Roadmap to recession, or You Own Too Much Common Stock

A 460 point decline in the DJIA still gives me sticker shock, for back in the day that was a big move. Yesterday the S&P 500 fell 1.9%. Such ought not be a big deal. When you checked your portfolio…did you get a sick in your stomach feeling? If so, you own way too much common stock.

At Independent Stock Analysis we operate under theory that the financial system was going to implode during the financial crisis and Great Recession from a decade ago. The imbalances were monstrous and a cleansing needed to occur. The crises would have been a painful depression had the government and FED not acted decisively. Had the depression been allowed to run it’s course, the event would now be long in the rear view mirror and with only scars preventing it from being a forgotten depression.

Instead, the world doubled down on the wrong prescription and is moving toward Modern Monetary Madness. In fact, when the next recession occurs, the world may well go down that rabbit hole, which would be more painful than the proverbial depression passed over a decade ago. Mainstream Business Week gives an explanation.

Ten years into an economic expansion ought to see government revenue surplus. Instead the U.S. Posts Largest Ever Monthly Budget (Bloomberg): “The budget deficit as a share of gross domestic product is expected to widen to 5.1 percent this year, up from 3.8 percent a year ago, according to projections from the White House Office of Management and Budget. The shortfall is expected to be 4.9 percent of GDP in 2020, and further narrow every year through 2024, according to the estimates.” There will be no tiny narrowing to the outrageousness, but instead an explosion.

Hearken back to the last crisis: Do you remember wishing you were positioned differently as the disaster unfolded? That the available opportunities were spectacular…

…the idea is the same, though the playbook this time is different. A decade ago the question was ‘shall economic deflation or inflation occur?’ Today’s playbook is to be in a combination of cash and gold, and in the years ahead the first the cash converting into shares of your favorite company’s at distressed prices, then the gold. A kind of dollar cost averaging. Over the medium term, this time we know it’ll be inflation as money is printed 10 trillion at a time.

The timing has everything to do with recession: “Recession fears have increased but first quarter growth weakness could be short-lived, as has often been the case with first quarters. We don’t see a recession in the near term, but believe trade policy remains a key factor in the span between now and the next recession.” Schwab

The Roadmap to recession makes a remarkably clear case. Nordea

In the chatter yesterday: An Old Recession Boogeyman—the Inverted Yield Curve—Returns, and It’s Spooking Some Investors. Fortune

Meanwhile, The Retirement Crisis Is Worse Than You Think.

“Global equity markets peaked in January 2018 while US markets peaked in September 2018…We are confident that was only the beginning of a downturn in asset prices from record global leverage and central-bank-driven asset bubbles for this cycle. US asset bubbles only just began to burst at the end of last year as one can see in the chart below.” Crescat CapitalA

A Different Way to Look At Market Cycles by Lance Roberts.

Valuation Determines Return says John Mauldin and here is part 2.

To desperately seek income, as Jeff Saut suggests, will end badly. This recommended strategy is the equivalent to writing naked puts. At the wrong time. Nevermind that in a bull market the covered call strategy sees the investors best stocks called away.

In Ground Rules of Existence John Hussman shares his compelling playbook.

“Fortunately, we believe there are things worth owning. First, we are excited about T-bills at this stage of the cycle. In addition to protecting capital, T-bills are very liquid, provide a competitive yield relative to equities, and allow investors to act decisively when future opportunities return. Second, as it relates to potential equity purchases, we are very attracted to businesses with strong balance sheets” Palm Valley. So, cash and a very small investment universe; we will be talking about this later in the year.

How to position? Cash. And Gold – Preparing for the next move by Alasdair Macleod.

Buy Gold, Sell Stocks Is the ‘Trade of Century’

There is a lot here to ponder. As I have only begun to get back in the saddle, a question to consider: How would you like to be positioned when outstanding opportunity arrives? I am bursting with things to say in the months ahead You know where I stand: You own way too much common stock. It will likely be late April before I post again. Subscribe by email to Independent Stock Analysis to avoid missing the next post.

Triumphant Return

No one has been more out of step with asset markets this decade than me.

As Warren Buffett recently said, “Prices are sky-high for businesses possessing decent long-term prospects.” (The Felder Report). Unfortunately that’s not a good environment for this fellow.

Been wrong for long, yet I’m still in the “There is no bull market without central bank intervention or jawboning” camp. (Northman Trader).

Absent recession, oil looks good. (Goehring & Rozencwajg) This decade U.S. oil & gas production boomed yet the sector has underperformed to near generational lows relative to the whole stock market. And the sector may still offer precious little value. We’ll discuss this in the future.

Copper looks better. (Goehring & Rozencwajg). We’ll discuss this in the future.

The move to 5G in wireless is a big deal. (Gavekal).

The next decade, the 2020’s, I expect to be filled with harrowing opportunity born in upheaval. (Lance Roberts). I’m watching carefully. (Northman Trader).

When the economy rolls over, the stock market is in huge trouble. The credit imbalances today compared to a decade ago are different, and worse than the Great Recession of a decade ago. Thus the positioning of oneself ought to be different.

Already profit margins are under pressure (Blackrock). Long time bear John Hussman eloquently writes like the market peak is definitely in the rear view mirror (Hussman Funds). Watch out below when the margin debt unwinds (Advisor Perspectives) simultaneous to the calm premium ending (Blackrock). The next recession will have to wring out monster excesses (Gundlach).

Getting this right is the opportunity. In today’s world I’m not sure the difference between protecting yourself and seizing the opportunity are a whole lot different. We’ll discuss this much in the future.

It’s been 3 and a half years since my last blog post. I’m back. Posting will be sporadic through April; by May I hope to be rolling on a regular basis.

Cash is King

I have been out of step with the market for several years.  The valuations and underlying fundamentals are pretty much outrageous.  Perhaps the proverbial bell rang this week.

Market internals have been horrible for quite some time, that’s why most market participates have been left behind despite the rising stock market of the last few years. The strength in the large momentum names is gone, there is no where left to hide.  The narrow market has reached exhaustion.  Already 74% of NYSE stocks are below their 200 DMA, a downtrend started early 2013.  Yesterday (8-21-2015) the NYSE had zero new highs and 627 new lows. The VIX has had the largest one week spike in history, from 12.83 to fear 28.03 in 5 days.  Yet YTD the S&P 500 index is down just 4.3% and the Nasdaq Comp is down only 0.63%.  The Biotech’s are still 10% higher in 2015 and 28.3% year over year; manias end badly for investors.  Initial public offerings as a froth indicator peaked last fall.  The Nasdaq 2000 and 2015 are a double top if I’ve ever seen one; perhaps she’ll punch through permanently in a decade.

This market cycle was dependent upon QE:Maybe it's spurious, but the market has shown an inability to push meaningfully higher in the absence of QE. $SPX

Don Coxe: Bond Bull Coming to an End and Bonds Now a Center of Risk is an excellent listen for those who haven’t run across Coxe’s commentary in a while.  The junk bond market has cracked with credit spreads at multi-year highs, something which began, ironically, with the energy issues.

When a stock market break occurs, the record margin debt will be a downside catalyst.  The familiar margin debt charts show margin debt 40% above previous peaks.  Further, margin debt as a percent of market value is high, with free cash being particularly frightening.  Just two days ago the DJIA and Nasdaq entered corrections (first since 2011!), and these newfound speculators will become forced sellers.

Commodity Weakness Persists.

In light of this decades financial advisor meme to charge 2% of assets for putting investors in index funds, this chart is particularly scary:Chart of the Day

The DJIA:Gold chart looks to finally reassert itself southward: Chart of the Day

Cash ought be the largest position of any investor.  Period.

Gold will be the asset of choice for the next recession (which is not imminent).  Central bank bond buying and ginormous fiscal stimulus (budget deficits) will drive the mania.  In the meantime, gold bulls will have to be content with a currency war.

Gold ought to be the second largest position of any investor.  Another bell was rung:  The 491 million ounces traded in two weeks is highest volume in history.

A little schedenfruede:  In mocking gold bugs he called the bottom!  Joe is right about the inguinity of humans, it’s the folly of the political class he missed:
That was fast!  Precious metals have already reached short term rebound targetsAdam Hamiliton provides a starting point for speculators in junior gold equities.  Student loans will be the next big political fight.
Little else is investable. Many speculative situations, however, do exist:
Silver is extremely interesting long term as a play on the remarkable booming solar build out worldwide.  Maybe the next silver bull market has already started.
Twice in this young century investors have made (and lost) fortunes in the energy complex.  Consider conservative Baytex Energy (BTE).  This heavy oil producer with low production costs has collapsed again.  Two days ago the income security cut the dividend to zero. In a stable $100 oil price environment Baytex provided shareholders with an annual C$2.88 dividend.  Yes, Virginia, that implies a return to robust oil prices means patient buyers of the stock could realistically see a 50% dividend yield on today’s shares.  It’s just not a bet I can recommend at this time.  Shares may be more likely to get cut in half before any sustained move higher and are a function of an unlikely oil price rebound.
House prices should remain stable (and homebuilding will be a tailwind for economic growth in the years ahead).  Higher interest rates are a financial pricing negative.  However, fundamental household formation supply-demand is strong.


The world outside of the United States is experiencing anemic economic growth.  But stateside conditions are better and job growth is not a bad as thought.  The difficult environment for asset prices can exist with decent economic growth.  The dynamic seems strange at first, but is the norm  in a rising interest rate environment.

“Overall, the U.S. “startup rate”—new firms as a portion of all firms—fell by nearly half between 1978 and 2011…” (WSJ).  Might be the right direction to head…


“Warren Buffett’s favorite valuation model is screaming that stocks are overvalued.”  (Ed Yardeni ) “The most important observation an investor can make is that foreign equities (EU and EM) have not made any progress since October 2009, while majority of the gains in the All Country World Index (NYSE: ACWI) has come from the US equities outperformance.”  Short Side of Long

In the extremely low interest rate environment many investors chased yield, and have begun to learn “investing for high income can sometimes be extremely risky…”  Richard Bernstein.

In short, Asset prices are very rich.  Stocks and bonds.  This isn’t the year 2000 either, when Russell 2000 stocks were in the bargain bin.  Precious little is investable.

The economy continues to plod along:  Employment, Housing & Autos Point To Continually Improving Economy at Value Plays.  Jobless claims are at a 40 year low (WSJ) though inflation adjusted incomes stinks (Doug Short).  Pent-up demand for housing is real and underappreciated (WSJ).

The commody complex disaster has continued, and even accelerated this summer.  “The Bloomberg Commodity index fell 3.3 per cent on the week, to the lowest level since 2009.”  Financial Times

Fortunately in the real world, “The long run economic benefits of structurally lower energy prices and energy security are slowly feeding through to the wider economy.”  In the Long Run

Salman Partners economist calls bottom in copper (Mining).  Many a commodity bull has said the same the last four years and been wrong all the way down.  Base metals are a tough business, and interetingly:  “But since 2005, the world’s copper industry has consistently produced 7% less copper than planned.”  TCK sports a $7 handle.

In commodities meltdown, natural gas is a bright spot at the Finacial Post.  The delinking arguement is at least interesting.

The entilement program picture with color:  Social Security, Medicare Outlook: Better but Still Bleak at the WSJ.

Commentary regarding the credit fiasco leading to the financial crisis often led to ‘gold to the moon’ as the investment conclution.  Perhaps the goldbugs were just an economic cycle early.  Household balance sheets have not improved.  The governement’s balance sheet worsened significantly.  Business balance sheets were strong going into the financial crisis, but the siren song of cheap money has turned out to be too much temptation for corperations as Companies May Be Running Out of Time to Borrow From Bond Investors to Pay Shareholders (Bloomberg).  With a Kansas City Fed research paper finding changes in the economy and financial markets are blunting the effects of Fed policy, the money printing to arrive with the next recession will be larger than can be imagined (WSJ).  We just don’t think it’ll be anytime soon.

“It could take many months — or even years — for the precious metals to form a bottom” says Peter Brandt.

Chart of the Day