On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability...

7
On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management Group There is a high probability of a global recession. Today, let’s take a look at two models that have done a good job identifying recessions. One says we are near or currently in a global recession. The reason this is important is that all significant equity market declines have come during recessions. Interestingly, you’ll see that not all recession driven market declines are the same. The valuation level of the market prior to a recession matters. The more the market is overvalued, the greater the decline. Data from Doug Short (see chart below) shows that, “of the nine market declines associated with recessions that started with valuations above the mean, the average decline was -42.8%.” Economists have a number of different ways to measure over and under valuation. Most measures currently show an overvalued equity market. I’ve been writing about valuation extremes for a number of months. You can read more here. Let’s just say the market is expensively priced. Recessions matter as it relates to your financial health and one looks to be near. Today’s letter is short and to the point. I hope you find it helpful. Included in this week’s On My Radar: High Probability of a Global Recession U.S. Recession Model Equity Market Returns During Recession Trade Signals – Wednesday July 8, 2015 Blog Post High Probability of a Global Recession This first chart shows, “The NDRG Global Recession Probability Model based on the Amplitude-Adjusted Composite Leading Indicators (“CLI”) created by OECD for 35 countries. Each CLI contains a wide range of economic indicators such as money supply, yield curve, building permits, consumer and business sentiment, share prices, and manufacturing production. There are usually five to ten indicators, which vary by type and weight, depending on the country, and are selected based on economic significance, cyclical behavior, and quality. The Global Recession Probability Model uses a logistic regression method incorporating both the CLI level and trend data of all 35 countries to predict the likelihood of a global recession. A score above 70 indicates high recession risks while a score below 30 means low risks. The CLIs are normally released on the second Friday of each month for two months prior, or about a six-week lag. Meanwhile, the NDRG Global Recession Probability Model is a forward-looking model using a two-month lead in the CLI data.” Source, NDR. The most recent reading is 82.8% (upper right of chart). What matters is a move above 70%. The model has been above 70% each of the last three months. The blue line shows the monthly mode reading over time. Near the bottom of the chart you’ll see the “Model vs. Actual Recession” data. The vertical gray shaded lines show the OECD defined global recession periods. Page 1, © 2020 Advisor Perspectives, Inc. All rights reserved.

Transcript of On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability...

Page 1: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

On My Radar: High Probability of a Global RecessionJuly 13, 2015

by Steve Blumenthalof CMG Capital Management Group

There is a high probability of a global recession. Today, let’s take a look at two models that have done a good jobidentifying recessions. One says we are near or currently in a global recession. The reason this is important is that allsignificant equity market declines have come during recessions.

Interestingly, you’ll see that not all recession driven market declines are the same. The valuation level of the market prior toa recession matters. The more the market is overvalued, the greater the decline. Data from Doug Short (see chart below)shows that, “of the nine market declines associated with recessions that started with valuations above the mean, theaverage decline was -42.8%.”

Economists have a number of different ways to measure over and under valuation. Most measures currently show anovervalued equity market. I’ve been writing about valuation extremes for a number of months. You can read more here.Let’s just say the market is expensively priced.

Recessions matter as it relates to your financial health and one looks to be near. Today’s letter is short and to the point. Ihope you find it helpful.

Included in this week’s On My Radar:

High Probability of a Global RecessionU.S. Recession ModelEquity Market Returns During RecessionTrade Signals – Wednesday July 8, 2015 Blog Post

High Probability of a Global RecessionThis first chart shows,

“The NDRG Global Recession Probability Model based on the Amplitude-Adjusted Composite Leading Indicators(“CLI”) created by OECD for 35 countries. Each CLI contains a wide range of economic indicators such as moneysupply, yield curve, building permits, consumer and business sentiment, share prices, and manufacturing production.There are usually five to ten indicators, which vary by type and weight, depending on the country, and are selectedbased on economic significance, cyclical behavior, and quality.

The Global Recession Probability Model uses a logistic regression method incorporating both the CLI level and trenddata of all 35 countries to predict the likelihood of a global recession. A score above 70 indicates high recession riskswhile a score below 30 means low risks.The CLIs are normally released on the second Friday of each month for two months prior, or about a six-week lag.Meanwhile, the NDRG Global Recession Probability Model is a forward-looking model using a two-month lead in theCLI data.” Source, NDR.

The most recent reading is 82.8% (upper right of chart). What matters is a move above 70%. The model has been above70% each of the last three months. The blue line shows the monthly mode reading over time. Near the bottom of the chartyou’ll see the “Model vs. Actual Recession” data. The vertical gray shaded lines show the OECD defined global recessionperiods.

Page 1, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 2: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

This model is suggesting we should be on guard to defend our equity exposure.

U.S. Recession Model and Equity Market Returns During RecessionsI post this next chart every Wednesday in Trade Signals. It looks at a five-month smoothing (kind of line a 125 daysmoothed moving average line) of the S&P 500 index. Signals are generated (up and down arrows in the chart) when thecurrent price declines below or rises above the five-month smoothing (green dotted line in the bottom section of the chart).The idea here is that the equity market is a leading indicator.

You can see that not all crosses in the trend (down arrows) have accurately predicted recession; however, 79% of thesignals generated since 1950 proved correct. Those are good probability numbers and it is why this model, to me, ispowerful.

Gray vertical lines represent recessions. The up and down arrows are the signals. The -5, +2, +1 numbers above thearrows tell you how many months early or late the signal turned out to be. We only know the beginning of recession manymonths after the actual start as the data lags. So it is important to be well ahead of recession. A minus number tells you themodel signaled 5 months or one month prior to actual recession start. A minus number tells you how late it signaled relativethe actual recession start.

Page 2, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 3: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

All in all it is the best model I have found to predict a U.S. recession. Currently, it is not signaling a recession but we keepwatch.

Equity Market Performance During RecessionsBeginning with the market peak before the epic Crash of 1929, there have been fourteen recessions as defined by theNational Bureau of Economic Research (NBER). Here is the performance history:

Page 3, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 4: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

Source: Doug Short – Advisor Perspectives

What I liked about how Doug Short sorted the data is that he first looked at how far above the mean valuation was themonth prior to the start of the recession. The red arrow points to the actual declines.

You can see that if valuations were high at the start, the declines were far more painful. Doug’s valuation approach (shownnext) says we are currently 86% above the mean. The second highest on record. The word “yikes” immediately comes tomind.

Page 4, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 5: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

Source: Doug Short – Advisor Perspectives

Here are a few thoughts as it relates to the historical relationships between equity valuations, recessions and marketprices:

High valuations lead to large stock market declines during recessions.During secular bull markets, modest overvaluation does not produce large stock market declines.During secular bear markets, modest overvaluation still produces large stock market declines. *a special thanks to Doug Short.

Finally, he noted that “of the four declines that began with valuations below the mean, the average was -19.9% (and thatdoesn’t factor in the 1945 outlier recession associated with a market gain).”

Trade Signals

A quick updated summary of the various Trade Signals:

Cyclical Equity Market Trend: The Primary Trend Remains Bullish for StocksVolume Demand Continues to Better Volume Supply: Sell Signalfor StocksWeekly Investor Sentiment Indicator:

o NDR Crowd Sentiment Poll: Extreme Pessimism (short-term Bullish for stocks)o Daily Trading Sentiment Composite: Extreme Pessimism (short-term Bullish for stocks)

Don’t Fight the Tape or the Fed: Modestly Bearish – Watch Out for Minus TwoU.S. Recession Watch – My Favorite U.S. Recession Forecasting Chart: Currently signaling No U.S. RecessionThe Zweig Bond Model: The Cyclical Trend for Bonds is Bearish

Click here for the link to all of the charts.

A few concluding thoughts:

The reality is that overvaluations can last a very long time. The overvaluation around the tech market bubble at the end of

Page 5, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 6: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

the 1990s lasted over four years. I do think that is an outlier. Risk is high and the downside potential is quite real.

Excessive debt and underfunded pensions are leading to higher taxes and slower growth. A sovereign debt crisis is beingplayed out before our eyes. Greece is just the beginning. Some form of debt default/restructure will have to occur. Whatcan’t be, can’t be.

The world’s two largest economies, U.S. and China, are the two primary reasons the Global Recession Model, highlightedabove, has weakened – signaling a high probability of recession. Several recent economic data points are signaling aslowdown in Asia. “Chinese CPI remains anemic while PPI just made a new cycle low, Australian unemployment ticked up,Japanese bank loans appear to be topping/rolling over, the Japanese economy watchers survey is rolling over, andJapanese machinery orders excluding ships keeps weakening.” Source: GaveKal

In the U.S., the OECD U.S. Composite Leading Indicator (CLI) fell 0.1 point in May, its 11th straight decline, to 99.5, thelowest level since November 2011. It has been below 100 for four straight months, indicating below-trend economic growth.Let’s continue to keep a close eye on the recession models.

During the week, I’ll be posting more to our advisor central blog page and also tweeting interesting articles/research I comeacross. You can follow me on twitter here.

If you are not yet signed up to receive this free On My Radar letter – You can sign up here. Your email is kept private andnever shared and you can unsubscribe at any time. To view past On My Radar letters, click here.

I was in NYC for a number of meeting this week. The high point was dinner with my good friend John Mauldin. We talkedabout recessions, risk management, models and portfolio construction. More importantly we talked about kids, our lives anda great future ahead. We had a wonderful time together.

I’m finishing this letter early today. It is 12:30pm. I’m writing just steps from the beach in beautiful Newport, RI. It is our firsttime here. I’m really looking forward to visiting the Vanderbilt Mansions. I hear they are amazing. But right now, Susan is onthe beach, the sun has just come out and it is a beautiful day.

Put a risk management process in place. In the overvaluation, high recession probability message exists a greatopportunity. Which lens you choose to view the world through matters. I see great opportunity (and a beach chair) ahead.Wishing you a wonderful weekend as well!

With kind regards,SteveStephen B. Blumenthal Chairman & CEO CMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Chairman, CEO and CIO.Steve authors a free weekly e-letter titled, On My Radar. The letter is designed to bring clarity on the economy, interestrates, valuations and market trend and what that all means in regards to investment opportunities and portfolio positioning.Click here to receive his free weekly e-letter.

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results. Different types of investments involvevarying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment orinvestment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMGCapital Management Group, Inc (or any of its related entities-together “CMG”) will be profitable, equal any historicalperformance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the contentshould be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities,investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpretedas recommendations to purchase or sell such securities.

Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations ofCMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors,including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions.Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may beappropriate investments only for sophisticated investors who are capable of understanding and assuming the risksinvolved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or

Page 6, © 2020 Advisor Perspectives, Inc. All rights reserved.

Page 7: On My Radar: High Probability of a Global Recession · 7/13/2015  · On My Radar: High Probability of a Global Recession July 13, 2015 by Steve Blumenthal of CMG Capital Management

as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extentthat a reader has any questions regarding the applicability of any specific issue discussed above to his/her individualsituation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nora certified public accounting firm and no portion of the newsletter content should be construed as legal or accountingadvice.

This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by anyCMG client from any specific funds or securities. Please note: In the event that CMG references performance results foran actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performancereferenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not beenindependently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experiencedmaterially different performance based upon various factors during the corresponding time periods. Mutual Funds involverisk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, andexpenses carefully before investing. This and other information about the CMG Global Equity FundTM, CMG TacticalBond FundTM and the CMG Tactical Futures StrategyFundTM is contained in each Fund’s prospectus, which can beobtained by calling 1-866-CMG-9456 (1-866-264-9456). Please read the prospectus carefully before investing. The CMGGlobal Equity FundTM, CMG Tactical Bond FundTM and CMG Tactical Futures Strategy FundTM are distributed byNorthern Lights Distributors, LLC, Member FINRA.

NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.

Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achievedby means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) themodel results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactiveapplication of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2)back-tested performance may not reflect the impact that any material market or economic factors might have had on theadviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’sclients may have experienced investment results during the corresponding time periods that were materially different fromthose portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, nocurrent or prospective client should assume that future performance will be profitable, or equal to any correspondinghistorical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. Forexample, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widelyheld stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&Pbased on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial,utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and themodel results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investmentmanagement fee, the incurrence of which would have the effect of decreasing indicated historical performance results. Forexample, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historicalS&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as toprovide general comparative information to assist an individual in determining whether the performance of a specificportfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the othercomparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings willcorrespond directly to any such comparative index. The model and indices performance results do not reflect the impact oftaxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.

In the event that there has been a change in an individual’s investment objective or financial situation, he/she isencouraged to consult with his/her investment professionals.

Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA.Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO,Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. Acopy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or viaCMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).

© CMG Captial Management Group

Page 7, © 2020 Advisor Perspectives, Inc. All rights reserved.