Posts filed under ‘Financial Markets’

Michael Jordan and Market Statistics

Basketball Match

Basketball is in the air as the NBA playoffs are once again upon us. While growing up in high school, Michael Jordan was my basketball idol, and he dominated the sport globally at the highest level. I was a huge fanatic. Besides continually admiring my MJ poster-covered walls, I even customized my own limited edition Air Jordan basketball shoes by applying high school colors to them with model paint – I would not recommend this fashion experiment to others.

Eventually the laws of age, physics, and gravity took over, as Jordan slowly deteriorated physically into retirement. On an infinitesimally smaller level, I also experienced a similar effect during my 30s when playing in an old man’s recreational basketball league. Day-by-day, month-by-month, and year-by-year, I too got older and slower (tough to believe that’s possible) as I watched all the 20-somethings run circles around me – not to mention my playing time was slashed dramatically. Needless to say, I too was forced into retirement like Michael Jordan, but nobody retired my number, and I still have not been inducted into the Hall of Fame.

“Air Wade” Before Retirement: No Photoshop in 1988, just an optical illusion created by an 8-foot rim.

“Air Wade” Before Retirement: No Photoshop in 1988, just an optical illusion created by an 8-foot rim.

Financial markets are subject to similar laws of science (economics) too. The stock market and the economy get old and tired just like athletes, as evidenced by the cyclical nature of bear markets and recessions. Statistics are a beautiful thing when it comes to sports. Over the long run, numbers don’t lie about the performance of an athlete, just like statistics over the long run don’t lie about the financial markets. When points per game, shooting percentage, rebounds, assists, minutes played, and other measurements are all consistently moving south, then it’s safe to say fundamentals are weakening.

I’ve stated it many times in the past, and I’ll state it again, these are the most important factors to consider when contemplating the level and direction of the stock market (see also Don’t Be a Fool, Follow the Stool).

  • Profits
  • Interest Rates
  • Valuations
  • Sentiment

While the absolute levels of these indicators are important, the trend or direction of each factor is also very relevant. Let’s review these factors a little more closely.

  • Profits: Profits and cash flows, generally speaking, are the lifeblood behind any investment and currently corporate profits are near record levels. When it comes to the S&P 500, the index is currently expected to generate a 2016 profit of $117.47. Considering a recent price closing of 2,092 on the index, this translates into a price-earnings ratio (P/E) of approximately 17.8x or a 5.6% earnings yield. This earnings yield can be compared to the 1.9% yield earned on the 10-Year Treasury Note, which is even lower than the 2.1% dividend yield on the S&P 500 (a rare historical occurrence). If history repeats itself, the 5.6% earnings yield on stocks should double to more than 10% over the next decade, however the yield on 10-year Treasuries stays flat at 1.9% over the next 10 years. The strong dollar and the implosion of the energy sector has put a lid on corporate profits over the last year, but emerging signs are beginning to show these trends reversing. Stabilizing profits near record levels should be a positive contributor to stocks, all else equal.
  • Interest Rates: Pundits have been pointing to central banks as the sole reason for low/negative interest rates globally (see chart below). NEWS FLASH: Central banks have been increasing and decreasing interest rates for decades, but that hasn’t stopped the nearly unabated 36-year decline in interest rates and inflation (see chart below). As I described in previous articles (see Why 0% Rates?), technology, globalization, and the rise of emerging markets is having a much larger impact on interest rates/inflation than monetary policies. If central banks are so powerful, then why after eight years of loose global monetary policies hasn’t inflation accelerated yet? Regardless, all else equal, these historically low interest rates are horrible for savers, but wonderful for equity investors and borrowers.

    Source: Calafia Beach Pundit

    Source: Calafia Beach Pundit

  • Valuations: The price you pay for an investment is one of the, if not the, most important factors to consider. I touched upon valuations earlier when discussing profits, and based on history, there is plenty of evidence to support the position that valuations are near historic averages. Shiller CAPE bears have been erroneously screaming bloody murder over the last seven years as prices have tripled (see Shiller CAPE smells like BS). A more balanced consideration of valuation takes into account the record low interest rates/inflation (see The Rule of 20).
  • Sentiment: There are an endless number of indicators measuring investor optimism vs. pessimism. Generally, most experienced investors understand these statistics operate as valuable contrarian indicators. In other words, as Warren Buffett says, it is best to “buy fear, and sell greed.” While I like to track anecdotal indicators of sentiment like magazine covers, I am a firm believer that actions speak louder than words. If you consider the post-crisis panic of dollars flowing into low yielding bonds – greater than $1 trillion more than stocks (see Chicken vs. Beef ) you will understand the fear and skepticism remaining in investors minds. The time to flee stocks is when everyone falls in love with them.

Readers of Michael Lewis’s book Moneyball understand the importance statistics can play in winning sports. Michael Jordan may not have been a statistician like Billy Beane, because he spent his professional career setting statistical records, not analyzing them. Unfortunately, my basketball career never led me to the NBA or Hall of Fame, but I still hope to continue winning in the financial markets by objectively following the all-important factors of profits, interest rates, valuations, and sentiment.

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 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 23, 2016 at 5:39 pm 2 comments

Invest with a Telescope…Not a Microscope

Telescope-Microscope

It was another bloody week in the stock market (S&P 500 index dropped -3.1%), and any half-glass full data was interpreted as half-empty. The week was epitomized by a Citigroup report entitled “World Economy Trapped in a Death Spiral.” A sluggish monthly jobs report on Friday, which registered a less than anticipated addition of 151,000 jobs, painted a weakening employment picture. Professional social media site LinkedIn Corp. (LNKD) added fuel to the fire with a soft profit forecast, which resulted in the stock getting almost chopped in half (-44%)…in a single day (ouch).

It’s funny how quickly the headlines can change – just one week ago, the Dow Jones Industrial index catapulted higher by almost +400 points in a single day and we were reading about soaring stocks.

Coherently digesting the avalanche of diverging and schizophrenic headlines is like attempting to analyze a windstorm through a microscope. A microscope is perfect for looking at a single static item up close, but a telescope is much better suited for analyzing a broader set of data. With a telescope, you are better equipped to look farther out on the horizon, to anticipate what trends are coming next. The same principle applies to investing. Short-term traders and speculators are great at using a short-term microscope to evaluate one shiny, attention-grabbing sample every day. The investment conclusion, however, changes the following day, when a different attention-grabbing headline is analyzed to a different conclusion. As Mark Twain noted, “If you don’t read the newspaper, you are uninformed.  If you do read the newspaper, you are misinformed.”

Short-termism is an insidious disease that will slowly erode short-run performance and if not controlled will destroy long-run results as well. This is not a heretic concept. Some very successful investors have preached this idea in many ways. Here are a few of them:

‘‘We will continue to ignore political and economic forecasts which are an expensive distraction for many investors and businessmen.” –Warren Buffett (Annual Newsletter 1994)

‘‘If you spend more than 14 minutes a year worrying about the market, you’ve wasted 12 minutes’’ –Peter Lynch

Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth” -Jack Gray Grantham

 

On the flip side, those resilient investors who have succeeded through investment cycles understand the importance of taking a long-term view.

Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.” –Peter Lynch

The farther you can lengthen your time horizon in the investment process, the better off you will be.” – David Nelson (Legg Mason)

Long term owners are more relaxed, more informed, more patient, less emotional.” –John Templeton

If you are really a long-term investor, you will view a bear market as an opportunity to make money.” –John Templeton

Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.” –Don Hays

In the long run, one of the greatest risk to your net worth is not owning stocks. Bonds do not grow. They can only return their face value at maturity…Inflation is a silent, insidious tax that erodes your net worth…Fortunately, there is an easy way to keep pace with and even beat inflation, and this is stocks.” – John Spears

In the short-term, the stock market is a voting machine; in the long-term a weighing machine.” -Benjamin Graham

 

There has been a lot of pain experienced so far in 2016, and there may be more to come. However, trying to time the market and call a bottom is a fruitless effort. Great companies and investments do not disappear in a bear market. At times like these, it is important to stick to a systematic, disciplined approach that integrates valuation and risk controls based on where we are in an economic cycle. Despite all the recent volatility, as I’ve repeated many times, the key factors driving the direction of the stock market are the following: 1) Corporate profits; 2) Interest rates; 3) Valuations; and 4) Sentiment (see also Don’t Be a Fool, Follow the Stool). Doom and gloom “Death Spiral” headlines may currently rule the day, but the four key stock-driving factors on balance remain skewed towards the positive…if you have the ability to put away your microscope and take out your telescope.

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 LNKD 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.

February 6, 2016 at 11:05 pm 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

Bargain Hunting for Doorbuster Discounts

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2015). Subscribe on the right side of the page for the complete text.

It’s that time of year again when an estimated 135 million bargain shoppers set aside personal dignity and topple innocent children in the name of Black Friday holiday weekend, doorbuster discounts. Whether you are buying a new big screen television at Amazon for half-off or a new low-cost index fund, everyone appreciates a good value or bargain, which amplifies the importance of the price you pay. Even though consumers are estimated to have spent $83 billion over the post-turkey-coma, holiday weekend, this spending splurge only represents a fraction of the total 2015 holiday shopping season frenzy. When all is said and done, the average person is projected to dole out $805 for the full holiday shopping season (see chart below) – just slightly higher than the $802 spent over the same period last year.

While consumers have displayed guarded optimism in their spending plans, Americans have demonstrated the same cautiousness in their investing behavior, as evidenced by the muted 2015 stock market gains. More specifically, for the month of November, stock prices increased by +0.32% for the Dow Jones Industrial Average (17,720) and +0.05% for the S&P 500 index (2,080). For the first 11 months of the year, the stock market results do not look much different. The Dow has barely slipped by -0.58% and the S&P 500 has inched up by +1.01%.

Given all the negative headlines and geopolitical concerns swirling around, how have stock prices managed to stay afloat? In the face of significant uncertainty, here are some of the calming factors that have supported the U.S. financial markets:

  • Jobs Piling Up: The slowly-but-surely expanding economy has created about 13 million new jobs since late 2009 and the unemployment rate has been chopped in half (from a peak of 10% to 5%).

Source: Calafia Beach Pundit

  • Housing Recovery: New and existing home sales are recovering and home prices are approaching previous record levels, as the Case-Shiller price indices indicate below.

Source: Calculated Risk Blog

  • Strong Consumer: Cars are flying off the shelves at a record annualized pace of 18 million units – a level not seen since 2000. Lower oil and gasoline prices have freed up cash for consumers to pay down debt and load up on durable goods, like some fresh new wheels.

Source: Calculated Risk Blog

Despite a number of positive factors supporting stock prices near all-time record highs and providing plenty of attractive opportunities, there are plenty of risks to consider. If you watch the alarming nightly news stories on TV or read the scary newspaper headlines, you’re more likely to think it’s Halloween season rather than Christmas season.

At the center of the recent angst are the recent coordinated terrorist attacks that took place in Paris, killing some 130 people. With ISIS (Islamic State of Iraq and Syria) claiming responsibility for the horrific acts, political and military resources have been concentrated on the ISIS occupied territories of Syria and Iraq. Although I do not want to diminish the effects of the appalling and destructive attacks in Paris, the events should be placed in proper context. This is not the first or last large terrorist attack – terrorism is here to stay. As I show in the chart below, there have been more than 200 terrorist attacks that have killed more than 10 people since the 9/11 attacks. Much of the Western military power has turned a blind eye towards these post-9/11 attacks because many of them have taken place off of U.S. or Western country soil. With the recent downing of the Russian airliner (killing all 224 passengers), coupled with the Paris terror attacks, ISIS has gained the full military attention of the French, Americans, and Russians. As a result, political willpower is gaining momentum to heighten military involvement.

Source: Wikipedia

Investor anxiety isn’t solely focused outside our borders. The never ending saga of when the Federal Reserve will initiate its first Federal Funds interest rate target increase could finally be coming to an end. According to the CME futures market, there currently is a 78% probability of a 0.25% interest rate increase on December 16th. As I have said many times before, interest rates are currently near generational lows, and the widely communicated position of Federal Reserve Chairwoman Yellen (i.e., shallow slope of future interest rate hike trajectory) means much of the initial rate increase pain has likely been anticipated already by market participants. After all, a shift in your credit card interest rate from 19.00% to 19.25% or an adjustment to your mortgage rate from 3.90% to 4.15% is unlikely to have a major effect on consumer spending. In fact, the initial rate hike may be considered a vote of confidence by Yellen to the sustainability of the current economic expansion.

Shopping Without My Rose Colored Glasses

Regardless of the state of the economic environment, proper investing should be instituted through an unemotional decision-making process, just as going shopping should be an unemotional endeavor. Price and value should be the key criteria used when buying a specific investment or holiday gift. Unfortunately for many, emotions such as greed, fear, impatience, and instant gratification overwhelm objective measurements such as price and value.

As I have noted on many occasions, over the long-run, money unemotionally moves to where it is treated best. From a long-term perspective, that has meant more capital has migrated to democratic and capitalistic countries with a strong rule of law. Closed, autocratic societies operating under corrupt regimes have been the big economic losers.

With all of that set aside, the last six years have created tremendous investment opportunities due to the extreme investor risk aversion created by the financial crisis – hence the more than tripling in U.S. stock prices since March 2009.

When comparing the yield (i.e., profit earned on an investment) between stocks and bonds, as shown in the chart below, you can see that stock investors are being treated significantly better than bond investors (6.1% vs. 4.0%). Not only are bond investors receiving a lower yield than stock investors, but bond investors also have no hope of achieving higher payouts in the future. Stocks, on the other hand, earn the opportunity of a  double positive whammy. Not only are stocks currently receiving a higher yield, but stockholders could achieve a significantly higher yield in the future. For example, if S&P 500 earnings can grow at their historic rate of about 7%, then the current stock earnings yield of 6.1% would about double to 12.0% over the next decade at current prices. The inflated price and relative attractiveness of stocks looks that much better if you compare the 6.1% earnings yield to the paltry 2.2% 10-Year Treasury yield.

Source: Yardeni.com

This analysis doesn’t mean everyone should pile 100% of their portfolios into stocks, but it does show how expensively nervous investors are valuing bonds. Time horizon, risk tolerance, and diversification should always be pillars to a disciplined, systematic investment strategy, but as long as these disparities remain between the earnings yields on stocks and bonds, long-term investors should be able to shop for plenty of doorbuster discount bargain opportunities.

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 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.

December 1, 2015 at 1:06 pm 1 comment

Extrapolation: Dangers of the Reckless Ruler

Ruler - Pencil

The game of investing would be rather simple if everything moved in a straight line and economic data points could be could be connected with a level ruler. Unfortunately, the real world doesn’t operate that way – data points are actually scattered continuously. In the short-run, inflation, GDP, exchange rates, interest rates, corporate earnings, profit margins, geopolitics, natural disasters, financial crises, and an infinite number of other factors are very difficult to predict with any accurate consistency. The true way to make money is to correctly identify long-term trends and then opportunistically take advantage of the chaos by using the power of mean reversion. Let me explain.

Take for example the just-released October employment figures, which on the surface showed a blowout creation of +271,000 new jobs during the month (unemployment rate decline to 5.0%) versus the Wall Street consensus forecast of +180,000 (flat unemployment rate of 5.1%). The rise in new workers was a marked acceleration from the +137,000 additions in September and the +136,000 in August. The better-than-expected jobs numbers, the highest monthly addition since late 2014, was paraded across television broadcasts and web headlines as a blowout number, which gives the Federal Reserve and Chairwoman Janet Yellen more ammunition to raise interest rates next month at the Federal Open Market Committee meeting. Investors are now factoring in roughly a 70% probability of a +0.25% interest rate hike next month compared to an approximately 30% chance of an increase a few weeks ago.

As is often the case, speculators, traders, and the media rely heavily on their trusty ruler to connect two data points to create a trend, and then subsequently extrapolate that trend out into infinity, whether the trend is moving upwards or downwards. I went back in time to explore the media’s infatuation with limitless extrapolation in my Back to the Future series (see Part I; Part II; and Part III). More recently, weakening data in China caused traders to extrapolate that weakness into perpetuity and pushed Chinese stocks down in August by more than -20% and U.S. stocks down more than -10%, over the same timeframe.

While most of the media coverage blew the recent jobs number out of proportion (see BOOM! Big Rebound in Job Creation), some shrewd investors understand mean reversion is one of the most powerful dynamics in economics and often overrides the limited utility of extrapolation. Case in point is blogger-extraordinaire Scott Grannis (Calafia Beach Pundit) who displayed this judgment when he handicapped the October jobs data a day before the statistics were released. Here’s what Grannis said:

The BLS’s estimate of private sector employment tends to be more volatile than ADP’s, and both tend to track each other over time. That further suggests that the BLS jobs number—to be released early tomorrow—has a decent chance of beating expectations.

 

Now, Grannis may not have guaranteed a specific number, but comparing the volatile government BLS and private sector ADP jobs data (always released before BLS) only bolsters the supremacy of mean reversion. As you can see from the chart below, both sets of data have been highly correlated and the monthly statistics have reliably varied between a range of +100k to +300k job additions over the last six years. So, although the number came in higher than expected for October, the result is perfectly consistent with the “slowly-but-surely” growing U.S. economy.

Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

While I spend much more time picking stocks than picking the direction of economic statistics, even I will agree there is a high probability the Fed moves interest rates next month. But even if Yellen acts in December, she has been very clear that this rate hike cycle will be slower than previous periods due to the weak pace of economic expansion. I agree with Grannis, who noted, “Higher rates would be a confirmation of growth, not a threat to growth.” Whatever happens next month, do yourself a favor and keep the urge of extrapolation at bay by keeping your pencil and ruler in your drawer.

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, 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.

November 7, 2015 at 7:07 pm 1 comment

More Treats, Less Tricks

pumpkin ornament

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 2, 2015). Subscribe on the right side of the page for the complete text.

Have you finished licking the last of your Halloween chocolate-covered fingers and scheduled your next cavity-filled dental appointment? After a few challenging months, the normally spooky month of October produced an abundance of sweet treats rather than scary tricks for stock market investors. In fact, the S&P 500 index finished the month with a whopping +8.3% burst, making October the tastiest performing month since late 2010. This came in stark contrast to the indigestion experienced with the -8.7% decline over the previous two months.

What’s behind all these sweet gains? For starters, fears of a Chinese economic sugar-high ending in a crash have abated for now. With that said, “Little Red Riding Hood” is not out of the woods quite yet. Like a surprising goblin or ghost popping out to scare you at a Halloween haunted house, China could still rear its ugly head in the future due to its prominent stature as the second largest global economy. We have been forced to deal with similar on-again-off-again concerns associated with Greece.

The good news is the Chinese government and central bank are not sitting on their hands. In addition to interest rate cuts and corruption crackdowns, Chinese government officials have even recently halted its decades-long one-child policy. China’s new two-child policy is designed to spur flagging economic growth and also reverse the country’s aging demographic profile.

Also contributing to the stock market’s sugary October advances is an increasing comfort level with the Federal Reserve’s eventual interest rate increase. Just last week, the central bank released the statement from its October Federal Open Market Committee meetings stating it will determine whether it will be “appropriate” to increase interest rates at its next meetings, which take place on December 15th and 16th. Interest rate financial markets are now baking in a roughly 50% probability of a Fed interest rate hike next month. Initially, the October Fed statement was perceived negatively by investors due to fears that higher rates could potentially choke off economic growth. Within a 30 minute period after the announcement, stock prices reversed course and surged higher. Investors interpreted the Fed signal of a possible interest rate hike as an upbeat display of confidence in a strengthening economy.

As I have reiterated on numerous occasions (see also Fed Fatigue), a +0.25% increase in the Federal Funds rate from essentially a level of 0% is almost irrelevant in my eyes – just like adjusting the Jacuzzi temperature from 102 degrees down to 101 degrees is hardly noticeable. More practically speaking, an increase from 14.00% to 14.25% on a credit card interest rate will not deter consumers from spending, just like a 3.90% mortgage rising to 4.15% will not break the bank for homebuyers. On the other hand, if interest rates were to spike materially higher by 3.00% – 4.00% over a very short period of time, this move would have a much more disruptive impact, and would be cause for concern. Fortunately for equity investors, this scenario is rather unlikely in the short-run due to virtually no sign of inflation at either the consumer or worker level. Actually, if you read the Fed’s most recent statement, Fed Chairwoman Janet Yellen indicated the central bank intends to maintain interest rates below “normal” levels for “some time” even if the economy keeps chugging along at a healthy clip.

If you think my interest rate perspective is the equivalent of me whistling past the graveyard, history proves to be a pretty good guide of what normally happens after the Fed increases interest rates. Bolstering my argument is data observed over the last seven Federal Reserve interest rate hike cycles from 1983 – 2006 (see table below). As the statistics show, stock prices increased an impressive +20.9% on average over Fed interest rate “Tightening Cycles.” It is entirely conceivable that the announcement of a December interest rate hike could increase short-term volatility. We saw this rate hike fear phenomenon a few months ago, and also a few years ago in 2013 (see also Will Rising Rates Murder Market?) when Federal Reserve Chairman Ben Bernanke threatened an end to quantitative easing (a.k.a., “Taper Tantrum”), but eventually people figured out the world was not going to end and stock prices ultimately moved higher.

fed cycles

Besides increased comfort with Fed interest rate policies, another positive contributing factor to the financial market rebound was the latest Congressional approval of a two-year budget deal that prevents the government from defaulting on its debt. Not only does the deal suspend the $18.1 trillion debt limit through March 2017 (see chart below), but the legislation also lowers the chance of a government shutdown in December. Rather than creating a contentious battle for the fresh, incoming Speaker of the House (Paul Ryan), the approved budget deal will allow the new Speaker to start with a clean slate with which he can use to negotiate across a spectrum of political issues.

debt limit

Source: Wall Street Journal

Remain Calm – Not Frightened

Humans, including all investors, are emotional beings, but the best investors separate fear from greed and are masters at making unemotional, objective decisions. Just as everything wasn’t a scary disaster when stocks declined during August and September, so too, the subsequent rise in October doesn’t mean everything is a bed of roses.

Every three months, thousands of companies share their financial report cards with investors, and so far with more than 65% of the S&P 500 companies reporting their results this period, corporate America is not making the honor roll. Collapsing commodity prices, including oil, along with the rapid appreciation in the value of the U.S. dollar (i.e., causing declines in relatively expensive U.S. exports), third quarter profit growth has declined -1%. If you exclude the energy sector from the equation, corporations are still not making the “Dean’s List,” however the report cards look a lot more respectable through this lens with profits rising +6% during the third quarter. A sluggish third quarter GDP (Gross Domestic Product) growth report of +1.5% is further evidence the economy has plenty of room to improve the country’s financial GPA.

Historically speaking, October has been a scary period, if you consider the 1929 and 1987 stock market crashes occurred during this Halloween month. Now that investors have survived this frightening period, we will see if the “Santa Claus Rally” will arrive early this season. Stock market treats have been sweet in recent weeks, but investors cannot lose sight of the long-term. With interest rates near generational lows, investors need to make sure they are efficiently investing their investment funds in a low-cost, tax-efficient, diversified manner, subject to personal time horizons and risk tolerances. Over the long-run, meeting these objectives will create a lot more treats than tricks.

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, 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.

November 2, 2015 at 12:18 pm Leave a comment

Out of the Woods?

Forest Free Image

In the middle of the 24/7 news cycle, many investors get distracted by the headline du jour, much like a baby gets distracted by a shiny new object. While investor moods have been swinging violently back and forth, October’s performance has bounced back like a flying tennis ball. So far, the reversal in the S&P 500 performance has more than erased the -9% correction occurring in August and September. Could we finally be out of the woods, or will geopolitics and economic factors scare investors through Halloween and year-end?

Given recent catapulting stock prices, investor amnesia has erased the shear horror experienced over the last few months – this is nothing new for emotional stock market participants. As I wrote in Controlling the Lizard Brain, human brains have evolved the almond-shaped tissue in our brains (amygdala) that controlled our ancestors’ urge to flee ferocious lions. Today the urge is to flee scary geopolitical and economic headlines.

I expanded on the idea here:

“When the brain in functioning properly, the prefrontal cortex (the front part of the brain in charge of reasoning) is actively communicating with the amygdala. Sadly, for many people, and investors, the emotional response from the amygdala dominates the rational reasoning portion of the prefrontal cortex. The best investors and traders have developed the ability of separating emotions from rational decision making, by keeping the amygdala in check.”

 

Evidence of lizard brains fear for flight happened just two months ago when the so-called “Fear Gauge” (VIX – Volatility Index) hit a stratospherically frightening level of 53 (see chart below), reached only once over the last few decades (2008-09 Financial Crisis).

Vix 10-23-15

Just as quickly as slowing China growth and a potential Fed interest rate hike caused investors to crawl underneath their desks during August (down –11% in four days), while biting their fingernails, investors have now sprung outside to the warm sunshine. The end result has been an impressive, mirror-like +11% increase in stock prices (S&P 500) over the last 18 trading days.

Has anything really changed over the last few weeks? Probably not. Economists, strategists, analysts, and other faux-soothsayers get paid millions of dollars in a fruitless attempt to explain day-to-day (or hour-by-hour) volatility in the stock markets. One Nobel Prize winner, Paul Samuelson, understood the random nature of stock prices when he observed, “The stock market has forecast nine of the last five recessions.” The pundits are no better at consistently forecasting stock prices.

As I have reiterated many times before, the vast majority of the pundits do not manage money professionally – the only people you should be paying attention to are successful long-term investors. Even listening to veteran professional investors can be dangerous because there is often such a wide dispersion of opinions based on varying time horizons, strategies, and risk tolerances.

Skepticism remains rampant regarding the sustainability of the bull market as demonstrated by the -$100 billion+ pulled out of domestic equity funds during 2015 (Source: ICI). The Volatility Index (VIX) shows us the low-hanging fruit of pessimism has been picked with the metric down -73% from August. With legislative debt ceiling and sequestration debates ahead in the coming weeks, we could hit some more choppy waters. Short-term volatility may resurrect itself, but the economy keeps chugging along, interest rates remain near all-time lows, and stock valuations, broadly speaking, remain reasonable. Investors may not be out of the woods yet, but one thing remains certain…an ever-changing stream of fearful headlines are likely to continue flooding in, which means we must all keep our lizard brains in check.

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, 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 24, 2015 at 3:15 pm Leave a comment

Older Posts


Subscribe to Blog

Meet Wade Slome, CFA, CFP®

More on Sidoxia Services

Recognition

Top Financial Advisor Blogs And Bloggers – Rankings From Nerd’s Eye View | Kitces.com

Wade on Twitter…

Like us on Facebook

Share this blog

Bookmark and Share

Monthly Archives


Follow

Get every new post delivered to your Inbox.

Join 1,303 other followers