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Positions, Valuations, And Cycles. All At Challenging Extremes.

Positions, Valuations, And Cycles. All At Challenging Extremes.

Be fearful when others are greedy and greedy when others are fearful.” Warren Buffett

I believe that the highest probability bet you can make in your investment strategy is that human nature will remain a constant for the foreseeable future. For my book “Predicting the Markets of Tomorrow”, I analyzed nearly 200 years of data. Historically, we have always seen reversion to the mean.” Jim O’Shaughnessy.

The chart above shows the sum of net futures positions in 3 key safe haven assets. Gold, US Treasuries, and VIX (options hedging vehicle for the S&P 500). This composite is a broad measure of demand for investment safety assets. Currently positions show that risk management across all three of these safety assets is now at a rare and extreme level of abandonment.

These are non-commercial futures positions which tend to work in the short term, but then always mean revert to zero. The short term conviction is that nothing could go wrong with buying US equities has NEVER been higher. Usually, this sows the seeds of its own destruction as at some stage everyone who could take a position expressing this bias already has. Then the stage is set for mean reversion and position closing of net short safe haven asset positions.

These positions clearly represent an extreme consensus on how little risk management is needed at the current time, and clearly invoke the 2 quotes above.

Long term strategy would suggest a contrarian imperative for some caution and a greater than usual need for risk management to be in place for investment strategy, but let’s check 2 other key measures, valuation and cycles.


The chart below shows the S&P 500 relative to earnings since 2011. The debt explosion over this period has clearly contributed to an earnings boom and last year’s tax reform bill created the biggest boom of all. Yet the S&P 500 has been far outpacing its own earnings by nearly a factor of 2.

Buybacks are a key element in outperformance relative to earnings and this year buybacks will break all previous records as shown in a recent note. However, it should also be highlighted  that revenue growth has only been at 14% of the earnings growth.

Revenue metrics, in many ways the most reliable metric, are therefore extremely challenging. Price/Sales for the S&P 500 has already eclipsed the 2000 highs but this measure is dominated by the big cap stocks. On this occasion, in addition, the median Price/Sales has broken far above 2000 levels.

Valuation does not tell us much about near term expected performance as expensive can get more expensive. However, it does correlate very well with performance over 5 to 10 years.

The above chart shows the clear correlation between valuation and expected return over 10 years. 7 different metrics were explored in the link above to calculate expected returns, but they all produced similar conclusions.

Right now the expected 10 year return is slightly below zero!


Perhaps the extremes mentioned above are related to longest ever cycle of quarterly accelerating YOY GDP growth just completed. 8 Quarters in a row!

The weakness of valuation as a metric is timing, because valuation is not a market catalyst. Cycles are a market catalyst. When the cycles are up valuation and a host of other problems do not typically matter. When cycles turn down they do matter.

This has been rigorously tested at Investment Research Firm  Hedgeye, who accurately called the 2017 Global Synchronized Recovery, and the 2018 Global Divergence between the US and international stocks, shown in a recent note.

Hedgeye currently anticipates that in the next 4 quarters the US, including the current quarter, that growth will be declining for the first time in over 8 quarters.


If we put together the current positions, valuation, and cycle outlook, with the words of wisdom from Warren Buffet and Jim O’Shaughnessy, then this is clearly a moment in time when it is important not to abandon risk management as seems to be the majority sentiment as indicated above. Indeed, quite the opposite. Risk management has rarely been more urgent and important.

There are many additional indicators that suggest the up cycle is mature. The yield curve has continued to flatten, as discussed before, and this year the Wiltshire 5000 index is showing major negative divergence, which was a significant signal at previous major equity highs.

Best Practice is a matter of your Best Interest.

Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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