Pring Turner Capital Group - Latest Observations

10/1/12 Update: What is the Current Business Cycle Stage

October 1st, 2012

One way of classifying the current business cycle stage is to look at the trend of Bonds, Stocks, and Commodities. Using a 12-month moving average is a relatively simple way to determine the current trend of each asset class. A market that is above its moving average is treated as bullish, and a market below its moving average is bearish. Using this simple moving average approach to identify the stages can give occasional “whipsaw signals”, but a vast majority of the time it works and is easy to follow. The tables below provides an October 2012 quick test example.

Answer: At month end, when bonds, stocks, and commodities are above their respective 12 month moving averages this quick test signals a stage 3 environment.

Use this handy cheat sheet to help identify the current business cycle stage.

The performance results for the 111-year period between 1900 and 2011 are shown in below, where the stages are defined using asset class relationships with their respective 12-month moving averages (process described above). Currently the moving average model puts us in a stage 3 environment which historically is a highly profitable time for stocks and commodities.

Historical results where stages are defined using asset class relationship with their respective 12 month moving averages. Asset performance for each stage should be carefully weighed against volatility. Standard deviation (as shown in parenthesis in columns 2,3, and 4) is a risk-management statistic, the lower the number, the lower the volatility (risk).

You will note that in addition to showing the returns for each class by stage, the table also includes the standard deviation as a measure of volatility (risk) to help investors balance returns with the risk taken. This historical information is useful in helping investors understand the important risk versus reward relationship between the three main asset classes and is one key factor in our asset allocation decisions.

Sector rotation through the business cycle stages will further improve performance and reduce risk. Not every cycle is the same, however certain sectors historically outperform or under-perform in each stage.

Historically the Communication Equipment, Diversified Metals, and Energy Sectors are some of the best performers during stage 3 of the business cycle while the Leisure, Airlines, and Home Furnishing Sectors are some of the worst performers.

Tags: Business Cycle, Pring Turner, Sector Rotation, Stage 3
Posted in Chapter 8 | Comments Off

10/1/12 Update: Will the Smiths Outlive Their Nest Egg?

October 1st, 2012

The period from January 2000 through December 2009 goes down in history as one of the worst 10-year investment periods ever for stocks. Two severe 50 percent-plus bear markets over the decade demoralized buy-and-hold investors leading to a -9 percent loss including dividends. A new cold reality set in. Expectations of double-digit stock market returns no longer dance in investors’ minds. Stories of individuals leaving their jobs to day-trade are long past—today people are satisfied just to have a full-time job. Other once dependable investment alternatives have their own legitimate concerns. The myth that real estate is a low risk investment and only goes up has been thoroughly shattered. Earnings on savings accounts have plummeted to near zero, and after the effects of inflation and taxes are actually negative. Government bond yields are at generational lows and offer little return potential and substantial principal risk if interest rates should go up. Yes, since 2000 investing has been a veritable minefield for most investors. A decade that began with wild-eyed optimism and confidence ended with investors anxious with fear and holding sobered expectations.

To illustrate our point, let’s take a close look at one couple’s retirement plans and how expectations changed since 2000. Mr. Smith was age 62 when he and Mrs. Smith decided to retire with a sizable nest egg. Using history as a guide, they decide to allocate $1 million of retirement savings to the stock market via a passive index fund. After all, at that time the S&P 500 had delivered 25-year average annual returns of over 17 percent, and since 1900 the performance averaged about 10 percent per year. They figured if they could earn just 10 percent and spend half the earnings, they would be able to leave the remaining 5 percent of earnings to compound. This seemingly sensible strategy would allow their retirement nest egg to continue to grow and even provide a “pay raise” from time to time to offset inflation. They planned to withdraw $50,000 annually ($12,500 quarterly) to help fund their living expenses. This sounded reasonable at the time—the Smiths weren’t being too greedy. At least they thought they made realistic assumptions and had reasonable expectations. After a dozen years in retirement (October 2012), Mr. Smith was a 74-year-old retiree, and Chart I-1 shows what happened to the $1 million nest egg.

The combination of the “lost decade” for stocks and steady withdrawals for retirement income leaves the Smiths’ nest egg severely depleted. How will they survive a second “lost decade”?

Combined with a “lost decade” of minimal total stock market returns and a steady withdrawal rate ($637,500 total), the Smith’s end the first 12 years and 9 months of retirement with a portfolio balance of only $345,802. How much longer will they be able to tap that portfolio for living expenses? And what will the Smiths do if, as we suspect, there is another lost decade ahead? When will they run out of money?

The Smiths are clearly lacking an All-Season Investment Approach designed to steadily grow and more importantly protect wealth in every market environment.

Tags: Chart I-1, Investing In the Second Lost Decade, Lost Decade, October 2012, The Smiths
Posted in A. Introduction | Comments Off

Is Betting on Bonds Really A Good Idea?

September 18th, 2012

Last week, Ben Bernanke’s helicopter flew into town and announced that QE3 was on the way. The previous two Q’s have not resulted in much inflation but that might be in the process of changing. For years we have maintained what we call the “Ultimate Inflation/Deflation Relationship,” the relationship between gold (inflation) and bonds (deflation).

A few months ago the relationship completed a head and shoulders top and looked as if deflation was going to reign. The gold bond ratio completed such a formation by breaking below the red line, known as a neckline (see Chart 1 below click to enlarge). That action suggested that gold had begun a period of under-performance against bonds, probably lasting a year or more.

However, a funny thing happened on the way to the deflation party as this relationship refused to continue to the downside. To us this is the first sign that a pattern is going to fail. The second signal is a break back above the neckline and the third is move back above the line joining the head with the right shoulder. When that final signal materializes (which it has for this relationship) the odds favor the head and shoulders pattern failing.

The rationale goes something like this. The downside break in the Ultimate Inflation/Deflation Ratio implies there are likely a lot of investors who were short inflationary positions. When prices surprised them by moving back above the two trendlines in Chart 1 it means they are underwater on their trade and are now motivated to cover those positions. At the same time, others look at the situation and speculate an inflationary outlook is more likely. Thus we have some folks caught on the wrong side of the market and others who want to get in on the other side of the trade. That’s why a failed head and shoulders pattern is often followed by an above average move in the opposite direction. Keep in mind, market prices are determined by the attitude of investors to the emerging fundamentals rather than the fundamentals themselves. People can and do change their minds and so do markets. This appears to be the case here.

So should you be avoiding bonds entirely? Not necessarily, because the Ultimate Inflation/Deflation Ratio only monitors relative performance. For the record, the ratio bottomed in 2001. In the intervening 11-years both assets rose in absolute terms, gold just happened to appreciate faster.

However, (Chart 2 below click to enlarge) shows, to borrow a well-known phrase “this time it may be different,” because the secular bull market in bond prices might be on its final legs. In fact, bond momentum has reached the same level in an opposite sense as it did at the 1981 secular, or very long-term, trough in prices (peak in yields). A perfect swing of the bond pendulum if you will. Bond momentum also reached similar levels in 1986, 1994 and 1999 and declines in bond prices followed in each instance.

Time will tell of course, as it always does. However, the ratio between gold and bonds is giving us a strong message that this time the effects of the latest Fed bond buying spree will result in greater inflationary conditions than is generally expected or desired.

Tags: Inflation/Deflation Ratio
Posted in Chapter 4, Chapter 5 | Comments Off

Video: Investing in the Second Lost Decade (Part 1 of 2)

September 9th, 2012

Tags: Investing In the Second Lost Decade
Posted in Video | Comments Off

Video: Investing in the Second Lost Decade (Part 2 of 2)

September 8th, 2012

Tags: Investing In the Second Lost Decade
Posted in Video | Comments Off

Update: Stock Prices Relative to Commodities

September 6th, 2012

We received a notification from a follower that chart 4-3 (Stock/Commodity Ratio) on page 63 was not in color, so we decided to update the chart in color. As the Stock/Commodity Ratio moves higher, stocks are outperforming commodities and vice versa. When the ratio is above its moving average (96-Month or 8-year), this typically signals a major equity bull market. On the other hand, when the ratio slips below its moving average you are typically in a secular bear market environment.

Over the past year you have seen a sharp improvement in the ratio but it still remains below the moving average. Since we believe we still have a ways to go in the current secular bear market we expect this ratio to remain below the moving average, but it’s something we will continue to monitor.

As the stock/commodity ratio moves higher, stocks are outperforming commodities. As the ratio moves lower, commodities outperform stocks, as is the case since 2000. The three previous secular bull markets for stocks were all preceded by a rally in this ratio.

Tags: Chart 4-3
Posted in Chapter 4 | Comments Off

September 2012: What is the Current Business Cycle Stage

September 1st, 2012

Answer: At month end, when bonds/stocks are above their respective 12 month moving averages and commodities are below their 12 month average, this quick test signals a stage 2 environment.

Use this handy cheat sheet to help identify the current business cycle stage.

The performance results for the 111-year period between 1900 and 2011 are shown in below, where the stages are defined using asset class relationships with their respective 12-month moving averages (process described above). Currently the moving average model puts us firmly in a stage 2 environment (since February 2012) which historically is a highly profitable time for bonds and stocks.

Looking ahead, the next phase in the chronological progression is stage 3, which would require a bullish signal from commodities. In that respect, some of our commodity models look as if industrial commodities are poised to move higher. This is not a prediction but merely an observation based on two facts.

Industrial commodity prices are in a confirmed secular bull market and cyclical reactions such as the current decline are usually brief in time and limited in magnitude.
Many reliable longer-term economic, financial and technical momentum indicators have fallen to levels that have traditionally been consistent with market lows.

Tags: Business Cycle, Pring Turner, Stage 2
Posted in Chapter 8 | Comments Off

Book Review:Investing in the Second Lost Decade

August 22nd, 2012

The website Scottsinvestments.com published a review of Investing In the Second Lost Decade on August 19th 2012. Below is an excerpt from the review.

Equity investors suffered through a difficult decade in the 2000s, with many investors seeing little or no returns for the greater part of the decade. Martin Pring, Joe Turner, and Tom Kopas co-authored Investing in the Second Lost Decade: A Survival Guide for Keeping Your Profits Up When the Market Is Down to guide us through the next lost decade of 2010-2020. The primary argument is that we are in a secular, or long-term, bear market for equities that began in 2000, and since most secular trends last for 20 years or more this bear market should continue for the rest of this decade.

The book’s these is told through a fictitious couple, the Smiths, who retired in 2000 and who face the challenge of needing income from their retirement savings while navigating the challenges of an equity bear market and low interest rates that are set to rise. Very few assumptions about the reader are made in the book, so if you are unfamiliar with the term “secular” or business cycles, these are explained in detail.

Are there still opportunities for profit in a secular bear market or should investors simply park their money in cash and wait it out? According to Pring, Turner and Kopas investors can hope to profit in secular bear markets. but they must be nimble and use cyclical trends to rotate between assets. Buy-and-hold works well in secular bull markets, with shallow drawdowns and an otherwise rising tide lifting all boats. However, secular bear markets are a more challenging environment – drawdowns can be more severe and downtrends can last for extended periods of time, resulting in lower overall returns, especially for the buy-and-hold investor.

Not only do the authors argue we are in an equity secular bear market but they also see interest rates rising in the near future and the potential for an increase in inflation (which, if we did decide to park our money in cash would quickly reduce our purchasin gpower). For fixed-income investors, rising rates lead to lower fixed-income prices leading to capital losses. With equities in a long-term bear market and interest rates set to rise, readers may at this point find themselves despondent.

The authors argue there is hope – commodities should serve as a hedge against rising inflation and help offset some of the losses investors could experience in other asset classes. They also present a strategy for rotating among major asset classes – cash, bonds, equities, and commodities – based on shorter-term cyclical trends that are based on the business cycle and typically last 4-6 years.

Cyclical trends exist within longer-term secular markets, thus even if we are in a 20 year (or more) equity bear market, asset classes including equities can have shorter-term bullish phases. The authors present a system comprised of simple indicators for indentifying cyclical trends, potentially providing readers an edge on when to over or under-weight equities, bonds, commodities, and cash.

One of the drawbacks of the book is the attempt to reach a multitude of audiences, leaving the book at times drifting between the perceived knowledge base of the reader. Novice investors might relate to the Smiths and will find the secular/cyclical explanations useful. However, the technical trend indicators and data points used to recognize market trends and then implement a trading strategy could be overwhelming for some investors. More experienced investors may find parts of the book slow, but the indicators used to identify cyclical trends are useful information. The appendix is also a must-read, with several indicators and strategies present in-depth for those wishing to manage their own tactical cyclical investment strategy.

Investing in the Second Lost Decade makes an important argument with monumental implications – that we are in the middle of a secular bear market. Their argument has implications for all investors in all asset classes as profits will be harder to attain during a secular bear. However, success is possible if investors have the knowledge and tools to recognize shorter-term cyclical trends.

Tags: Book Review, Investing In the Second Lost Decade, Scotts Investments
Posted in Book Review | Comments Off

Are You Prepared for Another Lost Decade for Stocks?

July 9th, 2012

Many investors and members of the financial press are only now recognizing that stock prices have lost ground over the last 11-plus years, labeling this period as the “Lost Decade”. Our opinion, based on extensive studies of previous secular bear markets, strongly suggests that investors should anticipate another “Lost Decade.” As we explain in great detail in our recently published book, Investing in the Second Lost Decade, today could mark only the mid-point in this secular bear market. This report covers the historic characteristics of long-term secular bear markets and when to anticipate the end of the current secular bear market.

What is A Secular Trend?

First let us define what a secular or long-term trend is and why it is important for investors to be able to identify it. Our investment decision-making process is heavily influenced by the sequential rhythm of the business cycle, which for the last 150 years has alternated between expansions and contractions. A secular trend is formed when a series of business cycles are linked together establishing long periods of stock market out or under-performance. These patterns typically last up to 20 years. In order to successfully protect and grow wealth, investors need to correctly identify which long-term price trend prevails. That is because the secular trend determines whether investors act primarily to accumulate wealth (secular bull) or to preserve it (secular bear).

What is the Current Secular Trend?

The 18-year period from 1982 to 2000 embraced the most recent secular bull market. Stocks were grossly over-valued and investors were wildly optimistic with unrealistic expectations at the conclusion of this secular bull. Since 2000, we have embarked on a much different and far less investor-friendly journey, which represents only the first half of a secular bear market. The chart below shows U.S. stock prices adjusted for inflation back to 1900. It strongly suggests we are currently in the 4th secular decline since 1900. The prior three secular trends began in the years 1901, 1929, and 1966 respectively, and lasted on average nearly 20 years.

The current secular bear market is only half over. Secular bear markets end at very low valuation levels. Source: http://www.econ.yale.edu/~shiller/data.htm

When Will the Current Secular Bear Market End?

With the benefit of over 150 years of financial history, it is possible to establish benchmarks that tell us when valuations have reached pessimistic extremes. The first benchmark to compare secular bear markets is duration. The chart and table below both show that the last three lasted on average 18 years and 7 months. The current trend has only lasted 11 years and 10 months, indicating greater potential if it is to even approach the average. As well as being measured in time, duration can also be looked at from the number of business cycles experienced. Prior secular bear markets averaged between 4 and 6 recessions. So far we have only experienced two. Allowing for a best-case scenario of 4 business contractions, this also suggests that we are halfway through the current cycle.

When will the current secular bear market finally reach bottom? Using history as a guide, generational low valuation levels and the start of a new secular bull market could begin in the 2016-2020 target area.

It may take two or more business cycles for valuations to reach historic secular lows. Source: http://www.econ.yale.edu/~shiller/data.htm

Valuation is the second benchmark to use for comparing secular bear markets. Arguably the most popular long-term measure of stock market valuation is the price investors are willing to pay for corporate earnings (Price to Earnings, or P/E Ratio). Why at one time are fearful investors only willing to pay $6.64 for $1 of earnings, (i.e. 1982 Secular Bottom) while at another time investors are eager to pay $44.20 for that same $1 of earnings (i.e. 2000 Secular Peak)? The answer lies in the extremes of confidence or lack thereof only seen at major secular turning points. Take a moment to study the Shiller P/E reading at key turning points as summarized in the Table above. Notice at the beginning of secular bear markets, the average P/E ratio is 27.3 (confidence high), in contrast to the average P/E ratios at the end of these periods that are 6.9 (confidence low). The current Shiller P/E reading is roughly 21. We may have traveled a long way from the 2000 historic overvaluation peak (P/E 44), but clearly there is a long way to go to reach truly undervalued levels once again.

Based on previous cycles, it is therefore not difficult to conclude that the current secular bear market has further to run in duration (we are only halfway there in terms of years and recessions) and valuation (P/E ratios must return to bargain levels). The combination of duration and inflation-adjusted price declines grind away and erode investor hope. This is why it is not difficult to rationalize any number of economic or geo-political problems, yet to be addressed, that will push us toward the secular bear market bottom.

Tags: Chart 3-2, Chart 3-5, Investing In the Second Lost Decade, Table 3-1
Posted in Chapter 3 | Comments Off

2003 Article: Whither the Secular Trend of Equities?

June 12th, 2012

Click here to read our 2003 article: Whither the Secular Trend of Equities

Tags: Whither the Secular Trend of Equities
Posted in Misc: 2003 Article | Comments Off