The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Invest with smart knowledge and objective odds

Strategy Write-Ups

My main strategy calls since March 2009 with the S&P 500 Index level colored. The main calls are charted here. Note that I always measure the upside potential against the downside risk. This is a probabilistic risk/reward game. To paraphrase a legendary mountaineer:

The art of investing is knowing when to go, when to stay, and when to retreat. Getting to the top is optional. Surviving is mandatory.

2205 STORY TIME! November 22, 2016  Either we buy this new story, however expensive equities may be, with all the ifs, as and whens that come with this new maverick President, or we remain patient waiting for more attractive valuations and a story that is based on solid facts, not on flaky possibilities. Once again, this is a game of probabilities. At the present time, the odds don’t look friendly, not solely from a valuation standpoint but also from a quality of the story viewpoint. Narratives can change quickly as we learned after 9-11 and after Obama’s infrastructure plan, just to use two from the same storybook collection. Personally, I am too old to invest on fairy tales, having heard them all. I remain prudent, stable income minded and very choosy on equities.
2180 HARD HAT ZONE AUGUST 26, 2016 On balance, slightly more downside than upside. Market fundamentals (inflation + EPS) are not providing much tail wind, if any, over the next 3-6 months. Central banks are the only major supports for equities nowadays but do they really know what they are doing? Given the large number of potentially adverse factors, I would not place many chips on the upside table at this point in time. Further tilting me towards the downside table are these facts: Economic surprises seem to be reverting to negative. Investors are pretty positive. Insiders are not acting positive. Brexit? Dunno. China? Dunno. Libor? Dunno. Elections? How bad would a surprise be? How bad would a non-surprise be? Dunno. I am staying negatively tilted with 2 stars. Not bailing out entirely because recession not in sight, yet, and a bear market seems unlikely, for now.2100 HOLD OR FOLD?  JUNE 6, 2016 Valuations are right at the high end of the “Lower Risk” band of 15-20 and neither higher earnings nor much lower inflation are likely to provide the key to enter the “Rising Risk” area over the shorter term at least. Upside thus appears limited.

2000 CETERIS NON PARIBUS JUNE 27, 2016 These hopelessly hopefuls seem to be completely incapable to figure out what’s going on, relying on old models while the world outside their ivory tower offices has changed so considerably.
  • Millenials are living very differently from their parents and grand-parents at the same age.
  • Many Americans are still struggling to emerge from the financial crisis.
  • ZIRP policies have totally deflated retirement incomes and expectations.
  • The dearth in demand coupled with the developing sharing economy result in excess capacity seven years into the recovery.
  • Digitization has modified consumption patterns away from “things” towards “software intangibles”.

We seem to have entered a torqueless economy whereby previous economic multipliers are no longer effective.

2050 Certain Uncertainties MAY 18, 2016 When equity valuations are on the high side like is the case now, there are two levels of risks to consider: the basic fundamental earnings risk and the valuation (P/E) risk. In the U.S., the earnings risk comes from very slow revenue growth rates coupled with accelerating labor costs (see MARGIN CALL NO MARGINAL RISK). Until there is relief on one of these two factors, the earnings risk will remain high. The valuation risk is more dangerous because stretched P/Es can drop precipitously from anything that spooks investors.

2032 EQUITIES: BACK TO 2 STARS MARCH 28, 2016 This latest rally is running out of fuel. I don’t like this volatile rating but I am nevertheless retreating back to 2 stars.

1840 UPGRADING EQUITIES TO 3 STARS FEBRUARY 16, 2016 Some of the best conditions for a meaningful rally are present: significant undervaluation coupled with very negative sentiment and media narratives. The drawbacks are that there is no earnings tailwind for a while and many technical indicators are not flashing positive. In particular, the 200-day m.a. is in a downtrend. Regular readers understand that the Rule of 20 is not a forecasting tool but rather an objective measure of risk and reward. In the current circumstances, the upside is between +13% and +25% while the downside seems limited in a no recession environment. That said, these not so trivial risks that remain, justifying 3 stars rather than 4.

2050 YIELDING TO HIGH YIELD DECEMBER 21, 2015 In February 2015, valuation began to test the darker side, reaching 21 on the Rule of 20 in mid-May, a first indication that risk tolerance might be rising and that the we could finally reach the 22-23 levels on the Rule of 20 scale, culminating the “normal” valuation cycle. I now believe that economic and financial conditions will not allow valuations to climax in the yellow zone, let alone reach the “Extreme Risk” area. In fact, investors are much more likely to seek safer grounds in coming months and downside to the 17.5 range on the Rule of 20 is quite possible as a result. At current earnings and inflation levels, this would take the S&P 500 Index down to 1825, 9% below current levels.(…) This is clearly a risk-off financial market with declining long-term moving averages on equities. Not friendly and rather dangerous. And I fail to see any chance of a credible Fed put around the corner.

2100 THAT STINKY BULL DECEMBER 1, 2015 Given the status of the domestic U.S. economy (i.e. a strong consumer), current inflation and earnings trends, the 15% upside potential against a 10% downside risk justifies a slightly above neutral stance on U.S. equities.

2100 MERRY CHRISTMAS? NOVEMBER 3, 2015 This is not a strong call. One, we are late in the economic and valuation cycles. Two, the Fed will most likely begin rate normalization in December, creating a headwind few investors are used to. Three, valuations are not cheap making equities vulnerable to any shock. This is a momentum play, banking on accelerating consumer expenditures in developed countries triggering rising production across the world, a stabilization or even turn in commodity prices and rising revenues and earnings expectations entering 2016. If you stay on this train, stay close to the exit and be alert.

1950 TIME TO GET SENTIMENTAL OCTOBER 5, 2015 This is a valuation correction like that of the spring 2010 (-13%), the summer of 2011 (-15%) and October 2014 (-10%). The former brought the Rule of 20 P/E from 19.0 to 15.5, the next one from 18.7 to 16.3 and the latter from 20.0 to 17.9. At 1950, the S&P 500 Index sells at 18.0 on the Rule of 20 P/E which restores the risk/reward ratio into positive territory for investors, as long as earnings stay up and/or inflation stays low. In effect, the Rule of 20 P/E seldom gets below 17. This provides a good valuation floor to equities (-5.5%). 

2085 BEWARE: CAMEL CROSSING AUGUST 20, 2015 Given the macro headwinds swirling, the growing deflation risks and the increasing evidence that central banks are in a free-for-all mode, it seems appropriate to manage risk down another notch.

2100 BAD BREADTH EQUITIES AUGUST 4, 2015 This is not a so-so equity market with so-so earnings. This is more like a twin engine vehicle, one engine pulling forward and one going backward. The resulting standstill gives a false impression that overall things, though admittedly not great, are nonetheless OK. Not so: this equity market is being pulled by half its cylinders, themselves running at only 60% of their capacity. So far, this has been enough to pull the whole market slightly upward, but unless headwinds abate, one must wonder for how long.

2125 SUMMIT FEVER MAY 21, 2015 Viesturs motto has always been that climbing has to be a round trip. All of his planning and focus during his climbs maintains this ethic and he is not shy about turning back from a climb if conditions are too severe. His story is about risk management as well as being patient enough for conditions to allow an ascent. Ultimately, in his words, “The mountain decides whether you climb or not. The art of mountaineering is knowing when to go, when to stay, and when to retreat.” The goal is not to sell right at the top, rather to objectively listen to the mountain and safely descend when danger is near so we can climb again when conditions improve. “Getting to the top is optional. Getting down is mandatory.”

2100 DEFLATING EQUITIES FEBRUARY 19, 2015 Downside? Five percent to the 200-day m.a. of 1986, 12% to the October lows (1840), but potentially more if earnings tumble. Given the very limited reasonable upside, I am moving to a below neutral equity position.

2020 SWAN LAKE JANUARY 21, 2015 This 6% upside is nothing to write home about but it is also not terrible in the current low rates environment, also considering that the 200-day moving average stands at 1968, only 2.6% lower, and is still rising.

2040 LONESOME COWBOY NOVEMBER 12, 2014 The current upside is thus around 2175, up 6.6% from current levels. Downside is around 1700 (16.0 – 1.5 inflation x 117), 16.7% lower. The risk/reward ratio is not equitable to investors. It is therefore better to play safe and wait for either a better risk/reward ratio or an improved narrative. 

1935 THREE-STARRED EQUITIES AUGUST 12, 2014 Using 25% probability of a 15% correction and a 75% probability of reaching 2150 before March 2015, the weighted outlook is +4% (5-6% total return) on the S&P 500 Index. Three stars, at best!

1920 SHOWTIME! JUNE 2, 2014 This is not a cheap market. But the earnings and economic backgrounds look good enough to increase my equity exposure, with a stronger emphasis on quality, income and liquidity.

1865 U.S. EQUITIES: BETTER INTERNALS, SCARY EXTERNALS APRIL 28, 2014 Getting more comfortable with equities is tempting given the current risk/reward ratio and the improving profit picture.

1840 THE WIZARD OF ODDS (March 3, 2014) MARCH 3, 2014 The financial heroin will continue to flow. I remain moderately invested.

1800 TAPERING…EQUITIES January 13, 2014 Not a bear, but an old bull that feels the need to be careful for a while.

1815 ENTERING THE DARK SIDE December 2, 2013 Current fair value is 1869, only 3% above current levels. By March, assuming inflation stays at 1.7%, rising trailing earnings would boost fair value to 1960, 8% above current levels. With 70% odds of equities selling through fair value, upside rises to 2070-2172 by March, +14-20% or 10-14% risk-adjusted. Technical downside is 5-10% but resumption of fear could set us back 15-20%.

1550 SPRING PEAK? YELLOW LIGHT ON EQUITIES March 18, 2013 What is going on in Europe is as significant as the outcome is uncertain. (…)How this will play out in coming days, weeks or months is anybody’s guess. (…)All I know is that the risk/reward equation as per the Rule of 20 is about even if the downside is limited to the 200-day m.a.. However, if we return to 15 on the Rule of 20 scale, that is a 19% slide to 1260.

1515 WINDLESS EQUITIES, STAY CURRENT! February 11, 2013 The 17% upside potential still outweighs the -7% technical downside risk more than 2:1 

1438 GREEN LIGHT ON EQUITIES December 18, 2012 Not a slam dunk but, all in all, the risk/reward ratio is very favorable and many catalysts are turning positive.

1420 EQUITIES: DADDY, ARE WE THERE YET August 21, 2012 U.S. equities are very cheap but the hope rests essentially on closing the gap to fair PE while the earnings tail wind has quieted to a virtual standstill. Given the dire state of the world and so little political leadership, I’d rather bet on rising earnings than on rising PE’s.

1278 BANKING (BETTING) ON BANKERS? June 6, 2012 We could well be about to get a big equity rally. Fear is extreme and visibility is very low, explaining the very attractive valuation. Normally, this is the time to close your eyes, pinch your nose, take a deep breadth and buy stocks. (…) Stocks are very attractive, but the environment is too toxic. This chicken is willing to leave money on the table until he feels safer. Better be safe than sorry.

1340 BOTTOM FISHING? BUT WHERE’S THE BOTTOM? May 14, 2012 Time to prepare for the fishing season, but no bottom fishing yet!

1400 EQUITIES: YELLOW FLAG WAVED HIGH April 30, 2012 Given the 9% “technical gap” which might get aggravated by disappointing earnings, 10% upside does not provide a good risk/reward ratio.

1375 U.S. EQUITIES: NERVOUS GREEN LIGHT! March 5, 2012 Will good inflation stats, the orgy of liquidity and exceedingly low interest rates keep equities rising closer to fair value? History answers “yes” as equities do not tend to stay deeply undervalued for very long.

1220 TIME TO INCREASE EQUITY EXPOSURE November 18, 2011 The current 22% undervaluation is very rare and has been a strong buying signal.

1180 BOTTOM FISHING TIME? August 15, 2011 Cheap equities, but the risks remain high and unpredictable.

1350 EQUITIES: CAREFUL OUT THERE! July 7, 2011 Undervaluation of 5% is not appealing in the current context. Both valuation components (EPS and inflation) are at risk currently

1315 US EQUITIES: APRIL PEAK? March 29, 2011 Equities are no longer very cheap, especially when considering the significant groundhog risks surrounding us. 

1285 YELLOW FLAGS ON EQUITIES January 28, 2011 At 1285, it stands 6.5% above its 100-day m.a. and 10.3% above its 200 day m.a.. From a valuation standpoint, the Rule of 20 continues to point to 1500 on current trailing earnings of $79-80, for a 15-20% upside potential to fair value. This remains a good target for this year. However, the risk of a technical correction towards the 200 day m.a. is not insignificant, skewing the risk/reward ratio and raising a yellow flag for the shorter term.

1200 US EQUITIES REMAIN ATTRACTIVE January 4, 2011 Like it or not, US equities remain very cheap. S&P 500 fair value under The Rule of 20 is 1500, 20% above current level. The underpinnings (rising profits and low inflation) are reasonably solid at this juncture.

1090 US EQUITIES ARE CLEARLY UNDERVALUED July 23, 2010 Clearly, it would not take much positive economic news for investors to shed some of their current (justified) fears and bid stocks up to close this large undervaluation at a time when interest rates are near zero.

1110 US EQUITY OUTLOOK: STILL POSITIVE March 18, 2010

666 S&P 500 P/E Ratio at Troughs: A Detailed Analysis of the Past 80 Years March 3, 2009 Valuation using the Rule of 20 method give “trough” valuation of 791-923 for the S&P Index using current trailing earnings, 3% to 20% above current levels. Using 2009 operating earnings estimates, “trough” valuation would be 720-840. The worst case scenario, using the $43 estimate would bring trough valuation of 516-602.