The Ronin

As we start the new year, investors continue to jump at the latest “leaf in the wind,” whether it’s the ongoing cryptocurrency bubble, the rumor that China is wavering on U.S. Treasuries, or the much-maligned melt-up in U.S. equities.

While these stories make for good clickbait and viewer eyeballs, they are nothing more than falling cones. Being disciplined is the only way to consistently see risks and opportunities that twitchy investors miss because they jump at every sound.

Discipline is telling me that there is currently just such an opportunity in U.S. energy and technology stocks.

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Regime Shift

In addition to the normal deluge of 2018 forecasts and 2017 year-in-review commentaries, last week we were swamped with interest rate decisions from central bankers all over the globe.

Rather than channeling Miss Cleo and guessing where the S&P 500 will be sitting on December 31, 2018, I’m going to cover some data-dependent intel that will actually prove useful to your portfolio as we look ahead to next year.

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The Omen

It’s that time of year again, when you can’t turn around without running into either a retail sale or a financial market forecast. But don’t worry, I’m not going to regale you with all the trouble that comes from making investment decisions based on a forecast, at least not this week.

No, this week I’m focused on that other time-honored financial market tradition: fear mongering. Wouldn’t it be nice if these guys at least cooled it during the holidays?

Unfortunately, that’s not the case, so we have to put up with their stories of impending financial doom while we drink eggnog and stuff our stockings. The catalyst du jour that fear mongers are pointing at for the coming market apocalypse is an indicator known as the “Hindenburg Omen.”


Opening Salvo

If you’ve never heard of the Hindenburg Omen as it pertains to stocks, then consider yourself lucky. This “indicator” is about as useful for predicting market corrections as a one-legged man in a butt kicking contest.

For the uninitiated, there are three criteria that together trigger the Hindenburg Omen. First, the number of stocks in a specific exchange hitting 52-week highs and lows must both exceed 2.2 percent of the total number of stocks that trade on that exchange. Second, the McClellan Oscillator, a measure of market breadth based on advancing and declining stocks, must be negative that day. Third, the benchmark index for the exchange must trade above its 50-day moving average.

Apparently, this doomsday indicator correctly called both the 1987 and 2008 market crashes. Unfortunately, outside of those two occurrences, it gives more false positives than a free clinic.


Data-Dependent Says What?

The Omen called for a market crash in 2010, but instead U.S. equities gained 13.1% that year, while experiencing just a 7.6% drawdown. We didn’t even get a stock market correction (i.e., a drawdown of over 10%), much less a crash (a drawdown of over 20%). This “boy who cried wolf” moment caused the indicator’s creator and main proponent, Jim Miekka, to abandon it all together.

If the guy who staked his reputation on this fairy-tale indicator wants nothing to do with it, then why is it still getting ink (or pixels)?

If what happened in 2010 isn’t enough for you to change the channel when the talking heads bring up the 1937 disaster-inspired indicator, how about an incident a bit closer to home?

This past May, the Hindenburg Omen was triggered on both the NYSE and the Nasdaq, marking just the tenth time ever that the Omen has made an appearance on two different exchanges at the same time.

“OMG-osh, what do we do?!” he says, putting his hands on his face and doing his best Macaulay Culkin impersonation.

Since May 5, when this ominous indicator was sighted like a Yeti, the S&P 500 has gained 11.4%, while experiencing a massive 2.1% drawdown. How has the Nasdaq fared since being marked with a Scarlet A, you may ask? The Nasdaq 100 has gained 12.9%, while experiencing a 4.8% drawdown.

The latest Hindenburg sighting occurred three weeks ago, just in time for Thanksgiving with the family. The result? Since making its presence felt like a Demogorgon in Stranger Things, the S&P has gained 2.6% (with a 0.50% drawdown), and the Nasdaq 100 is up 0.8% (with a 1.74% drawdown).

I hate to break it to the doom-and-gloom crowd hoping to sell you “crash-proof” portfolios and precious metals at a discount, but if U.S. growth accelerates, then the current market Hindenburg will continue flying, with no fiery crash in sight.


Seven Hours with Leo and Kate

In addition to The Omen, another doom-and-gloom indicator was also triggered on November 14: the “Titanic.” Apparently, this sign of impending doom occurs when the number of companies making new lows on the New York Stock Exchange exceeds the number of companies making new highs, within seven days of a 12-month high in the S&P 500 index.

The last time these two indicators reared their ugly heads simultaneously was July 2007. Well, if this combo platter really is predicting an analog to 2007, then the market should rally another 14% over the next three months. Furthermore, we have at least another fourteen months before any real market-related carnage begins.

If we really are headed for a market crash, there will be plenty of real economic and financial market signs of a coming correction. But remember, the signs won’t have scary names like “Hindenburg” and “Titanic.” The signals will be much more mundane and less “econopocalypse” worthy, like outright contractions in things like industrial production and retail sales.

The Bottom Line

If you remain data dependent, process driven and risk conscious, then you know it’s nothing but clear skies for U.S. equities from now through the end of the year. U.S. economic data remains robust, inflation is healthy and U.S. yields are holding steady. All of this adds up to a conducive environment for U.S. equities that is characterized by more upside potential than downside risks.

Do yourself and your portfolio a favor and ignore any market-related indicator or story with a historic calamity attached. These fear-mongering indicators predict website clicks better than they will ever predict actual market direction.

We Need to Talk

As a guy, these are the most dreaded four words you can hear when you’re in a relationship. In fact, there are only two likely outcomes following those four words. One is that you find yourself knee-deep in a bottle of bourbon on a guys’ night out. The other is that you personally prop up the stock price of when you order the “I’m so sorry and I’ll happily deplete my retirement account to show you how sorry” bouquet of roses, with expedited shipping.

For those who struggle to translate the opposite sex, “We need to talk” means she needs to talk and you need to listen.

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The Rant

There is a weekly paper in the small city where I live that covers all the local comings and goings. On the last page of the paper is a section called “The Rant.” 

Basically, it’s a place for people to unload about everything that pisses them off. People rant about everything from a lack of parking downtown to the person in front of them at Starbucks with their face buried in their phone when it’s time to order. 

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Valuation Investing

This year has been the year of broken records for the S&P 500, and the string of wins continued last week. The S&P 500 finished October with a positive total return, which means it has gained ground in all ten months of the year for the first time in the 90 years of S&P data. October also marks the twelfth consecutive positive month for the index, which equals a record set only twice before, in 1935 and 1949.

With a long list of historic records being smashed, there is no shortage of “gurus,” bloggers, and media types calling for anything from a pullback to an outright crash in U.S. equities. The primary rationale attached to these claims is “over-valuation.” This type of thinking is a great reminder of why it’s critical to always remain data-dependent in financial markets.

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The Boy Who Cried Wolf

Twenty-six hundred years before Cher, Bono, or Madonna, Aesop was the “one name” big shot. This guy accomplished a lot in his thirty-six years on this Earth; his fables are still a rite of passage for many children.

None capture the modern environment of financial media better than “The Boy Who Cried Wolf.”

Financial media, from mainstream news sources to blogs and newsletters, are full of people always calling for a financial market crash. These folks wear tinfoil hats and secretly wish the Illuminati would make a comeback. We refer to them around the office collectively as Dr. Doom.

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Fortune Teller

For the life of me I can’t understand Wall Street’s obsession with forecasts. These guys will forecast anything, like prop bets for the Super Bowl. It’s out of control! Regular readers know how I feel about forecasts, but for the uninitiated, Wall Street forecasts are the equivalent of fortune telling: a lot of pomp and circumstance but absolutely zero real value.

Wall Street has two particular favorite fortune telling games. The first happens each January, when strategists love forecasting where the S&P 500 is going to finish the year. In the second game, analysts forecast which companies will be winners and which will be dogs in the coming year.

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Fifty Shades of Gray

Get your mind out of the gutter; this isn’t that kind of commentary. Today we are going to discuss operating in the gray area that exists in financial markets.

It’s interesting to watch my teenage daughter navigate life with a very black and white view of the world. Things for her are either right or wrong, up or down. She doesn’t yet appreciate that it’s the nuances of life that make it simultaneously worth living and challenging to navigate.

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The Art of Knowing

A man known simply as Rumi said some of the most profound things I’ve ever read. No, I’m not talking about Beyoncé’s baby: Rumi was a 13th century poet, and he managed more memorable one-liners than a Vince Vaughn flick. One of my favorite Rumi quotes is “The art of knowing is knowing what to ignore.” Rumi would have made one hell of a global macro maven because that 800-year-old quote succinctly sums up the key to successful investing.

One objective of this weekly commentary is to shift your focus away from the plethora of distractions the markets and media send your way and towards the most critical developments.

With that in mind, let’s take a quick tour of Washington, D.C., a road trip to Cleveland and then discuss what markets are signaling as we begin the final three-month push of 2017.

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Doing Too Much

Multi-tasking has become a way of life for many people these days. I’ll admit that there are times when multi-tasking can boost productivity but, as usual, people have taken this concept way too far.

On my short commute to work the other day, I saw someone putting on makeup while driving. I’m not talking about a quick swipe of lipstick at a traffic light. It was the kind of makeup regimen Cher goes through before concerts, only this lady was doing it at 45 miles per hour.

I also saw a guy eating breakfast, and it wasn’t a breakfast burrito in one hand and the steering wheel in the other. This guy was eating a continental breakfast complete with freshly squeezed orange juice that he was juicing himself while driving through a school zone.

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Wax On, Wax Off

When anyone refers to the daily price action in financial markets as “risk on,” it makes me lose my freaking mind! It’s like being forced to watch the NBA Finals games from the ‘80s when the Lakers lost to the Celtics, while simultaneously listening to the Beaches soundtrack on repeat. It drives me crazy! That’s because there is no such thing as financial market risk being “on” and “off.” This isn’t the Karate Kid, you aren’t Ralph Macchio, and I’m sure as heck not Mr. Miyagi. There is no risk on, risk off, Daniel-son.

Risk is always on, my friends. The problem is that most investors have no idea what the word “risk” really means. I’m going to do my best to awaken the risk manager that lies dormant inside you. But be forewarned: once awakened, you won’t like what you see in financial markets at the moment.

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The Benjamins

There are tens of thousands of financial instruments investors can trade to gain access to hundreds of markets across all four major asset classes: stocks, bonds, currencies and commodities. Of the plethora of instruments and markets to be traded, there is one that causes more ripples across the globe than all the others, the US Dollar.

Despite being pronounced dead on many occasions in the past and despite the cryptocurrency fanatic’s best efforts to convince you otherwise, it’s still all about the benjamins. The dollar remains King and is currently at a critical inflection point, which will have widespread market ramifications.

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If You Focus on Average, You Get Average

No, this week’s commentary isn’t going to be a Tony Robbins-esque speech about not settling for mediocrity. Rather, with so many new readers, it’s a good opportunity to discuss why I believe in focusing on slopes rather than averages. Most investors, media gurus and other market participants are consumed by averages.

The simple fact is that if you focus on average, you get average.

A true edge and subsequent ability to outperform other investors over long periods comes from focusing on the “slopes,” which is how fundamental and quantitative data changes as we move through time.

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Divergence Creates Opportunity

The best trading opportunities come when investors’ perception of an event, or market, diverges from the most probable outcome of that event or the most probable direction of that market.

The most attractive opportunities present themselves when there is a shift in the Fundamental Gravity of a market from one bias, bullish or bearish, to the opposite but investors are slow to react. These divergences get me salivating like Pavlov’s dogs. Right now, there is a divergence occurring in the Eurozone that is being ignored and providing a compelling short opportunity. The origin of this divergence is Germany.

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The Most Valuable Commodity

Gordon Gekko may have been from the Bernie Madoff school of investing, but his quote from the 1985 film Wall Street holds up: “The most valuable commodity I know of is information.”

Fast forward thirty years, and the explosion in the amount of readily available information hasn’t necessarily reduced its value, but it’s made it critical to have a reliable and time-tested approach for processing it.

Make no mistake: as an investor, you are nothing more than a processor of information. The better and more efficiently you process information, the better your risk-adjusted returns and the more consistently you can earn them. Being a great processor of information comes down to being a combination of Jack Daniel and Eckhart Tolle.

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Shorts are Not Just for Summer

There are very few areas of life where the ability to “go both ways” isn’t a marked advantage. In basketball, the player who can dribble only with his dominant hand is a far weaker player, and much easier to defend, than the one who can dribble well with both hands. The baseball player who can switch hit is much harder for a pitcher to game plan against and is more valuable to his team because of his flexibility. Even Zoolander’s career didn’t break out to new heights until he figured out how to go right as well as left.

In financial markets, everyone can “go left” and invest on the long side. But far fewer investors are able to make the leap to being a capable and competent short seller. Being able to “go right” gives you a marked advantage over most market participants, who can only go left.

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Our Main Business

I’ll be the first to admit that talking about current economic conditions isn’t as entertaining as watching a guy push sound effect buttons while rattling off a bunch of stock tickers until he has you investing in every company in the Wilshire 5000. But if you can understand the impact that growth and inflation have on asset prices, then you can gain insights into risks and opportunities that other investors miss.

Since last week, it appears as though the world has started to drink my Kool Aid because all anyone can talk about is U.S. inflation. The problem is that they believe inflation is the key to forecasting the Fed’s next move.

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All We Need Is Just a Little Patience

Yes, I just started this week’s commentary with lyrics from Guns N’ Roses. Don’t count out a future Vague Destination entitled “Welcome to the Jungle.” Both titles are very appropriate springboards for a conversation about financial markets.

One of the overarching themes of my investment philosophy is patience. In the investing game, patience means acting only when opportunities present themselves, and not one moment earlier. Practicing patience, all by itself, can give you a huge edge over other investors because the hardest thing for most people to do is nothing. It’s incredibly difficult for investors to grasp the idea that making a decision to do nothing is just as proactive as making a decision to change something. But as you’ll see, doing nothing must become a regular part of your process if you want to be a successful investor.

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Somewhere Between Love and Hate

Author Shannon Alder wrote, “Somewhere between love and hate lies confusion, misunderstanding and desperate hope.” Last week, Mario Draghi spoke at the ECB forum in Sintra, Portugal, and the investor reaction to his comments made it clear that euro bulls are caught somewhere between love and hate.

These poor souls immediately piled into the long side of the trade at the fastest pace in five years, bidding the euro to a one-year high in the process. The bulls are desperately hopeful and confused, and have completely misunderstood Draghi and his intentions for ECB policy.

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