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Matthew Crews
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Matthew Crews, CFA is a registered representative of Smith Patrick Financial Advisors, LLC, a fee-only advisor in Saint Louis. Matthew's focus is on building durable portfolios for clients using a wide range of ETFs for diversification. Given that clients portfolio's don't exist in a vacuum, Mr.... More
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  • Symmetrical Triangles Redux

    Here is another long-term look at the competing trends that are taking place in the global equity markets. Kimble Charting Solutions shows the triangles in both the developed international equity market (NYSEARCA:EFA) and the emerging market equity market (NYSEARCA:EEM).

    I continue to see downside risk here as the intermediate trend is downward from the 2011 peak. Early 2012 was above the 10-month trend for these two ETFs but the May swoon broke the trend. Currently EFA and EEM are both slightly above their respective 10MMAs.

    The challenge that I see is that if the intermediate downward trend remains the dominant trend then the above 10MMA trend will likely not persist. The biggest whipsaw however has been International REITs (NYSEARCA:RWX) which only briefly broke its 10MMA in late May/early June only to rebound strongly and break the intermediate downward trend.

    (click to enlarge)

    Lastly, match the price trends with fundamental data in Europe and China coming in weak and I have a difficult time seeing upside. (Note however that valuations themselves are likely improving for future positive returns once these economies recover.) Therefore I am tending to weight caution above optimism at the junction.

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EEM, EFA over the next 72 hours.

    Tags: EEM, EFA
    Aug 15 10:47 AM | Link | Comment!
  • Bill Gross' Questionable Analysis: Cult Of Equity

    So now we know what Bill Gross really thinks of Jeremy Siegel. Mr. Gross, a famous bond fund manager, took his August monthly newsletter to discuss the demise of what he refers to as the cult of equity and its poster child, Jeremy Siegel, author of Stocks for the Long Run.

    The cult of equity references the shift in asset allocations towards equities (and away from bonds) in pension funds and other large institutionally managed assets. Behind the cult is the belief of an outsized equity risk premium (ERP) over bonds. While this subject might seem academic to individual investors - it underlies why asset allocations to equities often garners the highest percentage.

    Unfortunately Mr. Gross' attempt at humor ends up badly representing the subject. I believe he could have summed up his note in rather short order as follows:

    "Based on current equity valuations, equities are priced for lower-than-historical-average forward returns, which have been 6.6% on an inflation adjusted basis. We would expect forward returns closer to 4% on a nominal basis or 1% on a real return basis. Furthermore, based on the debt deleveraging cycle in most developed economies, expect persistent inflation created by central governments to combat the deflationary pressures of the deleveraging process."

    Instead, Mr. Gross presents a note that is more confusing than helpful. The following are snippets from the note followed by our thoughts:

    [A] 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes - a Ponzi scheme

    Mr. Gross argues that an equity real return of 6.6% can't happen when GDP growth is only 3.5%. First, a breakdown of the equity return components.

    Figure 1:

    Total Equity Return (1926-2010)





    Real Growth in Dividends


    Valuation Increase






    Source: Ibbotson from CFA Pub "Rethinking The Equity Risk Premium"

    As you can see the dividend yield of 4.1% was the largest contribution of returns. Furthermore the real growth in dividends contributed 1.3%. Dividends and dividend growth contributed 5.4% of the total returns and with compounding it increases to 5.8%. That hardly looks like a Ponzi scheme to me.

    Secondly, GDP growth is should be assumed by default to be greater than corporate earnings growth. Mr. Gross is misrepresenting reality. Entrepreneurial capital (new business and new stock) will dilute existing capital stock, which will slow corporate growth. This can easily be shown in the data (discussed next.)

    Lastly, corporate growth rates are better compared with GDP on a per capita basis -- not real GDP. GDP on a per capita basis has been ~1.8% since 1871. Corporate earnings and dividends grew at a lesser rate at 1.4% and 1.1% over the same period, respectively. (Data from Arnott, "Rethinking The Equity Risk Premium".)

    Economists will confirm that not only the return differentials within capital itself (bonds versus stocks to keep it simple) but the division of GDP between capital, labor and government can significantly advantage one sector versus the other.

    This is a valid point and a known channel for corporate profits to grow faster than the economy as a whole. However, with corporate real earnings having only grown at 1.4% compared to 1.9% real GDP per capita-- the data doesn't support the claim. Furthermore, any short-term dislocations between labor and capital should experience a reversion to the mean. (A better argument from Mr. Gross would have been on the impact of international profit share.)

    The legitimate question that market analysts … should answer is how that 6.6% real return can possibly be duplicated in the future given today's initial conditions …

    While I am befuddled by most of Mr. Gross' argument, here we are in agreement. Based on current valuations, I don't believe the historic return is possible. And I don't think many others do either. Mr. Gross rather expects (off handedly) 4% nominal equity returns or net of 3.0% inflation, a real return of 1.0%.

    With the S&P 500 (NYSEARCA:SPY) dividend yield currently at 2.0% and dividend growth of 1.2%, a more representative real return would be 3.6% (including compounding and no valuation increases).

    The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned

    Obviously Mr. Gross didn't recall the last market downturn which bottomed in March 2009. While brief, there was a period in the spring of 2009 where forward returns on the S&P 500 were priced in for that 6.6% real appreciation!


    The cult of equity is driven by the equity risk premium. Investing in equities requires compensation via the equity risk premium. Unfortunately, Mr. Gross confuses the discussion and argues incorrectly (in my opinion) that future equity returns can't replicate historical returns because of unsustainable "Ponzi-like" growth.

    The data clearly shows that previous returns are from dividends and dividend growth which are sustainable and proven to be durable. Furthermore, real return from growth is significantly less than real GDP growth and more importantly on a real GDP per capita basis. Rather the problem is that the current dividend yield of 2.0% is much lower than the historic level of 4.1%.

    Disclosure: I am long SPY.

    Aug 08 11:12 AM | Link | Comment!
  • Symmetrical Triangles Indicate A New Trend Soon

    "Two men enter, one man leaves"

    Mad Max Beyond Thunderdome

    After a stellar first quarter and a swoon in May, the equity markets have entered a choppy/sideways period. This has made it difficult for investors that rely on trend-following systems.

    To add additional insight to aid in the tactical asset allocation process, I have stepped back to a longer time frame and used basic trend line charting to highlight the various equity markets. The following is a review of how I see things unfolding in the broad equity markets. (In future commentary I will review fixed income and alternative investments.)

    In short, outside of large cap domestic stocks, most broad-based equity indices have been coiling into symmetrical triangles that will likely resolve in the several months or sooner. Symmetrical triangles are the creation of an upward and downward trend at the same time. Ultimately one trend will win out.

    Base on the continuation of these various symmetrical triangles - it is reasonable that the various equity markets will tighten around their long-term moving averages (which are the 10-month moving averages in this note). Therefore, expect intermediate trends to flatten out and/or become less-reliable until these patterns resolve themselves.

    Given that leadership in the markets over the past 12-to-18 months has shifted to defensive sectors in the domestic US large cap market, the bull market is on its 4th year, and global economic growth continues to slow -- I believe more consideration should be given to a potential negative outcome. Until volatility really picks up (say with a couple of 3% daily up/down swings in the S&P 500) I don't think there is enough fear in the market to play a contrarian strategy. Patience should be rewarded here.

    Domestic Equities

    Large cap domestic equities continue to outperform their peers on an intermediate-to-long term basis. Domestic large cap stocks have held their long-term trend set back in March of 2009. Underlying the performance over the past 18 months however has been strength in the early-cycle sectors (housing, consumer, technology) but also defensive sectors like consumer staples and utilities. Mid-cycle sectors industrial, basic material, and the energy sectors have underperformed.

    Figure 1: Domestic Large Cap Blend (NYSEARCA:SPY)

    (click to enlarge)

    Looking closer at large cap domestic stock performance will show that not all sectors have been making higher highs. Several sectors that I consider mid-to-late cycle (Industrial, Basic Material, and Energy) have begun coiling. It has been consumer-oriented sectors including housing as well as defensive sectors (health care, utilities) that have provided the recent boost in performance.

    Figure 2: Domestic Large Cap Industrial Sector (NYSEARCA:XLI)

    (click to enlarge)

    Domestic small cap stocks have not kept up with domestic large cap stocks either. This is just another indication that the market overall has down-shifted its risk tolerances and moved to the large cap domestic defensive sectors.

    As the symmetrical triangle resolves, we could see the 10-month moving average be whipsawed over the next couple of months.

    Figure 3: Domestic Small Cap Blend (NYSEARCA:IWM)

    (click to enlarge)

    International Equity

    International stocks have a similar symmetrical pattern that has evolved since 2011. The symmetrical triangle not unsurprisingly based on Europe's current currency and debt crisis looks more like descending triangle which has more negative implications. The more value-oriented PowerShares International Dividend Achievers ETF (NYSEARCA:PID) has a slightly more healthy looking profile (not shown).

    Figure 4: International Large Cap Blend (NYSEARCA:EFA)

    (click to enlarge)

    Emerging Markets Equity

    Lastly, emerging market stocks also have developed a symmetrical triangle starting with the peak in 2011. The emerging markets seem to be the only group that set a lower low in 2011. However, the triangle is set and looks like it will be resolved very soon. As with the International stocks, I suspect the emerging markets also to coil around the 10-month moving average over the near-term.

    Figure 5: Emerging Market Large Cap Blend (NYSEARCA:EEM)

    (click to enlarge)


    The sideways trading in the equity markets has made short-term trends unreliable. From a basic chart perspective, it seems as though the majority of markets are resolving between the longer-term bull market established in 2009 and the recent peak in 2011 which marks the beginning of a global economic slowdown.

    The 10-month moving averages will likely be less reliable over the next several months as long as the various triangles continue to resolve. However, we should expect a new trend to emerge over the next several months as to the direction of the markets.

    As noted in the beginning, leadership in the markets over the past 12-to-18 months has narrowed to defensive sectors in the domestic US large cap market. With an aging bull market and global economic growth slowing -- I believe caution is warranted. While volatility has been picking up, until we see a couple of 3% daily up/down swings in the S&P 500, there is not enough fear in the market to play a contrarian strategy.

    Disclosure: I am long SPY.

    Aug 03 11:10 AM | Link | 2 Comments
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