How to determine the proper time horizon to evaluate portfolio performance is always a subject for an interesting conversation. In a recent client survey on investment issues, we asked our clients “What time horizon do you feel is the best time frame to evaluate portfolio returns?” The results varied: 16% said “Monthly,” 43% said “Quarterly,” 37% said “Annually,” and 4% said “Over a complete market cycle.” (As an investment professional, I would have selected the last option.)
Every now and then I scan various Exchange Traded Fund (ETF) options to find out what is working to determine if new trends are emerging. During this scanning process I recently came across a very interesting industry that looked quite promising to me. It has been wise for investment professionals to ignore this industry over the past six years, but this year could be different. Fair warning: Before I proceed, you need to leave your opinion at the door.
Just two days ago the 4th quarter GDP came out as a negative number, which was much worse than expected. In fact, not one of 83 analysts had anticipated a negative number, meaning they were all too bullish on the 4th quarter growth number. But yesterday the Chicago Purchasing manager’s index, a growth barometer, was way above expectations for growth, and not one of 48 analyst estimates was in the ballpark, meaning they were all too bearish on growth.
In my last column, I described a bearish scenario where the markets come to the realization that the monetary authorities are out of bullets. This was simply an exercise in critical thinking and doesn’t actually line up with our current forecast, and I did promise I would come back with a bullish scenario.
Most Pinnacle Advisory Group clients are familiar with our view of secular (or very long-term) market cycles. My partner, Michael Kitces, and I first published a paper on secular bear markets in the Journal of Financial Planning in 2006, where we predicted correctly that stock prices were likely to deliver much less than average returns for years to come. In my 2009 book, Buy and Hold is Dead (AGAIN): The Case for Active Portfolio Management in Dangerous Markets, I reviewed in some detail the rationale for why stock prices can disappoint investors ‘on average’ for decades. (In fact, the “(AGAIN)” in the book title referred to the fact that we’re currently laboring through the fourth secular bear market since the 1900’s.)
One of my favorite scenes in the Pixar movie Finding Nemo comes at the end. The fish had managed to outwit the Dentist (who was holding them captive in a tank) by dirtying the water enough to force a water change. In order to do that, the Dentist had to bag the fish and leave them outside the tank, at which point they jumped out the window and into the harbor below. Unfortunately, they hadn’t considered how they were going to get out of the plastic bags. The movie ends with one of the fish asking, “Now what?”
Few people bothered to see Trouble with the Curve, a recent baseball movie starring Clint Eastwood and Amy Adams, and most critics didn’t like it. I did see the movie, and without giving away the plot, it is fair to say that the film is a cry against quantitative analysis in sports. Eastwood plays an aging baseball scout with failing eyesight who has to rely on his daughter (Amy Adams) to evaluate the home office’s number one prospect. In the end, all of the number crunching in the world can’t come up with a better analysis than Eastwood, who can hear the sound of the bat on the ball and subsequently knows better than to sign the prospect. It was impossible to watch this movie without thinking of last year’s hit film Moneyball.
The Federal Reserve spoke yesterday, and not surprisingly decided to buy more treasury bonds to keep expanding the balance sheet. It might have been a bit surprising that they have now also explicitly targeted an improvement in the unemployment rate (6.5%) and stated a tolerable inflation band (2.5%) for investors to use as guides for when the Fed might engage in policy withdrawal. The market went up for a few hours, and then drifted back to earth and closed unchanged on the day; Fed decisions can’t force politicians to trade in political theatre and come up with a deal before the 11th hour.
When I look at nonfarm payrolls, I try to disregard the headline figure and look at the year-over-year percent change in unadjusted total payrolls. This allows me to remove any seasonal effects from the series without making any of the hard assumptions required by “fancier” seasonal adjustment methodologies. The November report that came out Friday puts us at 1.42% year-over-year growth, up from 1.38% in the previous month. The exponential three-month moving average, which serves to smooth out some of the month-to-month volatility in the series, sits now at 1.41%, down slightly from 1.43% last month. This moving average is plotted as a green line in the chart below. The purple line in the chart is a measure of the six-month trend in year-over-year payrolls growth. This measure will be positive (negative) if in the previous six months year-over-year payrolls growth has been accelerating (decelerating) and near zero if it has been relatively steady. Currently, the six-month trend reads 0.19%, which is remarkably close to zero. In fact, over the past six months year-over-year payrolls growth has been range-bound between 1.3% and 1.5%. Analyzing the entire sample, which goes all the way back to the 1930s, we found that the following two conditions almost always coincide with economic recessions:
It is commonplace in the business news community to talk about ‘Golden Crosses’ and ‘Death Crosses’. If you’re unfamiliar with these terms, they refer to moving averages (MA) crossing each other. More specifically they describe the movement of a security’s short term MA moving above the long term MA (Golden Cross) and the short term MA moving below the long term MA (Death Cross). A strong signal is issued when using the 50 day MA and the 200 day MA as it is generally considered a move away from bears to bulls or bulls to bears (respectively).