Expect Selling This Week, and Harvard Gets Defensive

Written by Dennis Slothower
Posted May 9, 2017 at 7:58PM

Heading into France’s runoff election last weekend, all the major indexes closed in the black.

For the week, the larger-cap indexes managed to rise to the top of a sideways trading channel while the small-cap stocks showed another distinct downward trend developing:

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Notice how the smaller-cap index (Russell 2000) shows a distinct downward trend following the central bank intervention during the initial French elections.

Even the larger-cap Dow managed to drift negative in the last two weeks, with the exception of a strong advance on Friday to the top of the most recent sideways trading channel.

It is important to note that the runoff election in France probably justified the action by the central banks to inject more liquidity into equities and expand bank balance sheets to keep prices up and fend off panic selling.

But what we may likely see instead of intervention support, which has been expected and was demonstrated on Friday, is that the banks may deploy “buy the rumor and sell the fact” with the election of Macron.

We noted the following sell-off in the Eurodollar when it became clear the Macron was going to win:

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Typically, when the Eurodollar rises, U.S. equities rise and when the Eurodollar falls, U.S. equities fall. This suggests that we may see selling this coming week — by the banking cartel as well as the general public.

An Almost Perfect Jobs Report with a Big Blemish

Friday gave us another great jobs report, as the Labor Department reported that non-farm payrolls jumped by 211,00 new jobs in April versus expectations by economists of 185,000 new jobs.

Along with the impressive jobs numbers we also saw the unemployment rate drop to an essentially “full employment” level at 4.4% versus expectations of another tick upward to 4.6%. The last time the unemployment rate was this low was in 2007, just before the Great Recession of 2008.

The market would normally rally hard on this improvement. But everyone who uses their head for thinking knows that this better-than-expected data will likely force the Federal Reserve to hike rates again in its June FOMC meetings.

In fact, this report was so good, the Fed now has ammunition to hike a bit more than the minimal 25 basis points that has been its hike du jour for the last three hikes.

And this is also precisely why we may see selling take on greater momentum heading into summer. The Fed is targeting a serious tightening phase as the fiscal policies of the new Trump administration run into headwind after headwind — from Democrats and from Republicans.

Bottom line, the banked-on stimulus measures from the Trump fiscal stimulus measures may not ever see the light of day without more Republicans in the Senate.

All in all, this just demonstrates the overvalued status of equities just as the real economy shows a tightening effect from the Federal Reserve’s tightening policy.

But the even bigger pimple in this jobs report was the direction of wages — down! When you have essentially full employment there is normally competition for workers and an inducement by employers via higher wages.

We are not seeing higher wages, even in this almost perfect jobs report, where the annual rate of growth in average hourly employee earnings slowed to 2.5% in April from 2.6% in March.

Part of the explanation for this divergence is that the larger percentage of new jobs continues to be in the service sector, i.e., waiters and waitresses in the food industry rather than white collar and manufacturing jobs.

Another problem with the low wage divergence is the simple fact that Obamacare remains in place, where small employers are constrained to have only 50 employees or commit to high-cost group health insurance. This also means that employees throughout the nation continue to have rising health care premiums, higher deductibles, and no sure change in sight that would make things better, despite the fact the House managed to finally pass a weak bill to improve/replace the current Obamacare system. Too much money is being diverted from consumer discretionary spending and is being forced by the government into health care.

These are ugly blemishes on what would otherwise be a jobs report that might signal a healthy economy. The economy is not healthy and these simple blemishes will likely become chronic infections that will help take our economy back into recession, much like what happened in 2008.

Harvard Endowment Not Ignoring Warnings This Time

We see in today’s news that the Harvard Endowment, which manages $36 billion in assets, is selling $2.5 billion in private equity, venture capital, and real estate investments. These are not easy things to sell should a recession hit, so reducing illiquid assets is a defensive maneuver, as we’ve been seeing many financial institutions do recently.

What a history Harvard has with this Endowment.

Under the management of Jack Meyer, the Harvard Endowment grew from $4.7 billion in 1990 to $25.9 billion in the fall of 2005, when Meyer left. At that time the Harvard Endowment was the largest endowment in the world.

One of the successes of Meyer as a manager was how he managed the Endowment during bear markets. For example, the S&P 500 fell -10.14% in 2000, -13.04% in 2001, and -23.37% in 2002 in the dotcom recession.

The Harvard Endowment was up +32.2% in 2000, -2.7% in 2001, and only lost -0.5% in 2002 compared to the -23.37% in 2002.

In 1994, the S&P 500 suffered a minor recession and was down -1.54%, but Meyer’s endowment was up +9.8% in this lackluster year.

In the recession of 1990, the S&P 500 fell -6.56% but the Harvard Endowment was up +7.5%.

What was behind Meyer's success? Jack Meyer used active money management rather than passive money management. To protect his portfolio, Meyer used diversification but more importantly, he used a simple buy rule: Buy when the S&P 500 monthly was above its 10-month smoothed moving average. Sell and move entirely to cash when the S&P 500 monthly price fell below its 10-month moving average.

In July 2001, economist Lawrence Summers, having served in the Clinton administration as the Secretary of Treasury, became the 27th president of Harvard and he objected to the way Harvard was handling its cash account. Summers pushed to have it all invested, including the general operating account.

Despite warnings from Meyer, Harvard Management Chief for 15 years, Summers felt the cash risk was worth taking. Meyer left Harvard after clashing with Summers. In a vote of no-confidence by Harvard’s faculty, Summers then resigned.

Then the stock market crashed in 2008 and Harvard lost 27% of its $37 billion endowment in 2008!

The moral of this story is not Harvard, Jack Meyer, or Larry Summers. The moral of this story is that under Jack Meyer Harvard’s endowment had a risk management strategy to defend against the damages of bear markets, but when Meyer left Harvard, the endowment no longer had a strategy to defend itself against bear markets.

Whether it is the 10-month SMA or the death cross of the 50-day crossing through the 200-day moving averages, investors need to decide ahead of the next recession how they want to approach investing.

An investor can raise cash by selling the most vulnerable components of one’s portfolio, selling those corporations most vulnerable in a recession, or allocating to the best value and most liquid as many institutions did today with Apple (up $4.05 a share to $153.01), but these are all defensive maneuvers.


To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Wall Street Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club and Wall Street Underground Profits. For more about Dennis, check out his editor page.

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