Posts filed under ‘economy’
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (July 1, 2015). Subscribe on the right side of the page for the complete text.
Watching Greece fall apart over the last five years has been like watching a slow motion train wreck. To many, this small country of 11 million people that borders the Mediterranean, Aegean, and Ionian Seas is known more for its Greek culture (including Zeus, Parthenon, Olympics) and its food (calamari, gyros, and Ouzo) than it is known for financial bailouts. Nevertheless, ever since the financial crisis of 2008-2009, observers have repeatedly predicted the debt-laden country will default on its €323 billion mountain of obligations (see chart below – approximately $350 billion in dollars) and subsequently exit the 19-member eurozone currency membership (a.k.a.,”Grexit”).
Now that Greece has failed to repay less than 1% of its full €240 billion bailout obligation – the €1.5 billion payment due to the IMF (International Monetary Fund) by June 30th – the default train is coming closer to falling off the tracks. Whether Greece will ultimately crash itself out of the eurozone will be dependent on the outcome of this week’s surprise Greek referendum (general vote by citizens) mandated by Prime Minister Alexis Tsipras, the leader of Greece’s left-wing Syriza party. By voting “No” on further bailout austerity measures recommended by the European Union Commission, including deeper tax increases and pension cuts, the Greek people would effectively be choosing a Grexit over additional painful tax increases and deeper pension cuts.
And who can blame the Greeks for being a little grouchy? You might not be too happy either if you witnessed your country experience an economic decline of greater than 25% (see Greece Gross Domestic Product chart below); 25% overall unemployment (and 50% youth unemployment); government worker cuts of greater than 20%; and stifling taxes to boot. Sure, Greeks should still shoulder much of the blame. After all, they are the ones who piled on $100s of billions of debt and overspent on the pensions of a bloated public workforce, and ran unsustainable fiscal deficits.
For any casual history observers, the current Greek financial crisis should come as no surprise, especially if you consider the Greeks have a longstanding habit of not paying their bills. Over the last two centuries or so, since the country became independent, the Greek government has spent about 90 years in default (almost 50% of the time). More specifically, the Greeks defaulted on external sovereign debt in 1826, 1843, 1860, 1894 and 1932.
The difference between now and past years can be explained by Greece now being a part of the European Union and the euro currency, which means the Greeks actually do have to pay their bills…if they want to remain a part of the common currency. During past defaults, the Greek central bank could easily devalue their currency (the drachma) and fire up the printing presses to create as much currency as needed to pay down debts. If the planned Greek referendum this week results in a “No” vote, there is a much higher probability that the Greek government will need to dust off those drachma printing presses.
Protest, riots, defaults, changing governments, and new currencies make for entertaining television viewing, but these events probably don’t hold much significance as it relates to the long-term outlook of your investments and the financial markets. In the case of Greece, I believe it is safe to say the economic bark is much worse than the bite. For starters, Greece accounts for less than 2% of Europe’s overall economy, and about 0.3% of the global economy.
Since I live out on the West Coast, the chart below caught my fancy because it also places the current Greek situation into proper proportion. Take the city of L.A. (Los Angeles – red bar) for example…this single city alone accounts for almost 3x the size of Greece’s total economy (far right on chart – blue bar).
Give Me My Money!
It hasn’t been a fun year for Greek banks. Depositors, who have been flocking to the banks, withdrew about $45 billion in cash from their accounts, over an eight month period (see chart below). Before the Greek government decided to mandatorily close the banks in recent days and implement capital controls limiting depositors to daily ATM withdrawals of only $66.
But once again, let’s put the situation into context. From an overall Greek banking sector perspective, the four largest Greek Banks (Bank of Greece, Piraeus Bank, Eurobank Ergasias, Alpha Bank) account for about 90% of all Greek banking assets. Combined, these banks currently have an equity market value of about $14 billion and assets on the balance sheets of $400 billion – these numbers are obviously in flux. For comparison purposes, Bank of America Corp. (BAC) alone has an equity market value of $179 billion and $2.1 trillion in assets.
Anxiety Remains High
Skeptical bears will occasionally acknowledge the miniscule-ness of Greece, but then quickly follow up with their conspiracy theory or domino effect hypothesis. In other words, the skeptics believe a contagion effect of an impending Grexit will ripple through larger economies, such as Italy and Spain, with crippling force. Thus far, as you can see from the chart below, Greece’s financial problems have been largely contained within its borders. In fact, weaker economies such as Spain, Portugal, Ireland, and Italy have fared much better – and actually improving in most cases. In recent days, 10-year yields on government bonds in countries like Portugal, Italy, and Spain have hovered around or below 3% – nowhere near the peak levels seen during 2008 – 2011.
Other doubting Thomases compare Greece to situations like Lehman Brothers, Long Term Capital Management, and the subprime housing market, in which underestimated situations snowballed into much worse outcomes. As I explain in one of my newer articles (see Missing the Forest for the Trees), the difference between Greece and the other financial collapses is the duration of this situation. The Greek circumstance has been a 5-year long train wreck that has allowed everyone to prepare for a possible Grexit. Rather than agonize over every news headline, if you are committed to the practice of worrying, I would recommend you focus on an alternative disaster that cannot be found on the front page of all newspapers.
There is bound to be more volatility ahead for investors, and the referendum vote later this week could provide that volatility spark. Regardless of the news story du jour, any of your concerns should be occupied by other more important worrisome issues. So, unless you are an investor in a Greek bank or a gyro restaurant in Athens, you should focus your efforts on long-term financial goals and objectives. Ignoring the noisy news flow and constructing a diversified investment portfolio across a range of asset classes will allow you to avoid the harmful consequences of the slow motion, multi-year Greek train wreck.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and BAC, but at the time of publishing, SCM had no direct position in Bank of Greece, Piraeus Bank, Eurobank Ergasias, Alpha Bank or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on ICContact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (June 1, 2015). Subscribe on the right side of the page for the complete text.
Despite calls for “Sell in May, and go away,” the stock market as measured by both the Dow Jones Industrial and S&P 500 indexes grinded out a +1% gain during the month of May. For the year, the picture looks much the same…the Dow is up around +1% and the S&P 500 +2%. After gorging on gains of +30% in 2013 and +11% in 2014, it comes as no surprise to me that the S&P 500 is taking time to digest the gains. After eating any large pleasurable meal, there’s always a chance for some indigestion – just like last month. More specifically, the month of May ended as it did the previous six months…with a loss on the last trading day (-115 points). Providing some extra heartburn over the last 30 days were four separate 100+ point decline days. Realized fears of a Greek exit from the eurozone would no doubt have short-term traders reaching for some Tums antacid. Nevertheless, veteran investors understand this is par for the course, especially considering the outsized profits devoured in recent years.
The profits have been sweet, but not everyone has been at the table gobbling up the gains. And with success, always comes the skeptics, many of whom have been calling for a decline for years. This begs the question, “Are we in a stock bubble?” I think not.
Most asset bubbles are characterized by extreme investor/speculator euphoria. There are certainly small pockets of excitement percolating up in the stock market, but nothing like we experienced in the most recent burstings of the 2000 technology and 2006-07 housing bubbles. Yes, housing has steadily improved post the housing crash, but does this look like a housing bubble? (see New Home Sales chart)
Source: Dr. Ed’s Blog
Another characteristic of a typical asset bubble is rabid buying. However, when it comes to the investor fund flows into the U.S. stock market, we are seeing the exact opposite…money is getting sucked out of stocks like a Hoover vacuum cleaner. Over the last eight or so years, there has been almost -$700 billion that has hemorrhaged out of domestic equity funds – actions tend to speak louder than words (see chart below):
Source: Investment Company Institute (ICI)
The shift to Exchange Traded Funds (ETFs) offered by the likes of iShares and Vanguard doesn’t explain the exodus of cash because ETFs such as S&P 500 SPDR ETF (SPY) are suffering dramatically too. SPY has drained about -$17 billion alone over the last year and a half.
With money flooding out of these stock funds, how can stock prices move higher? Well, one short answer is that hundreds of billions of dollars in share buybacks and trillions in mergers and acquisitions activity (M&A) is contributing to the tide lifting all stock boats. Low interest rates and stimulative monetary policies by central banks around the globe are no doubt contributing to this positive trend. While the U.S. Federal Reserve has already begun reversing its loose monetary policies and has threatened to increase short-term interest rates, by any objective standard, interest rates should remain at very supportive levels relative to historical benchmarks.
Besides housing and fund flows data, there are other unbiased sentiment indicators that indicate investors have not become universally Pollyannaish. Take for example the weekly AAII Sentiment Survey, which shows 73% of investors are currently Bearish and/or Neutral – significantly higher than historical averages.
The Consumer Confidence dataset also shows that not everyone is wearing rose-colored glasses. Looking back over the last five decades, you can see the current readings are hovering around the historical averages – nowhere near the bubblicious 2000 peak (~50% below).
Even if you’re convinced there is no imminent stock market bubble bursting, many of the same skeptics (and others) feel we’re on the verge of a recession – I’ve been writing about many of them since 2009. You could choke on an endless number of economic indicators, but on the common sense side of the economic equation, typically rising unemployment is a good barometer for any potentially looming recession. Here’s the unemployment rate we’re looking at now (with shaded periods indicating prior recessions):
As you can see, the recent 5.4% unemployment rate is still moving on a downward, positive trajectory. By most peoples’ estimation, because this has been the slowest recovery since World War II, there is still plenty of labor slack in the market to keep hiring going.
An even better leading indicator for future recessions has been the slope of the yield curve. A yield curve plots interest rate yields of similar bonds across a range of periods (e.g., three-month bill, six-month bill, one-year bill, two-year note, five-year note, 10-year note and 30-year bond). Traditionally, as short-term interest rates move higher, this phenomenon tends to flatten the yield curve, and eventually inverts the yield curve (i.e., short-term interest rates are higher than long-term interest rates). Over the last few decades, when the yield curve became inverted, it was an excellent leading indicator of a pending recession (click here and select “Animate” to see amazing interactive yield curve graph). Fortunately for the bulls, there is no sign of an inverted yield curve – 30-year rates remain significantly higher than short-term rates (see chart below).
Stock market skeptics continue to rationalize the record high stock prices by pointing to the artificially induced Federal Reserve money printing buying binge. It is true that the buffet of gains is not sustainable at the same pace as has been experienced over the last six years. As we continue to move closer to full employment in this economic cycle, the rapid accumulated wealth will need to be digested at a more responsible rate. An unexpected Greek exit from the EU or spike in interest rates could cause a short-term stomach ache, but until many of the previously mentioned indicators reach dangerous levels, please pass the gravy.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in SPY and other certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Earlier this week, Janet Yellen, chair of the U.S. Federal Reserve, spoke at the Institute for New Economic Thinking conference at the IMF headquarters in Washington, D.C. In addition to pontificating about the state of the global economy and the direction of interest rates, she also decided to chime in with her two cents regarding the stock market by warning stock values are “quite high.” She went on to emphasize “there are potential dangers” in the equity markets.
Unfortunately, those investors who have hinged their investment careers on the forecasts of economists, strategists, and Fed Chairmen have suffered mightily. Already, Yellen’s soapbox rant about elevated stock prices is being compared to former Fed Chairman Alan Greenspan’s “Irrational Exuberance” speech, which I have previously discussed on numerous occasions (see Irrational Exuberance Déjà Vu).
Greenspan’s bubble warning talk was given on December 5, 1996 when the NASDAQ closed around 1,300 (it closed at 5,003 this week). Greenspan specifically said the following:
“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”
After his infamous speech, the NASDAQ index almost quadrupled in value to 5,132 in the ensuing three years before cratering by approximately -78%,
Greenspan’s successor, economics professor Ben Bernanke, didn’t fare much better than the previous Fed Chairmen. Unlike many, I give full credit where credit is due. Bernanke deserves extra credit for his nimble but aggressive actions that helped prevent a painful recession from expanding into a protracted and lethal depression.
With that said, as late as May 2007, Bernanke noted Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.” Moreover, in 2005, near the peak in housing prices, Bernanke said the probability of a housing bubble was “a pretty unlikely possibility.” Bernanke went on to add housing price increases, “largely reflect strong economic fundamentals.” Greenspan concurred with Bernanke. Just a year prior, Greenspan noted that the increase in home values was “not enough in our judgment to raise major concerns.” History has proven how Bernanke and Greenspan could not have been more wrong.
If you still believe Yellen is the bee’s knees when it comes to the investing prowess of economists, perhaps you should review Long Term Capital Management (LTCM) debacle. In the midst of the 1998 Asian financial crisis, Robert Merton and Myron Scholes, two world renowned Nobel Prize winners almost single handedly brought the global financial market to its knees. Merton and Scholes used their lifetime knowledge of economics to create complex computerized investment algorithms. Everything worked just fine until LTCM lost $500 million in one day, which required a $3.6 billion bailout from a consortium of banks.
NASDAQ 5,000…Bubble Repeat?
Janet Yellen’s recent prognostication about the valuation of the U.S. stock market happens to coincide with the NASDAQ index breaking through the 5,000 threshold, a feat not achieved since the piercing of the technology bubble in the year 2000. Investing Caffeine readers and investors of mine understand today’s NASDAQ index is much different than the NASDAQ index of 15 years ago (see also NASDAQ Redux), especially when it comes to valuation. The folks at Bespoke put NASDAQ 5,000 into an interesting context by adding the important factor of inflation to the mix. Even though the NASDAQ index is within spitting distance of its all-time high of 5,132 (reached in 2000), the index would actually need to rally another +40% to reach an all-time “inflation adjusted” closing high (see chart below).
Economists and strategists are usually articulate, and their arguments sound logical, but they are notorious for being horribly bad at predicting the future, Janet Yellen included. I agree valuation is an all-important factor in determining future stock market returns. Howeer, by Robert Shiller, Janet Yellen, and a host of other economists relying on one flawed metric (CAPE PE), they have not only been wildly wrong year after year, but they are recklessly neglecting many other key factors (see also Shiller CAPE Smells Like BS).
I freely admit stocks will eventually go down, most likely a garden variety -20% recessionary decline in prices. While from a historical standpoint we are overdue for another recession (about two recessions per decade), this recovery has been the slowest since World War II, and the yield curve is currently not flashing any warning signals. When the eventual stock market decline happens, it likely will not be driven by high valuations. The main culprit for a bear market will be a decline in earnings – high valuations just act as gasoline on the fire. Janet Yellen will continue to offer her opinions on many aspects of the economy, but if she steps on her soapbox again and yells about stock market valuations, you will be best served by purchasing a pair of earplugs.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (March 1, 2015). Subscribe on the right side of the page for the complete text.
Considering the following current event headlines, who would have guessed the stock market is trading near record, all-time highs and the NASDAQ index breaking 5,000 for the first time since the year 2000?
- Russia Lies Over Ukraine Ceasefire
- ISIS Beheadings and Jihadi John
- Strong Dollar, Weak Global Economy
- Fed’s Yellen: Rate Rise & Inflation
- Iranian Negotiations & Nuclear Weapons
- Grexit: The Likelihood of Greece’s Exit from the Euro
- The Chinese Bubble Pops
- Ebola and the Fear Epidemic
After reading all these depressing stories, I feel more like taking a Prozac pill than I do venturing into the investing world. Unfortunately, in the media world, the overarching motto driving the selection of published stories is, “If it bleeds, it leads!” Plainly and simply, bad news sells. The media outlets prey on our human behavioral shortcomings. Specifically, people feel the pain from losses at a rate more than double the feelings of pleasure (see Controlling the Lizard Brain and chart below).
This phenomenon leaves Americans and the overall investing public choking on the daily doom and gloom headlines. Investor skepticism caused by the 2008-2009 financial crisis is evidenced by historically low stock ownership statistics and stagnant equity purchase flow data. Talk of another stock bubble has been introduced again now that the NASDAQ is approaching 5,000 again, but we are not seeing signs of this phenomenon in the IPO market (Initial Public Offering) – see chart below. IPOs are on the rise, but the number of filings is more than -50% below the peak of 845 IPOs seen in the late 1990s when former Federal Reserve Chairman Alan Greenspan made his famous “irrational exuberance” speech (see also Irrational Exuberance Deja Vu and chart below).
Uggh! 0.08% Really?
Compounding the never-ending pessimism problem is the near-0% interest rate environment. Times are long gone when you could earn 18% on a certificate of deposit (see chart below). Today, you can earn 0.08% on a minimum $10,000 investment in a Bank of America (BAC) Certificate of Deposit (CD). Invest at that rate for more than a decade and you will have almost accumulated a $100 (~1%) – probably enough for a single family meal…without tip. To put these paltry interest rates into perspective, the U.S. stock market as measured by the S&P 500 index was up a whopping +5.5% last month and the Dow Jones Industrials climbed +5.6% (+968 points to 18,133). Granted, last month’s S&P 500 percentage increase was the largest advance since 2011, but if I wanted to earn an equivalent +5.5% return by investing in that Bank of America CD, it would take me to age 100 years old before I earned that much!
Globally, the interest rate picture doesn’t look much prettier. In fact, the negative interest rate bonds offered in Switzerland and other neighboring countries, including France and Germany, have left investors in these bonds with guaranteed losses, if held to maturity (see also Draghi Beer Goggles).
Money Seeking Preferred Treatment
Investors and followers of mine have heard me repeatedly declare that “money goes where it is treated best.” When many investments are offering 0% (or negative yields), it comes as no surprise to me that dividend paying stocks have handily outperformed the overall bond market in recent years. Hard to blame someone investing in certain stocks offering between 2-6% in dividends when the alternative is offered at or near 0%.
While at Sidoxia we are still finding plenty of opportunities in the equity markets, I want to extend the reminder that not everyone can (or should) increase their equity allocation because of personal time horizon and risk tolerance constraints. Regardless, the current, restricting global financial markets are highlighting the scarcity of investment alternatives available.
As we will continue to be bombarded with more cease fires, quagmires and other bleeding headlines, investors will be better served by ignoring the irrelevant headlines and instead create a long-term financial plan with an asset allocation designed to meeting their personal goals. By following this strategy, you can let the dooms-dayers bleed while you succeed.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and BAC, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (February 2, 2015). Subscribe on the right side of the page for the complete text.
In the weeks building up to Super Bowl XLIX (New England Patriots vs. Seattle Seahawks) much of the media hype was focused on the controversial alleged “Deflategate”, or the discovery of deflated Patriot footballs, which theoretically could have been used for an unfair advantage by New England’s quarterback Tom Brady. While Brady ended up winning his record-tying 4th Super Bowl ring for the Patriots by defeating the Seahawks 28-24, the stock market deflated during the first month of 2015 as well. Similar to last year, the stock market has temporarily declined last January before surging ahead +11.4% for the full year of 2014. It’s early in 2015, and investors chose to lock-in a small portion of the hefty, multi-year bull market gains. The S&P 500 was sacked for a loss of -3.1% and the Dow Jones Industrial index by -3.7%.
Despite some early performance headwinds, the U.S. economy kicked off the year with the wind behind its back in the form of deflating oil prices. Specifically, West Texas Intermediate (WTI) crude oil prices declined -9.4% last month to $48.24, and over -51.0% over the last six months. Like a fresh set of substitute legs coming off the bench to support the team, the oil price decline represents an effective $125 billion tax cut for consumers in the form of lower gasoline prices (average $2.03 per gallon nationally) – see chart below. The gasoline relief will allow consumers more discretionary spending money, so football fans, for example, can buy more hot dogs, beer, and souvenirs at the Super Bowl. The cause for the recent price bust? The primary reasons are three-fold: 1) Sluggish oil demand from developed markets like Europe and Japan coupled with slowing consumption growth in some emerging markets like China; 2) Growing supply in various U.S. fracking regions has created a temporary global oil glut; and 3) Uncertainty surrounding OPEC (Organization of Petroleum Exporting Countries) supply/production policies, which became even more unclear with the recent announced death of Saudi Arabia’s King Abdullah.
More deflating than the NFL football’s “Deflategate” is the approximate -17% collapse in the value of the euro currency (see chart below). Euro currency matters were made worse in response to European Central Bank’s (ECB) President Mario Draghi’s announcement that the eurozone would commence its own $67 billion monthly Quantitative Easing (QE) program (very similar to the QE program that Federal Reserve Chairwoman Janet Yellen halted last year). In total, if carried out to its full design, the euro QE version should amount to about $1.3 trillion. The depreciating effect on the euro (and appreciating value of the euro) should help stimulate European exports, while lowering the cost of U.S. imports – you may now be able to afford that new Rolls-Royce purchase you’ve been putting off. What’s more, the rising dollar is beneficial for Americans who are planning to vacation abroad…Paris here we come!
Another fumble suffered by the global currency markets was introduced with the unexpected announcement by the Swiss National Bank (SNB) that decided to remove its artificial currency peg to the euro. Effectively, the SNB had been purchased and accumulated a $490 billion war-chest reserve (Supply & Demand Lessons) to artificially depress the value of the Swiss franc, thereby allowing the country to sell more Swiss army knives and watches abroad. When the SNB could no longer afford to prop up the value of the franc, the currency value spiked +20% against the euro in a single day…ouch! In addition to making its exports more expensive for foreigners, the central bank’s move also pushed long-term Swiss Treasury bond yields negative. No, you don’t need to check your vision – investors are indeed paying Switzerland to hold investor money (i.e., interest rates are at an unprecedented negative level).
In addition to some of the previously mentioned setbacks, financial markets suffered another penalty flag. Last month, multiple deadly terrorist acts were carried out at a satirical magazine headquarters and a Jewish supermarket – both in Paris. Combined, there were 16 people who lost their lives in these senseless acts of violence. Unfortunately, we don’t live in a Utopian world, so with seven billion people in this world there will continue to be pointless incidences like these. However, the good news is the economic game always goes on in spite of terrorism.
As is always the case, there will always be concerns in the marketplace, whether it is worries about inflation, geopolitics, the economy, Federal Reserve policy, or other factors like a potential exit of Greece out of the eurozone. These concerns have remained in place over the last six years and the stock market has about tripled. The fact remains that interest rates are at a generational low (see also Stretching the High Yield Rubber Band), thereby supplying a scarcity of opportunities in the fixed income space. Diversification remains important, but regardless of your time horizon and risk tolerance, attractively valued equities, including high-quality, dividend-paying stocks should account for a certain portion of your portfolio. Any winning retirement playbook understands a low-cost, globally diversified portfolio, integrating a broad set of asset classes is the best way of preventing a “deflating” outcome in your long-term finances.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
While the financial market party has been gaining momentum in the U.S., Europe has been busy attending an economic funeral. Mario Draghi, the European Central Bank President is trying to reverse the somber deflationary mood, and therefore has sent out $1.1 trillion euros worth of quantitative easing (QE) invitations to investors with the hope of getting the eurozone party started.
Draghi and the stubborn party-poopers sitting on the sidelines have continually been skeptical of the creative monetary punch-spiking policies initially implemented by U.S. Federal Reserve Chairman Ben Bernanke (and continued by his fellow dovish successor Janet Yellen). With the sluggish deflationary European pity party (see FT chart below) persisting for the last six years, investors are in dire need for a new tool to lighten up the dead party and Draghi has obliged with the solution…“QE beer goggles.” For those not familiar with the term “beer goggles,” these are the vision devices that people put on to make a party more enjoyable with the help of excessive consumption of beer, alcohol, or in this case, QE.
Although here in the U.S. “QE beer goggles” have been removed via QE expiration last year, nevertheless the party has endured for six consecutive years. Even an economy posting such figures as an 11-year high in GDP growth (+5.0%); declining unemployment (5.6% from a cycle peak of 10.0%); and stimulative effects from declining oil/commodity prices have not resulted in the cops coming to break up the party. It’s difficult for a U.S. investor to admit an accelerating economy; improving job additions; recovering housing market; with stronger consumer balance sheet would cause U.S. 10-Year Treasury Note yields to plummet from 3.04% at the beginning of 2014 to 1.82% today. But in reality, this is exactly what happened.
To confound views on traditional modern economics, we are seeing negative 10-year rates on Swiss Treasury Bonds (see chart below). In other words, investors are paying -1% to the Swiss government to park their money. A similar strategy could be replicated with $100 by simply burning a $1 bill and putting the remaining $99 under a mattress. Better yet, why not just pay me to hold your money, I will place your money under my guarded mattress and only charge you half price!
Does QE Work?
Debate will likely persist forever as it relates to the effectiveness of QE in the U.S. On the half glass empty side of the ledger, GDP growth has only averaged 2-3% during the recovery; the improvement in the jobs upturn is arguably the slowest since World War II; and real wages have declined significantly. On the half glass full side, however, the economy has improved substantially (e.g., GDP, unemployment, consumer balance sheets, housing, etc.), and stocks have more than doubled in value since the start of QE1 at the end of 2008. Is it possible that the series of QE policies added no value, or we could have had a stronger recovery without QE? Sure, anyone can make that case, but the fact remains, the QE training wheels have officially come off the economy and Armageddon has still yet to materialize.
I expect the same results from the implementation of QE in Europe. QE is by no means an elixir or panacea. I anticipate minimal direct and tangible economic benefits from Draghi’s $1+ trillion euro QE bazooka, however the psychological confidence building impacts and currency depreciating effects are likely to have a modest indirect value to the eurozone and global financial markets overall. The downside for these unsustainable ultra-low rates is potential excessive leverage from easy credit, asset bubbles, and long-term inflation. Certainly, there may be small pockets of these excesses, however the scars and regulations associated with the 2008-2009 financial crisis have delayed the “hangover” arrival of these risk possibilities on a broader basis. Therefore, until the party ends or the cops come to break up the fun, you may want to enjoy the gift provided by Mario Draghi to global investors…and strap on the “QE beer goggles.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions, including positions in certain exchange traded funds positions , but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
It’s the holiday season and with another year coming to an end, it’s also time for a wide range of religious celebrations to take place. Investing is a lot like religion too. Just like there are a countless number of religions, there are also a countless number of investing styles, whether you are talking about Value investing, Growth, Quantitative, Technical, Momentum, Merger-Arbitrage, GARP (Growth At a Reasonable Price), or a multitude of other derivative types. But regardless of the style followed, most professional managers believe their style is the sole answer to lead followers to financial nirvana. While I may not share the same view (I believe there are many ways to skin the stock market cat), each investing discipline (or religion) will have its own unique core tenets that drive expectations for future returns (outcomes).
As it relates to my firm, Sidoxia Capital Management, our investment process is premised on four key tenets. Much like the four legs of a stool, the following principles provide the foundation for our beliefs and outlook on the mid-to-long-term direction of the stock market:
- Interest Rates
Why are these the key components that drive stock market returns? Let’s dig a little deeper to clarify the importance of these factors:
Profits: Over the long-run there is a very significant correlation between stock prices and profits (see also It’s the Earnings, Stupid). I’m not the only one preaching this religious belief, investment legends Peter Lynch and William O’Neil think the same. In answer to a question by Dell Computer’s CEO Michael Dell about its stock price, Lynch famously responded , “If your earnings are higher in five years, your stock will be higher.” The same idea works with the overall stock market. As I recently wrote (see Why Buy at Record Highs? Ask the Fat Turkey), with corporate profits at all-time record highs, it should come as no surprise that stock prices are near all-time record highs. Regardless of the absolute level of profits, it’s also very important to have a feel for whether earnings are accelerating or decelerating, because investors will pay a different price based on this dynamic.
Interest Rates: When embarrassingly low CD interest rates of 0.08% are being offered on $10,000 deposits at Bank of America, do you think stocks look more or less attractive? It’s obviously a rhetorical question, because I can earn 20x more just by collecting the dividends from the S&P 500 index. Now in 1980 when the Federal Funds rate was set at 20.0% and investors could earn 16.0% on CDs, guess what? Stocks were logging their lowest valuation levels in decades (approximately 8x P/E ratio vs 17x today). The interest rate chart from Scott Grannis below highlights the near generational low interest rates we are currently experiencing.
Source: Calafia Beach Pundit
Sentiment: As I wrote in my Sentiment Indicators: Reading the Tea Leaves article, there are plenty of sentiment indicators (e.g., AAII Surveys, VIX Fear Gauge, Breadth Indicators, NYSE Bulls %, Put-Call Ratio, Volume), which traditionally are good contrarian indicators for the future direction of stock prices. When sentiment is too bullish (optimistic), it is often a good time to sell or trim, and when sentiment is too bearish (pessimistic), it is often good to buy. With that said, in addition to many of these short-term sentiment indicators, I realize that actions speak louder than words, therefore I like to also see the flows of funds into and out of stocks/bonds to gauge sentiment (see also Market Champagne Sits on Ice).
Valuations: As Fred Hickey, the lead editor of the High Tech Strategist noted, “Valuations do matter in the stock market, just as good pitching matters in baseball.” The most often quoted valuation metric is the Price/Earnings multiple or PE ratio. In other words, this ratio compares the price you would pay for an annual stream of profits. This can be tricky to determine because there are virtually an infinite number of factors that can impact the numerator and denominator. Currently P/E valuations are near historical averages (see below) – not nearly as cheap as 1980 and not nearly as expensive as 2000. If I only had one metric to choose, this would be a good place to start because the previous three legs of the stool feed into valuation calculations. In addition to P/E, at Sidoxia one of our other favorite metrics is Free-Cash-Flow Yield (annual cash generation after all expenses and expenditures divided by a company’s value). Earnings can be manipulated much easier than cold hard cash in our view.
Source: Calafia Beach Pundit
Nobody, myself and Warren Buffett included, can consistently predict what the stock market will do in the short-run. Buffett freely admits it. However, investing is a game of probabilities, and if you use the four tenets of profits, interest rates, sentiment, and valuations to drive your long-term investing decisions, your chances for future financial success will increase dramatically. This framework is just as relevant today as it is when studying the 1929 Crash, the 1989 Japan Bubble, or the 2008-2009 Financial Crisis. If your goal is to not become an investing fool, I highly encourage you to follow the legs of the Sidoxia stool.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions, including BAC and certain exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.