Archive for the ‘Analysis’ Category

July ChartBook – Trend Indicators, Relative Performance & Top Momentum ETFs And Stocks

Monday, July 30th, 2018

Some of the information in this post:

  • Intermediate trend indication for 45 key asset categories.
  • S&P 1500 Net Buying Pressure.
  • Compare relative performance (momentum) of sectors, regions, countries, mkt-cap, styles, factors.
  • Identify leading relative performance stocks and ETFs.

This week I’m sharing with you a chart book that I put together for myself periodically to attempt a wide-angle view of markets. You may find bits of it here and there interesting, or the basis of questions you would like to discuss. The chart book contains chart and table data only and is color-coded in most places to be data visualization friendly as you scroll through the pages.

You can download the chart book here.

Important Note: This ChartBook focuses on relative performance and chart patterns, and does not consider thematic issues, forward earnings or revenue forecasts, valuation or company fundamentals or credit rating. Those are important factors that should be evaluated before any of the securities identified in this ChartBook are purchased. Relative performance is not a substitution for strategic allocation, and may not be a suitable subject matter for many investors. It may be useful to those with tactical ranges within their strategic allocation, or those seeking to make security substitutions within their allocation based on relative performance, or those operating a short-term tactical sleeve within their portfolio. Do additional research on any security listed here before purchase. These are not recommendations. They are filtered observations of performance over the past 12, 6, 3 and 1 months. This is an investment decision aid, not an investment decision solution.

Based on relative price performance to the S&P 500, this ChartBook identifies small-cap and large-cap growth as leading performance categories among mkt-cap, style, factors, and dividend approaches, as represented by these ETFs:

IJR, RPG

Based on relative price performance to the S&P 500, this ChartBook identifies the outperforming US sectors, as represented by these ETFs:

XLY, XLK, VCR, VGT

Based on relative price performance to the US Aggregate Bond index, this ChartBook identifies no favorable ETF categories. Note that ultra-short-term, investment grade, floating rate debts, tend to have minimal price fluctuation, but competitive total returns in a rising rate environment. That means that securities such as these might be considered as outperformers:

BIL, FLRN and FLOT

Based on relative price performance to the S&P 500, this ChartBook identifies none of the top 10 developed markets countries and none of the top 10 emerging market countries, nor the world, total international, Europe, emerging markets or frontier markets as outperforming.

Based on relative price performance, a minimum cumulative total return and visual chart pattern inspection, this ChartBook identifies these 12 ETFs as outperforming:

FDN, FINX, IBUY, IGM, IGV, IHI, IJT, PSCH, SKYY, SLYG, VGT, XHE

Based on relative price performance, a higher minimum total return than for ETFs, and visual chart pattern inspection, this ChartBook identifies these 11 members of the S&P 100 as outperforming:

AAPL, AMZN, BA, COP, COST, GOOG, GOOGL, MA, MSFT, UNH, V

Based on relative price performance, a higher minimum total return than for members of the S&P 100, possession of both quality and value attributes (as defined by Vanguard in their VFMF multifactor ETF) and visual chart pattern inspection, this ChartBook identifies these 12 stocks as outperforming:

ADBE, ALGN, CECO,CPRT, CWST, INGN, MED, NSP, TTGT, VRNS, WCG, WWE

Based on relative price performance, a lower minimum total return than for S&P 100 stocks, and visual chart pattern inspection, this ChartBook identifies these 12 quality dividend stocks (as defined by Northern Trust in their QDF quality dividend ETF) as outperforming:

AAPL, BA, BR, CDW, FIS, MSFT, NTAP, SSNC, TSS, UNH, UNP, V

 

A panoramic data document like this ChartBook is intended to not only give a wide perspective on the markets, but also to help unusual or abnormal data to stand out. Scroll through the pages to see what may be of interest to you.

To give you a starting point of reference on many of the pages here are some comments by page number. The comments are not complete, They may help you get into the data on each page .

  • Page 2 – Yield Curve: the yield spread between short-term rates and intermediate-term rates is compressing rapidly but still positive; and in the past when shorter-term rates become larger than longer-term rates it has signaled a coming recession and the decline in stock prices. We aren’t there yet, but this is a risk factor to be closely watched.
  • Page 3 – Forward Earnings Estimates: the 20% earnings growth rate expected for 2018 contrasts with the 10% earnings growth rate projected for 2019. The growth rate for 2018 is exceptional, and is partly due to a quantum, one-time increase in corporate profits due to recent tax legislation. Slower growth in 2019 may cause some compression of price-earnings multiples
  • Page 4 – PEG ratios (price earnings ratio divided by five year forecasted earnings growth rate) appear to be most attractive for Consumer Cyclicals among large-cap, mid-cap and small-cap US stocks; and you will see on page 19 that they show favorable momentum as well; but on page 5 they look a bit expensive versus historical valuations.
  • Page 5 – telecommunications services looks inexpensive, but in September that sector will be redefined as Communication Services and will include some stocks from Consumer Discretionary and from Information Technology, so those numbers really aren’t useful now. If we’re lucky analysts will restate history based upon the reconfigured sectors sometime later this year.
  • Page 6 -US stocks are in good trend condition as are international stocks overall, but Europe is wavering and emerging markets are down (as are real estate and gold). Even though the China ETF MCHI is still in an intermediate uptrend, you will see later on page 14 that the overall China market is doing poorly, and the larger-cap stocks represented by the ETF have broken down on a daily chart basis.
  • Page 7 -shows fundamental data for key equity categories revealing more attractive price to cash flow multiples for foreign stocks versus domestic stocks as well as higher yields: and it shows better Sharpe Ratios (basically return divided by volatility) for minimum volatility and momentum factor funds, and attractive ROE levels for quality minimum volatility and momentum factor funds.
  • Page 8 – taxable bonds are all in downtrends and some municipal bonds are not trending upward or are wavering.
  • Page 9 – Some bond categories show extraordinary interest rate risk as evidenced by the duration being substantially larger than the yield. As a rule of thumb, if the interest rate on the fund rises by 1% over a short period of time, the price will decline by the duration times the change in interest rate. Long-term government bonds are less than 3% and have more than 17 years of duration – dangerous. Long-term corporate’s pay less than 5% and have almost 14 years of duration – also dangerous in this time of rising Federal Reserve rates, rising GDP, and rising inflation.
  • Page 10 – S&P 1500 Buying and Selling pressure: net buying pressure began to decrease in the beginning of 2017 and has become flat to negative this year. It is a divergence from the rise in stock prices during that time. This is a cautionary sign. The indicator measures the total amount of money flowing through rising stocks divided by the total amount of money flowing through all stocks.
  • Page 11 – the percentage of stocks in Correction, Bear or Severe Bear have been in rough synchrony with price movements of the Standard & Poor’s 1500 stocks since 2017, and no particular signal is generated there.
  • Page 12 – the percentage of stocks within 2% of their high is in a normal range and is acting in synchrony with stock prices. There is no signal there.
  • Page 13 – the percentage of stocks above their 200-day moving average is at a healthy level, continuing to support rising stock prices.
  • Page 14 – breath is best in the USA, second-best at okay levels in Europe. Japan is in a week third place. Larger China market is doing badly with the median stock off more than 30% from its high, and 90% in a Correction and 75% in a Bear or worse. The chart below the table, however, shows the effect of what is called “sequence risk”. Someone who invested in China a year ago is doing okay, but someone who invested at the beginning of this year is doing very badly. The intermediate trend for China shown on page 6 is still positive, but a detailed review of the chart shows that it is near a turning point, and this daily chart on page 14 reveals that breakdown more clearly.
  •  Page 15 – looking at stocks in terms of regions, market-cap, style, factors, dividends and real assets; only small-cap and large-cap growth show good price momentum, as indicated by the light green shading on the symbol and name
  • Page 17 – looking at bonds only T-Bills and ultra-short-term investment grade floating rate bonds show price behavior that is positive. Note these are price returns , not total returns. The total return on US investment grade ultra-short-term floating rate bonds is higher than for T-bills. We have effectively shifted virtually all of our bond allocation to ultra-short-term investment grade floating rate bonds some time ago, and expect to remain there through the Fed rate hike cycle. You can see the steady positive return of ultra-short-term investment grade floating rate bonds relative to the aggregate bond index in the middle chart in the top line of page 18.
  • Page 19 – among US sectors Technology has the strongest price momentum, even though the last week was tough for some. Consumer Discretionary sectors also have good momentum.
  • Page 21 – none of the top 10 Developed market countries or top 10 Emerging market countries have favorable price momentum.
  • Page 23 – there are some ETF’s with favorable price momentum. They are primarily found in the Technology and Healthcare sectors.
  • Page 25 – less than 15% of the Standard & Poor’s 100 stocks have good price momentum, and they come from various sectors
  • Page 27 – within the Russell 3000 (essentially the entire US market of stocks of consequence) there are 100 or so stocks with good momentum that also have good Quality and Value characteristics. This page shows those with the largest 12 month price gains, and the following page 28 shows those that gained at least 200% over three years and have the best shape curves among those with favorable momentum.
  • Page 29 – looking at the 150+ stocks selected by Northern trust as “quality” dividend stocks, a limited number have favorable price momentum, and page 30 shows those 12 with the best shaped three-year curves among them.

 

Trend Indications for Key Asset Categories

Sunday, May 27th, 2018

Some observations:

  • Most key stock categories are in positive intermediate-term trends.
  • Only mid-cap, small-cap and micro-cap stocks are in positive short-term relative momentum trends.
  • Most key bond categories are in negative intermediate-term trends and negative short-term relative momentum trends, except for some municipal bond categories.
  • Equity REITs are in negative intermediate-term trends and short-term relative momentum trends, while gold and commodities are in positive intermediate-term trends, but gold is in a negative short-term relative momentum trend.

This letter presents these data for each of 42 key asset categories:

  • QVM Intermediate-Term Trend Indicator (and its elements)
  • QVM Short-Term Trend and Relative Momentum Indicator
  • Price Distance from moving average trend Lines over multiple periods
  • 3-year monthly charts containing the elements of the QVM Intermediate-Term Trend Indicator
  • Annualized total return spread versus total return of S&P 500 and US Aggregate Bond index
  • Short-term traditional technical ratings from BarChart.com
  • Fundamental stock and bond valuation metrics.

We produce this data regularly. It is currently available without subscription by email.  If you would like to be included in future email of this content, let us know at Info@QVMgroup.com, use subject TREND INDICATORS.

QVM Monthly Intermediate Trend Indicator is positive on stocks, gold, diversified commodities and some municipal bond categories, but negative on most bonds and equity REITs. Money market funds or ultra-short-term, investment-grade debt funds are a good placeholder for the bond allocation.

(click images to enlarge)

QVM Short-Term Trend and Relative Momentum:

Rules: All securities must have a 200-day trend line higher than 1 month ago, and their price must be above the trend line; and they must have price return higher than 3-month T-Bill total return over 1 month, 3 months and 6 months.

Stocks, REITs, gold and commodities must also have higher price return than price return of SPY (the S&P 500 proxy) over 1-month, 3 months and 6 months.

Bonds must also have higher price return than price return of BND (proxy for US Aggregate Bonds) over 1-month, 3 months, and 6 months.

Table Indications Summary:

  • Mid-cap, small-cap and micro-cap stocks pass, while large-cap and mega-cap stocks do not.
  • Long-term and high yield municipal bonds pass, while other bonds do not.
  • Diversified commodities pass, while equity REITs and gold do not.

Price Distance from Moving Average Trend Lines:

The QVM Relative Momentum rules judge whether the price is above or below the 200-day trend line. This table quantifies the magnitude of the price deviation from the trend line; and the deviation from other common moving average trend lines.

Pink means the price is below the trend line. Green means it is above.

Asset Category QVM Intermediate-Term Trend Charts

These charts plot the 3-year cumulative percentage performance of each key asset category for comparability. The four elements of the QVM Intermediate-Term indicator are on each chart.

In the main panel: (1) the trend line in dashed gold, (2) the price in black, (3) the parabolic pace curve in dotted red. In the lower panel: (4) the money flow index within a 0 to 100 scale. The cumulative total return for the security is shown in the upper left corner of the main panel.

A desirable chart has (1) the leading edge of the trend line moving up; (2) the price above the trendline; (3) the price above the parabolic pace setting; and (4) the money flow index above 50. The trendline tip must be up for a security to have a 100 rating, and at least 2 of the other 3 elements must be positive. For mutual funds which do not have volume, we use RSI as a second-best alternative to money flow.

The QVM Intermediate-Term Trend indicator does not distinguish between a weakening and strengthening trend. Visual chart inspection and other indicators, such as the QVM Short-Term Trend and Relative Momentum indicator do that.

A 19-minute video explaining the indicator in more detail and providing performance of the indicator with the S&P 500 since 1901 may be accessed here.

Annualized Total Return Spread to Stock and Bond Benchmarks

This table shows the annualized total return of each security minus the annualized total return of SPY (representing the S&P 500) and BND (representing the US Aggregate Bond index) over 4 weeks, 13 weeks, 26 weeks, 1 year and 3 years.

The cells are color coded to quickly visually distinguish between better and worse performing securities.

Note the performance in the charts in the previous section is cumulative for the security. The performance in this table is the annualized performance in excess of the performance of a benchmark.

Short-Term Technical Indicators from BarChart.com

Traditional short-term technical indicators from BarChart.com see domestic stocks mildly positive, but international stocks as negative. They give a mixed mostly positive view of Treasuries, and negative on corporate bonds except for investment-grade short-term corporate bonds. The indicators have a mixed view on municipal bonds, a negative view of gold, and a positive view of equity REITs and diversified commodities.

 

Fundamental Data

These data are accessed via Morningstar and are not independently verified.

Fundamental data is not useful for understanding short-term historical or future price action but are important in the long-term.

It is a good idea to be aware of the valuation attributes of key asset categories.

 
Symbols Examined In This Post:
XLG, OEF, SPY, MDY, IJR, IWC, VLUE, QUAL, USMV MTUM, VIG, VYM, DVYE, VT, VXUS, VEA, VGK, EWJ, VWO, MCHI, FM, VGSH, VGIT, VGLT, VTIP, TIP, VCSH, VCIT, VCLT, HYG, FPE, BND, BNDX, VWOB, VWSTX, VMLTX, VWITX, VWLTX, VWAHX, VNQ, GLD, DBC

How to prepare a portfolio for war with North Korea

Thursday, August 10th, 2017

QVM Clients:

I have received some calls asking whether and how to prepare portfolios for possible war with North Korea. Whether a war is likely is beyond my capacity to respond, but whether portfolios should be prepared for extreme market conditions resulting from any number of catastrophic situations is something on which I will comment.

Let me state right out of the gate, preparing a portfolio for a generalized Black Swan or catastrophic event is prudent. We should all have a protective component of our portfolios, all of the time – more for the older of us and less for the younger of us, based in great part on the time horizon before calling on the portfolio for withdrawals. However, tailoring a portfolio against a specific catastrophic event is generally not prudent, unless you are dead certain it will happen. And in that case, everybody else is probably dead certain too, and the event would already be substantially priced into the market.

So, while I can suggest a portfolio specifically tailored for a war between the USA and North Korea, I do not recommend implementing it. Such a portfolio would not represent your long-term strategy (which should include a protective component), and if that specific event did not materialize you could find yourself way off course.

With that caveat, let’s think about what a portfolio specifically tailored for an anticipated war between the USA and North Korea.

Don’t think me cold-hearted in discussing portfolio war preparation, because the tragic death of 100’s of thousands of people, including thousands of US troops stationed in South Korea would be horrific almost beyond imagination. According to former US Defense Secretary Cohen today, North Korea could lay waste to Seoul South Korea in about 1 minute from the 10,000 artillery pieces trained on that city at all times. But some of you asked about portfolios, not human tragedy. I am not inclined to plunge into portfolio war preparation, unless an individual should prevail upon me to do so, but I am prepared to say what portfolio might fare better in the event of such a war.

So whether it is war with North Korea, or worldwide plague, or hackers shutting down our electrical grid and somehow disabling our Internet for a prolonged period; the assets that provide clear defensive protection are:

• Cash (insured bank accounts or Treasury money market funds)
• Gold (proxy: GLD)
• Treasury bonds (proxy: VGIT).

Holding any of these three assets creates a current drag on portfolio income, and with the possible exception of gold, a drag on total return. Any form of protection (like insurance) has a cost, and that cost is a lower long-term total return than a flat-out equity market exposure. Except for investors with a very long time horizon before entering the withdrawal stage, some level of cash and bonds is appropriate in any event

Now for the specific war preparation portfolio, keep these index weights in mind, which will help interpret the allocation suggestions below:

  • South Korea is almost 15% of the Emerging Markets index followed by iShares; but 0% of the index followed by Vanguard
  • South Korea is almost 5% of the non-US Developed Markets index followed by Vanguard; but 0% of the index followed by iShares
  • China is about 29% of Emerging Markets indexes
  • Taiwan is about 16% of Emerging Markets indexes
  • Hong Kong is about 3% of non-US Developed Markets indexes
  • Japan is about 21% to 23% of non-US Developed Markets indexes
  • Apple is about 4% of the S&P 500 and about 5% of the Dow Jones Industrials

Changes one might consider (excluding shorting and options) to specifically prepare for possible war with North Korea are:

  • Above target cash
  • Target or above target level gold (proxy: GLD)
  • Above target intermediate-Treasuries (proxy: VGIT)
  • Add defense industry exposure (proxy: ITA)
  • Below target Emerging Markets allocation – to reduce China, Taiwan, Hong Kong and South Korea Exposure
  • Within reduced diversified Emerging Markets allocation; Hold VWO not EEM – to eliminate South Korea Exposure
  • Within non-US Developed Markets exposure, hold EFA not VEA – to reduce South Korea Exposure
  • Possibly replace diversified non-US Developed Markets funds with Europe funds (VGK) – to reduce Japan exposure (proxy: EWJ)
  • Reduce broadly diversified US stock holdings (proxy: SPY) beyond lowered target levels, and rebuild to lowered target levels with sector funds, not including technology sector (proxy: XLK)
  • Sell single stock Apple holdings (AAPL).

Note, there may be significant non-recoverable tax costs to such a portfolio reconfiguration in regular taxable accounts. That would need to be evaluated in terms of each investor’s embedded gains, and how much of which assets are held in tax deferred or tax-exempt accounts, as well as other aspects of the investor’s general tax situation.

Why sell Apple or reduce technology sector exposure? Because, South Korea (think Samsung) is a key part of the technology supply chain (including parts for iPhones). It could take a couple of years to build replacement chip foundries to supply the needed chips for Apple, unless they could find non-Asia suppliers.

Think of the war a step farther out. China decides not to fight the USA on behalf of North Korea, but does decide the war is the perfect time to invade Taiwan to reclaim it. The USA might well be unprepared to defend Taiwan while fighting North Korea, and might accept the invasion of Taiwan in exchange for China not involving itself in the North Korea conflict. Such an invasion could further damage the technology supply chain. Then, of course, Vladimir might decide to take the rest of the Ukraine or some other land grab, which would be very hard on the Europe stock markets.

What happens after the early war stages is unknowable, but as past wars have shown, the world rebuilds, and capital continues to work. So be prepared to restore equity allocation once hostilities are clearly over and stock markets begin to recover.

There would, of course, be no option to do those things to the portfolio once a shooting war opened up, as the pricing adjustments would be near instantaneous. For myself, I am not making such drastic single scenario preparations, but rather holding some level of generally protective assets along with a diversified global equity exposure. That is what I suggest to you.

This is a quite unpleasant topic to contemplate, but to make sure we’re always thinking, this is what we can fathom at the moment, as preparation for first order effects. Where second and third order effects go, is beyond pure speculation.

 

[securities mentioned in this letter: GLD, VGIT, ITA, VWO, EEM, VEA, EFA, VGK, SPY, EWJ, XLK, AAPL]

21 Lowest and 21 Highest Cost US Large-Cap ETFs In The Current Expenses Price War

Monday, May 1st, 2017

There is a price war going on among fund sponsors with some ETFs now having expense ratios from 3 basis points to 5 basis points.

Keeping costs low is key to long-term returns generally, and specifically to index funds.

Here is a list of the 21 lowest expense ratio and 21 highest expense ratio US large-cap ETFs that have at least $100 million of assets under management.

(click image to enlarge)

2017-05-01_LowestCostAndHighestCostUS-LC_ETFs
The largest ETF (the S&P 500 tracker, SPY) is among the least expensive at 9 basis points, but more expensive than two other S&P 500 ETFs (IVV at 7 basis points, and VOO at 4 basis points).

For a $1 million position, 1 basis point amounts to $100 per year; or $200 extra return per year with IVV and $500 per year extra return with VOO.

If all you want to do is buy and hold the S&P 500, VOO probably is the most sensible approach.  On the other hand, if you want to be able to sell covered options on your S&P 500 position for income, you need to stick with SPY.

Schwab has a US large-cap and a US broad market (also large-cap) ETF at 3 basis points.

Before you know it, some very large ETFs may have zero expense ratios — it could happen.

How so?  Two things possibly:

  • Some sponsors may chose to offer “lead funds” such as a US large-cap fund at zero expense (operating at a loss) to gather assets on the assumption that if they can capture a core assets, they have a good shot at capturing other assets that are operated profitably — certainly that has been the case with money market funds for the past 8 years.
  • The combination of mega-size and revenue from securities lending should make is possible to operate at least marginally profitably on some funds to either gather assets, or compete to retain assets against others who lower fees to gather assets.  When funds lend securities, they earn a fee, which is shared partially with the manager in most cases (not shared at Vanguard).

iShares, for example keeps from 15% to 28.5% of the securities lending revenue on it funds.  If sponsors could live off of the lending revenue share alone, and also make certain competitive asset gathering or retention decisions, expense ratios on some funds could go to zero.

Here is some of what iShares published about securities lending by ETFs:

2017-05-01_ishare sec lending dist

2017-05-01_sharesLendingRev

iShareSecLending

Whether sponsors do or do not keep a share of securities lending fees, as expense ratios approach zero (and 3 basis point to 5 basis point expense ratios are approaching zero in effect), the impact of securities lending begins to have a significant effect on the tracking error of an index fund — such that on occasion the fund could outperform its benchmark even with the drag of a management fee.

Other important factors that impact tracking error include the amount of cash held for liquidity; the effectiveness of sampling if index replication is not used; and the timeliness and accuracy of rebalancing and reconstitution.

Anyway, we are approaching the time where Warren Buffet’s concern about Wall Street drag on returns, and the damage to investors, may be approaching an end for large index funds.  It is typically said that you cannot buy an index, only a fund tracking an index.  Well, they two are approaching the point of being one and the same.

Overall, the highest costs US large-cap funds, with expense ratios from 48 to 64 basis points did not do worse than the lowest costs funds.

In fact if you simply average the returns (not asset weighted), the highest cost group did a little bit better than the lowest cost group.  That was not due to better management, but to somewhat specialized large-cap strategies that did better, such as technology oriented NASDAQ exposures.

That shows that it is possible for higher fees to be justified in some cases by deviating from the broadest indexes, but that is a case-by-case situation.

If you are buying broad indexes, pay really close attention to expenses as one of the primary drivers.  For specialized funds, category relative expenses can be important, but absolute expenses may not be as important as for broad index funds.

Securities Mentioned In This Article:

SCHX, SCHB, VOO, VTI, ITOT, VV, IVV, MGC, VIG, SPY, GSLC, VUG, SCHG, MGK, IUSG, VTV, SCHD, SCHV, MGV, VYM, IUSV, FTCS, PKW, FEX, PTLC, KLD, DSI, MOAT, FTC, QQXT, QQEW, FPX, PWB, FVD, DEF, FTA, PWV, PFM, RDVY, RDIV, RWL, OUSA

 

 

 

 

 

Breadth Character of the US Stock Market

Monday, March 27th, 2017
  • Major stocks indexes still in intermediate-term up trends
  • Breadth indicators suggest problems underneath with prospect of near-term corrective move
  • Maintain current reserves in anticipation of better entry point for broad index positions

WHAT ARE BREADTH INDICATORS?:

Stock market breath indicators  measure the degree to which the price of a market-cap weighted index, such as the S&P 500 index, and the broad equal weighted market are changing in harmony — looking for “confirmation” or “divergence”. With confirmation, expect more of the same. With divergence be prepared for the path of the index to bend toward the direction of the path of the breadth indicator.

It works in a way similar  to the physical world as described in Newton’s First Law of Motion, which says that an object in motion continues in motion with the same speed and direction unless acted upon by outside force. The object is the stock index price. The force is the breath indicator.

There are multiple forces acting upon the object (the stock index), and it is the sum of those forces  that determine the speed and direction of the  index. Breadth indicators are among the more  powerful forces, because they reflect the effect of other forces (such as earnings and growth prospects and microeconomic news) on each of the index constituents separately.

Breadth indicators tend to be more effective at signaling impending market tops than market bottoms.

As more and more of the broad market issues move in the opposite the direction of the market-cap weighted stock index, the greater is the probability of reversal in the direction of the stock index.  The breath indicator represents the equal weighted broad market, which normally peaks before the market-cap weighted indexes peak..

Additionally, when breath indicators reach extreme values in the same direction as a market-cap index,  the market-cap  index is thought to be overbought or oversold, and subject to moderation back toward the moving average.

Let’s look at a few breadth indicators that we follow weekly to see what they might be suggesting at this time about the Standard & Poor’s 500.

CURRENT S&P 500 INTERMEDIATE-TERM TREND CONDITION:

First, let us stipulate that the S&P 500 is in an uptrend. Actually most major indexes around the world are currently in up trends (see a recent post documenting trends around the world).

Figure 1 shows our 4-factor  monthly intermediate-term trend indicator in the top panel in black (100 = up trend, 0 = down trend, 50 = weak or transitioning trend).  (see video explaining methodology, uses, and performance in a tactical portfolio since 1901).

FIGURE 1:

(click images to enlarge)

2017-03-27_SPY trend

 

BREADTH INDICATORS CONDITION:

Percentage of S&P 1500 In Correction, Bear or Severe Bear

We  look for divergences between the direction of the combined constituents of the S&P 1500 broad market index with the direction of the S&P 500 index.

In Figure 2, we plot the percentages of constituents  in a 10%  Correction or worse;  in a 20% Bear or worse;  and in a 30% Severe Bear or worse versus the price of the S&P 500.

This measure’s how much bad stuff is happening in the broad market.  The weekly data is a bit noisy, so we also plot the 13 week ( 3 month) average shown as a dashed line over the weekly data.

Leading up to the 2015 correction, these indicators (particularly the 10% Correction or worse indicator) gave an early warning of developing risk of a market reversal.

After the 2015 correction, those indicators continued to deteriorate, event though the &P 500 recovered; once again giving a signal that not all was well, which led to the 2016 correction.

After the 2016 correction,  those indicators improved rapidly  until the period before the 2016 election where concerns were rising. After the election, the indicators once again improved very rapidly, but now those issues in Correction, Bear  or Severe Bear  are rising again, suggesting caution about the possibility of another market reversal.

(click images to enlarge)

FIGURE 2:

2017-03-26_CBSB

Percentage of S&P 1500 Stocks Within 2% of 12-Month High:

In Figure 3, we plot the percentage of S&P 1500  constituents within 2% of their 12 month high, versus the price of the S&P 500.   This measures how much good stuff is happening in the broad market.

That breadth indicator  began to decline months before the 2015 correction and continued to decline even as the market recovered from that correction, portending the early 2016 correction.

The 13 week average turned down before the larger part of the corrective move preceding the 2016 election and rose after the election, but now it is  rising again, suggesting the possibility for a corrective move in the near term.

FIGURE 3:2017-03-26_2pct

S&P 1500 Net Buying Pressure:

Figure 4 presents another breath indicator, which recall “Net Buying Pressure”.

It measures the flow of money into rising and falling prices of the constituents of the S&P 1500 for comparison with the  direction of movement of the S&P 500  index.

The chart below plots  the Net Buying Pressure for 3 months, 6 months, and 12 months.

We multiply the price change in Dollars of each of the 1500  constituents each day, and multiply that change by the volume of shares traded each day. We sum  the negative products, and sum the positive products.     We then divide the sum of the positive products by the sum of the positive and negative products combined. If the ratio is more 50%,  that means there is more positive product than negative product, which we called Net Buying Pressure.   If the ratio is less than 50%,  that means there is less positive product than negative product, which we call Net Selling Pressure.

You can see in the chart that Net Buying Pressure began to decline in advance of correction in 2015 and continued to decline even as the index recovered before going into a second correction 2016. Since then net buying pressure has risen until just recently, when it has begun to decline again. That suggests to us trend in the S& 500  is not well supported by the broad market, and may be ready for a corrective move.

FIGURE 4:

2017-03-26_NetPressure

 

Bottom line for us is the view that the broad market foundation of US stocks is materially weakening, making the major market-cap indexes (dominated by the largest stocks) increasingly, visibly vulnerable to a material corrective price move; which suggests a better time later to commit new capital than now.

 

 

Equity Market Conditions Assessment & Portfolio Allocation Intentions 2017-03-17

Monday, March 13th, 2017

This note has three parts:

  1. Short summary of our current market view and portfolio allocation implications
  2. Bullet point outline of details behind our thinking in 5 segments (Trend, Valuation, Sentiment, Breadth, Forecasts)
  3. Supporting graphics for most of the bullet points provided in 24 charts and tables.

The short summary is of our market view and intended allocation actions for discretionary accounts, and recommended actions for coaching or “prior approval” accounts

For those of you who want a feel for why we have our market view and why we believe the allocation changes are appropriate; the bullet points will help.

If you want to see what data is behind most of the bullet points, you will want to look at the 24 supporting graphics.

There is an unfortunate need to use some jargon in the bullet points and graphics which may be unfamiliar to some of you, so please call or write in to have any of them explained; and to discuss their significance to portfolio decisions.

THE SHORT SUMMARY …………

Major world equity markets are in up trends — but there is mounting evidence that the US markets are over-extended and significantly vulnerable to a meaningful downward adjustment based on a combination of valuation, breadth, possible turmoil from key elections in Europe; and as Goldman Sachs puts it “rhetoric meets reality” in Washington.

Downside risk exists, but while the trend remains upward, we are remaining invested.  However, we are not committing additional assets from cash positions to US equity risk positions at this time (except for dollar-cost-averaging programs) due to the elevated vulnerability of the US stocks market.  We will be transferring some of the US equity risk assets in portfolios to some international markets that are in intermediate-term up trends that offer better valuation opportunities.

Portfolio changes or recommendations will be framed within the strategic allocation policy level of each client which varies based on individual needs, goals, stage of financial life, preferences, risk tolerance, and other limits or factors.

Based on valuation and long-term forecasted returns, US stocks exposures will transition from the higher end of individual portfolio policy allocations to the long-term strategic objective levels, or a bit below.  We are currently underweighted non-US developed markets and emerging markets allocations, which we will gradually raise to the long-term strategic allocations levels of each individual portfolio’s allocation policy.

Emerging markets have a more attractive valuation level than other non-US international stock markets (although they pose significantly more volatility), and allocation to them may be raised somewhat above strategic target levels within individual permitted allocation ranges.

For determination of intermediate trend status, we relay on our monthly 4-factor indicator. For more information about our trend following indicator and its performance implications, click here to see our descriptive video.

THE BULLET POINTS …………

  • TREND (see Figures 1-6): The intermediate-term stock trends are:
    • United States – UP
    • Non-US Developed Markets – UP
    • Emerging Markets – UP
  • VALUATION (see figures 7-12): Based on history:
    • United States – Expensive on Price-to-Book and Price-to-10yrAvEarnings and not expensive when earnings yield is compared to Treasury yields.  However, when rates rise the comparison will worsen, making stocks more expensive.
    • Non-US Developed Markets – Moderately expensive on Price-to-Book and moderately inexpensive on Price-to-10yrAvEarnings
    • Emerging Markets – Significantly Inexpensive on Price-to-Book and Price-to-10yrAvEarnings
  • SENTIMENT (see Figures 13-17): for US stocks are:
    • Institutional Investors – are reducing equity allocations (a Bearish indication)
    • Investment Newsletter Writers – Bullish at record high levels (a Bearish contra indication)
    • Individual Retail Investors – strongly Bearish this week but neutral last week
    • Options Market – complacent to mixed (jargon terms defined below):
      • Volatility Index – below 200-day and long-term average (complacent, expects smooth ride next 30 days)
      • Skew Index – above 200 day average and long-term trend line (nervous about possible large downside move, next 30 days)
      • Individual Equities PUT/CALL ratio – is 9% above its 200-day and its 10-year average (more cautious that institutional investors)
      • Index PUT/CALL ratio – is 7 % above 200-day average and 4% below its 10-year average (cautious but mixed signal)
  • BREADTH (see Figures 18-21) the trends are:
    • Percent of S&P 1500 stocks in Correction, Bear or Severe Bear have decidedly turned up (Bearish)
    • Percent of S&P 1500 stocks within 2% of their 12-month highs have decidedly turned down (Bearish)
    • The net flow of money is into S&P 1500 stocks over 3 month, 6 months and 1 years, but the leading edge of those flow has turned down
    • The net flow is explained by the net Buying Pressure declining substantially more than the Selling Pressure; and both measures are at levels below the 12-month average indicating reduced overall force driving the market
  • FORECASTS (see Figures 22-24):
    • “Street” consensus 2017 S&P 500 earnings growth 8.9% on revenue growth of 7.2%
    • “Street” consensus 2018 S&P 500 earnings growth of 12.0& on revenue growth of 5.1%
    • Consensus 3-5 year earnings growth for S&P 500 is 8.89%
    • Consensus 3-5 year earnings growth for MSCI non-US developed markets stocks index is 8.76%
    • Consensus 3-5 year earnings growth for MSCI emerging markets stocks index is 10.37%
    • Consensus 3-5 year earnings growth for MSCI core Europe stocks is 8.11%
    • Consensus 3-5 year earnings growth for MSCI Japan stocks is 9.43%
    • Consensus 3-5 year earnings growth for MSCI China stocks is 7.13%
    • Bank of America/Merrill Lynch just raised its 2017 S&P 500 price target from 2300 to 2450
    • Research Affiliates (leading factor based investor) forecasts 10-year real (after inflation) returns:
      • US large-cap stocks 0.7% (with 14.4% volatility)
      • US small-cap stocks 0.5% (with 19.6% volatility)
      • Non-US Developed Markets stocks 5.4% (with 17.0% volatility)
      • Emerging Markets stocks 7.0% (with 23.3% volatility)
    • GMO Bearish Mgr (lowest min fund investment $10 million available) forecasts 7-year real returns
      • US large-cap stocks – negative 3.4%
      • US small-cap stocks – negative 2.7%
      • Large International stocks – positive 0.2%
      • Emerging Market stocks – positive 4.1%
    • BlackRock (fund manager in the world) forecasts 5-year nominal returns
      • Large US stocks 4.1% (with 15.5% volatility)
      • Small US stocks 4.1% (with 18.7% volatility)
      • Large International stocks 5.5% (with 18.5% volatility)
      • Emerging Markets stocks 5.5% (with 23.3% volatility)

Options Jargon Description:

VIX: VIX is the options pricing implied volatility of the S&P 500 index over the next 30 days, based on at-the-money options

SKEW: SKEW measures the relative options “implied volatility” (essentially price) of S&P 500 out-of-the-money PUTs versus out-of-the-money CALLs with strike prices the same distance from the market price – essentially measuring the perceived “left tail risk” (tail risk is the probability of prices going below the level that is predicted by a normal probability Bell curve).

Portfolio managers are predisposed to buy PUTs for protection and sell CALLs for yield, which tends to increase out-of-the-money PUT premiums and depress out-of-the-money CALL premiums.

SKEW of 100 means the market expects equal implied volatility (essentially prices) for out-of-the money PUTs and CALLS.  SKEW greater than 100 means the market expects higher implied volatility (prices) for PUTs relative to CALLS – more perceived large downside risk.

The record low SKEW was 101.9 on March 21, 1991. The long-term average SKEW is around 115, and the high is around 150. The current 200-day average SKEW is about 130, and the current level is about 140. That means there is a heightened concern about a greater than typical risk of a large downside move in US stocks.

INDIVIDUAL EQUITIES PUT/CALL RATIO: The Equities PUT/CALL ratio is the PUTs volume divided by the CALLs volume on individual stocks. This tends to be reflection of actions by retail investors; and is often a contrary indicator.

INDEX PUT/CALL RATIO: The Index PUT/CALL ratio is also the ratio of the volume of PUTS and CALLS, but tends to be a reflection of the actions of institutional investors; and is not considered a contrary indicator.

THE SUPPORTING GRAPHICS …………

(click images to enlarge)

TREND

FIGURE 1: 
Over the past year, US stocks (VOO), non-US Developed Markets (VEA) and Emerging Markets (VWO) are generally in an up trend, although the US is way out front.

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FIGURE 2:
Over 3 years, the three regions are up, but the US is way ahead, and did not have as severe down moves as the other two regions.

As you will see the outperformance by the US is related to its current overvaluation, and the weaker performance of the other markets, is related to their more attractive valuation.
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FIGURE 3:
Our 4 factor monthly trend indicators ranks each of the three regions as in an up trend.
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FIGURE 4:
This time series of our trend indicator for the US shows the up trend established since March 2016.
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FIGURE 5:
The up trend in non-US Developed Markets was established in November 2016.
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FIGURE 6:
The up trend in Emerging Markets was established at the end of December 2016.
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VALUATION

FIGURE 7:
On price-to-book basis the US is very expensive (at the top of its 10-year range). Non-US Developed Markets are “normally” valued (at just above their median level). Emerging markets are inexpensive (price significantly below their median level).
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FIGURE 8:
In terms of the Shiller CAPE Ratio (price vs 10-year inflation adjusted average earnings), the US is very expensive relative to is long-term history. Developed Markets are inexpensive, and Emerging Markets are significantly inexpensive.
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FIGURE 9:
Based on a variety of valuation metrics the US is expensive. The Developed and Emerging Markets inexpensive by comparison.  Emerging Market have more attractive valuations than the Developed Markets.

In terms of profitability, the US is tops, which partly explains the higher valuation. Developed Markets are less profitable than Emerging Markets.

Emerging markets have competitive dividend yields and the lowest payout ratios.

Emerging markets seem to be a bit less leveraged than US stocks, and the Developed Markets are the most levered.
2017-03-13_08
VALUATION of US ALONE ….

In addition to the price-to-book and Shiller P/E to their respective histories, several other valuation metrics for the US should be considered; almost all of which suggest the market is very expensive

The “equity risk premium” [(stock earnings / price) – (10-yr Treasury yield)] is the only key valuation metric that suggest that stocks may not be overvalued; and that argument depends of the current historically low Treasury yields.

FIGURE 10:

Current equity risk premium for the 10-year inflation adjusted earnings-to-S&P 500 price is 0.90%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  That suggest modest overvaluation.

However, since the risk premium first went negative in 1964 (except for 4 months in 1929), the equity risk premium was only higher than now 30% of the time — a Bullish suggestion.

The question is whether the 135 history, or the 52 year history is the more important to consider. If the long history is more important, then the S&P 500 is somewhat expensive relative to the yield on 10-year Treasuries; but if the shorter history is more important, then the S&P 500 is inexpensive relative to Treasury yields.  However, Treasury yields are suppressed, and if they normalize to something in the 3% to 4% range before profits increase a lot, then stocks are expensive.
2017-03-13_09
FIGURE 11:
Current equity risk premium for the 12-month trailing earnings-to-S&P 500 price is 1.17%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  This also suggests moderate overvaluation.

However, since that risk premium first went negative in 1967 (except for 1 month in 1921), the equity risk premium was only higher than now 29% of the time — a Bullish indication.

The question is whether the 135 history, or the 49 year history is the more important to consider. The same logic applies as it does for the equity risk premium based on the 10-year inflation adjusted earnings yield.
2017-03-13_10
FIGURE 12:

S&P 500 GAAP earnings are not much higher than they were 4 years ago, yet the price of the index is a lot higher. That means much of the rise in the price of the index is merely paying more the what you get, not getting proportionately more for paying more.

10-year Treasury rates in 2013 more than doubled from less than 1.5% to more than 3%, yet the S&P 500 continued to rise in price faster than earnings.

Once again 10-year Treasuries have risen in 2016 from less than 1.5% to more than 2.5% and the price of the S&P 500 has continued to rise, even in the face of flat earnings, with falling earnings close behind in the rear view mirror.

If interest rates should make it to 3% in the near-term (not an unthinkable event), the equity risk premium on trailing 12-month earnings would drop from 1.17% to about 0.75%. Since 1881, the risk premium has been higher than 0.75% more than 70% of the time; and since 1967 it has been higher 64% of the time.  That would be Bearish.

This suggests valuation vulnerability in the face of probable moderate interest rate increases.

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SENTIMENT

FIGURE 13
The State Street Investors Confidence index is a behaviorally measured sentiment index — a measure of increases or decreases in public equity allocation in actual institutionally managed portfolios, a real measure of market sentiment by large institutions.

The rate of increase in their public equity risk allocations began a decline in around 2 years ago.  They began actually decreasing their public equity allocations in 2016 and continue to do so.

This is not an endorsement of current stocks markets.
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FIGURE 14:
Investors Intelligence monitors 100 leading investment newsletters to gauge the Bullish or Bearish sentiment of those writers. Extreme peaks in sentiment tend to be contrary indicators (not perfectly, of course), but when “everybody” is Bullish or Bearish, a trend is often about to be exhausted; because there are few additional people to join the point of view and bring move more money in the direction of the trend.

The current Bull-Bear spread is among the most extreme Bullishness of the last 10 years.  This suggests that a corrective action is likely nearby.

2017-03-13_13
FIGURE 15:
The American Association of Individual Investors conducts a continuous online survey of it members — essentially the retail investor.  Last week when this chart was created, the Bull-Bear spread was 2.29%, barely on the Bullish side of neutral.  In the subsequent week it turned on a dime dropping to negative 16.5%; strongly Bearish.

The chart suggests that this data is more a coincident indicators than a forward indicator, so the drop in sentiment parallels the recent weakness in the up trend.
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FIGURE 16:
TD Ameritrade publishes the Investor Movement Index.  It is Bullish at this time.  Here is what they do to make their index.

Each month Ameritrade calculates a short-term Beta (volatility relative to a benchmark such as the S&P 500) for each security.
Then it takes a sample of hundreds of thousands of customer accounts with at least $2,000 in their account and in which at least 1 trade was done the month, from its approximate 6 million customers.
It measures the total equity allocation and the aggregate short-term Beta (volatility relative to volatility of the S&P 500) of the equities in each portfolio (and other undisclosed factors) to develop the risk level of each portfolio.
Then equal weighting each account without regard to size or number of trades, it finds the median equity risk exposure, and puts that on its index scale (scale parameters not disclosed), and plots that versus the S&P 500.
The level and direction of the index is an indication of actual retail investor behavior instead of what they might say about their sentiment.

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FIGURE 17:
The options market reveals the actual risk taking behavior of investors in terms of the pursuit of gain (buying CALLs) or seeking protections (buying PUTs).  Here are 4 measures of options market behavior.

VIX measures the expected volatility of the S&P 500 over the next 30 days.  At under 12, the VIX is well below the 10 year average of about 20, and among the lowest levels of the past 10 years.  This is complacency.  Complacency is probably like everybody being on the same side of a boat, which makes the boat prone to tip over.  Volatility is a mean reverting measure, which suggest more volatility in the relatively near future than in the relatively near past.

The SKEW Index (defined above in the jargon section) is a measure of the concern over the size and probability of an unusually large downside move.  That measure is elevated, which gives reason for caution.

The Equity PUT/CALL index (defined above in the jargon section) is a measure of the relative “protection seeking/opportunity seeking” behavior of mostly retail investors.  That ratio is slightly elevated versus average levels, indicating a mildly increased relative pursuit of protection.

The Index PUT/CALL index (defined above in the jargon section) is a measure of the of the relative “protection seeking/opportunity seeking” behavior of mostly institutional investors.  That ratio is slightly lower than average, indicating a mildly lower than average relative pursuit of protection.
2017-03-13_16
BREADTH
This is one of our favorite measures, and one that we directly measure weekly since the beginning of 2014.  Breadth measures the condition or behavior of the overall membership of the broad S&P 1500 index and compares it to the price level of the market-cap weighted S&P 500 index — in other words, it checks to see if the rank and file members of the market are going in the same direction as the mega-cap leaders of the market.

For example, the price movement of Apple and Exxon have a lot more impact of the price of the S&P 500 or the S&P 1500 than 100’s of smaller members of the S&P 500 and S&P 1500.  If the rank and file are going in the same direction as the leadership, that is Bullish breadth.  If they are going in the opposite direction, that is Bearish breadth.  The leaders can only go so far for so long without the rank and file coming along.

FIGURE 18:
The percentage of S&P 1500 index constituents in a Correction or worse (grey line — down 10% or more from their 12-month high) rose dramatically before the November presidential election, then dropped off just as steeply to among the lowest levels in the past 3 years.  Just recently, however, the percentage in Correction or worse sharply turned up — still in “normal” range, but the direction change is a negative for the current stocks rally.

The same is true, but to a lesser extent for the percentage of S&P 1500 stocks in a Bear or worse (blue line — down 20% or more), or in a severe Bear or worse (red line — down 30% or more).
2017-03-13_17
FIGURE 19:
The percentage of S&P 1500 stocks within 2% of their 12-month high was declining prior to the election, turned up sharply to reach the highest level in the past 3 years immediately after the election, but has since declined to the “normal” range with a current downward direction.  The provides a note of caution about the current rally.
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FIGURE 20:
The Net Buying Pressure (Buying Pressure / Sum (Buying Pressure + Selling Pressure), which has been net positive since the bottom of the early 2016 Correction, began to decline before the election; resumed growing strength after the election; but has recently been losing steam.  This is not supportive of the current rally.
2017-03-13_19

BuyingPressureMethod
FIGURE 21:

The separate Buying Pressure and Selling Pressure components of the S&P 1500 stocks Net Buying Pressure in the figure above are shown here.

The rising S&P 500 price in 2016 was not matched by rising Buying or Selling Pressure, showing waning enthusiasm for equities.  After the election both Buying and Selling Pressure rose, but Buying Pressure rose more than Selling Pressure.  Recently however, the decline in Net Buying Pressure noted above, is the result of Buying Pressure declining substantially, while Selling Pressure has declined far less.

These data also suggest the fuel of the rally may be running low.
2017-03-13_20

PressureCompnentsMethod
FORECASTS
Looking way down the road with 5-10 year forecasts, and supporting our view that a shift in allocation more toward international equities, and less in US equities is appropriate, are forecasts by Research Affiliates (a noted factor-based asset manager), by GMO ( a Bearish asset manager for the very wealthy — $10 million and up to invest in their funds); and by BlackRock (the largest fund manager in the world).
FIGURE 22:
Research affiliates studies factors with focus on the current Shiller CAPE Ratio (Price divided by the inflation adjusted 10-year average Earnings) relative to its historical median, and historical highs and lows.  They find that to be a good long-term indicator of opportunity.  They view the CAPE Ratio as mean reverting over the long-term.

Based on CAPE and other factors, this chart shows how they see the real (nominal less inflation) return and the volatility of US, non-US Developed Markets (“EAFE”) and Emerging Markets (“EM”) working out over the next 10 years on an annualized basis.  They definitely see international equities as the place to be — but with more volatility.

2017-03-13_21
FIGURE 23:
GMO does not disclose their forecasting methodology, but they are among the most Bearish institutional manager, so worth noting for that.  Over the next 7 years, they see the real return on US large-cap stocks as negative 3+%; the real return on large international stocks as barely positive; and the real return on Emerging Market as positive 4+%.  They also see negative real returns on US and Dollar hedged international bonds, but positive 1+% real returns on Emerging Markets debt.

2017-03-13_22
FIGURE 24:
Over the next 5 years, BlackRock sees nominal return on US stocks as very low, and much lower than international stocks.  They see non-US Developed Markets stocks as generating nominal return  at about the same level as Emerging Markets, but with volatility similar to that of US small-cap stocks; whereas they see much higher volatility for Emerging Market stocks.
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