Volatility is the brother of credit… and volatility regime shifts are always driven by the credit cycle – ValueWalk Premium

Volatility is the brother of credit… and volatility regime shifts are always driven by the credit cycle

“Remember teamwork begins by building trust. And the only way to do that is to overcome our need for invulnerability.” 
― Patrick Lencioni
The Five Dysfunctions of a Team: A Leadership Fable

I know I frustrate my team more often than I care to admit.  My head clicks through conversations or charts or data, “Doesn’t matter, doesn’t matter… matters!”  For some reason, I must race to the bottom line quickly.  While I feel comfortable being this way (ok, happy), it has its downsides and, frankly, gets me into trouble with those on my team that rightfully need to dot every “i” and cross every “t.”  Personality differences and group dynamics present challenges but those challenges are important on the path of building something great together.

Ned Davis – The Passive ‘Bubble’ Is About To Pop

My team is working on something we are really excited about but we’ve hit a bump.  The big picture personalities are banging heads with the dot the “i” detail-oriented people.  Big picture sees the end result while the “i’s” and “t’s” design the processes to get us there.  As I shared the latest frustrations with my wife, Susan, she said your team is simply “storming.”  I looked at her puzzled and she told me about Bruce Tuckman’s stages of small group development.

2017’s Top Performing Hedge Fund Maintains Bullish China Outlook For 2018

Susan is a soccer coach and she said the best teams work through steps on the way to, hopefully, great success.  Just recognize where you are and know that it is important to “storm.”  I felt like a weight was lifted from my shoulders.  It has been a few nights of restless sleep and head spinning.  Let’s just say I slept well after our talk.

Tuckman’s stages of small group development look like this:

Top-Returning Lyrical Explains How Active Managers Can Succeed

And the cycle goes on and on and on.  There is no way out of storming.  We must go through it.  And we might not get through it, but the most successful sports franchises and businesses are able to find their way through storming on their way to performing.  We humans do indeed cycle.

OK, that’s enough about that. Let’s forget the “i’s” and “t’s” and hang in there with me as my “get to the point” way jumps you right to the bottom line on the current state of the economy, interest rates and the stock market. In my view, the economy is solid, interest rates are moving higher and the higher interest rates will likely cause some more “storming” in both the stock and bond markets as 2018 steps forward. Following is a dashboard-like view of my current economic outlook:


  • Global growth remains steady.
  • Seeing broad breadth in Manufacturing Purchasing Managers Index – keep “recession” on your radar.
  • The overall economic outlook is good.


  • Recession probability charts continue to look good.
  • There is little chance of recession in the next six to nine months.

Equity Markets:

  • Stocks are richly priced by most valuation metrics. Risk is high.
  • Global breadth and momentum remains moderately positive (though trend evidence is weakening).
  • Stocks still look like a better value vs. bonds.
  • Long-term trend charts remain positive but weakening.

Bond Markets:

  • Seeing cyclically higher inflation, but long-term deflationary pressures (record high debt, demographics and growing pension crisis) are significant headwinds to secular change in inflation trend.
  • Fed remains in rate-raising mode. Tax cuts, government spending and current inflation whispers giving Fed the cover to raise rates.
  • Interest rate trend is up. That’s bad news for bonds and stocks.
  • Our Trade Signals bond market charts remain in sell signals.
  • Not yet enough evidence to declare the 35-year bond bull market is dead. But it may be. Follow price behavior/trend evidence.

Bottom line: The pickup in inflation will give the Fed cover to continue to raise rates… the Fed wants to normalize rates (get them to 3% before the next recession)… Expect three to four 25 bps rate increases this year… higher rates will send us into the next recession (2019?)…  In recession, rates will then move lower.  Stocks do not do well in rising rate environments (chart below) or recessions.  I shared with you in last week’s post, “Volatility is the brother of credit… and volatility regime shifts are always driven by the credit cycle.”  (Chris Cole, CFA of Artemis Capital Management, “Volatility and the Alchemy of Risk.”)  Rates are rising and volatility is picking up.  All things cycle, keep a close eye on the developing shift in the credit cycle.  The temperature is rising.

Ned Davis Research kindly gave me permission to share the next chart with you and it’s a good one.  What I want you to zero in on (bottom line!) is how stocks perform when rates are rising.

First, here is how you read the chart:

  • Dotted red line in the middle section is the 70-week linear regression.
  • Bottom green line is the percent difference between the current 10-year yield and the dotted red 70-week regression trend line.
  • When the green line is above the upper black dotted line, the trend in interest rates is higher. When the green line is between the two black dotted lines, the trend is neutral and when below the bottom black dotted line, the trend in interest rates is down.
  • The lower two boxes show the performance of the S&P 500 Index. The left-hand box shows performance of the S&P 500 for the three interest rate regimes since 1969.  The right-hand box shows performance since 2008.
  • The gray shading highlights the current regime.
  • Bottom line: Stocks do not do well when rates are above the upper bracket (today’s current state). Also note the percentage of time in each regime.

A more detailed explanation of the data:

  • The chart uses a variation on a deviation-from-trend calculation to create an interest rate indicator for the stock market using the benchmark 10-year Treasury yield.
  • A traditional deviation-from-trend indicator compares the current data (in this case, the current 10-year Treasury yield) to a longer-term moving average (representing the “trend”) of the data and plots the percent difference (the “deviation”) between the two.
  • In this chart, instead of a simple moving average to represent the trend, NDR uses the weekly endpoint of a rolling 70-week simple linear regression trend line of the 10-year Treasury yield (dashed line, middle clip). That is, each week they plot the last 70 weeks of data to calculate a best-fit linear regression line through the Treasury yield data, and the endpoint of the regression trend line is plotted for that week.
  • Then they determine the percent difference between the actual 10-year yield and the endpoint of the trend line, and that difference is plotted in the bottom clip of the chart.
  • To determine whether a given differential should be considered high or low, we plot moving standard deviation bands around a three-year (156-week) moving average of the differential (+/- 0.4 Standard Deviation move above and below).
  • By doing this, roughly one-third of the time historically is spent above the upper bracket (indicating rising interest rates), one-third of the time is spent below the lower bracket (falling interest rates), and one-third of the time is spent between the brackets (neutral rates).
  • The use of moving standard deviation brackets allows for longer-term shifts in the level and volatility of the indicator.

Bottom line:

  • NDR’s analysis, based on data from 1969 to present, has found that the S&P 500 has shown subpar returns on average when the differential has been above the upper bracket, while it has posted strong annualized gains when the differential has been below the lower bracket (neutral readings have been associated with average returns).
  • The results on the chart reflect the full history since 1969, but only the latest 10 years of data are plotted for better visibility.
  • This indicator gives a different perspective on where current bond yields are relative to their recent trend and the results show that it has been a useful timing indicator for the stock market.

Grab a coffee and find your favorite chair.  The balance of this week’s post is short.  I share some quick commentary around Tuckman’s stages of small group development and link to the most recent Trade Signals post where you’ll find some data on the 200-day Moving Average Rule from 1900 to present.  A pretty good risk management rule.  OK, dig in and thanks for reading.

♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦

Follow me on Twitter @SBlumenthalCMG.

Included in this week’s On My Radar:

  • Tuckman’s Stages of Small Group Development
  • Trade Signals — A Look at the 200-Day MA Rule and Current Signals
  • Personal Note

Tuckman’s Stages of Small Group Development

The four stages are a helpful framework for recognizing a team’s behavioral patterns; they are most useful as a basis for team conversation, rather than boxing the team into a “diagnosis.”  And just as human development is not always linear (think of the five-year-old child who reverts to thumb-sucking when a new sibling is born), team development is not always a linear process. Having a way to identify and understand causes for changes in the team behaviors can help the team maximize its process and its productivity.

(Source: “Using the Stages of Team Development,” J. Stein, Massachusetts Institute of Technology, Human Resources.

Technically there are five stages as the cycle trends over time as your business opportunities expand, new players are added to the team and your business adjusts and grows.

  • Forming – This is when the team is put together. People are new and trying to learn about each other.  They are also trying to learn more about their tasks.  The focus is usually still on themselves as individuals rather than on the team.  At this stage, team members skirt around tough, controversial topics.
  • Storming – In this stage, the team members start to broach topics that lead to potential conflict, such as structure, distribution of responsibilities, leadership and decisions. This stage is also where team members try to establish their status within the team.
  • Norming – When teams emerge from the storming stage, they enter the Norming stage where they begin to identify with the team’s common goals. Team members begin to accept each other as they are and display more tolerance.
  • Performing – With roles and norms established, teams may reach a high level of success. Motivation levels are high and so is expertise due to experience and team stability.  Dissent expressed in constructive ways is encouraged.
  • Adjourning – As the project ends, the team breaks up or disbands in the adjournment phase.

Are you caught in the Storm?

Many teams emerge from the storming stage stronger and better.  Team members will resolve their differences.  They will be comfortable working with each other and enter the norming stage sure-footedly.

On the other hand, for teams where the storming phase is allowed to get out of hand, it can be destructive and demotivating.  The storming stage can be upsetting for team members.  Some teams may never emerge from the storming stage.  Other teams may regress to this stage when a significant new challenge arises.

More information/source here.

Trade Signals — A Look at the 200-Day MA Rule and Current Signals

S&P 500 Index — 2,716 (02-21-2018)

Notable this week:

No significant changes since last week.  Fixed income signals are bearish.  The Zweig Bond Model (a trend model for the bond market) is in a bearish “sell” signal.  HY is also in a “sell” signal.  The equity market trend remains bullish as measured by the Ned Davis Research CMG U.S. Large Cap Long/Flat Index (indicator) and the 13- vs. 34-week Moving Average (MA) of the S&P 500 Index (charts below).  Volume demand (buyers) remains bullish.  Don’t Fight the Tape or the Fed is signaling a moderately bearish -1 reading (see information below).  Real concern will be signaled should the indicator move to -2.  The long-term trend in gold remains bullish.  Charts follow below.

Following are two charts showing stats on the 200-day MA rule.  The first simply shows historical performance since 11/26/1900 through 2/20/2018 of the DJIA when the 200-day MA trend line is rising (red dotted line in chart).   The second chart compares returns on $100 investment on 11/26/1900 using the 200-day MA cross (stop-loss) exit and renter rule vs. buy-and-hold to today.  Absent any other disciplined way to manage your risk, the 200-day has a strong hypothetical long-term record.  I don’t use the 200-day rule, as I feel many large hedge funds look to poach those known triggers.  But I do favor finding processes that protect your downside.  Absent anything else, the 200-day MA is a pretty good rule.

Long-time readers know that I am a big fan of Ned Davis Research.  I’ve been a client for years and value their service.  If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at 617-279-4876.  John’s email address is [email protected]  I am not compensated in any way by NDR.  I’m just a fan of their work.

Click HERE for the latest Trade Signals.

Important note: Not a recommendation for you to buy or sell any security.  For information purposes only.  Please talk with your advisor about needs, goals, time horizon and risk tolerances. 

Personal Note

Tomorrow I’m jumping in the car and heading to Bryce Mountain, a very small mountain ski resort in Northern Virginia.  Middle son, Matthew, is competing in the eastern regional freestyle collegiate ski finals.  Think slope style jumps and rails, but it is Virginia and not Utah, so dad’s a little more at peace with little air versus big air.  Regrettably, it is the first time I am getting to see him compete this season.  A spot at Nationals at Lake Placid, NY March 6-10 lies in the wake and, if successful, I will miss that one.  I’ll be in Austin presenting at an advisor event on March 5 and heading from there to San Diego to attend and present on valuations and returns at the Mauldin Economics Strategic Investment Conference on March 6-9.

The SIC lineup is exciting: David Rosenberg, Dr. Lacy Hunt, Mark Yusko, Stanford University’s Niall Ferguson, Karen Harris from Bain & Company, Jeffrey Gundlach, George Friedman, George Gilder, John Burbank and John Mauldin and more…  I’ll be taking notes and sharing them with you.

You can learn more and find the agenda information here.  Send an email to Shannon Staton ([email protected]) for conference info and I’ve asked her if she can provide you with a registration discount.

Wishing you and your family the very best.  I’m going to raise a glass of red wine in tribute to you, me and the gifts that “storming” can bring us.  And I’ll be toasting my Susan…  Grateful… I’d be lost without her.

♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦

With kind regards,


Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.


Saved Articles