Archive for October, 2019
Missing the Financial Forest for the Political Trees
In the never-ending, 24/7, polarizing political news cycle, headlines of Ukraine phone calls, China trade negotiations, impeachment hearings, presidential elections, Federal Reserve monetary policy, and other Washington based stories have traders and news junkies glued to their phones, Twitter feeds, news accounts, blog subscriptions, and Facebook stories. However, through the incessant, deafening noise, many investors are missing the overall financial forest as they get lost in the irrelevant D.C. details.
Meanwhile, as many investors fall prey to the mesmerizing, but inconsequential headlines, financial markets have not fallen asleep or gotten distracted. The S&P 500 stock market index rose another +1.7% last month, and for the year, the index has registered a +18.7% return. As we enter the volatile fourth quarter, many stock market participants remain shell-shocked from last year’s roughly -20% temporary collapse, even though the S&P 500 subsequently rallied +29% from the 2018 trough to the 2019 peak.
Why are many people missing the financial forest? A big key to the significant rally in 2019 stock prices can be attributed to two words…interest rates. Unlike last year’s fourth quarter, when the Federal Reserve was increasing interest rates (i.e., tapping the economic brakes), this year the Fed is cutting rates (i.e., hitting the economic accelerator). Interest rates are a key leg to Sidoxia’s financial four-legged stool (see Don’t Be a Fool, Follow the Stool). Interest rates are at or near generational lows, depending where on the geographic map you reside. For example, interest rates on 10-year German government bonds are -0.55%. Yes, it’s true. If you were to invest $10,000 in a negative yielding -0.55% German bond for 10-years starting in 2019, if you held the bond until maturity (2029), the investor would get back less than the original $10,000 invested. In other words, many bond investors are choosing to pay bond issuers for the privilege of giving the issuers money for the unpalatable right of receiving less money in the future.
The unprecedented negative-yielding bond market is reaching epic proportions, having eclipsed $17 trillion globally (see chart below). This gargantuan and growing dollar figure of negative-yielding bonds defies common sense and feels very reminiscent of the panic buying of technology stocks in the late 1990s.
Source: Bloomberg
At Sidoxia Capital Management, we are implementing proprietary fixed income strategies to navigate this negative interest rate environment. However, the plummeting interest rates and skyrocketing bond prices only make our bond investing job tougher. On the other hand, declining rates, all else equal, also make my stock-picking job easier. Nevertheless, many market participants have gotten lost in the financial trees. More specifically, investors are losing sight of the key tenet that money goes where it is treated best (go where yields are highest and valuations lowest). With many bonds yielding low or negative interest rates, bond investors are being treated like criminals forced to serve jail time and pay large fines because future returns will become much tougher to accrue. In my Investing Caffeine blog, I have been writing about how the stock market’s earnings yield (current approximating +5.5%) and the S&P dividend yield of about +1.9% are handily outstripping the +1.7% yield on the 10-Year Treasury Note (see Going Shopping: Chicken vs. Beef ).
Unless our economy falls into a prolonged recession, interest rates spike substantially higher, or stock prices catapult appreciably, then any decline in stock prices will likely be temporary. Fortunately, the economy appears to be chugging along, albeit at a slower rate. For instance, 3rd quarter GDP (Gross Domestic Product) estimates are hovering around +2.0%.
Low Rates Aid Housing Market
Thanks to low interest rates, the housing markets remain strong. As you can see from the chart below, new home sales continue to ratchet higher over the last eight years, and lower mortgage rates are only helping this cause.
Source: Calafia Beach Pundit
The same tailwind of lower interest rates can be seen below with rising home prices.
Source: Calculated Risk
Consumer Flexes Muscles
At 3.7%, the unemployment rate remains low and the number of workers collecting unemployment is near multi-decade lows (see chart below).
Source: Calafia Beach Pundit
It should come as no surprise that the more employed workers there are collecting paychecks, the more consumer confidence will rise (see chart below). As you can see, consumer confidence is near multi-decade record highs.
Source: Calafia Beach Pundit
Although politics continue to dominate headlines and grab attention, many investors are missing the financial forest because the political noise is distracting the irrefutable, positive effect that low interest rates is contributing to the positive direction of the stock market and the economy. Do your best to not miss the forest – you don’t want your portfolio to suffer by you getting lost in the trees.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 1, 2019). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and 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.
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