‘Tis the Season for Giving

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2017). Subscribe on the right side of the page for the complete text.

Holiday season is in full swing, and that means it’s the primetime period for giving. The stock market has provided its fair share of giving to investors in the form of a +2.7% monthly return in the S&P 500 index (up +18% in 2017). For long-term investors, stocks have been the gift that keeps on giving. As we approach the 10-year anniversary of the 2008 Financial Crisis, stocks have returned +68% from the October 2007 peak and roughly +297% from the March 2009 low. If you include the contributions of dividends over the last decade, these numbers look even more charitable.

Compared to stocks, however, bonds have acted more like a stingy Ebenezer Scrooge than a generous Mother Theresa. For the year, the iShares Core Aggregate bond ETF (AGG) has returned a meager +1%, excluding dividends. Contributing to the lackluster bond results has been the Federal Reserve’s miserly monetary policy, which will soon be managed under new leadership. In fact, earlier this week, Jerome Powell began Congressional confirmation hearings as part of the process to replace the current Fed chair, Janet Yellen. As the Dow Jones Industrial Average rose for the 8th consecutive month to 24,272 (the longest winning streak for the stock index in 20 years), investors managed to take comfort in Powell’s commentary because he communicated a steady continuation of Yellen’s plan to slowly reverse stimulative policies (i.e., raise interest rate targets and bleed off assets from the Fed’s balance sheet).

Because the pace of the Federal Funds interest rate hikes have occurred glacially from unprecedented low levels (0%), the resulting change in bond prices has been relatively meager thus far in 2017. In that same deliberate vein, the Fed is meeting in just a few weeks, with the expectation of inching the Federal Funds rate higher by 0.25% to a target level of 1.5%. If confirmed, Powell plans to also chip away at the Fed’s gigantic $4.5 trillion balance sheet over time, which will slowly suck asset-supporting liquidity out of financial markets.

Economy Driving Stocks and Interest Rates Higher

Presents don’t grow on trees and stock prices also don’t generally grow without some fundamental underpinnings. With the holidays here, consumers need money to fulfill the demanding requests of gift-receiving individuals, and a healthy economy is the perfect prescription to cure consumers’ empty wallet and purse sickness.

Besides the Federal Reserve signaling strength by increasing interest rates, how do we know the economy is on firm footing? While economic growth may not be expanding at a barn-burning rate, there still are plenty of indications the economy keeps chugging along. Here are a few economic bright spots to highlight:

  • Accelerating GDP Growth: As you can see from the chart below, broad economic growth, as measured by Gross Domestic Product (GDP), accelerated to a very respectable +3.3% growth rate during the third quarter of 2017 (the fastest percentage gain in three years). These GDP calculations are notoriously volatile figures, nevertheless, the recent results are encouraging, especially considering these third quarter statistics include the dampening effects of Hurricane Harvey and Irma.

Source: Bloomberg

  • Recovering Housing Market: The housing market may not have rebounded as quickly and sharply as the U.S. stock market since the Financial Crisis, but as the chart below shows, new home sales have been on a steady climb since 2011. What’s more, a historically low level of housing inventory should support the continued growth in home prices and home sales for the foreseeable future. The confidence instilled from rising home equity values should also further encourage consumers’ cash and credit card spending habits.

Source: Calculated Risk

  • Healthy Employment Gains: Growth in the U.S. coupled with global synchronous economic expansion in Europe, Asia, and South America have given rise to stronger corporate profits and increased job hiring. The graph highlighted below confirms the 4.1% unemployment rate is the lowest in 17 years, and puts the current rate more than 50% below the last peak of 10.0% hit in 2009.

Source: Calculated Risk

Turbo Tax Time

Adding fuel to the confidence fire is the prospect of the president signing the TCJA (Tax Cuts and Jobs Act). At the time this article went to press, Congress was still feverishly attempting to vote on the most significant tax-code changes since 1986. Republicans by-and-large all want tax reform and tax cut legislation, but the party’s narrow majority in the House and Senate leaves little wiggle room for disagreement. Whether compromises can be met in the coming days/weeks will determine whether a surprise holiday package will be delivered this year or postponed by the Grinch.

Unresolved components of the tax legislation include, the feasibility of cutting the corporate tax rate from 35% to 20%; the deductibility of state and local income taxes (SALT); the potential implementation of a tax cut limit “trigger”, if forecasted economic growth is not achieved; the potential repeal of the estate tax (a.k.a., “death tax”); mortgage interest deductibility; potential repeal of the Obamacare individual mandate; the palatability of legislation expanding deficits by $1 trillion+; debates over the distribution of tax cuts across various taxpayer income brackets; and other exciting proposals that will heighten accountants’ job security, if the TCJA is instituted.

Bitcoin Bubble?

If you have recently spent any time at the watercooler or at a cocktail party, you probably have not been able to escape the question of whether the digital blockchain currency, Bitcoin, is an opportunity of a lifetime or a vehicle to crush your financial dreams to pieces (see Bitcoin primer).

Let’s start with the facts: Bitcoin’s value traded below $1,000 at the beginning of this year and hit $11,000 this week before settling around $10,000 at month’s end (see chart below). In addition, blogger Josh Brown points out the scary reality that “Bitcoin has already crashed by -80% on five separate occasions over the last few years.” Suffice it to say, transacting in a currency that repeatedly loses 80% of its value can pose some challenges.

Source: CoinMarketCap.com  

Bubbles are not a new phenomenon. Not only have I lived through numerous bubbles, but I have also written on the topic (see also Sleeping and Napping through Bubbles). I find the Dutch Tulip Bulb Mania that lasted from 1634 – 1637 to be the most fascinating financial bubble of all (see chart below). At the peak of the euphoria, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation-adjusted basis), and one historical account states 12 acres of land were offered for a single tulip bulb.

Forecasting the next peak of any speculative bubble is a fool’s errand in my mind, so I choose to sit on the sidelines instead. While I may be highly skeptical of the ethereal value placed on Bitcoin and other speculative markets (i.e. ICOs – Initial Coin Offerings), I fully accept the benefits of the digital blockchain payment technology and also acknowledge Bitcoin’s value could more than double from here. However, without any tangible or intellectual process of valuing the asset, history may eventually place Bitcoin in the same garbage heap as the 1630 tulips.

For some of you out there, if you are anything like me, your digestion system is still recovering from the massive quantities of food consumed over the Thanksgiving holiday. However, when it comes to your personal finances, digesting record-breaking stock performance, shifting Federal Reserve monetary policy, tax legislation, and volatile digital currencies can cause just as much heartburn. In the spirit of “giving”, if you are having difficulty in chewing through all the cryptic economic and political noise, “give” yourself a break by contacting an experienced, independent, professional advisor. That’s definitely a gift you deserve!

www.Sidoxia.com

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 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.

December 2, 2017 at 6:30 am Leave a comment

Markets Fly as Media Noise Goes By

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 1, 2017). Subscribe on the right side of the page for the complete text.

That loud pitched noise is not a frightening scream from Halloween, but rather what you are likely hearing is the deafening noise coming from Washington D.C or cries from concerned Americans watching senseless acts of terrorism. Thanks to the explosion of real-time social media and smart phones, coupled with the divisive politics and depressing headlines blasted across all media outlets, it is almost impossible to ignore the daily avalanche of informational irrelevance.

As I have been writing for some time, the good news for long-term investors is the financial markets continue to plug their ears and ignore poisonous politics and the spread of F.U.D. (Fear, Uncertainty & Doubt). There is a financial benefit to turning off the TV and disregarding political rants over your Facebook feed. Regardless of your political views, President Trump’s approval ratings have objectively been going down, but that really doesn’t matter…the stock market keeps going up (see chart below).

Source: Bespoke

While politicians on both sides scream at each other, investment portfolios have been screaming higher. Stock prices are more focused on the items that really matter, which include corporate profits, interest rates, valuations (price levels), and sentiment (i.e., determining whether investors are too optimistic or too pessimistic). The proof is in the pudding. Stock prices continue to set new records, as witnessed by the 7th consecutive monthly high registered by the Dow Jones Industrial Average to a level of 23,377. For the month, these results translate into an astonishing +4.3% gain. For the year, this outcome equates to an even more impressive +18.3% return. This definitely beats the near-0% rate earned on your checking account and cash stuffed under the mattress.

On the surface, 2017 has been quite remarkable, but over the last decade, stock market returns have proved to be even more extraordinary. Bolstering my contention that politics rarely matter to your long-term pocketbook, one can simply observe history. We are now approaching the 10-year anniversary of the 2008-2009 Financial Crisis – arguably the worst recession experienced in a generation. Over the last decade, despite political power in Washington bouncing around like a hot potato, stock performance has skyrocketed. From early 2009, when the Dow briefly touched a low of 6,470, the index has almost quadrupled above the 23,000 threshold (see chart below).

Source: Barchart.com

To place this spectacular period into better context, one should look at the political control dynamics across Congress and the White House over the same time frame (see the right side of the chart below). Whether you can decipher the chart or not, anyone can recognize that the colors consistently change from red (Republican) to blue (Democrat), and then from blue to red.

More specifically, since the end of 2007, the Democrats have controlled the Senate for approximately 80% of the time; the Republicans have controlled the House of Representatives for 60% of the time; and the Oval Office has switched between three different presidents (two Republicans and one Democrat). And if that is not enough diversity for you, we have also had two Federal Reserve Chairs (Ben Bernanke and Janet Yellen) who controlled the world’s most powerful monetary system, and a Congressional mid-term election taking place in twelve short months. There are two morals to this story: 1) No matter how sad or excited you are about your candidate/political party, you can bank on the control eventually changing; and 2) One person alone cannot save the economy, nor can that same person singlehandedly crater the economy.

Source: Wikipedia

Waterfall of Worries

If you simply read the newspapers and watched the news on TV all day, you would be shocked to learn about the magnificent magnitude of this equity bull market. Reaching these new highs has not been a walk in the park for most investors. There certainly has been no shortage of issues to worry about, including the following:

  • Special Counsel Indictments: After the abrupt firing of former FBI Director James Comey by President Donald Trump, Deputy Attorney General Rod Rosenstein established a special counsel in May and appointed ex-FBI official and attorney Robert Mueller to investigate potential Russian meddling into the 2016 presidential elections. Just this week, Mueller indicted Paul Manafort, the former Trump campaign chairman, and Manafort’s business partner and Trump campaign volunteer, Rick Gates. The special counsel also announced the guilty plea of George Papadopoulos, a former foreign policy adviser for the Trump campaign who admitted lying to the FBI regarding interactions between Russian officials and the Trump campaign.
  • Terrorist Attacks: Senseless murders of eight people in New York  by a 29-year-old man from Uzbekistan, and 59 people shot dead by a 64-year-old shooter from a Las Vegas casino  have created a chilling blanket of concern over American psyches.
  • New Money Chief? The term of current Federal Reserve Chair, Janet Yellen, ends this February. President Trump has fueled speculation he will announce the appointment of a new Fed chief as early as this week. Although the president has recently praised Yellen, a registered Democrat, many pundits believe Trump wants to select Jerome Powell, a Republican, who currently sits on the Federal Board of Governors.
  • North Korea Rocket Launches: So far in 2017, North Korea has launched 22 missiles and tested a hydrogen bomb, while simultaneously threatening to fire missiles over the US territory of Guam and conduct an atmospheric nuclear test. Saber rattling has diminished somewhat in recent weeks since the last North Korean missile launch took place on September 15th. Nevertheless, tensions could rise at any moment, if missile launches resume.

Although media headlines are often depressing, F.U.D. will never go away – it’s only the list of worries that change over time. As noted earlier, the entrepreneurial DNA of the financial markets is focused on more important economic factors like the economy, rather than politics or terrorism. One barometer of economic health can be gauged by the chart below – Consumer Confidence is at the highest level since 2000.

Source: Bespoke

This trend is important because consumers make up approximately 70% of our nation’s economic output. Therefore, it should come as no surprise that Americans are feeling considerably better due to the following factors:

  • Strong Job Market: The 4.2% unemployment rate is at the lowest level in 16 years.
  • Strong Economy: Despite the dampening effect of the hurricanes, the economy is poised to register its best six-month performance of at least 3% growth in three years.
  • Strong Housing Market: Just-released data shows an acceleration in national home price appreciation by +6.1% compared to a year ago.
  • Low Interest Rates: Inflation has been low, credit has been cheap, and the Federal Reserve has been cautious in raising interest rates. These low rates have improved the affordability of credit, which has been stimulative for the economy.

Tax Reform Could be the Norm

The icing on the stock market cake has been the optimism surrounding the potential passage of tax reform, likely in the shape of corporate & personal tax cuts, foreign profit repatriation, and tax simplification. The process has been slow, but by passing a budget, the Republican-led Congress was able to pave the way for substantive new tax reform, something not seen since the Ronald Reagan administration, some 30-years ago. Everybody loves paying lower taxes, but victory cannot be claimed yet. Democrats and some fiscally conservative Republicans are not interested in exploding our country’s already-large deficits and debt levels. In order to achieve responsible tax legislation, Congress is looking to remove certain tax loopholes and is negotiating precious tax breaks such as mortgage interest deductibility, state/local tax deductibility, 401(k) tax incentives, and corporate interest expense deductibility, among many other possible iterations. Although corporate tax discussions have been heated, the chart below demonstrates individual income tax legislation is much more important for tax reform legislation because the government collects a much larger share of taxes from individuals vs. corporations.

Source: Calafia Beach Pundit

In spite of all the deafening political noise heard over social media and traditional media, it’s important to block out all the F.U.D. and concentrate on how to achieve your long-term financial goals. If you don’t have the time, energy, or emotional fortitude to follow a disciplined financial plan, I urge you to find an experienced investment advisor who is also a fiduciary. If you need assistance finding one, I am confident Sidoxia Capital Management can help you with this endeavor.

www.Sidoxia.com

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 FB, but at the time of publishing 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.

November 1, 2017 at 4:57 pm 1 comment

The September to Remember

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 2, 2017). Subscribe on the right side of the page for the complete text.

Given the volume of recent memorable events, it appears September will become a month to remember. Not only did we witness horrific natural disasters in Texas, Florida, Puerto Rico, and Mexico but Americans have also had to digest the saber rattling by the North Korean Rocket Man leader, Kim Jong Un*. If that wasn’t enough, there were a slew of headlines detailing the Washington gridlock and dysfunction over healthcare legislation / tax reform; hackings at Equifax affecting up to 143 million credit accounts; the planned unwinding of the Federal Reserves $4.2 trillion bond portfolio; and a controversy over NFL football players kneeling during the national anthem.

Despite all these notable events, the Dow Jones Industrial Average just posted its 8th consecutive quarter of advances. For the three months ending in September, the Dow impressively climbed more than 1,000 points (+4.7%) to a new record high of 22,381. For the year, the Dow remarkably has risen approximately +13%, excluding dividends, which translates into a total 2017 return of more than +15%, thus far.

However, not everybody has participated in the financial party. Negative political headlines have by and large paralyzed the hearts and minds of the general public, but as I have been writing for some time, stocks do not care much about governmental affairs – stock prices care about fundamentals. There have been two critical, fundamental components fueling the repetitive new highs experienced in the stock market: 1) The extraordinarily persistent surge in corporate profits (see chart below); and 2) The stubbornly declining interest rates,  which are near generationally-low levels. When investors are offered next-to-nothing interest rates in their bank accounts, and coupon payments on Treasury bonds remain paltry (10-Year Treasury closed month at a yield of 2.33%), suddenly stock opportunities can look much more attractive in a scarce investment environment.

Source: Yardeni.com

And geographically speaking, the rise in corporate profits has not been limited to the U.S. There has also been a synchronized escalation in corporate earnings globally. Whether we are talking about Europe, China, or emerging markets, in general, the economic recovery in these regions is now occurring coincidentally with the U.S. Case in point is the Purchasing Managers Index (PMI), which serves as a broad indicator of the economic health of the manufacturing sector. The chart below highlights the clear recovery that has been ongoing in the global manufacturing sector over the last year and a half.

Source: Yardeni.com

In addition to these numerous positive factors, a cheaper (weaker) U.S. dollar has also contributed to our nation’s economic tailwind. More specifically, a lower valued dollar makes American goods sold abroad cheaper for foreign buyers. This currency exchange rate dynamic is important because 43% of Fortune 500 sales (S&P 500) are derived from American products and services sold in foreign countries.

Tax Reform to be Born?

You probably don’t need me to tell you that gridlock in Washington D.C. is alive and well, but new details surrounding potential tax reform legislation that surfaced last week has lifted short-term investor optimism. As you can see from the chart below, the U.S. has the highest corporate tax rate among 35 developed countries in the OECD (Organisation for Economic Co-operation and Development), thereby making U.S. business less competitive globally. In hopes of reversing this trend, a basic framework was introduced by the President that proposed a top corporate rate of 20%, top small business rate of 25%, and streamlined personal tax brackets of 12%, 25%, and 35% (down from 7 brackets). Other key elements of the tax plan include, a doubling of the standard deduction for middle-class Americans; the elimination of the estate tax for the wealthy; the repeal of the alternative minimum tax; and immediate tax write-offs for business capital investments.

Source: The Financial Times

Many other important details have yet to be released and further specifics remain to be negotiated on Capitol Hill. For example, the removal of deductions for state and local taxes was announced, however additional information explaining how the estimated $2.2 trillion in tax cuts will be funded has yet to surface.

Regardless of the tax reform outcome, the economy continues to chug along at a healthy clip. Most recently, Gross Domestic Product (GDP), the central statistic in measuring the health of the U.S. economy, was revised higher to a respectable +3.1% rate in the second quarter. The latest natural disasters may clip third quarter growth temporarily, however, the consensus remains the economic expansion stands on firm ground, despite the financial drag of the hurricanes.

While geopolitical, meteorological, and athletic anthem headlines have made this a “September to Remember,” fundamental strength and other factors have contributed to this enduring and unforgettable bull market. There will be many more noteworthy headlines to occur in coming months and years, but placing these events in the proper context and investing wisely will lead to a much more positive, memorable existence.

*The article was written before the Las Vegas tragedy on October 1, 2017.

www.Sidoxia.com

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 had no direct position in EFX 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

 

October 2, 2017 at 1:08 pm Leave a comment

Hurricane & Political Surprises as Dow Rises

hurricane

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2017). Subscribe on the right side of the page for the complete text.

It was a tumultuous month politically, economically, and meteorologically. The devastating destruction left in the wake of Hurricane Harvey’s 130 mile per hour winds and 50+ inches of rain displaced more than 30,000 people in Texas, destroyed upwards of 40,000 homes, and created estimated damages of $190 billion, making this storm the costliest hurricane in history (see table below).

hurricane cost

But Hurricane Harvey wasn’t the only destructive force wreaking havoc on Americans. There were numerous geopolitical storms raining down over the newswires as well, including the following:

North Korea Nuclear Standoff: The war of words between North Korean dictator Kim Jong Un and President Trump intensified significantly. When leader Kim Jong Un threatened to launch missiles at the U.S. mainland and Guam, President Trump responded by warning that North Korea would face “fire and fury,” if the U.S. is provoked and promised our military was “locked and loaded.” Defense Secretary Jim Mattis backed the president by cautioning North Korea it would be “game on,” if North Korean missiles were fired against U.S. territories. Tensions were raised after a provocative North Korean ballistic missile test aimed at the U.S. was launched over Japan into the Pacific Ocean.

Racial Strains in Charlottesville: A demonstration in Charlottesville, Virgina, protesting the removal of a Confederate statue of General Robert E. Lee, led to the death of protester Heather Heyer by a neo-Nazi participant (Ku Klux Klan and white nationalists were also participants in the protest). After many journalists criticized President Trump for a lukewarm response, his top economic adviser Gary Cohn stirred the political pot by saying, “I believe this administration can and must do better in consistently and unequivocally condemning these groups and do everything we can to heal the deep divisions that exist in our communities.” Attorney General Jeff Sessions called the incident “domestic terrorism.”

White House Shuffle: After strained relations with President Trump, White House Chief Strategist Steve Bannon became the latest staff departure.  The other high profile firings / resignations include White House Communicator Director Anthony Scaramucci, White House Chief of Staff Reince Priebus, Press Secretary Sean Spicer, FBI Director James Comey, and National Security Advisor Michael Flynn.

Looming Government Shutdown: Will Congress agree on an increase in the $20 trillion debt ceiling, or will ideological factions within Congress sabotage an agreement that would prevent the government’s lights from shutting off and our country from defaulting on its debt obligations? The answer to this crucial question needs to be resolved by the end of this month. By chance, political lemonade could be made from natural disaster lemons. Due to the critical need for Hurricane Harvey disaster relief funding, Congress could be pressured into accelerating the signing of a combined legislative package that joins time-sensitive disaster relief funding with a resolution to the debt ceiling. If this wasn’t enough responsibility, Congress must also reauthorize the federal government’s flood insurance program, and reauthorize the Children’s Health Insurance Program (CHIP).

Terrorist Attack in Barcelona: A van plowed into pedestrians in the popular Las Ramblas tourist area in the center of Barcelona, Spain, killing at least 14 people and injuring more than 130. The ISIS terror group claimed credit for the attack and the police believe all 12 members of the terror cell are in custody or dead.

The Great Tax Hope: A cornerstone to the Trump administration’s economic agenda has been the promise of tax reform and tax relief to stimulate economic GDP (Gross Domestic Product) growth above 3%. Treasury Secretary Steve Mnuchin originally hoped to spearhead new legislation by the end of August, but now is hopeful a tax bill will reach the President’s desk for signing by the end of the year. Although details of the tax plan have been scarce, key components endorsed by many Republicans include, a simplification of the tax code that has not been overhauled since 1986; a reduction in corporate tax rates from 35% to 15%; repatriation of domestic profits trapped in overseas markets; and the abolishment of the estate tax. Time will tell what compromises and/or concessions will need to be made, if tax reform will succeed in achieving a different fate than healthcare reform.

Despite this storm of massively depressing news, all three major stock indexes (Dow Jones Industrial Average, S&P 500, & NASDAQ), once again, all notched gains for the month to new record highs. With the Dow now at a level of 21,948, the index is up a healthy +11% for 2017 with still a third of the year left. In what could turn out to be the worst-ever U.S. natural disaster and gloomy political headlines, how can stock prices keep going up? The short answer, as I have written continuously, stocks care about more important factors than politics and localized one-time disasters. Here are some of the factors the stock market does care about:

Rising Profits: 

On a day-to-day, week-to-week basis, stock prices can be extremely volatile. However, over the long-run, stock prices generally follow the direction of corporate profits. With profits at record levels (see chart below), and showing continued growth, observers should not be surprised by persistent price appreciation.

corp prof

Source: Calafia Beach Pundit

Near Record-Low Interest Rates:

In an environment where interest rates are near 75-year lows, and you are earning next to 0% on your bank savings, it’s no wonder that many shrewd investors have successfully flocked to stocks. This is not 1981, when you could earn upwards of 15% on a bank CD (stocks were much less desirable). As long as interest rates remain low, with healthy profits, stocks will remain attractive.

10y

Source: Trading Economics

Consumer Confidence Builds:

In spite of messy geopolitics and Washington gridlock, consumers are beginning to become desensitized to all the pessimistic noise. Two-thirds of our economy is driven by consumer spending, and with rising confidence (see chart below), this augurs well for the economy, corporate profits, and the stock market.

consumer confidence

Source: Bespoke

Strong Jobs – Low Unemployment:

Confidence is great, but you need to make money before you can spend it. And in order to make money, most people need a job. The good news is unemployment is at extremely low levels. In fact, as you can see from the chart below, unemployment claims are at the lowest levels since 1973. The unemployment rate of 4.3% also impressively dipped to a 16-year low. More discretionary income has also led to a sustainable recovery in the housing market, despite the low inventory of homes.

weekly unemploy

Source: Calculated Risk

Synchronized Global Recovery:

Not many people realize it, but the economic size (GDP) of the Eurozone is a larger combined economy than the U.S. The chart below serves as a general proxy for our respective economies. What you can see is that since the 2008-2009 financial crisis, Europe (red line) has for the most part lagged the U.S. (blue line), but in recent quarters, Europe has caught up with us. Seeing the manufacturing indices above the 50% level is a good sign, because it signals expansion. If you were to examine other larger developed economies (like China and Japan), you would also notice economic growth has been picking up or holding steady at strong levels. Together, these economic data points mean we are currently experiencing a synchronized global recovery, which is positive for stock prices.

manufacturing index

Source: Calafia Beach Pundit

Overall, while the newswires are buzzing with stories of political and natural hurricanes, there have been an abundance of positive factors that have pushed stock values to new record highs. The media loves politics, doom, and gloom, but your investments care more about profits, interest rates and the economy. Do yourself a favor and do not get emotionally involved in the panic headlines du jour. Instead, focus on the big picture and the many other opportunities for investment growth and preservation, otherwise your personal finances may turn into a scary natural disaster.

investment-questions-border

www.Sidoxia.com

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 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

September 1, 2017 at 1:59 pm Leave a comment

The Summer Heats Up

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 1, 2017). Subscribe on the right side of the page for the complete text.

The temperature in the stock market heated up again this month. Like a hot day at the beach, the Dow Jones Industrial Average stock index burned +542 points higher this month (+2.5%), while scorching +2,129 points ahead in 2017 (or +10.8%).

Despite these impressive gains (see 2009-2017 chart below), overall, investors remain concerned. Rather than stock participants calmly enjoying the sun, breeze, and refreshingly cool waters of the current markets, many investors have been more concerned about getting sunburned to a geopolitical crisp; overwhelmed by an unexpected economic tsunami; and/or drowned by a global central bank-induced interest rate crisis.

Stock market concerns rise, but so do stock prices.

The most recent cautionary warnings have come to the forefront by noted value investor Howard Marks, who grabbed headlines with last week’s forewarning memo, “Here They Go Again…Again.” The thoughtful, 23-page document is definitely worth reading, but like any prediction, it should be taken with a pound of salt, as I point out in my recent article Predictions – A Fool’s Errand. The reality is nobody has been able to consistently predict the future.

If you don’t believe my skepticism about crystal balls and palm readers, just listen to the author of the cautionary article himself. Like many other market soothsayers, Marks is forced to provide a mea culpa on the first page in which he admits his predictions have been wrong for the last six years. His dour but provocative position also faces another uphill battle, given that Marks’s conclusion flies in the face of value investing god, Warren Buffett, who was quoted this year as saying:

“Measured against interest rates, stocks actually are on the cheap side compared to historic valuations.”

Rather than crucify him, Marks should not be singled out for this commonly cautious view. In fact, most value investors are born with the gloom gene in their DNA, given the value mandate to discover and exploit distressed assets. This value-based endeavor has become increasingly difficult as the economy gains steam in this slow but sustainably long economic recovery. As I’ve mentioned on numerous occasions, bull markets don’t die of old age, but rather they die from excesses. So far the key components of the economy, the banking system and consumers, have yet to participate in euphoric excesses like previous economic cycles due to risk aversion caused by the last financial crisis.

Making matters worse for value investors, the value style of investing has underperformed since 2006 alongside other apocalyptic predictions from revered value peers like Seth Klarman and Ray Dalio, who have also been proved wrong over recent years.

However, worth stating, is experienced, long-term investors like Marks, Klarman, and Dalio deserve much more attention than the empty predictions spewed from the endless number of non-investing strategists and economists who I specifically reference in A Fool’s Errand.

Beach Cleanup in Washington

While beach conditions may be sunny, and stock market geeks like me continue debating future market weather conditions, media broadcasters and bloggers have been focused elsewhere – primarily the nasty political mess littered broadly across our American shores.

Lack of Congressional legislation progress relating to healthcare, tax reform, and infrastructure, coupled with a nagging investigation into potential Russian interference into U.S. elections, have caused the White House to finally lose its patience. The end result? A swift cleanup of the political hierarchy. After deciding to tidy up the White House, President Trump’s first priority was to remove Sean Spicer, the former White House Press Secretary and add the controversial Wall Street executive Anthony Scaramucci as the new White House Communications Chief. Shortly thereafter, White House Chief of Staff Reince Priebus was pushed to resign, and he was replaced by Secretary of Homeland Security, John F. Kelly. If this was not enough drama, after Scaramucci conducted a vulgar-laced tirade against Priebus in a New Yorker magazine interview, newly minted Chief of Staff Kelly felt compelled to quickly fire Scaramucci.

While the political beach party and soap opera have been entertaining to watch from the sidelines, I continue to remind observers that politics have little, if any, impact on the long-term direction of the financial markets. There have been much more important factors contributing to the nine-year bull market advance other than politics. For example, interest rates, corporate profits, valuations, and investor sentiment have been much more impactful forces behind the new record stock market highs.

Federal Reserve Chair Janet Yellen may not wear a bikini at the beach, but nevertheless she has become quite the spectacle in Washington, as investors speculate on the future direction of interest rates and other Fed monetary policies (i.e., unwinding the $4.5 trillion Fed balance sheet). In the hopes of not exhausting your patience too heavily, let’s briefly review interest rates, so they can be placed in the proper context. Specifically, it’s worth noting the spotlighted Federal Funds Rate target is sitting at enormously depressed levels (1.00% – 1.25%), despite the fact the Fed has increased the target four times within the last two years. How low has the Fed Funds rate been historically? As you can see from the historical chart below (1970 – 2017), this key benchmark rate reached a level as high as 20.00% in the early 1980s – a far cry from today’s 1.00% – 1.25% rate.

There are two crucial points to make here. First, even at 1.25%, interest rates are at extremely low levels, and this is significantly stimulative to our economy, even after considering the scenario of future interest rate hikes. The second main point is that that Federal Reserve Chair Janet Yellen has been exceedingly cautious about her careful, data-dependent intentions of increasing interest rates. As a matter of fact, the CME Fed Funds futures market currently indicates a 99% probability the Fed will maintain interest rates at this low level when the Federal Open Market Committee (FOMC) meets in September.

Responsibly Have Fun but Use Protection

It’s imperative to remain vigilantly prudent with your investments because weather conditions will not always remain calm in the financial markets. You do not want to get burned by overheated markets or caught off guard by an unexpected economic storm. Blindly buying tech stocks exclusively without a systematic disciplined approach to valuation is a sure-fire way to lose money over the long-run. Instead, protection must be implemented across multiple vectors.

From a broader perspective, at Sidoxia we believe it’s essential to follow a low-cost, diversified, tax-efficient, strategy with a long-term time horizon. Rebalancing your portfolio as markets continue to appreciate will keep your investment portfolio balanced as financial markets gyrate. These investment basics have produced a winning formula for many investors, including some very satisfying long-term results at Sidoxia, which is quickly approaching its 10-year anniversary. You can have fun at the beach, just remember to bring sunscreen and a windbreaker, in case conditions change.

www.Sidoxia.com

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 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.

August 1, 2017 at 12:16 pm Leave a comment

Stirring the Sentiment Tea Leaves Redux

Despite the Volatility Index (VIX) currently operating at the low end of historical ranges (9.36), the equity markets operate on a perpetual volatility rollercoaster. This period of relative calm has not stopped participants from searching for the Holy Grail of indicators in hopes of determining whether the next large move in the markets is upwards or downwards. Although markets may be efficient in the long-run (see Crisis Black Eye), in the short-run, financial markets are hostage to fear and greed, and these emotions have been on full display. Although the Dow Jones Industrial Average has almost catapulted almost +4,000 points since the period right before the 2016 Presidential Election, last June also produced a roughly -1,000 point decline in the Dow. With fresh fears over Russian intervention-collusion, global monetary policy uncertainty, and political risk in North Korea, investors are grasping for clues as they read the indicator tea leaves to better position their portfolios. Some of these contrarian sentiment indicators can be helpful to your portfolio, if used properly. However, in large part, interpreting many of the sentiment indicators is as useful as reading tea leaves for your winning lotto number picks.

The Art of Tea Leave Reading

The premise behind contrarian investing is fairly simple – if you follow the herd, you will be led to the slaughterhouse. There is a tendency for investors to succumb to short-termism and act on their emotions rather than reason. The pendulum of investment emotions continually swings back and forth between fear and greed, and many of these indicators are designed with the goal of capturing emotion extremes.

The concept of mass hysteria is nothing new. Back in 1841, Charles Mackay published a book entitled, Extraordinary Popular Delusions and the Madness of Crowds, in which Mackay explores the psychology of crowds and mass mania through centuries of history, including the infamous Dutch Tulip Mania of the early 1600s (see Soros Super Bubble).

Out of sympathy for your eyeballs, I will not conduct an in-depth review of all the contrarian indicators, but here is brief sampling:

Sentiment Surveys: The American Association of Individual Investors (AAII) releases weekly survey results from its membership. A different survey, conducted by Investors Intelligence, called the Advisors Sentiment Index, surveys authors of various stock advice newsletters. These data can provide some insights, but as you can probably gather, these surveys are also very subjective and often conflicting.

Put-Call Ratio: This is a widely used ratio that measures the trading volume of bearish put options to bullish call options and is used to gauge the overall mood of the market. When investors are fearful and believe prices will go lower, the ratio of puts to calls escalates. At historically high levels (see chart below), this ratio usually indicates a bottoming process in the market.

Volatility Index (VIX): The VIX indicator or “Fear Gauge” calculates inputs from various call and put options to create an approximation of the S&P 500 index implied volatility for the next 30 days. Put simply, when fear is high, the price of insurance catapults upwards and the VIX moves higher.

Strategist Sentiment: If you’re looking for a contrarian call to payoff, I wouldn’t hold your breath by waiting for bearish strategist sentiment to kick-in. Barry Ritholtz at the Big Picture got it right when he summarized Barron’s bullish strategist outlook by saying, “File this one under Duh!” Like most Wall Street and asset management firms, strategists have an inherent conflict of interest to provide a rosy outlook. More often than not, strategists’ opinions move like the wind in whatever direction stocks are currently moving.

Short Interest: The higher the amount of shares shorted, the larger the pent-up demand to buy shares becomes in the future. Extremely high levels of short interest tend to coincide with price bottoms because as prices begin to move higher, holders of short positions often feel “squeezed” to buy shares and push prices higher.

Fund Flow Data: The direction of investment dollars flowing in and out of mutual funds can provide some perspective on the psychology of the masses. This data can be found at the Investment Company Institute (ICI). Given the bloodletting of the 2008-2009 financial crisis, investors skepticism has made stocks about as popular as the approval ratings of Congress.

When it comes to sentiment indicators, I believe actions speak much louder than words. To the extent I actually do track some of these indicators, I pay much less attention to those indicators based on opinions, surveys, and technical analysis data (see Astrology or Lob Wedge). Most of my concentration is centered on those indicators explaining actual measurable investor behavior (i.e., Put-Call, VIX, Short Interest, Fund Flow, and other action-oriented trading metrics).

As we know from filtering through the avalanche of daily news data, the world can obviously can be a scary place (see Head Fakes Surprise). If you believe the world is on the cusp of ending and/or you do not believe investors are sufficiently bearish, I encourage you to build your own personal bunker and stuff it with gold or Bitcoin. If, however, you are looking to sharpen the returns on your portfolio and are thirsty for some emotional answers, pour yourself a cup of tea and pore over some sentiment indicators.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any 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.

July 24, 2017 at 12:10 pm Leave a comment

A Recipe for Disaster

Justice does not always get served in the stock market because financial markets are not always efficient in the short-run (see Black-Eyes to Classic Economists). However, over the long-run, financial markets usually get it right. And when the laws of economics and physics are functioning properly, I must admit it, I do find it especially refreshing.

There can be numerous reasons for stocks to plummet in price, but common attributes to stock price declines often include profit losses and/or disproportionately high valuations (a.k.a. “bubbles”). Normally, your garden variety, recipe for disaster consists of one part highly valued company and one part money-losing operation (or deteriorating financials). The reverse holds true for a winning stock recipe. Flavorful results usually involve cheaply valued stocks paired with improving financial results.

Unfortunately, just because you have the proper recipe of investment ingredients, doesn’t mean you will immediately get to enjoy a satisfying feast. In other words, there isn’t a dinner bell rung to signal the timing of a crash or spike – sometimes there is a conspicuous catalyst and sometimes there is not. Frequently, investments require a longer expected bake time before the anticipated output is produced.

As I alluded to at the beginning of my post, justice is not always served immediately, but for some high profile IPOs, low-quality ingredients have indeed produced low-quality results.

Snap Inc. (SNAP): Let’s first start with the high-flying social media darling Snap, which priced its IPO at $17 per share in March, earlier this year. How can a beloved social media company that generates $515 million in annual revenue (up +286% in the recent quarter) see its stock plummet -48% from its high of $29.44 to $15.27 in just four short months? Well, one way of achieving these dismal results is to burn through more cash than you’re generating in revenue. Snap actually scorched through more than -$745 million dollars over the last year, as the company reported accounting losses of -$618 million (excluding -$2 billion of stock-based compensation expenses). We’ll find out if the financial bleeding will eventually stop, but even after this year’s stock price crash, investors are still giving the company the benefit of the doubt by valuing the company at $18 billion today.

Source: Barchart.com

Blue Apron Holdings Inc. (APRN): Online meal delivery favorite, Blue Apron, is another company suffering from the post-IPO blues. After initially targeting an opening IPO price of $15-$17 per share a few weeks ago, tepid demand forced Blue Apron executives to cut the price to $10. Fast forward to today, and the stock closed at $7.36, down -26% from the IPO price, and -57% below the high-end of the originally planned range. Although the company isn’t hemorrhaging losses at the same absolute level of Snap, it’s not a pretty picture. Blue Apron has still managed to burn -$83 million of cash on $795 million in annual sales. Unlike Snap (high margin advertising revenues), Blue Apron will become a low-profit margin business, even if the company has the fortune of reaching high volume scale. Even after considering Blue Apron’s $1 billion annual revenue run rate, which is 50% greater than Snap’s $600 million run-rate, Blue Apron’s $1.4 billion market value is sadly less than 10% of Snap’s market value.

Source: Barchart.com

Groupon Inc. (GRPN): Unlike Snap and Blue Apron, Groupon also has the flattering distinction of reporting an accounting profit, albeit a small one. However, on a cash-based analysis, Groupon looks a little better than the previous two companies mentioned, if you consider an annual -$7 million cash burn “better”. Competition in the online discounting space has been fierce, and as such, Groupon has experienced a competitive haircut in its share price. Groupon’s original IPO price was $20 in January 2011 before briefly spiking to $31. Today, the stock has languished to $4 (-87% from the 2011 peak).

Source: Barchart.com

Stock Market Recipe?

Similar ingredients (i.e., valuations and profit trajectory) that apply to stock performance also apply to stock market performance. Despite record corporate profits (growing double digits), low unemployment, low inflation, low-interest rates, and a recovering global economy, bears and even rational observers have been worried about a looming market crash. Not only have the broader masses been worried today, yesterday, last week, last month, and last year, but they have also been worried for the last nine years. As I have documented repeatedly (see also Market Champagne Sits on Ice), the market has more than tripled to new record highs since early 2009, despite the strong under-current of endless cynicism.

Historically market tops have been marked by a period of excesses, including excessive emotions (i.e., euphoria). It has been a long time since the last recession, but economic downturns are also often marked with excessive leverage (e.g., housing in the mid-2000s), excessive capital (e.g., technology IPOs [Initial Public Offerings] in the late-1990s), and excessive investment (e.g., construction / manufacturing in early-1990s).

To date, we have seen little evidence of these markers. Certainly there have been pockets of excesses, including overpriced billion dollar tech unicorns (see Dying Unicorns), exorbitant commercial real estate prices, and a bubble in global sovereign debt, but on a broad basis, I have consistently said stocks are reasonably priced in light of record-low interest rates, a view also held by Warren Buffett.

The key lessons to learn, whether you are investing in individual stocks or the stock market more broadly, are that prices will follow the direction of earnings over the long-run. This helps explain why stock prices always go down in recessions (and are volatile in anticipation of recessions).

If you are looking for a recipe for disaster, just find an overpriced investment with money-losing (or deteriorating) characteristics. Avoiding these investments and identifying investments with cheap growth qualities is much easier said than done. However, by mixing an objective, quantitative framework with more artistic fundamental analysis, you will be in a position of enjoying tastier returns.

www.Sidoxia.com

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 SNAP, APRN, GRPN, 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 the information to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

 

July 14, 2017 at 11:54 pm 3 comments

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