Posts filed under ‘Currency – Foreign Exchange’

Trade War Bark: Hold Tight or Nasty Bite?

bark

In recent weeks, President Trump has come out viciously barking about potential trade wars, not only with China, but also with other allies, including key trade collaborators in Europe, Canada, and Mexico. What does this all mean? Should you brace for a nasty financial bite in your portfolio, or should you remain calm and hold tight?

Let’s take a closer look. Recent talks of trade wars and tit-for-tat retaliations have produced mixed results for the stock market. For the month, the S&P 500 index advanced +0.5% (+1.7% year-to-date), while the Dow Jones Industrial Average modestly retreated -0.6% (-1.8% YTD). Despite trade war concerns and anxiety over a responsibly cautious Federal Reserve increasing interest rates, the economy remains strong. Not only is unemployment at an impressively low level of 3.8% (tying the lowest rate seen since 1969), but corporate profits are at record levels, thanks to a healthy economy and stimulative tax cuts. Consumers are feeling quite well regarding their financial situation too. For instance, household net worth has surpassed $100 trillion dollars, while debt ratios are declining (see chart below).

house balance

Source:  Scott Grannis

Although trade is presently top-of-mind among many investors, a lot of the fiery rhetoric emanating from Washington should come as no surprise. The president heavily campaigned on the idea of reducing uniform unfair Chinese trade policies and leveling the trade playing field. It took about a year and a half before the president actually pulled out the tariff guns. The first $50 billion tariff salvo has been launched by the Trump administration against China, and an additional $200 billion in tariffs have been threatened. So far, Trump has enacted tariffs on imported steel, aluminum, solar panels, washing machines and other Chinese imports.

It’s important to understand, we are in the very early innings of tariff implementation and trade negotiations. Therefore, the scale and potential impact from tariffs and trade wars should be placed in the proper context relative to our $20 trillion U.S. economy (annual Gross Domestic Product) and the $16 trillion in annual global trade.

Stated differently, even if the president’s proposed $50 billion in Chinese tariffs quadruples in value to $200 billion, the impact on the overall economy will be minimal – less than 1% of the total. Even if you go further and consider our country’s $375 billion trade deficit with China for physical goods (see chart below), significant reductions in the Chinese trade deficit will still not dramatically change the trajectory of economic growth.

china trade

Source: BBC 

The Tax Foundation adds support to the idea that current tariffs should have minimal influence:

“The tariffs enacted so far by the Trump administration would reduce long-run GDP by 0.06 percent ($15 billion) and wages by 0.04 percent and eliminate 48,585 full-time equivalent jobs.”

Of course, if the China trade skirmish explodes into an all-out global trade war into key regions like Europe, Mexico, Canada, and Japan, then all bets are off. Not only would inflationary pressures be a drag on the economy, but consumer and business confidence would dive and they would drastically cut back on spending and negatively pressure the economy.

Most investors, economists, and consumers recognize the significant benefits accrued from free trade in the form of lower-prices and a broadened selection. In the case of China, cheaper Chinese imports allow the American masses to buy bargain toys from Wal-Mart, big-screen televisions from Best Buy, and/or leading-edge iPhones from the Apple Store. Most reasonable people also understand these previously mentioned consumer benefits can be somewhat offset by the costs of intellectual property/trade secret theft and unfair business practices levied on current and future American businesses doing business in China.

Trump Playing Chicken

Right now, Trump is playing a game of chicken with our global trading partners, including our largest partner, China. If his threats of imposing stiffer tariffs and trade restrictions result in new and better bilateral trade agreements (see South Korean trade deal), then his tactics could prove beneficial. However, if the threat and imposition of new tariffs merely leads to retaliatory tariffs, higher prices (i.e., inflation), and no new deals, then this mutually destructive outcome will likely leave our economy worse off.

Critics of Trump’s tariff strategy point to the high profile announcement by Harley-Davidson to move manufacturing production from the United States to overseas plants. Harley made the decision because the tariffs are estimated to cost the company up to $100 million to move production overseas. As part of this strategy, Harley has also been forced to consider motorcycle price hikes of $2,200 each. On the other hand, proponents of Trump’s trade and economic policies (i.e., tariffs, reduced regulations, lower taxes) point to the recent announcement by Foxconn, China’s largest private employer. Foxconn works with technology companies like Apple, Amazon, and HP to help manufacture a wide array of products. Due to tax incentives, Foxconn is planning to build a $10 billion plant in Wisconsin that will create 13,00015,000 high-paying jobs. Wherever you stand on the political or economic philosophy spectrum, ultimately Americans will vote for the candidates and policies that benefit their personal wallets/purses. So, if retaliatory measures by foreign countries introduces inflation and slowly grinds trade to a halt, voter backlash will likely result in politicians being voted out of office due to failed trade policies.

eps jul 18

Source: Dr. Ed’s Blog

Time will tell whether the current trade policies and actions implemented by the current administration will lead to higher costs or greater benefits. Talk about China tariffs, NAFTA (North American Free Trade Agreement), TPP (Trans Pacific Partnership), and other reciprocal trade negotiations will persist, but these trading relationships are extremely complex and will take a long time to resolve. While I am explicitly against tariff policies in general, I am not an alarmist or doomsayer, at this point. Currently, the trade war bark is worse than the bite. If the situation worsens, the history of politics proves nothing is permanent. Circumstances and opinions are continually changing, which highlights why politics has a way of improving or changing policies through the power of the vote. While many news stories paint a picture of imminent, critical tariff pain, I believe it is way too early to come to that conclusion. The economy remains strong, corporate profits are at record levels (see chart above), interest rates remain low historically, and consumers overall are feeling better about their financial situation. It is by no means a certainty, but if improved trade agreements can be established with our key trading partners, fears of an undisciplined barking and biting trade dog could turn into a tame smooching puppy that loves trade.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 3, 2018). Subscribe on the right side of the page for the complete text.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, AMZN, and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in WMT, HOG, HPQ, 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.

July 5, 2018 at 1:59 pm Leave a comment

‘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

No April Fool’s Joke – Another Record

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 3, 2017). Subscribe on the right side of the page for the complete text.

Having children is great, but a disadvantage to having younger kids are the April Fool’s jokes they like to play on parents. Fortunately, this year was fairly benign as I only suffered a nail-polish covered bar of soap in the shower. However, what has not been a joke has been the serious series of new record highs achieved in the stock market. While it is true the S&P 500 index finished roughly flat for the month (-0.0%) after hitting new highs earlier in March, the technology-laden NASDAQ index continued its dominating run, advancing +1.5% in March contributing to the impressive +10% jump in the first quarter. For 2017, the NASDAQ supremacy has been aided by the stalwart gains realized by leaders like Apple Inc. (up +24%), Facebook Inc. (up +23%), and Amazon.com Inc. (up +18%). The surprising fact to many is that these records have come in the face of immense political turmoil – most recently President Trump’s failure to deliver on a campaign promise to repeal and replace the Obamacare healthcare system.

Like a broken record, I’ve repeated there are much more important factors impacting investment portfolios and the stock market other than politics (see also Politics Schmolitics). In fact, many casual observers of the stock market don’t realize we have been in the midst of a synchronized, global economic expansion, helped in part by the stabilization in the value of the U.S. dollar over the last couple of years.

Source: Investing.com

As you can see above, there was an approximate +25% appreciation in the value of the dollar in late-2014, early-2015. This spike in the value of the dollar suddenly made U.S. goods sold abroad +25% more expensive, resulting in U.S. multinational companies experiencing a dramatic profitability squeeze over a short period of time. The good news is that over the last two years the dollar has stabilized around an index value of 100. What does this mean? In short, this has provided U.S. multinational companies time to adjust operations, thereby neutralizing the currency headwinds and allowing the companies to return to profitability growth.

Source: Calafia Beach Pundit

And profits are back on the rise indeed. The six decade long chart above shows there is a significant correlation between the stock market (red line – S&P 500) and corporate profits (blue line). The skeptics and naysayers have been out in full force ever since the 2008-2009 financial crisis – I profiled these so-called “sideliners” in Get out of Stocks!.

As the stock market continues to hit new record highs, the doubters continue to scream danger. There will always be volatility, but when the richest investor of all-time, Warren Buffett, continues to say that stocks are still attractively priced, given the current interest rate environment, that goes a long way to assuage investor concerns.

Politically, a lot could still go wrong as it relates to healthcare, tax reform, and infrastructure spending, to name a few issues. However, it’s still early, and it’s possible positive surprises could also occur. More importantly, as I’ve noted before, corporate profits, interest rates, valuations, and investor sentiment are much more important factors than politics, and on balance these factors are on the favorable side of the ledger. These factors will have a larger impact on the long-term direction of stock prices.

With approval ratings of Congress and the President at low levels, investors have had trouble finding humor in politics, even on April Fool’s Day. Another significant factor more important than politics is the issue of retirement savings by Americans, which is no joke. As you finalize your tax returns in the coming weeks, it behooves you to revisit your retirement plan and investment portfolio. Inefficiently investing your money or outliving your savings is no laughing matter. I’ll continue with my disciplined financial plan and leave the laughing to my kids, as they enjoy planning their next April Fool’s Day prank.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, FB, AMZN, 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.

April 3, 2017 at 12:03 pm Leave a comment

Wiping Your Financial Slate Clean

slate

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 3, 2017). Subscribe on the right side of the page for the complete text.

The page on the calendar has turned, and we now have a new year, and will shortly have a new president, and new economic policies. Although there is nothing magical about starting a fresh, new year, the annual rites of passage also allow investors to start with a clean slate again and reflect on their personal financial situation. Before you reach a desired destination (i.e., retirement), it is always helpful to know where you have been and where are you currently. Achieving this goal requires filtering through a never-ending avalanche of real-time data flooding through our cell phones, computers, TVs, radios, and Facebook accounts. This may seem like a daunting challenge, but that’s where I come in!

Distinguishing the signals from the noise is tough and there was plenty of noise in 2016 – just like there is every year. Before the S&P 500 stock index registered a +9.5% return in 2016, fears of a China slowdown blanketed headlines last January (the S&P 500 fell -15% from its highs and small cap stocks dropped -26%), and the Brexit (British exit) referendum caused a brief 48-hour -6% hiccup in June. Oil was also in the news as prices hit a low of $26 a barrel early in the year, before more than doubling by year-end to $54 per barrel (still well below the high exceeding $100 in 2014). On the interest rate front, 10-Year Treasury rates bottomed at 1.34% in July, while trillions of dollars in global bonds were incomprehensibly paying negative interest rates. However, fears of inflation rocked bond prices lower (prices move inversely to yields) and pushed bond yields up to 2.45% today. Along these lines, the Federal Reserve has turned the tide on its near-0% interest rate policy as evidenced by its second rate hike in December.

Despite the abbreviated volatility caused by the aforementioned factors, it was the U.S. elections and surprise victory of President-elect Donald Trump that dominated the media airwaves for most of 2016, and is likely to continue as we enter 2017. In hindsight, the amazing Twitter-led, Trump triumph was confirmation of the sweeping global populism trend that has also replaced establishment leaders in the U.K., France, and Italy. There are many explanations for the pervasive rise in populism, but meager global economic growth, globalization, and automation via technology are all contributing factors.

The Trump Bump

Even though Trump has yet to accept the oath of Commander-in-Chief, recent investor optimism has been fueled by expectations of a Republican president passing numerous pro-growth policies and legislation through a Republican majority-controlled Congress. Here are some of the expected changes:

  • Corporate/individual tax cuts and reform
  • Healthcare reform (i.e., Obamacare)
  • Proposed $1 trillion in infrastructure spending
  • Repatriation tax holiday for multinational corporate profits
  • Regulatory relief (e.g., Dodd-Frank banking and EPA environmental reform)

The chart below summarizes the major events of 2016, including the year-end “Trump Bump”:

16-sp-sum

While I too remain optimistic, I understand there is no free lunch as it relates to financial markets (see also Half Trump Full). While tax cuts, infrastructure spending, and regulatory relief should positively contribute to economic growth, these benefits will have to be weighed against the likely costs of higher inflation, debt, and deficits.

Over the 25+ years I have been investing, the nature of the stock market and economy hasn’t changed. The emotions of fear and greed rule the day just as much today as they did a century ago. What has changed today is the pace, quality, and sheer volume of news. In the end, my experience has taught me that 99% of what you read, see or hear at the office is irrelevant as it relates to your retirement and investments. What ultimately drives asset prices higher or lower are the four key factors of corporate profits, interest rates, valuations, and sentiment (contrarian indicator) . As you can see from the chart below, corporate profits are at record levels and forecast to accelerate in 2017 (up +11.9%). In addition, valuations remain very reasonable, given how low interest rates are (albeit less low), and skeptical investor sentiment augurs well in the short-run.

16-eps

Source: FactSet

Regardless of your economic or political views, this year is bound to have plenty of ups and downs, as is always the case. With a clean slate and fresh turn to the calendar, now is a perfect time to organize your finances and position yourself for a better retirement and 2017.

investment-questions-border

www.Sidoxia.com 

Wade W. Slome, CFA, CFP®

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

January 3, 2017 at 12:17 pm Leave a comment

EU Marriage Ends in Messy Brexit Divorce

divorce

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.

What Just Happened?

Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.

Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.

brexit votes

Source: Bloomberg

One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.

A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.

Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).

What Were Investors’ Reactions?

Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:

U.S. (S&P 500): -0.7%

U.K. (FTSE 100): +2.6%

Japan (Nikkei): -4.1%

Germany (DAX): -5.6%

Hong Kong (Hang Seng): +0.4%

China (Shanghai): +1.3%

India (BSE): -0.0%

Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.

Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.

To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).

currency v ppp

Source: Calafia Beach Pundit

Why Did it Happen?

While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.

18-24: 75% Remain

25-49: 56% Remain

50-64: 44% Remain

65+: 39% Remain

While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.

At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).

UK GDP Ratio

Source: The Wall Street Journal

What happens next?

While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.

In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity.  Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.

What does Brexit Mean for Global Markets?

The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:

1) What is the Brexit impact on the U.S. economy?

If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year   (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).

2) What is the Brexit impact on the global economy?

The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.

global gdp

Source: The National Archives

What to Do Next?

Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).

If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.

investment-questions-border

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.

July 2, 2016 at 9:00 am Leave a comment

Financial Markets Recharge with a Nap…Zzzzzz

sleep baby

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 4, 2016). Subscribe on the right side of the page for the complete text.

Did you enjoy your New Year’s festivities? If you were like me and ate excessively and drank too much egg nog, you may have decided along the line to take a nap. It’s not a bad idea to recharge those batteries before implementing those New Year’s resolutions and jumping on the treadmill.  That’s exactly what happened in the financial markets this year. After six consecutive years of positive returns in the Dow Jones Industrial Average (2009 – 2014), stock markets took a snooze in 2015, as measured by the S&P 500 and Dow, which were each down -0.7% and -2.2%, respectively. And bonds didn’t fare any better, evidenced by the -1.9% decline in the Aggregate Bond ETF (AGG), over the same time period. Given the deep-seated fears about the Federal Reserve potentially catapulting interest rates higher in 2015, investors effectively took a big yawn by barely nudging the 10-year Treasury Note yield higher by +0.1% from 2.2% to 2.3%.

Even though 2015 ended up being a quiet year overall, there were plenty of sweet dreams mixed in with scary nightmares during the year-long nap:

INVESTMENT SWEET DREAMS

Diamonds in the Rough: While 2015 stock prices were generally flat to down around the globe (Vanguard Total Word -4.2%), there was some sunshine and rainbows gleaming for a number of segments in the market. For example, handsome gains were achieved in the NASDAQ index (+5.7%); Biotech Index – BTK (+10.9%); Consumer Discretionary ETF – XLY (+8.3%); Health Care ETF – VHT (+5.8%); Information Technology ETF – VGT (+4.6%); along with numerous other investment areas.

Fuel Fantasy Driven by Low Gas Prices: Gas prices averaged $2.01 per gallon nationally in December (see chart below), marking the lowest prices seen since 2009. Each penny in lower gas prices roughly equates to $1 billion in savings, which has strengthened consumers’ balance sheets and contributed to the multi-year economic expansion. Although these savings have partially gone to pay down personal debt, these gas reserves have also provided a financial tailwind for record auto sales (estimated 17.5million in 2015)  and a slow but steady recovery in the housing market. The outlook for “lower-for-longer” oil prices is further supported by an expanding oil glut from new, upcoming Iranian supplies. Due to the lifting of economic sanctions related to the global nuclear deal, Iran is expected to deliver crude oil to an already over-supplied world energy market during the first quarter of 2016. Additionally, the removal of the 40-year ban on U.S. oil exports -could provide a near-term ceiling on energy prices as well.

gas comp

Counting Cash Cows

Catching some shut-eye after reading frightening 2015 headlines on the China slowdown, $96 billion Greek bailout/elections, and Paris/San Bernardino terrorist attacks forced some nervous investors to count sheep to fall asleep. However, long-term investors understand that underpinning this long-lived bull market are record revenues, profits, and cash flows. The record $4.7 trillion dollars in 2015 estimated mergers along with approximately $1 trillion in dividends and share buybacks (see chart below) is strong confirmation that investors should be concentrating on counting more cash cows than sheep, if they want to sleep comfortably.

American investors have been getting lots of cash back this year. Dividends and stock buybacks are on track to hit a new high this year and could top $1 trillion for the first time, says Michael Thompson, managing director of S&P Capital IQ Global Markets Intelligence. Companies have been increasing their buybacks and dividends to please investors for years. Total payouts from S&P 500 companies surged 84% in the past decade to $934 billion in 2014, from $507 billion in 2005, according to a report by S&P Capital IQ.

INVESTMENT NIGHTMARES

Creepy Commodities: Putting aside the -30% collapse in WTI crude oil prices last year, commodity investors overall were exhausted in 2015. The -24% decline in the CRB Commodity Index and the -11% weakening in the Gold Index (GLD) was further proof that a strong U.S. dollar, coupled with stagnant global growth, caused investors a lot of tossing and turning. While bad for commodity exporting countries, the collapse in commodity prices will ultimately keep a lid on inflation and eventually become stimulative for those consumers suffering from lower standards of living.

Dollar Dread: The +25% spike in the value of the U.S. dollar over the last 18 months has made life tough for multinational companies. If your business received approximately 35-40% of their profits overseas and suddenly your goods cost 25% more than international competitors, you might grind your teeth in your sleep too. Monetary policies around the globe, including the European Union, will have an impact on the direction of future foreign exchange rates, but after a spike in the value of the dollar in early 2015, there are signs this scary move may now be stabilizing. Although multinationals are getting squeezed, now is the time for consumers to load up on cheap imports and take that bargain foreign vacation they have long been waiting for.

January has been a challenging month the last couple years, and inevitably there will be additional unknown turbulence ahead – the opening day of 2016 not being an exception (i.e., China slowdown concerns and Mideast tensions). However, given near record-low interest rates, record corporate profits, and accommodative central bank policies, the 2015 nap taken by global stock markets should supply the necessary energy to provide a lift to financial markets in the year ahead.

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 VHT, AGG, and in certain exchange traded funds (ETFs), but at the time of publishing had no direct position VT, BTK, XLY, VGT, GLD, or 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.

January 4, 2016 at 11:53 am Leave a comment

E.M.s Want Cake & Eat It Too

Fancy Cake

Since the end of 2010, the emerging markets (E.M.) have gotten absolutely obliterated (MSCI Emerging Markets index –25%) compared to a meteoric rise in U.S. stocks (S&P 500 index +60%) over the same period.

Source: Financial Times

Source: Financial Times

Slowing global growth, especially with resource-hungry China going on a crash diet, has caused commodity-exporting emerging markets like Brazil to suffer economic starvation. Rising inflation, expanding debt, decelerating Chinese growth, collapsing commodity prices, and political corruption allegations are all factors pressuring the Brazilian economy. Weak emerging market economies like Brazil are contributing to global GDP forecast reductions. As you can see from the chart below, global GDP growth rates have been steadily declining since 2010, and the IMF recently lowered their 2015 forecast from +3.5% down to 3.1%.

Source: Financial Times

Source: Financial Times

Beginning in late 2008, when Ben Bernanke first announced his QE 1 (Quantitative Easing) money printing binge, the U.S. dollar remained relatively weak against other global currencies for years. The weak dollar provided a nice tailwind to U.S. exporters (i.e., American manufactured goods were more cost competitive for foreign buyers).

Multinationals loved the export lift, but emerging international politicians and investors cried foul. They complained the U.S. was starting a “currency war” by artificially deflating the value of the U.S. dollar, thereby making international markets less competitive. At the time, the thought process was the emerging markets (e.g., China, Russia, Brazil et.al.) would be disproportionately impacted because their economies are export-driven. In a 2010 article from the Guardian (World Gripped by International Currency War) Brazilian finance minister Guido Mantega explicitly stated, “We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”

This “currency war” griping stayed in place until the end of 2013 when the Fed announced its plans to begin “tapering” bond buying (i.e., pull away the financial punch bowl). We all know what has happened since then…the U.S. dollar has spiked by about +20% and the Brazilian real has depreciated by a whopping -37%. This is good news for emerging markets like Brazil, right? Wrong!

A few years ago, emerging market investors were initially worried about the depressing effects of a strong currency on exports, but now that emerging market currencies have depreciated, fears have shifted. Now, investors are concerned whether E.M. countries can pay off foreign borrowed debt denominated in pricey U.S. dollars (paid with vastly weaker E.M. currencies). Moreover, with foreign governments holding dramatically lower valued currency, investors are worried about the ability of these E.M. countries to raise additional capital or refinance existing debt.  SocGen’s head of emerging market strategy, Guy Stear, summed it up by noting,  “Prevailing risks of a deterioration of the external financing environment and disruptive capital flow and asset price shifts that increase volatility in the respective bond and currency markets, make a rapid rebound in EM growth over the next months unlikely.”

So which one is it…do E.M. investors want a weak currency to power exports, or a strong currency to pay down debt and raise additional capital? Unfortunately, investors can’t have their cake and eat it too – you can’t have a depreciating and appreciating currency at the same time.

While anxiety has shifted from strong emerging market currencies to the issues associated with weak currencies, India is one E.M that has reaped the rewards from a declining rupee (-20% since 2013). In other words, India is benefiting from a stronger trade balance via a boost in exports and reduction in imports – interestingly, the U.S. has experienced the exact opposite. Regardless, eventually, other emerging markets will benefit from these same positive trends as India – that will finally be a tasty slice of cake.

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) including EWZ, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

October 10, 2015 at 6:27 am Leave a comment

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