On My Radar — Reagan’s 1981 vs. Trump’s 2017May 15, 2017

by Steve Blumenthalof CMG Capital Management Group

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

– Benjamin Graham

When Ronald Reagan entered office in 1981, forward return expectations were a high 18.91% (see chart below: green line,left-hand side). Equally important was that risk of loss was a low -4.29% (red line, left-hand side). The prior bear marketreached its end, yet few knew it. Scream as one might, clients weren’t buying. The 1966-1982 secular bear market did littleto advance an equity market investor’s wealth. In 1981, it was the right time to aggressively own equities.

Today we sit on the opposite end of the seesaw. With valuations high, forward return probabilities near 0% (-0.35% greenline, right-hand side in the following chart) and risk of loss at -27.07% (red line, right-hand side), President Donald Trumpwill have a great deal of trouble making stock returns “great again.”

I’m rooting for tax cuts. But to project the great returns of the Reagan days is a risky wager. Risk versus reward? Zeropercent forward probable returns and risk near -30% is a really bad bet.

The above chart compares five-year average total returns of the S&P 500 Index and the maximum drawdowns that haveoccurred over the last 60 years at associated CAPE readings. (CAPE is the cyclically adjusted price-to-earnings ratio,commonly known as CAPE, Shiller P/E, or P/E10 ratio, is a valuation measure usually applied to the S&P 500 equitymarket. It is defined as price divided by the average of 10 years of earnings (moving average), adjusted for inflation.)

The following is from 720Global:

Despite the bargain basement equity prices, few investors believed that market trends would reverse. Equity valuations hadbeen low and falling for so many years to that point, the trend became a permanent state in many investors’ minds by wayof linear extrapolation.

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Contrast that with today. As in early 1981, there is a new president in office with a non-typical background presenting non-conventional economic ideas to aid a struggling economy. Unlike Reagan, however, public support for Donald Trump ismarginal.

Additionally, while Reagan’s and Trump’s economic policies may have similarities, there are stark differences between theeconomic landscapes that prevailed in the early 1980s and today.

Equity investors betting on Reagan in 1981 were investing in an environment where the probabilities of success wereasymmetrically high. With Cyclically Adjusted Price-to-Earnings (CAPE) ratios below 10, investors could buy in to a stockmarket whose valuation on this basis had only been cheaper 8% of the time going back to 1885.

Given the likelihood of success as inferred from valuations, investors did not need much help from Reagan’s policies.Current equity market valuations require investors to believe beyond all doubt that Trump’s policies can produce strongeconomic growth and overcome hefty economic and demographic headwinds. More bluntly, the risk-return profile of 1981is the polar opposite to that of today.

You can read 720Global’s full piece here.

Like tech in 1999, scream as I did then, it was not enough to stop my 68-year-old client Roberta from transferring heraccount to a broker. Her new broker was putting her into as she told me then, “safe stocks.” By October 2002, her$1,000,000 turned into $500,000. I know this because her husband remained a client. After adjusting for inflation, it tookher 15 years just to get back to even; assuming Roberta was able to stomach the ride and if she didn’t need some of thatmoney for retirement.

It looked like this (inflation adjusted).

Source: dshort.com

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Last Monday, the VIX broke below 10 to close at 9.77, the lowest level in more than a decade. There are only three otherdays the index has closed at lower levels, all of them in December 1993. Investors are complacent to risk. They shouldn’tbe.

What can you do? Put some form of stop-loss risk management process in place. A little more than three years ago, Iapproached Ned Davis Research with an idea. I wanted to create a U.S. equity market indicator similar to Ned’s famous“Big Mo.” “Mo” is short for momentum. I love NDR’s work and I have been a happy client for years. Their services are notcheap, but it is an expense I am happy to pay.

We co-created something we call the Ned Davis Research CMG U.S. Large Cap Long/Flat Index. I previously used Big Moand it’s a good indicator, but I now use the NDR CMG U.S. Large Cap Long/Flat Index to guide me in my long-termfocused stock market exposure.

My point in mentioning this is that, despite my risk versus reward concerns, my defined equity market exposure (30% inmoderate risk portfolios and 70% in aggressive risk portfolios) remains “risk on” and fully invested. Find something thatworks for you. Something that you can have full conviction in… then stick to the process. For your core portfolio allocations,you could diversify to several global ETF trading strategies. Broad diversification is key. On the other side of the nextrecession is the next great equity market opportunity. It is not today.

The impact of losses, in any given year, destroys the annualized “compounding” effect of money. It takes a return of 25%to overcome a loss of 20%. That’s doable and generally doesn’t take long to recover. It takes 100% to overcome a 50%loss and it takes 300% to overcome a 75% loss. Move forward carefully.

Roberta lost 50%. Others back then were ‘all in’ on tech stocks. They lost 75%. We’ve had one or two recessions perdecade over the last 100 years. The last one was in 2008/09. Maybe this decade is the exception, but I doubt it. Inrecession, it is normal to experience a 40% decline in stocks.

“Those who do not remember the past are condemned to repeat it.”

― Benjamin Graham, The Intelligent Investor

Reagan had a great deal of wind at his back. Trump does not. Let’s get excited about tax cuts (after this past week thattask may be tougher to achieve), but keep proper perspective about risk and reward. As the great Art Cashin says, “Stickwith the drill – stay wary, alert and very, very nimble.”

When you click through below you’ll find a link to Trade Signals as well as a few charts I found interesting and I believeworthy of your review. Also, the NDR CMG U.S. Large Cap Long/Flat Index is posted on our website every Wednesday inTrade Signals. Thanks for reading. I hope you find On My Radar helpful for you and your work with your clients. And pleasefeel free to reach out to me if you have any questions.

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Included in this week’s On My Radar:

Rate Hike Next Month is a Near CertaintyU.S. Equity Market Capital Flows – To Large Cap Stocks (It Remains “Risk On”)Charts of the WeekTrade Signals — Cyclical Equity Bull Market Remains Dominant TrendPersonal Note

Rate Hike Next Month is a Near CertaintyFrom the WSJ – The Daily Shot

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The dollar rose in response to what now looks like a near-certainty of a hike next month.

Based on the rising rate differentials with other countries, the dollar should be higher.

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Despite a soft first quarter, economists continue to call for 2017 full-year GDP growth of just above 2%. Here is thebreakdown from Natixis.

With the dollar on the rise and a possible China slowdown in the works, copper had the worst decline in 19 months.

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Iron ore was down nearly 6.5% on the day. And rubber futures tumbled 6%, continuing an unprecedented decline thatstarted in February. Weak auto sales in the U.S. were not helpful.

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U.S. Equity Market Capital Flows — To Large CapStocks (It Remains “Risk On”)Here is how to read the chart:

Look at the flows into U.S. equitiesMost of those flows are going to large cap and total market equities

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Charts of the WeekChart 1 — A look at interest rates since 2007:

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Chart 2 — The S&P 500 and Fed Intervention:

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Chart 3 — Average Total Real Return Based on Valuation & Life Expectancy:

Here is how you read this next chart:

Plotted are the P/E ratios in blue – think of that as your starting investment pointThe blue bar shows the average return from that point in time until end of life (based on life expectancy tables)Note that when valuations were high, the average return was low and when valuations were lower, the averagereturns were higherThe horizontal red line shows when, ON AVERAGE, you failed to achieve 6%-annualized average total returns (muchless 10%) from the starting age of 35 until death

Source: Advisor Perspectives

For long-term retirement income, it’s best to begin when your starting point is one where valuations are low and attractive…not high and expensive. Stay patient and risk minded until that opportunity presents.

Chart 4 — Selected Retirement Start Dates (Examples Age 35 to Death):

Here is how to read the chart (following from Lance Roberts):

As shown in the chart box below, I have taken a $1,000 investment for each period and assumed a real, total returnholding period until death. No withdrawals were ever made. (Note: the periods from 1983 forward are still running asthe investable life expectancy span is 40-plus years.)The gold sloping line is the “promise” of 6% annualized compound returns. The blue line is what actually happenedwith invested capital from 35 years of age until death, with the bar chart at the bottom of each period showing thesurplus or shortfall of the goal of 6% annualized returns.In every single case, at the point of death, the invested capital is short of the promised goal.The difference between “close” to goal, and not, was the starting valuation level when investments were made.This is why, you must compensate for both starting period valuations and variability in returns when making futurereturn assumptions.If you calculate your retirement plan using a 6% compounded growth rates (much less 8% or 10%) you WILL fallshort of your goals.

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Source – Advisors Perspectives: Lance Roberts is the Chief Portfolio Strategist/Economist for Clarity Financial. He is alsothe host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “RealInvestment Daily” blog and “Real Investment Report.”

Chart 5 — The Spend Down Problem:

The reality is that retirees in general will need to live off their retirement savings. Charts 1 and 2 don’t take into account theneed for portfolio income.

Here’s how you read this next chart:

Grab a cold beer or two – The chart does not paint a pretty picture.

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Lance concludes, “Time To Get Real”

“The analysis above reveals the important points that individuals should OF ANY AGE should consider:

Expectations for future returns and withdrawal rates should be downwardly adjusted due to current valuation levels.The potential for front-loaded returns going forward is unlikely.Your personal life expectancy plays a huge role in future outcomes.The impact of taxation must be considered.Future inflation expectations must be carefully considered.Drawdowns from portfolios during declining market environments accelerates the principal bleed. Plans should bemade during up years to harbor capital for reduced portfolio withdrawals during adverse market conditions.The yield chase over the last eight years, and low interest rate environment, has created an extremely riskyenvironment for investors. Caution is advised.Expectations for compounded annual rates of returns should be dismissed in lieu of variable rates of return based oncurrent valuation levels.”

Lance’s hard advice to investors: “You cannot continue under-saving for your retirement hoping the stock market will makeup the difference. This is the same trap that pension funds all across this country have fallen into and are now paying theprice for. Importantly, chasing an arbitrary index that is 100% invested in the equity market requires you to take on far morerisk that you most likely realize. Two massive bear markets over the last decade have left many individuals further awayfrom retirement than they ever imagined.”

Folks, we investors need to save more. The importance of a great trainer is to get you doing the extra reps that arerequired to make you stronger. It is not fun to do. It’s hard to push ourselves. Some can do it, many can’t. The importanceof a great advisor is much the same.

Picture yourself in the gym with your client. It might just be time to get up in their grill and push them to do a few extra reps.I was too nice to Roberta in 1999. It might have been better for me to scream. It’s time to scream.

Trade Signals — Cyclical Equity Bull MarketRemains Dominant TrendS&P 500 Index — 2,398 (5-10-2017)

Notable this week: The equity market, as measured by the Ned Davis Research CMG U.S. Large Cap Long/Flat Index,remains bullish. Don’t Fight the Fed or the Tape remains neutral. The Zweig Bond Model remains in a buy signal. Theshort-term gold trend indicator is in a sell signal. Investor sentiment is now Extremely Optimistic, which is S/T bearish for

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equities. Inflationary pressures are high but moderating. The overall weight of trend and breadth evidence supports acontinuation of the cyclical equity bull market.

Click here for the charts and explanations.

Personal NoteThe prom is this weekend for sons, Matt and Kyle. Brianna is coming in from NYC and we’ll have a fun time taking picturesand being together. Susan’s on the road to Connecticut to coach her soccer teams. My job is to get some good photos.

Happy Mother’s Day to you (your spouse and your mother). There is no more important person on the planet than mom.Through you comes life and love. May you always be held in the highest honor. Raise a glass and toast with me: To ourwonderful mothers…

On Sunday, I’ll be toasting with red wine held high to my beautiful mother who I lost too many years ago. Mom, I feel youwith me and I am grateful for you. And I’ll be toasting to my beautiful wife. And to my ex-wife as well. A good friend andwonderful mother to our children.

Travel ramps back up again next week. I’ll be traveling to Dallas on Wednesday for a two-day advisor due diligencemeeting to advance the ball forward with a dozen advisors interested in the Mauldin Solutions Smart Core Strategy. Thefollowing week I’ll be in Orlando on May 22-25 for Mauldin’s annual Strategic Investment Conference. The speaker lineupis outstanding. I’m really looking forward to learning a great deal. I’ll share my high-level notes with you over the comingweeks.

Hug your mother! All the best to you and your wonderful family. Have a fun weekend!

If you find the On My Radar weekly research letter helpful, please tell a friend … also note the social media linksbelow. I often share articles and charts during the week via Twitter and LinkedIn that I feel may be worth your time. Youcan follow me on Twitter @SBlumenthalCMG and on LinkedIn.

♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦

With kind regards,Steve

Stephen B. BlumenthalExecutive Chairman & CIOCMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman andCIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research,valuations, portfolio construction, asset allocation and risk management.

The objective of the letter is to provide our investment advisors clients and professional investment managers with uniqueand relevant information that can be incorporated into their investment process to enhance performance and clientcommunication.

Click here to receive his free weekly e-letter.

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CMG is committed to setting a high standard for ETF strategists. And we’re passionate about educating advisors andinvestors about tactical investing. We launched CMG AdvisorCentral a year ago to share our knowledge of tacticalinvesting and managing a successful advisory practice.

You can sign up for weekly updates to AdvisorCentral here. If you’re looking for the CMG white paper, “UnderstandingTactical Investment Strategies,” you can find that here.

AdvisorCentral is being updated with new educational resources we look forward to sharing with you. You can alwaysconnect with CMG on Twitter at @askcmg and follow our LinkedIn Showcase page devoted to tactical investing.

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A Note on Investment Process:

From an investment management perspective, I’ve followed, managed and written about trend following and investorsentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-basedindicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included withina broadly diversified total portfolio solution.

My objective is to position in line with the equity and fixed income market’s primary trends. I believe risk management isparamount in a long-term investment process. When to hedge, when to become more aggressive, etc.

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