Episode #192: Tim Hayes, “The Base Case Is We’re Still In The Same Secular Bull Market That We’ve Been In Since 2009”
Guest: Tim Hayes is NDR’s Chief Global Investment Strategist. He has been with the firm since 1986. Tim directs NDR’s global asset allocation services, develops strategy and major investment themes, and establishes NDR’s weightings for global asset allocation, presenting his views on the cyclical and secular outlook globally.
Date Recorded: 11/5/19
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Summary: In episode 192 we welcome our guest, Tim Hayes. Tim and Meb kick off the conversation with an overview of the data driven Ned Davis research process and how the team gains an understanding of what is going on the market.
Meb then asks Tim to expand on his current thoughts on the market. Tim covers the potential tactical opportunity in the market and the base case for the US stock market, that it’s in the same secular bull market it’s been in since 2009. He also notes that there is a risk to the bond market and that it’s late in the secular game.
The conversation then shifts to discussion about negative yielding bonds. Meb and Tim then touch on the worries Tim is seeing from institutional investors.
As the conversation winds down, Tim covers his belief that it is critical to be aware, and constantly watch what relationships are changing in markets to gauge what is relevant.
All this and more in episode 192.
Links from the Episode:
- 0:40 – Welcome our guest, Tim Hayes
- 1:42 – An overview of London and Brexit reaction
- 2:36 – An overview of Ned Davis research
- 3:37 – The Research Driven Investor: How to Use Information, Data and Analysis for Investment Success (Hayes)
- 3:45 – Being Right or Making Money (Davis)
- 5:17 – Ned Davis research process
- 10:07 – Current state of the markets
- 13:21 – Driving force behind the US performance this past decade
- 14:43 – Market outlook
- 19:49 – Negative yielding bonds and how they turn course
- 23:11 – Outlook for equities
- 25:57 – How Ned Davis guages sentiment
- 28:53 – Bright spots in the US going forward
- 34:13 – Perspective on commodities
- 37:38 – How the yield curve impacts investments
- 39:37 – What institutions can do to protect themselves in the coming years
- 42:42 – Investment beliefs that most of the community doesn’t agree with
- 45:56 – Favorite resources
- 49:12 – What’s changed in Tim’s world during his time at Ned Davis
- 51:38 – Most memorable investment
- 52:24 – Favorite market indicator
- 54:07 – Advice for big institutions
- 56:41 – How to connect with Tim: ndr.com
Transcript of Episode 192:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Welcome, podcast listeners. We got a great show for you today as the year is winding down. Our guest is joining us from London Town. He’s the chief global investment strategist at Ned Davis Research, and he’s been there since 1986. He directs NDR’s global asset allocation services, develop strategy, major investment themes, and establishes Ned Davis’s weightings for global asset allocation. He’s also the author of “The Research Driven Investor.”
In today’s episode we dive into their whole research process at Ned Davis. We explore Tim’s current base case for U.S. stocks, still being a secular bull market. And what scenario is a probabilistic going forward, including what conditions we’ll need to see for an environment of double-digit annualised returns. We also cover commodities, and in particular, gold, an area of interest for the NDR team right now. We also discussed some themes of worry among institutional investors and the insight that is in an environment of capital preservation with a high level of risk aversion. Please enjoy this episode with Tim Hayes.
Welcome to the show, Tim Hayes.
Tim: Thanks a lot, Meb.
Meb: Tim, I’m really excited to have you today. We’ve been harassing you for a long time to get on the show. And you’re joining us from London. What’s the mood over in the U.K.? You’ve been there for a few years now. What’s going on over there?
Tim: Well, it’s kind of funny. I mean, I got here right before Brexit. And then the Brexit vote, it seemed like things were going to be pretty clear-cut, but four years later and nothing is any more certain than it was when they did the votes. It’s just an air of uncertainty. And you’ve given up trying to predict the outcome because there’s so many possibilities. So I just think it’s one sort of just uncertainty really.
Meb: Yeah, it was funny, because I was there last spring and was laughing. I was in a pub. And all my local Brit friends were just like, at this point, just like throwing their hands up in the air. And no one could explain to me. I’m like, what’s the actual, I don’t even care like what’s gonna happen, but, like, what’s the path to, like, even coming to a decision. And it was just, like, it was funny.
Anyway, look, I’ve known you for a long time. Why don’t you tell the listeners who aren’t familiar, most should be, a little bit about the company, and then we’ll dive deep into all things markets?
Tim: Ned Davis Research was of course founded by Ned Davis, whose name is on the door, back in 1980. And the approach was really to use more of a quantitative approach or to actually use models, which at the time was something completely new, to try to establish sort of the weight of the evidence, what’s the data telling us about where the markets are going. Over the years the company has developed a pretty strong institutional following globally. And I interact with a lot of our clients in Europe and Asia from over here in London and also back in the U.S.
Our philosophy is to be objective, disciplined, risk-averse, and flexible, and really respond to what the data is telling us and not get too caught up and predict and forecast where things are going, because as we know, that’s a pretty unreliable strategy for investing.
I wrote the book Research Driven Investor, which is really about using good research to underpin your investment decisions. Ned had a book called Being Right or Making Money, which is the point there, is that we’d all like to be right all the time, but when it gets down to it, we want to make sure we put our money in the right place and don’t make a big mistake. A lot of what it’s about is risk management and making the right decisions.
Meb: By the way, Tim, you published this book about 20 years ago, and it’s about time I think for an update. The publisher talked you into that yet now that it’s near the end of the decade? Are we gonna get you to do an update to this puppy?
Tim: Yeah, I definitely need to do an update. It’s just, as always, it’s about finding the time. But it was interesting. I wrote it. It basically went to the press in, I think it was March of 2000 right before the tech blow up. And one of the pages in there, we had a focus list at the time, which was sort of generated by really more momentum. Almost all the stocks on there were internet stocks. And, like, a month later, they all started coming off the list because we got into…the tech bubble started to burst. So it was an interesting time.
And of course, since then we’ve been through the whole secular bear market, the ’07 – ’09 global financial crisis, and then the big recovery since then. So certainly, there’s a lot more to talk about. I think it’s something I may, in fact, want to do in the not-too-distant future.
Meb: One, because in the intro, you were like, “The days of easy stock market profits are over.” And I feel like you can make that argument again today. We come full circle at some point. But also, you know, the Millennials that buy your book, they’re gonna get it and see a CD on the cover and be like, “I don’t even know what this is.” What are these things on the cover of the book?
Tim: Yeah, exactly.
Meb: Let’s talk a little bit about y’all’s research process, and we’ll get into some market outlook and things after. But talk a bit a little bit about how you guys go about it. Most people self-identify, whether it’s Warren Buffett saying, “I’m a value guy.” Maybe some people say, “No, I’m pure technician.” And other people, you know, based on fundamentals. How do you guys kind of go about the whole process, utilise probably more data inputs than anybody on the planet? Talk to us a little bit about y’all’s framework for how to think about the world.
Tim: Okay. Well, I mean, for lack of a better term, we use what we sometimes can call 360 approach, which, essentially, you can think about it in two ways. Half of the challenge is understanding where the market is going, you know, what is market doing right now. And as simple as that sound, you really have to dig under the surface and look at the breadth of the market and look at a lot of indicators to tell you how healthy, is it advanced or, you know, whether it’s divergent or led only by a few stocks.
So that’s pretty much…half of it is understanding sort of the tape as we, you know, another term we, you know, we don’t use anymore, but based on the old ticker tape, but the point is how healthy is the actual trend of the market. So another way of describing is remaining trend-sensitive. And so to do that, we want to build indicators based on historical relationships and tendencies.
So example, 20 times over the past 30 years the indicator’s gotten to this level. And after that’s happened, the market is continuing higher. Things like deviation from trend, like one moving average versus another, or new highs in the market, momentum, which basically a moving rate of change. Those price-based indicators, that’s about half of the process. And how that can really help you is in an environment like 2007, 2009 when if you relied on non-price indicators, you could very well have gotten caught on the wrong side of that move.
So that’s half of it. So basically, the internals is another way of describing it, tell us what the market is doing, this sort of more technical approach to it. And the other half is sort of a non-price indicator, what we call the external factors. And this can include everything from sentiment in the market valuations. It includes a macro environment, liquidity, economic, momentum, earnings momentum, anything that’s not purely based on price that helps confirm what the internals have already been telling us.
And then what will happen often is that the price-based indicators will get favourable, and we don’t always understand why until we start to get the confirmation from the fundamental indicators. And in fact, the way our models work is that half is the internal factors, and then the more confirmation we get from the fundamentals, then the more bullish the picture, in that you sort of have that broad-based advance going on that’s explained by conditions that are reflected by the non-price indicators by the fundamental indicators.
And with all these things, like, we’ll take economic data and do the same approaches that we take with the internal data. At one point, for example, was the PMI, Purchasing Managers’ Index. Momentum get to a certain level. At what point does that become bullish for the market or bearish for the market? And what has the historical tendency been, what’s the annualised return been and different, as we often call, the modes? Really, the challenge is to find good reliable indicators. And then if you can put good reliable indicators together, then the composite of those indicators should give you a good reading and sort of the weight of the evidence, whether the glass is half-full or half-empty and where things are going.
So that’s pretty much the approach, very data-driven. Then, what that does is it allows you to be flexible. I can be ragingly bullish, and then two weeks later, the data starts changing, and you just have to go with the data and say, “Okay, things are working out differently than they were looking two weeks ago, so we need to respond and change our allocation, change your position.” So that’s pretty much, I’d say, the approach behind it.
Meb: I think you hit on a pretty important point, which is so many investors get stuck in the belief system where they have a position or they have a worldview, and you’re seeing this a lot with politics and everything else today, of these echo chambers is that they only search for confirming evidence. I don’t care if you’re a Tesla bull or bear, whatever it may be, same thing with the economy and positions. But the reality for many things is you should be looking for evidence that really works against your view, or at least be open to it, because as things change, the worst thing could happen is just staying stuck in your worldview when everything is flashing red against you.
So as we wind down the year and the decade, as you’re toasting a pine in the U.K., and we’re sipping champagne on December 31st, 2019 about to turn the page on the 2020 is maybe talk to us a little bit about, we could probably start with the economy, the way that the world economy looks today, and with a nod towards the U.S. as well, and then we’ll start to get into a little more market outlook. But how are things? Are things romping, things slowing? How’s the world look today?
Tim: The interesting thing is that, you know, it’s sort of you have this back and forth. You know, one-week things are looking better, and the next they aren’t. I think what’s sort of defined this year has been one where you’ve had these really sort of sentiment-driven moves where there’s talk of a trade deal, and then the market rallies, and then we learned there actually wasn’t a deal, there’s not going to be a deal, the market comes off.
But when he gets sound to it is really you’ve had this… The PMI data has really described this environment of uncertainty and lack of confidence from the business side that has really been defining the economic environment. And so you have this dichotomy where the manufacturing and business data is weakening, and yet you still have the consumer hanging on the employment data remaining favourable.
And the question has been, will the manufacturing slow down and the business confidence run its course now that we’ve had sort of a renewed phase of global accommodation, or is it really just a matter of the U.S. finally giving out. As businesses to start to look at their profit margins, they’re starting to be affected. This leads to employment numbers start to be affected. The wage starts to be affected. And then the U.S. follows suit.
And what we find is if the US is in a recession within a global slowdown, then that prolongs everything. In fact, your annualised return is about negative 5%, and you’ve had a U.S. recession and the global slowdown, whereas when you have just the global slowdown, which defines the environment we’ve been in since early last year, the mark’s actually up about 2% per annum.
So I think we’re sort of at a point now, a kind of a crucial turning point, here at the end of the year is that there are some signs that the global manufacturing picture may be starting to turn out better. And certainly, if there is going to be a trade deal that has any kind of significance that would support that, there’s also still negative momentum on a lot of the manufacturing data in the U.S. And that could catch up to the U.S. consumer and conceivably bring us into a recession.
So the way I’m thinking about it, we could very well have a tactical opportunity here. Whether or not that’s going to be a lasting recovery remains to be seen. If in fact, we’re going to avoid U.S. recession, the global economy is going to come back, then actually we could already be at the beginning of a pretty good, sustainable recovery in the markets ahead of our recovery next year. But I just think it’s a little bit too early here in early November 2019 to really know whether we can toast a glass of champagne or start to get ready for things to get a lot worse next year.
Meb: As we reflect back, the U.S. has really been the shining knight of this past decade. The U.S. stock market had just been gangbusters, a big outlier performer versus most of the rest of world. And I think, I may be wrong, but this may be one of the first decades, if not the first decade, without a recession in the U.S., if we make it through the end of the year. What do you think has been the driving force behind that? Is it central banks? Is it something else? Is the U.S. just that much more competitive? What’s a world view looking back on why things have been so much better here?
Tim: You’ve had a combination everywhere globally. It’s been more really the consumer that’s been a stronger force in propelling the U.S. And earnings have been coming through for the U.S. companies. And in fact, we defined this as a global bull market that really started with the lows in 2009, a secular bull market globally. So by definition, all the major markets around the world are participating. But you’re right. The U.S. has outperformed since 2009, and that was also the case in the last secular bull market, which went from 1982 to 2000.
Yeah, I think it gets pretty much down to the U.S. consumer being such a big part of this economy, whereas it’s not as much a role to such an extent, say, in Europe or in Japan to the other major regions, equity market regions.
Meb: As we shift from a look back to a look forward, start to walk me through market outlook, some of these market trends. What’s Ned Davis’s world in Tim’s worldview on, and you can start wherever you like, but I figured we’d start with U.S. stocks? What’s the world look like going forward?
Tim: The base case is we’re still in the same secular bull market that we’ve been in since 2009. If we go back to ’07, in fact, go all the way back to 2000, what started in 2000 with the bubble of 2000, it was really about a deleveraging process that took different forms, and it was really started with the internet bubble and a tech bubble of 2000. It sort of was transferred over to the subprime and housing bubble that led us into the global financial crisis of ’07 – ’09, which really finally took care of the deleveraging that had to finally bring that secular bear market to an end.
And during that secular bear market, the S&P was down 6% per annum. So over a period of almost 10 years, the market was losing money at a pretty consistent rate. Over to 2009, you have what I call a policy capitulation, and all the central bank is kind of finally get on the same page of trying to reflate the global economy. And they succeeded. From that point in time, the global economy began to gain traction in the stock market.
This underpinned the rallies we had a couple of what I call cooling phases during this reflation trend. You’re thinking about reflation as a gradual warming up of economic conditions. We had to cool off in 2011, 2015, and then 2018. But coming out of each of those, what happens is it sort of re-establishes that global policy, that accommodative monetary policy. And that’s what we’ve been seeing again over the last year, is the Fed getting back to easing again, a lot of other central banks getting back to easing.
And then what that does is just sort of reassert that same secular trend, and then, you know, you’re back into the average cyclical bull within a secular bull, last about two and a half years and takes market up 77%. So I think there’s going to be a good opportunity. The question is sort of, you know, has it started yet, or are we going to go up and come back down.
We’ve had one aspect of a secular bull, is that when you’ve had a secular bull market, and I mentioned this before with global slowdowns and U.S. recessions, and there have been… We had in the 1970s, there was two. One it started in 1970, ’73, ’75. And then in the early 1980s, you had one in 1980, those back-to-back recessions. And finally, we got to ’82, which was the beginning of a new secular bull market. You’ve had four of these really bad economic periods.
And then the same thing happened, 2001 was another U.S. recession within a global slowdown. And then the global financial crisis, you know, that was the big one. But there’s been one case where you actually had a global slowdown and a U.S. recession within a secular bull. And that was back in the early 1990s. So that’s sort of the worst case, I think, scenario that if the U.S. goes into a recession, it would be more of a shallow recession like it was then, and it sort of prolonged the global slowdown. The market really made no progress from ’89 until ’94. Or if we’re not gonna have a U.S. recession, then things start to look more like they did in around ’93, ’94, which eventually is when the market broke out and started that big run-up in the 1990s.
So either way, when we do finally have that confirmation that actually the global economy is turning around, and the U.S. is either coming out of recession or not going into one, what we’ll start to see is bond yields will start to move higher, stocks will move higher with them. Right now, we still have a positive correlation between bond yields and stock prices, which I think is best explained by the market viewing rising bond yields as a sign of economic growth, not as a negative sign of inflation. In fact, inflation is one of the ingredients that the markets want to see here.
So I see that sort of being what gets us back into an environment of those double-digit annualised returns again, which we haven’t seen, the market basically being flat over the last year. But then the question will become, over the next several years, when does actually reflation start evolving into inflation that becomes a negative threat to the markets. And that we would see when the correlation, remembering that the market inflation expectations will be reflected in rising bond yields, at some point in the future, the stock market will start to see that not as positive but as negative.
And then if that correlation then start turns negative, in other words, the rising bond yields are met with falling stock prices, and if by then the stock market has gotten a lot more overvalued, then the stock market is in a much worse position. But that’s clearly not the risk right now with inflation back down, the very low levels in the U.S. and globally and interest rates about as low as they can go.
Meb: Maybe go a little deeper on that while we’re on the topic of interest rates and bonds. I mean, I think a lot of people probably have been surprised by the amount, first, of any, but also the amount of negative-yielding sovereigns and even some corporates around the world. Talk to us a little bit about kind of how you guys see that over at Ned Davis. I mean, I was kind of smiling as you’re talking about inflation and bond yields going up, because so many of them have been going south. Talk to us a little bit about how you guys think about. And any predictions on kind of how that eventually resolves, any general thoughts.
Tim: One way I think about that is, when we talk about secular trends, again, is that equities have been in a secular bull market since 2009. Bonds have been in a secular bull market since the early 1980s. So, if you have a 40-year bull market like that, that eventually leads to is the excessive complacency, excessive optimism. And even the last year you’ve had about $240 billion flow in the bonds, or you’ve had about $230 billion flow out of equities is based on ETFs and mutual fund flows at a time when you have negative-yielding bonds.
So the point is this is just a sign of people putting money in bonds because it’s just this perceived lack of risk. The same kind of thing we heard back at the end of the ’90s about tech stocks. You should throw your money into tech stocks, and you’ll be fine. The world is different now. They’re never gonna go down. You’re never gonna lose money. Same thing with the bonds is I think the risk is that we’re getting very late in the secular game here, and that at some point, this is a sign of extreme overvaluation.
And when it finally does turn, especially since there’s such a lack of liquidity in the bond market, and so much exposure from these very low levels. It won’t take much of a yield rise for people to realise that they’re losing money. And when people realise they’re losing money in the area they thought was safe, that has potential to create a stampede and for people to, you know, head for the exits pretty quickly.
So, I think that’s the real risk in the bond market. It doesn’t have to happen right away. We could just sort of stay at these low levels for a lot longer. In fact, I think that would be probably the healthier environment for equities. If you see yields, maybe back up gradually, but they don’t really start to spike higher, then you could still have a continuation of the current environment with bond yields moving gradually higher and stocks outperforming bonds on the upside.
But I think that it is, on the negative yields, I just think it’s a sign of just this extreme one-sided thinking about bonds is that it really represents a longer-term risk and probably not sustainable.
Meb: You put your hat on. Do we ever see negative government bonds in the U.S.?
Tim: I think that gets back to that question I was addressing earlier. If the U.S. goes into a recession, last week’s number and the employment turns out to be as good as it’s going to get, and we do start to see the U.S. gradually move closer to moving into recession, yeah, I think that should definitely be considered as a possibility. And it’s happened everywhere else where economies have been sort of leading the U.S. And I wouldn’t rule that out at all. That could certainly make things more difficult, sort of prolong this environment we’re in right now.
Meb: You just gave all my retirees listening a heart attack. Now talk to me about stocks. So, U.S. stocks, how do they look going into the end of the year? We’ve had a pretty significant run. Are most indicators flashing green, yellow, red, something else?
Tim: Yeah, I mean, we’ve tried to do, and this is kind of out on a shorter-term base, is try to understand, I mentioned earlier, I mentioned breadth to the mark, and how much participation, how healthy is the advance. And then think about the sentiment, has the market gone too far too fast, is maybe gotten too complacent.
Our sentiment indicators have gotten to levels where they were back in April and July, those the last two times when we had a rally. This one has been a better rally in the sense that we’ve broken above the July highs. We’re starting to see some better breadth, the number of stocks and markets making new highs, has been expanding. Things are starting to look a little bit better from an internal standpoint. But the sentiment has been stretched.
So the other benefit, usually, this time of year seasonal influences get favourable. But a big caveat was, remember what happened last year, the year-end rally didn’t happen till like the last week of the year, so you have to be careful about seasonal tendencies. But things are looking a little bit better, but I’m not ready to say we’re off to the races. I think there’s still a lot of divergences. If you look at the percentage of stocks globally and in the U.S. above their 50-day moving averages, 200-day moving averages, and also you can do the same thing with markets globally. It just that still shows a pattern of lower highs, a non-confirmation.
The top 10 stocks globally, and you can see the same thing in the S&P 500, but globally the top 10 stocks account for 12% of the market cap, which is about as high as we’ve seen since going back to the tech bubble in 2000. And that means we’re really dependent on those FANG stocks. And the top 10 stocks globally, most of those are U.S. tech-related stocks, all the familiar names. So the benefit would be, if you can get some of the breadth indicators to really confirm…
I look at, for example, the equal-weighted all country in the world, and actually can do the same thing with the equal-weighted S&P 500, or other measures that sort of take out the influence of those big stocks, you know, that would be a sign that more and more stocks are anticipating that the economic growth will be there, and that will support earnings going forward, and then that will justify the valuations. But we’re not at that point yet.
So I’m still kind of cautious here because of the sentiment getting stretched and having not had that really significant breadth confirmation, being a little cautious. But things do look a little bit better than they did, say, in August.
Meb: You mentioned sentiment a few times. How do you guys think about sentiment? Because it tends to be, for a lot of people, somewhat squishy topic. Are there ways that you guys conduct your own work? Do you use outside sentiment gauges, or do you just read “Businessweek” covers? Are you looking on Instagram? What’s the way you guys gauge sentiment?
Tim: We use different providers of sentiment. And the thing about sentiment, too, is that some indicators have worked better in the past than they do currently, things like put/call ratios, but you try to use different outside services to get sort of a consistent or composite picture of the sentiment. One service that I use a lot is the DSI, the Daily Sentiment Index. It’s still a shorter term. But what I like about that is it’s a scale of 0 to 100 to surveys of futures traders, and you can compare the sentiment in the U.S. to the sentiment in another market, and you can do the same thing with currencies and other things.
But basically, the concept is when you get really your high levels of sentiment, you know, high levels of optimism, that suggests, well, if people are saying they’re that optimistic, they probably already bought, so, you know, who’s left to really buy at that point? And then what you need to be concerned about is that you don’t want to sell necessarily when the sentiment gets high, but you want to see if you get to extreme sentiment, that’s a warning. And then when the sentiment reverses, that’s the sign that the momentum is starting to move in the other direction, that those people who had bought are getting out. So then you want to do the same thing in the other direction, watch the sentiment until it gets to extreme pessimism levels, and then start to think contrarian.
But you don’t want to buy on the high pessimism and panic. Because we saw, for example, in 2008, that wouldn’t have really been a very good idea, because the market was going to do a lot worse before I finally bought them, and then reverse. So you want to see the sentiment, beat your bottom in reverse. And then you turn your attention to the breadth indicators and some of the indicators I was talking about to say, “Well, now this advance is broadening out,” and you’ve left behind us the extreme and pessimism, and now sort of new confidence is going to drive the market higher. So again, the way to think about sentiment is go with it till it reaches an extreme and then starts to go in the other direction, and then use that as your signal.
Meb: My favourite example I love giving, and this is super long-term, and I don’t know how particularly useful it is as a trading signal, but it’s fun to look back upon it, was the AAII Sentiment, whether it’s either the bullish, bearish, or percent-allocated stocks, bonds, cash. And then the most bullish people have ever been in the history of the survey going back to the ’80s was December 1999, and the most bearish they were was in March 2009. And so at the turning points, the big ones, it’s funny to see just how accurate it can be in the opposite direction.
So looking at sort of, you know, you mentioned a few times, breadth. And I think it’s an interesting topic, because each index or market is nothing more than a composite of underlying stocks and securities. And depending how you chop them up, whether it’s value or growth, whether it’s size like large cap, small cap, whether it’s sectors, they can have a very different composition, but also a very different composition in time.
You referenced 2000, where, you know, it was my favourite bubble. I was still graduating college at the time where you had these massive internet and tech market cap just crazy weighted bubble. But a lot of other smaller stocks weren’t too bad, including value. Is there anything you can tease from the data in 2019 about whether it’s size or sectors or areas that look particularly favourable or unfavourable in the U.S.?
Tim: Well, you know, what I do with that, too, is that I have a concept that we hear often here about risk-on versus risk-off. So a number of years ago, we try to kind of do this a little more systematically. And so we went back and identified different sectors, different indexes, also even different asset classes, bonds, and currencies that have stable, positive correlations with market. And then we did the same thing on the other side of the coin with inverse correlators.
So during a healthy market, if the mark is rallying on the idea that the economy is going to come back, these what we call risk-on proxies should be outperforming the defensive risk-off proxies. So on the risk-on side of the coin, we find that the relative strength of the tech sector is the most positive correlating sector. So you’d expect that if you’re in… We see this repeatedly when the market is really ready to take off, the tech is gonna lead the way higher.
We also find that other cyclical consumer ratios, so compositive cyclical stocks, consumer stocks will tend to be risk-on. And then outside of the market, high-yield bond prices, they have the most positive correlation. Though high-yield bonds tend to be sort of a equity proxy. Crude oil is a part of our risk-on index. And then a commodity-sensitive currency, the South African rand. And then on the risk-off side of the coin we have Japanese yen, Swiss franc, long-term Treasury bond prices. And then two sectors that have really stable inverse correlations, and those are the utilities and the consumer staples.
So I find that when you’re in a healthier environment, you see utilities, consumer staples holding up well. And actually, that’s been sort of the theme over the last year, especially with utilities. That’s a sign that the market has sort of a risk-off leaning. But when you see risk-on, so what we can do is take these risks on proxies and put them into an index, and do the same thing with the risk-off proxies and compare them. So it’s what I call our risk-on risk-off ratio or RORO ratio, and then we can look to see if that ratio is confirming what the major indexes are doing, and that’s something relevant right now because the ratio has not confirmed that it has been going up. But I want to see that breakout and the upside.
And then you see sectors like tech start, and more cyclical sectors like the industrials, more commodity sectors, consumer discretionary, energy materials doing well. And then the defensive sectors like utilities and staples starting to lag. If you see that together with a broadening out the market according to a lot of the breadth indicators, where, you know, you basically treat all stocks and sectors the same, that’s a good sign.
And the other thing we can do with this is I look at the percentage of risk-on indices that are above their 50-day, 200-day moving averages. And I do the same thing with the risk-offs. And then you compare them. So you get a diffusion index. And then, you know, the 50-day version recently has gotten favourable. The 200 hasn’t confirmed.
So there’s a lot you can do with sort of trying to understand what it is that’s outperforming and underperforming to give you a sense of whether the market is really moving into a risk-on phase, which probably has something to do where the economy is going, and therefore where earnings are going, or if maybe it’s a less sustainable move that would still have risk-off sort of overriding the relative performance. So that’s kind of how I think about it.
Meb: It’s interesting this year, too, because you’ve seen certain dispersion in markets. I mean, it’s funny to look back on what happens to be in sort of the news flow and geopolitical discussion when it comes to investing in markets. I mean, a few years ago, the only thing that anyone could talk about was Greece and then Russia. I think Greek stock market went down like 80% to 90%. But very quietly, it’s up I think almost 40% this year, maybe 50%. It’s getting up there. And Russia is having a good year too.
But also, the one that I look back on pre-financial crisis that you alluded to as an asset class, and I’d like to explore now, too, is also commodities. And that was one that every investment, endowment, institution, individual advisor in the mid-2000s was hoarding into as an asset class that many had not had before. And then fast-forward 10 years later, everyone has been puking it out over the last few years. I don’t know anyone that still likes commodities anymore. But talk to me a little bit about your perspective on shiny metal, other commodities, the dark oil, everything else. Any thoughts on commodities in general?
Tim: That’s exactly right. What you said is that we actually had what’s called, what I used to call the China-driven commodity demand theme, that really sort of started around the early 2000s. And from that point on, really from 2002 to the financial crisis, and then had a sort of a final run-up in 2010, but you saw China and emerging market relative strength, material sector, commodities, Latin America, energy, crude oil, all these things would move together. And then they’d all kind of turned around again once you got to the end of that move in 2011, 2012. Yeah, I think part of it was a lot of liquidity went back into the stock market as well as the bond market.
And I mentioned commodities are generally risk-on, and the market has been pretty much on the defensive for the past year, and crude oil certainly has not been going anywhere. But if we’re gonna move back into a better economic environment, I think that would help commodities. But the one area that we’ve really liked, and I went bullish at the beginning of the year when we went too overweight on bonds, and the same day we went bullish on gold.
And what happens with gold is gold participated in the China-driven commodity demand theme, and then it came back down. But more recently, Gold has kind of taken on and sort of separated from the other commodities, because it’s taken on sort of its store of value role. Also, it’s helped by the fact that you have negative real interest rates, and that gold, you know, it’s often said, when rates are rising, gold doesn’t pay interest, so it’s at a competitive disadvantage. Well, that’s not the case if you have zero or negative interest rates.
So negative real rates, in particular, have been helpful to gold, but also, in this sort of defensive environment, gold has benefited from its tendency actually to outperform during bear markets. The past eight global bear markets, gold has been up about 5% on average, and it’s been up every time. And the other element of gold is that when you have a trade war that sort of we started hearing the middle of the year, talk about a currency wars. Well, nobody really wins a currency war because everybody is trying to weaken their currency, so no currency actually benefits except for gold, because you’re not gonna have that ability to weaken it through central bank policies.
So gold is an area that I think continues to look very good. Also, it does not look extended relative to its own history, or relative to other asset classes unlike in 1980. I think we’re quite likely gonna see gold continue to work higher until we get in a much more threatening interest rate environment, and especially with the inflation complacency, the way it is, I think you’ll probably see real rates remain very low for quite a while longer. And that should help gold probably go back and make new highs over the next couple years.
Meb: Gold is interesting because you just hinted at the end this effect of real interest rates, which, at least historically, has been a pretty strong indicator of gold outperformance. And you would think with the rates around the world, that gold would be just booming relative to a lot of these negative-yielding sovereigns. So I think it makes a lot of sense in that perspective.
There was a lot of talk briefly this summer about the yield curve and how that affects various investments. Is that something you guys have been talking much about? I imagine you got a bunch of client requests, probably midsummer, on some of that topic?
Tim: That’s right. The yield curve, I mean, not only, and it was like a lot of these trends, and you mentioned that with the raise, but now they are global in magnitude, and the yield curve had a lot of tension given to the negative economic implications of an inverted yield curve. And the fact that it inverted the most inverted curve since 1991, and I mentioned a period earlier, I mean, the curve back then started to steepen because that finally drove. And we started to see signs of that recession. The fed became very aggressive with the rate cuts. And then as a result, that started to steep in the curve. But, yeah, I think that’s been one of the concerns.
And some people say, “Well, it doesn’t matter as much because it’s caused by the long end coming down rather than the short end going up,” which is sort of the more traditional way in an inflationary environment. You see the yield curve flatten and turn inverted because short rates are moving higher. But I think what that speaks to is if the bond market is that sort of that proxy for economic growth, it really is picking up the concerns for the global economy, and you really need to have the long end start to pick up to think, okay, maybe the economy is stabilising. It’s looking better.
So that has implications for certain, you know, for the financials in particular, financials are actually a pretty good cyclical sector to pay attention to. And if the yield curve… And also, steepening helps margins of the banks in particular, but it’s also a sign of an economic recovery. So I think the yield curve is definitely something to keep paying attention to. And it just recently it started to steepen again. Still too soon to know whether this is temporary or whether this is the beginning of a more sustained move. But, yes, I’d say I would definitely pay attention to it as an indicator.
Meb: I’m gonna ask you some shorter form questions. You don’t have to answer them shorter form, but there’s sort of a shorter form in my mind as we’ve kind of worked our way around the world. We didn’t get into crypto, so I figured that would be a 2020 plus discussion.
You spent a lot of time talking to the big money institutions, what we call the real money, these guys that have foundations, pension funds, endowments, family offices that manage really significant wealth, and also advisers, too. As we kind of go into 2020, what is on everyone’s mind? And you can answer this one or two ways, either what are all these institutions worried about, or what should they be worried about as we go into the end of the year?
Tim: The term I think described is a capital preservation. And also, the fact that the industry itself is being threatened. I think there’s a pretty high level of risk aversion, I would say. And I think there’s a lot of awareness of the role of the algos here with some of these rallies, how fast they went, for example, in the January run-up, and how that’s become more of a trader’s market as opposed to an investor’s market.
And I think we see that in the, I mentioned earlier, about the flows of the market, how you’ve had a $240-billion inflow into bonds and then a $230-billion outflow from equities. And you don’t have any significant money coming back into equities. So, yeah, I’d say the general mindset is one of let’s play it defensively, let’s not over-commit and lose money here. But as I mentioned earlier, I think the risk there is that if there’s an accident ahead of us in the bond market, it may cause a lot of damage before institutions are willing to adjust for it.
I would say one other thing, though. I have heard more interest in gold as we were discussing earlier from institutions, you know, takes time for pension funds to actually go through the process of adding gold to their portfolios. But there is sort of awareness that there hasn’t been much return out there in anything over the last years, whereas gold has actually been up double digits. But I think that also reflects the idea that gold is that sort of that store of value. And when you start to get worried about where things are going, and the global economy slowing, and the U.S. potentially going into recession, you’re gonna play it safe. So that I think it’s generally the mindset that I’ve taken away from talking to clients.
Meb: You’re starting to see the numbers come down in the U.S., but the expectations certainly of many of these plans that used to always hover around 8%, they’ve started to notch down a little bit. But in a world of sub two, sub one, zero interest rates, you start to see some effects. And the biggest one that you continually see in the U.S., I think, is this stampeding into private equity is the only potential saviour, which, in my prediction, is going to be the big problem of the next decade, where I think private equities is gonna be a low performer relative to expectations. Because you guys are talking about expectations. I think that’s the big daddy that’s gonna muck up all these pension funds.
What does something that, and this may take a second for you to think about, so take your time, but I talk a lot about investment, either concepts or just general beliefs that I hold that the vast majority of our profession doesn’t, when I tweeted out about 10 the other day. Are there any beliefs that you hold or that you think are important that at least half, preferably 90%, but at least half of you think your investor contemporaries don’t agree with? Anything come to mind?
Tim: I have an answer. I don’t know whether or not you can agree or disagree. But a simple concept is that relationships change. As much as we look at history and try to understand how history repeats itself, correlations can completely flip and change. And if that happens, if relationships between data and markets or between two markets…I always use the example of the stock market and the bond market used to be.
When bond yields were going up, the stock market would down. That was back in the inflationary 1970s in particular. And that persisted throughout the ’80s. When there were signs of inflation, the market remembered how damaging the 1970s were when there was, what we used to hear, you know, whiff of inflation. And then bond yields would go up, and the stock market would go down.
And finally, you know, that continued until we got to the bubble of 2000, and we started the whole deflationary wave, which is when actually their worry was not inflation. It was deflation. And then the correlation completely flipped. And then by then, bond yields going down was considered a bad thing because it was a sign of deflation, and bond yields going up is seen as a good thing and sign of growth. And so the stock market rallies on that.
So what I think it means is that we have to be aware of and constantly watch what might possibly be changing in the current environment, what relationship might be breaking down, what data might no longer be giving us the same message it did before. And that’s sending a big challenge of doing research and understanding where the markets are going is knowing what is giving us the most useful information.
I don’t know if you can necessarily disagree with that, but I think it’s something that I hear a lot of people say, especially managers will say, “Yeah, I look at these three things. I look at this thing. Yeah, and then I look at that, and I look at that.” And that’s how they come to their conclusions in the markets. Well, we sometimes need to evolve that, especially if it’s a small list of conditions we’re looking for, influences we’re looking for, because they may lose the relevance.
Meb: I think it’s really important. You mentioned two topics that I think is really interesting. One, we used to always joke that markets are always different and will continue to surprise us. And people love writing, advisors love writing, it’s okay. We’ve seen this before. This is fully within expectations. But we always joke that what they should be writing half the time is, it’s okay. We’ve never seen this before. And, you know, that’s to be expected.
And I think the challenge for a lot of people is trying to decide, is this something that…is this time really different, or is this an actual structural change, the one we talked a lot about going back years ago was a good example, would have been how companies started distributing cash via buybacks instead of just dividends. I mean, that was a very real structural change that happened over the past few decades.
And the one that I think could be a big surprise for people that most people believe is in… We started this discussion with this, which was the correlation of stocks and bonds is not necessarily stable. And in a world where you have very low yielding bonds, most of the time, the batting average of bonds, diversifying stocks, and the bad months for bear markets is pretty good. But it’s not always. And I think that could be a scenario, not guaranteed, but where in the future at some point, if we ever have another bear market, the bonds may not help. And that I think would cause a lot of people a lot of pain, because they believe that, in general, stocks and bonds diversify.
I think that’s an accurate belief. A lot of people are very closely held to their investment beliefs, whatever they may be. Mine are very loosely held. Talk to me a little bit about… I once sat down at Ned Davis’s offices in West Coast of Florida. It’s on the West Coast side. Do I remember correctly?
Tim: Yeah, that’s correct.
Meb: Many moons ago. And I was talking to someone, I don’t think it was you, but we were having a discussion. And they said one of the books that was a big influence in the early days was Fosback’s “Stock Market Logic,” which most of our listeners have probably never heard of. But outside of y’all’s books, what other resources have been big inspirations or do you think, even currently, are wonderful resources for people that want to get a little more involved in a data-driven research that you guys focus on? Anything come to mind?
Tim: I think probably just as a general source would be the CMT Association, which oversees the CMT, Chartered Market Technician. It has quite a bit of information that you can read about. If you’re interested in modelling or the journal that they produce is a good source of articles about how to use technical analysis.
And actually, it has evolved technical analysis that used to be thought of more sort of drawing trend lines and making forecasts based on point and figure and so on, but it’s gotten a lot more quantitative, a lot more data-driven. Without naming a specific publication, I would say just generally you might want to go check out the CMT Association because I think there’s a lot of good information there that they have in their library that you can draw upon.
Meb: Certainly, I’ve been a long-time member. They have guided, not intentionally, put my career in positive directions as well. And Tim, our guest, is a former Dow Award winner. What research piece is that for? I’m trying to remember.
Tim: It’s called the quantification predicament, which is basically, this was back in the ’90s, early ’90s. It was basically kind of about sort of what NDR tries to do with data as opposed to just coming up with a viewpoint based on how you think the charts look, and how you’re drawing a trend line, and how you’re interpreting the pattern, is actually try to do this quantitatively in a more systematic way so that we don’t deceive ourselves, you know, we can be more objective in developing indicators. So that was pretty much the point of it.
Meb: For someone who’s been through a handful of cycles, I mean, you hit upon the data-driven approach to market. It’s pretty early in the evolution. What’s changed in Tim’s worldview over the past few cycles or while you’ve been at Ned Davis. Is there anything that you look back and like, “Oh my God, I can’t believe I used to believe that,” or you just say, “Hey, I’ve had a total change of heart and think about things quite a bit differently today than I do maybe in the years past?”
Tim: Well, I think, other than the sort of that correlation point that I was making earlier, back in the earlier cycles, we still have that opposite correlation between stocks and bonds. But I think that probably the one thing that I’m trying… It’s very difficult to understand what we can’t quantify or what is really…and that is things like the influence of algo trading and dark pools, and what is not included in the data we look at such as, you used to be able to be pretty confident looking at volume data, I think, is an example of what you’re asking about.
And when I see volume, you could say, normally, volume, you know, under the old Dow theory approaches, volume leads price and you look for spikes and volume and market lows. Well, trading volume is in many ways different than it used to be. It may not capture a lot of what’s really driving stock prices.
So I think that’s what I’m trying to understand as best I can is what is not captured in the data that’s driving stocks. And again, the one now, I think the big one now, is the whole algo influence on trading that tends to be sort of moving a lot of things, like the advanced decline line for example. It improved so quickly earlier this year. And was that a result of, you know, a lot of these programs that were just making everything move together, or was it really an actual sign that the market was broadening out?
And I think, as it turned out, we didn’t get confirmation from other breadth indicators. So it kind of told us there was something else going on here. Maybe we should give a little bit less influence than we might otherwise, which is another example of why it’s really good to look at a variety of indicators for confirmation and not put too much weight on any one indicator, because who knows if it’s actually start to go awry for some unexpected change in influence.
Meb: I think that’s a great point. As you look back on your career, and you can answer this one of two ways, I’ll leave it up to you, we tend to ask our guest what’s been their most memorable investment, good, bad, in between. Since you publish and write so much, you could also take it as your most memorable publication, if you do so choose. But anything come to mind?
Tim: Yeah, I’d say that the number one was in April 2009 when we went bullish on equity, went overweight on equities. First of all, we had been bearish in ’07. And then to be able to kind of turn that around in April 2009, which was right after the bottom was in March 2009, yeah, I’d say that’s probably the big one.
Meb: If you could pick just one, this is gonna be hard, what would be your favourite indicator? I think I would have to go with 200-day moving average for me, but any favourites?
Tim: I can’t really disagree too much of that. Yeah, I mean, go with a 200-day. It’s a good one. And I think it’s actually the direction of the 200-day which is a good one, because it takes… It’s a slow indicator. And it’s gonna be late. I talked about this earlier, markets and stocks, above their moving averages. But the problem with that is you can kind of get above it and then sort of just go back and forth around it. And so you get a lot of noise sometimes. But, yeah, I think the 200-day is a good one.
I can’t think of any other specific indicator. I mean, I’ve always thought you don’t want to be careful about having pretty too much emphasis on any one indicator, kind of to the point I mentioned earlier that something can enter the picture. But if it’s going to be an indicator, it should definitely be a price-based indicator, because price is what it is. The price of the stock is the price of the stock, and it’s not going to be…your conclusion will be, well, over 200 days, yeah, it’s going up, so it’s going up, you know it is.
Meb: I like to credit you guys, it’s either you or Ned or someone in your organisation, and if not, I give you guys fake credit for it, but if even just been a quote in your book, but it said something along the line, “Price is unique in that it’s the only indicator that can’t diverge from itself.” Do you say that, or do I just attribute it to you?
Tim: I don’t think I said that, but I know it’s something…
Meb: Market maxim.
Tim: Right, right. It’s something Ned has said, or we’ve kind of as a shop have sort of said.
Meb: Okay. Well, I give you guys credit for it.
Tim: Yeah, that’s good.
Meb: So to wrap things up, a lot of people, I think, struggle with sort of noise and indicator exhaustion, meaning, like, most of these advisors we talk to, or even institutions, they’ll sort of latch on to whatever the indicator topic du jour is. So everyone is talking about yield curve this summer. They’ll forget about it and move on to something else.
What sort of advice, when you’re talking to these big institutions, do you give them, or if you’re maybe not giving them advice, what would you give them or general takeaways on how to put this all together? So, if someone’s doing, you know, their asset allocation, and they say, “Look, I want to implement some of these tools and ideas, I just don’t know how. How should I go about thinking about building a worldview or framework to actually put this into practice?”
Tim: Yeah, I mean, I think that you want to start with, kind of as I mentioned earlier, start with price-based indicators, a diversity of kinds of indicators, but also a diversity of time frames. You don’t want to have everything based on the 200-day or everything based on the 50-day. You want to have different time frames. Look for a variety so that you can come to the conclusion. The way I often think about it is the more confirmation you have, the more conviction you can have in your view, and therefore the more decisive you can be in your allocation.
And the way to have that confirmation is to have both internal indicators that should start to give you a consistent picture if things are starting to show more conviction. And then do that on the other side with external or non-price indicators, as I said, and then you put those together. So half internal, half non-price, half external. And then a lot of times, it’s going to be a very mixed kind of neutral picture.
And that’s what markets do a lot. They don’t sometimes you get into these trading ranges where nothing really goes anywhere. And you want to understand if that’s the environment you’re in, but you also want to know when you move out of that, then you should get the internals will start to give you a consistent bullish picture, and then the external or non-price factors should also tell you whether your risk is diminishing and you’re in a more healthier environment. So, yeah, that’s how I would approach it. That’s the way we’ve done it. And it’s always, I think, it’s been a good process over the years for understanding where things are going.
Meb: Simple answers. Just used Fab Five and Big Mo. Listeners, that are some multi-factor models, if I remember correctly, Ned Davis used. Tim, it’s been a lot of fun. Where do listeners follow if they want to follow all your writings, all your thoughts, what’s going on? How do they best follow what you’re up to?
Tim: Well, we have a number of services you can go. You can start by going to ndr.com, and that should maybe point you in the right direction, you know, for most of our…what we do is we’re institutional clients. We have an advisory service, which you might want to look at. But maybe start with the website. And I think that could maybe point you in the right direction.
Meb: Very cool. Tim, this has been a lot of fun. Thanks for joining us today.
Tim: All right, Meb. I enjoyed it. Thanks a lot.
Meb: Listeners, we’ll post show note links at mebfaber.com/podcast. Shoot us questions, comments, firstname.lastname@example.org. Leave us review. We’d love to read them. Subscribe to the show on iTunes, anywhere else good podcasts are sold. Thanks for listening, friends, and good investing.