Before the Brexit, 28 countries joined the European Union since its inception in 1957, without a single country leaving. The story is similar if you look at the World Trade Organization (WTO), which has witnessed more than 160 countries unite, without one country exiting since it began in 1948. Are the leaders of these countries idiots and blind to the benefits of trade and globalization? I think not.
For centuries, the advantages of free trade and globalization have lifted the standards of living for billions of people. However, pinpointing the timing or attributing the precise actions leading to these tremendous economic advantages is difficult to do because most trade benefits are often invisible to the naked eye.
Today, populist sentiment on both sides of the political aisle has demonized trade, whether referring to TPP (Trans-Pacific Partnership), NAFTA (North America Free Trade Agreement), trade with China, or announcements by corporations to manufacture goods internationally.
Although it would be naïve to adopt a stance that there are no negative consequences to globalization (e.g., lost American jobs due to offshoring), myopically focusing on job displacement is only half the equation.
While I can attempt to articulate the economic costs and benefits of free trade, and I’ve tried (see Productivity & Trade), Dan Ikenson of the Cato Institute explains it much better than I can. Here is a more eloquent synopsis of free trade (hat-tip: Scott Grannis):
“The case for free trade is not obvious. The benefits of trade are dispersed and accrue over time, while the adjustment costs tend to be concentrated and immediate. To synthesize Schumpeter and Bastiat, the “destruction” caused by trade is “seen,” while the “creation” of its benefits goes “unseen.” We note and lament the effects of the clothing factory that shutters because it couldn’t compete with lower-priced imports. The lost factory jobs, the nearby businesses on Main Street that fail, and the blighted landscape are all obvious. What is not so easily noticed is the increased spending power of the divorced mother who has to feed and clothe her three children. Not only can she buy cheaper clothing, but she has more resources to save or spend on other goods and services, which undergirds growth elsewhere in the economy.
Consider Apple. By availing itself of lowskilled, low-wage labor in China to produce small plastic components and to assemble its products, Apple may have deprived U.S. workers of the opportunity to perform that low-end function in the supply chain. But at the same time, that decision enabled iPods and then iPhones and then iPads to be priced within the budgets of a large swath of consumers. Had all of the components been produced and all of the assembly performed in the United States — as President Obama once requested of Steve Jobs — the higher prices would have prevented those devices from becoming quite so ubiquitous, and the incentives for the emergence of spin-off industries, such as apps, accessories, Uber, and AirBnb, would have been muted or absent.
But these kinds of examples don’t lend themselves to the political stump, especially when the campaigns put a premium on simple messages. This is the burden of free traders: Making the unseen seen. It is this asymmetry that explains much of the popular skepticism about trade, as well as the persistence of often repeated fallacies.
The benefits of trade come from imports, which deliver more competition, greater variety, lower prices, better quality, and new incentives for innovation. Arguably, opening foreign markets should be an aim of trade policy because larger markets allow for greater specialization and economies of scale, but real free trade requires liberalization at home. The real benefits of trade are measured by the value of imports that can be purchased with a unit of exports — our purchasing power or the so-called terms of trade. Trade barriers at home raise the costs and reduce the amount of imports that can be purchased with a unit of exports.
Protectionism benefits producers over consumers; it favors big business over small business because the cost of protectionism is relatively small to a bigger company; and, it hurts lower-income more than higher-income Americans because the former spend a higher proportion of their resources on imported goods.
…Even if there were a President Trump or President Sanders, rest assured that the Congress still has authority over the nuts and bolts of trade policy. The scope for presidential mischief, such as unilaterally raising tariffs, or suspending or amending the terms of trade agreements, is limited. But it would be more reassuring still if the intellectual consensus for free trade were also the popular consensus.”
Fortunately, Ikenson supports the case I’ve made repeatedly. The power of presidential politics is limited by the Congress (see Politics and Your Money). Frustration with politics has never been higher, but in many cases, gridlock is a good thing.
The destructive impacts of protectionist, anti-trade policies is unambiguous – just consider what happened from the implementation of Smoot-Hawley tariffs in 1930 around the time of the Great Depression. U.S. imports decreased 66% from $4.4 billion (1929) to $1.5 billion (1933), and exports decreased 61% from $5.4 billion to $2.1 billion. GNP fell from $103.1 billion in 1929 to $75.8 billion in 1931 and bottomed out at $55.6 billion in 1933.
It’s important to remember, any harmful downside to trade is overwhelmed by the upside of growth. Greg Ip of the WSJ used Doug Irwin, a trade historian at Dartmouth College, to make this pro-growth point:
“If two million American workers lose $15,000 in annual income forever—an extreme estimate of the impact of trade with China—while 320 million American consumers gain just $100 from trade, the benefits to all of society still exceed the costs.”
The benefits of free trade may be invisible in the short run, but over the long-run, the growth advantages of free trade are perfectly visible, despite protectionist, anti-trade rhetoric and propaganda dominating the presidential election conversation.
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 AAPL, 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.
Are you a value investor? If you said “yes,” how would you feel about buying an $18 stock with a P/E (Price/Earnings) ratio of greater than 100x and a Price/Sales ratio of 14x for a company that three years earlier was started in a garage? This may not sound like a value stock, but had you bought this stock at the initial public offering (IPO), it would have been a screaming bargain – priced at less than 1x P/E ratio, based on this year’s earnings estimates.
You may be surprised to know, this company with a meager $18 IPO share price is now worth $9,192 per share today (if you adjust for three stock splits)! Yes, that’s correct, a +50,900% return. If you are wondering to which stock I’m referring, I am talking about Amazon.com Inc. (AMZN). Incredibly, ever since Amazon went public in 1997, the CEO Jeff Bezos has managed to command the start-up e-commerce company from $31 million in revenues to $121 billion (with a “b”) on an annual basis in 2016 (a +389,000% increase).
Discovering the next IPO that turns into a $363 billion behemoth is easier said than done, and unfortunately these types of companies are a rare breed. Even if you are lucky enough to identify these diamonds-in-the-rough, early in their growth cycle, very few investors have the fortitude and discipline to continually own the stocks through the perpetual volatility (i.e., peaks and valleys).
The good news is, although you may be unable to find every unicorn out there, you can still apply the same principles and characteristics to any growth stock you invest in. In order to prudently achieve outsized returns, one must identify innovative market leaders that have gained some type of sustainable competitive advantage, which will serve as the profit and cash flow growth engine for the stock over the long-term.
If a company does not have a unique advantage over industry competitors, they will likely be unable to compound earnings growth – the key to becoming a big winner. Albert Einstein, Nobel Prize winner is credited with identifying compounding as the “eighth wonder of the world,” and without compounding there will be no gigantic results.
Amazon may be a rare breed, but there are plenty of other examples of so-called “expensive” stocks that get dismissed or fall through the cracks as they explode in value to the stratosphere. Consider Starbucks Corp. (SBUX), which at the time of its IPO in 1992 was priced at a very rich P/E of 52x. Sound expensive? Actually, this was a greatest offer in a generation. Adjusted for stock splits, the IPO shares were valued at $0.27 – in the most recent trading session Starbucks shares closed at $55.90, a +20,600% increase. Similar to Amazon, had you purchased Starbucks shares at the IPO price, you would have been paying less than a measly, eye-popping 1x P/E ratio based on 2016 earnings.
Alphabet Inc. (GOOGL), formerly Google Inc., is another case of growth stock appearing pricey on the outside, but really a value of a lifetime on the inside. The hype surrounding the Google IPO was so palpable in 2004, the stock priced at a relatively nose-bleed level of 60x P/E level, approximately. The unconventional auction bidding method to buy the initial shares made investors even more skeptical. Suffice it to say, the greater than +1,600% gain has once again shown that investors can reap handsome rewards, if they do thorough enough due diligence and ignore the illusory big ticket IPO prices.
What most investors fail to realize is that P/E ratios are temporary. By purchasing a growth stock, the numerator of the P/E ratio (price) becomes static or fixed. As earnings of a growth company expand, the stock becomes cheaper by the day. More specifically, the numerator of the P/E (price) is flat, while the denominator (earnings) grows, thereby making the P/E ratio smaller (cheaper). And as you can see from the few previous examples I have provided, if you are able to identify winners, and hold them long enough, you will eventually realize the initial hefty price tag at purchase will be considered almost free after all the earnings compounding.
Legendary growth investor Peter Lynch summed it up concisely when he noted, “People concentrate too much on the P, but the E really makes the difference.” Lynch goes on to highlight the importance of patience in growth investing because stocks often go down or move sideways for long periods of time before dramatic increases occur:
“My best stocks performed in the 3rd year, 4th year, 5th year, not in the 3rd week or 4th week.”
I’ve illustrated a few successful examples of meteoric growth stocks, but more importantly the misconception many investors place on the current P/E ratio. There still is no substitute for hard-nosed, detailed fundamental research for finding big growth winners, because true growth stocks bought and held for a long enough period, will become cheaper by the day. If you don’t have the time, discipline, or patience to execute this winning strategy, find and hire an experienced investment manager who understands these concepts.
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), AMZN, and GOOGL, but at the time of publishing had no direct position in SBUX, 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 1, 2016). Subscribe on the right side of the page for the complete text.
The XXXI Olympics in Rio, Brazil begin this week, but stocks in 2016 have already won a gold medal for their stellar performance. The S&P 500 index has already triumphantly sprinted to new, all-time record highs this month. A significant portion of the gains came in July (+3.6%), but if you also account for the positive results achieved in the first six months of 2016, stocks have advanced +6.3% for the year. If you judge the 2%+ annualized dividend yield, the total investment return earns an even higher score, coming closer to +8% for the year-to-date period.
No wonder the U.S. is standing on the top of the economic podium compared to some of the other international financial markets, which have sucked wind during 2016:
- China Shanghai Index: -15.8%
- Japan Nikkei Index: -12.9%
- French Paris CAC Index: -4.3%
- German Dax Index: -3.8%
- Europe MSCI Index: -3.5%
- Hong Kong Heng Sang Index: -0.1%
While there are some other down-and-out financial markets that have rebounded significantly this year (e.g., Brazil +61% & Russia +23%), the performance of the U.S. stock market has been impressive in light of all the fear, uncertainty, and doubt blanketing the media airwaves. Consider the fact that the record-breaking performance of the U.S. stock market in July occurred in the face of these scary headlines:
- Brexit referendum (British exit from the European Union)
- Declining oil prices
- Declining global interest rates
- More than -$11,000,000,000,000.00 (yes trillions) in negative interest rate bonds
- Global terrorist attacks
- Coup attempt in Turkey
- And oh yeah, a contentious domestic presidential election
With so many competitors struggling, and the investment conditions so challenging, then how has the U.S. prospered with a gold medal performance in this cutthroat environment? For many individuals, the answer can be confusing. However, for Sidoxia’s followers and clients, the strong pillars for a continued bull market have been evident for some time (described again below).
Bull Market Pillars
Surprising to some observers, stocks do not read pessimistic newspaper headlines or listen to gloomy news stories. In the short-run, stock prices can get injured by emotional news-driven traders and speculators, but over the long-run, stocks and financial markets are drawn like a magnet to several all-important metrics. What crucial metrics am I referring to? As I’ve reiterated in the past, the key drivers for future stock price appreciation are corporate profits, interest rates, valuations (i.e., price levels), and sentiment indicators (see also Don’t Be a Fool).
Stated more simply, money goes where it is treated best, and with many bonds and savings accounts earning negative or near 0% interest rates, investors are going elsewhere – for example, stocks. You can see from the chart below, economy/stocks are treated best by rising corporate profits, which are at/near record high levels. With the majority of stocks beating 2nd quarter earnings expectations, this shot of adrenaline has given the stock market an added near-term boost. A stabilizing U.S. dollar, better-than-expected banking results, and firming commodity prices have all contributed to the winning results.
Price Follows Earnings…and Recessions
What history shows us is stock prices follow the direction of earnings, which helps explain why stock prices generally go down during economic recessions. Weaker demand leads to weaker profits, and weaker profits lead to weaker stock prices. Fortunately for U.S. investors, there currently are no definitive signs of imminent recession clouds. Scott Grannis, the editor of Calafia Beach Pundit, sums up the relationship between recessions and the stock market here:
“Recessions typically follow periods of excesses—soaring home prices, rising inflation, widespread optimism—rather than periods dominated by risk aversion such as we have today. Risk aversion can still be found in abundance: just look at the extremely low level of Treasury yields, and the lack of business investment despite strong corporate profits.”
Similar to the Olympics, achieving success in investing can be very challenging, but if you want to win a medal, you must first compete. If you’re not investing, you’re not competing. And if you’re not investing, you have no chance of winning a financial gold medal. Just as in the Olympics, not everyone can win, and there are many ups and downs along the way to victory. Rather than focusing on the cheers and boos of the crowd, implementing a disciplined and diversified investment strategy that accounts for your time horizon, objectives, and risk tolerance is the championship approach that will increase your probability of landing on the Olympic medal podium.
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.
Will you be able to retire, and what impact will the elections have on your financial future? Answering these questions can be a scary endeavor. And unless you have been living in a cave, you may have noticed we are in the middle of a heated U.S. presidential election campaign between Donald Trump and Hillary Clinton. Regardless of which side of the political fence you stand on, the prospects of your retirement are much more likely to be impacted by your personal actions than by the actions of Washington politicians.
Even if you despise politics and were living in a cave (with WiFi access), there’s a high probability you would be overloaded with detailed and dogmatic online editorials from overconfident Facebook friends. Besides offering self-assured predictions, these impassioned political pleas generally itemize the top 10 reasons your favorite candidate is a moron, and another 10 reasons why their candidate is the greatest.
Your friends’ opinions may have pure intentions, but unfortunately, rarely, if ever, do their thoughts alter your views. A reference from a recent Legal Watercooler article summed it up best:
“Political Facebook rants changed my mind…said nobody, ever.”
Nearly as ineffectual as political Facebook opinions on your politics is the ineffectual influence of presidential elections on your finances. For example, over the last four decades, stock prices have gone up and down during both Republican and Democrat presidential terms. The picture looks much the same, if you analyze the fiscal performance of conservatives and liberals since 1970 – debt burdens as a percentage of economic output have risen and fallen under both political parties. No matter who wins the presidency, many investors forget the ability of that individual to affect change is highly dependent upon the political balance of power in Congress. If Congress holds a split majority in the House and Senate, or the opposition party commands the entire Congress, then the winning presidential candidate will be largely neutered.
Rather than panic over a political loss or celebrate a candidate’s victory, here are some tangible actions to improve your finances:
- Organize. Typically individuals have investment and saving accounts scattered with no cohesive accounting or strategy. Get your financial house in order by gathering and organizing all your accounts.
- Budget. Spend less than you take in. Or in other words…save. You can achieve this goal in one of two ways – cut your spending, or increase your income.
- Create a Plan. When do you plan to retire? How much money do you need for retirement? What asset allocation and risk profile should you adopt to meet your financial goals?
If you have difficulty with any of these actions, then meet with an experienced financial professional to assist you.
Politics can trigger very emotional responses. However, realizing your actions have a much more direct impact on your finances than political Facebook rants and temporary elections will benefit you in achieving your long-term financial goals.
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 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.
Do you remember the panic-inducing headlines related to PIIGS, Crimea, Ebola, Cyprus, and the Flash Crash? Probably not. But if you do remember, these false alarms have likely been relegated to the financial memory graveyard, along with the many other sensationalist news events that have been killed off in the post-financial crisis era. Time will tell whether Brexit dies off or becomes a resurrected concern, like the repeating fears of a China slowdown or Greek collapse. Regardless, as the S&P 500 stock index reaches new all-time record highs, investors are currently shrug off the noise while muttering, “Brexit-Schmexit.”
Individuals have tried to use scary headlines as a timing tool to consistently time market corrections for all of recorded history. Unfortunately, emotional, knee-jerk reactions to alarming news stories rarely is the best strategy. Famed fund manager Peter Lynch said it best when he noted,
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Having invested for some 25 years, experience has taught me not only is conventional wisdom often wrong, but it also is frequently an accurate contrarian indicator. In other words, frightening news often should be an indicator to buy…not sell. Case in point is the U.K. European Union referendum. The Brexit referendum “Leave” vote caught virtually everyone by surprise, but the rebound in stock prices to new record highs may be even more surprising to most observers. However, for investors following the key factors of interest rates, profits, valuation, and sentiment (see also Don’t Be a Fool, Follow the Stool), may not be shocked by the positive price action.
- Interest Rates: For starters, you don’t have to be a genius to realize that stocks become more attractive when there is a scarcity of investment alternatives. When there are an estimated $13 trillion of negative interest rate bonds, a layman can quickly understand a 2%, 3%, or 4% dividend yield offered on certain stocks (and funds) can represent a much more attractive opportunity. With interest rates at record lows (see chart below), the overall dividend yield of stocks has provided a floor for stock prices and has limited the depth and duration of sell-offs and corrections.
- Profits: Corporate profits are near record highs but have been sluggish due to several factors, including the negative impact of the strong dollar on multinational exports; the depressing effect of declining interest rates on the banking sector’s net interest profit margins; the general decline in oil and commodity prices; and general lethargic economic growth overall in international markets (emerging and developed economies). Encouragingly, a stabilization in the value of the U.S. dollar, along with a rebound in energy prices augurs well for a potential shift back to earnings growth in the coming quarters.
- Valuation: On a valuation basis, the Price/Earnings ratio of the stock market is about 10-15% above historical averages (see chart below). The average S&P 500 stock price trades around 19x’s the value of trailing twelve-month earnings. However, in the context of all-time record low-interest rates, a premium valuation is well deserved, especially for those companies paying a dividend and growing their bottom line.
- Sentiment: Since the Great Financial Crisis / Recession, there has been about $1.5 trillion in equity investments that have been pulled out of U.S. equity mutual funds. This statistic is a clear sign of the extreme risk aversion and pervasive pessimism. Despite money flowing out of equity funds, corporations have bolstered the upward trajectory in stock prices with hundreds of billions in corporate stock buybacks and trillions in mergers & acquisition transactions. With all the universal jitteriness, I like to remind investors of Warren Buffett’s credo, “Buy fear, and sell greed.”
Brexit-Schmexit NOT Brexit-Panic
Despite the risk aversion in the marketplace, stock prices in the U.S. continue to grind higher to record levels. The stock market is currently communicating interest rates, profits, valuation, and sentiment are more important factors to price direction than are Brexit and other geopolitical concerns.
The silver lining behind severe investor skepticism is the creation of additional investment opportunities. As famous investor Sir John Templeton stated regarding stock market cycles, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Even the most objective observers have difficulty pointing to a broad set of indicators signaling euphoria, and the recent Turkish military coup attempt and domestic gun violence incidents will not squash out the negativity. Until optimism and elation rule the day, there’s no need to worry-schworry.
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 , 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.
Investing comes in many shapes and sizes. And like religion (see Investing Religion article), most investment strategies are built on the essential belief that following certain rules and conventions will eventually lead to profit enlightenment. When it comes to technical analysis (TA), a discipline used with the principal aim of predicting future prices from past patterns, some consider it a necessity for making money in the market. Others, regard the practice of TA as a pseudoscience, much like astrology.
I feel there is a proper place for TA on selective basis, which I will describe later, but for the most part I agree with some of the legendary investors who have chimed in on the subject:
Warren Buffett: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”
Peter Lynch: “Charts are great for predicting the past.”
Technical Analysis Linguistics
Fundamental analysis, the antithesis of technical analysis, strives to predict future price direction by analyzing facts and data surrounding a company, industry, and/or economy. It too comes with its own syntax and versions, for example: value, growth, top-down, bottom-up, quantitative, etc.
I do not claim to be a TA expert, however in my many years of investing I have come across a smorgasbord of terms and flavors surrounding the discipline. Describing and explaining the density of material surrounding TA would encompass too large of a scope for this article, but here are some prevalent terms one should come to grips with if you want to become a technical analysis guru:
Technical Analysis Approaches
- Elliot Wave
- Relative strength / Momentum (see Momentum Investing article)
- MACD (Moving Average Convergence / Divergence)
- Fibonacci retracement
- Dow Theory
- Bollinger bands
- Head and shoulders
- Double bottom
- Cup and handle
- Pivot points
- Dead cat bounce (my personal favorite)
Each of these patterns are supposes to provide insight into the future direction of price. At best, I would say the academic research surrounding the subject is “inconclusive,” and at worst I’d say it’s considered a complete “sham.”
The Lob Wedge
As I’ve stated earlier, I fall in the skeptical camp when it comes to TA, since fundamental analysis is the main engine I use for generating and tracking my investment ideas. For illustrative purposes, you may consider fundamental analysis as my group of drivers and irons. I do, however, utilize selective facets of TA much like I use a lob wedge in golf for a limited number of specific situations (e.g., shots over high trees, downhill lies, and fast greens). When it comes to trading, I do believe there is some value in tracking the relationship of extreme trading volume (high or low), especially when it is coupled with extreme price movement (high or low). The economic laws of supply and demand hold true for stock trades just as they do for guns and butter, and sharp moves in these components can provide insights into the psychological mindset of investors with respect to a security (or broader market). Beyond trading volume, there are a few other indicators that I utilize as part of my trading strategies, but these tactics play a relatively minor role, since most of my core positions are held on a multi-year time horizon.
Overall, there is a stream of wasteful noise, volatility, and misinformation that permeates the financial markets on a daily basis. A major problem with technical analysis is the many false triggered signals, which in many cases lead to excessive trading, transaction costs, and ultimately subpar investment returns. Although I remain a skeptic on the subject of technical analysis and I may not read my horoscope today, I will continue to keep a lob wedge in my golf bag with the hopes of finding new, creative ways of using it to my advantage.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own exchange traded funds and various securities, including BRK.B, but at time of publishing had no direct position in BRK.A or any company mentioned 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.