A look at the bull market ahead

My latest missive on the near-term stock market outlook can be seen at Financial Sense web site.  You can see it by clicking on the following link:

https://www.financialsense.com/clif-droke/what-will-end-bull-market

Special thanks to FSO for publishing the article.

Gold’s silent comeback and the middle class rebound

The middle class has been stuck in a rut – psychologically if not economically – for years, and they’re not afraid to admit it.  Last year’s upset victory for Donald Trump in the U.S. presidential race was a manifest token of middle class angst.  Opinion polls have shown that many of the anxieties expressed by the middle class last year are still a concern for them this year.  In other words, not much has changed since a year ago.  There are some strong indications that the middle class outlook will change for the better in the coming months, however, as we’ll discuss in this commentary.

Ask the typical middle class wage earner if they think they’re economic prospects will improve in the year ahead, however, and you’ll likely receive a cynical response.  If there was any doubt that Middle America’s economic prospects haven’t improved much since last year, the following graph will lay them to rest.  Shown here is the Middle Class Index (M.C.I.), a share price composite of several leading companies that cater to a largely middle class customer base.  The components of this index include JC Penny (JCP), Ford (F), Dollar General (DG), Wendy’s (WEN), Wal-Mart (WMT), and Kroger (KR). 

If the above graph is any indication of middle class consumption patterns, then middle income Americans haven’t exactly set the world on fire with their spending.  The implication of the M.C.I. is that while middle class spending has certainly increased over the last several years, it has essentially flat-lined on a 3-year basis.  While there is admittedly a danger in reading too much into such a simplified overview of middle class spending, it’s likely not far from the truth to assume that middle class Americans aren’t making much progress.  At least, that’s how they feel based on the trend of the Middle Class Index.

So the question is, “Will the economic prospects ever improve for the middle class?”  While many would respond with a bleak “Never!” there is actually a good indication that the year ahead will witness some solid improvement.  Consider the next chart exhibit, which highlights the prospects for the upper middle class (i.e. individuals who earn in excess of $75K/year).  The Upper Middle Class Index shown here is a stock price average of several companies which cater mainly to the upper middle, including Target (TGT), Starbucks (SBUX), BMW (BMWYY), Apple (AAPL), and Ruth’s Chris (RUTH).

What this graph suggests is that, in contrast to the middle class, upper middle class consumers have increased their spending over the last year.  In just the last few months alone the Upper Middle Class Index has trended decisively higher as luxury spending among upper middle and upper income consumers has been buoyant.  The message of this indicator is that the upper middle class is in much better shape than the middle class.

There is another takeaway from our discussion of the Upper Middle Class Index, however.  Historically, economic improvement following a major downturn like the last recession proceeds from the highest economic classes to the lowest.  It’s much like a freight train when it starts rolling from a standstill; the engine moves first, then the cars closest to the engines, and so on until at last the final cars begin moving forward.  The upper class is always the first to benefit from an increase in credit and money supply, then the upper middle, then the middle, and finally the lower class.  Like a train, economic momentum takes time to build up but when it finally becomes established it tends to be self-sustaining. 

The fact that the Upper Middle Class Index is increasing is a positive indication for the middle class, for it suggests that the increased spending patterns of the upper class of recent years have finally spilled over into the upper middle class.  Eventually the middle class will eventually follow the lead of the upper middle, as is always the case. 

One sign that the U.S. economy may be on the cusp of truly breaking out is found in the graph illustrating the rate of change in M2 money velocity.  This is one way of measuring the demand for money.  Money demand, as measured by the ratio of M2 money stock to nominal GDP, has been extremely high by historical standards for the last several years.  In fact, the demand for cash has been extraordinary since the 2008 crash, as investors have feared a recurrence of the crisis years.  The inverse of this measure is the velocity of M2 money (nominal GDP divided by M2).  Velocity remains near multi-decade lows in reflection of the public’s massive demand for cash; however, it shows signs that it may be reversing. 

The following graph, courtesy of the St. Loius Fed (https://fred.stlouisfed.org), shows the year-over-year change in M2 money stock.  As you can see, it’s trending gradually higher and is close to entering positive territory for the first time since Q1 2010, when the combined impact of Federal Reserve and U.S. government stimulus was at its highest following the Great Recession.  This is also a sign that the perennial problem of low inflation is gradually reversing as inflation slowly, almost imperceptibly, makes its return.

Another indication that things are about to improve for the middle class is, perhaps surprisingly, the price of gold.  Gold serves two primary functions in today’s economy.  The first is as a reflection of how much fear exists among investors as it pertains to the future outlook.  The gold price is basically one way of gauging how much confidence stakeholders (producers, consumers, and investors) have in the future prospects for business. 

More than this, gold is also a measure of future inflation expectations.  When the economy was still quite fragile between the years 2009 and 2011, investors placed a high premium on gold ownership as reflected in runaway gold prices.  When it became clear in late 2011, however, that the U.S. recovery was gaining traction, gold lost much of its luster as a safe haven and it became less desirable for investors to commit the bulk of their investment capital to it.  Risk assets instead became more attractive, undermining the demand for gold.

Since last year, however, gold has embarked on a “silent comeback,” effectively ending a four-year bear market.  (See the SPDR Gold Shares ETF chart below for illustration.)  It has been consolidating its gains in recent months as it prepares to continue its long-term rebound.  The going has been slow for the most part, mainly because inflation has been slow to return and equities continue to steal some of the yellow metal’s thunder.  If the M2 velocity chart shown above is any indication, however, then inflation should slowly increase in the coming years.  This would certainly brighten gold’s longer-term prospects and make gold ownership more attractive to the average investor once again.  A moderate amount of inflation, besides boosting gold’s lure, would also help the middle class to recover even more.

In the final analysis, a full-fledged middle class economic revival has been talked about and anticipated for years, and its failure to arrive has been frustrating.  Its manifestation is long overdue, however, and while it has been slow in coming the indicators discussed here bode well for the middle class in the months ahead.  History shows that sustained improvement in the upper middle class always eventually spills over to the next level down, which is good news for Middle America in 2018.

MSR Performance Review

Following is the 2014-2017 weekly performance of the MSR total stock/ETF portfolio based on all buy/sell trading recommendations in the Momentum Strategies Report. The performance graph pictured here was updated as of Aug. 7, 2017.

Recommendations made in the Momentum Strategies Report are based on a combination of technical analysis, fundamental analysis, relative strength analysis and investor sentiment analysis.  Recommendations are only made in what are deemed to be high-probability, low-risk, low-volatility trading opportunities. 

All trades are initiated once a “buy” signal is confirmed by the price line of the stock or ETF in relation to its 15-day moving average, along with other pertinent technical confirmation (e.g. relative strength, internal momentum, etc.).  Conservative stop-loss recommendations are given and continually updated with each trading position.  The average length of the trades made in MSR is approximately two months, but can sometimes be longer. 

MSR rarely recommends short selling (only in confirmed bear markets) and prefers a 100% cash position whenever faced with a dearth of potential high-probability buy candidates.

In the vast majority of cases, there are only 1-2 stocks/ETFs in the model portfolio at any given time.  Rarely are more than three positions recommended at one time.  This allows us to concentrate all our attention on a few positions without being distracted by having to worry about multiple positions.  This also limits draw downs.  Most recommended positions involve low-volatility, actively traded NYSE stocks and ETFs.

The preceding graphs reflect only entry and exit signals, not profit-taking advice.

[Note: Performance graph is updated each Friday based on change in portfolio value from previous Friday.]

Prepare for a 30-year bull market

Heading into 2017, Wall Street was excited by the prospect of a U.S. president who sympathized completely with business.  His promised tax and healthcare reforms were widely cheered by investors in the wake of his election.  Yet the Congress has so far failed to deliver on those promises and investors are no longer giving the Trump administration a free pass based on the assumption that tax breaks are on the way.

This loss of enthusiasm is reflected in the long periods of dullness the market has experienced since March.  While the bull market leg which began with the November election remains intact, the market has proceeded in a halting fashion and has gradually lost some of its erstwhile momentum.  The following graph illustrates this principle. 

Along these lines, a number of Wall Street economists have expressed the belief that if Trump’s promised reforms fail to materialize, the stock market’s current valuation precludes a continuation of the bull market.  There are a number of reasons why this statement is likely false, however, not the least of which is that the market doesn’t need a political excuse to rally.  Indeed, if that were the case then China’s equity market, in view of the country’s Communist government, would forever be stuck in neutral.  The pace of innovation and productivity in countries with a market-driven economy is consistently high enough to always provide some justification for higher valuations and stock prices, regardless of the political climate.

Writing nearly 200 years ago, Alexis de Tocqueville observed that in America no matter how much the tax burden increased, American ingenuity and resourcefulness always found a way to counteract its malignant effect.  He stated:

“It is certain that despotism ruins individuals by preventing them from producing wealth, much more than by depriving them of the wealth they have produced; it dries up the source of riches, whilst it usually respects acquired property.  Freedom, on the contrary, engenders far more benefits than it destroys; and the nations which are favored by free institutions invariably find that their resources increase even more rapidly than their taxes.”  [Democracy in America]

Tocqueville understood that America is unique among the nations in that its people and commercial spirit are strong enough to countervail even the most strenuous attempts by politicians at slowing commercial progress.   This principle is as true today as it was then, perhaps even more so.

While many analysts are concerned by currently high market valuation indicators, the reality is that valuations can climb considerably higher before the market is in imminent danger of a bear market.  The S&P 500 P/E ratio may be high at 26.13 by historical standards, it’s still a ways from those high levels in the late 1990’s/early 2000’s which preceded the death of the powerful ‘90’s bull market.  Moreover, price/earnings alone isn’t a reliable measure of how undervalued or overvalued a market is.  One must also take into account the investor sentiment backdrop, levels of participation among retail investors, and other technical and monetary policy factors when forming a final determination as to whether or not the market is truly “overvalued.” 

To illustrate how important it is to consider investor sentiment along with valuation, I reprint here the words of William Jiler, who wrote investment books in the 1960s.  Using International Business Machines (IBM) as an example, he wrote:

“How could [an investor] anticipate that IBM would sell as low as 12 times its annual profit in the late Nineteen Forties and at 60 times earnings in the late Fifties?  Obviously, ‘investor confidence’ went up sharply in the Fifties.  And obviously, the psychology of the market – that is, the sum of the attitudes of all potential buyers and sellers – is a crucial factor for determining prices.”  [How Charts Can Help You in the Stock Market]

The main consideration for stocks going forward is the level of participation among individual investors.  With investor sentiment still neutral and few small investors actively trading, the bull market still has plenty of room to run.  The informed investors who are keeping the bull market alive need someone to sell to when it finally comes time for them to unload their holdings.  That someone is the uninformed public which by and large has been afraid of owning stocks since the 2008 credit crash.  Until they rediscover the “joys of investing” the 8-year-old bull market will continue to age, all the while maintaining its vigor. 

History teaches that following a major financial crisis, a bull market lasting from around 20 to 30 years normally follows.  Such was the case following the Great Crash and Depression of the 1930s, the economic and political turmoil of the early 1970s, and in other eras in U.S. market history.  The last crisis in 2008-09 witnessed the birth of a new secular bull market which is already eight years old.  A generation is around 20-30 years, which partly explains why bull market typically last so long until the next great crash; it takes that long for the generation that experienced the last crisis to be replaced by an entirely new one which doesn’t remember it.  It’s only when the new generation has come of age that the mistakes which led to the previous crisis are repeated and the cycle begins anew.

Given that the current generation is still, nearly 10 years later, still averse to stocks to a large extent, the secular bull market has probably another 10-20 years to run before encountering the problems which always prove fatal to it.  I’m referring of course to the dangers of over-participation and excess enthusiasm.  Those dangers are nowhere in sight today.  We can therefore assume that the long-term bull market still has many more years to run before eventually reaching its terminus.   

Is the market all-knowing?

“The tape tells all” is a Wall Street bromide we’re all familiar with.  It neatly summarizes the belief that the major averages discount everything pertaining to the business outlook.  It’s also a basic tenet of Dow Theory.

Writing a century ago, Richard Wyckoff was one of the very first market pundits to put this belief in writing.  “The tape tells the news minutes, hours and days before the news tickers or newspapers and before it can become current gossip,” he wrote.  “Everything from a foreign war to the passing of a dividend; from a Supreme Court decision to the ravages of the boll-weevil is reflected primarily upon the tape.”

This sentiment was also eloquently summarized by author Robert Rhea over 80 years ago.  Writing in his classic book, The Dow Theory, Rhea observed:

“The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movement.  The averages quickly appraise such calamities as fire and earthquakes.”

The late Joe Granville took this a step further by suggesting that the stock market represents the sum total of a nation’s intelligence across many different fields.  He maintained that the market knows virtually everything worth knowing about the short-to-intermediate-term outlook.

Writing in September 2004, just after a devastating series of Florida hurricanes, Granville observed: “When the stock market turns down it is warning of trouble ahead.  It doesn’t matter what the trouble turns out to be…For a look at the future it was only necessary to follow the market instead of hurricane reports.”  In view of the vulnerable state of the market prior to the major hurricanes of 2005 and 2012 (Katrina and Sand), perhaps Granville was on to something.

Not all investors believe that Mr. Market reflects the sum of all wisdom as it pertains to the future outlook, however.  Proponents of Random Walk Theory in particular dismiss this notion with scorn.  But are they right to reject this proposition?

Experience has shown that Granville’s proposition is essentially correct, if overly simplistic.  To assume that the market always declines at the first scent of trouble would be the height of folly.  The collective wisdom of informed investors does tend to trace out its foresight in the charts, but it isn’t always blatantly obvious at first and sometimes is evident only in retrospect.  The market action of the year 2007 is instructive.  Consider that beginning in February that year the market commenced a series of volatility plunges as insiders first began to manifest their advance knowledge of the coming credit storm.

In between, and immediately after, the market plunges in February and August ’07, however, the S&P made new highs.  This was either a consequence of the recoil rallies going too far, or was the result of manipulation to disguise insider selling.  The lesson here is that while Mr. Market will usually provide advance warning signals for trouble on the horizon you must often pay close attention to discern those signals, for it isn’t always obvious. 

If the tape does indeed tell all, what is it telling us now?  The major indices and the NYSE breadth indicators have been in good shape for most of the year.  By the same token, cumulative trading volume has been subdued because of diminished participation among individual traders as passive ETF investing has gained popularity.  The major averages have been buoyant, but not lively, in recent months.  This has been reflected in the economic news for most of the year, and there have been no crisis events to speak of.  The market, in short, has been dull and listless in reflection of the lack of bad news news.  You could even say that the market has predicted the lethargic U.S. political/economic scene of recent months by its own lack of excitement. 

If the tape indeed tells all (and I believe it does), then it’s telling us that there are currently no major worries among informed investors and insiders about anything that might torpedo the U.S. ship of state and disturb the country’s equanimity.  Developments of this magnitude take time to develop and the traces of these dangers always eventually manifest in the stock market long before making an announcement anywhere else. 

This is not to say that the market will necessarily continue to experience smooth sailing for the balance of the year, as short-term volatility tends to be erratic and isn’t always predictable.  But the tape doesn’t suggest anything calamitous on the horizon, contrary to the warnings of the perpetual alarmists.  The secular bull market which began in 2009 is still very much intact with lots of room to run before entering those tumultuous shoals which always mark the end of the line.  By the time that point has arrived, however, the tape will have long since whispered the danger to those who bother to listen.  

The silent economic boom

[Note: I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here: https://crushthestreet.com/videos/live-interviews/economic-bubble-burst-trumps-watch-clif-droke-interview]

Though many Americans aren’t feeling it, the economy is quietly gathering forward momentum.  With consumers gaining in confidence and real estate heating up on both the commercial and residential levels, the U.S. economy is much stronger than it may seem at first glance.

One reflection of the strengthening economy is the equity market, which is in the eighth year of a bull market since the bottom of the credit crash.  The bromide, “As goes the stock market, so goes the economy,” is something that hardly needs explaining, yet so many investors lose sight of this cogent fact that it bears repeating.  Rising corporate profits and efficiencies in recent years have contributed in large part to the economic improvement. 

Another reflection of the recovery can be seen in our in-house New Economy Index (NEI), which combines the stock prices of the leading U.S. retail and business service stocks.  The graph below shows that NEI continues to hit all-time highs on almost a weekly basis and as such is reflecting a strong consumer retail economy.

With so many indicators pointing to a strong economy, why then are so many Americans acting as if recession is imminent?  That’s the question we’ll address here.

Ed Hyman is one of the most respected, and accurate, economists.  As Barron’s recent observed, he has been voted Wall Street’s top economist for 36 of the past 41 years in Institutional Investor’s annual poll.

In an interview conducted by Barron’s editor Randall Forsyth, Hyman said he sees cities around the U.S. “booming,” including smaller ones away from the megalopolises on the coasts. His conclusion is that this will benefit Main Street more than Wall Street.

Hyman has a rather old-fashioned, yet highly effective, method of gathering data from which to make his forecasts.  His team of researchers simply contact companies such as employment agencies, truckers, car dealerships and home builders and ask, “How’s business?”  A rating scale of zero to 100 is used by respondents to describe business conditions and from this tally Mr. Hyman is able to get a good read on what’s happening in the economy. 

According to Barron’s, Hyman’s surveys were trending higher well ahead of last year’s election.  “At that time,”  quoting the Barron’s article, “his model was forecasting real growth in gross domestic product of about 1.5%, although not as ‘uplifting’ as the recent ‘soft data,’ such as confidence surveys, indicate.  Now, the model points to 3% growth, bolstered by indicators such as tight credit spreads and high consumer net worth, which accords with what he calls a ‘scientific method.’”

Ad Ed travels around the country, he’s finding that “every place is booming,” he told Barron’s.  “Every major city, Chicago, Minneapolis, Kansas City, they’re doing great.”  Smaller cities are also outperforming, he says.

Hyman also reports that “millennials are coming on like locusts,” as they emerge from years of living in their parents’ basements.  “They’re getting jobs and apartments,” he told Barron’s.  “Millennials’ employment is growing at 3% while everything else is growing 1%.”

Hyman also pointed out that many observers have undervaued the extent to which central banks around the globe “are still flooding the system every week” with liquidity, with the Bank of England and the ECB having purchased more than two trillion euros’ ($2.14 trillion) worth of bonds in less than three years.  Meanwhile the BOJ and the Federal Reserve, along with the ECB, hold $13 trillion in assets, which has lowered interest rates around the globe.  This, he says, explains how the Fed funds rate at just 0.80% while U.S. companies are doing so well.

If Hyman’s macro optimism is to be believed – and our indicators strongly suggest he is right – then 2017 may prove to be the year that the U.S. economy finally takes off and leaves investors with no doubts as to its latent strength and momentum. 

Crush The Street Interview

I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here:

https://crushthestreet.com/videos/live-interviews/economic-bubble-burst-trumps-watch-clif-droke-interview