Posts filed under ‘Stocks’
Summer may be coming to an end, but the heat in the stock market has not cooled down, as the stock market registered its hottest August performance in 14 years (S&P 500 index up +3.8%). With these stellar results, one would expect the corks to be popping, cash flowing into stocks, and the champagne flowing. However, for numerous reasons, we have not seen this phenomenon occur yet. Until the real party begins, I suppose the champagne will stay on ice.
At the end of last year, I wrote further about the inevitable cash tsunami topic in an article entitled, “Here Comes the Dumb Money.” At that point in time, stocks had remarkably logged an approximate +30% return, and all indications were pointing towards an upsurge of investor interest in the stock market. So far in 2014, the party has continued as stocks have climbed another +8.4% for the year, but a lot of the party guests have not arrived yet. With the water temperature in the pool being so enticing, one would expect everyone to jump in the stock market pool. Actually, we have seen the opposite occur as -$12 billion has been pulled out of U.S. stock funds so far in 2014 (see ICI chart below).
How can the market be up +8.4% when money is coming out of stocks? For starters, companies are buying stock by the hundreds of billions of dollars. An estimated $480 billion of stock was purchased by corporations last year via share repurchase authorizations. Adding fuel to the stock fire are near record low interest rates. The ultra-low rates have allowed companies to borrow money at unprecedented rates for the purpose of not only buying back chunks of stock, but also buying the stock of whole companies (Mergers & Acquisitions). Thomson Reuters estimates that M&A activity in 2014 has already reached $2.2 trillion, up more than +70% compared to the same period last year.
Another factor contributing to the lackluster appetite for stocks is the general public’s apathy and disinterest in the market. This disconnected sentiment was captured beautifully by a recent Gallup survey, which asked people the following question:
As you can see, only 7% of the respondents realized that stocks were up by more than +30% in 2013. More specifically, the S&P 500 (Large Cap) index was up +29.6%, S&P 600 (Small Cap) +39.7%, and the S&P 400 (Mid Cap) +31.6% (all percentages exclude dividends). Despite these data points, if taken with near 15-year low household stock ownership data, the results prove sentiment is nowhere near the euphoric phases reached before the 2000 bubble burst or the 2006-2008 real estate collapse.
Beyond the scarring effects of the 2008-2009 financial crisis, tempered moods regarding stocks can also be attributed to fresher geopolitical concerns (i.e., military tensions in Ukraine, Islamic extremists in Iraq, and missile launches from the Gaza Strip). The other area of never-ending anxiety is Federal Reserve monetary policy. The stock market, which has tripled in value from early 2009, has skeptics continually blaming artificial Quantitative Easing/QE policies (stimulative bond purchases) as the sole reason behind stocks advance. With current Fed Chair Janet Yellen pulling 70% of the QE punch bowl away (bond purchases now reduced to $25 billion per month), the bears are having a difficult time explaining rising stock prices and declining interest rates. Once all $85 billion in monthly QE purchases are expected to halt in October, skeptics will have one less leg on their pessimistic stool to sit on.
Economy and Profits Play Cheery Tune
While geopolitical and Federal Reserve clouds may be preventing many sourpusses from joining the stock party, recent economic and corporate data have party attendees singing a cheery tune. More specifically, the broadest measurement of economic activity, GDP (Gross Domestic Product), came in at a higher-than-expected level of +4.2% for the 2nd quarter (see Wall Street Journal chart below).
Moreover, the spike in July’s Durable Goods orders also paints a healthy economic picture (see chart below). The data is volatile (i.e., Boeing Co orders – BA), nevertheless, CEO confidence is on the rise. Improved confidence results in executives opening up their wallets and investing more into their businesses.
Source: Calafia Beach Pundit
Last but not least, the lifeblood of appreciating stock prices (earnings/profits) have been accelerating higher. In the most recent quarterly results, we saw a near doubling of the growth rate from 1st quarter’s +5% growth rate to 2nd quarter’s +10% growth rate (see chart below).
Source: Dr. Ed’s Blog
With the S&P 500 continuing to make new record highs despite scary geopolitical and Federal Reserve policy concerns, the stock market party is still waiting for guests to arrive. When everyone arrives and jumps in the pool, it will be time to pop the corks and sell. Until then, there is plenty of appreciation potential as the champagne sits on ice.
Investing in the stock market can be quite stressful, especially during periods of volatility…but investing doesn’t have to be nerve-racking. Investing legend T. Rowe price captured the beneficial sentiments of growth investing beautifully when he stated the following:
“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”
What I’ve learned over my investing career is that fretting over such things as downgrades, management changes, macroeconomic data, earnings misses, geopolitical headlines, and other irrelevant transitory factors leads to more heartache than gains. If you listen to a dozen so-called pundits, talking heads, journalists, or bloggers, what you quickly realize is that all you are often left with are a dozen different opinions. Opinions don’t matter…the facts do.
Finding Multi-Baggers: The Power of Compounding
Rather than succumbing to knee-jerk reactions from the worries of the day, great long-term investors realize the benefits of compounding. We know T. Rowe Price appreciated this principle because he agreed with Nobel Prize winning physicist Albert Einstein’s view that “compounding interest” should be considered the “8th wonder of the world” – see also how Christopher Columbus can turn a penny into $121 billion (Compounding: A Penny Saved is Billions Earned).
People generally refer to Warren Buffett as a “Value” investor, but in fact, despite the Ben Graham moniker, Buffett has owned some of the greatest growth stocks of all-time. For example, Coca Cola Co (KO) achieved roughly a 20x return from 1988 – 1998, as shown below:
If you look at other charts of Buffett’s long-term holdings, such as Wells Fargo & Company (WFC), American Express Co (AXP), and Procter & Gamble – Gillette (PG), the incredible compounded gains are just as astounding.
In recent decades, there is no question that stocks have benefited from P/E expansion. P/E ratios, or the average price paid for stocks, has increased from the early 1980s as long-term interest rates have declined from the high-teens to the low single-digits, but the real lifeblood for any stock is earnings growth (see also It’s the Earnings, Stupid). As growth investor extraordinaire Peter Lynch once said:
“People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”
As Lynch also pointed out, it only takes the identification of a few great multi-bagger stocks every decade to compile a tremendous track record, while simultaneously hiding many sins:
“Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”
The Scarcity of Growth
Ever since the technology bubble burst in 2000, Growth stocks have felt the pain. Since that period, the Russell 1000 Value index – R1KV (Ticker: IWD) has almost doubled in value and outperformed the Russell 1000 Growth index – R1KG (Ticker: IWF) by more than +60% (see chart below):
Although the R1KG index has yet to breach its previous year 2000 highs, ever since the onset of the Great Financial Crisis (end of 2007), the R1KG index has been on the comeback trail. Now, the Russell 1000 Growth index has outperformed its Value sister index by an impressive +25% (see chart below):
Why such a disparity? Well, in a PIMCO “New Normal & New Neutral” world where global growth forecasts are being cut by the IMF and a paltry advance of 1.7% in U.S. GDP is expected, investors are on a feverish hunt for growth. U.S. investors are myopically focused on our 2.34% 10-Year Treasury yield, but if you look around the rest of the globe, many yields are at multi-hundred year lows. Consider 10-year yields in Germany sit at 0.96%; Japan at 0.50%; Ireland at 1.98%; and Hong Kong at 1.94% as a few examples. This scarcity of growth has led to outperformance in Growth stocks and this trend should continue until we see a clear sustainable acceleration in global growth.
If we dig a little deeper, you can see the 25% premium in the R1KG P/E ratio of 20.8x vs. 16.7x for the R1KV is well deserved. Historical 5-year earnings growth for the R1KG has been +52% higher than R1KV (17.8% vs. 11.7%, respectively). Going forward, the superior earnings performance is expected to continue. Long-term growth for the R1KG index is expected to be around 55% higher than the R1KV index (14% vs 9%).
In this 24/7, Facebook, Twitter society we live in, investing has never been more challenging with the avalanche of daily news. The ultra-low interest rates and lethargic global recovery hasn’t made my life at Sidoxia any easier. But one thing that is clear is that the investment tide is not lifting all Growth and Value stocks at the same pace. The benefits of long-term Growth investing are clear, and in an environment plagued by a scarcity of growth, it is becoming more important than ever when reviewing your investment portfolios to ask yourself, “Got Growth?”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in KO/PG (non-discretionary accounts) and certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, FB, WFC, AXP, IWF, IWD 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 IC Contact page.
#2. Don’t waste your time listening to the media.
Like dieting, the framework is simple to understand, but difficult to execute. Theoretically, if you follow Rule #1, you don’t have worry about Rule #2. Unfortunately, many people have no rules or discipline in place, and instead let their emotions drive all investing decisions. When it comes to following the media, Mark Twain stated it best:
“If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.”
It’s fine to be informed, as long as the deluge of data doesn’t enslave you into bad, knee-jerk decision-making. You’ve seen those friends, family members and co-workers who are glued to their cell phones or TVs while insatiably devouring real-time data from CNBC, CNN, or their favorite internet blog. The grinding teeth and sweaty palms should be a dead giveaway that these habits are not healthy for investment account balances or blood pressure.
Thanks to the endless scary headlines and stream of geopolitical turmoil (fear sells), millions of investors have missed out on one of the most staggering bull market rallies in history. More specifically, the S&P 500 index (large capitalization companies) has almost tripled in value from early 2009 (666 to 1,931) and the S&P 600 index (small capitalization companies) almost quadrupled from 181 to 645.
Becoming a member of the Successful Investors Club (SIC) is no easy feat. As I’ve written in the past, the human brain has evolved dramatically over tens of thousands of years, but the troubling, emotionally-driven amygdala tissue mass at the end of the brain stem (a.k.a., “Lizard Brain“) still remains. The “Lizard Brain” automatically produces a genetic flight response to perceived worrisome stimuli surrounding us. In other words, our “Lizard Brain” often interprets excessively sensationalized current events as a threat to our financial security and well-being.
It’s no wonder amateur investors have trouble dealing with the incessantly changing headlines. Yesterday, investors were panicked over the P.I.I.G.S (Portugal, Italy, Ireland, Greece, Spain), the Arab Spring (Tunisia, Egypt, Iran, etc.), and Cyprus. Today, it’s Ukraine, Argentina, Israel, Gaza, Syria, and Iraq. Tomorrow…who knows? It’s bound to be another fiscally irresponsible country, terrorist group, or autocratic leader wreaking havoc upon their people or enemies.
During the pre-internet or pre-smartphone era, the average person couldn’t even find Ukraine, Syria, or the Gaza Strip on a map. Today, we are bombarded 24/7 with frightening stories over these remote regions that have dubious economic impact on the global economy.
Take the Ukraine for example, which if you think about it is a fiscal pimple on the global economy. Ukraine’s troubled $177 billion economy, represents a mere 0.29% of the $76 trillion global GDP. Could an extended or heightened conflict in the region hinder the energy supply to a much larger and significant European region? Certainly, however, Russian President Vladimir Putin doesn’t want the Ukrainian skirmish to blow up out of control. Russia has its own economic problems, and recent U.S. and European sanctions haven’t made Putin’s life any easier. The Russian leader has a vested economic interest to keep its power hungry European customers happy. If not, the U.S.’s new found resurgence in petroleum supplies from fracking will allow our country to happily create jobs and export excess reserves to a newly alienated EU energy buyer.
Rather than be hostage to the roller coaster ride of rising and falling economic data points, it’s better to follow the sage advice of investing greats like Peter Lynch, who averaged a +29% return per year from 1977 – 1990.
Here’s what he had to say about news consumption:
“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Rather than fret about the direction of the market, at Sidoxia Capital Management we are focused on identifying the best available opportunities, given any prevailing economic environment (positive or negative). We assume the market will go nowhere and invest our client assets (and personal assets) accordingly by focusing on those areas we see providing the most attractive risk-adjusted returns. Investors who try to time the market, fail miserably over the long-run. If timing the market were easy, you would see countless people’s names at the tops of the Forbes billionaire list – regrettably that simply is not the case.
Since “fear” sells in the media world, it’s always important to sift through the deluge of data to gain a balanced perspective. During panic periods, it’s important to find the silver linings. When everyone is euphoric, it’s vital to discover reasons for caution.
While a significant amount of geopolitical turmoil occurred last month, it’s essential to remember the underlying positive fundamentals propelling the stock market to record highs. The skeptics of the recovery and record stock market point to the Federal Reserve’s unprecedented, multi-trillion dollar money printing scheme (Quantitative Easing – QE) and the inferior quality of the jobs created. Regarding the former point, if QE has been so disastrous, I ask where is the run-away inflation (see chart below)? While the July jobs report may show some wage pressure, you can see we’re still a long ways away from the elevated pricing levels experienced during the 1970s-1980s.
Source: Calafia Beach Pundit
A final point worth contemplating as it relates to the unparalleled Fed Policy actions was highlighted by strategist Scott Grannis. If achieving real economic growth through money printing was so easy, how come Zimbabwe and Argentina haven’t become economic powerhouses? The naysayers also fail to acknowledge that the Fed has already reversed the majority of its stimulative $85 billion monthly bond buying program (currently at $25 billion per month). What’s more, the Federal Open Market Committee has already signaled a rate hike to 1.13% in 2015 and 2.50% in 2016 (see chart below).
Source: Financial Times
The rise in interest rates from generationally low levels, especially given the current status of our improving economy, as evidenced by the recent robust +4.0% Q2-GDP report, is inevitable. It’s not a matter of “if”, but rather a matter of “when”.
On the latter topic of job quality, previously mentioned, I can’t defend the part-time, underemployed nature of the employment picture, nor can I defend the weak job participation rate. In fact, this economic recovery has been the slowest since World War II. With that said, about 10 million private sector jobs have been added since the end of the Great Recession and the unemployment rate has dropped from 10% to 6.1%. However you choose to look at the situation, more paychecks mean more discretionary dollars in the wallets and purses of U.S. workers. This reality is important because consumer spending accounts for 70% of our country’s economic activity.
While there is a correlation between jobs, interest rates, and the stock market, less obvious to casual observers is the other major factor that drives stock prices…record corporate profits. That’s precisely what you see in the chart below. Not only are trailing earnings at record levels, but forecasted profits are also at record levels. Contrary to all the hyped QE Fed talk, the record profits have been bolstered by important factors such as record manufacturing, record exports, and soaring oil production …not QE.
Join the Club
Those who have been around the investing block a few times realize how challenging investing is. The deafening information noise instantaneously accessed via the internet has only made the endeavor of investing that much more challenging. But the cause is not completely lost. If you want to join the bull market and the SIC (Successful Investors Club), all you need to do is follow the two top secret rules. Creating a plan and sticking to it, while ignoring the mass media should be easy enough, otherwise find an experienced, independent investment advisor like Sidoxia Capital Management to help you join the club.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds ans securities, 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.
With the World Cup in full swing and rabid fans rooting for their home teams, one may notice the many similarities between investing in stocks and handicapping in sports betting. For example, investors (bettors) have opposing views on whether a particular stock (team) will go up or down (win or lose), and determine if the valuation (point spread) is reflective of the proper equilibrium (supply & demand). And just like the stock market, virtually anybody off the street can place a sports bet – assuming one is of legal age and in a legal betting jurisdiction.
Soon investors will be poring over data as part of the critical, quarterly earnings ritual. With some unsteady GDP data as of late, all eyes will be focused on this earnings reporting season to reassure market observers the bull advance can maintain its momentum. However, even positive reports may lead to unexpected investor reactions.
So how and why can market prices go down on good news? There are many reasons that short-term price trends can diverge from short-run fundamentals. One major reason for the price-fundamental gap is this key factor: “expectations”. With such a large run-up in the equity markets (up approx. +195% from March 2009) come loftier expectations for both the economy and individual companies. For instance, just because corporate earnings unveiled from companies like Google (GOOG/GOOGL), J.P. Morgan (JPM), and Intel (INTC) exceed Wall Street analyst forecasts does not mean stock prices automatically go up. In many cases a stock price correction occurs due to a large group of investors who expected even stronger profit results (i.e., “good results, but not good enough”). In sports betting lingo, the sports team may have won the game this week, but they did not win by enough points (“cover the spread”).
Some other reasons stock prices move lower on good news:
- Market Direction: Regardless of the underlying trends, if the market is moving lower, in many instances the market dip can overwhelm any positive, stock- specific factors.
- Profit Taking: Many times investors holding a long position will have price targets or levels, if achieved, that will trigger selling whether positive elements are in place or not.
- Interest Rates: Certain valuation techniques (e.g. Discounted Cash Flow and Dividend Discount Model) integrate interest rates into the value calculation. Therefore, a climb in interest rates has the potential of lowering stock prices – even if the dynamics surrounding a particular security are excellent.
- Quality of Earnings: Sometimes producing winning results is not enough (see also Tricks of the Trade article). On occasion, items such as one-time gains, aggressive revenue recognition, and lower than average tax rates assist a company in getting over a profit hurdle. Investors value quality in addition to quantity.
- Outlook: Even if current period results may be strong, on some occasions a company’s outlook regarding future prospects may be worse than expected. A dark or worsening outlook can pressure security prices.
- Politics & Taxes: These factors may prove especially important to the market this year, since this is a mid-term election year. Political and tax policy changes today may have negative impacts on future profits, thereby impacting stock prices.
- Other Exogenous Items: Natural disasters and security attacks are examples of negative shocks that could damage price values, irrespective of fundamentals.
Certainly these previously mentioned issues do not cover the full gamut of explanations for temporary price-fundamental gaps. Moreover, many of these factors could be used in reverse to explain market price increases in the face of weaker than anticipated results.
If you’re traveling to Las Vegas to place a wager on the World Cup, betting on winning favorites like Germany and Argentina may not be enough. If expectations are not met and the hot team wins by less than the point spread, don’t be surprised to see a decline in the value of your bet.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, GOOG, and GOOGL, but at the time of publishing had no direct positions in JPM and INTC. 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.
Martin Luther King, Jr. famously stated, “The only thing we have to fear is fear itself,” but when it comes to the stock market, the only thing to fear is the “unknown.” As much as people like to say, “I saw that crisis coming,” or “I knew the bubble was going to burst,” the reality is these assertions are often embellished, overstated, and/or misplaced.
How many people saw these events coming?
- 1987 – Black Monday
- Iraqi War
- Thai Baht Currency Crisis
- Long-Term Capital Management Collapse & Bailout
- 9/11 Terrorist Attack
- Lehman Brothers Bankruptcy / Bear Stearns Bailout
- Flash Crash
- U.S. Debt Downgrade
- Arab Spring
- Sequestration Cuts
- Cyprus Financial Crisis
- Federal Reserve (QE1, QE2, QE3, Operation Twist, etc.)
Sure, there will always be a prescient few who may actually get it right and profit from their crystal balls, but to assume you are smart enough to predict these events with any consistent accuracy is likely reckless. Even for the smartest and brightest minds, uncertainty and doubt surrounding such mega-events leads to inaction or paralysis. If profiting in advance of these negative outcomes was so easy, you probably would be basking in the sun on your personal private island…and not reading this article.
Coming to grips with the existence of a never-ending series of future negative financial shocks is the price of doing business in the stock market, if you want to become a successful long-term investor. The fact of the matter is with 7 billion people living on a planet orbiting the sun at 67,000 mph, the law of large numbers tells us there will be many unpredictable events caused either by pure chance or poor human decisions. As the great financial crisis of 2008-2009 proved, there will always be populations of stupid or ignorant people who will purposely or inadvertently cause significant damage to economies around the world.
Fortunately, the power of democracy (see Spreading the Seeds of Democracy) and the benefits of capitalism have dramatically increased the standards of living for hundreds of millions of people. Despite horrific outcomes and unthinkable atrocities perpetrated throughout history, global GDP and living standards continue to positively march forward and upward. For example, consider in my limited lifespan, I have seen the introduction of VCRs, microwave ovens, mobile phones, and the internet, while experiencing amazing milestones like the eradication of smallpox, the sequencing of the human genome, and landing space exploration vehicles on Mars, among many other unimaginable achievements.
Despite amazing advancements, many investors are paralyzed into inaction out of fear of a harmful outcome. If I received a penny for every negative prediction I read or heard about over my 20+ years of investing, I would be happily retired. The stock market is never immune from adverse events, but chances are a geopolitical war in Ukraine/Iraq; accelerated Federal Reserve rate tightening; China real estate bubble; Argentinian debt default; or other current, worrisome headline is unlikely to be the cause of the next -20%+ bear market. History shows us that fear of the unknown is more rational than the fear of the known. If you can’t come to grips with fear itself, I fear your long-term results will lead to a scary retirement.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds, 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 (June 2, 2014). Subscribe on the right side of the page for the complete text.
Winning at any sport is lot easier if you can compete without an opponent. Imagine an NBA basketball MVP LeBron James driving to the basket against no defender, or versus a weakling opponent like a 44-year-old investment manager. Under these circumstances, it would be pretty easy for James and his team, the Miami Heat, to victoriously dominate without even a trace of sweat.
Effectively, stocks have enjoyed similar domination in recent years, while steamrolling over the bond competition. To put the stock market’s winning streak into perspective, the S&P 500 index set a new all-time record high in May, with the S&P 500 advancing +2.1% to 1924 for the month, bringing the 2013-2014 total return to about +38%. Not too shabby results over 17 months, if you consider bank deposits and CDs are paying a paltry 0.0-1.0% annually, and investors are gobbling up bonds yielding a measly 2.5% (see chart below).
The point, once again, is that even if you are a skeptic or bear on the outlook for stocks, the stock market still offers the most attractive opportunities relative to other asset classes and investment options, including bonds. It’s true, the low hanging fruit in stocks has been picked, and portfolios can become too equity-heavy, but even retirees should have some exposure to equities.
As I wrote last month in Buy in May and Dance Away, why would investors voluntarily lock in inadequate yields at generational lows when the earnings yield on stocks are so much more appealing. The approximate P/E (Price-Earnings) ratio for the S&P 500 currently averages approximately +6.2% with a rising dividend yield of about +1.8% – not much lower than many bonds. Over the last five years, those investors willing to part ways with yield-less cash have voted aggressively with their wallets. Those with confidence in the equity markets have benefited massively from the approximate +200% gains garnered from the March 2009 S&P 500 index lows.
For the many who have painfully missed the mother of all stock rallies, the fallback response has been, “Well, sure the market has tripled, but it’s only because of unprecedented printing of money at the QE (Quantitative Easing) printing presses!” This argument has become increasingly difficult to defend ever since the Federal Reserve announced the initiation of the reduction in bond buying (a.k.a., “tapering”) six months ago (December 18th). Over that time period, the Dow Jones Industrial Average has increased over 800 points and the S&P 500 index has risen a healthy 8.0%.
As much as everyone would like to blame (give credit to) the Fed for the bull market, the fact is the Federal Reserve doesn’t control the world’s interest rates. Sure, the Fed has an influence on global interest rates, but countries like Japan may have something to do with their own 0.57% 10-year government bond yield. For example, the economic/political policies and demographics in play might be impacting Japan’s stock market (Nikkei), which has plummeted about -62% over the last 25 years (about 39,000 to 15,000). Almost as shocking as the lowly rates in Japan and the U.S. and Japan, are the astonishingly low interest rates in Europe. As the chart below shows, France and Germany have sub-2% 10-year government bond yields (1.76% and 1.36%, respectively) and even economic basket case countries like Italy and Spain have seen their yields pierce below the 3% level.
Suffice it to say, yield is not only difficult to find on our shores, but it is also challenging to find winning bond returns globally.
Well if low interest rates and the Federal Reserve aren’t the only reasons for a skyrocketing stock market, then how come this juggernaut performance has such long legs? The largest reason in my mind boils down to two words…record profits. Readers of mine know I follow the basic tenet that stock prices follow earnings over the long-term. Interest rates and Fed Policy will provide headwinds and tailwinds over different timeframes, but ultimately the almighty direction of profits determines long-run stock performance. You don’t have to be a brain surgeon or rocket scientist to appreciate this correlation. Scott Grannis (Calafia Beach Pundit) has beautifully documented this relationship in the chart below.
Supporting this concept, profits help support numerous value-enhancing shareholder activities we have seen on the rise over the last five years, which include rising dividends, share buybacks, and M&A (Mergers & Acquisitions) activity. Eventually the business cycle will run its course, and during the next recession, profits and stock prices will be expected to decline. A final contributing factor to the duration of this bull market is the abysmally slow pace of this economic recovery, which if measured in job creation terms has been the slowest since World War II. Said differently, the slower a recovery develops, the longer the recovery will last. Bill McBride at Calculated Risk captured this theme in the following chart:
Despite the massive gains and new records set, skeptics abound as evidenced by the nearly -$10 billion of withdrawn money out of U.S. stock funds over the last month (most recent data).
I’ve been labeled a perma-bull by some, but over my 20+ years of investing experience I understand the importance of defensive positioning along with the benefits of shorting expensive, leveraged stocks during bear markets, like the ones in 2000-2001 and 2008-2009. When will I reverse my views and become bearish (negative) on stocks? Here are a few factors I’m tracking:
- Inverted Yield Curve: This was a good precursor to the 2008-2009 crash, but there are no signs of this occurring yet.
- Overheated Fund Inflows: When everyone piles into stocks, I get nervous. In the last four weeks of domestic ICI fund flow data, we have seen the opposite…about -$9.5 billion outflows from stock funds.
- Peak Employment: When things can’t get much better is the time to become more worried. There is still plenty of room for improvement, especially if you consider the stunningly low employment participation rate.
- Fed Tightening / Rising Bond Yields: The Fed has made it clear, it will be a while before this will occur.
- When Housing Approaches Record Levels: Although Case-Shiller data has shown housing prices bouncing from the bottom, it’s clear that new home sales have stalled and have plenty of head room to go higher.
- Financial Crisis: Chances of experiencing another financial crisis of a generation is slim, but many people have fresh nightmares from the 2008-2009 financial crisis. It’s not every day that a 158 year-old institution (Lehman Brothers) or 85 year-old investment bank (Bear Stearns) disappear, but if the dominoes start falling again, then I guess it’s OK to become anxious again.
- Better Opportunities: The beauty about my practice at Sidoxia is that we can invest anywhere. So if we find more attractive opportunities in emerging market debt, convertible bonds, floating rate notes, private equity, or other asset classes, we have no allegiances and will sell stocks.
Every recession and bear market is different, and although the skies may be blue in the stock market now, clouds and gray skies are never too far away. Even with record prices, many fears remain, including the following:
- Ukraine: There is always geopolitical instability somewhere on the globe. In the past investors were worried about Egypt, Iran, and Syria, but for now, some uncertainty has been created around Ukraine.
- Weak GDP: Gross Domestic Product was revised lower to -1% during the first quarter, in large part due to an abnormally cold winter in many parts of the country. However, many economists are already talking about the possibility of a 3%+ rebound in the second quarter as weather improves.
- Low Volatility: The so-called “Fear Gauge” is near record low levels (VIX index), implying a reckless complacency among investors. While this is a measure I track, it is more confined to speculative traders compared to retail investors. In other words, my grandma isn’t buying put option insurance on the Nasdaq 100 index to protect her portfolio against the ramifications of the Thailand government military coup.
- Inflation/Deflation: Regardless of whether stocks are near a record top or bottom, financial media outlets in need of a topic can always fall back on the fear of inflation or deflation. Currently inflation remains in check. The Fed’s primary measure of inflation, the Core PCE, recently inched up +0.2% month-to-month, in line with forecasts.
- Fed Policy: When are investors not worried about the Federal Reserve’s next step? Like inflation, we’ll be hearing about this concern until we permanently enter our grave.
In the sport of stocks and investing, winning is never easy. However, with the global trend of declining interest rates and the scarcity of yields from bonds and other safe investments (cash/money market/CDs), it should come as no surprise to anyone that the winning streak in stocks is tied to the lack of competing investment alternatives. Based on the current dynamics in the market, if LeBron James is a stock, and I’m forced to guard him as a 10-year Treasury bond, I think I’ll just throw in the towel and go to Wall Street. At least that way my long-term portfolio has a chance of winning by placing a portion of my bets on stocks over bonds.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
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