All Articles

Last month we advised not to get sidetracked by the spectacle of the military activities and lose sight of the major trend, which is revealed by our Diffusion Indexes. Since then, the S&P 500 rose to record highs.

We rely on the Sound Advice Diffusion Indexes (page 9) to identify business cycles because they have an accurate track record of predicting major stock market trends for the last 50+ years. They work by observing changes in the most sensitive leading and lagging economic indicators that lead to shifts in interest rates...

It has been a wild month with the first significant downdraft since last April. The Sound Advice portfolio did well in the first quarter, thanks primarily to our energy holdings and downside hedges, but the overall market did not.  It was very easy to get sidetracked by the spectacle of the military activities and lose sight of the major trends.  When the activities die down in Iran, oil prices are certain to drop, perhaps not to the low levels seen before escalations, but substantially lower than they are now...

It has been the best of times for stock market indexes. The S&P 500 Index rose 16.4 percent in 2025 because the Magnificent 7 -- Nvidia, Apple, Microsoft, Amazon, Alphabet Class A (Google Class A & C), Tesla, Meta Platforms Class A, and Broadcom – did very well and comprised 37.7 percent of the S&P 500 Index due to their heavy capitalization weighting. It was the worst of times for rest of the market. Churning and rotations undermined the other 493 stocks comprising the S&P 500 Index. Without the Magnificent 7, the Index rose only 2.9 percent.

At the end of January, the so-called Magnificent 7 reported earnings that were good, but not good enough in view of the growth expected by sky-high price earnings ratios averaging 78.5. The reactions were mixed and the group has been flat so far this year. In 2025, the Magnificent 7 -- Nvidia, Apple, Microsoft, Amazon, Alphabet Class A (Google Class A & C), Tesla, Meta Platforms Class A, and Broadcom – did very well and comprised 37.7 percent of the S&P 500 Index because of the heavy capitalization weighting.

Venezuela has the world’s largest proven oil reserves of any country in the world, even more than Saudi Arabia. Since 2007, after the prior Venezuelan president nationalized all oil assets in 2007, production has dwindled to a trickle. The surprising capture of Venezuelan President Maduro over the weekend and the prospect of changing leadership there favorably impacted our energy holdings on the following Monday market opening.

Most investors believe that the S&P 500 Index is a reliable broad measure of the stock market, but it is not. The S&P 500 is heavily weighted by 7 stocks, the so-called Magnificent 7: Nvidia, Apple, Microsoft, Amazon, Alphabet Class A (Google Class A & C), Tesla, Meta Platforms Class A, and Broadcom. The S&P 500 Index rose 16.4 percent in 2025, but without the Magnificent 7, it only rose 2.9 percent. The dramatic difference was because the S&P 500 Index weights each of the 500 stocks by their respective capitalization (shares outstanding multiplied by the price of the stock)...

There has been more consternation about this question recently and for good reasons. There is little doubt that AI will change our world, which is prompting billions of AI capital expenditures in data centers, chips, infrastructure, and AI related equipment. The stocks of the companies spending the billions are at very lofty levels sporting high price/earnings (P/E) ratios that are anticipating high earnings growth directly ahead. Yet, there is not a clear picture of when and how much of a payout will come. 

The Invesco S&P 500 Equal Weight ETF (ticker symbol RSP) is our most durable investment recommendation. This ETF invests in all the S&P 500 stocks but on an equally weighted basis and rebalances its portfolio each quarter to maintain its equal weights. This preservation of value is behind the superior performance over the traditional S&P 500 Index recently and over the long-term...

The S&P 500 Index is currently inflated and distorted by its top ten holdings, which still comprise 40.4 percent of the Index. They are Apple, Microsoft, Amazon, Nvidia, Alphabet Class A (Google Class A & C), Tesla, Meta Platforms Class A, Broadcom, Berkshire Hathaway, and JP Morgan. Because of their large capitalization, these 10 stocks are responsible for distorting the S&P 500 Index. On average, the price/earnings (P/E) ratio of these 10 stocks is 59 – an extremely high value by historical standards...

We reported last month that our Diffusion Index of Leading Indicators (page 8) recorded a zero reading, revealing that the economy has softened sufficiently to spawn a decline in interest rates. This month, we have another zero reading. The last time we have had a string of zero readings was in late 2022, which led to a new signal change from “Caution” to “Aggressive”. That signal was prescient as we began a new bull market...

Artificial Intelligence is suddenly everywhere—in headlines, in boardrooms, and increasingly, in the way businesses operate. But what does it actually mean for the economy, for jobs, and for the future we’re investing in?

To shed light on that, I’ve asked someone close to me, my son Myles Cardiff, who works directly with companies implementing AI. He has a front-row seat to how it’s being used in the real world—not just in theory—and the ripple effects it’s already creating. Here’s his perspective:

It has been an eventful year so far. Uncertainty over fluctuating tariff proposals and fluid deadlines, along with escalating tensions in the Middle East, contributed to volatility. Although the S&P 500 Index managed to grind to a new high because it is dominated by a handful of large cap stocks with astronomical price/earnings (P/E) ratios, the more representative broad market measures and most portfolios did not.

We rely on the Sound Advice Diffusion Indexes (page 8) because they have an accurate track record of predicting major stock market trends for the last 50 years. They work by observing changes in the most sensitive leading and lagging economic indicators. During “Aggressive” signals over the last 50 years, the S&P 500 climbed an average of 31.5 percent. The market has undergone corrections but has never crashed. All market crashes have occurred during “Caution” signals...

It has been the best of times and the worst of times. Since the bull market began in 2010, we have had a wide range of economic conditions, from deflation to inflation, from a near systemic collapse of the world’s financial system to exuberance. The price to earnings (P/E) ratio of the S&P 500 Index has moved over a wide range, but for more than two-thirds of the time it has been bound within a specific range. As a fundamental measure of value, P/E ratios are the key to determining the best or worst of times to invest.

At the end of March, inflation rose to an annual rate of 2.8 percent as measured by core personal consumption expenditures (CPE) which is the Federal Reserve’s favorite inflation index. It was also reported the consumer confidence fell sharply again in March, by 11.9 percent from two- February and by 28.2 percent from one year ago. With consumer spending accounting for two-thirds of the US economy, the sharp drop in consumer confidence is bound to lead to a softer economy. Of course, the market has not been happy about these trends because they portend stagflation.

Despite the broad market sell-off, our Model Portfolio held its ground and was up 1.5 percent for the first quarter, thanks to substantial profits from our downside hedges (page 3) and resilience of our energy holdings (page 5)...

New tariffs are looming for Mexico, Canada, and Europe, along with doubling tariffs on China. Increasing the cost of imported goods is bound to have an inflationary impact. The Trump Administration believes that inflationary pressures can be combated by lowering energy prices. However, that is unlikely anytime soon based on the reasons discussed in the “Special Selections in Energy” section...

On February 1, executive orders were signed imposing 25 percent tariffs on Mexico and Canada, except with a carve-out for Canadian energy products which now have a reduced tariff of 10 percent. An additional 10 percent tariff was also levied on China. These tariffs will have to be absorbed by producers or passed on to customers through higher prices. To the extent that higher prices can be passed on, the overall effect will certainly be inflationary because a wide range of products will be impacted, nearly half of all US imports....

Most investors believe that the S&P 500 Index is a reliable broad measure of the stock market, but it is not. The S&P 500 is heavily weighted by ten stocks, which were largely responsible for its 23.3 percent rise in 2024. However, without these 10 stocks, the other 490 stocks only increased by 7.3 percent, which is more representative of how the stock market actually performed in 2024...

As investors, our job is not to be political but to analyze the impact of political shifts on our investments. Most of the time, investments are immune to politics. But every now and then, a change in the Presidential Administration matters. This is one of those times.

Our Sound Advice Diffusion Index of Leading Indicators (page 10) hit zero again for September based on the latest leading economic indicators released in late October. This is significant because it reveals that the bull market is still alive and well.

We rely on the Sound Advice Diffusion Indexes because they have an accurate track record of predicting major stock market trends for the last 50 years....

In September, two significant signs surfaced revealing that the economy is slowing down: The Federal Reserve cut its primary interest rate sharply by 50 basis points, and the Conference Board’s consumer confidence index plunged by its largest one-month drop in three years.

This was not a surprise. Our Sound Advice Diffusion Indexes (page 11) have been telling us this was coming...

In last month’s issue of Sound Advice published on July 31, we explained the Salm Rule, an infallible indicator of signaling recessions since 1960, with no false alarms. We noted that if the July unemployment rate rose to 4.2 percent or higher, the Salm Rule would signal that the US economy would already be in a recession. On Friday, August 3, we sent out an email update when it was announced that the unemployment rate rose to 4.3 percent for July. According to the infallible Salm Rule, the US Economy is in a recession.

While the Salm Rule reveals when recessions occur, it does not predict the severity of recessions. Of course, it is the severity that has far-reaching implications -- for our general welfare, our businesses, and our investments.

In the final days of July, Bill Dudley, the former president of the Federal Reserve Bank of New York, warned that the Federal Reserve needs to cut rates ASAP to avoid a recession. Dudley cited the Sahm Rule as the source of his urgent concern.

The Federal Reserve of St. Louis (FRED) keeps tabs on the Sahm Rule for good reason. Indeed, it has been an infallible indicator of recessions since 1960. A screenshot is below. Every time the Sahm Rule rose above 0.50 percentage points, the economy had already entered a recession, as noted by the shaded areas. And there have not been any false alarms.

When you come to a fork in the road, take it. -- Yogi Berra

It’s no secret that the S&P 500 is dominated by seven stocks, which have become known as the “Magnificent Seven” -- Apple, Microsoft, Amazon, Nvidia, Alphabet Class A (Google Class A & C), Tesla, and Meta Platforms Class A.

Most people have the impression that the traditional S&P 500 Index is a diversified balanced index comprised of 500 stocks. However, the Index is anything but balanced. In fact, it is so unbalanced that it presents more risk than the stock market as a whole...

The Sound Advice Diffusion Indexes (page 11) have a remarkable track record of predicting major stock market trends for 50 years. All market crashes have occurred during “Caution” signals. When the stock market was not crashing, the S&P 500 either meandered, climbed moderately, or declined in an extended bear market, recording an average decline of 0.6 percent. At the beginning of 2022, we were in “Caution” mode which proved prophetic. The S&P 500 Index ended the year down 19.4 percent. As a result of heeding our caution signal and ...

The latest reading from of our Sound Advice Diffusion Indexes confirms that we are still in a bull market. This reading comes from our Diffusion Index of Leading Indicators (Page 11) which is based on the Commerce Department’s leading economic indicators.

Our Diffusion Indexes observe changes in ...

The FOMC [Federal Open Market Committee] has considerable control over short-term interest rates. We have much less influence over long-term rates, which are set in the marketplace. -- Jerome Powell, Chairman, Federal Reserve

In mid-March, the FOMC emerged from its two-day meeting without changing its short-term interest rates, the Federal Funds rate. Late last year, the market rallied on expectations of at least 5 quarter-point cuts in the Federal Funds rate, starting with the most recent March meeting. As the economy remained healthy, expectations declined to maybe 3 cuts, and then probably not until the second half of 2024. However, ...

“Risk comes from not knowing what you’re doing.” -- Warren Buffett

Risk is one of the most elusive factors in investing. Even if considered by many investors, it is not something they usually evaluate. An investment may seem risky or safe, but how do we really know?

In 1966, William F. Sharpe proposed his “reward-to-variability” ratio as part of his work on his capital asset pricing model for which he won the Nobel Prize in economics in 1990. Sharpe’s ratio became useful in analyzing reward-to-risk ratios of investments, and it is now known as the “Sharpe Ratio”.

“The four most dangerous words in investing are: this time it’s different.” -- Sir John Templeton

These are the words we hear every business cycle, but it is never different. Our Diffusion Indexes (page 11) have predicted business cycles for 49 years. The only thing that is different is the degree. All market crashes have occurred during “Caution” signals. When the stock market was not crashing, the S&P 500 either meandered, climbed moderately, or declined in an extended bear market, recording an average decline of 0.6 percent. Conversely, during “Aggressive” signals, the S&P 500 climbed an average of 31.5 percent, and the market never crashed. These have been times of declining or low interest rates, along with declining or low inflation.

“When I was young, I thought money was the most important thing in life: now that I am old, I know that it is.” – Oscar Wilde

Passive investing is appealing, especially in 2023 when the traditional S&P 500 Index climbed 24.2 percent. Investors could just sit back and watch their investment capital grow without expending any efforts to research and monitor individual stocks.

While the traditional S&P 500 Index did well in 2023, it has not been the best performing Index over the longer term.

In our November 28 e-mail update, we added two energy stocks to the portfolio. They have both reached low-points for the year with attractive dividend yields. The high and secure dividends put a floor under the stock prices and make the downside risk exceptionally low. Along with strong growth prospects, the risk/reward ratio is very favorable.

Most people have the impression that the S&P 500 Index is a diversified balanced index comprised of 500 stocks of reputable companies. Many investors prefer to invest in the Index because they believe it is safer than individual stocks. While the companies comprising the S&P 500 Index are as reputable as they come, the Index is anything but balanced. In fact, it is so unbalanced that it presents more risk than the stock market as a whole.

Each of the stocks in the Index is not weighted equally. Each is weighted according to its capitalization (the number of shares outstanding multiplied by the price of the stock). The unequal weighting has caused 7 stocks to dominate the S&P 500 Index and comprise 28 percent of the Index, as opposed to 1.8 percent if they were equally weighted.

In fact, removing these 7 stocks reveals that the balance of the S&P 500 Index is actually down 7.0 percent for the year.

History tells us that the level of interest rates is a driving force on the stock market. If we are to be successful investors, we must determine the prospects for interest rates. In the words of American philosopher George Santayana, “Those who do not remember the past are condemned to repeat it.”

Accordingly, the critical question we now face is “What is the new normal interest rate?”

We introduced 2 new recommendations to the Sound Advice Model Portfolio in our August 8 mid-issue update. We noted that we have been following and analyzing two real estate investment trusts (REITs) for many years, Hersha Hospitality Trust and RLJ Lodging Trust. We already had their preferred stocks in our Model Portfolio, paying 8+ percent income.

At the time of our August mid-issue update, the common stocks of these REITs were presenting compelling values. As you may know, an announcement was made in the final days of August to purchase Hersha Hospitality Trust at a large premium over the price of the common stock. If you acted on our advice, you would have reaped a large windfall profit. Here is our analysis and advice on what to do now.

The popular stock market averages are telling us that the market is up for the year. However, the overwhelming majority of individual stocks are not.

The S&P 500 Index is comprised of 504 stocks of reputable companies, but each of the 504 stocks is not weighted equally. Each holding is weighted according to its capitalization (the number of shares outstanding multiplied by the price of the stock). The weighted S&P 500 Index has become the standard. The weighting factors are not readily evident because it is simply referred to as the S&P 500 Index. The implication is that it is a diversified balanced index, but it is not.

The unequal weighting has caused 9 stocks to dominate the S&P 500 Index and comprise 29 percent of the Index, as opposed to 1.8 percent if they were equally weighted. The additional weighting of these 9 stocks has boosted the S&P 500 Index by 30 percent more than if each stock were evenly weighted. In fact, removing these 9 stocks reveals that the balance of the S&P 500 Index is essentially flat for the year.

A widely accepted way to invest in the stock market is to buy into an S&P 500 Index ETF, giving you a balanced diversified investment in 500 of the most established companies on Wall Street. Indeed, that has been a wise strategy in the past, but it is not right now. Although the S&P 500 Index is comprised of 504 stocks of reputable companies, each of the 504 stocks is not weighted equally. Each holding is weighted according to its capitalization (the number of shares outstanding multiplied by the price of the stock). This weighting has caused 9 stocks to dominate the S&P 500 Index and comprise 29 percent of the Index, as opposed to 1.8 percent if they were equally weighted. This means that the S&P 500 Index is not a balanced diversified investment...There is a much better alternative.

Most of us think we are long-term investors. However, that notion changes when we are faced with the threat of an immediate down-draft in stock prices. If we see a substantial correction coming, we adjust our portfolios and become short-term investors, until there is a better time to be long-term investors. There is nothing wrong with that; it is prudent.

he consensus among Wall Street pundits is that our economy is heading for a soft landing. There may not even be a recession. If there is one, it will be mild. This notion is not consistent with history. Just as the Federal Reserve was late in tightening its monetary policy to fight inflation, it will be late in fighting a recession. In fact, it is already late. We can see this from our Diffusion Indexes.

The collapse of Silicon Valley Bank rattled markets in March and brought into question the competence of regulators. There was little question regarding the incompetence of the bank’s management, which allowed the core of its capital to reside in long-term Treasury bonds that were purchased before interest rates started rising. At that time, the bank’s $21 billion bond portfolio had an average yield of 1.8 percent. Of course, the value of the portfolio dropped precipitously as rising interest rates pushed up bond yields. However, these bonds were held in a “hold to maturity account” which allowed the bank to value them at par and ignore the steep drop in value. When customer deposit withdrawals began increasing as capital dried up for its start-up and venture customers, the bank was forced to move these bonds out of that special account and devalue them to current market prices, leading to the collapse.

This is astonishing for two reasons....

It was announced in February that the annual inflation rate slowed only slightly to 6.4 percent in January from 6.5% the previous month. The slowdown was impeded by increases in the cost of shelter as well as energy with gasoline prices rising 1.5%, reversing a 1.5% decline from the previous month. This was not good news for the financial markets because stubborn inflation will prompt the Federal Reserve to continue tightening its monetary policy.

However, as long as the Federal Reserve continues to keep interest rates high in its resolve to quell inflation...

At the beginning of 2022, our Sound Advice Diffusion Index of Lagging Indicators (page11) was in “Caution” mode. Once again, this warning proved prophetic. The S&P 500 index ended the year down 19.44 percent. As a result of heeding our caution signal and positioning our holdings accordingly, the Sound Advice portfolio gained 4.02 percent in 2022.

As we began 2023, we had a completely different situation...

At the beginning of 2022, in our January 1, 2022, issue of Sound Advice, we warned “Historically low interest rates and bond yields have pumped up stock prices in 2021, but as we roll into 2022, those buoyant forces will be attenuating. By April, these forces will be gone, and the specter of rising interest rates will start haunting the markets.”

Our Sound Advice Diffusion Index of Lagging Indicators (page11) was in “Caution” mode at the beginning of 2022, and once again, this warning proved prophetic. The S&P 500 index ended the year down 19.44 percent. As a result of heeding our caution signal and positioning our holdings accordingly, the Sound Advice portfolio gained 4.02 percent in 2022.

As we begin 2023, we have a completely different situation...

For fun, let’s say that inflation abates soon, which is entirely possible when the economy cools down under the pressure of rising interest rates. If, for example, monthly increases in the consumer price index (CPI) flatten out, registering zero percent increases for a string of months, inflation would drop to zero in 12 months. That is because inflation is measured by year-over-year changes of the CPI. Inflation would drop automatically as an unchanging CPI registers continuously smaller increases each month from the readings of one year ago, finally reaching zero in 12 months.

That would be fun! The members of the Federal Reserve would rejoice as inflation drops below their target of 2 percent within 8 months. The stock and bond markets would love it too.

By contrast, it would not be fun if monthly increases in the CPI continued at 0.63 percent...

Our Sound Advice Diffusion Indexes (page 11) have had a remarkable track record over the last 47 years. During “Aggressive” signals, the S&P 500 climbed an average of 31.5 percent. In sharp contrast, all market crashes have occurred during “Caution” signals. When the stock market was not crashing, the S&P 500 either meandered, climbed moderately, or declined in an extended bear market, recording an average decrease of 0.9 percent.

We are currently in a “Caution” mode. Based on the historical reliability of our Diffusion Indexes, our next “Aggressive” signal will come when the current bear market is close to the end...

Once again, this old Wall Street axiom has proved to be a reliable guide, and still needs to be heeded.

In our January 1, 2022, issue of Sound Advice, we warned that “historically low interest rates and bond yields have pumped up stock prices in 2021, but as we roll into 2022, those buoyant forces will be attenuating. By April, these forces will be gone, and the specter of rising interest rates will start haunting the markets.”

On the last Friday of August, Chairman Jerome Powell delivered a stern commitment following the Federal Reserve’s symposium in Jackson Hole. He said that the central bank will “use our tools forcefully to attack inflation that is still running near its highest level in more than 40 years.” He went on to say, “We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%...restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy … While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

As we have been pointing out in recent issues, the US is in the grip of an economic dilemma called “stagflation” -- persistent high inflation combined with stagnant demand in a country’s economy.

At the end of July, it was announced that gross domestic product (GDP) was negative for the second quarter. Recessions are defined by two consecutive declines in real GDP, after adjusting for inflation. Because both the first and second quarters were negative, we are officially in a recession.

It is still a risky investing landscape now, and it will remain so until interest rates stop increasing. When will that be?

The S&P 500 index just completed its worst first-half performance since 1970. That is a surprising statistic, considering the numerous market crashes we have had since then. However, the fact that the market declined is not surprising. In our January 1, 2022, issue of Sound Advice, we wrote:

Until December, the Federal Reserve believed that the current inflation surge would be “transitory”. In December, Chairman Powell dropped the “transitory” idea and said that inflation has spread to areas outside supply bottlenecks. Powell said that it would not make sense to start raising interest rates while the QE program is still in force. Accordingly, the Federal Reserve sped up tapering Quantitative Easing (QE) purchases to give it the ability to begin hiking interest rates in mid-March to quell inflation.

Definition: “Persistent high inflation combined with stagnant demand in a country’s economy.”

Stagflation is an investor’s nightmare and a scenario dreaded by financial analysts and money managers alike. The overall impact is not favorable for most stocks or bonds.

In the maturing phase of a typical business cycle, a strong economy increases demand to production capacity, and then prices increase because demand is outstripping supply. Our current business cycle is different.

This time, we have “monetary” inflation, which occurs when extraordinary money supply growth is largely responsible for rising prices, rather than an overheated economy reaching production capacity. Monetary inflation...

The Federal Reserve has a difficult job ahead. It is walking a tightrope, with the fires of inflation on one side and the fears of recession on the other. The Fed is being forced to change its extremely stimulative monetary policy, which pumped up M2 (a broad measure of the money supply) by 41 percent since April 2020, the beginning of its latest quantitative easing (QE) program. To put this into context, M2 has averaged an annual growth rate of 6 percent since 1980, rarely increasing periodically by low double-digit rates.

Now that the QE program was recently stopped, the Fed must now try to arrest the inflationary spiral by raising interest rates aggressively from historic lows. It must also

Last month’s recommendation, Moderna (MRNA), has since advanced by 12 percent. The recommendation was based on the extremely low price of the stock, after its fall from $495 per share in September to below $140 per share. Behind the deflation was the consensus that revenue from Moderna’s revolutionary and highly effective messenger RNA (mRNA) Covid-19 vaccine, called Spikevax, would be declining in the years ahead. It was a classic Wall Street swing of excesses, as MRNA turned from a high-flying, over-valued speculation into an outright value proposition.

Two years ago, Moderna was still a fledgling drug research company with miniscule revenues, but Covid-19 suddenly changed the company’s fortunes. When Moderna introduced a revolutionary and effective messenger RNA (mRNA) Covid-19 vaccine to the world, Moderna became a house-hold name and a prominent industry leader. The company’s stock, with the ticker symbol MRNA, had a meteoric rise, rocketing 450 percent in 2020 and another 140 percent in 2021 to above $495 per share in September.

Since then, the wind has been whistling out of MRNA as it plunged below $140 per share recently. Behind the deflation was the consensus that

Since the first of the year, the stock market has been volatile. In the final days of January, the S&P 500 index was down as much as 9.2 percent. Last month’s issue, published on January 1, was titled The 2022 Specter which referred to the looming prospects of rising interest rates. That specter haunted the markets in January and is not going away.

Following the Federal Reserve meeting in the last week of January, Chairman Powell confirmed that the quantitative easing (QE) bond-buying program ...

The most significant force on financial markets in 2021 was the Federal Reserve’s quantitative easing (QE) program. At the rate of $80 billion per month, the Federal Reserve purchased 68 percent of all US Treasury securities issued during the government’s most recent fiscal year ending October 31, 2021.

Treasury security issuances increased in the fourth quarter as Federal deficits expanded from increased government spending, prompting larger borrowing needs...

The day after Thanksgiving, the World Health Organization (WHO) assigned the Greek letter “omicron” to a newly identified Covid variant emanating from South Africa. The WHO categorized omicron as a “variant of concern” because it has a large number of mutations, and some of these mutations have some worrying characteristics, potentially making it more transmissible, more virulent, and/or more adept at eluding vaccines. Omicron contains more than 30 mutations in the spike protein which unlocks human cells. Moreover, the “receptor binding domain”, the part of the virus that first makes contact with human cells, has 10 mutations as opposed to just two mutations in the previous delta variant. The WHO has said it will be a matter of weeks to understand how omicron may affect diagnostics, therapeutics and vaccines.

This unsettling news comes at a time when the market is vulnerable.

When the Federal Reserve declares an end to its current QE program, which is likely to be in its upcoming monthly meetings, interest rates are bound to rise.

We all know that the stock and bond markets do not fare well during times of rising interest rates. Our Diffusion Indexes reveal that fact. During “Caution” signals, the S&P 500 has either crashed, meandered, or climbed moderately, recording an average increase of 0.4 percent. This is in comparison to periods during “Aggressive” signals, when the S&P 500 climbed an average of 31 percent.

If we look through the popular stock market averages to the broader market, we can see that additional caution is being exercised by investors...

Based on favorable trends and developments, Cisco Systems (CSCO) is being added to the Sound Advice Model Portfolio. Cisco is the world’s largest manufacturer of networking switches and routers. It is considered a blue-chip high-tech stalwart that develops and manufactures networking hardware as well as software, telecommunications equipment, and other high-technology products.

One of the most reliable stock market indicators is its breadth. A healthy bull market will have broad participation among a wide range of stocks. Conversely, near major tops, participation will narrow. The largest capitalized stocks will still be rising as money managers look for places to put the onslaught of money coming to them from eager investors. Because large cap stocks carry more weight in the popular market averages, they will be hitting new highs. However, the overall breadth of the market will be declining.

It is no secret that the popular stock market indexes have been pumped up by historically low interest rates. Massive government aid and stimulus packages are adding fuel to the recovery. Meanwhile, the Federal Reserve is allowing the money supply to explode. Since the beginning of 2020, the broad measure of the money supply, M2, has increased by 33 percent. Since 1980, M2 has averaged an annual growth rate of 6 percent, rarely increasing by low double-digit rates.

Nothing is more dangerous than to assume a current trend is transitory, but that is what the majority of investment advisors are assuming about today’s surge in inflation.

They say that comparisons to pandemic figures are distorting the current inflation readings. They argue that supply shortages are temporary, and commodity prices will come down as supply increases in the months ahead. While there is some truth to that, and commodity prices have pulled back from recent highs, future year-over-year comparisons to post-pandemic readings are still bound to be higher than pre-pandemic readings. What is often forgotten is that while inflation surges may come and go, higher prices tend to be sticky. Prices don’t often come down significantly. Vendors don’t lower their prices unless faced with extraordinary conditions – like recessions. However, that is the last thing the Federal Reserve will allow in the foreseeable future. Additionally, profligate Congressional spending is quite the opposite, aimed at pumping up the economy, not slowing it down.

Consumer prices have increased 5 percent over the last year ending in May....

There is little disagreement that America’s infrastructure needs renovating. We are beginning to hear regular reports about a bridge or tunnel somewhere in the US that is failing and interfering with transportation of goods, particularly in the eastern US where bridges and tunnels are older and more obsolete.

Accordingly, one of the surest long-term investments is in the companies specializing in repairing and constructing US infrastructure pathways. Benefits flowing to these companies are also likely to be soon because the current Administration is pushing for a 10-year, government-sponsored program targeted at spending billions on rehabbing America’s infrastructure. While debates are ongoing regarding the size of the program and how to pay for it, there is common ground between parties regarding making physical renovations, and a sizeable program is bound to be emerging in the months ahead.

By holding short-term interest rates close to zero, the Federal Reserve is holding a beach ball under water.

Vaccine rollouts are reopening the economy. Massive government aid and stimulus packages are adding fuel to the recovery. Meanwhile, the Federal Reserve is allowing the money supply to explode. Since the beginning of 2020, the broad measure of the money supply, M2, has increased by 29.8 percent. Since 1980, M2 has averaged an annual growth rate of 6 percent, rarely increasing by low double-digit rates.

For centuries, there has been an undeniably strong correlation between changes in the money supply and changes in the inflation rate in developed countries...

The fifth generation (5G) of wireless technology is able to download data 100 times faster than the previous generation of 4G. This is a game-changer in today’s world of ever-increasing demand for digital streaming and massive amounts of data. This powerful new technology promises to expand the reach of the digital world, not to just faster cell phones, but to billions of other digital devices (the Internet of Things) and to artificial intelligence networks which can be scaled more readily with the power of 5G. There are three 5G investment sectors to consider that present varying amounts of risks and rewards:

We are introducing the Invesco DWA Healthcare Momentum Portfolio ETF (Ticker Symbol PTH). This is an electronically traded fund (ETF) which means it is liquid and can be bought and sold readily like a stock, unlike a mutual fund which can only be traded on the next day’s open.

PTH has been a stellar performer in recent years. It has returned 24 percent annually for the last five years, 31 percent annually for the last three years, and 67 percent during the past year. PTH has resoundingly out-performed the S&P Healthcare Index which has grown 11.6 percent for the last five years, 13.4 percent for the last three years, and 15.9 percent during the past year.

The economic landscape is changing dramatically. Vaccine rollouts, however bumpy, will be reopening the economy in 2021, aided by the government’s massive aid and stimulus packages. Meanwhile, the Federal Reserve will be holding short-term interest rates down to zero and buying massive amounts of Treasury bonds to finance a burgeoning Federal deficit while allowing the money supply to explode. The basic materials sector will be a prime beneficiary.

Despite the worst first quarter in history, the popular stock market indexes closed out 2020 at all-time highs, dominated by the so-called “Stay-at-Home” stocks because of their large capitalization and heavy weighting in those indexes. These are the FANGMA stocks – Facebook, Amazon, Netflix, Google, Microsoft, and Apple. The rise in these six stocks brought their price/earnings ratios to an astronomical 60 on average. However, most portfolios under-performed the popular averages in 2020 because they did not contain such an unreasonable weighting of these six stocks.

When the extremely effective vaccines were announced in early November, the stratification of the market became apparent. A huge rotation began out of the bloated Stay-at-Home stocks and into stocks that had been languishing and were offering better value propositions. Being value-oriented, the Sound Advice model portfolio was a beneficiary of that rotation, with a strong performance since early November.

Does this mean 2021 will be a good year for the stock market? Yes, and no.

Our Sound Advice Model Portfolio did very well in November. Our strongest gain of 39 percent came from oil refiner Valero (VLO). In second place was a gain of 36 percent from NCR, the leading provider of retail point of sale machines. In third place was a gain of 27 percent from our Hersha Hospitality preferred. JP Morgan climbed 20 percent. Our RTP preferred stock, whose company owns retail malls, rose 15 percent.

The Sound Advice Model Portfolio is well positioned for either a natural recovery sponsored by vaccines or a Blue Wave (or both). Holdings are value-oriented and economically sensitive, and will benefit strongly from economic vitality regardless of the reason.

Our job as investors is not to be political. However, there are occasions when political changes impact the economic landscape, and this could be one of those times.

If Trump is re-elected, taxes are likely to remain low. He has promised a middle-class tax cut, reduced taxes on capital gains, as well as continued regulatory relief. Both candidates have pledged massive coronavirus relief bills. Trump’s stimulus plan could be implemented soon after the election if he is re-elected. Historically, the market does better if the incumbent wins, and most analysts agree that would be the case this time.

By contrast, a Biden victory will bring sweeping economic changes, so it is imperative that we prepare for that possibility.

The Sound Advice Risk Indicator (page 10) remains substantially above 2.0, revealing that the risk in the stock market is still historically high. Additionally, the Sound Advice Diffusion Index of Lagging Indicators (page 11) is still in caution mode.

In addition to the Sound Advice indicators, we can see that the market is substantially over-valued by traditional measures...Based on an average P/E of 18, the current downside risk for the S&P index is substantial. TTM operating earnings of the companies that comprise the S&P 500 index are projected to decline to $113.73 in the fourth quarter. At a P/E of 18, the S&P 500 index would be 2,047 – a drop of 39 percent below today’s level of 3,363.

At the end of August, the Federal Reserve announced an unprecedented policy shift: that it will let inflation run hotter than its traditional 2 percent limit as the economy recovers. This change has profound implications for our investing strategy.

Chairman Powell announced that the current low inflation situation can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations. As a result, policymakers would be left with little room to lower rates again during future times of economic stress.

As we all know, inflation is a stock and bond market killer because it drives up long-term interest rates. However, ...

You are not alone if you are perplexed about the recent strength in the stock market. In the midst of a spiking pandemic, mushrooming unemployment, and plunging earnings, how can the popular market indexes be climbing to new highs? We explore four primary reasons.

You are also not alone if your portfolio has not risen in accordance with popular market indexes. Unlike the S&P 500 index, it is a rare portfolio that has risen to its peak value reached earlier this year. We explain why.

The stock market has risen to its previous heights, reached prior to the introduction of the COVID-19 pandemic. Evidently, the market has been anticipating a V-shaped recovery, looking past the valley of any destruction caused by the pandemic, to a quick restoration of growth. Integral in this view is that a vaccine is around the corner, and as a result, economic activity will resume quickly at an essentially uninterrupted continuation of past growth...

GDP is still projected to contract another 12 percent in the second quarter according to the Congressional Budget Office (CBO). To put this into context, during the last recession, which was the most brutal since the Great Depression in the 1930s, GDP fell 4.3 percent from its peak in the fourth quarter of 2007 to its trough in the second quarter of 2009...

Consumer staples are those unexciting products we use every day without much thought, ranging from food, beverages (including alcohol), household goods (including cleaning supplies), hygiene products, and tobacco. These are products that people are unable (or unwilling) to remove from their budgets regardless of their financial situation. The nature of these products makes this sector defensive and much less vulnerable to recessions and bear markets.

Earnings of consumer staple stocks are expected to continue to grow or remain steady while earnings of most other stocks are crashing and expected to be even worse throughout 2020.

The market rallied off its lows in April, based primarily on hopes that injecting more money into the economy through the CARES Act would insure a speedy economic recovery. We think this confidence is misplaced.

Gross domestic product (GDP) contracted 1.2 percent in the first quarter and is projected to contract another 7.5 percent in the second quarter. To put this into context, during the last recession, which was the most brutal since the Great Depression in the 1930s, GDP fell 4.3 percent from its peak in the fourth quarter of 2007 to its trough in the second quarter of 2009.

We have been one of the few advisory services warning that the market was over-valued, and that you should be defensive while keeping a substantial amount of cash on the sidelines. Our concern was that the market was vulnerable to “an accident waiting to happen”. Of course, no one could have predicted this COVID-19 crisis, but this is the “accident”. Although we were in a defensive mode and waiting for a substantial correction, we were still surprised by the gravity of crisis and the astonishingly rapid drop in stock prices.

Projections of the ultimate number of people likely to become infected are still rising. According to a recent “worst case” projection from economists at the Federal Reserve’s St. Louis district, total employment reductions

In recent issues, we have been warning that the market was over-valued and vulnerable to “an accident waiting to happen”. Well, here it is.

In our last issue at the beginning of February, we noted that “until it is clear that containment efforts are working, the market is likely to suffer in the near term.” That certainly happened. Concerns over containing the Coronavirus (COVID-19) and the potential for slowing world-wide economic growth began to hit the market in late January and spread fear into nearly all sectors in February.

The US has become the world’s largest oil producer because shale oil producers continue to frack. Barring geopolitical events threatening other major supply sources, the added supply from US frackers is bound to keep oil prices meandering in the vicinity of current levels. This outlook has tarnished the energy sector and related stocks indiscriminately. In some cases, extraordinary values have been created.

We believe one of those is ...

As investors, we have been sailing with the wind at our back since the 2008-09 financial crisis. The Federal Reserve has been lowering interest rates and buying massive amounts of Treasury bonds through its quantitative easing (QE) programs to stimulate the economy. While it is not the Federal Reserve’s mandate to stimulate the stock and bond markets, its extraordinary monetary manipulation has effectively done that too.

However, Federal Reserve officials now agree that ....

As we all know, one of the strongest forces on the stock market is the Federal Reserve because its policies influence the level and direction of interest rates. Since the 2008-09 financial crisis, we have been investing in stocks and bonds with the wind at our back; the advantage of the so-called “Fed Put”.

A “put” option is a financial tool that offers insurance against a downward move of a given security. It allows the holder to sell (“put”) a security at a pre-determined price, even though the price of the security has dropped.

Since the 2008-09 financial crisis, the Federal Reserve has been providing insurance against a potentially falling stock market by lowering interest rates and instituting its massive bond-buying programs collectively known as quantitative easing (QE). This aggressive expansionary monetary program has become known as the “Fed Put”.

Be careful. That’s what our Sound Advice indicators are telling us. Our Sound Advice Diffusion Index of Lagging Indicators (page 11) is still giving us a Caution Signal by revealing that the economy is strong enough to put upward pressure on interest rates. Our Sound Advice Risk Indicator (page 10) remains above 2.0, revealing that it is a very high-risk time for stocks. Accordingly, our investing approach continues to be defensive.

A stock that currently fits our defensive mode, while still providing upside profit potential, is

Our Sound Advice Diffusion Index of Lagging Indicators (page 11) is still giving us a Caution Signal. It is telling us that the economy is still strong enough to put upward pressure on interest rates. Our Sound Advice Risk Indicator (page 10) remains above 2.0, revealing that it is a very high-risk time for stocks. Accordingly, our investing approach continues to be defensive.

We are not alone in our concern over the risk in the stock market. This is evidenced by the fact that traditionally defensive stocks, such as utilities and consumer staples, have become expensive as money has piled into them looking for safe harbor. It has become extremely difficult to find defensive but good values.

In our quest for defensive and safe investments that also present a good value, we are introducing two preferred stocks into the portfolio.

In August, the yield curve became inverted when long-term Treasury bond yields fell below yields on short-term bonds. Although falling bond yields are generally good for stock prices, the stock market reacted negatively because an inversion is believed to be a reliable indicator that a recession is on the horizon. Of course, recessions are bad for stocks because earnings decline and so do price/earnings ratios, giving stocks a double whammy.

Is It Different This Time?

As we celebrate the longest economic recovery in modern history, we cannot help but ask those famous last words: Is it different this time?

July saw a high watermark for stock prices. For the first time, the S&P climbed over 3,000. The exuberance of lower interest rates has been propelling stock prices. The question we constantly ask is “How high is too high?”

The way to answer this question is to look at relevant metrics within their historical contexts. We start with....

In the wake of the G-20 summit in Japan this past weekend, the Trump Administration pulled back on imposing more tariffs. As investors, our job is not to be political, but to realistically assess situations that could have a meaningful impact on our investments. The course of the trade war certainly qualifies as one of those forces.

Now that May has come and gone, last month’s analysis of the adage “Sell in May and Go Away” is proving to be appropriate again this year. The S&P 500 declined 6.5 percent in May.

In last month’s issue, we verified that since 1965, the best gains from the stock market were earned from January through April, averaging a 4.2 percent return. The second-best time is in November and December, when gains averaged 3.1 percent. Those two periods account for nearly all of the average yearly gain, leaving a scant 0.3 percent in May through October, when the market is generally stagnant or declines.

Now that May is here, the above saying comes to mind, which is based on the belief that most of the stock market gains are earned from November through April, leaving May through October when the market is generally stagnant or declines. We updated our study on this topic to determine just how accurate this saying is.

Biotech is the best performing sector in the US year to date. Over the last 15 years, biotechnology has become a major industry and the source of the world’s top breakthrough drugs. Biotech companies offer the most explosive profits in the healthcare industry. However, stocks of individual biotech companies are often volatile and can have unforeseen risks, which makes diversification essential. This diversification can be accomplished by investing in a diversified biotech electronically traded fund (ETF) investing exclusively in a portfolio of biotech companies.

We have been in Caution Mode since January 2018 when our Sound Advice Diffusion Index of Lagging Indicators (page 11) gave us a new Caution Signal.

Then our Sound Advice Risk Indicator (page 10) climbed over 2.0 in July 2018, revealing a high-risk time for stocks. After these signals, the market corrected substantially, bringing stocks down 20 percent, to the brink of a bear market.

Since the Christmas low point, the stock market has bounced back, fueled primarily by a more accommodative Federal Reserve monetary policy. We are all aware that this is the longest bull market in post-World War II history. It is only natural to be nervous that a significant decline is overdue.

Our Sound Advice Diffusion Index of Lagging Indicators (page 11) has been in Caution mode since January 2018. The Sound Advice Risk Indicator (page 10) climbed over 2.0 in July 2018 for only the sixth time in the last 123 years, revealing a high-risk time for stocks. After these signals, the market corrected substantially, bringing stocks down 20 percent, to the brink of a bear market.

Our next bull market signal will come from a zero reading from our Diffusion Index of Leading Indicators (page 11).

For the first time in nearly a decade, 2018 saw a change in the weather on Wall Street. A blustery storm arrived near the end of the year, ushering in an alarming disturbance and sending stocks hovering on the brink of a bear market. In early 2018, our Sound Advice indicators enabled us to see what was ahead for the year, and we can use them again now to project the most likely scenario ahead for 2019.

At the beginning of 2018, we advised that a storm was coming. The February 2, 2018, issue of Sound Advice was called Caution: Storm Warning. We recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction.

Exuberance was high as 2018 dawned. Corporate tax cuts, coupled with robust economic growth, were going to propel earnings to new highs, and stock prices were certain to follow. The market rallied through most of January, confirming the bull market was still alive and well. On January 25, the Conference Board released its leading and lagging economic indicators, which caused our Sound Advice Diffusion Index of Lagging Indicators (page 10) to switch to a Caution Signal. The next day, Friday, January 26, the S&P 500 peaked at 2,872.87.

Our February 2018, issue of Sound Advice was published on the following Friday, February 2, and it was called Caution: Storm Warning. We recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction. After that exuberant market close on January 26, the market was down 10 percent by April.

The best performing position in our portfolio since the last issue was the ProShares UltraShort S&P 500 (SDS), our recommended ETF that essentially short-sells the S&P 500 and acts as a hedge against our other holdings. SDS was up 14.3 percent since our last issue.

Our February 2018, issue of Sound Advice was published on Friday, February 2 (called Caution: Storm Warning). The S&P 500 closed the previous Friday, January 26, at 2,872.87. Exuberance was high because the corporate tax cuts, coupled with robust economic growth, were going to propel earnings to new highs, and stock prices were certain to follow. However, we were not optimistic. We recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction. Since that exuberant market close on January 26, the market has been volatile to say the least and is well off its peak.

We are adding Carnival Cruise Lines (CCL) to our portfolio. This stock is a good value now, especially when compared to the rest of the market. Growth prospects are strong because of the company’s dominance in the industry, efficiencies of scale, and favorable demographic trends driving a lasting increase in demand.

The Sound Advice Risk Indicator, which measures the titanic struggle between the stock market and its foremost competitor for investment dollars, real estate, remained firmly above the high-risk level of 2.0 in August. (See page 10.) This has only happened five times in the last 123 years, and it has marked the beginning of a major peak in the stock market. A brief walk through history shows just how reliable this indicator is.

It has only happened five times in the last 123 years. Now, for the sixth time since 1895, the Sound Advice Risk Indicator rose above 2.0 in July. In each of the five previous times this Risk Indicator has risen above 2.0, it has marked the beginning of a major peak in the stock market – in 1906, 1928, 1937, 1965, and 1998. Stock prices often stayed high for many months, sometimes even a couple of years. However, in all cases, a major decline or crash followed, pulling down stock prices by 50 percent or more.

Our February 2018, issue of Sound Advice was published on Friday, February 2 (called Caution: Storm Warning). The S&P 500 closed the previous Friday, January 26, at 2872.87 as exuberance was high. It was bound to be a good year. The corporate tax cuts, coupled with robust economic growth, were going to propel earnings growth to new highs, and stock prices were certain to follow. However, we were not optimistic. We recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction. Since that exuberant market close on January 26, the market has been volatile to say the least and is well off that peak.

At midnight, May 31, US tariffs went into effect for aluminum and steel products coming from Canada, Mexico, Japan, and the European Union (EU). These tariffs were enacted by the first salvo when President Trump signed the executive order on March 8. The second salvo was launched on March 22, when President Trump signed an executive memorandum to impose approximately $50 billion of regulatory tariffs on Chinese imports.

Both of these salvos were launched with a warning period before the tariffs would actually take effect. The deadline for the China tariffs will be this month. By June 15, a final list will be released of $50 billion in imports from China that would be subject to 25 percent tariffs, which are to be put in place shortly thereafter. June 30 is the date for announcing investment restrictions meant to prevent Chinese “theft” of U.S. technology.

The market closed on Friday, January 26, 2018, with the S&P 500 closing at 2872.87. Exuberance was high. The corporate tax cuts had just come into effect. Robust economic growth, combined with the tax cuts, were underscoring escalating earnings growth. 2018 was bound to be a good year.

We published our February issue on the following Friday, February 2, and recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction. Since that exuberant market close on January 26, the market has been rocky to say the least. We saw the Dow-Jones dropping 1,000 points in a single day. The market was down by 10 percent at one point and is still down more than 7 percent.

The first salvo came on March 8, when President Trump signed an executive order enacting tariffs on steel and aluminum. On Thursday, March 22, as President Trump signed an executive memorandum to impose approximately $60 billion of regulatory tariffs on Chinese imports, the Dow dropped 724 points. On the following day, China retaliated with $3 million of tariffs on selected US products, and promised more to come. The Dow dropped another 400 points. Of course, the market was terrified of a full-blown trade war.

We published our last issue of Sound Advice on Friday, February 2 (called Caution: Storm Warning) just as the market was slipping off its peak. We recommended that you should have a substantial amount of cash on the sidelines and wait for a substantial correction in the overall market to restore value to stock prices. Since then, the market has seen some breath-taking downdrafts, with the Dow dropping over 1,000 points in a single day.

Our reasoning for recommending caution came from our Sound Advice Risk Indicator (page 10); our Sound Advice Diffusion Index of Lagging Indicators (page 11); as well as the lofty level of the S&P 500 index in relation to earnings and revenues of the underlying stocks in the index.

Our Sound Advice Risk Indicator (page 10) detects the seasons that roll across the market’s landscape. Our Diffusion Indexes (page 11) detect the more visible business cycles that are the storms which we actually perceive as weather -- the bull and bear markets that fluctuate along the path of Supercycles.

In the last week of January, the Commerce Board released the latest of economic indicators. These indicators caused the Sound Advice Diffusion Index of Lagging Indicators to switch into a Caution Signal. This signal reveals that the economy is gaining enough strength to fuel a significant rise in interest rates.

At the beginning of each year, we as investors always look forward and wonder what to expect. Will the bulls stay in charge, or will the bears emerge from hibernation?

The Case for the Bulls

The bulls need the status quo to continue. This requires inflation to remain dormant, along with low interest rates that may be rising slowly but not too fast, while the Federal Reserve sells its $4 trillion Treasury bond portfolio without disrupting the bond markets. Earnings will need to continue to grow at a robust rate, by 10 percent or more. Stock prices will also need to stay relatively high in relation to earnings and sales revenue. There also cannot be any geopolitical surprises, domestic political scandals, a shift in political leadership, or significant changes in the economies of the rest of the industrialized world. Steady as she goes.

The Case for the Bears

The bears need something to interrupt the status quo for a significant correction or new bear market. At the risk of sounding like Chicken Little, a number of potential developments warrant our watchful attention.

As the market inexorably rises into new all-time high territory, we know that stock prices are high. We also know that stock prices have been rising for a long time. This bull market will be 105 months old on December 9, making it one of the longest in post World War II history. Only the bull market that ended in March, 2000, lasted longer for 113 months, which ended with a bear market that took prices down 50 percent. Are we there yet? Are stock prices too high?

The rate of inflation is perhaps the most important macro force on our investments. It directly impacts market interest rates because investors want a “real” rate of return – something above the rate of inflation. Historically, the desired real investment return has been in the vicinity of 3 percent. In addition, the Federal Reserve has a dual mandate: to maintain a stable economy with inflation close to 2 percent. When inflation heats up, the reaction will be to tighten monetary policy by raising short-term interest rates (the Federal Funds rate).

In the closing days of September, the blueprint of the long-awaited tax overhaul plan was introduced. For us as investors, our job is not to be political, but to assess the ramifications of this tax package on the stock market as a whole, and on our holdings.

Although harder to quantify, the proposed changes in personal taxes are aimed at stimulating growth and are bound to benefit corporate earnings, to at least some degree. What is easier to quantify is the impact of the reduced maximum corporate tax from 35 percent to 20 percent.

We usually shy away from hi-tech stocks, and certainly new companies with cutting edge products. While they sound interesting and exciting, it is usually just a matter of time before competition floods the market with the next, newly improved generation.

Although, Intel (INTC) is a high-tech company, it is anything but new. In fact, it is a well-established leader in micro-processing chip innovation and production. With its extensive research and development (R&D), Intel has a one to two year lead over the rest of the chip industry.

To pull the economy out of the 2008-09 melt-down, the Federal Reserve instituted three massive rounds of “Quantitative Easing” (QE) programs. These involved buying large quantities of Treasury bonds and mortgage-backed securities. As we now know, the QE programs worked. The economy was stimulated into a long and steady recovery.

In addition to pumping new money into the economy, these purchases pushed up the prices of these securities which forced their yields down. The downward pressure on bond yields and interest rates also stimulated the financial markets. Mortgage rates dropped to enticing levels. Bond prices soared, forcing bond yields to historically low levels. The stock market staged a bull market that is now 100 months old and still going strong. If it lasts for another 13 months, it will be the longest in modern history.

The S&P 500 is 25.7 times its trailing twelve month earnings. Most analysts consider this expensive. At the peak of the previous bull market in July, 2007, the trailing twelve month (TTM) price/earnings (P/E) ratio was only 18.36. It was much higher at the peak of the bull market before that, in March, 2000, when the TTM P/E was 28.31.

Actually, from an historical perspective, these trailing P/E figures are not high. It was after these bull markets peaked that P/E ratios really soared. At the bottom of the last bear market, in March, 2009, the TTM P/E on the S&P 500 was 110.37, because earnings had fallen even faster than stock prices. As the recovery took place, earnings rose faster than stock prices, squeezing the TTM P/E below 20 by February, 2010.

On June 9, the current bull market will turn 99 months old. The definition of a bull market is a continual rise without the interruption of a 20 percent decline -- which is the definition of a bear market. In the current bull market, there have been four official corrections, which are defined as a decline of at least 10 percent, but less than 20 percent.

There have been 12 bull markets in modern history (since WW II). The average length of these bull markets is 53.5 months. Our current bull market is not the longest, but is so far, a close second.

In the last week of April, the Trump Administration released an outline of its tax overhaul plan. The plan proposes to lower the corporate tax rate to 15 percent, and would include personal “business” income generated from pass-through entities, such as Sub S corporations used by small businesses. Currently, Sub S income is taxed at the higher individual tax brackets. The personal standard deduction would be increased, but nearly all itemized deductions would be eliminated except for home mortgage interest and charity donations. Some sort of border tax is being considered, especially against countries that impose tariffs on the US.Plans seem to be moving away from the GOP plan that proposed eliminating tax deductions for all costs for importing goods into the US.

“Crumbling infrastructure will be replaced with new roads, bridges, tunnels, airports and railways gleaming across our beautiful land…To launch our national rebuilding, I will be asking the Congress to approve legislation that produces a $1 trillion investment in the infrastructure of the United States — financed through both public and private capital — creating millions of new jobs.”

Trump’s recent address to the joint session of Congress sent the Dow Jones soaring 350 points the following day; led by construction and infrastructure stocks. The Trump Administration has since started working on its infrastructure plan. Gary Cohn, the ex-CEO of Goldman Sachs and now the Director of the National Economic Council, is organizing officials from 15 federal agencies and departments to identify the most urgent infrastructure projects. More than 400 shovel-ready projects have been submitted by the National Governors’ Association.

The recent strength in the stock market has been underpinned by the anticipation of corporate tax reduction. For 8 years, the Republican members of the House Ways and Means Committee have been working on their plan. On the surface there is a lot to like about the Grand Old Party’s (GOP) proposed tax plan.

The GOP plan reduces the highest corporate tax bracket from 35 to 20 percent. In addition to lowering the tax burden of US corporations, the plan lines up with the tax plans of virtually all of the US trading partners.

The top goal of President Trump’s “America First Energy Plan”, is to make the US energy independent. Here are the bullet points on his website, https://www.donaldjtrump.com/policies/energy:

Make America energy independent, create millions of new jobs, and protect clean air and clean water. We will conserve our natural habitats, reserves and resources. We will unleash an energy revolution that will bring vast new wealth to our country.

By the time you receive your next monthly issue of Sound Advice, Donald J. Trump will be the President of the United States. Our job as investors is not to be political, but to assess the ramifications to our holdings. It’s like the old good news/bad news jokes. So far, the market has only heard the good news: corporate tax cuts, infrastructure spending, deregulation, and repatriation.
Tax Cuts
Reducing the corporate tax rate has the most obvious benefits. Not only will a tax cut reduce corporate expenses, it will lower the burden of paying dividends because they are not tax deductible.

Both President Reagan and President-elect Trump had economic plans based on cutting taxes to stimulate growth. Reaganomics, as it was called, became the Tax Reform Act of 1981, which cut taxes by 3 percent of GDP. Trump’s plan, which is becoming known as Trumponomics, proposes to cut taxes by approximately 4 percent of GDP. The prospect of a boost in economic growth, along with lowering corporate taxes, has propelled the stock market to new highs since election-day.
A primary difference between the two is that Reagan’s plan was enacted

Cushing, Oklahoma, is not a tourist destination. Unless you are in the oil business, you may not have heard of it. Until the US fracking boom, it was a sleepy small town in the middle of the northern half of the state. However, these days Cushing is not sleepy anymore. Cushing is home to the largest oil hub in the US, where a spidery network of pipelines converges into a sprawling array of huge crude oil storage tanks.
It is no secret that Cushing’s oil tanks are brimming with oil. This supply overhanging the market is often cited as the reason for persistently low oil prices. However, the glut is not as large as is perceived, and in reality, there is actually not much of a glut.

Our Diffusion Index of Lagging Indicators (page 11) hit 100 percent again this month, for the fourth consecutive month. These readings tell us that the US economy is strong enough to push up interest rates. This Index is worth noting because it has warned of major past downturns in the stock market, most notably in August 1987, just before the so-called Crash of 1987; again in June 2000, as the market headed into a 50 percent dive; and then again in March 2008, just prior to the 2008-09 meltdown.
Economic strength is being confirmed again by a surge in consumer confidence. This is significant because consumer spending accounts for more than two-thirds of GDP. The September Conference Board Consumer Confidence Index jumped to 104.1 (1985=100) in September, the highest level in 9 years, after jumping to 101.1 in August from 96.7 in July.

Once again, our Diffusion Index of Lagging Indicators (page 11) hit 100 percent this month, for the third consecutive month in a row. These readings tell us that the US economy is strong enough to push up interest rates. This strength is being confirmed by the August Conference Board Consumer Confidence Index, which jumped to 101.1 (1985=100) from 96.7 in July. The latest data on US consumer spending show increases for a fourth straight month through July. This is significant because consumer spending accounts for more than two-thirds of GDP.
Our Diffusion Index of Lagging Indicators has been a very reliable indicator in the past because it has warned of major downturns in the stock market, most notably in August 1987, just before the so-called Crash of 1987; again in June 2000 as the market headed into a 50 percent dive; and then again in March 2008, just prior to the 2008-09 meltdown.

In our July 8 mid-month update, we recommended RLJ Lodging Trust (RLJ). This should prove to be a timely addition to the portfolio. In the wake of Brexit, investors are seeking investments that are normally considered safe, including utility stocks and bonds. However, the current sky-high prices of these traditional hiding places have diminished their yields and make them risky now.
One pocket of value currently being over-looked is the hospitality industry, which has a large growth in jobs recently. We already have a recommended investment in this area: Hersha Hospitality (HT), which is timely now, and offers a solid high yield with growth prospects. (See portfolio updates.)
RLJ also offers a high dividend yield of 5.6 percent which is well covered by funds from operations (FFO) of double the dividend payout. Debt is also low at less than 30 percent of assets.

Whee! What a ride. The Dow dropped 900+ points during the 2 days following the Brexit vote and then recovered 799 points during the next three days. Is Brexit a big deal or is all of this an overreaction?
Brexit is not the seed of another melt-down. In his speech addressing Parliament the day following the Brexit vote, Prime Minister (PM) David Cameron said that the UK banking system is substantially more resilient than it was before the banking crisis, with capital requirements now 10 times higher than then.
The governor of the Bank of England added that stress tests show that banks have more than enough capital and liquidity reserves to withstand a scenario worse than the one the country currently faces. And the Bank of England can make available 250 billion pounds if it needs to support banks and markets.
While not the seed of a melt-down, a withdrawal from the European Union (EU) is bound to cast a pall of uncertainty over the UK and the EU. It would mean the passport to preferential free trade would be lost. Currently, close to half of the UK’s current exports go to the EU.

Since the Sound Advice Diffusion Index of Lagging Economic Indicators gave us a “Caution” signal in May, 2015, with the S&P 500 above 2,100, the market has since been fluctuating. Aside from an occasional breath-taking downdraft, the market has essentially gone nowhere.

The crash in energy prices has been undermining inflation. At the end of its regular March meeting, Federal Reserve officials noted that inflation continued to run below target because of earlier declines in energy prices."However

The stock market is still obsessed with the price of oil. When oil goes up, so does the market. Normally the reverse is the case because the cost of energy is an operating cost for most companies, and lower oil prices means higher earnings. These days, however, the stock market views the price of oil as a barometer of the economic health of the world because stronger economies exert a higher demand for energy. To gain a better grasp on the direction of the stock market, it will help us to understand the moving parts of the oil market.
The most significant change in the landscape of the world’s oil market in recent years occurred in the US, from the fracking boom which added nearly 5 million barrels a day to world supplies. That doubled US production. To put the increase into perspective, it was half of Saudi Arabia’s output. Once the world’s largest producer by a large margin, Saudi Arabia’s 10 million barrel per day output was almost matched by US peak production. With oil prices north of $100, US fracking was profitable and it was proliferating. As an oil glut appeared, Saudi Arabia launched a price war aimed at forcing the price of oil down below the cost of fracking in order to drive US frackers out of business. Without that additional 5 million barrels per day on the world’s markets, Saudi Arabia and its OPEC allies would be back in the driver’s seat again.

“It’s tough to make predictions, especially about the future.”
--Yogi Berra
When it comes to investing, it’s all about the future, because that is what markets anticipate. Normally, this long into the expansionary phase of the business cycle, inflation would be heating up. To quote Yogi again: “The future ain’t what it used to be.”
Inflation has a powerful impact on interest rates, bond yields, currencies, as well as on the Federal Reserve’s monetary policy, and consequently, on the general direction of stock prices.

In mid-March, it was reported that US consumer prices declined by 0.2 percent, after a flat reading for January. These readings, along with soft economies around the world, lead us to believe that inflation is dead. The economies of major countries around the world are soft with little or no inflation. Consequently, interest rates are low around the world. The US Treasury bond markets are no exception, with yields hovering near historic lows.

These days, the stock market is moving in concert with the price of oil which is being seen as a refl ection of the health of the world economy. The demand for oil is governed by GDP growth, so the oil and stock markets have that parameter in common. Aside from that connection, however, oil is a separate market and is being governed by distinct and identifi able forces. The US Energy Information Administration (EIA) assembles data to gauge the global supply and demand for oil and gas, along with petroleum products. A snapshot of the world situation is summed up by the following chart.

The new year was inaugurated with the worst opening week ever. Oil dropped below $30 a barrel briefly, further rattling the stock market.
So, what could possibly be the good news?
As we noted in our January 15 email update, the drop in commodity prices is undermining inflation and will impede the Federal Reserve’s mission to normalize interest rates. That is good news for the stock market as a whole. Since then, the market has been showing signs of strength.

It was the best of times, it was the worst of times, for many stocks and industries in 2015. The market as a whole ended the year essentially the same place it began, down 0.73 percent.

As we assess the prospects for the markets for 2016, a primary consideration is the probable path for interest rates. Since our last issue, the Federal Reserve’s Federal Open Market Committee (FOMC) unanimously decided to begin normalizing interest rates at its December 16 meeting. It increased the Federal funds rate to range from 0.25 to 0.5 percent from the near zero level established 7 years ago to bail out the economy from the 2008-09 melt-down. The FOMC also voted to raise the discount rate by 0.25 percent to 1.0 percent.

Since our last issue

This is the chant heard at football games. That’s because all good football teams have a strong defense. We should always keep that in mind as investors because successful investing is achieved by defending ourselves against adverse markets. On October 28, the Federal Reserve finished its 2-day meeting. As expected, it announced that it was not going to change its current monetary stance of near-zero interest rates, which was established after the 2008-09 melt-down as an emergency measure to bail out the economy.

This is the chant heard at football games. That’s because all good football teams have a strong defense. We should always keep that in mind as investors because successful investing is achieved by defending ourselves against adverse markets. On October 28, the Federal Reserve finished its 2-day meeting. As expected, it announced that it was not going to change its current monetary stance of near-zero interest rates, which was established after the 2008-09 melt-down as an emergency measure to bail out the economy.

This is the chant heard at football games. That’s because all good football teams have a strong defense. We should always keep that in mind as investors because successful investing is achieved by defending ourselves against adverse markets. On October 28, the Federal Reserve finished its 2-day meeting. As expected, it announced that it was not going to change its current monetary stance of near-zero interest rates, which was established after the 2008-09 melt-down as an emergency measure to bail out the economy.

This is the chant heard at football games. That’s because all good football teams have a strong defense. We should always keep that in mind as investors because successful investing is achieved by defending ourselves against adverse markets. On October 28, the Federal Reserve finished its 2-day meeting. As expected, it announced that it was not going to change its current monetary stance of near-zero interest rates, which was established after the 2008-09 melt-down as an emergency measure to bail out the economy.

In our June 29, 2015, issue, with the market considerably higher than it is today, our Diffusion Index of Lagging Indicators (page 11) rose to 100 percent, and we issued a caution signal. 

We also noted that the stock market was dangerously high, based on the ratio of the total capitalization of the stock market (stock prices of all publicly traded companies multiplied by their respective amounts of shares outstanding) to the gross domestic product (GDP) of the US. At the time, this ratio was close to 1.3. This ratio rose above 1.2 in the late 1990s prior to the 2000-02 bear market that took stocks down nearly 50 percent. It also rose above 1.1 just prior to the 2008-09 bear market which took stocks down nearly 50 percent again.

Last month we pointed out the deteriorating market breadth of the stock market. We noted it was a harbinger of a vulnerable market, and indeed, the final days of August introduced some breath-taking down-drafts; the largest since the days of the 2008-09 melt-down. A healthy bull market will have broad participation among a wide range of stocks, but participation will narrow as it runs out of gas. Near major tops, the largest capitalized stocks continue rising because they are the easiest places for money managers and mutual funds to put incoming cash. This causes the popular market averages to continue rising because they are heavily weighted by the stocks of the largest companies. However, the overall breadth of the market will be deteriorating. As we graphically illustrated last month, the phenomenon has preceded major market declines, including the crashes of 2000-02 and 2008-09.

One of the most reliable stock market indicators is its breadth. A healthy bull market will have broad participation among a wide range of stocks. Conversely, near major tops, participation will narrow. The largest capitalized stocks will still be going up as money managers and mutual funds look for places to put the onslaught of money coming to them from eager investors. Because large cap stocks carry more weight in the popular market averages, they will be hitting new highs. However, the overall breadth of the market will be declining. We can measure the breadth of the market by tracking the number of stocks that advance on the New York Stock Exchange, and subtract the number that decline. By keeping a cumulative total, we construct an “advance-decline line” or ADL.

It’s like the childhood game: move when you hear “green light” and freeze when you hear “red light”. If you don’t freeze on “red light”, you are out of the game.

We rely heavily on our Diffusion Indexes (page 11) to give us green and red lights. Our Diffusion Indexes have been extremely reliable in guiding us through the major movements in stocks caused by the business cycle.

We recently had a green light from our Diffusion Index of Leading Indicators, which gave a zero reading in March, 2015. This reading revealed that the economy had softened and was providing an atmosphere for low interest rates. This reading was confirmed by the reluctance of the Federal Reserve to begin normalizing interest rates by initiating the first increase in the Federal Funds rate since they were set at zero to bail out the economy from the 2008-09 melt-down. Chair Yellen said in a recent speech: “To support taking this step, I will need to see continued improvement in labor market conditions.”

We rely heavily on our Diffusion Indexes (page 11) to guide us through the major movements in stocks caused by the business cycle. Those indexes have been reliable except when the Federal Reserve launches extraordinary monetary programs.

An obvious example has been the Federal Reserve’s quantitative easing (QE) program since the 2008-09 melt-down. The green light given by our Diffusion Index of Leading Indicators in April of 2009 was close to the bottom of the stock market. This Index signaled that the economy was soft and was providing an atmosphere for low interest rates. That signal lined up with the Federal Reserve’s initiation of its first QE program.

There have been some interesting cross-currents acting on the Treasury bond market. Just recently, long-term Treasury bond yields broke out of their 6-month trading ranges to the upside, even after the dovish comments following the Federal Reserve meeting in the final days of April. The rise is significant. Evidently, the market is anticipating something that the Federal Reserve is not.

As part of the Federal Reserve’s economic projections, each member of the Federal Open Market Committee (FOMC) makes a prediction regarding the future path of interest rates. Those predictions are plotted in the so-called “Dot Plot”, and medians are taken to formulate the Federal Reserve’s official prediction.

With oil prices down 50 percent from their peak since mid-2014, it is easy to forget that the US still imports 7.35 million barrels per day, which is 44 percent of its use, even with US oil wells pumping at their peak production levels. The US is still highly dependent on other sources of oil – whether from the Middle East or from deep water wells on ocean floors.

Over the long run, oil prices are certain to be significantly higher in the years ahead. Yet, with a chorus of pundits projecting that lower oil prices are still ahead, it is hard to determine if we have seen the lows in oil prices.

The Saudi Arabian attack on the rebels in Yemen last week caused oil prices to jump. While these geopolitical fl are-ups in the Middle East can cause spikes in the price of oil, when the disturbances end, we are left with a less emotional market where underlying fundamentals still determine the longer term path of prices.

A few days ago, Janet Yellen gave her semiannual testimony to Congress. As usual, the investment community was hanging on every word, looking for hints as to when interest rates will begin to normalize. Low interest rates have been pumping up stock and bond prices for many years, and a change in interest rate trends will change the investment landscape and impact all of our investments.

Our reliable Diffusion Index of Leading Indicators (page 11) tells us when the economy is strong enough to start pushing up interest rates. It first warned us in 2012, and then with a string of warnings in 2014. However, interest rates have remained low under the pressure of the Federal Reserve’s extremely expansionary monetary policy which began with a zero interest on the Federal funds in late 2008 to bail out the economy from the meltdown. With the economy approaching full employment, and the Federal funds rate still at zero, it is only a matter of time until the ascent of interest rates begins. The only question is when.

In late January, Mario Drahgi, the President of the European Central Bank (ECB), announced a massive quantitative easing (QE) program for the Euro zone. On a similar scale to the US QE program, the ECB will be flooding the Euro zone with €60 billion per month, beginning this March and extending to September 2016, totaling more than one trillion euros. This will have an impact on US markets in several ways.

Most importantly, Europe’s QE program will stimulate growth across Europe, just as our QE program bailed out the US economy from its 2008-09 meltdown and fueled a 6-year recovery that is still going strong. An improving Euro zone economy will assist the US recovery through increased demand for our exports.

Interest rate movements are a powerful force on the direction of the stock market. That is why the exact words in the Federal Reserve’s offi cial statements can be very important. In her statement after the mid-December meeting, Chair Janet Yellen carefully chose the word “patient” to describe the Federal Reserve’s approach to begin normalizing monetary policy by starting to raise interest rates. She said:

“Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.”

Here is how the dictionary defines “patient” when it is used as an adjective: able to accept or tolerate delays, problems, or suffering without becoming annoyed or anxious. “Be patient, your time will come”.

That is the age-old question. As bull markets rise year after year, the natural tendency is to believe that a rising market is the natural state. Even looking over the history of the market, it indeed tends to rise over the longer term. However, we all know that the market eventually gets “too high”, and a serious correction ensues. 

These corrections are very important because they erase many years of growth in our portfolios. For example, a fifty percent drop takes a 100 percent recovery, which normally takes many years, just to break even. If the drop was avoided, the 100 percent increase would double our investment capital rather than just recovering. With this in mind, it becomes evident that it is worth missing the frothy end of bull markets if it means avoiding the crashes.

That is the age-old question. As bull markets rise year after year, the natural tendency is to believe that a rising market is the natural state. Even looking over the history of the market, it indeed tends to rise over the longer term. However, we all know that the market eventually gets “too high”, and a serious correction ensues.

These corrections are very important because they erase many years of growth in our portfolios. For example, a fifty percent drop takes a 100 percent recovery, which normally takes many years, just to break even. If the drop was avoided, the 100 percent increase would double our investment capital rather than just recovering. With this in mind, it becomes evident that it is worth missing the frothy end of bull markets if it means avoiding the crashes.

For nearly 6 years, the Federal Reserve has had interest rates at emergency levels in order to bail out the economy from the 2008-09 recession. In view of the considerable economic improvement since then, the debate within the members of the Federal Reserve is heating up regarding when it will be appropriate to abandon emergency interest rates and let them rise to normal levels.

The Federal Reserve is in a quandary. On one hand, it will have to raise interest rates relatively soon as the US economy and job market continue to improve. In addition, everyone knows it is ending its massive Treasury bond buying program under the quantitative easing (QE) program which will remove the last of the support for Treasury bond prices. Moreover, the Fed has collected a large portfolio of Treasury bonds during QE, about four times normal, which it will need to sell at some point which will put upward pressure on bond yields. It is like a ticking bomb, and the longer the Fed waits to let interest rates seek normal levels, the bigger the bomb gets.

The Sound Advice Diffusion Index of Lagging Indicators gave us a “Caution” signal in May based on the latest data for March. This occurs when its underlying individual lagging economic indicators rise above their respective levels of six months earlier, providing a 100 percent reading. (See page 11.) We use this as a caution signal because it reveals that the economy is strong enough to put upward pressure on interest rates.

We have been operating under a “Caution” signal since this index hit 100% in 2012. We continued to be bullish on stocks because of the Federal Reserve’s expansive monetary policy and its Quantitative Easing program. Although we were cautious, we still earned a 25.74 percent investment return in 2013.

One problem with bull markets is that rising prices make good values harder to fi nd. In our quest, we found a mutual fund group with our orientation to value investing, the Third Avenue Funds.

Last October, we introduced the Third Avenue Real Estate Value Investor Fund (TVRVX) into our portfolio. It has led the pack of all real estate mutual funds during the last 3 years. This is still where the best real estate values can be found in a mutual fund.

Third Avenue management uses the same value-oriented approach for its other funds as well. This month we are recommending the Third Avenue Small-Cap Value Investor Fund (TVSVX) which invests in companies with small capitalizations, or “small caps” in Wall Street vernacular. This mutual fund was up 31.5 percent in 2013 and 16.5 percent in 2012.

Just after the markets broke into new high territory last week, Putin sent Russian troops into Crimea over the weekend. Monday the US stock market sold off. On Tuesday morning, Putin said there is no need for military action and there are no plans to annex the Crimean peninsula. Putin called the ousting of the Moscow-supported Ukrainian President a coup, and the current Ukrainian government unconstitutional. Putin cited the coup as the reason for the troops because the ethnic Russians living in Crimea no longer have Moscow support. The stock market responded positively and erased the losses of the previous day.

Although only one percent of US trade was with Russia last year, Ukraine is strategic to the health of the European and Asian economies, which is highly relevant to the US.

Just after we made the #1 spot in Hulbert’s 2014 Honor roll for the best track record in both up and down markets, the stock market put us to the test. The S&P 500 was down 3.6 percent in January. However, the Sound Advice portfolio was down substantially less, by 1.6 percent. We would like to have been profitable, but we held our ground better than the market.

Our Diffusion Index of Lagging Indicators (see page 11) has been telling us to be cautious since 2012. The market continued to do well throughout 2013 mainly because the Federal Reserve’s Quantitative Easing program was holding interest rates and bond yields artificially low. Although we were operating under the caution flag, we still earned 25.74 percent in 2013 from our model portfolio.

As we said in our January blog called The Great Investment Paradox

Just after we made the #1 spot in Hulbert’s 2014 Honor roll for the best track record in both up and down markets, the stock market put us to the test. The S&P 500 was down 3.6 percent in January. However, the Sound Advice portfolio was down substantially less, by 1.6 percent. We would like to have been profitable, but we held our ground better than the market.

Our Diffusion Index of Lagging Indicators (see page 11) has been telling us to be cautious since 2012. The market continued to do well throughout 2013 mainly because the Federal Reserve’s Quantitative Easing program was holding interest rates and bond yields artificially low. Although we were operating under the caution flag, we still earned 25.74 percent in 2013 from our model portfolio.

As we said in our January blog called The Great Investment Paradox

We are recommending Hersha Hospitality Trust (HT) as a timely addition to our portfolio.Hotels in general are cyclical investments and benefit strongly from an economic expansion. The timing is particularly good right now for the Hersha portfolio of hotels because the company is making substantial improvements and additions to its portfolio.

Hersha has interests in 64 hotels concentrated in its core markets of New York, Washington DC, Boston, Philadelphia, San Diego, Los Angeles and Miami. The assets are characterized as a young, high-quality portfolio of hotels in metro areas with high barriers to entry. Eighty-five percent of Hersha’s hotels are also well-branded as Hilton (27%), Intercontinental (24%), Marriott (21%), and Hyatt (13%).

Stocks hit new record highs in October despite a disappointing September jobs report. The market sees those numbers as not strong enough to force the Fed to stop its massive bond-buying and begin tapering, nor weak enough to suggest economic gloom: It’s the Goldilocks syndrome – not too hot and not too cold.

Tepid growth is bound to continue as long as the Government grid-lock hangs over the economy and brinksmanship continues until February 7, when the borrowing authority expires from the temporary extension. Once we get past this deadline and the drama, things will be different. Are the bears waiting for Goldilocks?

The bears will come eventually, but not for a while. They are going to have to wait for the economy to recover signifi cantly. Why? As long as the economy remains soft, the Federal Reserve will continue to keep interest rates low and continue its massive infusions of money into the economy through its bond-buying program. As long as the economy is not over-heating, the specter of infl ation will remain out of sight. This is a bullish scenario for the stock market. Although stocks may no longer be cheap, we must abide by the axiom “never fi ght the Fed” and ride the bull market.

Choosing the best real estate mutual fund is not easy.  There are 15+ no-load real estate funds from which to choose, and sorting them out is a project. We have done that recently, and here are the results.

The first question is: Why invest in a real estate mutual fund, and why now?

Most of the time, above average investment returns can be earned. So far, the current year happens to be an exception. However, over the last 10 years, real estate funds have outperformed the S&P 500.

 Therefore, just finding the average real estate mutual fund will likely bring you investment returns that are superior and more reliable than the stock market over the long run. Moreover, at certain times, investment returns are exceptional from real estate funds, especially the funds that perform consistently better than the averages.  We believe the months immediately ahead will be one of those times.

Mr. Bernanke’s semi-annual testimony before the House Committee on Financial Services was revealing and shed more light on the near-term path of interest rates and bond yields. Not only is this information significant for our “No-Brainers”, it lays the foundation for the future path of the stock market as well.

One new perspective was that senator after senator bid Mr. Bernanke farewell and thanked him for his service. Mr. Bernanke did not comment or react, which was a silent confirmation of the wide expectation that this was his final semiannual appearance before Congress as Fed chairman, and that he will step down in January.

While Mr. Bernanke has not offi cially said he is stepping down, he has pointed out that others “are well equipped to manage the central bank’s exit from unconventional monetary policy.” President Obama commented before the testimony that Bernanke “has been in the job longer than he intended to be”. After the testimony, an administration official said that President Obama won’t be appointing a successor until this fall. The choice appears to have narrowed to either Janet Yellen or Lawrence Summers. Yellen was the President of the San Francisco Federal Reserve from 2004 into 2010, and was one of the few Federal Reserve officials to point out the risks of subprime mortgages in 2007. She worked closely with Mr. Bernanke during the height of the financial crisis and has since been #2 at the Fed during the quantitative easing programs.

Bond prices dropped sharply in mid-June, sending yields upward, just after Mr. Bernanke said that the Federal Reserve may begin scaling back its $85 billion monthly bond purchases later this year as long as the economy continues to improve. What seemed like an obvious statement turned into a bombshell.

At the time of our May 1, 2013, Issue titled “No-Brainer Buying Opportunity”, the yield on 10-year Treasury bonds was 1.61%. The Bernanke reaction sent that yield to 2.67 percent. The yield on 30-year Treasury bond jumped over 3.6 percent from just under 2.86 percent on May 1.

Although we have been expecting bond yield to rise, as they always do after a recession, even we were surprised at the market’s sharp reaction and how much bond yields rose in a matter of days. As evidenced by statements from other Federal Reserve members aimed at calming the markets after the Bernanke bombshell, it became obvious that Fed members were also surprised at the bond market reaction.

Since the Federal Reserve started its quantitative easing program, its inventory of Treasury securities has expanded to $3.35 trillion. This compares to $879 billion six years ago in May, 2007. Federal Reserve officials have recently been debating the risks on continuing their massive quantitative easing bond-buying program for fear it will ignite future inflation or blow up asset bubbles.

Of course, the size of these holdings is raising concerns about how the Federal Reserve is going to unwind its position without disrupting the financial markets. Before the Fed can start selling Treasuries, it will need to start tapering purchases from the current program of $85 billion a month.

Recent negative economic reports undermined the markets in April. The Conference Board’s Leading Economic Indicators reported in April declined slightly for March for the first time since late last year. This was disappointing because gains have been widespread in recent months.

Negative contributions in March were from building permits, new orders, average work week in manufacturing, and initial unemployment claims. These declines offset the positive contributions from all the financial components and manufacturing new orders for both capital and consumer goods.

 In the six-month period ending in March, the composite index of Leading Economic Indicators increased 1.6 percent which is faster than the growth of 0.1 percent during the previous six months. While the most recent six-month growth rate eased somewhat, it remained in expansionary territory.

Our portfolio would benefit from more exposure to the energy sector. We believe the timing is particularly good because the demand for energy accelerates with an economic expansion. The best time to invest is when the economy is coming
out of a slump, before demand increases.

Aside from the cyclical timing, above average investment returns can be earned over the long run. Over the last 10 years, the Energy Equity Index produced an average of 14.58 percent annually while the S&P 500 produced an annual return of 7.24 percent. (See the graph on the top of page 2.)
The superior performance is due to the fact that energy is in the fabric of the economy. It takes energy to make everything, and especially large amounts to make the most vital materials and substances, such as chemicals, plastics,
and to run data centers. There is always the possibility of the added “bonus” of geopolitical disturbances threatening supplies and driving up energy prices.

The best way to add energy to your portfolio is with a diversified no-load mutual fund that specializes in picking out the best energy companies for the immediate future. Choosing the best energy mutual fund is not easy. There are 17+ no-load energy funds from which to choose, and sorting them out is a project. We have just done that, and here are the results.

Over the long run, simply finding an energy mutual fund that matches the Energy Equity Index is bound...

On February 25th, CommonWealth REIT (CWH) announced that it planned to issue up to 31 million shares to pay off some of its debt, and the stock dropped to under $16 a share. On the following day, activist investors challenged the planned offering and CWH jumped over 50 percent, closing at $24.40.
The offering fi rst drew the ire of Keith Meister, hedge-fund manager of Corvex Management, who demanded the board cease the offering, claiming that management incentives do not mesh with the creation of shareholder value.

Joining the challenge was Related Fund Management, part of the Related Companies, founded by billionaire Stephen Ross. These two activists had purchased a stake of 9.8 percent of CWH outstanding shares.

The Federal Reserve Bank of Philadelphia compiles a “Beige Book” which measures economic vitality across the US. Based on data collected for the Beige Book in December, (during the uncertainties of the Fiscal Cliff) the Federal Reserve reported  “…the twelve Federal Reserve Districts indicated that economic activity has expanded since the previous Beige Book report, with all twelve Districts characterizing the pace of growth as either modest or moderate… Economic activity across the United States expanded at either a moderate or modest pace in recent weeks with consumer spending picking up.”

Although the fourth quarter GDP was slightly negative, the list of economic indicators reported in mid-January confirmed the economic expansion in December. Industrial production rose substantially across the board including manufacturing, mining output, and utility output. Manufacturing also saw solid gains including primary metals, electronic products, motor vehicles and auto parts. Even capacity utilization inched ahead which ordinarily rises late in an economic expansion.

The Sound Advice portfolio was up 27.9 percent in 2012. This compares to 13.4 percent for the S&P 500. We have an average gain in the Sound Advice Model Portfolio of 45.8 percent based on the prices at which each stock or mutual fund was recommended.

In this Issue, we update all of our current recommendations. We begin with our “No-Brainers”, the reverse ETFs that will benefit strongly from a rise in yields on long-term Treasury bonds.  We then update all of our other recommended positions in alphabetical order.

The uncertainty over the Fiscal Cliff has given us another opportunity to invest in our “No-Brainer” ETFs at advantageous prices. We do not see much room for long-term rates to go lower -- even if we go over the Fiscal Cliff. Although an economic recovery would likely be delayed or be slower at first, the uncertainty will be over and the economy will still recover.

Even in the face of potentially going over the Fiscal Cliff, there are significant signs of strength in the economy. The S&P/Case-Shiller index, which is a three-month moving average of property values in 20 cities, increased again in September for the sixth month in a row, showing strong and persistent gains. Among the 20 cities tracked by the index, 13 posted monthly gains. There have also been recent gains in new construction, home-builder sentiment, and existing-home sales. In addition, there continues to be an increasing number of reports that homebuilders are not able to find enough lots on which to build homes in desirable areas.

The avalanche of home foreclosures that began in 2007 compromised the assets of the US banking system and undermined the entire US economy. At such climatic times, the nation’s real estate markets and the economy become tethered together, and a sustainable recovery in the economy is not possible without the sale of the bulk of the foreclosed real estate overhanging the market. 

We have seen this before in the Savings and Loan Crisis of the 1980s.  After years of loose and questionable lending practices, regulators were forced to liquidate hundreds of savings and loans and dump their foreclosed real estate onto already-depressed real estate markets. Although the crash was most severe in Texas and other energy belt areas, the damage undermined the whole US economy. However, once the inventory of real estate was sold off, the economy was able to recover once it was unfettered by the overhang.

Real estate prices not only recovered from the 1980s debacle, they boomed for decades. During a real estate crash, financing dries up which freezes building. The supply shrinks for the most desirable new homes in good locations, which lays a foundation for a strong price recovery. As the housing recovery unfolds, consumer confidence grows, and consumer spending increases, which accounts for two-thirds of the economy. That is the cycle, and today is no different.

The Budget Control Act of 2011 is scheduled to go into effect on December 31, 2012. This is what Ben Bernanke has dubbed the “fiscal cliff.” 

Along with deep automatic cuts in over 1,000 government programs, especially in defense and Medicare, the Bush tax cuts expire, and new taxes for Obama’s health care begin. Estimates range that the impact will reduce US GDP growth from 2.3 to 4 percent in 2013. If allowed to go through, it would certainly dampen growth, increase unemployment, and could push the US economy back into recession next year. The only good news is that it would cut the Federal deficit in half (as a percentage of GDP.)

Congress passed the Budget Control Act of 2011 to force themselves into cutting spending and/or increase taxes to achieve a deficit reduction of $1.2 trillion over the next 10 years. Of course, that has not happened yet. 

Although no one expects anything to happen before election-day, both presidential candidates and senior members of Congress agree that going over the cliff is irresponsible. In addition, Federal Reserve has been warning politicians not to allow the legislated cuts of the Budget Control Act of 2011 to take effect.

We have seen some volatility in our three reverse ETFs that are designed to benefit from an increase on long-term Treasury bond yields. The ETF with the most leverage, TMV with 3:1 leverage, got close to $60 a share as 30-year Treasury bond yields approached 3 percent. These ETFs have since settled back as yields pulled back, which is giving us another opportunity to invest.

It is interesting to see these ETFs in action and understand exactly how they work. Each ETF is using futures and other derivatives to match the reverse of the percentage changes in yields as measured by the 20+year index of Treasury bond yields. The ticker symbol of this index is AXTWEN. If for example the change in AXTWEN is a decline of say, 0.5 percent in a given day, TBF (the reverse ETF using no leverage) should increase by 0.5 percent. TBT, which uses 2:1 leverage, should increase by 1.0 percent. TMV, which uses 3:1 leverage, should increase by 1.5 percent. Of course, these ETFs are set up to match the reverse of the increases in AXTWEN, which will produce corresponding declines in the prices of these ETFs in accordance with prescribed leverage. These ETFs have been behaving as they should on a daily basis during the recent past few months.

If you are a European, and still have a substantial amount of your capital in Europe, you have to be worried. Not only is your currency sinking against other currencies around the world, you have to be concerned about the safety of your cash in European banks – especially because there is no European version of FDIC insurance.

These concerns have been driving capital into US Treasury securities. The yield Europeans are receiving is not of particular consequence in view of perceived safety. In fact, they are actually profiting as the dollar appreciates against the euro. This capital flight has been assisting the Federal Reserve in its Operation Twist – the massive program of purchasing of long-term Treasuries in an effort to flatten, or twist the yield curve, thus lowing interest rates on mortgages to stimulate the housing market along with the economy.

We have to go back to the depths of the 2008-9 financial crisis to find Treasury yields close to this low. That was when the entire banking system was facing systemic risks, and there was a massive

We have an investment recommendation that will be exceedingly profitable when Operation Twist begins to un-twist. This investment will benefit dramatically from rising yields on long-term Treasury bonds. “Operation Twist” has been in force since November 2008 in a huge effort to stimulate the economy. As you may know, this is the program whereby the Federal Reserve has been aggressively buying long-term Treasury bonds in order to force long-term interest rates down. With long-term interest rates low, mortgages are more affordable, and borrowing in general becomes more feasible. The name, Operation Twist, describes the impact on the yield curve. Normally, the yield curve slopes upward, reflecting low interest rates on short-term securities with higher interest rates on longer term securities. The reason for the normal shape of the yield curve is because expectations of inflation are higher the further out we look, or certainly less predictable...

For the reasons discussed in the sidebar to the left, we view the recent correction as a buying opportunity. It is easy to get swept up in the midst of a blizzard of bad economic news. However, keep in mind that this is a correction -- and only that.

The guiding light is the fact that interest rates are historically low, as exemplified by the incredibly low yield on 10-year Treasury bonds. Low interest rates mean that the primary trend is up. It is as simple as that.

Here is a progress report on our current recommendations. We begin with our stock recommendations (in alphabetical order), and then the mutual funds.

The Sound Advice portfolio is up 17.9% so far this year, compared to the 11.5% rise in the S&P500. Twenty of the 24 Sound Advice model portfolio positions are up, two are unchanged, and two are down slightly.  We have an average gain of 38.8% based on the prices at which each stock or mutual fund was recommended.  See page 4 for a progress report on each of our recommendations.

New subscribers often ask how to approach investing in the portfolio recommendations. If you are investing in the entire portfolio, we recommend spreading allocations evenly. When we recommend adding to your position, then add the same dollar amount you first invested.

If you are picking and choosing, we advise focusing on the sector of the portfolio that matches your investment objectives; income with growth, diversified growth, energy/natural resources, or aggressive...

So far this year, the Sound Advice portfolio is up 12.3 percent.  We have had some help, a tailwind from the rise in the overall market of 9 percent (as measured by the S&P 500). Twenty-two of the 26 Sound Advice model portfolio positions are up, two are essentially unchanged, and two are down slightly.  We have an average gain of 31% based on the prices at which each stock or mutual fund was recommended. See pages 5, 6, and 7 for a progress report on each of our recommendations.

So far this year, the Sound Advice portfolio is up 15.4%, more than double the 6.7% rise in the S&P500. Twenty of the 26 Sound Advice model portfolio positions are up (14 by 10% or more), four are essentially unchanged, and two are down slightly.  We have an average gain of 33% based on the price at which each stock or mutual fund was recommended.

We dedicated last month’s Issue (Sound Advice, January 5, 2012), to the concerns we had about Europe, and the dampening effect it will have on the US and the rest of the world.

The European Financial Stability Fund (EFSF) has been established to help the weakest countries and their banks. However, we pointed out that the majority of the EFSF is capitalized by the weakest countries.  Italy is 17.8% of the EFSF. Adding Greece (2.8%), Ireland (1.6%), and Portugal (2.5%) brings the total from countries in critical mass to...