Back to the basics. Ok. It’s time to discuss the value of using the John Wooden basics of basketball as an investment strategy. As you may know, John Wooden was the greatest head coach of men’s college basketball of all time. His coaching acumen started as a player. At just 5’ 10” tall, he was the first player to be named a basketball All-American three times as a guard at Purdue. As the head coach of the UCLA men’s basketball team, he became known as the “Wizard of Westwood” after winning 10 NCAA national championships in a 12-year period. The way John Wooden tells it, his winning edge came from focusing on the basics – passing, dribbling, fast-break training, turnovers, and rebounds. I often review this strategy for asset allocation and now seems to be a good time to discuss these basics given the recent market turbulence.
Here are the basics, from a technical investment standpoint, to help understand whether the stock market is predicting the advanced stages of an economic downturn… or not.
- If the 10-day moving average of one of the major indices (the S&P 500 Index, the Nasdaq Index, the Dow Jones Industrial Average Index, or the Utility index) falls to sit at or below its 200-day moving average, that’s concerning.
- If the 50-day moving average of one of the major indices falls to kiss the 200-day moving average, that’s concerning.
- If the 50-day moving average of one of the major indices falls below the 200-day moving average-ooh, that could be bad. This last indicator shows that the market is predicting a recession, though many times this indicator has occurred without a recession.
So where do we stand right now? The scoreboard below shows that some of the concerning technical indicators have occurred. Please note that we have raised our cash and cash equivalents levels since the last newsletter and before the recent pullback to mitigate what may be short-term risk.
|Mid August 2019|
|Scoreboard||10-day av||50-day av||50-day av|
|Major Indices||≤ 200-day ma||≤ 200-day ma||˂ 200-day ma|
|S&P 500 Index||Yes||Yes||No|
|Dow Jones Industrial Av Index||Yes||Yes||No|
Yes, the markets have a significant number of fundamental issues and technical cross-currents that have enhanced choppy movement lately. Some of the current issues are:
- Valuations can cause short-term corrections
- Lower Interest rates can cause high multiples or lower price-to-earnings multiples dependent on how low interest rates go both domestically or globally
- German and European Union measures to engage in fiscal stimulus now that monetary stimulus is all but ineffective in stimulating economic growth
- Tariffs/trade war Good for the major democratic industrial nations longer term but short-term causes enhanced market volatility-bad for farming.
- A polarized political environment Constant political sparring between the two major political parties continues to increase tension.
- Short selling pressure Short sellers have become more emboldened lately with valuations stretched and ultra-low rates causing the potential for price-earnings deflation.
- Look-throughs to improved 2020 earnings are on a collision course with lower interest rates as both September and December are in play now for a total of three potential rate cuts this year. If the economy responds positively leading to more houses and cars sold the bond market will sell off sharply. However, if company earnings come close to 2020 estimates, the equities market will advance at the expense of the bond market.
- Tweets and China Take your pick on market effect. Red or black. Who knows? Clearly the President’s tweets are his real time bully pulpit. He may tweet for effect and this includes the markets to encourage, frustrate or discourage the Chinese in his (1) bid to win reelection, (2) to end intellectual property transfers, and to (3) put a cap on the growth of the spy state. With regard to items 2 and 3 there is agreement with the Democrats.
- Brinksmanship Both China and the President are masters at brinksmanship. Neither can be trusted to agree on a single promise. If the Chinese say they’ll stop intellectual property transfers only to renege since their roll out of 5-G includes massive spying, it’s just the Chinese being the Chinese. They’re just better than the west at thinking (world domination) long-term, right? The President and his staff understand this thinking as do the farmers in the Midwest.
So, if the President engages in a softer tone leading to a cease-fire in this trade war, don’t believe it. He’ll renege. It’s just the Chinese way. Love or hate the President, these are unique times. We live in a different period in world history. By the way, if you hate the President because of the way he is dealing with the Chinese, blame Richard Nixon. He started it all with ping pong. So, dealing with the Chinese, we are learning the long game is frustrating. This is much different than dealing with the Russians. We never knew if the Russians wanted world domination through nuclear power. With the Chinese, it’s different. I’ll leave it at that for now. What’s important is the recognition that, for now, globalism has been slowed because the beneficiaries of globalism, the Chinese, have controlling interests that conflict with U.S. manufacturing interests, jobs and western hegemony.
To account for the prospects of slowing investors have begun to reduce price-to-earnings multiples for fear of lower earnings reports from corporations in 2020. For now, this means a multiple of 16 rather than 18. For now, this means earnings estimates of $168 dollars on the S&P 500 for 2020 rather than $170. It doesn’t seem like much and it’s not, until you account for the multiplier effect. To illustrate, at $170 times 18 the S&P 500 trades at 3060. However, at $168 times 16 the market backs off to 2688. If, however, a firestorm of fear and panic sets in and a steam roller of selling ensues the market, as represented by the S&P 500, could retest 2528, a number last seen in February of 2018. If so, this would establish the loss on the S&P 500 at just above 15% and set the price-to-earnings multiple for the index to sell at 15 times $168; a very compelling time to buy historically. I encourage you to prepare yourself for a grinding lower S&P 500 through December. I have conflicting signals on this, so if the S&P 500 stays above 2730 that’s good. That’s a bit more than three percent from the market as of this writing.
Vaughn Woods, CFP, MBA
Vaughn Woods Financial Group
2226 Avenida De la Playa
La Jolla, CA 92037
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided her is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0236.