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Authored by Lance Roberts via RealInvestmentAdvice.com,

“Stock prices have reached what looks like a permanently high plateau” – Irving Fisher, New York Times September 3, 1929

One of the more infamous quotes from the roaring ‘20s came within two months of a market peak, which would not be surpassed again until the 1950s. Between 1920 and September 1929, the Dow Jones Industrial Average rose over 18% on an annualized basis.  Economist Irving Fisher essentially declared that such outsized gains were the norm. As he discovered a couple of months later, that time was not different.

Today, with valuations as stretched as they were in 1929 and 1999, the calls for a lengthy continuation of the current bull market are growing to a crescendo. The sentiment is so extreme that some outlandish predictions on individual stocks and indexes are treated as gospel as opposed to the warnings they likely are.  

Despite the high likelihood of poor returns over the coming decade, more and more stock analysts are telling us this time is different. One particular article caught our attention and is worth discussing to show how data can be used to support nearly any view.

4x by 2030

The Investor’s Fallacy by Nick Magguilli, states the following:

“And the crazy part is that the red star represents “only” a doubling over the next decade.  If history were to repeat itself in some meaningful way, the S&P 500 would be 4x higher by 2030 than where it is today.” 

Magguilli’s bold statement is based on an analysis comparing prior returns to forward returns. Correctly, he assumes that periods of lower than average returns are typically followed by a period of higher returns. We wholeheartedly agree; however, one must first understand that this method of forecasting returns is heavily reliant on the dates one assigns to prior and forward periods.

The article shows several charts using different periods. The intention is to show that 20 year prior returns have a stronger correlation with ten year forward returns than other date ranges. The graph below from the article highlights his findings.

Below the graph Magguilli states the following:

“Think about how insane this would be relative to history.  If you are expecting anything less than a doubling of the S&P 500 by 2030, then you are suggesting that the red star above will be even lower on the y-axis than where I already placed it.  If this were to occur, it would be unlike anything we have ever seen before in terms of growth over such a long time period.

And the crazy part is that the red star represents “only” a doubling over the next decade.  If history were to repeat itself in some meaningful way, the S&P 500 would be 4x higher by 2030 than where it is today. 

This statement seems crazy right now, but that’s what has happened historically.  I understand that there is no law forcing U.S. markets to follow this trend indefinitely.  However, if you are forecasting an awful coming decade for U.S. stocks, I have some bad news for you—the evidence is heavily against you.

We repeat- the evidence is heavily against you. We find not only the forecast crazy but his assertion that anyone bracing for a period of weak returns is an outlier.”

With that ringing endorsement to quadruple your money in the next ten years, it is worth highlighting two significant flaws in the analysis.

Flaw #1

One of the reasons that his forecast for the 2020s is so high is that the preceding 20-year period started in 2000 at the peak of a ten-year bull market and what was clearly an equity market bubble. The total annualized return (dividends included) from that peak to today is 5.30%, as shown below. If instead he had used 17 years as his backward-looking period, the start date would have coincided with the bottom of the dot com crash, and the total annualized returns over the past period would have been significantly higher.

Recall, from his graph, the higher the prior period return, the lower the forecasted return and vice versa. The graph below shows how a relatively small change in the start date makes a big difference in the analytical conclusion.

Data Courtesy Shiller

As we will detail below, when one uses a 17-year prior period starting at the market trough, the expected annualized return is only 10% as opposed to Magguilli’s approximated 16% return using a 20-year time frame. This is certainly not the end of the world, as 10% is still an above-average return. To put the two returns in context, the 6% annualized difference on a $100,000 portfolio results in a $182,000 difference in returns over the ten-year period.

Most analysts, ourselves included, like to use even numbers when conducting long term analysis. In this case, an even 20 years coincides with an important market peak. The lesson from the first flaw is that the start and end dates and associated index values are very important.

Flaw #2

“And though my process is limited by the amount of data that I have, I know that it’s not unreasonable.”

Despite Magguilli’s attestation, the amount of data he used could have been more robust. The second flaw in the article relates to the span of data used to assess correlation. We believe he is using approximately 60 years of data. While 60 years encompasses a lot of data, more data is readily available to make the analysis better. If we include data back to 1900, as shown below, the chart tells us something different about the future.

Data Shiller

The first thing to notice is that R2, or measure of correlation, drops significantly from .83 to .33. It appears a primary reason for the loss of correlation is the performance from the depression era, as shown with orange dots.   

The following graph uses prior 17-year returns from 1900 forward. The red line highlights the current prior 17 years annualized return of 9.47%.

Data Shiller

The expected total annualized return for the next decade is approximately 10%, denoted on the chart above where the red line crosses the dotted regression line. More importantly, the range of possible returns is much larger than what Nick’s graph shows.  Annualized returns could be as high as 18% but may also be as low as negative 3%. As it should, the risk-adjustment considering dispersion, or range of possible returns, raises a variety of other questions and concerns, among them, certitude in the original analysis.

Your guess is as good as ours on where returns will fall over the next ten years. However, consider that in 1929 valuations were similar to where levels stand today across a wide variety of metrics. Many valuation-based forecasts predict returns of plus or minus a few percent annualized over the next ten years.  The graph below, for example, shows that returns could easily be below zero for the next ten years.

For further perspective on valuations, the following table contrasts current valuations versus prior periods.

Additionally, the more rigorous and detailed analysis of Jeremy Grantham of GMO show 7-year projected returns which are not encouraging.

Summary

Maggiulli humbly states that he doesn’t know what the future holds, but the substance of the article suggests that you, dear investor, would be a fool not to buy and hold stocks for the next decade.

Although you cannot predict the future, you can prepare for it. What we do know is that we are well into a historically long bull market and valuations are in record territory. We believe that at this stage of the cycle investors should focus less on the potential rewards and much more on the risks. The primary reason is that market reversals are often sudden and vicious, especially from points of extreme valuation. As one example, after peaking on March 10, 2000, the NASDAQ composite wiped out 29% of its value in only three weeks and 37% in less than five weeks. Having been conditioned to “buy-the-dip” over the previous months and years, investors could not envision a lasting selloff despite the radical dislocation between market prices and fundamentals.  

For those who have enjoyed the benefits of the surging equity market over the past several quarters, congratulations on a race well run, but do not forget the importance of risk management. Those who fail to heed signs of caution or are blinded by false confidence tend to lose what they gained. Remember, the objective is compounding wealth over the long haul and not keeping up with the S&P 500 index.

We hope this article encourages you to think about current circumstances and develop plans to hedge and/or reduce exposure if and when you deem appropriate.

That “high plateau” Irving Fisher thought we had achieved in September 1929 cost him his reputation and his net worth. The cost of being prudent is not that expensive and, in part, depends on one questioning both bullish and bearish arguments.

Airlines around the world have already taken a hit thanks to Boeing, now the coronavirus outbreak is set to kick the industry while it’s already down. And the US and China will be hit especially hard.

Plenty of countries are cutting off are limiting flights to China right now. Air Canada just announced its cancelling select flights, South Korea, Hong Kong and other Asian countries have either cut off travel, or are reducing flights and screening for symptoms of nCoV, which has already killed more than 100 people in China, and possibly a Thai woman in India as well. But when it’s all said and done, air traffic between the US and China might never really recover, dealing a serious blow to both Chinese and American airlines at a time when their shares are already taking a beating.

In a recent column, Forbes contributor Michael Boyd warned that air   said that even with solid data, is full of unknowns. But one thing we can rely upon in aviation forecasting is that it’s unforeseen factors that suddenly spring out of left field that will drive change.

Two years ago, the future looked bright. China’s burgeoning middle class was traveling more, and the US was a perennial favorite destination, not just for students, but for travelers and shoppers looking to buy luxury goods on NYC’s Fifth Avenue, or SoHo.

But by the middle of 2019, with the trade war, having raged for more than a year, in full swing, China’s economy started to show signs of strain, as growth started to cool from a frantic, often double-digit pace of expansion, eventually notching its weakest quarter of growth in 29 years.

However, the slowdown from the trade war and the drag of China’s economy at least allowed the airlines to easily model slowing traffic and coordinate accordingly. Now, that’s all gone out the window: the coronavirus has arrived and that’s created many new unknowns.

After the bell on Tuesday, Starbucks announced that the coronavirus will likely hurt growth in its international business, which is heavily dependent on China. The chain seemed to already have its hands full competing against a slew of new local competitors.

It’s a virtual certainty that the airlines will follow up with similar warnings, though theirs will likely be much more dismal, and preceded by a wave of downgrades to the Street’s projections.

Boyd, whose analysis focuses on the airline industry, said his previous forecast of 7.08 million passengers on US-China flights in 2020 is “now history,” and he barely knows where to begin to put together the next set of forecasts. The damage will linger for six months or longer, he added.

Take it to the bank: this epidemic will materially affect the flight levels between China and the United States, because airlines don’t like to fly nearly-empty airplanes.

Perhaps the word “affect” is too weak. The reality is that this event is going to devastate traffic for a period of at least six months or maybe longer. It will depend on how much this epidemic spreads, and how the Chinese government addresses it.

My consultancy had estimated that U.S.-China flights would carry about 7.08 million passengers for 2020, adding inbound and outbound travelers.

That number is now history.

It’s possible that the number of passengers on US-China flights could fall by 75% in 2020. It’s possible that this supposition is optimistic. As leisure travel dries up, more than half of the passenger base for these flights will disappear.

As of today, and depending on the developments in China, through this June we are forecasting at least a 75% drop in passenger traffic between the USA and China. That figure sounds extreme, but as the knowledge of the nature and the extent of the new virus grows, it may actually be optimistic.

Cutting to the chase, airline flights between China and the USA are going to be financial disasters. That assumes, somewhat optimistically, they all will even continue to operate.

For one thing, leisure traffic – about 60% of the passenger base – is effectively ended. Gone. No more. Evaporated.

In response, flights to the US from China’s second-tier cities will likely become too costly to continue (since near-empty planes rack up tremendous losses pretty quickly). These routes may never reopen.

Boyd jokes that these flights will soon be carrying nothing but “sailboat fuel” (get it?). Before the virus, the average flight between China and the US was 83% filled to capacity. Expect that figure to drop to below 50%. And for the remaining airports that continue running flights between the US and China, well, those flights are about to become major loss-leaders. In the US, airports that are common gateways for Chinese travelers will take the brunt of the damage: San Francisco’s international airport will see about 344,000 fewer passengers, while LA will see 702,000 fewer passengers.

On the other hand, trade between the US and China is expected to climb now that Beijing has pledged to increase imports of ag products, energy and other items from the US to the tune of $200 billion using old-fashioned, centrally-planned mandates for state companies. However, some are skeptical that this is a promise that Beijing intends to keep.

Though if epidemiologists are correct in their projections about the coronavirus’s infectious potential, then we might all have more important things to worry about very soon.

Via SchiffGold.com,

Bernie Sanders has gained in the polls of late and only trails Joe Biden by about three percentage points, according to the latest Fox News poll. On top of that, Sanders matches up against President Trump. He leads 48% to 42% in a head-to-head matchup.

Peter Schiff told Fox Business that said a Sanders presidency would be an economic disaster for the US, but it would be good for gold.

If Sanders becomes president in 2020, the price of gold will be well above $2,000 on the day after election night.”

In fact, Peter said gold could rise to $2,000 before the election if the market thinks Sanders is going to win.

Peter projected what a Sanders presidency would look like.

What a Sanders win means is much bigger government deficits, and much more money printing by the Fed because there is no way to finance all of the spending that will happen with tax hikes on the rich. We’ll get tax hikes on the rich, but they’re not going to provide the revenue to pay for the programs.”

The federal budget deficit is on track to cross $1 trillion in fiscal 2020. That’s only happened four times in US history, all in the wake of the 2008 crash. Peter said the budget deficits would get even bigger with Sanders in the White House.

There is gonna be no Republican opposition to the deficits that would finance the spending because after all, the Republicans didn’t object to record deficits under Trump when the economy was supposedly the greatest ever. The deficits could be three or four trillion dollars a year and the money printing will be off the charts.”

As far as coronavirus, Peter echoed what he said on RT Boom Bust last week: markets have bigger things to worry about. He told Fox Business gold was rallying before the outbreak and that it is “not why” the price is going up now, even though metals are considered a safe-haven buy.

Peter said even though the Fed has paused rate cuts, for the time being, he thinks the central bank will ultimately cut all the way back to zero and the Fed’s balance sheet will “explode to a much higher than the four-and-a-half trillion that they tapered from.”

And a Sanders presidency would do nothing but exacerbate this and speed up the dollar’s demise.

There’s no way the dollar’s reserve status will survive a Sanders presidency. America is going to be a much, much poorer nation. Our standard of living is going to implode, but the money printing is going to be crazy.”

Last week, we reported that US prosecutors had recommended to a judge presiding over the sentencing of 2010 ‘flash crash’ scapegoat Nat Sarao that the former day trader be sentenced to time served.

Though that’s not exactly how things went during his Tuesday sentencing, at least Sarao – nicknamed the ‘Hound of Hounslow, the London neighborhood where his parents own a home – won’t see the inside of another jail cell. According to the Guardian, “the story of the British day trader charged with triggering a trillion-dollar “flash crash” that caused havoc on Wall Street in 2010 ended where it began on Tuesday with a judge sentencing him to one year of home incarceration at his parent’s house.”

Sarao’s parents leave in West London, and after five years of legal struggles that included being extradited from the UK to the US, the former day trader, who has been diagnosed as being on the autism spectrum, and who was reportedly scammed out of nearly all of the $35 million-plus he earned trading. Sarao used a custom-designed algorithm that cancelled his orders before execution to manipulate markets, prosecutors said.

Spoofing, or placing orders and then cancelling them before execution to create the appearance of more – or less – demand, is illegal in the US.

Sarao

However, there’s one important caveat: Prosecutors, who had asked the judge to deliver a sentence of time served, pointed out that a sentence of home confinement in the UK would be impossible to enforce. Though the judge and Sarao’s lawyers reportedly came to an agreement that would only allow him to leave the house under special circumstances.

The sentence means Sarao, who earned roughly $1 million on the day of the flash crash, will have only spent four months in a UK prison.

Prosecutors praised Sarao for his cooperation in other cases, and for expanding prosecutors’ understanding of how criminal traders game the system.

Initially, Sarao was charged with 22 counts of fraud related to his ‘spoofing’ trades over five years. During the May 6 2010 flash crash, the Dow Jones Industrial Average plunged 600 points in five minutes, then regained most of that amount over the following 20 minutes.

The sentence marks the end of a nearly five year ordeal: Sarao was arrested by British authorities in 2015 and spent four months in Wandsworth prison before being extradited to the US.

Authored by Charles Hugh Smith via OfTwoMinds blog,

Unthinkable doesn’t mean unsinkable.

As we all know, the “unsinkable” Titanic suffered a glancing collision with an iceberg on the night of April 14, 1912. A half-hour after the iceberg had opened six of the ship’s 16 watertight compartments, it was not at all apparent that the mighty vessel had been fatally wounded, as there was no evidence of damage topside. Indeed, some eyewitnesses reported that passengers playfully scattered the ice left on the foredeck by the encounter.

But some rudimentary calculations soon revealed the truth to the officers: the ship would sink and there was no way to stop it. The ship was designed to survive four watertight compartments being compromised, and could likely stay afloat if five were opened to the sea, but not if six compartments were flooded. Water would inevitably spill over into adjacent compartments in a domino-like fashion until the ship sank.

We can sympathize with the disbelief of the officers, and with their contradictory duty to simultaneously reassure passengers and attempt to goad them into the lifeboats. Passengers were reluctant to heed the warning because it was at odds with their own perceptions. With the interior still warm and bright with lights, it seemed far more dangerous to clamber into an open lifeboat and drift off into the icy Atlantic than it did to stay onboard.

The evidence was undeniable, but humanity’s first response is denial, regardless of the evidence. The evidence that the coronavirus is contagious is undeniable, as is the evidence that carriers who have no symptoms can transmit the virus to others.

Just as the eventual sinking of Titanic could be extrapolated from the basic facts (six watertight compartments were flooding), so the eventual spread of the coronavirus can be extrapolated from these basic facts.

But the official global response is “these facts don’t matter,” and so hundreds of airline flights continue to leave cities swept by the disease. That once the virus spreads globally it will impact the global economy is easily extrapolated, but few want to consider the sinking of the unsinkable, so they don’t.

As a result, the first lifeboats left the doomed ship only partially full. Only when it became undeniable that the ship was doomed did people attempt to get on a lifeboat, but by then it was too late: the lifeboats had all been launched.

This may be an appropriate analogy to the U.S. stock market, which is widely considered “unsinkable” due to the Federal Reserve’s unlimited ability to create “liquidity” (cash) out of thin air.

The stock market just had a minor collision with the coronavirus, and few are heeding the warnings, preferring to heed the reassurances that thanks to the omnipotent Federal Reserve, the market is unsinkable, and the party in the First Class deck will continue indefinitely.

The lifeboats are already leaving, but few have escaped the doomed ship, i.e. sold all their equities.

When the crowd partying in First Class awakens to the inevitability of the stock market sinking, it will be too late to get on the lifeboat, i.e. sell out at the top.

A half-hour after the fatal collision, the reassurances are so comforting and credible: how could this great ship sink? Indeed, how could a stock market racing so confidently to Dow 30,000 sink to Dow 20,000 or even 10,000? It’s unthinkable.

Unthinkable doesn’t mean unsinkable.

Why Our Financial System Is Like the Titanic (March 15, 2016)

Here are some informative science-based links on the coronavirus, courtesy of longtime correspondent Cheryl A.:

Another Decade, Another Coronavirus

New coronavirus can cause infections with no symptoms and sicken otherwise healthy people, studies show

Map of Global Case of Wuhan Coronavirus

Coronavirus contagious even in incubation stage, China’s health authority says

Preliminary Risk Assessment of Coronavirus Spreading

Preliminary estimation of the basic reproduction number of novel coronavirus (2019-nCoV) in China, from 2019 to 2020

Containing new coronavirus may not be feasible, experts say, as they warn of possible sustained global spread

How fast can biotech come up with a vaccine for the latest outbreak?

DNA sleuths read the coronavirus genome, tracing its origins and looking for dangerous mutations

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If there ever was a “kitchen sink” quarter, Boeing just had it.

Moments ago, the ailing US aerospace giant reported Q4 earnings which prompted traders to do a double take after revenues cratered by 37% Y/Y, down from $28.3BN a year ago, and nearly $4 billion below the Wall Street consensus of $21.7BN; Q4 EPS was a whopping loss of $2.33/share, compared to expectations of a $1.47 profit, and down from $5.48 a year ago, resulting in the worst quarter in over two decades.

As a result of the abysmal quarter, Boeing posted an annual loss for the first time since 1997, the last time the plane maker had to shut down production of its cash-cow 737 jetliner. Core loss per share was $3.47 in 2019, down from $16.01  year ago, with operating cash flow tumbling to a $2.4BN cash burn.

Predictably, the biggest item here was the continued grounding of the 737 MAX or rather attempts to get it back in the air, and in Q4 the company laid out its latest estimated costs for the 737 Max grounding, which as Bloomberg put it, “is a doozy” at nearly $20 billion:

• included $2.6B additional costs to produce aircraft in the 737 program accounting quantity in 4Q19; bringing the total for the full year to $6.3B
• Booked an additional $2.6B pre-tax charge related to estimated potential concessions and other considerations to
  customers in 4Q19; bringing the total for the full year to $8.3B
• Estimated an additional $4 billion in “abnormal production costs” that it expects to book this year to cover extra expenses as it halts and then gradually resumes work in its 737 factory.

The full details of the 737MAX kitchen sinking can be found here:

The continued grounding of the 737 MAX means that Boeing’s commercial airplane inventory is now a record high, rising 26% from a year earlier as the company continues to produce planes that nobody wants to buy (as they can’t fly them).

But wait there’s more, because it’s not just 737MAX anymore: as had been leaked previously, Boeing also confirmed that it is cutting 787 Dreamliner output to 10/month in early 2021, a number which it expects to return back ti 12 planes/month in 2023 (but may not). One hopes this is not on the same ground as the, pardon the pun, 737 MAX grounding. Boeing also reported that the 787 deferred production cost in 4Q was $18.7 billion, that’s down from $19.8 billion in 3Q and $23.0 billion a year ago.

And so, with earnings in freefall, it is hardly a surprise that operating cash flow plunged from $15.3BN to cash burn of $2.4BN in Q4 which however was modestly better than the $3.9BN expected…

… and with the company keeping cash at roughly $10BN, this meant that total debt rose to a new record high of $27.3BN in total debt.

Don’t worry though, the company’s dividend is safe and sound: Boeing paid $1.2 billion of dividends in the quarter.

Commenting on the result, the company’s new CEO Calhoun regurgitated the same old trite pablum we have come to expect from the company:

“We are focused on returning the 737 MAX to service safely and restoring the long-standing trust that the Boeing brand represents with the flying public. We are committed to transparency and excellence in everything we do. Safety will underwrite every decision, every action and every step we take as we move forward. Fortunately, the strength of our overall Boeing portfolio of businesses provides the financial liquidity to follow a thorough and disciplined recovery process.”

And while the stock initially tumbled on the abysmal results, it then promptly rebounded…

… as the sellside quickly decided that it can’t possibly get any worse, or as Bloomberg put it, Calhoun has “really brought forth everything,” trying to put a “bottom” on the bad news at Boeing so the jet maker can start trying to “take the news flow positive from here.”

As a reminder, this is what the market thought about last quarter too, and everyone knows what happened next.

Incidentally, for Boeing the only question that matters is a simple one: if and when the 737 MAX is allowed to return to the sky again, will anyone ever want to fly on that airplane again?