What happens after Santa leaves?

Trend Model signal summary
Trend Model signal: Risk-on
Trading model: Bullish

The Trend Model is an asset allocation model used by my inner investor. The trading component of the Trend Model keys on changes in direction in the Trend Model - and it is used by my inner trader. The actual historical (not back-tested) buy and sell signals of the trading component of the Trend Model are shown in the chart below:

Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent. In addition, I have been trading an account based on the signals of the Trend Model. The last report card of that account can be found here.


Enjoy the Santa Claus rally, but...
I just have a relatively brief trading oriented comment as blogging will be light for the remainder of the week:

I have remained steadfastly bullish during the brief downturn in December and pounded the table to make the case for an oversold rally to begin (see Why today (Dec 9) was like the October bottom and Dear Santa, May I have new highs for Christmas?). If you followed my writing and profited from the current melt-up, I urge you to show your appreciation by contributing to the Vancouver Youth Symphony Orchestra by clicking here (also please see No guarantees, but...).

So far, the current rally has followed the typical seasonal pattern, as shown by Bespoke:

If history is any guide, the rally should continue into the early parts of January (via Pension Partners):

Warnings from overseas
However, I remain concerned as non-US markets are misbehaving and their market action is suggestive of economic weakness. Such signals have the potential to spook the global growth outlook once the seasonal rally peters out. In fact, it is only the combination of the short-term seasonal pattern and the recent oversold readings that have kept the Trend Model from moving to a more cautious reading.

Consider that, in Europe. not only is growth anemic, Greek politics are in turmoil again. The latest presidential election faces an uncertain outcome (via Ekathimerini):

The government garnered 160 votes in the first round of crucial presidential elections on Wednesday, performing slightly worse than anticipated and increasing speculation about snap polls.

In addition to the 155 coalition MPs, five independents backed the government’s candidate, former European commissioner Stavros Dimas. Another 135 voted “present” while five were absent. The result was far short of the 200 votes required in the first round, a target that the government is also certain to miss in next week’s second round. However, ahead of the critical third vote on December 29 when the threshold drops to 180, the government had hoped to gain between 161 and 165 in the first round in a bid to build momentum for the votes to come.

Should the third vote fail, it would mean parliamentary elections which would lead to a probable win by the far left SYRIZA party. As a result, the Euro STOXX 60 has been extremely volatile:

Across the English Channel, UK stocks are showing even a greater level of weakness. The energy heavy FTSE 100 is in a downtrend and the most recent rally barely regained the 50 dma.

Moving to Asia, Mr. Market is also showing his concerns over the outlook for Greater China. The Shanghai Composite (top panel) has begun to pause from its recent rally as it appears that the parabolic rise is accounted mainly by speculative activity in the wake of the Shanghai-HK link-up.By contrast, the other regional stock markets of China's major Asian trading partners (middle panels) have not confirmed the strength in Chinese stocks as they have all broken their uptrends. In addition, the AUDCAD currency cross (bottom panel), which is important as both Australia and Canada are resource economies but Australia is more sensitive to Chinese growth, is tanking. These are all signs that the market is concerned about slowing Chinese growth.

Another worry that I am seeing is the lack of signs that China is re-balancing its economy from credit-driven infrastructure growth to the consumer led growth. The chart below shows two relative return pair trades of New China to Old China, as measured by the PGJ-FXI pair (in black) and CHIQ-CHIX pair (green). By any measure, Old China is outperforming New China.

Is Santa Claus rally sustainable?
With weakness evident in overseas markets, the key question is whether US equities can de-couple and continue to strengthen in the face of rising global worries. In other words, is the current US market rally just a seasonal snap-back rally after the weakness seen in early December, or is it more reflective of confidence of continued US economic growth?

My base case scenario at this point is we are seeing a typical oversold rally from tax-loss selling which will stall out in early January. That`s because forward EPS estimates are falling, indicating the current lack of a fundamental backdrop for stock market strength. The latest weekly analysis from John Butters of Factset shows that forward EPS is still falling (annotations in red are mine). Such episodes have historically coincided with equity market weakness.

While I continue to believe that the Street will eventually raise growth estimates because of lower oil prices, these changes will occur with a lag because the analyst community haven't fully quantified the effects of falling energy prices (see 2015: Bullish skies with scattered periods of volatility). Corporate America will see eventually benefits from decreased input costs and higher consumer spending as oil prices decline. Indeed, New Deal Democrat highlighted analysis indicating consumer confidence is rising the most in the bottom 1/3 of the US population. Falling fuel prices are likely to act as an immediate wage boost (or tax cut) to that population segment, which would feed through directly to consumer spending:

Overall, the sentiment index rose to a higher-than-expected 93.8, mirroring levels seen in boom years like 1996 and 2004. The best part is that the biggest increase in optimism comes from the lowest 1/3 of households measured by income.

It's not too difficult to believe that lower gas prices and consistent job gains of over 200,000 a month, with unemployment under 6%, are finally having an effect.

It`s just that EPS growth estimates have not risen much because the benefits of lower oil prices are diffuse and the Street hasn't quantified them yet.


Watching for the New Year hangover
Tactically, here is what I am watching. The key indicator to watch for the sign that the Santa Claus rally can continue into year-end and beyond is the nature of the market leadership during this period. Will relative strength led by the recent high-beta leadership, such as biotechs and semiconductors, which would be a sign of continued market strength, or down-and-out groups such as small caps and energy, which are the most likely tax-loss selling candidates and whose rallies would likely peter out soon?

The chart below shows the relative returns of these groups. If the beaten down groups like energy and small caps start to show relative strength, then the Santa Claus rally is most likely to be short-lived and traders should be wary of a post-New Year hangover. If, on the other hand, we see continued strength from leading groups like the biotechs and semiconductors, then the bull run is far more likely to continue.

In the meantime, my inner trader remains long this market. He is nervously watching how foreign markets and US market leadership will behave in the next week or two.



Disclosure: Long SPXL, TNA

Financial planning challenges in an unequal society

The topic of inequality has been a hot topic lately, I have been writing off and on about its effects for some time. There is no question that inequality has been growing for the last few decades in the United States. The debate is over whether the economic and social policies surrounding this change. Here is an informative if somewhat wonkish chart from Chart Book of Economic Inequality:

In Thomas Piketty's latest book, his thesis explaining inequality can be summarized as:

Whenever the rate of return on capital is significantly and durably higher than the growth rate of the economy, it is all but inevitable that inheritance (of fortunes accumulated in the past) predominates over saving (wealth accumulated in the present).... Wealth originating in the past automatically grows more rapidly, even without labour, than wealth stemming from work, which can be saved.

Today, we seem to be seeing those kinds of conditions. The returns to capital are durably higher than the returns to labor and they are "durably higher" than the economy's growth rate. It's no wonder inequality has grown.


The Downton Abbey asset management challenge
Regardless, this presents a whole new set of challenges for those working in the wealth management business. The New York Times had an interesting article about the intersection of growing inequality, Baby Boomer demographics and inheritances:

Rich families today are holding onto a big piece of the pie. The top 1 percent of households owns about 35 percent of American wealth, more than the entire bottom 90 percent does. But at least at the moment, growing inequality has not resulted in a big boom in inheritances. Since the 1980s, the value of inherited wealth has only drifted upward slightly. In fact, wealth transfers as a proportion of net worth have fallen, to 19 percent in 2007 from 29 percent in 1989.

But the baby boomers are only now retiring. Once that process accelerates and reaches its inevitable conclusion, get ready for a flood of princelings — and some potentially worrisome consequences for social mobility in the United States, as the immense earnings of an already stratified economy are entrusted to a new generation. The inheritance boom will come, eventually. What’s unclear is what the country will look like afterward.

The money will go to the children of Boomers, otherwise known as Generation X and Generation Y:

That money will flow into the bank accounts of the by-then-over-the-hill members of Generation X and Generation Y, and the United States might look a little more like aristocratic Europe, with its Downton Abbeys and super-hyphenated names — maybe with a few more tattoos. Lists like the Forbes 400 might be filled less with financiers and technology entrepreneurs and more with third-generation Waltons and second-generation Zuckerbergs and Bezoses or, perhaps, first-generation Walton-Zuckerberg von Bezoses.

Running a dynasty vs. retirement planning
This expected transfer of wealth presents a challenge for people who are in the wealth management business. Much of the discussion in the current low interest rate environment revolves around the right withdrawal rate from savings for retirees. For the super-wealthy, the withdrawal rate question is not relevant - and therefore financial planners and wealth managers need to deal with a paradigm shift in their business.

The current underlying model for retirement planning goes something like this. When you are young, you save for retirement, aided by tax-deferred vehicles like 401ks, IRAs, etc. When you cannot work anymore and retire, you draw down on those savings to fund your living expenses. Upon death, those savings are exhausted or nearly exhausted and the residual goes to the heirs.

While that model of retirement remains relevant for the mass affluent market, it's less relevant for the super-wealthy. This demographic will not need to draw down their savings to retire. The income generated by their wealth far outstrips their spending needs. After all, if you have $100 million, does it matter that much if your withdrawal rate is 2% or 4%? How much could you possibly spend? For this group, their savings will outlive them and the financial planning framework shifts from "will I outlive my savings" to "how do I maintain my wealth for my heirs after I die" . In other words, how do I sustain my dynasty?

If you are a financial planner and wealth manager, you have to be aware of these trends. America has been getting more unequal and the wealth distribution is getting more skewed. If you get caught with a business model that caters the to common man by on the idea that the American Dream is still relevant, then be aware that the size of your market is stagnant or shrinking. The growth market is serving the super-wealthy, which presents its own sets of challenges, massive changes in the infrastructure of your services and business model.

The NY Times article indicated that these clients often focused on philanthropy, so you need to have the financial planning infrastructure to service those needs.

For one, the wealthy tend to give away a big chunk of their money, leaving less for their heirs, Wolff says. Bill Gates, Warren Buffett, Mark Zuckerberg and many others, for instance, have signed onto the “giving pledge,” promising the bulk of their estates to charity.

For clients who look to maintain wealth in a dynastic framework, then the financial planning challenge shifts from attracting 401k and IRA savings to sustaining wealth for generations in a tax efficient fashion. Do you have the legal and tax planning resources to do that? Do you have the resources to diversify into other asset classes, such real estate development and management, for clients with such long time horizons? No longer are you dealing with the plain vanilla bonds and equity asset classes for the mass affluent market.

This Reuters article offers the example of one firm that is re-orienting itself towards new business model:

Baltimore financial adviser Lyle Benson describes his work as that of "Personal CFO" or chief financial officer.

His boutique financial planning firm manages money, but it also does everything from bill paying to estate planning, even assisting clients' adult children negotiate terms for their first automobile purchase or mortgage.

"We coordinate and work with all of our clients' advisers" including attorneys, accountants and insurance agents, says Benson. "We make sure everyone is on the same page and working together."

The services necessary to quarterback a client's complete financial life, often referred to as family office services, are not just for the ultra-rich. Benson says anyone with investable assets of more than $2 million can benefit from such comprehensive oversight. At his firm, those services are used by more than 30 percent of clients.

However, advisors should be aware of the business challenges of chasing after such accounts. A separate Reuters article outlines the issues and it is well worth reading in its entirety:

High-net-worth clients, especially those with $30 million or more, are different from garden-variety millionaires. They do not sweat the small stuff, like planning for their kids' education or retiring comfortably, so they do not value basic financial planning services as much as less-affluent clients.

Very wealthy clients often expect investment services and products beyond those offered by smaller wealth managers. They may require income- and estate-tax strategies that are more complex than the adviser can deliver.

This mismatch of client expectations and adviser services can actually hurt a wealth management practice that is not set up to manage all that money.

Regardless, the super-wealthy is an enormous growth market in an unequal America. The size of the market is exemplified by the CNBC report that American billionaires gained nearly $1 trillion in the bull market. The private banking divisions of a number of get it, even though the term "dynasty" is distinctly un-American and is far more reminiscent of Old Europe, it is a growth business that deserves to be addressed.




Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.