Posts filed under ‘Financial Markets’
Markets Soar and Investors Snore
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (August 1, 2013). Subscribe on the right side of the page for the complete text.
If you haven’t been paying close attention, or perhaps if you were taking a long nap, you may not have noticed that the stock market was up an astounding +5% in July (+78% if compounded annualized), pushing the S&P 500 index up +18% for the year to near all-time record highs. Wait a second…how can that be when that bald and grey-bearded man at the Federal Reserve has hinted at bond purchase “tapering” (see also Fed Fatigue)? What’s more, I thought the moronic politicians were clueless about our debt and deficit-laden economy, jobless recovery, imploding eurozone, Chinese real estate bubble, and impending explosion of inflation – all of which are expected to sink our grandchildren’s grandchildren into a standard of living not seen since the Great Depression. Okay, well a dash of hyperbole and sarcasm never hurt anybody.
This incessant stream of doom-and-gloom pouring over our TVs, newspapers, and internet devices has numbed Americans’ psyches. To prove my point, the next time you are talking to somebody at the water cooler, church, soccer game, or happy hour, gauge how excited your co-worker, friend, or acquaintance gets when you bring up the subject of the stock market. If my suspicions are correct, they are more likely to yawn or pass out from boredom than to scream in excitement or do cartwheels.
You don’t believe me? Reality dictates the wounds from the 2008-2009 financial crisis are still healing. Panic and fear may have disappeared, but skepticism remains in full gear, even though stocks have more than doubled in price in recent years. Here is some data to support my case there are more stock detractors than defenders:
Record Savings Deposits
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| Source: Calafia Beach Pundit |
Although there are no signs of an impending recession, defensive cash hoarded in savings deposits has almost increased by $3 trillion since the end of the financial crisis.
Blah Consumer Confidence
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| Source: Calafia Beach Pundit |
As you can see from the chart above, Consumer Confidence has bounced around quite a bit over the last 30+ years, but there is no sign that consumer sentiment has turned euphoric.
15-Year Low Stock Market Participation
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Source: Gallup Poll
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There has been a trickling of funds into stocks in 2013, yet participation in the stock market is at a 15-year low. Investors remain nervous.
Lack of Equity Fund Buying
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| Source: ICI & Calafia Beach Pundit |
After a short lived tax-driven purchase spike in January, the buying trend quickly turned negative in the ensuing months. Modest inflows resumed into equity funds during the first few weeks of July (source: ICI), but the meager stock fund investments represent < 95% of 2012 positive bond flows ($15 billion < $304 billion, respectively). Moreover, these modest stock inflows pale in comparison to the hundreds of billions in investor withdrawals since 2008. See also Fund Flows Paradox – Investing Caffeine.
Decline in CNBC Viewership
In spite of the stock market more than doubling in value from the lows of 2009, CNBC viewer ratings are the weakest in about 20 years (source: Value Walk). Stock investing apparently isn’t very exciting when prices go up.
The Hater’s Index:
And if that is not enough, you can take a field trip to the hater’s comment section of my most recent written Seeking Alpha article, The Most Hated Bull Market Ever. Apparently the stock market more than doubling creates some hostile feelings.
JOLLY & JOVIAL MEMO
Keeping the previous objective and subjective data points in mind, it’s clear to me the doom-and-gloom memo has been adequately distributed to the masses. Less clear, however, is the dissemination success of the jolly-and-jovial memo. I think Ron Bailey, an author and science journalist at Reason.com (VIDEO), said it best, “News is always bad news. Good news is simply not news…that is our [human] bias.” If you turn on your local TV news, I think you may agree with Ron. Nevertheless, there are actually plenty of happier news items to report, so here are some positive bullet points to my economic and stock market memo:
16th Consecutive Positive GDP Quarter*
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| Source: Quartz.com |
The broadest measure of economic activity, GDP (Gross Domestic Product), was reported yesterday and came in better than expected in Q2 (+1.7%) for the 16th straight positive reported quarter (*Q1-2011 was just revised to fractionally negative). Obviously, the economists and dooms-dayers who repeatedly called for a double-dip recession were wrong.
40 Consecutive Months & 7 Million Jobs
Source: Calculated Risk
The economic recovery has been painfully slow, but nevertheless, the U.S. has experienced 40 consecutive months of private sector job additions, representing +7.2 million jobs created. With about -9 million jobs lost during the most recent recession, there is still plenty of room for improvement. We will find out if the positive job creation streak will continue this Friday when the July total non-farm payroll report is released.
Housing on the Mend
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| Source: Calafia Beach Pundit |
New home sales are up significantly from the lows; housing starts have risen about 40% over the last two years; and Case Shiller home prices rose by +12.2% in the latest reported numbers. The housing market foundation is firming.
Auto Sales Rebound
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| Source: Calafia Beach Pundit |
Auto sales remain on a tear, reaching an annualized level of 15.9 million vehicles, the highest since November 2007, and up +12% from June 2012. Car sales have almost reached pre-recessionary levels.
Record Corporate Profits
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| Source: Dr. Ed’s Blog |
Optimistic forecasts have been ratcheted down, nonetheless corporate profits continue to grind to all-time record highs. As you can see, operating earnings have more than doubled since 2003. Given reasonable historical valuations in stocks, as measured by the P/E (Price Earnings) ratio, persistent profit growth should augur well for stock prices.
Bad Banks Bounce Back
Europe on the Comeback Trail
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| Source: Calafia Beach Pundit |
There are signs of improvement in the Eurozone after years of recession. Talks of a European Armageddon have recently abated, in part because of Markit manufacturing manager purchasing statistics that are signaling expansion for the first time in two years.
Overall, corporations are achieving record profits and sitting on mountains of cash. The economy is continuing on a broad, steady recovery, however investors remain skeptical. Domestic stocks are at historic levels, but buying stocks solely because they are going up is never the right reason to invest. Alternatively, bunkering away excessive cash in useless, inflation depreciating assets is not the best strategy either. If nervousness and/or anxiety are driving your investment strategy, then perhaps now is the time to create a long-term plan to secure your financial future. However, if your goal is to soak up the endless doom-and-gloom and watch your money melt away to inflation, then perhaps you are better off just taking another nap.
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.
Hammering Heads with Circular Conversations
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (July 1, 2013). Subscribe on the right side of the page for a complete monthly update.
Deciphering what is driving the markets on a day-to-day, week-to-week, or month-to-month basis can feel like repeatedly hammering your head. In order to grasp the reasons why financial markets go up and down, one must have a conversation with your brain explaining that good news can be bad for asset prices, and bad news can be good for asset prices. Huh…how can that be? These circular conversations are what keep newspapers, magazines, media commentators, and bloggers in business… and what baffle many investors.
For example, headlines often reflect sentiments such as these:
- “Unemployment Figures Disappoint…Dow Jones Rallies +200 Points on QE3 Continuation Hopes”
- “Unemployment Figures Delight…Dow Jones Tanks -200 Points on QE3 Discontinuation Fears”
- “Economic Figures Revised Lower by -0.2%…Dow Jones Skyrockets +200 Points as Lower Interest Rates Propel Stock Prices.”
- “Economic Figures Revised Higher by +0.2%…Dow Jones Plummets -200 Points as Higher Interest Rates Deflate Stock Prices.”
On rare occasions these headlines make sense, but often online media outlets are frantically changing the headlines as the markets whip back and forth from positive to negative. News-producing editors are continually forced to create ludicrous and absurd explanations that usually make no sense to informed long-term investors.
It’s important to recognize that if the financial markets made common sense, then investing for retirement would be simple and everyone would be billionaires. Unfortunately, financial markets frequently make no sense in the short-run. Stocks are volatile (often times for no rational reason), which is why stocks offer higher returns over the long-run relative to more stable asset classes.
Explaining the latest spike in stock/bond price volatility has been exacerbated in recent weeks as a result of the nation’s banker (the Federal Reserve) and its boss, Ben Bernanke, attempting to explain their future monetary policy plans. In theory, bringing light to a traditionally mysterious, closed-door Washington process should be a good thing…right?
Well, ever since a few weeks ago when Ben Bernanke and the FOMC (Federal Open Market Committee) disclosed that the stimulative bond buying program (QE3) could be slowed in 2013 and halted in 2014, financial markets globally experienced a sharp jolt of volatility – stock prices dropped and interest rates spiked. Counter-intuitively, Bernanke’s belief that the economy is on a sustained recovery path (expected GDP growth of +3.25% in both 2014 & 2015) spooked investors. More specifically, in the month of June, the S&P 500 index declined -1.5% in June; Dow Jones Industrial Index -1.4%; and the 10-year Treasury note’s yield jumped +0.3% to 2.5%. Greedy investors, however, should not forget that the stock market just posted its 2nd best quarter since 2009 – the S&P 500 climbed +2.4%. What’s more, the S&P 500 is up +13% and the Dow up +14% in the first half of 2013.
Bernanke Threatening to Take Away Investor Lollipops
Another way of looking at the recent volatility is by equating investors to kids and stimulative QE bond buying programs (Quantitative Easing) to lollipops. If the economy continues on this improvement trajectory (i.e., unemployment falls to 7% by next year) and inflation remains benign (below 2.5%), then Bernanke said he will take away investors’ QE lollipops. But like a pushover dad being pressured by kids at the candy store, Bernanke acknowledged that he could continue supplying investors QE lollipops, if the economic data doesn’t improve at the forecasted pace. At face value, receiving a specific timeline given by the Fed should be appreciated and normally people are happy to hear the Chairman speak rosily about the economy’s future. However, the mere thought of QE lollipops being taken away next year was enough to push investors into a “taper tantrum” (see also Investing Caffeine – Fed Fatigue article).
With scary headlines constantly circulating, a large proportion of investors are sitting on their hands (and cash) while staring like deer in headlights at these developments. Rather than a distracted driver texting, investors should be watching the road and mapping out their future investment destinations – not paying attention to irrelevant diversions. Astute investors realize that uncertainty surrounding Greece, Cyprus, fiscal cliff, sequestration, presidential elections, Iran, N. Korea, Syria, Turkey, taxes, QE3, etc., etc., etc., have been a constant. Regrettably the fear mongers paying attention to these useless headlines have witnessed their cash, gold, and Treasuries get trounced by equity returns since early 2009 (the S&P 500 index is up about +150%, including dividends). Optimists and realists, on the other hand, have seen their investment plans thrive. While the aforementioned list of concerns has dangled in front of our noses over the last year, we will have a complete new list of concerns to decipher over the coming weeks, months, and years. That’s the price a long-term investor pays if they want to earn higher returns in the volatile equity markets.
As strategist Don Hays points out, “Nothing is certain. Good investors love uncertainty.” Rather than getting consumed by fear with the endless number of changing uncertainties, the real risk for investors is outliving your savings. Paychecks are being stretched by inflationary pressures across all categories (e.g., healthcare, gasoline, utilities, food, movies, travel, etc.) and entitlements like Social Security and Medicare will likely not mean the same thing to us as it did for our parents. Unless investors plan on working into their 80s as greeters at Wal-Mart, and/or enjoy clipping Top Ramen coupons in a crammed apartment, then they should do themselves a favor by taking a deep breath and turning off the television, so they can be insulated from the constant doom and gloom.
So as intimidating, circular conversations about good news being bad news, and bad news being good news continue to swirl around, focus instead on building a diversified investment plan that can adjust and adapt to the never-ending list of uncertainties. Your head will feel a lot better than it would after repetitive hammer strikes.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and WMT, 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.
Fed Fatigue Setting In
Uncle…uncle! There you have it – I have finally cried “uncle” because I cannot take it anymore. I don’t think I can listen to another panel or read another story debating about the timing of Fed “tapering”, or heaven forbid the Fed actually “tighten” the Federal Funds rate (i.e., increasing the targeted rate for inter-bank lending). Type in the words “Bernanke” and “tapering” into Google and you will get back more than 41,000,000 results. The build up to the 600-word FOMC (Federal Open Market Committee) statement was almost deafening, so much so that live coverage of Federal Reserve Chairman Ben Bernanke was available at your fingertips:
Source: Yahoo! Finance
Like a toddler (or a California-based, investment blog writer) going to the doctor’s office to receive an inoculation, the anxiety and mental anguish caused in anticipation of the event is often more painful than the actual injection. As I highlighted in a previous Investing Caffeine article, the 1994 interest rate cycle wasn’t Armageddon for equity markets, and the same can be said for the rate hikes from 1.0% to 5.25% in the 2004-20006 period (see chart below). Even if QE3 ends in mid-2014 and the new Federal Reserve Chairman (thank you President Obama) raises rates in 2015, this scenario would not be the first (or last) time the Federal Reserve has tightened monetary policy.
Source: Wikipedia
Short Memories – What Have You Done for Me Lately?
People are quick to point out the one-day -350 Dow point loss earlier this week, but many of them forget about the +3,000 point moon shot in the Dow Jones Industrial index that occurred in six short months (November 2012 – May 2013). The same foggy recollection principle applies to interest rates. The recent rout in 10-year Treasury prices is easily recalled as rates have jumped from 1.5% to 2.5% over the last year, however amnesia often sets in for others if you ask them where rates were a few years ago. It’s easy to forget that 30-year fixed rate mortgages exceeded 5% and the 10-year reached 4% just three short years ago.
Bernanke: The Center of the Universe?
Does Ben Bernanke deserve credit for implementing extraordinary measures during extraordinary times during the 2008-09 financial crisis? Absolutely. But should every man, women, and child wait with bated breath to see if a word change or tonal adjustment is made in the eight annual FOMC meetings?
Like the public judging Ben Bernanke, my Sidoxia clients probably give me too much credit when things go well and too much blame when things don’t. I love how Bernanke gets blamed/credited for the generational low interest rates caused by his money printing ways and QE punch bowl tactics. Last I checked, the interest rate downtrend has been firmly in place over the last three decades, well before Bernanke came into the Fed and worked his monetary magic. How much credit/blame are we forgetting to give former Federal Reserve Chairmen Paul Volcker, Alan Greenspan, and other government policy-makers? Regardless of what happens economically for the remainder of 2013, Bernanke will do whatever he can to solidify his legacy in the waning sunset months of his term.
Another forgotten fact I like to point out: There is more than one central banker living on this planet. If you haven’t been asleep over the last few decades, our financial markets have increasingly become globally interconnected with the assistance of technology. I know our 10-year Treasury rates are hovering around 2.50%, and our egotistical patriotism leads us to hail Bernanke as a monetary god, but don’t any other central bankers or government officials around the world deserve any recognition for achieving yields even lower than ours? Here’s a partial list (June 22, 2013 – Financial Times):
- Japan – 0.86%
- Germany – 1.67%
- Canada – 2.33%
- U.K. – 2.31%
- France – 2.27%
- Sweden – 2.15%
- Austria – 2.09%
- Switzerland – 0.92%
- Netherlands – 2.07%
Although it may be fun to look at Ben Bernanke as our country’s financial Superman who is there to save the day, there are a lot more important factors to consider than the 47 words added and 19 subtracted from the latest FOMC statement. If investing was as easy as following central bank monetary policy, everyone would be continually jet setting to their private islands. Rather than wasting your time listening to speculative blathering about direction of Fed monetary policy, why not focus on finding solid investment ideas and putting a long-term investment plan in place. Now please excuse me – Fed fatigue has set in and I need to take a nap.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and GOOG, 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.
U.S. Small-Caps Become Global Big Dog
With the emerging market currencies and financial markets under attack; Japan’s Nikkei index collapsing in the last three weeks; and the Federal Reserve hinting about its disciplinarian tapering of $85 billion in monthly QE3 bond purchases, one would expect higher beta small cap stocks to get hammered in this type of environment.
Before benchmarking results in the U.S., let’s take a closer look at some of the international carnage occurring from this year’s index value highs:
- Japan: -19% (Nikkei 225 index)
- Brazil: -22% (IBOVESPA index)
- Hong Kong: -12% (Hang Seng index)
- Russia: -19% (MICEX/RTS indexes)
Not a pretty picture. Given this international turmoil and the approximately -60% disintegration in U.S. small-cap stock prices during the 2007-2009 financial crisis, surely these economically sensitive stocks must be getting pummeled in this environment? Well…not necessarily.
Putting the previously mentioned scary aspects aside, let’s not forget the higher taxes, Sequestration, and ObamaCare, which some are screaming will push us off a ledge into recession. Despite these headwinds, U.S. small-caps have become the top dog in global equity markets. Since the March 2009 lows, the S&P 600 SmallCap index has more than tripled in value ( about +204%, excluding dividends), handily beating the S&P 500 index, which has advanced a respectable +144% over a similar timeframe. Even during the recent micro three-week pullback/digestion phase, small cap stocks have retreated -2.8% from all-time record highs (S&P 600 index). Presumably higher dividend, stable, globally-diversified, large-cap stocks would hold up better than their miniature small-cap brethren, but that simply has not been the case. The S&P 500 index has underperformed the S&P 600 by about -80 basis points during this limited period.
How can this be the case when currencies and markets around the world are under assault? Attempting to explain short-term moves in any market environment is a hazardous endeavor, but that has never slowed me down in trying. I believe these are some of the contributing factors:
1) No Recession. There is no imminent recession coming to the U.S. As the saying goes, we hear about 10 separate recessions before actually experiencing an actual recession. The employment picture continues to slowly improve, and the housing market is providing a slight tailwind to offset some the previously mentioned negatives. If you want to fill that half-full glass higher, you could even read the small-cap price action as a leading indicator for a pending acceleration in a U.S. cyclical recovery.
2) Less International. The United States is a better house in a shaky global neighborhood (see previous Investing Caffeine article), and although small cap companies are expanding abroad, their exposure to international markets is less than their large-cap relatives. Global investors are looking for a haven, and U.S. small cap companies are providing that service now.
3) Inflation Fears. Anxiety over inflation never seems to die, and with the recent +60 basis point rise in 10-year Treasury yields, these fears appear to have only intensified. Small-cap stocks cycle in and out of favor just like any other investment category, so if you dig into your memory banks, or pull out a history book, you will realize that small-cap stocks significantly outperformed large-caps during the inflationary period of the 1970s – while the major indexes effectively went nowhere over that decade. Small-cap outperformance may simply be a function of investors getting in front of this potential inflationary trend.
Following the major indexes like the Dow Jones Industrials index and reading the lead news headlines are entertaining activities. However, if you want to become a big dog in the investing world and not get dog-piled upon, then digging into the underlying trends and market leadership dynamics of the market indexes is an important exercise.
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 emerging market ETFs, IJR, and EWZ, but at the time of publishing, SCM had no direct position in Hong Kong ETFs, Japanese ETFs, Russian ETFs, 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.
1994 Bond Repeat or 2013 Stock Defeat?
Interest rates are moving higher, bond prices are collapsing, and fear regarding a stock market plunge is palpable. Sound like a recent news headline or is this a description of a 1994 financial market story? For those with a foggy, double-decade-old memory, here is a summary of the 1994 economic environment:
- The economy registered its 34th month of expansion and the stock market was on a record 40-month advance
- The Federal Reserve embarked on its multi-hike, rate-tightening monetary policy
- The 10-year Treasury note exhibited an almost 2.5% jump in yields
- Inflation was low with a threat of rising inflation lurking in the background
- An upward sloping yield curve encouraged speculative bond carry-trade activity (borrow short, invest long)
- Globalization and technology sped up the pace of price volatility
Many of these listed items resemble factors experienced today, but bond losses in 1994 were much larger than the losses of 2013 – at least so far. At the time, Fortune magazine called the 1994 bond collapse the worst bond market loss in history, with losses estimated at upwards of $1.5 trillion. The rout started with what might have appeared as a harmless 0.25% increase in the Federal Funds rate (the rate that banks lend to each other) from 3% to 3.25% in February 1994. By the time 1994 came to a close, acting Federal Reserve Chairman Alan Greenspan had jacked up this main monetary tool by 2.5%.
Rising rates may have acted as the flame for bond losses, but extensive use of derivatives and leverage acted as the gasoline. For example, over-extended Eurobond positions bought on margin by famed hedge fund manager Michael Steinhardt of Steinhardt Partners lead to losses of about-30% (or approximately $1.5 billion). Renowned partner of Omega Partners, Leon Cooperman, took a similar beating. Cooperman’s $3 billion fund cratered -24% during the first half of 1994. Insurance company bond portfolios were hit hard too, as collective losses for the industry exceeded $20 billion, or more than the claims paid for Hurricane Andrew’s damage. Let’s not forget the largest casualty of this era – the public collapse of Orange County, California. Poor derivatives trades led to $1.7 billion in losses and ultimately forced the county into bankruptcy.
There are plenty of other examples, but suffice it to say, the pain felt by other bond investors was widespread as a massive number of margin calls caused a snowball of bond liquidations. The speed of the decline was intensified as bond holders began selling short and using derivatives to hedge their portfolios, accelerating price declines.
Just as the accommodative interest rate punch bowl was eventually removed by Greenspan, so too is Ben Bernanke (current Fed Chairman) threatening to do today. Even if Bernanke unleashes a cold-turkey tapering of the $85 billion per month in bond-purchases, massive losses in bond values won’t necessarily mean catastrophe for stock values. For evidence, one needs to look no further than this 1994-1995 chart of the stock market:
Source: Ciovaccocapital.com
Volatility for stocks definitely increased in 1994 with the S&P 500 index correcting about -10% early in the year. But as you can see, by the end of the year the market was off to the races, tripling in value over the next five years. Volatility has been the norm for the current bull market rally as well. Despite the more than doubling in stock prices since early 2009, we have experienced two -20% corrections and one -10% pullback.
What’s more, the onset of potential tapering is completely consistent with core economic principles. Capitalism is built on free trading markets, not artificial intervention. Extraordinary times required extraordinary measures, but the probabilities of a massive financial Armageddon have been severely diminished. As a result, the unprecedented scale of quantitative easing (QE) will eventually become more harmful than beneficial. The moral of the story is that volatility is always a normal occurrence in the equity markets, therefore any significant stock pullback associated with potential bond tapering (or fed fund rate hikes) shouldn’t be viewed as the end of the world, nor should a temporary weakening in stock prices be viewed as the end to the bull market in stocks.
Why have stocks historically provided higher returns than bonds? The short answer is that stocks are riskier than bonds. The price for these higher long-term returns is volatility, and if investors can’t handle volatility, then they shouldn’t be investing in stocks.
If you are an investor that thinks they can time the market, you wouldn’t be wasting your time reading this article. Rather, you’d be spending time on your personal island while drinking coconut drinks with umbrellas (see Market Timing Treadmill).
Although there are some distinct similarities between the economic backdrop of 1994 and 2013, there are quite a few differences also. For starters, the economy was growing at a much healthier clip then (+4.1% GDP growth), which stoked inflationary fears in the mind of Greenspan. Moreover, unemployment was quite low (5.5% by year-end vs. 7.6% today) and the Fed did not communicate forward looking Fed policy back then.
It’s unclear if the recent 50 basis point ascent in 10-year Treasury rates was just an appetizer for what’s to come, but simple mathematics indicate there is really only one direction left for interest rates to go…higher. If history repeats itself, it will likely be bond investors choking on higher rates (not stock investors). For the sake of optimistic bond speculators, I hope Ben Bernanke knows the Heimlich maneuver. Studying history may help bond bulls avoid indigestion.
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.
Bond-Choking Central Banks Expand Investment Menu
Central banks around the globe are choking on low-yielding bonds, and as result are now expanding their investment menu beyond Treasuries into equities. Expansionary monetary policies purchasing short-term, low-rate bonds means that central banks have been gobbling up securities on their balance sheets that are earning next to nothing. To counteract the bond-induced indigestion of the central banks, many of them are considering increasing their equity purchasing strategies. How can you blame them? With the 10-year U.S. Treasury notes yielding 1.66%; 10-year German bonds eking out 1.21%; and 10-year Japanese Government Bonds (JGBs) paying a paltry 0.59%, it’s no wonder central banks are looking for better alternatives.
More specifically, the Bank of Japan (BOJ) is planning to pump $1.4 trillion into its economy over the next two years to encourage some inflation through open-ended asset purchases. Earlier this month, the BOJ said it has a goal of more than doubling equity related exchange traded funds (ETFs) by the end of 2014. According to Business Insider, the BOJ is currently holding $14.1 billion in equity ETFs with an objective to reach $35.3 billion in 2014.
I can only imagine how stock market bears feel about this developing trend when they have already blamed central banks’ quantitative easing initiatives as the artificial support mechanism for stock prices (see also The Central Bank Dog Ate my Homework).
While expanded equity purchases could break the backs of bond bulls and stock naysayers, some smart people agree that this strategy makes sense. Take Jim O’Neill, the chairman of Goldman Sachs Asset Management, who is retiring next week. Here’s what he has to say about expanded central bank stock purchases:
“Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short term, liquid things when they’re not going to ever need it? To help their future returns for their citizens, why would they not invest in equity?”
How big is this shift towards equities? The Royal Bank of Scotland conducted a survey of 60 central banks that have about $6.7 trillion in reserves. There were 13% of the central banks already invested in equities, and almost 25% of them said they are or will be invested in equities within the next five years.
While I may agree that stocks generally are a more attractive asset class than bubblicious bonds right now, I may draw the line once the Fed starts buying houses, gasoline, and groceries for all Americans. Until then, dividend yields remain higher than Treasury yields, and the earnings yields (earnings/price) on stocks will remain more attractive than bond yields. Once stocks gain more in price and/or bonds sell off significantly, it will be a more appropriate time to reassess the investment opportunity set. A further stock rise or bond selloff are both possible scenarios, but until then, central banks will continue to look to place its money where it is treated best.
The central bank menu has been largely limited to low-yielding, overpriced government bonds, but the appetite for new menu items has heightened. Stocks may be an enticing new option for central banks, but let’s hope they delay buying houses, gasoline, and groceries.
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.
Damned if You Do, and More Damned if You Don’t
Source: Photobucket
In the stock market you are damned if you do, and more damned if you don’t.
There are a million reasons why the market should or can go down, and the press, media, and bears come out with creative explanations every day. The “Flash Crash,” debt ceiling debate, credit downgrades, elections, and fiscal cliff were all credible events supposed to permanently crater the market. Now we have higher taxes (capital gains, income, and payroll), sequester spending cuts, and a nagging recession in Europe. What’s more, the pessimists point to the unsustainable nature of elevated corporate profit margins, and use the ludicrous Robert Shiller 10-year Price-Earnings ratio as evidence of an expensive market (see also Foggy Rearview Mirror). If an apple sold for $10 ten days ago and $0.50 today, would you say, I am not buying an apple today because the 10-day average price is too high? If you followed Robert Shiller’s thinking, this logic would make sense.
Despite the barrage of daily concerns and excuses, the market continues to set new record highs and the S&P 500 is up by more than +130% since the 2009 lows – just a tad higher than the returns earned on cash, gold, and bonds (please note sarcasm). Cash has trickled into equities for the first few months of 2013 after years of outflows, but average investors have only moved from fear to skepticism (see also Investing with the Sentiment Pendulum ). With cash and bonds earning next to nothing; gold underperforming for years; and inflationary pressures eroding long-term purchasing power, the vice is only squeezing tighter on the worrywarts.
Are there legitimate reasons to worry? Certainly, and the opportunities are not what they used to be a few years ago (see also Missing the Pre-Party). Although an endangered species, long-term investors understand backwards looking economic news is useless. Or as Peter Lynch wisely stated, “If you spend 13 minutes a year on economics, you’ve wasted 10 minutes.” The fact remains that the market is up 70% of the time, on an annual basis, and has been a great place to beat inflation over time. It’s a tempting endeavor to avoid the down markets that occur 30% of the time, but those who try to time the market fail miserably over the long-run (see also Market Timing Treadmill).
Equity investors would be better served by looking at their investment portfolios like real estate. Homeowners implicitly know the value of their home changes on a daily basis, but there are no accurate, real-time quotes to reference your home value on a minute by minute basis, as you can with stocks. Most property owners know that real estate is a cyclical asset class that is not impacted by daily headlines, and if purchased at a reasonable price, will generally go up in value over many years. Unfortunately, for many average investors, equity portfolios are treated more like gambling bets in Vegas, and get continually traded based on gut instincts.
Volatility is at six-year lows, and investors are getting less uncomfortable with owning stocks. Although everybody and their mother has been waiting for a pullback (myself included), don’t get too myopically focused. For the vast majority of investors, who should have more than a ten year time horizon, you should understand that volatility is normal and recessions will cause stocks to gown significantly, twice every ten years on average. If you are a long-term investor, like you should be, and you understand these dynamics, then you will also understand that you will be more damned if you don’t invest in equities as part of a diversified portfolio.
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.
Fine Tuning Your Stock Fishing Skills
If you are one of those fishing hobbyists crowded among a large group while hunting for a big fish, mathematics dictates your odds of reeling in a grand prize are significantly diminished. Expert fishermen are generally the first to arrive because they understand once the masses appear the opportunities will disappear. Like big fish, colossal stocks are rarely discovered by a large herd of investors. Financial bubbles occur in this manner, however these periods are usually short-lived and the investor pack often ends up losing more money on the way down relative to the profits earned on the way up. Successful investors are usually the ones following a disciplined systematic approach that is often contrarian in nature. In other words, not chasing performance requires patience, an elusive quality in these fast-paced, frenetic financial markets.
More prevalent in these markets are impulsive day-traders, unruly high frequency traders, and tempestuous hedge funds. Why own stocks, if you can rent them? Like a fisherman who constantly casts his/her bait in and out of the water, a short-sighted investor cannot realize outsized gains, unless the bait is given sufficient time to lure (find) the next winning idea.
Like many professions, experts often optimally mix the quantitative science and behavioral art of their craft. Whether it’s a teacher, doctor, accountant, attorney, or bus driver, the people who excel in their profession are the ones who move beyond the statistical and procedural basics of their trade. Practicing and understanding the nuts and bolts of your job is important, but developing those intangible, artistic skills only comes with experience. Unfortunately, many investing hobbyists don’t appreciate these artistic nuances and as a result go on destroying their portfolios, even though they act as if they were experts.
On the flip-side, decisions purely based on gut instincts will also lead to sub-par outcomes. The fisherman who does not account for the wind, temperature, geography, light, and seasonal differences will be at a distinct disadvantage to those who have studied these scientific factors.
In the fishing world, there is no miracle GPS device that will guide fish onto your hook, and the same is true for stocks. No software package or technical pattern will be a panacea for profits, however having some type of scientific tool to assist in the identification of investment opportunities should be exploited to its fullest. For us at Sidoxia Capital Management (www.Sidoxia.com), our tool is called SHGR (pronounced “SUGAR”), or Sidoxia Holy Grail Ranking. The name was created tongue-in-cheek; however its purpose is crucial. Following a quantitative system like SHGR ensures that a healthy dosage of discipline and objectivity is factored into our investment decisions, so inherent biases do not creep into our process and detract from performance. Specifically, our proprietary SHGR model incorporates multiple factors, including valuation, growth, sentiment indicators, profitability, and other qualitative measurements.
Although we use a “Holy Grail” ranking system, the fact of the matter is there are none in existence – for fishermen or investors. Experience teaches us the best opportunities are found where few are looking, and if proper quantitative tools are integrated into a multi-pronged process, then you will be uniquely positioned to catch a big fish.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and CMCSA, but at the time of publishing SCM had no direct position in BRKB, HNZ, HRL, UL, T, VZ, CAR, ZIP, AMR, LCC, ORCL, APKT, DELL, MSFT, RDSA, Repsol, ODP, OMX, HLF, BUD, STZ, GE, 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.
Vice Tightens for Those Who Missed the Pre-Party
The stock market pre-party has come to an end. Yes, this is the part of the bash in which an exclusive group is invited to enjoy the fruits of the festivities before the mobs arrive. That’s right, unabated access to the nachos; no lines to the bathroom; and direct access to the keg. For those of us who were invited to the stock market pre-party (or crashed it on their own volition), the spoils have been quite enjoyable – about a +128% rebound for the S&P 500 index from the bottom of 2009, and a +147% increase in the NASDAQ Composite index over the same period (excluding dividends paid on both indexes).
Although readers of Investing Caffeine have received a personal invitation to the stock market pre-party since I launched my blog in early 2009, many have shied away, out of fear the financial market cops may come and break-up the party.
Rather than partake in stock celebration over the last four years, many have chosen to go down the street to the bond market party. Unlike the stock market party, the fixed-income fiesta has been a “major-rager” for more than three decades. However, there are a few signs that this party has gotten out-of-control. For example, crowds of investors are lined up waiting to squeeze their way into some bond indulgence; after endless noise, neighbors are complaining and the cops are on their way to shut the party down; and PIMCO’s Bill Gross has just jumped off the roof to do a cannon-ball into the pool.
Even though the stock-market pre-party has been a blast, stock prices are still relatively cheap based on historical valuation measurements, meaning there is still plenty of time for the party to roll on. How do we know the party has just started? After five years and about a half a trillion dollars hemorrhaging out of domestic funds (see Calafia Beach Pundit), there are encouraging signs that a significant number of party-goers are beginning to arrive to the party. More specifically, as it relates to stocks, a fresh $10 billion has flowed into domestic equity mutual funds during this January (see ICI chart below). This data is notoriously volatile, and can change dramatically from month-to-month, but if this month’s activity is any indication of a changing mood, then you better hurry to the stock party before the bouncer stops letting people in.
Source: Investment Company Institute (ICI)
Vice Begins to Tighten on Party Outsiders
Many stock market outsiders have either been squeezed into the bond market, hidden in cash, or hunkered down in a bunker with piles of gold. While some of these asset classes have done okay since early 2009, all have underperformed stocks, but none have performed worse than cash. For those doubters sitting on the equity market sidelines, the pain of the vice squeezing their portfolios has only intensified, especially as the economy and employment picture slowly improves (see chart below) and stock prices persist directionally upward. For years, fear-mongering stock skeptics have warned of an imploding dollar, exploding inflation, a run-away deficit/debt, a reckless money-printing Federal Reserve, and political gridlock. Nevertheless, none of these issues have been able to kill this equity bull market.
Source: Calafia Beach Pundit
But for those willing and able investors to enter the stock party today, one must realize this party will only get riskier over time. As we exit the pre-party and enter into the main event, you never know who may join the party, including some uninvited guests who may steal money, get sick on the carpet, participate in illegal activities, and/or ruin the fun by clashing with guests. We have already been forced to deal with some of these uninvited guests in recent years, including the “flash crash,” debt ceiling debate, European financial crisis, fiscal cliff, and lastly, sequestration is about to arrive as well (right after parking his car).
New investors can still objectively join the current equity party, but it is necessary to still be cognizant of not over-staying your welcome. However, for those party-pooping doubters who already missed the pre-party, the vice will continue to tighten, leaving stock cynics paralyzed as they watch additional missed opportunities enjoyed by the rest of us.
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 HLF, Japanese ETFs, 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.
Risk of “Double-Rip” on the Rise
Okay, you heard it here first. I’m officially anointing my first new 2013 economic term of the year: “Double-Rip!” No, the biggest risk of 2013 is not a “double-dip” (the risk of the economy falling back into recession), but instead, the larger risk is of a double-rip – a sustained expansion of GDP after multiple quarters of recovery. I know, this sounds like heresy, given we’ve had to listen to perma-bears like Nouriel Roubini, Peter Schiff, John Mauldin, Mohamed El-Erian, Bill Gross, et al shovel their consistently wrong pessimism for the last 14 quarters. However, those readers who have followed me for the last four years of this bull market know where I’ve stood relative to these unwavering doomsday-ers. Rather than endlessly rehash the erroneous gospel spewed by this cautious clan, you can decide for yourself how accurate they’ve been by reviewing the links below and named links above:
Roubini calling for double-dip in 2012
Roubini calling for double-dip in 2011
Roubini calling for double-dip in 2010
Roubini calling for double-dip in 2009
If we switch from past to present, Bill Gross has already dug himself into a deep hole just two weeks into the year by tweeting equity markets will return less than 5% in 2013. Hmmm, I wonder if he’d predict the same thing now that the market is up about +4.5% during the first 18 days of the year?
Why Double-Rip Over Double-Dip?
How can stocks rip if economic growth is so sluggish? If forced to equate our private sector to a car, opinions would vary widely. We could probably agree the U.S. economy is no Ferrari. Faster growing countries like China, which recently reported 4th quarter growth of +7.9% (up from +7.4% in 3rd quarter), have lapped us complacent, right-lane driving Americans in recent years. But speed alone should not be investors’ only key objective. If speed was the number one priority, the only places investors would be placing their money would be in countries like Rwanda, Turkmenistan, and Libya (see Business Insider article). However, freedom, rule of law, and entrepreneurial spirit are other important investment factors to be considered. The U.S. market is more like a Toyota Camry – not very flashy, but it will reliably get you from point A to point B in an efficient and safe manner.
Beyond lackluster economic growth, corporate profit growth has slowed remarkably. In fact, with about 10% of the S&P 500 index companies reporting 4th quarter earnings thus far, earnings growth is expected to rise a measly 2.5% from a year ago (from a previous estimate of 3.0% growth). With this being the case, how can stock prices go up? Shrewd investors understand the stock market is a discounting mechanism of future fundamentals, and therefore stocks will move in advance of future growth. It makes sense that before a turn in the economy, the brakes will often be activated before accelerating into another fast moving straight-away.
In addition, valuation acts like shock absorbers. With generational low interest rates and a below-average forward 12-month P/E (Price-Earnings) ratio of 13x’s, this stock market car can absorb a significant amount of fundamental challenges. The oft quoted message that “In the short run, the market is a voting machine but in the long run it is a weighing machine,” from value icon Benjamin Graham holds as true today as it did a century ago. The recent market advance may be attributed to the voters, but long-term movements are ultimately tied to the sustainable scales of sales, earnings, and cash flows.
If that’s the case, how can someone be optimistic in the face of the slowing growth challenges of this year? What 2013 will not have is the drag of election uncertainty, the fiscal cliff, Superstorm Sandy, and an end-of-the-world Mayan calendar concern. This is setting the stage for improved fundamentals as we progress deeper into the year. Certainly there will be other puts and takes, but the absence of these factors should provide some wind under the economy’s sails.
What’s more, history shows us that indeed stock prices can go up quite dramatically (more than +325% during the 1990s) when consensus earnings forecasts continually get trimmed. We have seen this same dynamic since mid-2012 – earnings forecasts have come down and stock prices have gone up. Strategist Ed Yardeni captures this point beautifully in a recent post on his Dr. Ed’s Blog (see charts below).
CLICK TO ENLARGE – Source: Dr. Ed’s Blog
What Will Make Me Bearish?
Am I a perma-bull, incessantly wearing rose-colored glasses that I refuse to take off? I’ll let you come to your own conclusion. When I see a combination of the following, I will become bearish:
#1. I see the trillions of dollars parked in near-0% cash start coming outside to play.
#2. See Pimco’s Bill Gross and Mohammed El-Erian on CNBC fewer than 10 times per week.
#3. See money flow stop flooding into sub-3% bonds (Scott Grannis) and actually reverse.
#4. Observe a sustained reversal in hemorrhaging of equity investments (Scott Grannis).
#5. Yield curve flattens dramatically or inverts.
#6. Nouriel and his bear buds become bullish and call for a “triple-rip” turn in the equity markets.
#7. Smarter, more-experienced investors than I, á la Warren Buffett, become more cautious. I arrogantly believe that will occur in conjunction with some of the previously listed items.
Despite my firm beliefs, it is evident the bears won’t go down without a fight. If you are getting tired of drinking the double-dip Kool-Aid, then perhaps it’s time to expand your bullish horizons. If not, just wait 12 months after a market rally, and buy yourself a fresh copy of the Merriam-Webster dictionary. There you can locate and learn about a new definition…double-rip!
Read Also: Double-Dip Guesses are “Probably Wrong”
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 Fiat, Toyota, 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.
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