Posts filed under ‘Financial Planning’
Glass Half Empty Becomes Record Glass Half Full
Oh my! What a difference a few months makes. Originally, what looked like an economic glass half empty in December has turned into a new record glass half full. What looked like Armageddon in December has turned into a v-shaped bed of roses to new all-time record stock market highs for the S&P 500 index (see chart below). For the recent month, the S&P 500 climbed another +3.9% to 2,945, bringing total 2019 gains to an impressive +17.5% advance. Before you get too excited, it’s worth noting stocks were down in value during 2018. When you combine 2018-2019, appreciation over the last 16 months equates to a more modest +10.2% expansion. Worth noting, since the end of 2017, profits have climbed by more than +20%, which means stocks are cheaper today as measured by Price-Earnings ratios (P/E) than two years ago (despite the historic, record levels). For any confused investors, we can revisit this topic for discussion in a future writing.
Source: Trading Economics
From Famine to Feast
As I noted in my “December to Remember” article, there were no shortage of concerns ranging from impeachment to Brexit. How do those concerns look now? Let’s take a look:
Government Shutdown: The longest government shutdown in history (35 days) ended on January 25, 2019 with minimal broad-based economic damage.
Global Trade (China): Rhetoric coming from President Trump and his administration regarding a trade deal resolution with China has been rather optimistic. In fact, a CNBC survey shows 77% of respondents believe that the U.S. and China will complete a trade deal.
Federal Reserve Interest Rate Policy: After consistently increasing interest rates nine times since the end of 2015 until late 2018, Federal Reserve Chairman Jerome Powell signaled he was effectively taking monetary policy off rate-hiking “autopilot” and would in turn become “patient” as it relates to increasing future interest rates. Interestingly, traders are now forecasting a 70% chance of a rate cut before January 29, 2020.
Mueller Investigation: Special counsel Robert Mueller released his widely anticipated report that investigated Russian collusion and obstruction allegations by the president and his administration. In Mueller’s 22-month report he could “not establish that members of the Trump Campaign conspired or coordinated with the Russian government in its election interference activities.” As it relates to obstruction, Mueller effectively stated the president attempted to obstruct justice but was not successful in achieving that goal. Regardless of your political views, uncertainty surrounding this issue has been mitigated.
New Balance of Power in Congress: Democrats took Congressional control of the House of Representatives and reintroduced gridlock. But followers of mine understand gridlock is not necessarily a bad thing.
Brexit Deal Uncertainty: After years of negotiations for Britain to exit the European Union (EU), the impending Brexit deadline of March 29th came and went. EU an UK leaders have now agreed to extend the deadline to October 31st, thereby delaying any potential negative impact from a hard UK exit from the EU.
Recession Fears: Fears of a fourth quarter global slowdown that would bleed to a recession on U.S. soil appear to have been laid to bed. The recently reported first quarter economic growth (Gross Domestic Product – GDP) figures came in at a healthy+3.2% annualized growth rate, up from fourth quarter growth of +2.2%, and above consensus forecasts of 2.0%.
Curve Concern
The other debate swirling around the investment community this month was the terrifying but wonky “inverted yield curve.” What is an inverted yield curve? This is a financial phenomenon, when interest rate yields on long-term bonds are lower than interest rate yields on short-term bonds. Essentially when these dynamics are in place, bond investors are predicting slower economic activity in the future (i.e., recession). The lower future rates effectively act as a way to stimulate prospective growth amid expected weak economic activity. Furthermore, lower future rates are a symptom of stronger demand for longer-term bonds. It’s counterintuitive for some, but higher long-term bond prices result in lower long-term bond interest rate yields. If this doesn’t make sense, please read this. Why is all this inverted yield curve stuff important? From World War II, history has informed us that whenever this phenomenon has occurred, it has been a great predictor for a looming recession.
As you can see from the chart below, whenever the yield curve (red line) inverts (goes below zero), you can see that a recession (gray vertical bar) occurs shortly thereafter. In other words, an inverted yield curve historically has been a great way to predict recessions, which normally is almost an impossible endeavor – even for economists, strategists, and investment professionals.
Source: Calafia Beach Pundit
Although the curve inverted recently (red line below 0), you can see from the chart, historically recessions (gray vertical bars) have occurred only when inflation-adjusted interest rates (blue line) have climbed above 2%. Well, the data clearly shows inflation-adjusted interest rates are still well below 1%, therefore an impending recession may not occur too soon. Time will tell if these historical relationships will hold, but rest assured this is a dynamic I will be following closely.
It has been a crazy 6-9 months in the stock market with price swings moving 20% in both directions (+/-), but it has become increasingly clear that a multitude of 2018 fears causing the glass to appear half empty have now abated. So long as economic growth continues at a healthy clip, corporate profits expand to (remain at) record levels, and the previously mentioned concerns don’t spiral out of control, then investors can credibly justify these record levels…as they peer into a glass half full.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 1, 2019). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Are Stocks Cheap or Expensive? Weekly Rant and the Week in Review 4-7-19
The Weekly Grind podcast is designed to wake up your investment brain with a weekly overview of financial markets and other economic-related topics.
Episode 7
Weekly Market Review and This Week’s Rant: Are Stocks Cheap or Expensive?
Don’t miss out! Follow us on iTunes, Spotify, SoundCloud or PodBean to get a new episode each week. Or follow our InvestingCaffeine.com blog and watch for new podcast updates each week.
SoundCloud: soundcloud.com/sidoxia
PodBean: sidoxia.podbean.com
Spotify: open.spotify.com
March Madness Leads to Gladness
As usual, there was plenty of “madness” in March, and this year did not disappoint. Just as is the case with the annual NCAA basketball tournament, certain investors suffered the agony of defeat in the financial markets, but overall, the thrill of victory triumphed in March. So much so that the S&P 500 index posted its largest first-quarter gain in more than 20 years. Not only did the major indexes post gains for the month, but the winning record looks even better for the year-to-date results. For 2019, the S&P 500 index is up +13.1%; the Dow Jones Industrial Average +11.2%; and the tech-heavy NASDAQ index +16.5% for the year. The monthly gains in the major indexes were more muted, ranging from 0% for the Dow to +2.6% for the NASDAQ.
Busy? Listen to Wade discuss this article and other topics each week on the Weekly Grind podcast:
While 2018 ended with a painful injury (S&P 500 -6.2% in Q4), on fears of a deteriorating China trade deal and a potentially overly aggressive Federal Reserve hiking interest rates, the stock market ultimately recovered in 2019 on changing perceptions. Jerome Powell, the Federal Reserve Chairman, indicated the Fed would be more “patient” going forward in increasing interest rates, and President Trump’s tweet-storm on balance has been optimistic regarding the chances of hammering out a successful trade deal with China.
With the new cautious Fed perspective on interest rates, the yield on the 10-Year Treasury Note fell by -0.28% for the quarter from 2.69% to 2.41%. In fact, investors are currently betting there is a greater than 50% probability the Fed will cut interest rates before year-end. Moreover, in testimony before Congress, Powell signaled the economic dampening policy of reducing the Fed’s balance sheet was almost complete. All else equal, the shift from a perceived rate-hiking Fed to a potentially rate-cutting Fed has effectively turned an apparent headwind into tailwind. Consumers are benefiting from this trend in the housing market, as evidenced by lower 30-year fixed mortgage rates, which in some cases have dropped below 4%.
Economy: No Slam Dunk
However, not everything is a slam dunk in the financial markets. Much of the change in stance by the Fed can be attributed to slowing economic growth seen both here domestically and abroad, internationally.
Here in the U.S., the widely followed monthly jobs number last month only showed a gain of 20,000 jobs, well below estimates of 180,000 jobs. This negative jobs surprise was the biggest miss in more than 10 years. Furthermore, the overall measure for our nation’s economic activity, growth in Gross Domestic Product (GDP), was revised downward to +2.2% in Q4, below a previous estimate of +2.6%. The so-called “inverted yield curve” (i.e., short-term interest rates are higher than long-term interest rates), historically a precursor to a recession, is consistent with slowing growth expectations. This inversion temporarily caused investors some heartburn last month.
If you combine slowing domestic economic growth figures with decelerating manufacturing growth in Europe and China (e.g. contracting Purchasing Managers’ Index), then suddenly you end up with a slowing global growth picture. In recent months, the U.S. economy’s strength was perceived as decoupling from the rest of the world, however recent data could be changing that view.
Fortunately, the ECB (European Central Bank) and China have not been sitting on their hands. ECB President Mario Draghi announced three measures last month that could cumulatively add up to some modest economic stimulus. First, it “expects the key ECB interest rates to remain at their present levels at least through the end of 2019.” Second, it committed to reinvesting all maturing bond principal payments in new debt “for an extended period of time.” And third, the ECB announced a new batch of “Targeted Long-Term Refinancing Operations” starting in September. Also, Chinese Premier Li Keqiang announced the government will reduce taxes, primarily Value Added Taxes (VAT) and social security taxes (SST). Based on the rally in equities, it appears investors are optimistic these stimulus efforts will eventually succeed in reigniting growth.
Volume of Political Noise Ratcheted Higher
While I continually try to remind investors to ignore politics when it comes to their investment portfolios, the deafening noise was especially difficult to overlook considering the following:
- Mueller Report Completed: Robert Mueller’s Special Counsel investigation into potential collusion as it relates Russian election interference and alleged obstruction of justice concluded.
- Michael Cohen Testifies: Former President Trump lawyer, Michael Cohen, testified in closed sessions before the House and Senate intelligence committees, and in public to the House Oversight Committee. In the open session, Cohen, admitted to paying hush money to two women during the election. Cohen called President Trump a racist, a conman, and a cheat but Cohen is the one heading to jail after being sentenced for lying to Congress among other charges.
- Manafort Sentenced: Former Trump Campaign Chairman Paul Manafort was sentenced to prison on bank and tax fraud charges.
- North Korea No Nuke Deal: In geopolitics,President Trump flew 21 hours to Vietnam to meet for a second time with North Korean leader Kim Jong Un on denuclearization of the Korean peninsula. The U.S. president ended up leaving early, empty handed, without signing an agreement, after talks broke down over sanction differences.
- Brexit Drama Continues: The House of Commons in the lower house of the U.K. Parliament continued to stifle Prime Minister Theresa May’s plan to exit the European Union with repeated votes rejecting her proposals. Brexit outcomes remain in flux, however the European Union did approve an extension to May 22 to work out kinks, if the House can approve May’s plan.
Positive Signals Remain
March Madness reminds us that a big lead can be lost quickly, however a few good adjustments can also swiftly shift momentum in the positive direction. Although growth appears to be slowing both here and internationally, corporate profits are not falling off a cliff, and earnings remain near record highs (see chart below).
Source: Calafia Beach Pundit
Similar to the stock market, commodities can be a good general barometer of current and future economic activity. As you can see from the chart below, not only have commodity prices remained stable in the face of slowing economic data, but gold prices have not spiked as they did during the last financial crisis.
Source: Calafia Beach Pundit
After 2018 brought record growth in corporate profits and negative returns, 2019 is producing a reverse mirror image – slow profit growth and record returns. The volatile ending to 2018 and triumphant beginning to 2019 is a reminder that “March Madness” does not need to bring sadness…it can bring gladness.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 1, 2019). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Podcast 3/24/19: Week in Review and Interview: Russ Murdock, CFA
The Weekly Grind podcast is designed to wake up your investment brain with weekly overviews of financial markets and other economic-related topics.
Episode 5
Market Review and Interview: Russ Murdock, CFA – Small Cap Value Manager and Founder of Seabreeze Capital Management
Don’t miss out! Follow us on iTunes, Spotify, SoundCloud or PodBean to get a new episode each week. Or follow our InvestingCaffeine.com blog and watch for new podcast updates each week.
SoundCloud: soundcloud.com/sidoxia
PodBean: sidoxia.podbean.com
Spotify: open.spotify.com
Podcast 3/17/19: Week in Review and BREXIT
The Weekly Grind podcast is designed to wake up your investment brain with weekly overviews of financial markets and other economic-related topics.
Episode 4
Market Review, Stock Ideas, and The Weekly Rant: BREXIT
Don’t miss out! Follow us on iTunes, Spotify, SoundCloud or PodBean to get a new episode each week. Or follow our InvestingCaffeine.com blog and watch for new podcast updates each week.
SoundCloud: soundcloud.com/sidoxia
PodBean: sidoxia.podbean.com
Spotify: open.spotify.com
Podcast 3/10/19: Week in Review and Market Forecasting
The Weekly Grind podcast is designed to wake up your investment brain with weekly overviews of financial markets and other economic-related topics.
Episode 3
Market Review, Stock Ideas, and The Weekly Rant: Market Forecasting
Don’t miss out! Follow us on iTunes, Spotify, SoundCloud or PodBean to get a new episode each week. Or follow our InvestingCaffeine.com blog and watch for new podcast updates each week.
Spotify: open.spotify.com
SoundCloud: soundcloud.com/sidoxia
PodBean: sidoxia.podbean.com
Podcast 3/3/19: Week in Review and Share Buybacks
The Investing Caffeine podcast is designed to wake up your investment brain with weekly overviews of financial markets and other economic-related topics.
Episode 2
Market Review, Stock Ideas, and The Weekly Rant: Share Buybacks
Don’t miss out! Follow us on either SoundCloud or PodBean to get a new episode each week. Or follow our InvestingCaffeine.com blog and watch for new podcast updates each week.
SoundCloud: soundcloud.com/sidoxia
PodBean: sidoxia.podbean.com
Arm Wrestling the Economy & Tariffs
Financial markets have been battling back and forth like a championship arm-wrestling match as economic and political forces continue to collide. Despite these clashing dynamics, capitalism won the arm wrestling match this month as investors saw the winning results of the Dow Jones Industrial Average adding +4.7% and the S&P 500 index advancing +3.6%.
Fueling the strength this month was U.S. economic activity, which registered robust 2nd quarter growth of +4.1% – the highest rate of growth achieved in four years (see below).
The job market is on fire too with U.S. jobless claims hitting their lowest level in 48 years (see chart below). This chart shows the lowest number of people in a generation are waiting in line to collect unemployment checks.
Source: Dr. Ed’s Blog
If that isn’t enough, so far, the record corporate profits being reported for Q2 are up a jaw-dropping +23.5% from a year ago. What can possibly be wrong?
Excess Supply of Concern
While the economic backdrop is largely positive, there is never a shortage of things to worry about – even during decade-long bull market of appreciation. More specifically, investors have witnessed the S&P 500 index more than quadruple from a March 2009 low of 666 to 2,816 today (+322%). Despite the massive gains achieved over the last decade, there have been plenty of volatility and geopolitics to worry about. Have you already forgotten about the Flash Crash, Arab Spring, Occupy Wall Street, Government Shutdowns, Sequestration, Taper Tantrum, Ebola, Iranian nuclear threat, plunging oil prices, skyrocketing oil prices, Brexit, China scares, Elections, and now tariffs, trade, and the Federal Reserve monetary policy?
Today, tariffs, trade, Federal Reserve monetary policy, and inflation are top-of-mind investor concerns, but history insures there will be new issues to worry about tomorrow. Ever since the bull market began a decade ago, there have been numerous perma-bears incorrectly calling for a deathly market collapse, and I have written a substantial amount about these prognosticators’ foggy crystal balls (see Emperor Schiff Has No Clothes [2009] & Clashing Views with Dr. Roubin [2009]. While these doomsdayers get a lot less attention today, similar bears like John Hussman, who like a broken record, has erroneously called for a market crash every year for the last seven years (click chart link).
Although many investment accounts are up over the last 10 years, many people quickly forget it has not been all rainbows and unicorns. While the stock market has more than quadrupled in value since 2009, we have lived through about a dozen alarming corrections, including the worrisome -12% pullback we experienced in February. If we encounter another -5 -10% correction this year, this is perfectly healthy, normal, and should not be surprising. More often than not, these temporary drops provide opportunistic openings to scoop up valued bargains.
Longtime readers and followers of Sidoxia’s investment philosophy and Investing Caffeine understand the majority of these economic predictions and political headlines are useless noise. Social media, addiction to smart phones, and the 24/7 news cycle create imaginary, scary mountains out of harmless molehills. As I have preached for years, the stock market does not care about politics and opinions – the stock market cares about 1) corporate profits (at record levels) – see chart below; 2) interest rates (rising, but still near historically low levels); 3) the price of the stock market/valuation (which is getting cheaper as profits soar from tax cuts); and 4) sentiment (a favorable contrarian indicator until euphoria kicks in).
Source: Dr. Ed’s Blog
Famed investor manager, Peter Lynch, who earned +29% annually from 1977-1990 also urged investors to ignore attempts of predicting the direction of the economy. Lynch stated, “I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.”
I pay more attention to successful long-term investors, like Warren Buffett (the greatest investor of all-time), who remains optimistic about the stock market. As I’ve noted before, although we remain constructive on the markets over the intermediate to long-term periods, nobody has been able to consistently prophesize about the short-term direction of financial markets.
At Sidoxia, rather than hopelessly try to predict every twist and turn in the market, or react to every meaningless molehill, we objectively analyze the available data without getting emotional, and then take advantage of the opportunities presented to us in the marketplace. Certain asset classes, stocks, and bonds, will constantly move in and out of favor, which allows us to continually find new opportunities. A contentious arm wrestling struggle between uncertain tariffs/rising interest rates and stimulative tax cuts/strong economy is presently transpiring. As always, we will continually monitor the evolving data, but for the time being, the economy is flexing its muscle and winning the battle.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 1, 2018). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in 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.
Tariff, Fed, & Facebook Fears but No Easter Bunny Tears
After an explosive 2017 (+19.4%) and first month of 2018 (+5.6%), the Easter Bunny came out and laid an egg last month (-2.7%). It is normal for financial markets to take a breather, especially after an Energizer Bunny bull market, which is now expanding into its 10th year of cumulative gains (up +296% since the lows of March 2009). Investors, like rabbits, can be skittish when frightened by uncertainty or unexpected events, and over the last two months, that’s exactly what we have seen.
Fears of Tariffs/Trade War: On March 8th, President Trump officially announced his 25% tariffs on steel and 10% on aluminum. The backlash was swift, not only in Washington, but also from international trading partners. In response, Trump and his economic team attempted to diffuse the situation by providing temporary tariff exemptions to allied trading partners, including Canada, Mexico, the European Union, and Australia. Adding fuel to the fire, Trump subsequently announced another $50-$60 billion in tariffs placed on Chinese imports. To place these numbers in context, let’s first understand that the trade value of steel (roughly $300 billion – see chart below), aluminum, and $60 billion in Chinese products represent a small fraction of our country’s $19 trillion economy (Gross Domestic Product). Nevertheless, financial markets sold off swiftly this month in unison with these announcements. The selloff did not necessarily occur because of the narrow scope of these specific announcements, but rather out of fear that this trade skirmish may result in large retaliatory tariffs on American exports, and ultimately these actions could blow up into a full-out trade war and trigger a spate of inflation.
Source: Bloomberg
These trade concerns are valid, but at this point, I am not buying the conspiracy theories quite yet. President Trump has been known to use fiery rhetoric in the past, whether talking about building “The Wall” or threats to defense contractors regarding the pricing of a legacy Air Force One contract. Often, the heated language is solely used as a first foray into more favorable negotiations. President Trump’s tough tariff talk is likely another example of this strategy.
Interest Rate/Inflation Phobia: Beginning in early February, anxiety in the equity markets intensified as interest rates on the benchmark 10-year Treasury note have now risen from a September-low yield of 2.40% to a 2018-high of 2.94%. Since that short-term high this year, rates have moderated to +2.74%. Adding to this month’s worries, Fed Chairman Jerome Powell hiked interest rates on the Federal Funds interest rate target by +0.25% to a range of 1.50% to 1.75%. While the direction of rate increases may be unnerving to some, both the absolute level of interest rates and the level of inflation remain relatively low, historically speaking (see 2008-2018 inflation chart below). Inflation of 1.5% is nowhere near the double digit inflation experienced in the late-1970s and early 1980s .
Source: Dr. Ed’s Blog
It is true that rates on mortgages, car loans, and credit cards might have crept up a little, but from a longer-term perspective rates still remain significantly below historical averages. Even if the Federal Reserve increases their interest rate target range another two to three times in 2018 as currently forecasted, we will still be at below-average levels, which should still invigorate economic growth (all else equal). In car terms, if the current strategy continues, the Fed will be moving from a strategy in which they are flooring the economic pedal to the medal, to a point where they will only be going 10 miles per hour over the speed limit. The strategy is still stimulative, but just not as stimulative as before. At some point, rising interest rates will slow down (or choke off) growth in the economy, but I believe we are still a long way from that happening.
Why am I not worried about runaway interest rates or inflation? For starters, I believe it is very important for investors to remove the myopic blinders, so they can open their eyes to what’s occurring with global interest rate trends. Although, U.S. rates have more than doubled from July 2016 to 2.74%, as long as interest rates in developed markets like Japan, the European Union, and Canada, remain near historically low levels (see chart below), the probabilities of runaway higher interest rates and inflation are unlikely to transpire.
Source: Ed Yardeni
With the Japanese 10-year government bond yielding 0.04% (near-zero percent), the German 10-year bond yielding 0.50%, and the U.K. 10-year bond yielding 1.35%, one of two scenarios is likely to occur: 1) global interest rates rise while U.S. rates decline or remain stable; or 2) U.S. interest rates decline while global rates decline or remain stable. While either scenario is possible, given the lack of rising inflation and the slack in our employment market, I believe scenario #2 is more likely to occur than scenario #1.
Privacy, Politics, and Facebook: A lot has recently been made of the 50 million user profiles that became exposed and potentially exploited for political uses in the 2016 presidential elections. How did this happen, and what was the involvement of Facebook Inc. (FB)? If you have ever logged into an internet website and been given the option to sign in with your Facebook password, then you have been exposed to third-party applications that are likely mining both your personal and Facebook “friend” data. The genesis of this particular situation began when Aleksandr Kogan, a Russian American who worked at the University of Cambridge created a Facebook quiz app that not only collected personal information from approximately 270,000 quiz-takers, but also extracted information from about 50 million Facebook friends of the quiz takers (data scandal explained here).
Mr. Kogan (believed to be in his early 30s) allegedly sold the Facebook data to a company called Cambridge Analytica, which employed Steve Bannon as a vice president. This is the same Steve Bannon who eventually became a senior adviser for the Trump Administration. Facebook has defended itself by blaming Aleksandr Kogan and Cambridge Analytica for violating Facebook’s commercial data sharing policies. Objectively, regardless of the culpability of Kogan, Cambridge Analytica, and/or Facebook, most observers, including Congress, believe that Facebook should have more closely monitored the data collected from third party app providers, and also done more to prevent such large amounts of data to be sold commercially. Now, the CEO (Chief Executive Officer) of Facebook, Mark Zuckerberg, faces an appointment in Washington DC, where he will receive tongue lashings and be raked over the coals, so politicians can better understand the breakdown of this data breach.
It is certainly possible that a large amount of data was compromised for political purposes relating to the 2016 presidential election. There has been some backlash as evidenced by a few high profile users threatening to leave the Facebook platform like actor/comedian Will Ferrell, Tesla CEO Elon Musk, and singer Cher, but since the data scandal was unearthed, there has been little evidence of mass defections. Even considering all the Facebook criticism, the stickiness and growth of Facebook’s 1.4 billion (with a “b”) monthly active users, coupled with the vast targeting capabilities available for a wide swath of advertisers, likely means any negative impact will be short-lived. Even if there are defectors, where will all these renegades go, Instagram? Well, if that were the case, Instagram is owned by Facebook. Snapchat, is another Facebook alternative, however this platform is skewed toward younger demographics, and few people who have invested years of sharing/saving memories on the Facebook cloud, are unlikely to delete these memories and migrate that data to a lesser-known platform.
Financial markets move up and financial markets down. The first quarter of 2018 reminded us that no matter how long a bull market may last, nothing money-related moves in a straight line forever. The fear du jour constantly changes, and last month, investors were fretting over tariffs, the Federal Reserve’s monetary policy, and a Facebook data scandal. Suffice it to say, next month will likely introduce new concerns, but one thing I do not need to worry about is an empty Easter basket. It will take me much longer than a month to work through all the jelly beans, chocolate bunnies, and marshmallow Peeps.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 2, 2018). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in FB, AMZN, TSLA, 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.
The Scary Blip
I hated it when my mom reminded me when I was a younger, but now that I’ve survived into middle-aged adulthood, I will give you the same medicine she gave me:
“I told you so.”
As I cautioned in last month’s newsletter, “It’s important for investors to remember this pace of gains cannot be sustainable forever.” I added that there were a whole bunch of scenarios for stock prices to go down or “stock prices could simply go down due to profit-taking.”
And that is exactly what we saw. From the peak achieved in late January, stock prices quickly dropped by -12% at the low in early February, with little-to-no explanation other than a vague blame-game on rising interest rates – the 2018 yield on the 10-Year Treasury Note rose from 2.4% to 2.9%. This explanation holds little water if you take into account interest rates on the 10-Year increased from roughly 1.5% to 3.0% in 2013 (“Taper Tantrum”), yet stock prices still rose +20%. The good news, at least for now, is the stock correction has been contained or mitigated. A significant chunk of the latest double-digit loss has been recovered, resulting in stock prices declining by a more manageable -3.9% for the month. Despite the monthly loss, the subsequent rebound in late February has still left investors with a gain of 1.5% for 2018. Not too shabby, especially considering this modest return comes on the heels of a heroic +19.4% gain in 2017.
As you can see at from the 22-year stock market chart below for the S&P 500, the brief but painful drop was merely a scary blip in the long-term scheme of things.
Whenever the market drops significantly over a short period of time, as it did this month, conspiracy theories usually come out of the woodwork in an attempt to explain the unexplainable. When human behavior is involved, rationalizing a true root cause can be very challenging, to say the least. It is certainly possible that technical factors contributed to the pace and scale of the recent decline, as has been the case in the past. Currently no smoking gun or fat finger has been discovered, however some pundits are arguing the popular usage of leveraged ETFs (Exchange Traded Funds) has contributed to the accelerated downdraft last month. Leveraged ETFs are special, extra-volatile trading funds that will move at amplified degrees – you can think of them as speculative trading vehicles on steroids. The low-cost nature, diversification benefits, and ability for traders to speculate on market swings and sector movements have led to an explosion in ETF assets to an estimated $4.6 trillion.
Regardless of the cause for the market drop, long-term investors have experienced these types of crashes in the past. Do you remember the 2010 Flash Crash (down -17%) or the October 1987 Crash (-23% one-day drop in the Dow Jones Industrial Average index)? Technology, or the lack thereof (circuit breakers), helped contribute to these past crashes. Since 1987, the networking and trading technologies have definitely become much more sophisticated, but so have the traders and their strategies.
Another risk I highlighted last month, which remains true today, is the potential for the new Federal Reserve chief, Jerome Powell, to institute a too aggressive monetary policy. During his recent testimony and answers to Congress, Powell dismissed the risks of an imminent recession. He blamed past recessions on previous Fed Chairmen who over enthusiastically increased interest rate targets too quickly. Powell’s comments should provide comfort to nervous investors. Regardless of short-term inflation fears, common sense dictates Powell will not want to crater the economy and his legacy by slamming the economic brakes via excessive rate hikes early during his Fed chief tenure.
Tax Cuts = Profit Gains
Despite the heightened volatility experienced in February, I remain fairly constructive on the equity investment outlook overall. The recently passed tax legislation (Tax Cuts and Job Act of 2017) has had an undeniably positive impact on corporate profits (see chart below of record profit forecasts – blue line). More specifically, approximately 75% of corporations (S&P 500 companies) have reported better-than-expected results for the past quarter ending December 31st. On an aggregate basis, quarterly profits have also risen an impressive +15% compared to last year. When you marry these stellar earnings results with the latest correction in stock prices, historically this combination of factors has proven to be a positive omen for investors.
Source: Dr. Ed’s Blog
Despite the rosy profit projections and recent economic strength, there is always an endless debate regarding the future direction of the economy and interest rates. This economic cycle is no different. When fundamentals are strong, stories of spiking inflation and overly aggressive interest rate hikes by the Fed rule the media airwaves. On the other hand, when fundamentals deteriorate or slow down, fears of a 2008-2009 financial crisis enter the zeitgeist. The same tug-of-war fundamental debate exists today. The stimulative impacts of tax cuts on corporate profits are undeniable, but investors remain anxious that the negative inflationary side-effects from a potential overheating economy could outweigh the positive economic momentum of a near full-employment economy gaining steam.
Rather than playing Goldilocks with your investment portfolio by trying to figure out whether the short-term stock market is too hot or too cold, you would be better served by focusing on your long-term asset allocation, and low-cost, tax-efficient investment strategy. If you don’t believe me, you should listen to the wealthiest, most successful investor of all-time, Warren Buffett (The Oracle of Omaha), who just published his annual shareholder letter. In his widely followed letter, Buffett stated, “Performance comes, performance goes. Fees never falter.” To emphasize his point, Buffett made a 10-year, $1 million bet for charity with a high-fee hedge fund manager (Protégé Partners). As part of the bet, Buffett claimed an investment in a low-fee S&P 500 index fund would outperform a selection of high-fee, hot-shot hedge fund managers. Unsurprisingly, the low-cost index fund trounced the hedge fund managers. From 2008-2017, Buffett’s index fund averaged +8.5% per year vs. +3.0% for the hedge fund managers.
During scary blips like the one experienced recently, lessons can be learned from successful, long-term billionaire investors like Warren Buffett, but lessons can also be learned from my mother. Do yourself a favor by getting your investment portfolio in order, so my mother won’t have to say, “I told you so.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2018). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in 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.
