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Wall Street’s Finest are Starting to Get Bearish. Should we be Paying Attention?

By: John Del Vecchio

Talk about mixed signals… which, of course, is itself a solid indication that things are getting harder in the market.

The pros and the eggheads are getting cautious. The average individual investor is not.

How will the tension resolve?

Well, investment banks are getting bearish. Should we accord these Masters of the Universe any special attention?

Under most circumstances, the answer is, “NO!!!”

Wall Street firms are notorious for picking their clients’ pockets. That’s how Masters of the Universe fund their fancy vacations, private jets, elite schools, and tony estates: by taking the opposite side of client trades.

But, sure, it’s interesting that Goldman Sachs recently warned investors of lower returns ahead.

And, while the “great vampire squid” isn’t calling for a nasty bear market, it is approaching stocks with caution.

Rather than just accept its conclusion, though, I’ve reviewed my own metrics to see where we are and what we should do about it.

Let’s start here: Valuations are rich.

I like to look at market valuation relative to revenue. And we’re in uncharted territory here, an all-time record.

The S&P 500 Index is priced at 2.63 times its median price-to-sales ratio. Back in the heady days of the dot-com bubble, we hit about 1.8 times. And it went as low as 0.8 times in early 2009. (It’s easy to see now, but that’s a screaming buy.)

Let’s take a look at how individual investors have allocated their portfolios. The portion dedicated to stocks isn’t at record levels. But it’s close.

At 70%, we’re (un)comfortably are in the danger zone. And cash levels are at 16%, down from 45% at the beginning of the bull market.

At the same time, consumer confidence is skyrocketing.

Professional investors, meanwhile, are 85% invested in stocks, which is the functional equivalent of “all in.” They’re way too optimistic, too.

And let’s not forget that investors of all stripes are leveraged to the gills.

OK, how about the macro picture? Well, the Federal Reserve Bank of New York recently raised its measure of the probability of a recession to 15%.

That’s still “low” – it was 40% prior to the Global Financial Crisis/Great Recession. But it’s as high as it’s been in 10 years.

“Direction” is the real key: The New York Fed’s recession meter has been trending up for a while…

When everyone’s feeling flush and willing to spend, I hide my dough in a coffee can and bury it out in the backyard. The time to get the best deals is when everyone’s fearful.

But we’re still very far from fearful.

This complacency is a function of the fact that interest rates have been so low for so long. Interest rates are rising, and we’re starting to see smaller, “growth” stocks underperform.

And we could be in for a particularly volatile earnings season, as investors look to justify their holdings in the face of updated operating and financial numbers. At the very least, companies carrying large debt loads will see some cash flow eaten up by higher interest costs.

This combination of rich equity valuations and overly optimistic sentiment has been suggesting lower stock returns ahead for years. And still we rise.

So, what to do?

I’m going to keep my eyes on one trusty indicator, the 200-day moving average.

Since 1929, returns are nearly six times greater when we’re trading above the 200-day moving average of stock prices. And stocks are barely positive when the market is below the 200-day moving average.

So, a strategy built around investing when the market is above the 200-day moving average trumps a buy-and-hold approach.

A break of the 200-day moving average could signal that it’s time to get defensive. That’s when I’ll start to cut risk.

Unless the stock market crashes, odds are extremely high we’ll cross the 200-day moving average before any nasty bear market occurs.

It’s important to recognize the risks in the market right now.

But it’s equally important to not overreact.

The 200-day moving average helps me take emotion out of the equation. It’s how I let “price” tell me when it’s time to move to the sidelines.

It’s how I sleep at night amid crazy valuations and rising volatility…

-Originally appeared in the Rich Investor.

Are Rich Investors About to Get Crushed?

By John Del Vecchio

Dear JOHN,

No, I’m not talking about you, Rich Investor readers. I’m talking about individuals with huge stock positions.

These folks are neck-deep in the market. And while that might read as “confidence” to some, to me it reads “the other shoe is going to drop.”

We’re quickly closing in on the longest bull market in history, and it’s been a great ride.

Unfortunately, with investors and speculators leaning so heavily to one side, it could get nasty when the worm turns.

Merrill Lynch recent published a report indicating that its wealthiest clients’ cash positions as a percentage of their assets under management are at a low for this cycle.

Private clients (aka rich folks) hold their lowest cash position since just before the financial crisis.

You know, the one that turned a lot of 401(k)s into 201(k)s. Then, when the market bottomed, investors were flush with cash.

At exactly the wrong time.

Given their track record, I would consider private-client cash positions to be a contrary indicator.

That means it’s time to get cautious.

Since cash positions are at lows for the cycle, that means investors are, well, fully invested.

There’s little fresh capital waiting in the wings to buy stocks and boost prices. Everyone’s loaded to the gills.

But here’s where it gets even more disconcerting…

The beta, or the “juice” of their portfolios, has revisited the peak for this cycle and is at a much higher level than just before the 2008 crash.

A beta over 1.0 means that a portfolio is likely to make disproportionately large moves relative to the market.

Back in 2008, the beta of private clients’ top 20 stock holdings stood at about 0.85. Now it’s over 1.0.

That means you can expect losses to be magnified.

Additionally, everyone owns the same stocks because of substantial inflows into market index funds.

That means there will be nowhere to hide when the reckoning comes.

Market valuations are stretched. Volatility is low. Investors are fully loaded into aggressive stock positions. Now’s not the time to have your head in the sand, even if you like the view.

Good luck out there,

As appeared in the rich investor

LaCrock of Shit

By John Del Vecchio, Editor, Hidden Profits

Last week, National Beverage (Nasdaq: FIZZ) shocked the market by announcing it received a Securities and Exchange Commission (SEC) inquiry into a couple of “unique” financial metrics the company uses to measure sales performance.

National Beverage produces LaCroix seltzer water, the favored drink of Millennials and “influencers” the world over. The stock has been on fire as fizzy water gains share on traditional soda companies.

When the government asks for information, I find it wise to give it to them.

National Beverage refused, and the stock price sprung a leak.

This isn’t some random government meddling. The company’s actions raise serious concern.

On the surface, it’s a blazing hot market – which means any sign that growth may be slowing or unable to meet future expectations could send the stock into a tailspin.

Trust me, I know of which I speak.

I’ve spent the last 20 years focused on financial statement analysis and catching aggressive management teams with their hands in the cookie jar. The No. 1 red flag is when management messes around with revenue recognition.


Well, a modern company’s entire financial model flows from revenue on down. Revenue impacts profit margins, cash flow, and the strength of the balance sheet. When business is doing well and customers are eager for more product, there’s no incentive on the part of management to plays games with the top line.

Why mess with success?

That mostly happens when there’s a bump in the road and management isn’t open and honest about it.

That’s when they make stuff up.

And, to be clear, LaCroix’s metrics are made up. The company uses a figure called “velocity per outlet” and another one called “velocity per capita” to measure sales performance.

No one outside of the company knows what to do with those metrics.

That’s a problem, and it’s nothing new.

It probably won’t surprise you that companies do it all the time. The sweet spot for sour numbers is in the reporting of non-GAAP financial performance. GAAP is the acronym for “Generally Accepted Accounting Principles – you know, the legitimate stuff.

When it comes to non-GAAP figures, there’s a lot of leeway for management to create new metrics and, in doing so, report earnings in a sparkling light.

Warren Buffett calls these metrics “earnings before the bad stuff.”

FIZZ’s numbers might not be fraudulent. But management touted them enough to pique the curiosity of the SEC. When asked about what these velocity metrics measure, the company refused to answer and called them “secretive.”

Um, OK. We’re free to call them “bullshit.”

While “velocity per outlet” may look great on paper, using it in the first place is a solid red flag.

The stock has now recovered most of its losses. But that doesn’t mean the concerns have gone flat. In the end maybe, it’s nothing.

There’s a primary rule you should follow when it comes to stocks you own. It’s especially true for high-growth companies, where expectations might be in nosebleed territory.

Here it is…

Every company is guilty until proven innocent.

That might sound cynical. But that’s two decades of looking at these kinds of numbers talking.

Management must show you – not just tell you – with its financial disclosures that everything is fine. It must demonstrate there’s no reason to be concerned, that it’s presented a true financial performance and it’s sustainable.

This requires looking beyond the press release and digging deep.

One of the best things you can do for yourself each quarter is to analyze your portfolio’s quality of revenue recognition and look for red flags.

It’s the sort of work I do each month with my Hidden Profits recommendations. We’ve closed seven positions so far, with six winners averaging 35.35%. Our top winner’s at 56.16%.

Good luck out there,


As originally appeared in The Rich Investor.

Not Your Grandfather’s Robot Overlord

Hey John,

Recently, I wrote about how automation is increasingly becoming a part of our lives. I’m ultimately bullish on automation in cars, not so much for my beer-drinking experience.

Computers and robots have pervaded our lives at an ever-increasing rate – not always for the good. Regardless, the concept of automating just about everything is gaining steam.

Many predict that in just a few short years, much of the work we humans do will be performed instead by “artificial intelligence.”

A 2017 report by McKinsey Global Institute forecast that half of today’s work activities could be automated by 2055.

Buzzwords always crop up around the new – “disruptive” technologies, for instance.

But a particular phrase attached to the automation trend really bothers me.

“Surplus humans”…

That’s both sad and scary. It feels like our robot overlords are just steps off scene.

As machines clock in on the factory floor, humans get pushed aside.

The problem is humans have mortgages, energy bills, health insurance, student loan debt, food to buy, and other humans to rear.

Robots don’t.

My grandfather worked for General Motors. He had three children and a stay-at-home wife. He owned a home and a car. There was food on the table. Life was not extravagant. But his family was comfortable.

He and my grandmother, both products of the Great Depression, saved their money, too. In their later years, it led to a comfortable existence. They were self-sufficient.

Those days are over for most people.

It’s possible there’s too much of good thing. You don’t have to be a card-carrying communist to think that as humans get displaced, the risk of civil unrest rises.

Automation might, in fact, make the world a much more dangerous place.

Enter Amazon.

The company recently announced an initiative to allow humans to run a service of up to 40 vehicles and deliver packages from 75 Amazon stations. A relatively small $10,000 investment is all that’s required.

I’m sure the devil is in the details.

However, if a company has “surplus vehicles,” it might make sense to work with Amazon to generate revenue when they otherwise would be sitting in the parking lot not making money.

Score one for the humans!

Back to autonomous driving…

I’m bullish on the sector, ultimately. While I wouldn’t have much confidence in the technology today, it is improving rapidly. Over the long haul, we may be much safer and more productive with self-driving vehicles.

In the upcoming issue of Hidden Profits, I highlight a hiding-in-plain-sight stock with a unique technology that’s gaining traction in the space.

In fact, I once shorted the stock and made a substantial return as it cratered. Despite that dive, it’s still very much unloved by Wall Street.

Now, I like its prospects – for very different reasons than the rationale for my bearish bet a few years ago.

It just goes to show there’s no room for emotion in investing. And, when the facts change, change your mind.

A company can be a disaster waiting to happen one day, only to emerge as a leader in a new industry the next.

(Let’s just hope “leader” doesn’t turn into “we welcome our robot overlords.”)

Good investing,


As Appeared In The Rich Investor

New Regulations Guarantee a Market Thrashing

Dear John,

Here we go again!

Earlier this week, when I noted the market’s bad breadth suggests lower returns ahead, I mentioned that this is occurring at the same time regulations are getting rolled back.

Human nature is a funny thing.

It’s almost as if our behavior never changes, and we forget (or ignore) all the bad stuff that happened just a few years ago.

That’s why 100-year storms in the market happen every 10 years. Once it looks like we’re in the clear, we allow the same problems to punch us right in the face all over again.

In the meantime, we insist “this time it will be different.”

“This time” is never different.

Most of the regulatory rollback has been in the gutting of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
This was a key campaign promise that Donald Trump ran on during the presidential election.

Dodd-Frank was passed in 2010. It was aimed at limiting the damage from banks deemed “too big to fail.” It was also meant to protect consumers from having to bail those banks out again. There haven’t been any Lehman Brothers or Bear Stearns disasters since, so now must surely be the time to loosen up the rules, right?

Congress just voted to soften up the rules a bit to help out small and mid-sized banks. We’re talking banks with less than $250 billion in assets. They get a reprieve from rules they thought were expensive and onerous. These rules include stress tests, increased cash requirements, and more reporting, to name a few.

While most of the story has centered on Dodd-Frank, the devil’s is in the details.

The rollback of this legislation is just the first step in a broader effort to weaken the administrative state. It’s the next round of deregulation that could pose huge threats to our financial system.

The Federal Reserve is getting ready to ease up on rules that allow banks to use other people’s money – your money – to make huge, risky bets. That’s the real story. Not Dodd-Frank.

This type of trading works until it doesn’t. Then, the bankers walk away with millions of dollars, and Joe Sixpack gets caught holding the bag.

This is where the deregulation is headed next. It could do a doozy on the economy.

Banks have no business taking on massive leverage to make risky trades. The great investor Warren Buffett aptly calls these trades “financial weapons of mass destruction.”

There are plenty of rewards for traders when things go well, such as million-dollar bonuses, but few, if any, traders go to jail when they flush the financial system right down the toilet with risky bets.

We’ll end up right back where we started.

Actually, we’ll end up worse off in the end.

A major bank failure is practically assured. The market will implode with it. Trillions of dollars in bailouts will be given to folks that took excessive risk. It wasn’t fun the first time around, and it won’t be fun this time around.

Due to the massive Federal Reserve liquidity bubble created by low interest rates, the next bear market will be one for the history books.

Good luck out there,

John Del Vecchio

*Originally published in the Rich Investor

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