Opportunity, Not Crisis, Looms In 2019

December 10, 2018

Steve BlumenthalStephen Blumenthal, a well-respected ETF strategist heading CMG Capital Management Group (based in King of Prussia, Pennsylvania), says there’s a 40% chance we are headed for a recession in 2019. How steep the plunge? It could go as low as 50-70%, he says. But fret not. If you are prepared, and have a process in place, you can find that instead of a major portfolio-crushing crisis, you could be about to face a great investment opportunity.

ETF.com: What are some of the biggest concerns you’re hearing from your clients looking into 2019?

Steve Blumenthal: The biggest concern is recession—the timing of recession. And the reason is that we're in a completely different stage of the business cycle. We're very late-stage. The average expansion of a business cycle has been roughly 40 months since the 1950s. We’ve had one or two recessions every 10 years since 1950, with the exception of the current decade. If we get through 2019 without a recession, it would be a first.

The longest record period of expansion we've had on record was 1991 to 2001, 120 months. The current one is 114 months old, second-longest in history. All this means is that we're late-stage. And starting conditions matter.

The second biggest concern is that assets are inflated, interest rates are super low. Bonds have had a long run since the early 1980s, from high interest rates to low interest rates. There's no way that 3% yields can do what 6-7% yields can do for a portfolio. The stock market is at the second-most-overvalued price level in history. We're at a tougher spot.

ETF.com: Are these concerns universal, or are you finding demographics play a part in what investors are worried about right now?

Blumenthal: I get a lot of calls of concern because most of the wealth now is in the hands of pre-retirees and retirees. Roughly within a year, 75% of the wealth is going to be in the hands of pre-retirees and retirees. We don't have the five to 15 years it might take to recover from a 50% correction. And the biggest corrections come when the market's the most overvalued.

We're late-cycle, extremely overvalued and due for a recession. The average correction is 37%. The last two brought us down 50%. And we've tripped up on the very same debt behaviors and central bank policies that created the last big problem. My view is—and what I'm advising our clients—is when a 50-70% correction is highly probable, keep recession front-of-mind on your radar, and have a defined process in every asset to both participate but also risk-protect.

ETF.com: If you lived through 2008-2009, but stayed in the market, in 10 years you did pretty well. What’s a good process to survive a similar downturn?

Blumenthal: You did well, but here's the difference: For my daughter, who's 25 years old and putting money every year into a Roth IRA, who cares? You'll have an opportunity to dollar-cost-average over a long period of time. It's a great approach. But if you're 60 or 70, and you've got to wait 10 years to recover, and that's not going to happen.

If you were 60 to 70 years old and it was 1999, it took you 12 years to recover if you were in the Dow. It took you 13 years to recover if you were in the S&P 500. And it took you 16 years to recover if you were in tech stocks. You don't have the time to recover, and behaviorally, you're not going to allow yourself to go through it again.

I just don't believe the traditional buy-and-hold approach is going to serve 75% of the population that's pre-retiree or retiree. They can't afford to take that hit.

Put a 200-day moving stop-loss average on everything that you own as some sort of rules-based way to minimize your downside, but still participate in the upside. It's not hard to do. The hard part is being disciplined and following it.

ETF.com: Basically, managing risk is going to be the No. 1 driver of portfolio allocation decisions going forward.

Blumenthal: It should always be, in my view. It's the advisor's job to make sure you do things you may not want to do. It’s like a trainer at the gym making you do some things you don't want to do, but they're good for you.

The point is that we’re at a point in this cycle where it makes sense to play more defense than offense. By doing so in a disciplined way, you can still seek growth opportunities, manage downside risk, and put yourself in a position like in 2002 or 2009 where you can take advantage of an investment opportunity.

ETF.com: Specifically, what does that allocation look like? All S&P 500 sectors are down in the past year with the exception of utilities. What should investors own in their equity sleeve?

Blumenthal: We’ve actually reduced our overall exposure to equities. We run different portfolios, but as an example, in a moderate growth portfolio, we have 30% in equities. Of that 30%, 10% is in large-cap equities, where we run a long/flat strategy on that to de-risk out of the market when needed.

We have another 10% where we do the same thing with midcap exposure. We own the Invesco S&P MidCap 400 Equal Weight ETF (EWMC). And we have 10% into a strategy that we call beta rotation. Right now, we're invested in utilities through the Vanguard Utilities ETF (VPU). It’s risk-off or risk-on based on relative strength, and we’ve moved it between utilities or the Vanguard Total Stock Market Fund (VTI).

We also have 20% in fixed income, and 50% in what we call liquid alternatives.

ETF.com: If we hit a recession, as an investor, how do you know when we’ve moved from crisis into buying opportunity?

Blumenthal: From my 34 years of experience as a trader and investment manager who also has to deal with his own emotions, you need a process to do that. It's all about having a process, and then sticking to the process.

Perhaps John Templeton said it best. The secret to his success was to buy when everybody else is selling, and to sell when everybody else is buying. Be greedy when everyone is fearful. Very few people can do that.

That said, there’s a really simple rule people could follow. If you look at the 200-day moving average—it shows the average price of the S&P 500 for the last 200 days—and it drops by 0.5% from any high watermark, you move to Treasury bills. When it moves up by 0.5% from any low mark, you trade back in. This process would have had you out of the crisis the last time, and in for the bulk of the recovery.

If you do something like this on every asset you own—have in place a rules-based process—and you are diversified, you put risk management in place.

ETF.com: What about parking cash into safe havens like gold?

Blumenthal: Same rule. Remember that everything you need to know about direction is in price behavior. I can have a fundamental view that gold makes a lot of sense because of the irresponsibility of global leaders and central bankers, but my gold signal has been in a down trend. When it moves into an up trend, I'm going to put 5% in my portfolio, maybe 10%. But right now, despite any fundamental views, gold is in a down trend.

A lot of people get really emotional about politics and really emotional about gold, but you have to ask, where's the trend?

Contact Cinthia Murphy at [email protected]

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