Category Archives: Quarterly

For What It’s Worth – These 2 will Not Cause the End of the Bull Market

Fortis Wealth Q3 2019 Firm Letter

“For What It Is Worth”

Buffalo Springfield

Paranoia strikes deep
Into your life it will creep
It starts when you’re always afraid
You step out of line,

the man come and take you away

We better stop, hey, what’s that sound
Everybody look what’s going down
Stop, hey, what’s that sound
Everybody look what’s going down
Stop, now, what’s that sound
Everybody look what’s going down
Stop, children, what’s that sound
Everybody look what’s going down

Written by: Stephen Stills
Lyrics © Warner Chappell Music, Inc

The U.S. Political Landscape is Leading Concern Among Investors – SCHWAB

The U.S political landscape is overwhelmingly the leading concern about investing among clients.

Click here for source and full document

he paranoia around presidential elections is hitting record levels, we better stop and listen to what’s going down.  We spend a big portion of our life listening to storytelling.  As kids, parents and teachers tell us stories.  As adults the news media is about storytelling, investing is about storytelling, and nothing paints a better story than politics.  I may be early with this letter as the presidential election is more than a year away but it’s possibly shaping up to be the ultimate scary story for investors.

As I write this letter, it is increasingly looking like a Trump vs. Warren election and a Trump impeachment investigation, which may be the ultimate binary event for American voters.  Never in history has an election been so important except for every other election in history.  Most of my conservative friends thought the world would end if Obama got elected and most of my liberal friends thought the world would end if Trump got elected.

If you made either of those investing bets based on politics, your wallet is probably lighter.  The chart below shows that Obama obviously did a better job with the economy.  Actually this would be a false assumption, as Obama took office when the S&P was trading at generational low valuations.  The single best predictor of future returns is where valuations are today, the next President will not have the luxury of beginning his or her term with low valuations.

click here for source

I write a daily blog, a weekly newsletter, quarterly letters and occasional white papers, none of which mention politics as that is not my expertise plus the last thing people need in today’s connected world is another political pundit.  I am also a registered independent so although I do not worship at a partisan political church, I do worship at the altar of behavioral investing.  Many of you who have read my letters in the past know the mantra of Fortis is “investing is a psychology game not an IQ game.”  Our emotions are the enemy, and nothing agitates the emotions like politics.  For a perfect example of knee jerk emotional reaction see the bottom left of previous image marked “inauguration,” on Obama’s inauguration day the S&P, Nasdaq and Dow all dropped over 5% in a spontaneous short-term reaction to the thought that America could indeed become communist.

Every investor I speak with today goes right to politics and the presidential election; I believe that would make you normal.  All issues are political issues, so keeping out of politics is an impossible human folly but I think keeping them out of your investment portfolio is a necessity.  As humans, we are full of personal biases, it’s best not to let them creep into your retirement portfolio because the result could be permanently toxic.

Why is it so toxic?  When the chips are down, we would rather be wrong and still belong to our tribe.

Let me quote from a Financial Times article that, in my assessment, goes to the core of human behavior:

“We humans are social creatures. Given a choice between being right on a partisan question (abortion, guns, Brexit, globalisation, climate change) and having mistaken views that our friends and neighbours support, we would rather be wrong and stay in the tribe. … in surveys of views on climate change: college-educated Republicans and Democrats are further apart on the topic than those who are less educated.”

Click here for source

Sticking with your tribe may be fine for social purposes as we all need a community to achieve a sense of happiness but leave your tribes behind when it comes to investing.  Investing based on political party in office can get you broke in a hurry as the following chart depicts staying fully invested versus riding only your tribe’s donkey or elephant.

Inevitably when friends and clients see this chart, they flat out don’t believe it.  It’s simple math but the political tribe pull is so strong that it seems for many it’s hard to  comprehend the truth.  In very few sports rivalries as vicious as politics does a 150-year game end in a tie but Republican versus Democrat stock returns delivered a dead tie from 1853-2015.

Click here for image source and full document

Keep in mind, you should definitely care in a passionate manner about your political beliefs and always participate in the political process, but you should probably turn off the dashboard of your investment portfolio when you do it.  Treat investments and politics as church and state, two completely separate silos of thinking within your household.

Raymond James surveyed 1,000 US investors with at least $75,000 in the markets in August. Forty percent said that politics were either “extremely or very important.”  What’s more, 70% said that news headlines in general influence their investment decisions.

Click here for source

In my opinion, don’t make changes to your long-term portfolio based off elections but do get ready for short-term volatility from political storms especially an impeachment.  Thankfully, we don’t have much history on impeachment hearings, but my friend Bill Stone at Avalon does a good job of summarizing the stock market returns under Nixon and Clinton impeachments.  It’s tough to flesh out much from these statistics because the economic cycle was in massively different stages during these presidencies.  The Nixon 1970’s saw inflation, stagnation and high employment while the Clinton 1990’s saw low inflation, booming economic growth and full employment. 

S&P Returns Around Impeachment Hearings.

From Bill Stone Avalon

Click here for source

Right now, the American investor is obsessed with a slowdown and recession, every CPA, banker, investment professional and lawyer I speak with uses the same term “late in the cycle.”  Every investor I speak with asks when is the stock market going to crash, as you can see in the below image, Google searches on the word recession took a hockey stick spike as we enter possible impeachment hearings and a heated election season, this obsession could be exacerbated.

Google searches show recession fears have spiked dramatically since the end of July, when the Federal Reserve cut interest rates for the first time since the financial crisis.

It would appear this negative obsession heading into election season is not grounded in the history of the stock markets as the following images illustrate.  As you can see below, the years prior to a presidential election, and the election year itself, tend to be good for stocks as candidates make promises for a new tomorrow.

Click here for source

5 Investing Topics to Think About Seriously

1. The Fortis Q2/2019 Firm Letter Pointed Out Inverted Yield Curve.

Read in the letter below how this is a serious recession signal but not a timing mechanism

CLICK TO READ FORTIS Q2 2019 LETTER: Every Time It Gets Cloudy This Bull Market Finds a Way to Shine Until Tomorrow by Matt Topley

In a 1986 dissertation, economist Campbell Harvey identified an economic indicator that would precede the next seven recessions that indicator is known as “a yield curve inversion”

Courtesy of Campbell Harvey

Click here for source

2. Vanguard Updated 10 Year Projected Returns.

Vanguard returns appear to be telling investors to temper expectations after a great 10 year run and we may see a rotation in leadership for the next decade.

These probabilistic return assumptions depend on current market conditions and, as such, may change over time.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of March 31, 2019.  Results from the model may vary with each use and over time.

Click here for full article from Vanguard

3. The Unemployment Rate Can’t Go Much Lower So Wages Have to Go Higher. 

Unemployment Rate Slightly Higher than Post WW II Record Lows.

Click here for source

4. This Feels Like the Biggest Bull Market Ever. In Reality the Last One Was a Lot Bigger.

1987-2000 Bull Market +600%

Click here for source

5. After a Demographic Lull, American Prime Age Spenders may be About to Hit a Growth Spurt.

Click here for source


If you built an investment portfolio based off politics or geopolitical events, it could permanently sit in cash because the world is such a scary place.  As pointed out in previous letters, reality is that the S&P 500 is up 15,000% in the last 70 years surviving an endless amount of doomsday scenarios that never fully pan out. 

Now as we are about to move to the forefront of our news cycle political theatre is at its highest level, but the end of the bull market will likely not be about presidential election combat.  Bull markets historically end due to higher inflation, rising interest rates, war, overvaluations or recessions.  This bull is likely to fall under traditional recession with overvaluations but timing it, as always, will be impossible.   An inverted yield curve is certainly a first shot across the bow of this bull but the average time before a recession starts after inversion is one year out.

If the bull market was to end quickly in the next couple quarters, it would certainly be a strange set-up with the Fed lowering interest rates, money pouring into bonds, and positive election cycle seasonality kicking in.

As hard as it may be, we should separate our political passions from our investment passions.  In my view invest based off your goals not your political affiliation, if you don’t need to live off your investments in the near term, embrace any political sparked stock market volatility as an opportunity to buy lower priced stocks.

At some point America will have a crisis but I expect we will survive and thrive because that’s what Americans do.  When the crisis hits just don’t make things worse by getting emotional and making irrational decisions.  You don’t have to be super smart, just keep it simple and don’t be foolish.  Do you think the next crisis will be worse than the 6 on the following graph?  We survived them all.

Every Time it Gets Cloudy This Bull Market Finds a Way to Shine Until Tomorrow

2nd Quarter 2019 Letter

Let It BeThe Beatles

And when the night is cloudy there is still a light that shines on me
Shine until tomorrow, let it be
I wake up to the sound of music, Mother Mary comes to me
Speaking words of wisdom, let it be

Let it be, let it be, let it be, yeah, let it be
There will be an answer, let it be
Let it be, let it be, let it be, yeah, let it be
There will be an answer, let it be
Let it be, let it be, let it be, yeah, let it be
Whisper words of wisdom, let it be

Source: LyricFind
Songwriters: John Lennon / Paul McCartney
Let It Be lyrics © Sony/ATV Music Publishing LLC


It’s official. July 1st marked the date of the longest economic expansion in U.S. history. As the Beatles sang in their iconic anthem, “Let It Be,” every time the night gets cloudy for this bull market there is still a light that manages to shine through. Will this record-setting expansion shine until tomorrow?  Should you just sit by patiently and let it be?  These are questions that have been vexing economists and financial advisors for quite some time, so let’s try to bring some clarity.

Yes, the U.S. economy is in the midst of its longest expansion on record—121 months and counting–but some other milestones are being surpassed that could change the dynamic of this market. Take interest rates. As mentioned in my letter to you last quarter, the U.S. yield curve has inverted for the first time since 2007. True, the curve initially corrected itself after inverting earlier this year, but it quickly inverted again and has remained that way for over 30 days. Again, an inverted yield curve means investors are being paid more for holding very short term debt than they are for holding long-term debt. It’s counter-intuitive and usually means investors are very nervous about the future.

Longest Economic Expansion Since WWII.

Another eye-catching statistic is that the performance spread between growth stocks and value stocks is at its fourth highest level in a century.

As BlackRock’s Andrew Angle noted, “The value drawdown that started at the beginning of 2017 is one of the worst investors have faced.” 

Yield curve update and global interest rates

As mentioned in last quarter’s letter, the yield curve inversion is not a timing mechanism, since the market historically performs pretty well another 12 to 18 months post-inversion. We also saw yields on the 10-year Treasury bond break below 2 percent in Q2 of this year—a time when $12 trillion of international bonds are trading at negative interest rates in the midst of a global move downward. That could be a massive amount of money essentially being parked in shoeboxes under investors’ beds!

Source : Torsten Sløk, Ph.D.Chief Economist Managing Director Deutsche Bank Securities

Everyone is talking about the end of the long-running bull market in U.S. equities, but in the second quarter of 2019, the most crowded trade in the world became U.S. Treasuries. Even though rates are abnormally low, the Fed Funds futures market is now signaling a 100 percent chance that the central bank coule ease its monetary policy next month. Incredible!

Here are some excerpts of the notes coming across my radar recently:

For the first time ever, being long US Treasuries was considered the most-crowded trade according to the June global fund manager survey conducted by Bank of America Merrill Lynch.

The bet on government bonds beat out popular crowded trades such as tech, high-quality and emerging markets, each of which has occupied the list’s top spot since 2013.

The study was released Tuesday during a week in which traders were watching multiple events that could set the course for global growth going forward: the Federal Reserve meeting Wednesday, and the G20 summit later in the month.

Historically, when equity bull markets end money pours almost exclusively into stocks. But today, we have seen government bonds beat tech stocks as the most crowed trade in the market and bond ETF assets have doubled over the past year alone.  I don’t know anyone who is bulled up on stocks–, it’s the single biggest anomaly I have witnessed in my 20-plus year career in finance. As mentioned in previous letters, the Great Recession of 2008-09 caused the massive equities risk hangover we haven’t seen since the Great Depression of 1929.

Bond ETFs double assets in one year

As shown above, bond ETFs are booming. According to Dave Lutz (Jones Trading), essentially every category has recorded double-digit growth in average weekly volumes between last year and 2019.

With the inverted yield curve being in place as the first serious sign of a recession in the near future, could the American investing public be right?  After hundreds of years of market flows proving the American public and professional investors as horrific market timers, could this time be different?

As I discussed in my Q1 letter, it’s important to be sure that an inverted yield curve is not just a temporary anomaly:

“First, it’s important to remember that not everyone uses the same definition of ’inversion.’ Like the San Francisco Fed, I consider an inversion to be a situation in which the yield on 3-month Treasuries is higher than the yield on 10-year Treasuries. According to the Cleveland Fed, inversions of that 3-month/10-year spread have preceded each of the past seven recessions, including the 2007-2009 contraction. The Cleveland Fed acknowledged there have been two ‘false positives’ — an inversion in late 1966 and a ’very flat’ curve in late 1998.

First crack in the bull market, but don’t get fooled again

Refer to last quarter’s letter for details about historical returns post-yield curve inversion. Again, the important piece of new data this quarter is that the inverted yield curve has remained inverted—it’s not a temporary blip.

Why aren’t oil prices spiking—another key recession indicator?

Most finance textbooks and market historians argue that recessions are caused by the Fed raising rates and/or oil prices spiking. As Moody’s chief economist Mark Zandi told CNBC, “Quickly rising oil prices have been a contributing factor to every recession since World War II.”   

The first 17 years of my finance career were spent on a trading desk. If you ever had a situation in which Iran attacked oil tankers in the Strait of Hormuz and shot down a U.S. military drone in the same month, you can bet your butt that oil prices would skyrocket!  But today it’s different. Sure, Iran’s recent actions put us on the brink of a hostile U.S. military response, but the price of oil barely budged. Further, the oil volatility index was rolling over just a few days later. Which is hard to believe!

It’s almost unthinkable that President Trump was within hours of a military response against Iran and oil only moved 2 percent higher. But the next several charts help explain why:  

Crude oil production exploded after the 2008 Great Recession

Ed Yardeni


As domestic oil supply expanded to the point that the U.S. become a net oil exporter, our reliance on Persian Gulf crude evaporated. In late June, President Trump said the U.S. may lessen its role in the Strait of Hormuz as domestic oil and gas output grows and our energy imports from the Middle East decline.
Combine massive oil supply and demand changes with climate change and shifting attitudes toward clean energy technology and you have an impetus for massive economic transformation in the Middle East. United States imports of Persian Gulf crude are down by nearly 70 percent over the 10 years. As a result, a number of Middle Eastern countries will need to adjust their economies substantially.

4 major themes dominating global markets

Theme 1-passive management fund flows continue to crush active management

So far this year, about $39 billion has shifted into passive funds and $90 billion has shifted out of active funds. Many think that 80 percent of the market is now on autopilot. Passive investments control about 60 percent of equity assets, while quantitative funds — those relying on trend-following models instead of on fundamental research — now account for 20 percent of market share, according to estimates from J.P. Morgan.

“The pace of outflows from active is at a cycle high while the pace of passive equity inflows has bottomed and [is] beginning to reaccelerate,” Dubravko Lakos-Bujas, J.P. Morgan’s chief U.S. equity strategist, said in a note on late in June.

Theme 2-Large -cap growth stocks and S&P 500 stocks continues to dominate performance

In past letters I have talked about the widening spread in performance and valuations between large cap U.S. stocks and international markets. Large cap growth stocks now trade at close to 9x price to book (P/B) value compared to 1.5x P/B for emerging market stocks and 2.5x P/B for developed market stocks. 

The entire outperformance of emerging market stocks since 2003 has been erased

This might explain why the sell-off at the end of last year functioned as a correction to drawn-out U.S. outperformance, while this latest moment has seen emerging markets lag behind the S&P 500 even more. At this point, all the outperformance by emerging markets since 2003 has been canceled out – an extraordinary statistic given the speed of growth in much of the emerging world. 

(placeholder Vanguard growth vs. EEM emerging markets 5 year)

Theme 3 -Growth investing is crushing value investing

  1. S&P growth stock vs. value stock rallies above 1999 record spread
  2. I started my trading career in 1997 in the early innings of the Internet bubble. I never thought we would witness such a large spread between growth and value stocks again. I was wrong. Not only are we seeing a spread of historical proportions – but we are hearing many of the same themes that we heard in 1999. Twenty years ago, Goldman Sachs published an ill-timed piece about the death of value stocks and a Forbes article suggested for Warren Buffett should call it quits after 10 years of under-performance.

On December 7th, 1999, Barron’s published the infamous “What’s Wrong,Warren” cover eerily before the Nasdaq crashed 50% and Berkshire recovered years’ worth of underperformance.

The below graph plots the time period 6/30/98 through 2/29/00 for the Nasdaq where many dot-com and technology stocks traded, and the price of Berkshire Hathaway, Warren Buffett’s holding company, which consisted of value stocks:

S&P 500 Growth vs Value gets over the 2000 peak, twits notes.

S&P 500 Growth vs Value gets over the 2000 peak, twits note

20 years later “The Big Guy” is back on the cover of Barron’s as “CEO of the Year.”

Take a minute to review the chart below. How many Millennials are familiar with this chart? In my experience, Amazon means just two things to them–(1) that’s where they order almost everything in their lives and (2) the stock only goes up. 

1999-2000 Nasdaq and Amazon chart.

Theme 4-Demographics is destiny

Speaking of Millennials, we tend to be passionate believers in the power of demographic trends.  Consider these facts:

  • By the year 2020, eight of the top ten demographic cohorts will be under age 40 (Boomers will be fading away).
  • By the year 2030 the top 11 cohorts will be the youngest 11 cohorts.

There will be plenty of “gray hairs” walking around in 2020 and 2030, but the key for the economy is that the number of Americans in their prime working years is now increasing. If nothing else, this should be a positive trend for housing and the economy.

U.S. Demographics: Largest 5-year cohorts, and Ten most Common Ages in 2018

by Calculated Risk on 6/11/2019 11:59:00 AM


As shown above, the U.S. has the largest demographic group in history hitting its prime spending years. That makes me believe the next recession–like all previous economic slowdowns–will present great buying opportunity for stock investors. But make no mistake – I believe we will have a recession before reaping the full benefits of Millennial spending power.  If you doubt this macro trend, just scan some of the charts about student loan growth and urban apartment expansion. The “pig through the python” is coming and it may have a profound impact on our economy over the next two decades. There will be more on this trend in a future letter focused on demographics.

Beyond U.S. demographics, we have global population projections predicting the rise of Africa as Asian hyper-growth rolls over.

Future Population Growth.


After being historically bullish about stock pullbacks–including hosting a webinar at the beginning of this year [LINK] that the end of 2018 was a buying opportunity, not the start of recession, I believe we are now in a more precarious situation. The inverted yield curve should not be ignored, and our economy appears to be running out of qualified workers as the jobless rate settles below 4 percent. Amazingly we have not experienced inflation despite such a historically low unemployment rate, so the stock market continues to rise.

Sure, stocks are on the pricey side, but I don’t believe it means the market is on the brink of crashing. I wouldn’t consider this to be a bubble when you consider how low interest rates and low inflation are. Now is not the time to give up on a diversified portfolio. The S&P is expensive versus other options and we should temper our expectations for equity returns over the next half decade as stocks will likely face new headwinds.

Final thoughts: Prepare for the years ahead

I’d like to reiterate the advice from my Q1 letter:

• Stick to your plan. Investing is a psychology game, not an IQ game. Do not get emotional, have a plan.

• Prepare for lower but acceptable returns.

• Mentally prepare for a recession size drawdown in equities, possibly 30-40%

• Get aggressive when stocks are on sale.

• Ignore the headlines and doomsayers.

 • Ignore politics as elections approach.

• Don’t leverage up now. Opportunities will likely present themselves in the near future to use your debt/margin in a more efficient manner.

First Crack in the Bull Market, but Don’t Get Fooled Again

First Quarter 2019

“Won’t Get Fooled Again”

I’ll tip my hat to the new constitution
Take a bow for the new revolution
And smile and grin at the change all around
Pick up my guitar and play just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again, don’t get fooled again, no no no no
Meet the new boss
Same as the old boss

Songwriters: Pete Townsend
Produced by: The Who

Key Takeaways

Don’t get fooled again by rising interest rates doomsayers.

  • The yield curve just inverted for the first time since 2007—short term rates are now higher than long term rates.
  • There’s typically a 17-month lag between a yield curve inversion and the start of a recession.
  • The curve did not stay inverted very long further confusing outcomes.
  • Markets tend to perform well during the post-inversion lag period–but stocks eventually draw down when the economy contracts.
  • Stick to your plan. Ignore the media. Buy when things are cheap and take lower but acceptable returns.

 The Yield Curve Inverts

In 2007, I was in China and purchased a statue of a bull for my home office. The statue arrived via FedEx with a crack down the middle. Little did I know that crack would be an eerie warning of the 2008-09 financial crisis—the most punishing global recession we had seen since 1929?   I’m not superstitious, but a more traditional recession indicator flashed negative soon after my damaged shipment arrive from the Far East–the yield curve had “inverted.” In other words, rates on long-term (10-year) Treasury bonds were actually paying investors less than short-term (3-month) notes were. As we’ll see in a minute, this phenomenon has happened at least five other times over the past 40 years, and each time a recession has followed.

A similar inversion just occurred at the end of March 2019 while U.S. stock markets had rebounded nearly 20-percent from a recent bottom and the bond markets were on a win streak as well. Does that mean another recession is looming? Quite likely it is, but there are some important caveats to consider in terms of timing, severity and what you should do with your portfolio. The markets like life are never easy.

First, it’s important to remember that not everyone uses the same definition of “inversion.” Like the San Francisco Fed, I consider it to be when the yield on 3-month Treasuries is higher than the yield on 10-year Treasuries. According to the Cleveland Fed, inversions of that 3-month/10-year spread have preceded each of the past seven recessions, including the 2007-2009 contraction. The Cleveland Fed acknowledged there have been two false positives — an inversion in late 1966 and a “very flat” curve in late 1998.

What does the yield curve really mean?

The 10-year rate is set by market supply and demand as investors determine the equilibrium point of where that 10-year rate should be. But, the 3-month rate is set not by market forces, but by policymakers at the Fed. As the old saying goes, when investors are scared, they run to the 10-year and when the Fed is scared it raises short-term interest rates. These two forces collide to invert the curve. As a result, when short-term rates are higher than longer term rates, investors are indicating that they’re cautious about the future of the economy and they don’t want to tie up their money.

Yield Curve is Not a Timing Mechanism

The problem with using the yield curve blindly as a recession indicator is that there is historically a lag of 10 to 24 months between when the yield curve inverts and when the economy limps into a recession (see below). More importantly, you don’t want to head for the hills immediately because markets tend to perform very well during that initial post-inversion lag period to the tune of PLUS 15 percent on average (see subsequent chart).  Here are the start dates for the five previous inverted yield curves along with the beginning of the ensuing recessions:

Source: Ben Carlson, A Wealth of Common Sense

As you can see, there has been a substantial lag from the time of the inversion until the start of the recession in each of these instances. The average number of months was 17, meaning it took about a year and a half for the economic slowdown to hit after the yield curve inverted. Again, history shows that markets tend to perform very well in the initial year or two following an inversion.

Source: Ben Carlson, A Wealth of Common Sense

As mentioned earlier, the average return during these lag periods was a gain of more than 15 percent. There was just one downturn which occurred after the dot-com bust in the early 2000s. Although the stock market doesn’t need to see a recession for a large correction, it’s a safe bet that an economic contraction will lead to a draw-down in stocks.

What does it All Mean?

I know what you’re thinking: “Thanks Matt. You just hit me with a bunch of financial gibberish that I don’t understand and have thrown out some conflicting signals.” I’ll make it easy: It appears we have our first serious recession signal in over a decade, so we should take this indicator seriously. However, the other Fortis recession signals are not yet flashing red:

  1. Wage growth is still below 4 percent.
  2. Inflation is not accelerating.
  3. Initial jobless claims are not rising, and
  4. Inventories are up, but not at recession levels.
  5. Bonus factor- the yield curve only stayed inverted for a couple days.

Our 4th Quarter Letter encouraged investors to be aggressive and take advantage of the near 20 percent correction in the markets. Over that time, as U.S. market valuations pulled back to median levels, we said the probability of a significant rally following a bad quarter would be quite high (see below grid). We followed that Q4 letter with our first webinar for investors that discussed in greater length the opportunity at hand. As most of you know, the first three months of 2019 ended up being the best quarterly return for the Dow and S&P 500 in a decade.

Source: Ben Carlson, A Wealth of Common Sense

Looking Ahead?

While we can’t avoid a recession forever, we’re not likely to endure a downturn as punishing as we had in 2008. Bank balance sheets are in rock solid shape. American citizens have been cutting debt aggressively, resulting in stronger personal balance sheets than we’ve seen in many years. But we have to be disciplined, because the probability of a cyclical recession is rising and there is a strong likelihood of lower portfolio returns after a decade of euphoria.

At this point, employment numbers can’t get much better–we have more jobs available in the U.S. than eligible unemployed citizens. As is usually the case with markets, unemployment numbers are counter-intuitive: The time to invest is when unemployment is high. When unemployment is high, stock valuations are usually low and no one is buying equities. As Warren Buffet always says: “Stocks are the only thing people don’t buy when they are on sale.”

Interest Rates

I am sure you thought this Quarterly Letter’s theme (“Don’t Get Fooled Again,”) would be a warning about the next 2008.  It’s actually about the probability of interest rates going higher. One of the reasons the yield curve inverted is because the Fed was raising short-term rates at a time when the rates on longer term 10-year Treasuries were falling. As I mentioned earlier, short term rates are driven by Fed policymakers, while long-term rate are driven by market forces.

The chart below shows that estimates for rates under “preferred conditions” have dropped from 3.5 percent in 2018 to 2.5 percent in 2019. Further, there is ample speculation about a rate cut in 2019.

Historical S&P Returns when Unemployment Low

Estimate of Fed Policy Going Forward


Think of Fed Fund Futures as a Betting Line

The line has now moved heavy in favor of a rate cut in 2019.

Global Bond Yields Slide to Fresh Lows Following ECB Comments

As the Wall Street Journal recently reported, yields have slipped as central banks have signaled they are willing to hold rates low for significantly longer than expected.

For 25 years, economists have been predicting doom due to rising interest rates. Here we are again with mortgage rates near historical lows. I am already trying to teach my kids that betting on sports is a loser’s game, but an even biggest loser’s game is making bets with your money based on expert predictions about interest rates. “Don’t get fooled again.

Since 1992, Economists Have Predicted Higher Interest Rates.  How did that work out?


Source:  Blackrock

If you do not believe me, here are Warren Buffet’s comments from his latest Berkshire Hathaway shareholder letter???


Equity investors have enjoyed a historic run over the past decade, and now it appears we have our first serious signal of a downturn.  Again, the inverted yield curve is not a timing mechanism, nor is it a 100-percent reliable recession indicator. We also have a de-levered banking system and a de-levered high-net-worth population in the U.S.

America’s wealthiest households are stashing their cash at record levels. The top 1-percent of households now have three times more money in readily available cash than the bottom 50-percent holds! The 1-percenters have about 20-times more in cash today ($304 billion) than they did before the last recession ($15 billion) according to Federal Reserve data released last week.

 We are blessed to live during a dynamic time in U.S. history. Bull markets are getting longer and bear markets are getting shorter. Most of us endured a once-in-a-lifetime recession in 2008, but came out with a record setting bull market run. When the the next recession arrives, it will most likely follow the same path as shown in the chart below.

For investors who are net savers, over the next decade, you should welcome the recession as an opportunity to buy stocks on sale. I am a firm believer in Warren Buffett’s American Tailwind theory: “Over the next 77 years, however, the major source of our gains will almost certainly be provided by The American Tailwind.  We are lucky-gloriously lucky-to have that force at our back,” quipped Buffet.

History of U.S. Bear & Bull Markets Since 1926

Final thoughts: Prepare for the years ahead

  • Stick to your plan. Investing is a psychology game, not an IQ game. Do not get emotional and have a plan.
  • Prepare for lower but acceptable returns.
  • Mentally prepare for a recession size drawdown in equities 30-40%
  • Get aggressive when stocks are on sale
  • Ignore the headlines and doomsayers.
  • Ignore politics as elections approach.
  • Don’t lever up now. Opportunities will present themselves in the near future to use your debt/margin in a more efficient manner.

As Springsteen Takes Off on Broadway, Investors Got Blinded By the Light

4th Quarter, 2018

 “She Got Down But She Never Got Tight She’s Gonna Make It Through the Night”

 Blinded by the Light

Blinded by the light
Revved up like a deuce
Another runner in the night

She got down but she never got tight
She’s gonna make it through the night


Songwriters: Bruce Springsteen

Blinded by the Light lyrics © Downtown Music Publishing

Springsteen’s off-Broadway

I recently watched Springsteen’s fabulous Broadway performance on Netflix, having seen The Boss over 20 times myself, it still was unreal to hear him tell personal stories around growing up and his career.  As I watched one of the most volatile stock market year ends in history, I couldn’t help but apply investors psyche to a Springsteen song.  Most investors got Blinded by the Light, it was just too easy, buy FANG stocks, buy S&P index, buy anything.  After 2017 being one of the least volatile years in market history including no drawdown of S&P over 3% versus historical annual average drawdown of 14%, the market sent a giant wake-up call that investing is always emotional including an all-time record almost 3% Christmas Eve smack down.  Here’s the good news, it seems she (market) is going to make it through the night as she always does, it’s not 2008 or anything close, we have some wood to chop in the short-term but valuations are reverting to mean.

2018 was a historic year for financial markets in more ways than one-first time in 27 years that stocks and bonds were both negative in the same year, worse stock market December since 1931, over 90% of investable assets were negative in 2018, and no asset class returned over 5% for the first time since 1974.

A Record Share of Asset Classes Posted a Negative Return in 2018

Investors felt pain this year across the board as diversified portfolios were nowhere to hide, in fact some well diversified holdings returned less than the S&P due to exposure to bonds, commodities, international stocks and U.S. small cap stocks.  Three of these groups were down more than the S&P and most bonds were flat to negative.  The tradtional 60/40 model was negative for the year with returns coming in 13% below historic median, if you’re 60/40 was global returns were even lower.  Target Date funds are popular and growing especially in 401k plans, see below as they are posting first negative returns in 10 years.

Diversified Portfolios Big Red Year – Target Dates Down for First Time in Ten Years

In my first quarter 2018 letter I wrote at length about tech facing its Machevellian moment in the next 12 months, mentioning that a small cadre of tech stocks were responsible for most of the markets gains which is unsustainable.   But the bigger problem was the market was due for sector rotation especially since traditional defensive sectors of market hit record low capatalization in the S&P even lower than 1999 or 2008.  This sector rotation back to defensive certainly started in the 4th quarter now the question becomes how long will it last?

Click here for first quarter letter

As popular stocks and sectors started to crumble, retail investors as in the past started to get emotional, including pulling a calendar-month record  $98 billion from U.S. based stock funds in December.  In fact it was almost double the previoius record of $48.8 billion in October of 2008.  As anyone who has read my thoughts in the past knows, investors are terrible market timers.

Investors usually sell in market panic downturns and buy when they are blinded by the light of euporia.  But as you can see from the chart below, selling during bad quarters can cost you, buying during bad quarter has proven profitable on 1yr, 3yr and 5 year periods.

The good news is that markets will most likely, like Springsteen says, “make it thru the night.”  Banks balance sheets are in good shape as are household balance sheets, the debt overhang this time around is corporate debt and private lending, not enough to spark another 2008.  This could leave us looking at a bear market without a recession or a cyclical bear market within a longer-term secular bull.  The good news on these two scenarios is that the pain will be short-lived.  For anyone who is a net saver for the next 5-10 years or more, buying opportunities will present themselves as some are already coming to fruition.

See chart below the length of bull markets versus bear markets, especially some of the shorter corrections or cyclical bears.

History of U.S. Bear and Bull Markets Since 1926

How about returns for the market after bad quarters and months like December?  The market actually has impressive returns on a 1 year, 3 year and 5year basis after a 4th quarter like 2018.  If you strip out the American depression years, last quarter was the top 10 worse quarter in stock market history.  So we should run for the hills right, contrary to the natural emotional response, instead we should channel our inner Warren Buffet and stay to a disciplined system for the long-term.

The good news about market sell off is that valuations naturally come down, as you can see in the following chart, S&P price to earnings ratios have pulled back to the mean.  Even though investors and the media love to talk in terms of the S&P, diversified portfolio holders invest internationally, across market caps in U.S., in commodities and real estate.  The even better news is some of these non-S&P asset classes are trading at 25 year lows.  Value stocks are at record discounts to growth stocks in the U.S., International stocks are trading at half the fundamental valuation measures of U.S. growth stocks and commodities are at a 25 year low valuation to the S&P.  The idea that all asset classes are expensive after this 10 year bull market is fake news.

S&P Valuations Trading Below 25 Year Average P/E

Valuation Grid

Value Stocks and International Stocks Trading at Discount to U.S. Growth Stocks.

Global Valuations as of 12/17/18


Diversified portfolios generally work well over the long-term but they are sometimes painful to hold in the short-run.  The last 10 years have been an S&P dominated investment environment, this has left some asset classes behind resulting in cheap valuations.  Investors that are net savers for the next 10 years now have an opportunity to invest more aggressively at more attractive valuations.  As one of our earlier charts indicated most investors are selling, historically this has been the best time to buy and post bad quarters data also puts probabilities in your favor for a 3-5 year horizon.

Investors should expect more volatility in the first quarter as company earnings hit the tape and the market decides whether this is a correction of something bigger.  Valuations in many asset classes have already priced in something bigger but as the song goes “she will make it through the night.”  As I like to remind readers in most letters, the S&P 500 has experienced twelve 20% corrections in the last 70 years and it’s returned 15,000%.  I believe investing is a psychology game not an IQ game, I suggest you keep your emotions in check and stick to your plan.