In this video, Louis Llanes, CFA CMT founder of Wealthnet Investments, discusses how late-cycle markets are being driven by growth-starved millennials and boomers. With low rates forcing most investors out of fixed income, investors are increasingly turning to equity markets regardless of the risk of potential downturn. Llanes lays out his framework for trading equities in this high-risk environment. Filmed on December 5, 2019 in Denver. The video and transcript is below:
https://www.realvision.com/an-investment-framework-for-late-cycle-markets
Hi. This is Louis Llanes with Wealthnet Investments for Real Vision. Today, I want to talk a little bit about some situations that I'm seeing and how it affects traders and investors.
The current environment is very unique and challenging. One of the things that we're seeing is we're seeing investors-- and our primary clients are people who are investors with a million dollars or more. And there's two main things that we're seeing. We're seeing boomers who are retiring who are in real need of having some consistent growth. And we also are seeing independent-minded young millennials who are very financially ambitious who are looking to retire early. And they're also looking for strong growth, maybe a little bit more aggressive, and to be more consistent.
But one of the things that we're seeing is concern. We're seeing concern for the problem with potentially we're in a late cycle. It looks like the economy has been in a boom cycle for quite a while now. We haven't had a serious correction or serious recession for quite some time. And we also have low interest rates. So there's not a lot of income that can be earned or reasonable returns earned in the interest rate markets, in the fixed income markets.
We also see high valuations in equities. A lot of people are concerned that the values are not looking strong there. And really, nobody knows when the bull market's going to end. This is one of the biggest problems. A lot of people who want to get defensive in this market, they'll suffer from what's called cash drag. They'll get out of the market, have too much cash. And their portfolio performance will be hurt.
So how do we deal with that? First of all, what are the implications? And how do we deal with that?
Well, first of all, the implication is kind of obvious that we're probably going to have potentially lower rates of return in the indexes. The S&P 500 will probably not be doing as well in the next two or three years, at least two years than it did in the last five years. So it's one of those things where we have to kind of look forward and not backwards.
And the other thing is that although we have strong economic numbers, a lot of times the economic numbers look the strongest before you have a slowdown. So we want to keep that in mind.
And so what we really need is a strategy. We need a strategy that is disciplined. And we always, obviously, want to be disciplined. But we're looking for consistent growth that has a couple of different characteristics. And the first is it must be adaptable. It's got to be adaptable to changes in the market if we get into a bear. And it must be robust and durable during bear markets.
So what I want to talk about today is I'm going to talk a little bit about several key things that we think are necessary for strategy right now. And then I'm going to use an actual trading strategy or an actual trading idea for you to look at as a good example of the kinds of things that we think make sense in the market today.
So as far as the strategy for this environment, there's three basic things. The first would be your selection criteria. The second would be the need for a catalyst that's being recognized. And the third would be changes to how managing risk is being done.
So let me just kind of walk through them, the first having to do with selection criteria. Really, what we want to be focusing in on in this environment is special situations where the business is not tied to the general economy. And I'm not talking about the general economy-- I'm not talking about your defensive stocks. That's not what I'm talking about.
I'm talking about companies that are innovative and unique. So what that means is that they're likely to have good products and services and good demand there for those products and services, because they're unique, and because they're innovative. And it's changing the way business is being done. So that's what we're looking for. That's more of the focus, because that's going to allow us to have opportunities that could grow during a rocky period.
And if you're not in those situations, those special situations, we want to have instruments that are safe and reliable, fixed income instruments that do not have a lot of credit risk. A lot of people have been reaching for yield, going to the high-yield market, lower credit qualities or high-yield dividend stocks. That's not the right way to go based on our research and our experience in this type of environment.
It's better to be more bifurcated. We're either in the special situations, or we're in credit safe instruments.
So the third thing we want to have in the selection criteria part is liquid. We want have instruments that are very liquid so we can be nimble, and we can be prepared for opportunities and to take advantage of them, so we have dry powder, if you will, if we have an opportunity for a bear market, and we can dive in. We really want to have that liquidity. We don't want to worry about we can't get out of something, because we see an opportunity. So that's the selection criteria strategy adjustments in this environment.
The second, I would say, would be the catalyst element. We want to have situations where there's a catalyst fundamentally, and the market is actually recognizing it. In general, that's always what we want to see. But in particular now in this environment, you want to see that, because you don't want to have good news come out, and the market just go, ho-hum, I don't care. No, we want to see that the market is saying, you know what, I like this. And it's actually showing that in the price. And this is where technical analysis can come into play.
And the third item we talked about was risk management. And there's several things with risk management that we're looking at, at how you would adjust in this environment. The first would be smaller position sizes. Second would be to shorten up your time frame. We really want to have a time frame where it's a little bit shorter, we have tighter protective stops to keep our capital protected. And then we also want to take our profits more soon than we normally would. That's really, really important, because in this environment, you want to be able to take money off the table as you're going along.
And the last part of this has to do with the general market. We want to have a general market overlay, if you will, where we're saying, we're going to stop taking new positions if the market shows distribution, higher volume selling in the market, because we know that we want to let our current positions work themselves out. We don't want to be adding on more risk and be more fully invested when the market is starting to stumble a little bit.
As long as the market is showing positive movement, then we want to go ahead and allow those new positions to come in. But we don't want to do that if we see the general market start to tumble.
And one of the things that's interesting is the leadership will tend to start tumbling before the general market will. So these types of companies that have the strong innovation, many times, will actually be a great indicator that the market is going to tumble.
So that's it for the strategy there. Now, I want to kind of talk a little bit about an example. The first example I'm going to use-- and I'm really going to just talk about this company called Globus Medical, symbol GMED. This company, they are in the musculoskeletal area. And basically, their one product that is really doing well is they have a robotics product. It's a guidance product to do spine surgery. It's called the ExcelisusGPS.
They're also introducing other products. They have the AUTOBAHN nailing system. Basically, it helps fractures. It helps for surgery for fractures in the tibia and in the femur.
So what's interesting about this is that this particular situation, they're innovative and unique. And so they're likely to have-- they're going to help surgeons. They're going to help the industry. So they're likely going to have demand even if the economy stumbles. So that's what we want to see. That's the idea.
They're also increasing their guidance. They've increased their guidance recently. And we're seeing acceleration in the revenue numbers. This is the kind of thing that we want to see, a catalyst that is actually going to be recognized by the marketplace. We see the catalyst.
But now I want to talk about the technicals so we can see how this catalyst is being shown in the marketplace and how I believe it's still relatively early in the cycle. So let's talk a little bit about the technicals and dive into this chart.
This right here is a chart of Globus Medical. And it's a relatively long-term chart. It's three years-plus, and it's a weekly chart. In the top there you can see the weekly bars and the candlestick chart pattern. And then in the middle there, there's a green line. And that green line is a relative strength line. And when that line is rising, it's telling you that the stock is outperforming the market. And when it's declining, it's telling you the stock is underperforming the market.
And what you notice here is that the company did its classic situation where it sells off on higher volume. And then you have a stabilization phase, what technicians call a basing phase. And you can see that what happened is the classic move. You have a big decline on high volume with a shakeout. A lot of weak holders were shaken out.
And then you have a rise and another decline. And then now you're starting to see lower volume with breakouts and a base upon a base. That's one of the classic patterns where you see kind of a tug of war with supply and demand going sideways. And volume is starting to lighten up a little bit. But yet it's outperforming the market. And then you see a breakout.
This is the kind of pattern we want to see. And it's showing us that there are smart money that are starting to recognize this. The other key thing is that you can see this little E here. Stock is rallying on earnings. And it's recognizing this catalyst. It's not going ho-hum. It's saying, yes, this makes sense. And that's what we want to see.
So based on this particular chart pattern, normally what we'd want to do is we want to dive in more granular. And this is a daily chart to show you more of the micro. This daily chart shows that we had this base upon base right here. And between $52 and $48, that's really a support zone. It should be a support zone where buyers should step in if it were to get a little weak. So we wouldn't want to see the stock stay above that.
And we also want to see the stock stay above this shorter-term support level. So normally, we'll do like a scaling out kind of a situation, where we scale out in the range there. And I'll get more specific on the range. But basically, we want to see it's breaking out from this more minor base. And it's looking strong there. But it also has lots of support levels that we can rely on and use as a guidance to help us on our risk management.
So if you look at it from a standpoint of how much it could go up, basically, there's a few different ways to look at it. We first of all look at the fundamentals and say, OK, what is the fundamental upside. And then we also look at the volatility of the instrument. And what is a normal volatility move for this particular stock? Because we have a lot of statistics on how much stocks move over various time frames.
And one of the things that's very interesting is that if you look at a six month time frame, for example, and you look at the winners, only the winners over a six month time frame going back over 20 years, very rarely do stocks go down by more than 10% when they're winners. And it's an interesting statistic. It's literally 75% of the stocks that are winners don't go down by more than 10%. So that's a key thing to know just as a sidebar.
But in this particular instance, we're looking at a profit target of three times our risk, three times the daily volatility parameters. And most of the time, most stocks will stay within that time frame, will stay within that volatility scale. From a fundamental perspective, it can go much higher. But again, we're in this environment where we want to take profits.
So as far as the risk volatility, we're looking at a downside of $51.46. And our profit target, based on a measured move would be $69. So it gives us some ideas about where selling points can be scaled in and out on this using a protective stop based on daily volatility and sizing your positions accordingly.
So this is the kind of thing that I think investors could do better in if they use this kind of strategy in a diversified way and having a cohesive strategy. And that's the kind of thing that we're doing for clients.
Now, just to kind of summarize this. The strategy for this environment, we look at focusing on special situations not tied to the economy, innovative and unique with a catalyst, shorten that frame, smaller sizes, tighter protective stops and profit taking, and a market overlay to help you not take new positions, don't take on more risk when the markets look like they're having distribution.
And just to summarize this trade, we're looking at entering this stock. And for full disclosure, we do own this stock, did enter in. We want to enter in at current levels at around $56. And I would buy it all the way up to $59. Upside target range is between $68 and $71. Protective scale out here on our stops is between $54 and $52 to manage that risk.
So the upside potential, just to summarize, is about 26%, about $15 a share. Risk is between 7% and 9% on this stock. This is the kind of thing that we recommend doing right now, the kind of trades that we're taking. So I hope you got something out of this.