Is the Newfound Euphoria Warranted?

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The powerful post-election stock market rally has turned a great many skeptics into hopeful, if not confident, speculators.  And while momentum should never be discounted, there are numerous reasons to pay close attention to contrasting risk and reward possibilities.

Events of the past several months—the Brexit vote, the Trump election and the Italian referendum— have cast grave doubt on the predictive accuracy of the world’s major pollsters.  Such surprise results have emboldened those looking for outlier outcomes.  And while low probability outcomes will periodically occur, oft-repeated precedent is a far safer bet.  Let’s examine today’s stock market conditions on a probability scale.

Many market commentators have dubbed the recent strong rally in U.S. stocks the “Trump rally”, and there can be no doubt but that many people have strong expectations that proposed regulation reduction, tax cuts and foreign profit repatriation will do marvels for corporate profits and, in turn, stock prices.  They have either ignored or downplayed the potential negative economic effects of proposed tariffs and more restrictive immigration.  However the interplay of those factors may unfold, it is unlikely that many proposed changes will have an immediate significant effect.  And while Trump will have a Republican majority in both houses of Congress, a sizeable number of far-right members of his party have developed their political careers on the principle of reduced debt and deficits.  It seems highly unlikely that they will find massive infrastructure spending an appetizing prospect.

The most optimistic bulls seem to believe that Trump brings to the presidency a “can do” spirit that will overcome objections on such mundane grounds as excessive debt.  Many project parallels to the positive effects on the economy and the stock market that unfolded through the eight-year presidency of Ronald Reagan.  While similar results could happen, dramatically different conditions exist today than at the beginning of the Reagan years.

The excellent Ned Davis Research Group outlined several striking differences between the two eras.  Reagan lowered the top income tax rate from 70% to 28%.  That same potential doesn’t exist today with a top tax rate of 39.6%.  Inflation was in double digits when Reagan took office but had begun its steep plunge to low single digits through most of the Reagan years.  Trump inherits low single digit inflation, which the Fed and all major world central banks are trying to push higher.  Having flooded their respective economies with freshly minted money, countries around the world face the potential of surging inflation if disinflationary forces fade and extreme money creation produces its historically normal result.

Interest rates declined through most of the Reagan years, but Trump appears ready to assume office with rates rising and forecasted to rise further by the Fed and almost all private forecasters.  Government debt was below $1 trillion when Reagan took office.  It will be more than 21 times that amount when Trump takes the oath of office.  With debt at such an extreme level, rising interest rates could have a devastating effect on the nation’s finances.

At the beginning of the 1980s, Reagan inherited a stock market that had been suffering through a long weak cycle since the mid-1960s and was trading at extremely low levels of valuation with price to earnings ratios in single digits.  By contrast, Trump takes office after eight years of a central bank-fueled stock market rally that has pushed U.S. broad market valuation levels to the second highest ever, trailing only those of the era at the turn of the century.  Today’s median stock is at its greatest valuation extreme ever.

Throughout global history, extreme levels of overvaluation have always returned to long-term norms by price declines, not by underlying fundamentals rising to meet elevated prices.  In the current instance, however, central bankers have successfully prevented stock prices from reverting to their historic means by verbal intervention and by unprecedented monetary largesse whenever prices appeared to be in danger of more than a moderate decline.  Investors are left with what we have characterized as “the bet”: a) whether to count on continuing central bank success in supporting overvalued stock prices or b) to expect a reversion of stock prices to their historic norms.

We continue to urge investors to evaluate not just the probability of rising or falling prices but also the potential degree of increase or decrease.  While there is no way to know how high a price ceiling might be, more than a century of data indicates that the growth potential over the next decade from even lower levels of valuation is minimal.  On the downside, when valuation excesses have been unwound in the past, many years of profit have been erased.  Most recently, the 57% stock market decline from late-2007 to early-2009 took prices back to 1996 levels.  Earlier market declines eliminated even more than 13 years of gains.  Retreats from severe levels of overvaluation can be devastating, no matter how long deferred.

Returning to more immediate matters, the current post-election rally is normal, although stronger than most.  Roughly 80% of the time, stocks rally from election day to the new president’s inauguration.  That pattern, however, has not typically foretold a continuation of the rally.  The first year of the four-year election cycle is on average the weakest, especially in the second half of the year.  Over the past 80 years, post-inauguration weakness has been especially pronounced when Republican presidents have succeeded Democrats, although the sample size of four is very small.  The average decline from inauguration through September of the first year has been about 13% in the Eisenhower, Nixon, Reagan and Bush administrations.  While the full eight years of the Reagan presidency saw good gains, the early years included a recession and a 25% market correction.  In fact, every Republican president in the past 70 years, with or without a majority in the House and Senate, experienced a recession in the first two years of his presidency.  A recession with valuations anywhere near today’s levels would likely lead to severe stock market losses.

With U.S. stock prices close to all-time highs and investor sentiment improving, it’s hard to imagine a drastic change in the near term.  And, frankly, many technical readings of supply and demand and new highs and lows point to likely higher prices in the months immediately ahead.  That makes “the bet” both confusing and dangerous.  Nobody likes to miss upside opportunities, but when stocks are severely overvalued, an unexpected economic, political or military event can crush stock prices very quickly.  The most dramatic example of a sudden change of sentiment and market direction followed the 1928 election of Herbert Hoover.  The new president was seen to be an excellent candidate to continue the strength of the Roaring Twenties, and stocks jumped by double digits between election day and his March 4 inauguration in 1929.  Positive sentiment continued for a few more months only to be extinguished late that same year by the most devastating stock market crash in this country’s history.  Thus began the Great Depression of the 1930s, exacerbated by isolationism and protectionism, which led to widespread trade wars.  President-elect Trump and politicians worldwide are campaigning on nationalistic themes that were direct forerunners of the trade wars that crippled world trade in the 1930s.  The dangers are there again today.  We can only hope that the world will not proceed too far down that potentially destructive path.

Adding to stock holdings at current levels will prove profitable only if prices never again dip below today’s level or if prices go higher and sales are strategically timed before a later decline.  Neither is a high probability option.


Quarterly Commentary 3rd Quarter 2016

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At our annual client conference on October 6th, we were pleased to host a large number of guests.  I presented what I believe to be the most important issues I have addressed in my 47 years in the investment business.  While I will reprise those comments here in necessarily abridged form, we would be pleased to provide annotated copies of the conference’s presentation materials on request.

Investors today are faced with the greatest dichotomy in the history of financial markets.  Interest rates are hitting record lows while stocks are near record highs.  Bonds are pricing in Armageddon, while stockholders have pushed prices of the majority of companies to unprecedented levels of overvaluation.

The Bet

This unique paradox forces investors to make a critical bet. I use the word “bet” advisedly, because the resolution of the bet, at least over the next year or two, depends on factors independent of traditional investment analysis.

Investors have to choose between the following alternatives:

  1. Worldwide, stocks and bonds are more overvalued than ever before, yet global economic growth is scarcely above recession levels. If stock and bond prices revert to their historic valuation means, portfolio values could fall precipitously and stay down for years. Throughout history, prices have always ultimately reverted to their means.
  2. Our Federal Reserve and other central banks around the world are flooding their respective economies with newly created money. For the past 7 ½ years, central bankers have overcome weak fundamental conditions, while stock and bond prices remain near all-time highs. This could continue.

Central Bankers Good For Stock Prices

At least ostensibly, historic levels of central bank stimulus have been designed to boost the economy and stabilize the currency with about a 2% level of inflation (to lessen the negative effects on overindebted companies and governments). Unfortunately, while that stimulus has had extraordinarily powerful effects on stock and bond prices, it has done precious little for the underlying economy.

The positive effect of the various iterations of the Fed’s quantitative easing efforts is obvious when a graph of stock market prices is overlaid with one that traces the growth of the Fed’s balance sheet. Since 2009, stocks have powered higher each time the Fed has authorized additional money creation.  Yet stock prices have fallen from 13% to 17% at the end of each quantitative easing episode, only to have the declines halted by new central bank reassurance that monetary authorities stood ready to continue to support securities prices as needed.  In recent months, individual central bankers have quickly voiced their support to halt declines of as little as 2% or 3%, as though afraid that their entire monetary experiment will unravel if equity prices experience a significant decline.

Can This Continue?

Any analysis of the potential for the vast collection of domestic and international stimulus efforts continuing to work should include former Fed Chairman Alan Greenspan’s comments:

“This is an unprecedented period in monetary history. We’ve never been through this.  We really cannot tell how it will work out.”

“Monetary policy is largely economic forecasting. And our ability to forecast is significantly limited.”

Paraphrasing comments to the Council on Foreign Relations:

  • Boosting the economy via bond buying has not worked.
  • Boosting asset prices has been a terrific success.
  • I don’t think it’s possible for the Fed to end its easy-money policies in a trouble-free manner.

Negative Interest Rates

Normal central bank tools, even carried to historic extremes, have neither lifted economies, nor raised the level of inflation. European and Japanese central bankers have even resorted to negative interest rates to rev up their economies and inflation.

Today, there are over $15 trillion in negative yielding securities worldwide. Even corporate bonds have begun to show negative yields.  One commentator recently indicated that 16% of European Union investment grade debt is trading at negative yields.  The holders of such bonds are guaranteed to lose money if they hold the bonds to maturity.  The only way to realize a profit is for interest rates to go even further negative and for the investor to sell the bonds at that lower yield.  That is an incredible condition and threatens the viability of many banks and insurance companies.  And unless circumstances change dramatically, many pension plans will fall far short of meeting promised retirement benefits in the years ahead.  This shortfall could have immense negative consequences for the broader economy.

Negative interest rates have yet to improve the economic outlook where implemented. Ironically, in almost every country in which central banks have moved interest rates into negative territory, equity prices have suffered.

Central Banks Buying Stocks

Having tried virtually everything else without apparent success, a few central banks have decided to buy stocks, hoping that the resulting wealth effect would boost the overall economy. Japan has been the most aggressive buyer, with China, Hong Kong, Israel and Switzerland actively participating, the latter possibly as a surrogate for others (perhaps the US).  The European Central Bank has recently speculated about buying stocks.  Within the past month, Fed Chair Janet Yellen floated a trial balloon about our Fed buying corporate bonds and stocks, ostensibly to help in an economic downturn — a disastrous idea on so many levels!  When will Congress step up and rein in the Fed, which has assumed powers far beyond what was ever envisioned when they established the central bank in 1913?

Costs of Central Bank Intervention

All this economic masterminding comes at a cost. In its first 95 years of existence, the Fed grew its balance sheet to a bit over $800 billion.  In the past eight years, the Fed has grown that debt level to five times what it had taken nearly a century to produce.  This is our generation’s gift to our grandchildren and their grandchildren.  But all this financial legerdemain has produced record stock and bond prices for this generation.  Can they be sustained?

Risks To Bondholders

On the bond side, risks are that interest rates rise and/or companies or countries default. If interest rates rise, as is inevitable eventually, a great deal of money can be lost, even in very creditworthy bonds.  The ten-year US Treasury note, for example, trading today at 1.79%, would provide a negative total return for a year with a rate increase as little as a quarter of one percent.  Many investors shrug off such concerns, because they expect to hold their fixed income securities to maturity.  And certainly, if the issuing company or country does not default, the investor will get back principal and interest.  There is however, no guaranty of what that money will buy at maturity.  In the last rising interest rate cycle extending from early 1941 to late 1981, for example, a typical portfolio of government and corporate bonds lost over 2% of its purchasing power per year despite collecting regular interest payments.  Even unmanaged, risk-free US Treasury bills outperformed almost all bond portfolios for more than four decades.  Investors apparently do not recognize the dangers as they pour extraordinary amounts of money into bonds at historically low interest rates.  They can’t buy yesterday’s performance, only tomorrow’s.

Risks To Stockholders

On the equity side, dangers lurk in several areas. As indicated earlier, the majority of stocks are at their most overvalued levels ever.  When calculated by a composite of the most commonly employed valuation measures, the entire market is at its second most overvalued level, slightly behind valuations in the era at the turn of the century.

It is ironic that investors are so enthusiastic about stock ownership with the US and world economies sluggish and in many instances slowing. Just weeks ago, the International Monetary Fund lowered its global growth forecast to 3.1% for 2016, a number they have been steadily lowering.  This is barely above recession level for world growth.  The Federal Open Market Committee of the Federal Reserve Board also recently dropped its estimate of long-term US growth to 1.85%, the lowest level on record.  Despite unparalleled stimulus, the US continues in the slowest recovery from recession in three-quarters of a century.

Not surprising in a weak economic environment, corporate profits have been declining year over year for the past five quarters. And measured on a Generally Accepted Accounting Principles basis, profits are approximately back to 2007 levels.  Over the past six quarters, profits have fallen by about 20%.  Thanks to central bank support, stock prices are up in that time period.

Declining earnings growth is not limited to the US. According to Goldman Sachs, world earnings per share have increased over the past decade by less than 2% per year.  On average, European countries have actually seen earnings per share decline by more than 2% per year over that decade.

Debt A Threat

Those who have attended our conferences or who have read our commentaries over the years know that I consider extreme levels of debt in almost all major countries around the world to be the single most dangerous threat to our long-term economic wellbeing. In recent years, dramatically growing debt levels, on top of already excessive debt loads, have been controlled by central bankers piling on even more debt while effectively printing previously inconceivable amounts of new money.  History argues convincingly, however, that for centuries countries with debt levels even lower than most today have suffered extended economic malaise, often accompanied by significant inflation and severe market disruptions.

Investment Stars Voice Warnings

Over the past few months, some of the most successful investors of our era have sounded alarms about the danger in today’s markets. Stanley Druckenmiller, whose hedge fund produced 30% per year returns for 25 years before closing to outside money in 2010, summarized his concerns with: “Get out of all stocks.”  George Soros, a hugely successful hedge fund pioneer, returned to investment management from philanthropy to take advantage of opportunities on the short side.  He sees “a serious challenge which reminds me of the crisis we had in 2008.”  “The world is running into something it doesn’t know how to handle.”  Jeff Gundlach, CEO of DoubleLine Capital, a very successful bond manager, recently counselled: “Sell everything.  Nothing here looks good.  Sell the house.  Sell the car.  Sell the kids.”

So far, those concerns have not played themselves out in US markets. Equity prices in most other countries, however, have moved appreciably lower than they were at their highs a year and a half ago.

But More Stocks Going Up Than Down

Notwithstanding all those negatives, many more stocks in the US have been advancing recently than declining. And markets generally show a marked deterioration in such advance/decline figures before forming major tops.  To this point, central bankers continue to prevail.

Mission’s Approach

Where does Mission stand? As a deep discount value manager, we won’t bet heavily on the more speculative “central bank winning” side of the bet.  We are, however, willing to increase the risk-assumption level of any portfolio for clients who want that exposure.  We have, though, been in a similar position twice before in the past two decades where we leaned against the prevailing trend and ended up benefiting our clients handsomely.

At the turn of the century, we warned aggressively that equity prices were on thin ice because of the unhealthy combination of extreme levels of debt and unmatched levels of overvaluation. The vast majority of our clients employed our Risk Averse strategy, which targeted absolute, rather than relative returns.  Equity prices began a major decline in 2000.  Despite our concern with the overall market level, our bottom-up individual stock selection process found quite a few stocks that met all our purchase criteria.  Over the 2 ½ years from April 1, 2000 to September 30, 2002, Mission’s average client portfolio grew by over 17% while the S&P 500 declined by almost 38%, including dividends paid.  Mission’s stocks actually rose while most stocks fell precipitously.

By 2007, amidst massive speculation and the never-to-be-forgotten housing bubble, we were far more defensive than in the earliest years of the new century, but still finding some stocks that met our purchase criteria. The S&P 500 plummeted by more than 50% from November 1, 2007 to February 28, 2009.  Mission’s stocks lost money also in that horrendous decline but nowhere near as much as the S&P 500.  Because we had cut back so substantially on our risk exposure, our clients emerged from that excruciating bear market with a total portfolio loss of less than 1%.

Because we did not believe that the weak cycle that began in 2000 had ended, even after the initial 2000-02 bear market, we remained cautious and had limited risk exposure during the strong stock market rally up to the peak in 2007. That caution was eventually rewarded, as we avoided the portfolio decimation that many investors experienced in the 2007-09 decline.  In the almost nine-year period from early-2000 to early-2009, Mission’s risk-averse portfolios outperformed the S&P 500 by 10.6% per year.

As a manager that bases investment decisions on proven, historically sound data, Mission has been unwilling to assume significant market risk since 2009, a period in which, in retrospect, risk assumption was well rewarded. Central banker largesse has overcome far below normal fundamental data and Mission has lagged behind those willing to accept substantial risk.  If central bankers win “the bet”, it’s unlikely that Mission will keep pace with more aggressive managers.  On the other hand, if history plays out as it always has before, I expect Mission will again catch and pass those assuming substantial risk in the current, very dangerous environment.

Consequences As Well As Probability

While we can’t know the probability, at least in the short term, of which way the bet will be resolved, it’s important to evaluate the potential consequences of whatever the outcome might be. On the upside, we know what historically normal returns have been: about 10% per year for stocks, 5+% for bonds and 3.5% for risk-free cash equivalents with inflation about 3%.  These are 90 year averages, and, logically, they are computed from average levels of interest rates, valuations and economic conditions.  Today, not one of those conditions is average or normal, and because of that, we’re not likely to experience historically normal returns over the next few years.

On the other hand, there is significant danger to both stocks and bonds should investor faith in central bankers falter. If investors begin to doubt either the willingness or effectiveness of central bank efforts to keep stock and bond prices aloft, a nonsupportive air pocket exists below current stimulus-supported levels.  Not knowing the details of market history, most investors underestimate the damage that major bear markets can inflict.  The most recent serious decline that ended in 2009 brought stock prices back to their 1996 level, erasing 13 years of price gains.  That drop was actually less painful than the carnage unleashed by three prior US bear markets which erased price gains of 16, 18 and 28 years.  The bear market that began in Japan at the end of 1989 leaves prices today at levels of three decades ago.

Because markets have bounced back so robustly from the two precipitous declines since 2000, many investors have lost their fear of big declines. It is important to recognize that those rebounds were precipitated by unprecedented government support.  And government may be running out of ammunition.  It is sobering to recognize that prior to the last two major declines, it took 12, 16 and 24 years for stock prices to permanently exceed the price peaks at the beginning of the three big bear markets in the mid-to-late 20th century.

The Investor’s Dilemma

Every investor and investment manager has to decide how much of each side of the bet to accept. If you choose to align yourself with underlying economic and market fundamentals, yet prices continue to rise in response to central bank stimulus, you’ll inevitably wish you had assumed more risk.  If, on the other hand, you bet on central bankers and market conditions revert to their means as they always eventually have, you may be nursing portfolio wounds for years to come.  Any individual’s or organization’s ability to withstand such a risk undoubtedly depends on the depth of current resources and future earning power.  As indicated earlier, Mission will not bet heavily on central banks winning for any further extended period of time.  We may assume controllable risks on a strategic basis, but we anticipate that the next significant opportunity to profit from substantial stock and bond holdings will come with patience and at far more attractive valuations.  That approach has proven extremely beneficial twice since 2000, and we believe that the probabilities lie heavily on the side of at least one more repetition until the debt and valuation excesses are significantly reduced.


Quarterly Commentary 2nd Quarter 2016

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Notwithstanding brief periods of weakness, both stock and bond markets have experienced remarkable success for more than seven years running. Through that period, those who have continued to highlight various dangers as reason for caution have been perceived as boys who cried “wolf”.  Copious quantities of newly printed money have flooded the equity and fixed income markets, keeping prices at elevated levels.  Those without much investment experience or historical perspective might view this phenomenon as normal or in some way the birthright of investors willing to accept market risk.  Nothing could be farther from the truth.

Informed investors must recognize the monumental bet they are making. (And I use the word “bet” advisedly.)  Positive returns remain possible over the next few years if the Fed and other world central bankers remain willing and able – two separate considerations – to keep stock and bond prices elevated.  Confidence in their price support has been a winning bet since 2009.  Traditionalists who believe that fundamental conditions will prevail, as they always ultimately have, see great danger in the extraordinary combination of slow economic growth, stagnant corporate earnings, extreme overvaluation, suppressed interest rates and unprecedented debt levels.  Reversion to historic means could produce destructive losses.  In my nearly half century in the investment industry, I have never before seen such a clear divergence between underlying fundamentals pointing in a negative direction and powerful central bankers aggressively promoting higher securities prices.

In a May article, “‘Normal’ Returns Are Unlikely In A Far From ‘Normal’ Environment,” I outlined the extraordinary economic and market conditions that make historically normal returns highly unlikely. By way of quick summary:

  1. Risk-free cash equivalents have provided an essentially zero return for the past eight years.
  2. Longer fixed income securities are at all-time low yields throughout most of the world. Over $11 trillion of securities now trade at negative yields.
  3. Common stocks are near all-time valuation highs, second only to the period around the mania peak, from which point stocks were trading more than 50 % lower nine years later.
  4. The US and world economies are extremely slow. The IMF, OECD and World Bank all continue to ratchet down their estimates of domestic and world economic growth. The US remains in its slowest recovery from recession in three-quarters of a century.
  5. Corporate profits in this country are essentially unchanged from four years ago, despite stock prices having progressed significantly higher. Earnings and revenue estimates have been far too optimistic for several years.
  6. Debt levels in the US and around most of the world are extreme and dangerous. Current debt levels are far above levels that have led to significantly below normal economic growth throughout history.

Access the article here for a fuller exposition of each of these points.

Having appraised this confluence of precarious conditions, two of the greatest living investors have turned decisively bearish. Stanley Druckenmiller, whose hedge fund returned 30% per year for a quarter of a century before being closed to the public, indicated recently his belief that investors should sell all stocks and own gold.  George Soros, one of the legendary early hedge fund operators, recently returned to money management from philanthropy.  Soros believes that opportunities on the short side are sufficiently attractive to draw him back to his earlier extremely profitable pursuit.  He also expressed his currency preference to be gold.  In addition, just weeks ago, Goldman Sachs did the unthinkable for a major investment firm, saying that it could see no reason to own stocks.  Druckenmiller, Soros and Goldman Sachs could all be wrong, but, at the very least, it should be a sobering consideration that they all see great risk in the stock market.

Reversion to the mean has been a process that has characterized securities markets throughout history. At current levels of overvaluation, it is logical to expect that significant price declines may realign stock and bond prices with underlying fundamentals.  There is, however, another long-appreciated aphorism, widely attributed to John Maynard Keynes: Markets can stay irrational longer than you can stay solvent.  In other words, while markets will almost certainly mean revert, they might not do it on your timetable.  That, again, frames the bet investors must make: Do you bet on historically normal mean reversion, leading to a highly defensive stance, or do you bet on a continuation of central bankers’ successful exercise of experimental monetary policies?

Factors in any risk-assumption analysis are not just the probability of one outcome or another but also the consequence flowing from each alternative. With interest rates at multi-century lows, the potential return from fixed income is not only severely limited, there is a possibility of substantial losses if interest rates should rise rapidly.  For all the factors profiled earlier, while stocks could still advance, it is highly unlikely that they will make dramatic gains.  On the other hand, having declined by 50% or more twice already in the past 16 years, equities could repeat such aggressive bear market behavior if investor confidence in central bankers should wane.

With upside potential limited and downside risks substantial, maintaining traditional portfolio allocations and the widely followed buy and hold approach is likely a prescription for substantial portfolio damage in the years ahead. Organizations and individuals with little potential to replace lost capital should be particularly careful about betting on continuing central bank success.


“Normal” Returns Are Unlikely In A Far From “Normal” Environment

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Almost all investors have at least a general familiarity with the long-term performance record of stocks, bonds and cash equivalents. Over the 90-year span from the end of 1925 to year-end 2015, common stocks provided an average annual total return of 10.0%; Intermediate U.S. Government Bonds 5.3%; and risk-free U.S. Treasury Bills 3.5%.  All this transpired in an environment marked by an average inflation rate of 2.9% per year.  Substituting corporate bonds or long-term U.S. Governments would increase the volatility of fixed income returns but do little to change the 5.3% long-term return provided by Intermediate U.S. Governments.  Deducting inflation reduces average real returns to 0.6% for cash equivalents, 2.4% for bonds and 7.1% for stocks over the 90 years studied.

If we could count on such average returns over any upcoming five- or ten-year period, portfolio construction would be decisively simpler. Over the decades, however, history has taught us repeatedly that many factors conspire to make decision-making very difficult.  Performance of the major asset classes frequently varies dramatically from long-term averages, occasionally for extended periods of time.

Most investors are astounded to learn that risk-free cash equivalents have outperformed both stocks and bonds for several very long periods of time. Over more than half of the twentieth century in three distinct stretches (1903-20; 1929-49; 1966-82), unmanaged risk-free cash equivalents outperformed common stocks.  And for more than 40 years from the early-1940s through the early-1980s, cash equivalents also outperformed a typical broadly diversified bond portfolio.

Unfortunately, no one is kind enough to ring a bell announcing the inception of those lengthy periods of stock and bond underperformance. We have to examine available evidence to determine whether we should expect historically “normal” returns or, perhaps, something very different.  Evaluating today’s conditions, we see little that looks “normal”.

Thanks to the Federal Reserve, risk-free return has been essentially non-existent for eight years, robbing the elderly retired of any return if they were unable or unwilling to accept the investment risk of other asset categories. This is not only not “normal”, but unprecedented, with the yield below even the minimal risk-free returns of the Great Depression.

The yields on longer fixed income securities are not appreciably better, resting at or near all-time lows throughout most of the world. Many have absurdly descended into negative territory, thanks again to the geniuses at work in a number of central banks.  At such levels, yield is non-existent, profit potential severely limited and risk levels extremely high.  Nothing “normal” here.

Common stocks are currently priced near all-time valuation highs. A composite of commonly employed valuation measures (stock market capitalization relative to the size of the economy, price-to-dividends, price-to-book value, price-to-earnings, price-to-sales and price-to-cash flow) is higher than ever before in U.S. history but for the period immediately around the mania at the turn of the century.  From that price peak, stock prices were more than 50% lower nine years later.  Nobel Prize winner Robert Shiller’s research, covering the years since 1881, demonstrates clearly that far below average returns consistently follow periods of far above average valuations.  From current levels of valuation, “normal” real annual returns over the next decade or more are likely to be either negative or low single digit positive.  If history repeats, that period is also likely to encompass at least one major stock market decline, which could be similar to the two that we have experienced so far in the still young twenty-first century.  “Normal” returns from such conditions are likely to be very different from the 90-year “normal”.

The U.S. and world economies are in danger of far below normal progress in the years ahead. The international Monetary Fund, the Organization for Economic Cooperation and Development and the World Bank have for several years been reducing their estimates of economic growth worldwide.  That growth slowdown has been more persistent and far more severe than economists have anticipated, despite the most aggressive monetary stimulus in history.  Notwithstanding some recent growth, the U.S. is still experiencing its slowest recovery from recession in more than three-quarters of a century.  Reflecting a drying up of global demand, global exports have recently declined year over year, a condition occurring only during U.S. recessions in the past quarter century.  Whether a recession is pending or not, it is likely that we continue to face a far below “normal” economic environment.

Over many decades, common stock prices and corporate earnings have grown at roughly the same rate, although not always in lock step. While stock prices have continued to climb, corporate profits are approximately unchanged over the past three years–far below a “normal” rate of growth.  Stock prices have clearly outrun corporate earnings.  Earnings and revenue guidance for the period immediately ahead is tepid at best.

The most serious ab-“normal” condition facing investors and society in general is the extreme and dangerous level of debt built up both domestically and internationally. In their attempts to rescue the U.S. and major world economies from the financial crisis and to sustain growth during the lethargic recovery, central bankers have created unprecedented levels of debt.  In This Time Is Different, Carmen Reinhart and Ken Rogoff chronicle in great detail how excessive debt levels have led to extended periods of far below “normal” economic growth over many centuries in countries throughout the world.  Today’s levels of debt relative to the size of most major countries’ economies are well beyond the danger points outlined in Reinhart and Rogoff’s research.  And history’s greatest stock market declines have almost invariably unfolded soon after a period of extreme debt buildup.

What then are the prospects for securities over the next few years? Risk-free cash equivalents are likely to provide little over zero for some time to come if central bankers retain control.  The singular advantage to cash, however, is liquidity, which buys the investor the option to take advantage of occasional dramatic price declines in other asset classes.

With yields on longer fixed income securities near historic lows, there is far more room above current levels than below. To make more than the meager coupon on today’s bonds and notes, yields have to go even lower, and investors have to make a timely sale at those lower yields.  The far more likely prospect of higher rates in the years ahead will lead to a loss of principal value–a bad risk/reward equation.

Despite very slow economic growth, stagnant corporate earnings and excessive valuations, common stock prices could still move higher if investors retain confidence in the willingness and ability of our Fed and other central bankers to support the securities markets. While possible, such a scenario flies in the face of what is “normal” with today’s conditions.  Add the issue of unprecedented levels of domestic and worldwide debt, and normal corrective price moves could be powerfully magnified.

Short-term traders may be able to navigate such turbulent waters, although very few hedge funds have done that successfully in recent years. Buy and hold investors face particularly difficult prospects.  It is not inconceivable that a reversion to “normal” valuations could cut stock prices in half or more, as has happened twice since year 2000.

Many buy and hold investors expect to survive such episodes, painful as they may be, by just staying the course. After all, that’s been a successful formula in this country during today’s investors’ lifetimes.  It may be instructive, however, to look to Japan for cautionary guidance.  At the end of the 1980s, the Japanese stock market was the biggest in the world.  It had been rising inexorably through that decade, as Japan had come to dominate the automotive and electronics industries.  Japan appeared to have the new industrial paradigm.  As the excesses of their prior long strong cycle began to unwind, however, stock prices began to fall.  So ab-“normal” were conditions that prices ultimately declined about 80% and today, more than a quarter century later, remain more than 50% below the 1989 peak.  No one could have foreseen such an outcome when the Japanese market was near its top.

The fixed income portion of portfolios could simultaneously be damaged severely if interest rates should revert to historically “normal” levels.  Should inflation rates also return to “normal”, the purchasing power of bond proceeds at maturity would be markedly compromised.

There is no easy pathway to investment success in the years immediately ahead. As long as central bankers retain control, traditional approaches may continue to provide some success.  Should current rates, valuations and conditions revert to historically “normal” levels, however, traditional approaches may be severely punished.  In such an environment, avoiding major losses may become as important as seeking gains.  Even very low-return cash equivalents may come to play a valuable role in preserving assets so they may be productively deployed at more attractive future valuations.  In both equity and fixed income areas, proven strategic approaches are likely to be far more productive than a traditionally allocated buy and hold approach.  Retirees or organizations with largely irreplaceable capital should be particularly risk-averse.  There is very little “normal” in the current environment.

Thomas J. Feeney is Managing Director and Chief Investment Officer of Mission Management & Trust Co., Tucson, Arizona.


Quarterly Commentary 1st Quarter 2016

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The historic volatility evident since mid-2014 was even more extreme in this year’s first quarter. The dramatic market decline in last year’s third quarter was followed by an equally dramatic fourth quarter rally.  An almost identical decline and rally were compressed into the first three months of 2016.  Following the worst start to a year in U.S. stock market history, Fed Chair Janet Yellen gave stock prices at least a temporary boost when she surprised markets by not hiking interest rates at the Fed’s January meeting.  Her dovish tone gave investors hope that the Fed would still be supportive in the months ahead.  The brief late-January rally quickly faded, however, and prices retreated to a new low, breaking a potentially important support area on February 11.  Conspiracy theorists were given ammunition when rumors surfaced within ten minutes of the breakdown that the OPEC countries were preparing to meet to discuss cutting back oil production.  Oil prices immediately rallied, and stock prices followed.  Prices rallied into the end of the quarter, recovering all of the January – February decline, closing with a slight gain.

Late in the quarter, further dovish comments by Fed Chair Yellen as well as additional stimulative central bank actions in Europe and Asia were designed to boost economies and support stock and bond prices. They succeeded on the bond side, but stocks have shown far less enthusiasm in recent weeks in the US and throughout most of the world.  Despite extremely aggressive stimulus, Japan is a prime example of central bank ineffectiveness, with the Nikkei down about 11% year-to-date as this is written.  Despite an aggressive negative interest rate policy by the European Central Bank, European stock indexes declined an average7.7% in the first quarter.  Many opponents of central bankers’ experimental monetary policies are now arguing that such stimulative strategies have reached the limits of their effectiveness and may now, in fact, have become counterproductive.

Former Fed Chairman Alan Greenspan made a remarkable confession last week, saying: “Monetary policy is largely economic forecasting. And our ability to forecast is significantly limited.”  Bill King, who writes The King Report, had a classic response: “Nowwww he tells us that the Fed is Mr. Magoo when forecasting!”  I have written two articles in the past several weeks pointing out the absolute absurdity of granting the Fed, comprised entirely of academics and regulators, the power to effectively orchestrate the US economy.  (See and Also over the past several weeks the Organisation for Economic Co-operation and Development, the International Monetary Fund and the World Trade Organization all continued their now longstanding pattern of dropping earlier estimates of world GDP growth.  Their average estimate is now about 3% for 2016, essentially a recessionary level in much of the world.  In this country, the Atlanta Fed’s most recent estimate of first quarter US GDP growth is barely above zero, having been sharply reduced in recent weeks.  Reflecting slowing global growth, global corporate profits have been declining since 2011(according to Bloomberg) and are today well below their 2007 peak levels.  In the US, “as reported” profits for the S&P 500 are at 2012’s level, although stock prices have risen substantially over that same timespan, thanks to central bank support.

Wall Street remains silent about an imminent recession either domestically or globally. It is noteworthy, however, that over the past 45 years, Wall Street has forecast none of the past seven US recessions.  Wall Street isn’t likely to predict recessions, because it’s just not good for business.  One very telling statistic, however, that argues strongly for a global slowdown is the pronounced decline in global exports.  Exports are slowing because global demand has dried up.  Over the past quarter of a century, export growth has declined year-over-year only during recessions.

The unprecedented global central bank actions have so distorted normalcy that world interest rates in this cycle have descended to lows seen only once before, in the late-1500s. Short-term rates in Europe and Japan have been pushed into negative territory.  In this country, they are barely positive.  Thirteen European countries’ fixed income securities have negative yields to maturities out beyond a year, with Germany and the Netherlands negative out to eight years and Switzerland out to 15.  Owners of more than $7 trillion worth of securities have decided that paying those governments to hold their money is more attractive than all other alternatives– a remarkable distortion of everything we know about investments.  Some market commentators refer to today’s fixed income securities as “return-free risk.”  In the US, with the 10-Year Treasury Note at 1.8% as I write, it would take a very small increase in yield to produce a negative total return for a year or more.  While yields could always go lower, the risk/reward equation at these yields is extremely unattractive.

The credit quality of non-government loans is increasingly being called into question. According to The Wall Street Journal, energy company loans in danger of default are expected to top 50% this year at several major banks.  And J.D. Power estimates that the delinquency rate on subprime auto loans will hit 17.5% this year, approaching the 19.6% peak reached just before the financial crisis in 2007.  Bonds are hardly an attractive safe haven in the current environment.

Because of central bank actions, today’s debt excesses around the world are the most severe in history. In this country, equity valuations are at their historical highs but for the bubble at the turn of the century, from which point stock prices were more than 50% lower nine years later.  Over the decades, there has been a very clear negative relationship between valuations at the time stocks are purchased and subsequent returns.  With valuations currently stretched near all-time highs, stocks will be swimming against the historic tides in the years ahead.

Aldous Huxley famously observed: “Facts do not cease to exist because they are ignored.” The facts are that debt and equity valuations remain at dangerous extremes, having been ignored for years.  Instead, trust has been placed in government’s willingness and ability to keep stock prices elevated.  So far, over this market cycle, that trust has been well placed.  Investors are still faced, however, with the dilemma of whether to bet on a continuing divergence between equity prices and underlying fundamentals or to expect market prices to revert toward historic fundamental norms.  For all but relatively short-term traders, we strongly suggest the latter alternative.  It is important to recognize that virtually no investors get to keep what they have at market highs, but rather what still remains at market lows.  And given how overextended this market is after seven years of powerful government support, we fully expect there will be opportunities to become more aggressive in equities in the quarters and years ahead at lower prices—possibly substantially lower.





Reduce the Fed’s Mandate

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Why do we refuse to call absurdity absurd? Meeting after meeting, news conference after news conference, it becomes increasingly apparent that we have conferred on the Fed Chair the role of economic and securities market orchestrator.  Markets typically tip-toe into Fed announcements only to explode into paroxysms of volume as algos move prices violently – often in alternating directions – in the initial moments following each announcement.  The ultimate market direction is dictated by the Fed’s dovish or hawkish tone relative to the market’s expectation leading into the meeting.  Imagine how much more orderly and intelligent it would be to have a rule-based decision-making formula that investors could monitor as new data unfold.

Because the Fed’s Congressionally-conferred mandate extends beyond currency stabilization to include maximizing employment, Fed members now scan the world for economic, monetary and securities market data, all of which now seem relevant in their decision-making process. In this week’s speech to the Economic Club of New York, Fed Chair Yellen relied heavily on global uncertainties as rationale for large doses of caution in considering future interest rate increases.

The Fed’s long history is replete with flawed judgments and policy moves. For years, forecasts of the current Fed have been far off the mark on economic growth and interest rates.  Off past performance, why would we expect this group of academics and regulators to have greater insight into domestic and world economic prospects than the broad universe of business people and investors?  It flies in the face of all logic to allow Chair Yellen and any small band of academics and regulators to wield the power that the Fed holds over domestic and world economies and markets.  Congress must take that giant club out of the Fed’s hands by reducing its mandate.

Since the general public and its representatives in Congress don’t understand this highly complex policy-making process, they vest power in a perceived wise person. They fail to recognize that any Fed Chair is less like Solomon and more like the wizard behind the curtain.

Either the Fed doesn’t appreciate the full effects of its decisions and actions, or it is simply satisfied with having rewarded Wall Street, though not Main Street. Whatever benefits accrued from history’s most generous monetary experiment have come at the expense of a generation of elderly retired who have had to choose between spending down life savings or risking those assets in historically overvalued securities.  The final chapter on how that unfortunate generation’s retirement will play out has almost certainly not been written.

Far greater pain likely lies ahead, perhaps to be borne primarily by generations which have had no role in approving the Fed’s decisions. Monumental debt loads, like today’s, have throughout history led to greatly inhibited economic growth for extended spans of years.  And many of history’s greatest securities market declines have accompanied such periods of economic lethargy.

Our unwillingness to confront the absurdity of allowing a few academics and regulators to orchestrate domestic and world economies is allowing the pain to continue for the elderly retired and to increase for future generations that will almost certainly inherit unprecedented debt burdens. We are allowing Janet Yellen to dig us deeper into a destructive dungeon of debt.  Congress and the general citizenry must make their voices heard in opposition.

Congress should immediately set about reducing the Fed’s current dual mandate to a single mandate of stabilizing the currency. Ideally, within that mandate, Fed decision-making would be formally rule-based rather than, as today, with each Fed voting member formulating his or her own non-binding and often fluctuating rules.

Let’s recognize the absurdity of the current arrangement in which any Fed Chair, essentially without veto, plays the largest single role in orchestrating the world economy.

Thomas J. Feeney is Managing Director and Chief Investment Officer of Mission Management & Trust Co., Tucson, Arizona.

For a related analysis of the inappropriate scope of Fed power, please see Tom’s immediately prior blog post “Where’s the Outrage?”.


Where’s The Outrage?

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In 1976’s Network, Howard Beale famously yelled: “I’m mad as hell, and I’m not going to take this anymore!”

The rise of Donald Trump and Bernie Sanders testifies powerfully to the anger felt by large segments of the American population. Tragically, that anger does not extend to the ascension of the Federal Reserve as orchestrator of the U.S. economy, despite no public approval of such a “third mandate.”

The Fed’s assumption of its expanded role displays a remarkable lack of humility given the long and checkered track record of that body’s errors of omission and commission. In recent months, regional Fed presidents Charles Evans and James Bullard have highlighted seriously flawed Fed forecasts.  In almost any other context, such frequent failings would lead affected constituencies to reduce a body’s decision-making authority.  Remarkably, just the opposite has occurred over the past several years with respect to the Fed and central bankers around the world.

To solve problems brought on by excessive debt, central bankers have conducted the greatest monetary experiment in history. They have attempted and continue to attempt to solve those problems with unprecedented amounts of new debt.  While it sounds simplistic, it is a very apt analogy to compare that solution to trying to cure a hangover with more “hair of the dog.”  It flies in the face of all logic.

Likely because monetary economics is a highly complex study, the general public and their representatives in Congress have little understanding even of its broad strokes, much less its intricacies. As a result, there has been only mild opposition by those most impacted today – a generation of retirees who have so far been able to earn no risk-free return for half an expected retirement span.  And, of course, there has been no objection from future generations who will inherit the monumental debt levels we have generated to paper over problems of our own creation.  If we actually understood the problem, who among us would deliberately improve our own wellbeing and demand that our children, grandchildren, even great grandchildren pay the bill?  So we silently allow central bankers to conduct what they themselves characterize as experimental monetary policies.  But this is not a small experiment.  Should the world’s monumental debt burdens unravel in an uncontrolled fashion, central bankers will be seen to have bet the world’s economy and the wellbeing of generations on little tested and certainly unproven policies.

Who are these people to whom we have defaulted such power? They are, virtually without exception, academics and regulators.  By all appearances, each is intelligent, well-intentioned and respected in his or her field.  But they are academics and regulators, unsullied by any practical experience in running even a single significant business, much less the world’s largest economy.  Regardless of their academic credentials, few, if any, would qualify for senior management roles in major domestic or international corporations.  Individual Fed members could certainly be blended with experienced business people to comprise capable boards.  Shareholders of any large corporation, however, would have every reason to be appalled by a board restricted solely to Federal Reserve Board members.  Where’s the real world experience, the appreciation of the profit and loss consequences of regular decision making?  Where’s the breadth of experience required to appreciate the effects of a company’s actions on both its customers and on the broader citizenry its actions affect?  Their academic and regulatory pursuits leave them remarkably sheltered from a real world appreciation of the breadth of the effects they create.  Yet we have allowed them to assume far more extensive power than exists in even the world’s most prestigious corporate or non-profit boards.  It can only be from ignorance or from a deplorable lack of concern that we as a citizenry have permitted central bankers to acquire such a powerful role in picking society’s winners and losers.  The mandate they have assumed is entirely too large.

In fact, the dual mandate given the Fed by Congress is responsible for the current overreach. Virtually anything unfolding in the domestic or international economies arguably affects domestic employment.  Consequently, the mandate to maximize employment effectively charges the Fed with monitoring and responding to massive numbers of potentially critical variables.  Recent quotes from several Fed members make it clear that monitoring and responding to the world’s financial markets falls well within the Fed’s perceived purview.

Wall Street is nothing if not ingenious and capable of creating its preferred market picture. In an era of rampant spoofing and bluffing, it’s hardly a stretch to expect self-interested, financial megacorps to paint the picture they want the Fed to perceive leading up to important central bank decisions.  When experienced investment pros misread market signals with some regularity, what are the odds that a group of academics and regulators are going to read them accurately?  At best, it’s an exercise fraught with hazard.  We’re asking Fed members to make decisions far beyond their areas of experience and competence.

Allowing the Fed to wield the power it now has is also creating massive stock market distortions. So much market reaction flows from Fed proclamations that analysts spend an inordinate amount of time attempting to interpret the slightest variations in language or attitude of Fed voting members.  For many strategists this has become even more important than the analysis of underlying fundamental conditions.  That dynamic becomes blatantly obvious whenever we see markets surge on an announcement of disappointing economic news, as the prospect for more stimulus increases–a clear distortion of traditional free markets.

In recent years, Fed Chairs Bernanke and Yellen have gone to great lengths to promote the idea of Fed transparency. At the same time, we are subjected to Fed members repeatedly performing like traditional two-handed economists with the apparent intent of keeping upcoming decisions unclear.  A rule-based system to determine monetary policy would certainly be preferable to the frequently flawed Chair-led decisions heavily influenced by personal perceptions and biases.  The arguments against relying on a rule-based system typically involve pointing out how such a system would have led to an arguably unacceptable monetary position in one or more instances– as if the existing system itself has not placed the country in an extremely dangerous position.  If a rule-based system appears imperfect, improve the rules.  Clearly, each voting member of the Fed relies on his or her own set of rules in making monetary decisions.  They are not, however, publicly known, so we are left to speculate on how voters, especially the Chair, will make their decisions.  The securities markets would be far better served if analysts knew the rules on which monetary decisions would be based.  Strategists could abandon the psychological analysis of voting members and their probable decision-making patterns and return to an analysis of how the data align.

If we are not to turn to a formularized rule-based monetary system, we need to expand the influence of the many constituencies affected by monetary decisions. Obviously, any decision-maker would need a strong background in monetary economics.   Additionally, it’s only fair that they represent the many segments of society that will be impacted by those decisions: large and small businesses, employees, elderly retired, investors, non-profits.  The current Fed has much too broad a mandate and is woefully unqualified to pursue the many objectives on its plate.

Notwithstanding the best of intentions, the Fed in recent years has bet America’s future on a flawed (now failed) experimental monetary policy. Until we speak up loudly, we remain at risk of their experiments further decimating the future economic prospects of our nation and coming generations.

Difficult and confusing as this subject is, Congress needs to step up now and rein in Fed power. It’s important for all of us to recognize that this king wears no clothes.


Markets At A Crossroad

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In a September 8, 2015 blog, I indicated my strong belief that a major worldwide bear market had begun.  At the recent February 11 lows, the S&P 500 was about 15% below its May and July 2015 highs.  Most foreign markets had suffered more significant declines.  The dangerous conditions outlined in that earlier blog remain major intermediate and long-term concerns.

One of the weakest beginnings to a new year ever turned short-term investor sentiment very negative.  At extremes, sentiment measures can be excellent contrary indicators.  In a bear market, sentiment can remain pessimistic far longer than during bull market corrections, but significant pessimism often marks at least a short-term market bottom.  Notwithstanding numerous ongoing negative conditions, we must now remain alert to see whether stock prices need to rise appreciably to relieve excess negative sentiment.  A telling point is likely to be whether stock prices can remain above their February 11 lows (about 1810 on the S&P 500 and 15,500 on the Dow Jones Industrials).  Remaining above those levels could rekindle more bullish feelings for a while, even leading to a test of former highs.  On the other hand, a break below the February 11 lows could unleash torrents of selling as investors come to believe that central bank rescue efforts have become ineffective.  Either way, the year ahead is likely to be extremely volatile with the potential for a market, economic, political or military event decimating longer-term investor confidence and leading to a persistent, destructive market decline.


Quarterly Commentary 4th Quarter 2015

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2015 disappointed almost all investors. At the start of the year, there was unanimity among strategists from all major investment firms that the Fed-supported stock market rally would continue. It did not, as the average U.S. stock declined and at year-end was 24% below its 52-week high. The strength in a small number of institutional favorites kept the major equity indexes from similar declines. In fact, while the total return on the Dow Jones Industrials was negative, a 2% dividend return on the S&P 500 lifted that index out of the negative column to a total return just above 1%. Risk-free cash equivalents continued to provide no return, and bonds were mixed with the broadly followed Barclays Aggregate Bond Index registering a total return of 0.55%. At the lower end of the quality spectrum, high yield bonds lost 4% for the year.

Such nondescript returns masked an unprecedented level of volatility. Throughout the year, there were repeated violent market swings with no lasting trends developing. Hedge funds had a particularly difficult time – with some of the most successful over the past few years dropping by 20% or more. Warren Buffett’s normally profitable Berkshire Hathaway Corporation declined by 12%.

As we begin 2016, investment strategists and economists are once again convinced that stocks and the economy are primed for a positive year. We disagree. About four months ago, I wrote a blog explaining why Mission believed that a major bear market had begun. Subsequent events have done nothing to dampen that conviction. Let me update the major factors that led to that belief.

Even after the worst first week of a new year in U.S. stock market history, valuations remain higher than ever before but for the months surrounding 2000’s peak. Data stretching back more than a century make the point that returns for the years following periods of significant overvaluation tend to be much weaker than average. It has been in such time spans that the market’s most destructive declines have unfolded.

The vast majority of U.S. stocks are trading below their 50- and 200-day moving averages, showing that they are trending down. Of the 46 world markets that we monitor, only five are trading above their 200-day moving averages and only three above their 50-day.

Even on most rally days, more stocks are reaching 52-week lows than 52-week highs. The market’s internal deterioration can be seen clearly in statistics compiled by Lowry Research Corporation, an institution with an 88-year history of highly respected research. In twelve months through December 30, the percentage of stocks within 2% of their 52-week highs declined significantly: Large caps from 27.1% to 17.45%; Mid caps from 23.24% to 15.53%; and Small caps from 14.38% to 3.33%. Over the same time period, the percentage of stocks down from their 52-week highs by 20% or more increased dramatically: Large caps from 8.87% to 19.81%; Mid caps from 18.06% to 34.36%; and Small caps from 39.05% to 61.71%. These statistics are not consistent with a healthy market.

This internal deterioration took place while our Federal Reserve and other major central banks were flooding their respective economies and markets with historic amounts of monetary stimulus. The European Central Bank and the Bank of Japan have pledged to continue that torrent of new money, but the Fed has begun a belated process of “normalization”. Interest rates have been nudged above the zero bound for the first time in years, and the essentially free new money from quantitative easing will be missing in 2016. We can only speculate how the economy and markets will behave without that familiar stimulus.

In a process that began over two years ago, volume going into rising stocks has deteriorated steadily relative to volume going into declining stocks. In the second half of 2015, the cumulative volume total going into declining stocks surged above the volume going into advancing stocks. As measured by Ned Davis Research since 1981, the S&P 500 has on average declined when that condition has prevailed, and the index has performed an annualized 13.5% worse than when advancing volume has dominated.

For most of the past two years, the yield on lower quality debt has been rising notably– both absolutely and relative to U.S. Treasuries. That trend has preceded some of history’s most severe stock market declines.

Those who interpret Dow Theory announced a bearish signal in August when both the Dow Industrials and Transports descended below their October 2014 lows. The precipitous market decline in 2016’s first week has brought the Transports to a new low not yet confirmed by the Industrials.

Weakness in technical conditions is not alone in sounding an alarm. Fundamental conditions, as well, continue to deteriorate. Notwithstanding consistently optimistic forecasts from investment bankers and brokerage firms, worldwide growth remains weak. The International Monetary Fund (IMF), the Organization for Economic Cooperation and Development (OECD) and, most recently, the World Bank have all once again dropped their estimates for both U.S. and world growth. IMF head Christine Lagarde last week forecast 2016 global growth to be “disappointing and uneven.”

China’s growth continues to slow, and smaller emerging economies are increasingly distressed by the strengthening U.S. dollar. After China’s surprise devaluation of the yuan, an increasing number of countries are likely to be motivated to weaken their currencies to maintain or improve their export potential. Aggressive currency wars are possible as countries fight to avoid recession. When last common, such currency wars contributed greatly to the length and depth of the 1930s’ worldwide depression.

In the U.S., corporate earnings declined in 2015 and are at approximately the same level as at the end of 2013. With no net earnings growth for two years and the most optimistic forecasts projecting uncertain growth in 2016, valuations not far below all-time highs make no sense.

Weak technicals and fundamentals by themselves pose significant dangers. Mix them into an environment marked by the highest debt levels in history throughout most of the world, and the risk of severe and rapid market price declines is high.

Standing guard against such an outcome are Janet Yellin, Mario Draghi and central bankers worldwide. For several years, they have stepped into the breach whenever significant price declines have threatened.

History argues strongly, however, that central bankers can prevail over weak fundamental conditions only so long. Markets eventually adjust to fundamental levels, and the adjustment can be abrupt if, as now, prices have diverged dramatically from underlying fundamentals.

We continue to caution investors against being lulled into a state of complacency by apparent central bank control over market prices. In past communications, we have highlighted two striking 2015 examples of the power of markets ripping control from the best efforts of governments. The highly respected Swiss National Bank (SNB) saw the euro diverge from the franc by 38% in minutes when the SNB dropped its long-held peg between the currencies. Far less respected Chinese monetary authorities were shocked when stock prices plummeted by 45% in weeks despite significant governmental support for markets. More surprises are likely in 2016.