Posts filed under ‘Interest Rates’
Want to Retire at Age 90?
Do you love working 40-50+ hour weeks? Do you want to be a Wal-Mart (WMT) greeter after you get laid off from your longstanding corporate job? Do you love relying on underfunded government entitlements that you hope won’t be insolvent 10, 20, or 30 years from now? Are you banking on winning the lottery to fund your retirement? Do you enjoy eating cat food?
If you answered “Yes” to one or all of these questions, then do I have a sure-fire investment program for you that will make your dreams of retiring at age 90 a reality! Just follow these three simple rules:
- Buy Low Yielding, Long-Term Bonds: There are approximately $7 trillion in negative yielding government bonds outstanding (see chart below), which as you may understand means investors are paying to give someone else money – insanity. Bank of America recently completed a study showing about two-thirds of the $26 trillion government bond market was yielding less than 1%. Not only are investors opening themselves up to interest rate risk and credit risk, if they sell before maturity, but they are also susceptible to the evil forces of inflation, which will destroy the paltry yield. If you don’t like this strategy of investing near 0% securities, getting a match and gasoline to burn your money has about the same effect.
Source: Financial Times
- Speculate on the Timing of Future Fed Rate Hikes/Cuts: When the economy is improving, talking heads and so-called pundits try to guess the precise timing of the next rate hike. When the economy is deteriorating, aimless speculation swirls around the timing of interest rate cuts. Unfortunately, the smartest economists, strategists, and media mavens have no consistent predicting abilities. For example, in 1998 Nobel Prize winning economists Robert Merton and Myron Scholes toppled Long Term Capital Management. Similarly, in 1996 Federal Reserve Chairman Alan Greenspan noted the presence of “irrational exuberance” in the stock market when the NASDAQ was trading at 1,350. The tech bubble eventually burst, but not before the NASDAQ tripled to over 5,000. More recently, during 2005-2007, Fed Chairman Ben Bernanke whiffed on the housing bubble – he repeatedly denied the existence of a housing problem until it was too late. These examples, and many others show that if the smartest financial minds in the room (or planet) miserably fail at predicting the direction of financial markets, then you too should not attempt this speculative feat.
- Trade on Rumors, Headlines & Opinions: Wall Street analysts, proprietary software with squiggly lines, and your hot shot day-trader neighbor (see Thank You Volatility) all promise the Holy Grail of outsized financial returns, but regrettably there is no easy path to consistent, long-term outperformance. The recipe for success requires patience, discipline, and the emotional wherewithal to filter out the endless streams of financial noise. Continually chasing or reacting to opinions, headlines, or guaranteed software trading programs will only earn you taxes, transaction costs, bid-ask spread costs, impact costs, high frequency trading manipulation and underperformance.
Saving for your future is no easy task, but there are plenty of easy ways to destroy your savings. If you want to retire at age 90, just follow my three simple rules.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in WMT or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Financial Markets Recharge with a Nap…Zzzzzz
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 4, 2016). Subscribe on the right side of the page for the complete text.
Did you enjoy your New Year’s festivities? If you were like me and ate excessively and drank too much egg nog, you may have decided along the line to take a nap. It’s not a bad idea to recharge those batteries before implementing those New Year’s resolutions and jumping on the treadmill. That’s exactly what happened in the financial markets this year. After six consecutive years of positive returns in the Dow Jones Industrial Average (2009 – 2014), stock markets took a snooze in 2015, as measured by the S&P 500 and Dow, which were each down -0.7% and -2.2%, respectively. And bonds didn’t fare any better, evidenced by the -1.9% decline in the Aggregate Bond ETF (AGG), over the same time period. Given the deep-seated fears about the Federal Reserve potentially catapulting interest rates higher in 2015, investors effectively took a big yawn by barely nudging the 10-year Treasury Note yield higher by +0.1% from 2.2% to 2.3%.
Even though 2015 ended up being a quiet year overall, there were plenty of sweet dreams mixed in with scary nightmares during the year-long nap:
INVESTMENT SWEET DREAMS
Diamonds in the Rough: While 2015 stock prices were generally flat to down around the globe (Vanguard Total Word -4.2%), there was some sunshine and rainbows gleaming for a number of segments in the market. For example, handsome gains were achieved in the NASDAQ index (+5.7%); Biotech Index – BTK (+10.9%); Consumer Discretionary ETF – XLY (+8.3%); Health Care ETF – VHT (+5.8%); Information Technology ETF – VGT (+4.6%); along with numerous other investment areas.
Fuel Fantasy Driven by Low Gas Prices: Gas prices averaged $2.01 per gallon nationally in December (see chart below), marking the lowest prices seen since 2009. Each penny in lower gas prices roughly equates to $1 billion in savings, which has strengthened consumers’ balance sheets and contributed to the multi-year economic expansion. Although these savings have partially gone to pay down personal debt, these gas reserves have also provided a financial tailwind for record auto sales (estimated 17.5million in 2015) and a slow but steady recovery in the housing market. The outlook for “lower-for-longer” oil prices is further supported by an expanding oil glut from new, upcoming Iranian supplies. Due to the lifting of economic sanctions related to the global nuclear deal, Iran is expected to deliver crude oil to an already over-supplied world energy market during the first quarter of 2016. Additionally, the removal of the 40-year ban on U.S. oil exports -could provide a near-term ceiling on energy prices as well.
Counting Cash Cows
Catching some shut-eye after reading frightening 2015 headlines on the China slowdown, $96 billion Greek bailout/elections, and Paris/San Bernardino terrorist attacks forced some nervous investors to count sheep to fall asleep. However, long-term investors understand that underpinning this long-lived bull market are record revenues, profits, and cash flows. The record $4.7 trillion dollars in 2015 estimated mergers along with approximately $1 trillion in dividends and share buybacks (see chart below) is strong confirmation that investors should be concentrating on counting more cash cows than sheep, if they want to sleep comfortably.
INVESTMENT NIGHTMARES
Creepy Commodities: Putting aside the -30% collapse in WTI crude oil prices last year, commodity investors overall were exhausted in 2015. The -24% decline in the CRB Commodity Index and the -11% weakening in the Gold Index (GLD) was further proof that a strong U.S. dollar, coupled with stagnant global growth, caused investors a lot of tossing and turning. While bad for commodity exporting countries, the collapse in commodity prices will ultimately keep a lid on inflation and eventually become stimulative for those consumers suffering from lower standards of living.
Dollar Dread: The +25% spike in the value of the U.S. dollar over the last 18 months has made life tough for multinational companies. If your business received approximately 35-40% of their profits overseas and suddenly your goods cost 25% more than international competitors, you might grind your teeth in your sleep too. Monetary policies around the globe, including the European Union, will have an impact on the direction of future foreign exchange rates, but after a spike in the value of the dollar in early 2015, there are signs this scary move may now be stabilizing. Although multinationals are getting squeezed, now is the time for consumers to load up on cheap imports and take that bargain foreign vacation they have long been waiting for.
January has been a challenging month the last couple years, and inevitably there will be additional unknown turbulence ahead – the opening day of 2016 not being an exception (i.e., China slowdown concerns and Mideast tensions). However, given near record-low interest rates, record corporate profits, and accommodative central bank policies, the 2015 nap taken by global stock markets should supply the necessary energy to provide a lift to financial markets in the year ahead.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions VHT, AGG, and in certain exchange traded funds (ETFs), but at the time of publishing had no direct position VT, BTK, XLY, VGT, GLD, or in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Sweating in the Doctor’s Waiting Room
My palms are clammy, heart-rate is elevated, and sweat has begun to drip down my brow. There I sit with my hands clenched in the doctor’s office waiting room. I’m trying to mentally prepare for the inevitable poking, prodding, and personal invasion, which will likely involve numerous compromising cavity searches from head to toe. The fun usually doesn’t end until a finale of needle piercing vaccinations and blood tests are completed.
Every year I go through the same mental fatigue war, battling every fear, uncertainty, and doubt. Will the doctor find a new ailment? How many shots will I have to get? Am I going to die?! Ultimately it never turns out as badly as I expect and I come out each and every doctor’s appointment saying, “Well, that wasn’t as bad as I thought it was going to be.”
Investors have been nervously sitting in the waiting room of the Federal Reserve for the last nine years (2006), which marks the last time the Fed increased the interest rate target for the Federal Funds rate. In arguably the slowest economic recovery since World War II, pundits, commentators, bloggers, strategists, and economists have been speculating about the timing of the Fed’s first rate hike of this economic cycle. Like anxious patients, investors have fretted about the reversal of our country’s unprecedented zero interest rate monetary policy (ZIRP).
Despite dealing with the most communicative Federal Reserve in a few generations signaling its every thought and concern, uncertainty somehow continues to creep into investors’ psyches and reign supreme. We witnessed this same volatility occur between 2012-2014 when Ben Bernanke and the Fed decided to phase out the $4.5 trillion quantitative easing (QE) bond buying program. At the time, many people felt the financial markets were being artificially propped up by the money printing feds, and once QE ended, expectations were for exploding interest rates and the stock market/economy to fall like a house of cards. As we all know, that prediction turned out to be the furthest from the truth. In fact, quite the opposite occurred. Investors took their medicine (halting of QE) and the market proceeded to move upwards by about +40% from the initial “taper tantrum” (talks of QE ending in spring of 2012) until the actual QE completion in October 2014.
The thought of rate hike cycles are never fun, but after swallowing the initial rate hike pill, investors will feel just fine after coming to terms with the gentle trajectory of future interest rate increases. The behavioral model of 1) investor fear, then 2) subsequent relief has been a recurring process throughout economic history. As you can see below, the bark of Federal Reserve interest rate target hikes has been much worse than the bite. Initially there is a modest negative reaction (approximately -7% decline in stock prices) and then a significant positive reaction (about +21%).
With an ultra-dove Fed Chief in charge, this rate hike cycle should look much different than prior periods. Chairwoman Yellen has clearly stated, “Even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative.” Her colleague, New York Fed Chair William Dudley, has supported this idea by noting the path of rate hikes will be “shallow.”
Even if you are convinced rate hikes will cause an immediate recession, history is not on your side as shown in the study below. On average, since 1955, the time to a next recession after a Fed Rate hike takes an average of 41 months (ranging from 11 months to as long as 86 months).
As a middle aged man, one would think I would get used to my annual doctor’s check-up, but somehow fear manages to find a way of asserting itself. Investors’ have been experiencing the same anxiety as anticipation builds before the first interest rate hike announcement – likely this week. Markets may continue their jitteriness in front of the Fed’s announcement, but based on history, a ¼ point hike is more likely to be a prescription of economic confidence than economic doom. Everyone should feel much better leaving the waiting room after Janet Yellen finally begins normalizing an unsustainably loose monetary policy.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Bargain Hunting for Doorbuster Discounts
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2015). Subscribe on the right side of the page for the complete text.
It’s that time of year again when an estimated 135 million bargain shoppers set aside personal dignity and topple innocent children in the name of Black Friday holiday weekend, doorbuster discounts. Whether you are buying a new big screen television at Amazon for half-off or a new low-cost index fund, everyone appreciates a good value or bargain, which amplifies the importance of the price you pay. Even though consumers are estimated to have spent $83 billion over the post-turkey-coma, holiday weekend, this spending splurge only represents a fraction of the total 2015 holiday shopping season frenzy. When all is said and done, the average person is projected to dole out $805 for the full holiday shopping season (see chart below) – just slightly higher than the $802 spent over the same period last year.
While consumers have displayed guarded optimism in their spending plans, Americans have demonstrated the same cautiousness in their investing behavior, as evidenced by the muted 2015 stock market gains. More specifically, for the month of November, stock prices increased by +0.32% for the Dow Jones Industrial Average (17,720) and +0.05% for the S&P 500 index (2,080). For the first 11 months of the year, the stock market results do not look much different. The Dow has barely slipped by -0.58% and the S&P 500 has inched up by +1.01%.
Given all the negative headlines and geopolitical concerns swirling around, how have stock prices managed to stay afloat? In the face of significant uncertainty, here are some of the calming factors that have supported the U.S. financial markets:
- Jobs Piling Up: The slowly-but-surely expanding economy has created about 13 million new jobs since late 2009 and the unemployment rate has been chopped in half (from a peak of 10% to 5%).
Source: Calafia Beach Pundit
- Housing Recovery: New and existing home sales are recovering and home prices are approaching previous record levels, as the Case-Shiller price indices indicate below.
Source: Calculated Risk Blog
- Strong Consumer: Cars are flying off the shelves at a record annualized pace of 18 million units – a level not seen since 2000. Lower oil and gasoline prices have freed up cash for consumers to pay down debt and load up on durable goods, like some fresh new wheels.
Source: Calculated Risk Blog
Despite a number of positive factors supporting stock prices near all-time record highs and providing plenty of attractive opportunities, there are plenty of risks to consider. If you watch the alarming nightly news stories on TV or read the scary newspaper headlines, you’re more likely to think it’s Halloween season rather than Christmas season.
At the center of the recent angst are the recent coordinated terrorist attacks that took place in Paris, killing some 130 people. With ISIS (Islamic State of Iraq and Syria) claiming responsibility for the horrific acts, political and military resources have been concentrated on the ISIS occupied territories of Syria and Iraq. Although I do not want to diminish the effects of the appalling and destructive attacks in Paris, the events should be placed in proper context. This is not the first or last large terrorist attack – terrorism is here to stay. As I show in the chart below, there have been more than 200 terrorist attacks that have killed more than 10 people since the 9/11 attacks. Much of the Western military power has turned a blind eye towards these post-9/11 attacks because many of them have taken place off of U.S. or Western country soil. With the recent downing of the Russian airliner (killing all 224 passengers), coupled with the Paris terror attacks, ISIS has gained the full military attention of the French, Americans, and Russians. As a result, political willpower is gaining momentum to heighten military involvement.
Source: Wikipedia
Investor anxiety isn’t solely focused outside our borders. The never ending saga of when the Federal Reserve will initiate its first Federal Funds interest rate target increase could finally be coming to an end. According to the CME futures market, there currently is a 78% probability of a 0.25% interest rate increase on December 16th. As I have said many times before, interest rates are currently near generational lows, and the widely communicated position of Federal Reserve Chairwoman Yellen (i.e., shallow slope of future interest rate hike trajectory) means much of the initial rate increase pain has likely been anticipated already by market participants. After all, a shift in your credit card interest rate from 19.00% to 19.25% or an adjustment to your mortgage rate from 3.90% to 4.15% is unlikely to have a major effect on consumer spending. In fact, the initial rate hike may be considered a vote of confidence by Yellen to the sustainability of the current economic expansion.
Shopping Without My Rose Colored Glasses
Regardless of the state of the economic environment, proper investing should be instituted through an unemotional decision-making process, just as going shopping should be an unemotional endeavor. Price and value should be the key criteria used when buying a specific investment or holiday gift. Unfortunately for many, emotions such as greed, fear, impatience, and instant gratification overwhelm objective measurements such as price and value.
As I have noted on many occasions, over the long-run, money unemotionally moves to where it is treated best. From a long-term perspective, that has meant more capital has migrated to democratic and capitalistic countries with a strong rule of law. Closed, autocratic societies operating under corrupt regimes have been the big economic losers.
With all of that set aside, the last six years have created tremendous investment opportunities due to the extreme investor risk aversion created by the financial crisis – hence the more than tripling in U.S. stock prices since March 2009.
When comparing the yield (i.e., profit earned on an investment) between stocks and bonds, as shown in the chart below, you can see that stock investors are being treated significantly better than bond investors (6.1% vs. 4.0%). Not only are bond investors receiving a lower yield than stock investors, but bond investors also have no hope of achieving higher payouts in the future. Stocks, on the other hand, earn the opportunity of a double positive whammy. Not only are stocks currently receiving a higher yield, but stockholders could achieve a significantly higher yield in the future. For example, if S&P 500 earnings can grow at their historic rate of about 7%, then the current stock earnings yield of 6.1% would about double to 12.0% over the next decade at current prices. The inflated price and relative attractiveness of stocks looks that much better if you compare the 6.1% earnings yield to the paltry 2.2% 10-Year Treasury yield.
Source: Yardeni.com
This analysis doesn’t mean everyone should pile 100% of their portfolios into stocks, but it does show how expensively nervous investors are valuing bonds. Time horizon, risk tolerance, and diversification should always be pillars to a disciplined, systematic investment strategy, but as long as these disparities remain between the earnings yields on stocks and bonds, long-term investors should be able to shop for plenty of doorbuster discount bargain opportunities.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AMZN and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
More Treats, Less Tricks
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 2, 2015). Subscribe on the right side of the page for the complete text.
Have you finished licking the last of your Halloween chocolate-covered fingers and scheduled your next cavity-filled dental appointment? After a few challenging months, the normally spooky month of October produced an abundance of sweet treats rather than scary tricks for stock market investors. In fact, the S&P 500 index finished the month with a whopping +8.3% burst, making October the tastiest performing month since late 2010. This came in stark contrast to the indigestion experienced with the -8.7% decline over the previous two months.
What’s behind all these sweet gains? For starters, fears of a Chinese economic sugar-high ending in a crash have abated for now. With that said, “Little Red Riding Hood” is not out of the woods quite yet. Like a surprising goblin or ghost popping out to scare you at a Halloween haunted house, China could still rear its ugly head in the future due to its prominent stature as the second largest global economy. We have been forced to deal with similar on-again-off-again concerns associated with Greece.
The good news is the Chinese government and central bank are not sitting on their hands. In addition to interest rate cuts and corruption crackdowns, Chinese government officials have even recently halted its decades-long one-child policy. China’s new two-child policy is designed to spur flagging economic growth and also reverse the country’s aging demographic profile.
Also contributing to the stock market’s sugary October advances is an increasing comfort level with the Federal Reserve’s eventual interest rate increase. Just last week, the central bank released the statement from its October Federal Open Market Committee meetings stating it will determine whether it will be “appropriate” to increase interest rates at its next meetings, which take place on December 15th and 16th. Interest rate financial markets are now baking in a roughly 50% probability of a Fed interest rate hike next month. Initially, the October Fed statement was perceived negatively by investors due to fears that higher rates could potentially choke off economic growth. Within a 30 minute period after the announcement, stock prices reversed course and surged higher. Investors interpreted the Fed signal of a possible interest rate hike as an upbeat display of confidence in a strengthening economy.
As I have reiterated on numerous occasions (see also Fed Fatigue), a +0.25% increase in the Federal Funds rate from essentially a level of 0% is almost irrelevant in my eyes – just like adjusting the Jacuzzi temperature from 102 degrees down to 101 degrees is hardly noticeable. More practically speaking, an increase from 14.00% to 14.25% on a credit card interest rate will not deter consumers from spending, just like a 3.90% mortgage rising to 4.15% will not break the bank for homebuyers. On the other hand, if interest rates were to spike materially higher by 3.00% – 4.00% over a very short period of time, this move would have a much more disruptive impact, and would be cause for concern. Fortunately for equity investors, this scenario is rather unlikely in the short-run due to virtually no sign of inflation at either the consumer or worker level. Actually, if you read the Fed’s most recent statement, Fed Chairwoman Janet Yellen indicated the central bank intends to maintain interest rates below “normal” levels for “some time” even if the economy keeps chugging along at a healthy clip.
If you think my interest rate perspective is the equivalent of me whistling past the graveyard, history proves to be a pretty good guide of what normally happens after the Fed increases interest rates. Bolstering my argument is data observed over the last seven Federal Reserve interest rate hike cycles from 1983 – 2006 (see table below). As the statistics show, stock prices increased an impressive +20.9% on average over Fed interest rate “Tightening Cycles.” It is entirely conceivable that the announcement of a December interest rate hike could increase short-term volatility. We saw this rate hike fear phenomenon a few months ago, and also a few years ago in 2013 (see also Will Rising Rates Murder Market?) when Federal Reserve Chairman Ben Bernanke threatened an end to quantitative easing (a.k.a., “Taper Tantrum”), but eventually people figured out the world was not going to end and stock prices ultimately moved higher.
Besides increased comfort with Fed interest rate policies, another positive contributing factor to the financial market rebound was the latest Congressional approval of a two-year budget deal that prevents the government from defaulting on its debt. Not only does the deal suspend the $18.1 trillion debt limit through March 2017 (see chart below), but the legislation also lowers the chance of a government shutdown in December. Rather than creating a contentious battle for the fresh, incoming Speaker of the House (Paul Ryan), the approved budget deal will allow the new Speaker to start with a clean slate with which he can use to negotiate across a spectrum of political issues.
Source: Wall Street Journal
Remain Calm – Not Frightened
Humans, including all investors, are emotional beings, but the best investors separate fear from greed and are masters at making unemotional, objective decisions. Just as everything wasn’t a scary disaster when stocks declined during August and September, so too, the subsequent rise in October doesn’t mean everything is a bed of roses.
Every three months, thousands of companies share their financial report cards with investors, and so far with more than 65% of the S&P 500 companies reporting their results this period, corporate America is not making the honor roll. Collapsing commodity prices, including oil, along with the rapid appreciation in the value of the U.S. dollar (i.e., causing declines in relatively expensive U.S. exports), third quarter profit growth has declined -1%. If you exclude the energy sector from the equation, corporations are still not making the “Dean’s List,” however the report cards look a lot more respectable through this lens with profits rising +6% during the third quarter. A sluggish third quarter GDP (Gross Domestic Product) growth report of +1.5% is further evidence the economy has plenty of room to improve the country’s financial GPA.
Historically speaking, October has been a scary period, if you consider the 1929 and 1987 stock market crashes occurred during this Halloween month. Now that investors have survived this frightening period, we will see if the “Santa Claus Rally” will arrive early this season. Stock market treats have been sweet in recent weeks, but investors cannot lose sight of the long-term. With interest rates near generational lows, investors need to make sure they are efficiently investing their investment funds in a low-cost, tax-efficient, diversified manner, subject to personal time horizons and risk tolerances. Over the long-run, meeting these objectives will create a lot more treats than tricks.
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.
Oxymoron: Shrewd Government Refis Credit Card
With the upcoming Federal Reserve policy meetings coming up this Wednesday and Thursday, investors’ eyes remain keenly focused on the actions and words of Federal Reserve Chairwoman Janet Yellen.
If you have painstakingly filled out an IRS tax return or frustratingly waited in long lines at the DMV or post office, you may not be a huge fan of government services. Investors and liquidity addicted borrowers are also irritated with the idea of the Federal Reserve pulling away the interest rate punch bowl too soon. We will find out early enough whether Yellen will hike the Fed Funds interest rate target to 0.25%, or alternatively, delay a rate increase when there are clearer signs of inflation risks.
Regardless of the Fed decision this week, with interest rates still hovering near generational lows, it is refreshing to see some facets of government making shrewd financial market decisions – for example in the area of debt maturity management. Rather than squeezing out diminishing benefits by borrowing at the shorter end of the yield curve, the U.S. Treasury has been taking advantage of these shockingly low rates by locking in longer debt maturities. As you can see from the chart below, the Treasury has increased the average maturity of its debt by more than 20% from 2010 to 2015. And they’re not done yet. The Treasury’s current plan based on the existing bond issuance trajectory will extend the average bond maturity from 70 months in 2015 to 80 months by the year 2022.
If you were racking up large sums of credit card debt at an 18% interest rate with payments due one month from now, wouldn’t you be relieved if you were given the offer to pay back that same debt a year from now at a more palatable 2% rate? Effectively, that is exactly what the government is opportunistically taking advantage of by extending the maturity of its borrowings.
Most bears fail to acknowledge this positive trend. The typical economic bear argument goes as follows, “Once the Fed pushes interest rates higher, interest payments on government debt will balloon, and government deficits will explode.” That argument definitely holds up some validity as newly issued debt will require higher coupon payments to investors. But at a minimum, the Treasury is mitigating the blow of the sizable government debt currently outstanding by extending the average Treasury maturity (i.e., locking in low interest rates).
It is worth noting that while extending the average maturity of debt by the Treasury is great news for U.S. tax payers (i.e., smaller budget deficits because of lower interest payments), maturity extension is not so great news for bond investors worried about potentially rising interest rates. Effectively, by the Treasury extending bond maturities on the debt owed, the government is creating a larger proportion of “high octane” bonds. By referring to “high octane” bonds, I am highlighting the “duration” dynamic of bonds. All else equal, a lengthening of bond maturities, will increase a bond’s duration. Stated differently, long duration, “high octane” bonds will collapse in price if in interest rates spike higher. The government will be somewhat insulated to that scenario, but not the bond investors buying these longer maturity bonds issued by the Treasury.
All in all, you may not have the greatest opinion about the effectiveness of the IRS, DMV, and/or post office, but regardless of your government views, you should be heartened by the U.S. Treasury’s shrewd and prudent extension of the average debt maturity. Now, all you need to do is extend the maturity and lower the interest rate on your personal credit card debt.
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.
Digesting Stock Gains
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (June 1, 2015). Subscribe on the right side of the page for the complete text.
Despite calls for “Sell in May, and go away,” the stock market as measured by both the Dow Jones Industrial and S&P 500 indexes grinded out a +1% gain during the month of May. For the year, the picture looks much the same…the Dow is up around +1% and the S&P 500 +2%. After gorging on gains of +30% in 2013 and +11% in 2014, it comes as no surprise to me that the S&P 500 is taking time to digest the gains. After eating any large pleasurable meal, there’s always a chance for some indigestion – just like last month. More specifically, the month of May ended as it did the previous six months…with a loss on the last trading day (-115 points). Providing some extra heartburn over the last 30 days were four separate 100+ point decline days. Realized fears of a Greek exit from the eurozone would no doubt have short-term traders reaching for some Tums antacid. Nevertheless, veteran investors understand this is par for the course, especially considering the outsized profits devoured in recent years.
The profits have been sweet, but not everyone has been at the table gobbling up the gains. And with success, always comes the skeptics, many of whom have been calling for a decline for years. This begs the question, “Are we in a stock bubble?” I think not.
Bubble Bites
Most asset bubbles are characterized by extreme investor/speculator euphoria. There are certainly small pockets of excitement percolating up in the stock market, but nothing like we experienced in the most recent burstings of the 2000 technology and 2006-07 housing bubbles. Yes, housing has steadily improved post the housing crash, but does this look like a housing bubble? (see New Home Sales chart)
Source: Dr. Ed’s Blog
Another characteristic of a typical asset bubble is rabid buying. However, when it comes to the investor fund flows into the U.S. stock market, we are seeing the exact opposite…money is getting sucked out of stocks like a Hoover vacuum cleaner. Over the last eight or so years, there has been almost -$700 billion that has hemorrhaged out of domestic equity funds – actions tend to speak louder than words (see chart below):
Source: Investment Company Institute (ICI)
The shift to Exchange Traded Funds (ETFs) offered by the likes of iShares and Vanguard doesn’t explain the exodus of cash because ETFs such as S&P 500 SPDR ETF (SPY) are suffering dramatically too. SPY has drained about -$17 billion alone over the last year and a half.
With money flooding out of these stock funds, how can stock prices move higher? Well, one short answer is that hundreds of billions of dollars in share buybacks and trillions in mergers and acquisitions activity (M&A) is contributing to the tide lifting all stock boats. Low interest rates and stimulative monetary policies by central banks around the globe are no doubt contributing to this positive trend. While the U.S. Federal Reserve has already begun reversing its loose monetary policies and has threatened to increase short-term interest rates, by any objective standard, interest rates should remain at very supportive levels relative to historical benchmarks.
Besides housing and fund flows data, there are other unbiased sentiment indicators that indicate investors have not become universally Pollyannaish. Take for example the weekly AAII Sentiment Survey, which shows 73% of investors are currently Bearish and/or Neutral – significantly higher than historical averages.
The Consumer Confidence dataset also shows that not everyone is wearing rose-colored glasses. Looking back over the last five decades, you can see the current readings are hovering around the historical averages – nowhere near the bubblicious 2000 peak (~50% below).
Source: Bespoke
Recession Reservations
Even if you’re convinced there is no imminent stock market bubble bursting, many of the same skeptics (and others) feel we’re on the verge of a recession – I’ve been writing about many of them since 2009. You could choke on an endless number of economic indicators, but on the common sense side of the economic equation, typically rising unemployment is a good barometer for any potentially looming recession. Here’s the unemployment rate we’re looking at now (with shaded periods indicating prior recessions):
As you can see, the recent 5.4% unemployment rate is still moving on a downward, positive trajectory. By most peoples’ estimation, because this has been the slowest recovery since World War II, there is still plenty of labor slack in the market to keep hiring going.
An even better leading indicator for future recessions has been the slope of the yield curve. A yield curve plots interest rate yields of similar bonds across a range of periods (e.g., three-month bill, six-month bill, one-year bill, two-year note, five-year note, 10-year note and 30-year bond). Traditionally, as short-term interest rates move higher, this phenomenon tends to flatten the yield curve, and eventually inverts the yield curve (i.e., short-term interest rates are higher than long-term interest rates). Over the last few decades, when the yield curve became inverted, it was an excellent leading indicator of a pending recession (click here and select “Animate” to see amazing interactive yield curve graph). Fortunately for the bulls, there is no sign of an inverted yield curve – 30-year rates remain significantly higher than short-term rates (see chart below).
Stock market skeptics continue to rationalize the record high stock prices by pointing to the artificially induced Federal Reserve money printing buying binge. It is true that the buffet of gains is not sustainable at the same pace as has been experienced over the last six years. As we continue to move closer to full employment in this economic cycle, the rapid accumulated wealth will need to be digested at a more responsible rate. An unexpected Greek exit from the EU or spike in interest rates could cause a short-term stomach ache, but until many of the previously mentioned indicators reach dangerous levels, please pass the gravy.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in SPY and other 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.
Fink & Capitalism: Need 4 Kitchens in Your House?
Do you need four kitchens in your house? Apparently financial industry titan Larry Fink does. If Mr. Fink were a designer for millionaire homeowners, he would advise them to use their millions to build more kitchens in their house (reinvest) rather than distribute those monies to family members (dividends) or use that money to pay back an equity loan from mom and dad for the down payment (share buybacks). Essentially that is exactly what is happening in the stock market. Companies that are generating record profits and margins (millionaires) are increasingly choosing to pay out larger percentages of profits to stockholders (family members) in the form of rising dividends and share buybacks. Contrary to Mr. Fink’s belief, corporate America is actually doing plenty with room additions, landscaping, and roof replacements – I will describe more later.
As a consequence of corporate America’s increasingly shareholder friendly practices of returning cash, Fink believes this trend will stifle innovation and long-term growth in American companies. Here’s a snapshot of the supposed dividend/buyback problem Mr. Fink describes:
Source: Financial Times
Fink Mails Letter from Soapbox
For those of you who do not know who Larry Fink is, he is the successful Chairman and CEO of BlackRock Inc. (BLK), an investment manager which oversees about $4.65 trillion in investment assets. Mr. Fink ignited this recent financial controversy when he jumped on his soapbox by mailing letters to 500 CEOs lecturing them on the importance of long-term investing. What is Mr. Fink’s beef? Fink’s issues revolve around his belief that CEOs and corporations are too short-term oriented.
In his letter, Mr. Fink had this to say:
“This pressure [to meet short-term financial goals] originates from a number of sources—the proliferation of activist shareholders seeking immediate returns, the ever-increasing velocity of capital, a media landscape defined by the 24/7 news cycle and a shrinking attention span, and public policy that fails to encourage truly long-term investment.”
He goes on to bolster his argument with the following:
“More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
What Mr. Fink does not say in his letter is that large, multinational S&P 500 corporations driving this six-year bull run are sitting on a record hoard of cash, exceeding $1.4 trillion (see chart below). In this light, it should come as no surprise that CEOs are forking over more cash to investors in the forms of dividends and share repurchases.
What’s more, despite Fink’s assertion that share buybacks and dividends are killing innovation, he also fails to mention in his letter that 2014 capital expenditures of $730 billion are also at a record level. That’s right, CAPEX has not been cut to the bone as he implies, but rather risen to all-time highs.
It’s true that generationally low (and declining) interest rates have accelerated the pace of dividends/repurchases, however dividend payout ratios (the percentage of profits distributed to shareholders) of about 32% remain firmly below the long-term payout ratio of approximately 54% (see chart below) – see also Dividend Floodgates Widen. I find it difficult to fault many companies doing something with the gargantuan piles of inflation-losing cash anchoring their balance sheets. Don’t cash-rich companies have a fiduciary duty to borrow reasonable amounts of near-0% debt today (see Bunny Rabbit Market) in exchange for share buybacks currently providing returns of about 5.5% (inverse of 18x P/E ratio) and likely yielding 7%+ returns five years from now?
Source: Financial Times
The “Short-Term” Poster Child – Apple
There is no arguing that excessive debt eventually can catch up to a company. Our multi-year expanding economy is eventually due for another recession in the coming years, and there will be hell to pay for irresponsible, overleveraged companies. With that said, let’s take a look at the poster child of “short-termism” according to Mr. Fink …Apple Inc. (AAPL).
Of the roughly $500 billion in buybacks spent by S&P 500 companies in 2014, Apple accounted for approximately $45 billion of that figure. On top of that, CEO Tim Cook and his board generously decided to return another $11 billion to shareholders in the form of dividends. Has this “short-term” return of capital stifled innovation from the company that has launched iPhone version 6, iPad, Apple Watch, Apple Pay, and is investing into exciting areas like Apple Television, Apple Car, and who knows what else?
To put these Apple numbers into perspective, consider that last year Apple spent over $6 billion on research and development (R&D); $10 billion on capital expenditures; and hired over 12,000 new full-time employees. This doesn’t exactly sound like the death of innovation to me. Even after doling out roughly -$28 billion in expenditures and -$56 billion in dividends/share repurchases, Apple was amazingly able to keep their net cash position flat at an eye-popping +$141 billion!
Mr. Fink abhors “activist shareholders seeking immediate returns” but rather than deriding them perhaps he should send the greedy, capitalist Carl Icahn a personal thank you letter. Since Icahn’s vocal plea for a large Apple share buyback, the shares have skyrocketed about +85%, catapulting BlackRock’s ownership value in Apple to over $19 billion.
With respect to these increasing outlays, Mr. Fink also notes:
“Returning excessive amounts of capital to investors—who will enjoy comparatively meager benefits from it in this environment—sends a discouraging message.”
This would be true if investors took the dividends and stuffed them under their mattress, but an important message Mr. Fink neglects to address as it relates to dividends and share buybacks is demographics. There are 76 million Baby Boomers born between 1946 – 1964 and a Boomer is turning age 65 every 8 seconds. With many bonds trading at near 0% yields (even negative yields) it is no wonder many income starving retirees are demanding many of these cash-rich corporations to share more of the growing spoils via rising dividends.
Capitalism Works
After looking at a few centuries of our country’s history, one of the main lessons we can learn is that capitalism works – especially over the long-run. With about 200 countries across the globe, there is a reason the U.S. is #1…we’re good at capitalism. As our economy has matured over the decades, it is true our priorities and challenges have changed. It is also true that other countries may be narrowing the gap with the U.S., due to certain advantages (e.g., demographics, lower entitlements, easier regulations, etc), but the U.S. will continue to evolve.
In many respects, capitalism is very much like Darwinism – corporations either adapt with the competition…or they die. I repeatedly hear from pessimists that the U.S. is in a secular state of decline, but if that’s the case, how come the U.S. continues to dominate and innovate in major industries like biotechnology, mobile technology, networking, internet, aviation, energy, media, and transportation? Quite simply, we are the best and most experienced practitioners of capitalism.
Certainly, capitalism will continue to cultivate cyclical periods of excess investment/leverage and insufficient regulation. But guess what? Investors, including the public, eventually lose their shirts and behaviors/regulations adjust. At least for a little while, until the next period of excess takes hold. If Apple, and other balance sheet healthy companies allocate capital irresponsibly, capital will flow towards more aggressive and innovative companies. BlackBerry Limited (BBRY) knows a little bit about the consequences of cutthroat competition and suboptimal capital allocation.
While I emphatically share Mr. Fink’s focus on long-term investing values (including his self-serving tax reform ideas), I vigorously disagree with his attacks on shareholder friendly actions and his characterization of rising dividends/buybacks as short-term in nature. In fact, increasing dividends and share buybacks can very much coexist as a long-term investment and capital allocation strategy.
The question of proper capital allocation should have more to do with the age of a company. It only makes sense that younger companies on average should reinvest more of their profits into growth and innovation. On the other hand, more mature S&P 500-like companies will be in a better position to distribute higher percentages of profits to shareholders – especially as cash levels continue to rise to record levels and leverage remains in check.
BlackRock’s Larry Fink may continue to urge CEOs to reinvest their growing cash hoards into superfluous corporate kitchens, but Sidoxia and other prudent capitalist investors will continue to exhort CEOs to opportunistically take advantage of near-free borrowing rates and responsibly share the accretive gains with shareholders. That’s a message Mr. Fink should include in a letter to CEOs – he can use BlackRock’s lofty, above-average dividend to cover the cost of postage.
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 AAPL and iShares ETFs, but at the time of publishing, SCM had no direct position in BLK, BBRY 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.
“Patient” Prick Proves More Pleasure than Pain
I will be the first one to admit I hate needles. In fact, I’ve been known to skip my annual flu shots out of cowardice simply to avoid the harmless prick of the syringe. The mere thought of a long needle jabbing into my arm, or other fleshy part of my body, has had the chilling effect of generating irrational decisions (i.e., I forgo flu shot benefits for no logical reason).
For months the talking heads and so-called pundits have speculated and fretted over the potential removal of the term “patient” from the periodically issued Federal Open Market Committee (FOMC) statement. Since the end of 2014, the statement read that the Fed “can be patient in beginning to normalize” monetary policy.
For investors, the linguistic fear of the removal of “patient” is as groundless as my needle fears. In the financial markets, the consensus view is often wrong. The stronger the euphoric consensus, the higher the probability the consensus will soon be wrong. You can think of technology in the late 1990s, real estate in the mid-2000s; or gold trading at $1,800/oz in 2011. The reverse holds true for the pessimistic consensus. Value guru, extraordinaire, Bill Miller stated it well,
“Stocks do not get undervalued unless somebody is worried about something. The question is not whether there are problems. There are always problems. The question is whether those problems are already fully discounted or not.”
Which brings us back to the Fed’s removal of the word “patient”. Upon release of the statement, the Dow Jones Industrial index skyrocketed about 400 points in 30 minutes. Considering the overwhelming consensus was for the Fed to remove the word “patient”, and given the following favorable factors, should anyone really be surprised that the market is trading near record highs?
FAVORABLE FACTORS:
- Queen Dove Yellen as Fed Chairwoman
- Declining interest rates near generational low
- Stimulative, low oil prices that are declining
- Corporate profits at/near record highs
- Unemployment figures approaching cyclical lows
- Core inflation in check below 2% threshold
While the short-term relief rally may feel good for the bulls, there are still some flies in the ointment, including a strong U.S. dollar hurting trade, an inconsistent housing recovery, and a slowing Chinese economy, among other factors.
Outside the scandalous “patient” semantics was the heated debate over the Fed’s “Dot Plot,” which is just a 3rd grader’s version of showing the Fed members’ Federal Funds rate forecasts. While to a layman the chart below may look like an elementary school dot-to-dot worksheet, in reality it is a good synopsis of interest rate expectations. Part of the reason stocks reacted so positively to the Fed’s statement is because the “Dot Plot” median interest rate expectations of 0.625% came down 0.50% for 2015, and by more than 0.60% for 2016 to 1.875%. This just hammers home the idea that there are currently no dark clouds looming on the horizon that would indicate aggressive rate hikes are coming.
Source via BusinessInsider
These sub-2% interest rate expectations over the next few years hardly qualify as a “hawkish” stance. As I’ve written before, the stock market handled a 2.5% hike in stride when the Fed Funds rate increased in 1994 (see also 1994 Bond Repeat or Stock Defeat?). What’s more, the Fed Funds rate cycle peaked at 5.0% in 2007 before the market crashed in the Great Recession of 2008-2009.
Although volatility is bound to increase as the Federal Reserve transitions out of a six-year 0% interest rate policy, don’t let the irrational fear of a modest Fed hike prick scare you away from potential investment benefits.
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.
Ceasefires & Investor Quagmires
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (March 1, 2015). Subscribe on the right side of the page for the complete text.
Considering the following current event headlines, who would have guessed the stock market is trading near record, all-time highs and the NASDAQ index breaking 5,000 for the first time since the year 2000?
- Russia Lies Over Ukraine Ceasefire
- ISIS Beheadings and Jihadi John
- Strong Dollar, Weak Global Economy
- Fed’s Yellen: Rate Rise & Inflation
- Iranian Negotiations & Nuclear Weapons
- Grexit: The Likelihood of Greece’s Exit from the Euro
- The Chinese Bubble Pops
- Ebola and the Fear Epidemic
After reading all these depressing stories, I feel more like taking a Prozac pill than I do venturing into the investing world. Unfortunately, in the media world, the overarching motto driving the selection of published stories is, “If it bleeds, it leads!” Plainly and simply, bad news sells. The media outlets prey on our human behavioral shortcomings. Specifically, people feel the pain from losses at a rate more than double the feelings of pleasure (see Controlling the Lizard Brain and chart below).
This phenomenon leaves Americans and the overall investing public choking on the daily doom and gloom headlines. Investor skepticism caused by the 2008-2009 financial crisis is evidenced by historically low stock ownership statistics and stagnant equity purchase flow data. Talk of another stock bubble has been introduced again now that the NASDAQ is approaching 5,000 again, but we are not seeing signs of this phenomenon in the IPO market (Initial Public Offering) – see chart below. IPOs are on the rise, but the number of filings is more than -50% below the peak of 845 IPOs seen in the late 1990s when former Federal Reserve Chairman Alan Greenspan made his famous “irrational exuberance” speech (see also Irrational Exuberance Deja Vu and chart below).
Uggh! 0.08% Really?
Compounding the never-ending pessimism problem is the near-0% interest rate environment. Times are long gone when you could earn 18% on a certificate of deposit (see chart below). Today, you can earn 0.08% on a minimum $10,000 investment in a Bank of America (BAC) Certificate of Deposit (CD). Invest at that rate for more than a decade and you will have almost accumulated a $100 (~1%) – probably enough for a single family meal…without tip. To put these paltry interest rates into perspective, the U.S. stock market as measured by the S&P 500 index was up a whopping +5.5% last month and the Dow Jones Industrials climbed +5.6% (+968 points to 18,133). Granted, last month’s S&P 500 percentage increase was the largest advance since 2011, but if I wanted to earn an equivalent +5.5% return by investing in that Bank of America CD, it would take me to age 100 years old before I earned that much!
Globally, the interest rate picture doesn’t look much prettier. In fact, the negative interest rate bonds offered in Switzerland and other neighboring countries, including France and Germany, have left investors in these bonds with guaranteed losses, if held to maturity (see also Draghi Beer Goggles).
Money Seeking Preferred Treatment
Investors and followers of mine have heard me repeatedly declare that “money goes where it is treated best.” When many investments are offering 0% (or negative yields), it comes as no surprise to me that dividend paying stocks have handily outperformed the overall bond market in recent years. Hard to blame someone investing in certain stocks offering between 2-6% in dividends when the alternative is offered at or near 0%.
While at Sidoxia we are still finding plenty of opportunities in the equity markets, I want to extend the reminder that not everyone can (or should) increase their equity allocation because of personal time horizon and risk tolerance constraints. Regardless, the current, restricting global financial markets are highlighting the scarcity of investment alternatives available.
As we will continue to be bombarded with more cease fires, quagmires and other bleeding headlines, investors will be better served by ignoring the irrelevant headlines and instead create a long-term financial plan with an asset allocation designed to meeting their personal goals. By following this strategy, you can let the dooms-dayers bleed while you succeed.
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 BAC, 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.
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