Stock Exchange: Can Humans Compete with High Frequency Traders?

Many individual investors have been frustrated by the growing prominence of High Frequency Trading. Complicated algorithms can process new information and react in fractions of a second. It sounds intimidating, and in some sense, it is. Individual Investors would be poorly suited for direct competition.

Instead, stick to what the market is giving you. The connections made by these programs are often spurious – totally unrelated to the fundamentals of a given business. This is intentional. After all, they’re after a quick buck rather than a long-term investment.

For that reason, a stock being walloped for frivolous story in the 24-hour news cycle may present an attractive buying opportunity. It all comes down to the individual investor’s process and commitment to their goals.

To help give us perspective this week, we’re bringing in earnings expert Brian Gilmartin. Since 1995, Brian has managed Trinity Asset Management. You can find his regular writings on Fundamentalis.

This Week—Holmes sniffs out a deal

It can be tempting to make a trading decision based on a glance at its recent chart. Unfortunately, a stock that has underperformed in recent days might be providing a big opportunity. Holmes uses a mix of advanced trading techniques and technical analysis to avoid significant drawdowns. When he chases after a down stock, it’s because he sees some serious upside. Let’s see what he’s up to this week:


Holmes: This week I’m buying  Jack-in-the-Box (Jack) a restaurant chain in the U.S. (95.98).

It’s not easy finding stocks that fit the exact criteria I’m looking for. I try to find stocks that have been trending higher, then have broken down below that trend, and have started to base a for reasonable period of time.

This gives me a good entry with limited downside risk and upside gains that may get back to the previous levels before the most recent debacle. I like risk/reward ratios of 2:1 or better.  With Jack, my downside is 93.70(Stop), my upside is 106, risking $2.28 to make $10.02. Woof Woof!

Brian: a comp miss sent the stock down to its 200-day moving average after February ’17 comp’s for JACK as the industry that the “low-end” consumer has taken a breather. Forward earnings and revenue estimates are a little weaker following the February ’17 miss, but JACK is trading at 20(x) expected ’17 earnings for expected 17% growth. Even if EPS growth slips to 15% or even low teens the stock is cheap on a PEG (P.E to growth) basis.

Holmes: Glad to hear you approve! Jeff is usually a bit harsher.

Brian: It’s not a bad pick, depending on how long you’re holding onto this one.

Holmes: My usual target is about 4-6 weeks, though I wouldn’t hesitate to unload this if another downturn became apparent.

Brian: Solid reasoning – for a talking dog, at least…


Oscar: My big pick this week is the China Large-Cap ETF (FXI).

We’re in the midst of March Madness, so let’s call this pick a rebound. Not in the classic sense: that’s better suited for FXI’s behavior through early January.

Still, I made this my pick on 2/9 and hung with it for a couple of weeks. Now that we’ve seen another drop, I’m ready to jump off the bleachers and get back in the game.

Brian: BRIC’s and Emerging Markets have traded well since the bottom in Q1 ’16. FXI is the safer asset class in a crowded China ETF market. As someone who was never a fan of China as a strategic or even tactical asset allocation recipient, Emerging Market ETF’s might be a better risk / reward. The ETF is scraping along its 200-day moving average.

Oscar: So, you like this one too?

Brian: I’ve always thought China was like playing the US stock market in the late 1800’s – it is the Wild Wild West of outcomes, as a Communist country tries to centrally plan a free-market economy.

Oscar: It’s a risk I’m willing to take!



Continental Resources (CLR) is my next long position.

The decline here has been sustained and significant, which I find attractive. At $43.22, there is definitely potential for the stock to improve near previous highs above the $55 mark. I could hang onto this one for months.

Brian: Continental took a beating on Wednesday as crude oil fell 5%. The Energy sector is a battleground sector as crude gyrates around $50 per barrel and CLR is leveraged to the price of crude. The stock is oversold and trading below its 200-day moving average.

Felix: I agree the stock is oversold, but I don’t like the sound of that “battleground.” How do I know when I’ve hit a proper valuation here?

Brian: Tell me what crude oil will do and you can figure out what CLR will do.

Felix: Uh oh.


Athena: I understand my methods are often met with skepticism. That’s why I like to pause now and then and reflect on some small successes. Let’s review my recent foray into Advanced Micro Devices (AMD).

I recommended this stock back on 2/9/17, just after a huge spike in price. Put lightly, this was not my most-loved pick. That was fine by me. Because I had the right time frame in mind, I was able to collect a tidy sum and close out this position near the end of the month.

Brian: A semiconductor company that was a serial capital destroyer for most of its life and long an “also-ran” to Intel, AMD had an impressive string of “earnings beats” and raises in 2016. On the other hand, the valuation is stretched with the Street looking for $0.07 and $0.26 thus AMD is trading at 50(x) next year’s earnings.

Athena: Would you say something like this might be due for another pop in the near future? How hot is this trend?

Brian: The semiconductor space looks good both technically and fundamentally, and AMD is a resurgent laggard in the space.

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert or stock.


If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).


The growing establishment of High Frequency Trading algorithms has changed the investment landscape. However, that doesn’t spell doom for the individual investor. Overreactions to trivial matters, like a POTUS tweet, can actually create bargain opportunities. Keep these ideas in mind:

  • Do not compete directly by trying to react more quickly to news.
  • Find a method that differs in time frame.
  • Do not use stops that become limit orders.  A random move can take you out of a position at a poor price.
  • If possible, use the HFT algorithms to your advantage.  If a stock is solid, consider buying dips by having some standing buy orders.

Take what the market is giving you.

Stock Exchange: How to Trade an Overbought Market

For the last three weeks, the term “overbought” has been frequently used to describe the overall market as well as many specific stocks. What does this really mean?

It has a dangerous sound, and that is indeed the common message. A stock, or a sector, or the overall market has rallied more than expected over an extended time.  What does that mean for traders?  Or for investors?

It is an excellent question for our experts.


Our last Stock Exchange focused on trading sector rotations, Oscar’s regular mission. There was an excellent discussion. It provides special value when readers engage with our crew of “technical analysts.”

To encourage this discussion and diversity we will have some visiting experts for the next two weeks:

  • Brian Gilmartin of Trinity Asset Management, a leading expert on corporate earnings and fundamental analysis reported at his blog, Fundamentalis.
  • Robert Marcin of Defiance Asset Management. Bob is an oft-quoted legend, a deep value manager, and a curmudgeon par excellence.  While I often do not agree with him, I always listen carefully in our discussions on Scutify.  You will enjoy the banter and can keep your own scorecard.

Today’s Theme

An extended stock move is often described as overbought or oversold.  For most observers, an overbought stock or market is poised for a selloffSome technical analysts measure this in terms of relative strength measures (RSI).

How important is this warning sign?

Pension Partners warns of an “optical illusion,” citing multiple prior examples and then considering the current NASDAQ 100.  Look at the interesting evidence in the entire article leading to this conclusion:

If one is going to predict anything based on extreme overbought levels (and I would advise against doing so), it would be further gains. I realize that doesn’t conform to the prevailing narrative of “overbought is always bearish,” but the truth in markets rarely does.

Chris Ciovacco has a nice chart pack of prior overbought conditions.  The mixed results are a warning to anyone thinking about trading on this approach – despite the recent somber warnings from the NYSE floor via Art Cashin.

What do our Stock Exchange experts think about overbought markets?  We will hear them out and, as usual, I will conclude with a brief observation about the key points. I will begin with Athena, who specializes in short-term momentum trades.

This Week—Trading an Overbought Market.


My approach is to find winners and ride the gains.  Fundamental analysts are skeptical of momentum, but trend-following is one of the strongest historical methods.  The “trend is your friend” is not just a cliché. Principal Financial Group (PFG) is a great example; it has been on tear for a month. That is enough to put it on my radar. The sharp increases may be off-putting to some, but they are mistaken.  The trend line is strong. I’m looking for an increase of 2-3% over the next 2-4 weeks.

J:  Are you concerned that the stock might be overbought?

A: In my evaluation methods, the price action is a sign of strength.

J:  At what point would a major gain worry you?

A:  I like stocks that are showing strength, but I am ruthless when it comes time to get out.

J: So, you do not worry about overbought conditions on the entry?

A:  Some of the best trades come when an “overbought” stock gets more overbought.

J:  For a welcome change, your choice is also attractive on a value basis.

A:  Value?  What does that mean?

J:  You can see it in the fine chart from F.A.S.T graphs.  Let us turn to Felix, who also follows a momentum strategy.


I will once again begin with my responses to reader votes for the favorites list.

My list provides rankings within each zone, as well as the basics about buy, hold, and sell.  The list includes the most recent reader questions as well as former requests where my rating has moved.

J: AMD is still on top?

F: It leads the reader list, but not my own.

J:  I have had some questions about that.  Readers want to know your own top picks.

F: If I talked about that here, I would be revealing what I recommend for your clients.

J: That is a problem.  I want to be helpful to readers, but emphasizing that it should be a start for their own research. We did have a couple of questions last week.  What do you think about reader Jim Irving’s questions about CRX and CXRX, which he identifies as debt-laden drug companies?

F:  He is right to be concerned.  CRX is on my sell list and CXRX is a very weak hold.  I wish that more readers would submit such questions.  I need my incentive bonus to kick in.

J:  Do you have anything fresh for us this week?

F:  Nothing new, since my focus is longer than the others.  Let me take up a holding that some are worried about, NVIDIA Corporation (NVDA).  This was one of my long-term picks in early December of 2016. We’ve had two major spikes in price since then, followed by decline in February. Those with a short-term mindset are worried.  Since I’m interested in holding out for the long haul, I haven’t been preoccupied by the dips. I’m up about 10% here after nearly a full quarter in the position – nothing to sneeze at!

J: Would you call this an “overbought” stock?

F:  Not on my time frame.  The definition of overbought should adjust to your investment purpose.



We haven’t hit March Madness yet, so I am mostly thinking spring training.  For many teams the question is whether to play big ball or small ball. In small ball baseball, players trade the long odds on huge plays in favor of more manageable base hits.  Sometimes the small ball approach generates more runs and winning baseball.

On that theme, I’m looking closely at the Russell 2000 Index (IWM). Small caps and large caps performed very differently in 2016. Large caps were generally in favor due to their relatively low volatility and risk. However, I see potential for growth in the small caps over the next several weeks. From the looks of the chart, I’m probably not alone!


J:  Are you worried that small cap stocks might be overbought?

O: What I see is strength?

J:  What if the small-cap sector fades?

O:  As I always do, I’ll dump it and move to what is working.  I always like to have my money working.

J:  Does that mean that you are getting ready for March Madness?

O:  That is where a longshot can really work.

J:  I suppose we are going to hear more on that subject.

O:  You can count on it!

J:  Do you have your updated sector ratings?

O: Yes.  I monitor about 40 sectors and hold positions in the top three.  $IWM is a new holding.  It is not on the list because no readers asked about it.



This week I’m buying YELP, an internet content & information provider in the U.S. (34.66)

Although it traded at 97 in 2014, I have no illusions that is going back there. Instead I like this stock because it’s showing some resilience at 32.5 level. Trading down to 32.5 in late October this stock rebounded all the way 42.5 before getting pounded again down towards the 32.5 price, BUT, it didn’t get there before turning up. So now we have a stop, (32.5), and a price target 42, with a current price of 34.66, I like the risk/reward this setup provides. Plus, I like the name, it reminds me of my pack when I was a young pup.

J:  Are you worried about overbought stocks.

H:  Never!  I let others chase the recent winners.  I find strong stocks experiencing a temporary setback.  I don’t need to worry about “overbought” market conditions.


The term “overbought” can mean many different things.  Effective trading systems use recent trends and technical indicators in quite different ways.  No single method has a monopoly on success.  Drawing upon expert systems, let’s highlight three key conclusions.

  1. Overbought need not spell danger. Overbought stocks and sectors often get even more overbought.  This might even be the best part of the move, augmented by short covering.
  2. You must gauge your reaction and stops to your price target, loss tolerance, and time frame.
  3. Your system must fit your trading personality, as illustrated by our four models.

If you like selling the rips and buying the dips, do not take a momentum approach.  Check out our post on dip-buying.  If you are contrarian and flexible, consider this week’s advice about various ways to deal with momentum.

We welcome comments, suggestions, and followers for each character.  Even Jeff.  I try to have fun once a week in writing this, and I hope you get a chuckle or two from reading it. Here is how to join in.

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.


If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Getting Updates

We have a new (free) service to subscribers to our Felix/Oscar update list.  You can suggest three favorite stocks and sectors.  We report regularly on the “favorite fifteen” in each category– stocks and sectors—as determined by readers.  Sign up with email to “etf at newarc dot com”.  Suggestions and comments are welcome.  In the tables below, green is a “buy,” yellow a “hold,” and red a “sell.”  Each category represents about 1/3 of the underlying universe.  Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Weighing the Week Ahead: Have Stock Prices Lost Touch with Reality?

It is a big week for economic data and the first address to Congress from the new President. Most of the punditry is engaged in a collective head-shake about overbought conditions. Even if the data flow remains strong, pundits will be asking:

Have stock prices lost touch with reality?


Personal Notes

I always try to publish for Sunday morning, which is convenient for most readers. Occasionally circumstances delay me. Sorry about this weekend.

On a second front, a reader thought he spotted me at a political rally. Readers know that I emphasize political agnosticism in investing. Like most of you, I have opinions, but try to keep them separated from our decisions. With that in mind, I have an alibi for this occasion!

Last Week

Last week the economic news was mostly positive, and stocks responded.

Theme Recap

In my last WTWA I predicted a discussion about Trump policies and the business cycle. This was partially correct, but the prevailing theme – by a widespread margin – emphasized the likely delays in key economic policies. That will be a transition point for the week ahead.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes yet another record close based on the week’s gain of 0.7%.

Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post for several more charts providing long-term perspective.

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something very positive. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

This week’s news was mostly positive.

The Good


The Bad

  • Hotel occupancy softened over the last few weeks (Calculated Risk).
  • New home sales missed expectations. The prior three months were all revised lower. While sales were up 5.5% year-over-year, the comparison months were among the weakest. Calculated Risk notes that these were the first months after mortgage rates moved higher and provides analysis and this key chart.

  • European tourism interest in America is down 12% after the travel ban. (Forbes).

The Ugly

Russia may have interfered with the Brexit vote say UK officials. Jake Kanter and Adam Bienkov have the story at Business Insider.


The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to EconompicData, for an important and careful analysis of the effect of rising interest rates on bond investors.

The problem is that the debate over the Fed and interest rates became political. To maintain consistency, many argue that higher rates will be good for bond investors. Here is Jake’s summary of the problem:

I’ve read too many posts / articles that outline why a rise in rates is good for long-term bond investors (as that would allow reinvestment at higher rates). While this can be true depending on the duration of bonds owned and/or for nominal returns over an extended period of time, it is certainly not true over shorter periods of time and absolutely not true for an investor in most real return scenarios… even over very long periods of time.

There are a range of possible assumptions and consideration of each. Here is a key illustrative chart:

To summarize a great post – which bond investors should read carefully – higher rates will be great for future bond investors, but painful for those with current holdings.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have very big week for economic data, with all of the big reports except the employment situation.

The “A” List

  • ISM index (W). Important for both concurrent and leading qualities. Strength continuing?
  • Auto sales (W). More gains from a key sector or “peak auto?”
  • Consumer confidence (T). Will the great strength continue?
  • Personal income and spending (W). January data, but a very important business cycle series.
  • Fed beige book (W). With the Fed resuming a role as a key worry, there will be extra attention.
  • Initial jobless claims (Th). How long can the amazing strength continue?

The “B” List

  • ISM services index (F). Continuing strength? More important than manufacturing, but harder to interpret.
  • GDP Q4 (T). The second estimate includes more data, but little change is expected.
  • Durable goods (M). January data in a volatile series, but progress is needed.
  • Pending home sales (M). Not as important as new construction, but a good read on the market.
  • Chicago PMI (T). Best of the regional surveys is a little preview of the national ISM report the next day.
  • Construction spending (W). Big rebound expected in the important but volatile series.
  • Crude inventories (Th). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.


President Trump’s first Address to Congress on Tuesday night will command attention in many ways. Most importantly for our purposes will be hints about legislative priorities and the Congressional reaction. Insider tip: Watch for things that get applause from both sides of the aisle.

Next Week’s Theme


The punditry, locked into a mindset about valuations, Trump policies, Fed significance, and daily preoccupation with what could go wrong is engaged in a collective head shake. Isn’t it obvious that many of the Trump policies will be delayed? Won’t this derail the “Trump Rally?”

The commentary increasingly expresses amazement, wondering:

Have Stock Prices Disconnected from Reality?

On one side, those who date the rally from the day of the election infer cause and effect. Anything that damages the prospects for tax and regulatory relief also damages the bullish story.

Another group notes that the market, after an extended period of strength is “overbought.”

An increasing number of observers is questioning whether Trump policies are actually the basis for the increase in stock prices.

If these policies are crucial, Tuesday night’s Presidential Address to Congress is definitely the key moment of the week – regardless of economic data.

What does this mean for investors? As usual, I’ll have a few ideas of my own in today’s “Final Thought”.

Quant Corner

We follow some regular great sources and the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot



The Featured Sources:


Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment. (see below).

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The World Markets Weekend Update (and much more).

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed.

Georg Vrba: The Business Cycle Indicator and much more.Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. His interpretation suggests the probability creeping higher, but still after nine months.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. His most recent post notes that the expected growth rate in S&P earnings is now 8.41% — the highest level since October, 2014.

The legal Marijuana business will create nearly 300,000 jobs by 2020.


How to Use WTWA (especially important for new readers)

In this series, I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have eight different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)


Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and the top sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our four technical experts, and some rebuttal from a fundamental analyst (usually me). We try to have fun, but there are always fresh ideas. Last week the focus was on sector rotation strategies, with a recent example from Oscar.

Top Trading Advice


Brett Steenbarger explains how knowledge is part of trading. He makes a powerful analogy between traders that can see both the macro and micro pictures and a quarterback who sees the entire field. His work always helps traders discover both what they should know, and how to learn it. While this was my favorite for the week, the daily posts should all be on the trader’s must-read list.

The early T-Wops (a negative Presidential tweet) had a negative impact on stocks. Traders learned this, of course, and the high-frequency algorithms did automated tracking. As often happens, once everyone catches on, things change. The WSJ shows that a Negative Tweet may not crush a stock

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Warren Buffett’s annual letter to his investors. It is full of wit and humor – and plenty of great insights. You can learn about tax policy, accounting issues, stock buybacks, and Mr. Buffett’s ten-year bet where he took the overall market versus hedge funds.

Stock Ideas


Mr. Buffett’s dividend stocks versus the “dogs of the dow.” Jon C. Ogg crunches the numbers.

Big biotech? Battered down, but with good earnings and cash flow. Some of the companies also have a pipeline. Check out some large cap choices.


Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is the post from Dan Danford. He explains the difference between excellent but general advice from experts and advice specific to your circumstances. Keep this in mind when reading the Warren Buffett letter. Here is a key quote:

Those experts don’t know a thing about you or your situation. They don’t know your age, health, marital status or personality quirks. They don’t know where you live or how much your house cost. They don’t know how much you spend on groceries or hobbies, or that you were forced into early retirement by an ungrateful employer. They know none of this. Nada.


Seeking Alpha Editor Gil Weinreich’s strong series is ostensibly aimed at financial advisors – a must-read for them. It also attracts many DIY investors. The zesty topic of the week started with an explanation from a noted writer and advisor, David Merkel, on why investors need good advice. I strongly agree with David, but I realize that some investors enjoy doing the work to maintain a successful program. (Is that you? My (free) short paper on the top investor pitfalls is a good test of whether you can successfully fly solo. Send a request to main at newarc dot com).


Watch out for…


Rising interest rates. In a riff on this week’s Silver Bullet analysis, Davidson (via Todd Sullivan) explains some key fundamentals about rates, the yield curve and the Fed. It is another myth-busting analysis.


Final Thoughts


How the punditry interprets the current market depends on how one defines base valuations and expectancy.

  • Stock values are attractive
    • Emphasis on earnings expectations and forecasts
    • Belief in relative valuations – comparing stock expected performance, with bonds, real estate, gold, etc.
    • Confidence that a recession is not imminent.
  • Stocks are over-valued
    • Emphasis on trailing earnings
    • Analysis based partially on 19th century data
    • Belief that valuation is absolute. A sector’s value is independent of the alternatives
    • Focus on headline risk – uncertainty, world events, etc.

The result?

Most people choose the over-valued path. It is the conventional wisdom in the media. Even the bullish pundits choke out a statement that stocks are “reasonably valued.” This world view requires some explanation of why the stock rally continues. The explanation has changed over time —

  • Stocks are overvalued and a crash is likely.
  • A crash might not happen, but returns over the next five, ten, twelve years will be lower.
  • Valuation is not a good method of market timing, and who knows when the “half-cycle” will end?
  • Stock strength is due to extraordinary Fed policy, providing liquidity that banks or the plunge protection team use to buy stocks. It will end with the end of QE, which probably will never happen.
  • The end of QE merely shifted focus to Europe, where the ECB has taken over the money printing.
  • The current rally is based upon Trump promises, which will never come to pass and might not even work.

Investment Conclusion

I hope most will notice that the forward valuation approach and the recession data I report weekly is a simple explanation. The current market is what we would expect. The Republican victory had increased small business confidence, but is not the main driver of stock prices.

The prevailing explanation was wrong-footed at the start and has remained so. Like bad science, it has not explained anything, so it must be continually re-invented.

It is really not complicated. There will be a time to become cautious. Meanwhile, mid to late- stage cyclical stocks, financials, homebuilders, and technology remain attractive.