorly. We will continue to monitor stocks, bonds, commodities, and currencies for signs of either an economic turnaround or further deterioration. However, I seriously doubt the central planners of the world will be able to bend economic gravity and prevent a good old fashioned bear market.

After all, the Federal Reserve has NEVER proactively predicted a recession. Remember, policy makers and Wall Street will forever cheerlead for rising stock prices. They will ALWAYS have a story to tell that supports their interests. They’re very good at it, actually. But sometimes the lies and misinformation can be deafening. On the other hand, clients and I can’t afford to ignore the economic cycle for what it really is. By paying keen attention to the cycle we won’t blow up our wealth every time there is a late cycle slowdown in the economy. Instead, I hope to achieve the opposite.

I have over 25 years of experience doing financial planning and risk managing investments, and in particular 401k plans at work. If you’re not happy and would like to have a conversation, call me at (914) 761-3237.

2016 forecast

Filed Under: Angelo's Commentary

A Change of Seasons

September 3, 2015 by Angelo Gallo Leave a Comment

It seems that investors have become complacent regarding the health of the economy. Changes occur at the margin as things go from great to less great. We are a very late cycle economy with a global slowdown in growth combined with dis-inflation. This is what the markets are now dis-counting. Lower interest rates, bonds, the US dollar, commodities, gold, and emerging markets have been forecasting this all year. It seems that many haven’t been paying attention. Things always look the best at the end. 2007 was the same way. Everything looked great until all of a sudden it wasn’t. The market swoon the last two weeks is the market’s first step in making the downward adjustment.  Don’t be surprised to see the S&P 500 make a last gasp rally to the former highs…maybe even new highs. It’s the historical pattern all the way back to 1929. People always seem to think Bear Markets come out of nowhere—they don’t. The signs are visible if you’re looking for them.

Filed Under: Angelo's Commentary

2015-07-31 Market Comments

July 31, 2015 by Angelo Gallo Leave a Comment

According to Bloomberg, $406B of Mergers & Acquisition deals have been announced globally this quarter, including $170B in the past week alone. This puts 2015 on track for a record year with projected volumes north of $1T. The annual record prior to that? Yup: 2000. As I’ve told clients many times, Bull stock markets and the economic cycle end on euphoria, not bad news! Risk management in retirement accounts is extremely important at this juncture.

7-29-15

Filed Under: Angelo's Commentary

The Bull Still Has Legs

May 15, 2015 by Angelo Gallo Leave a Comment

Despite its age, the current bull market in stocks is still alive. Historically they average 39 months, but at 62 months the current one is not showing any signs to indicate the end is imminent or as we call it, Major Market Top. In recent months, market pundits have been calling for a Bear market (decline) in stocks simply because of the current Bull’s age. In past commentaries I have explained the historical pattern of how markets erode over time until the end finally does arrive. While it’s true that the bull has aged quite a bit, our studies suggest he still has life left in his legs.

What could trigger the end of the bull market? Possible causes of a recession include the following:

  1. Corporate earnings begin to decline. Currently, revenue growth is difficult but corporate earnings per share continue to increase due to cost cutting and the implementation of labor saving technology.
  2. Gas prices go back up causing consumers to cut-back on spending.
  3. Weak labor markets persist along with the poor quality of jobs being created.
  4. Consumers fear tougher times ahead and decide to save more and spend less. It appears that most of the money saved on lower energy costs has in fact been saved not spent.
  5. The Federal Reserve decides to take the punch bowl away and begins a cycle of interest rate increases. With global deflation the order of the day, we think this is unlikely in 2015.
  6. A geopolitical event causes havoc. These cannot be forecasted, and the current ones (ISIS, Iran, Syria, Afghanistan, and Ukraine) are inconsequential.

We constantly worry about which economic perils lurk around the corner and we attempt to model a multitude of economic data points in order to glean insight into what the future holds. However, the greatest prognosticator and most reliable predictor of future economic activity is the market itself. The stock and bond markets are discounting mechanisms that adjust their prices daily with a pattern emerging over time. This pattern is visible to those watching for it. Over the years I have written many times about the market’s ability to forecast economic conditions 6-12 months into the future in a way that no person or group of persons can.

With this in mind, our studies suggest that the stock and bond markets have been consolidating within a trading range. There has been a lot of volatility for the last two months with upward and downward surges. However, our study of the interaction between buyers and sellers reveals that while there has been a lack of buyers sufficient to sustain another leg higher in prices, there has also been a commensurate withdrawal of sellers which removes the risk of a sustained move lower in prices. Historically this kind of pattern resolves itself to the upside.  So in the weeks ahead, we expect an eventual breakout of the S&P 500 to new all-time highs. We are also aware that it may take one final flush-pullback to the bottom of this two month trading range before that happens.

Aging stock markets bear special risks upon 401k and IRA accounts. If you would like to review the mutual funds held within your 401k, IRA or Variable Annuity for potential exposure to these risks, feel free to call me at (914) 761-3237.

secular-bull-bear-markets

Filed Under: Newsletters

2014-09-12 “Some Grey around the Temples”

September 12, 2014 by Angelo Gallo Leave a Comment

In previous letters I’ve written about how the current long-term uptrend of the stock market is beginning to show signs of age. I’ve characterized it as “getting gray around the temples.” What it means is that slow, albeit subtle, change is taking place beneath the surface and this change is not being reflected in the major stock averages such as the S&P 500. The result is that the stock market’s risk level is slowly beginning to rise undetected by most investors.

The risk I’m referring to is the historical pattern whereby market erosion usually begins in the small cap stock segment, eventually spreads to mid-cap stocks, and finally to large-cap stocks. As this pattern unfolds, investors don’t realize it’s happening because the S&P 500 continues to rise to a new all-time high. So, small-cap stocks and eventually mid-cap stocks decline under the cover of a rising S&P 500. This happens because the S&P 500 consists of large-cap stocks which are usually to last to succumb to intense selling. Market indicators we follow have been telling the story of slight deterioration in the mid-cap segment but substantial deterioration in small-cap stocks. This is one of the early warning signs of an eventual major market top, and resultant bear market. However, it’s important to note that the more advanced signs of an aging bull market have yet to appear, signaling that many more months remain in the primary uptrend.

With this cycle of erosion in mind, an investment strategy must be in place to deal with it as it occurs. As I’ve said, we have already been seeing substantial weakness in the small-cap segment. Therefore, each time the S&P 500 achieves a new all-time high, investors should review their IRA and 401k accounts, looking for any stocks or mutual funds, particularly those in the small-cap segment that did not also rise to a new high. After closer inspection, if signs of sluggishness exist such as poor relative strength, they may be candidates for culling. Generally speaking, once stocks begin to underperform in an aging bull market, they rarely regain their former strength.

To repeat, large company stocks are usually the last to weaken as a bull market ages. Therefore, a process of culling weak performers and reinvesting the proceeds into large company stocks within the strongest industry groups and sectors should be done on an ongoing basis. This disciplined process of upgrading your IRA or 401k should be done throughout the remainder of this aging, yet resilient bull market. Failing to do this could cause serious harm to your retirement account and retirement goals in general. As an aside, this process of culling and upgrading should be a key component to every investor’s strategy regardless of where we are in the market cycle.

secular bull and bear markets

us-equities-bull-and-bear

Filed Under: Newsletters

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