Posts filed under ‘International’

EU Marriage Ends in Messy Brexit Divorce

divorce

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

What Just Happened?

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

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

brexit votes

Source: Bloomberg

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

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

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

What Were Investors’ Reactions?

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

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

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

Japan (Nikkei): -4.1%

Germany (DAX): -5.6%

Hong Kong (Hang Seng): +0.4%

China (Shanghai): +1.3%

India (BSE): -0.0%

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

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

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

currency v ppp

Source: Calafia Beach Pundit

Why Did it Happen?

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

18-24: 75% Remain

25-49: 56% Remain

50-64: 44% Remain

65+: 39% Remain

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

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

UK GDP Ratio

Source: The Wall Street Journal

What happens next?

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

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

What does Brexit Mean for Global Markets?

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

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

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

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

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

global gdp

Source: The National Archives

What to Do Next?

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

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

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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

Yield Starving Foreigners Go Muni Hunting

hunter pointing rifle in blaze orange gear

In the current cold, barren, negative interest rate environment, foreign investors are getting hungry and desperate as they hunt for yield. In the hopes of kick-starting economic activity around the globe, central bankers are taking the drastic measure of establishing negative interest rate policies. This unusual endeavor is pressing international investors to chase yield, no matter how small, wherever they can find it.

One of those areas in which foreigners are hunting for yield is the U.S. municipal bond market (see FT article). On the surface, this sounds ludicrous. Why would an outsider living in Germany or Japan invest in a U.S. municipal bond that yields a paltry rate that’s less than 1.7%, especially considering those investors will not benefit from the tax-free income advantages offered to Americans?

As strange as it sounds, Natalie Cohen, Wells Fargo’s head of municipal research correctly pointed out this pursuit for municipal bond yield across continents boils down to simple math. “Even if [foreign investors] are not subject to the US tax code, a plus two is better than a minus one,” Cohen notes.

Although foreign investment in the $3.7 trillion municipal bond market is relatively small, the rapidly rising appetite for munis is clearly evident, as shown in the chart below.

Source: The Financial Times

Source: The Financial Times

With our country’s crumbling roads and bridges, these ever-increasing piles of foreign cash pouring into our municipal bonds are helping fund a broad array of U.S. infrastructure projects. Given the election season is upon us, this issue may gain heightened attention. Both likely-presidential candidates are highlighting the need for infrastructure investment as part of their platforms, and the NIRP (negative interest rate policies) agenda of international central banks may make these municipal infrastructure dreams a reality.

We Americans are no stranger to the idea of borrowing money from foreigners. In fact, the Chinese own about $1.3 trillion of our Treasury bonds. This is all fine and dandy as long as the international appetite for lending us money remains healthy. If our city, state, and federal governments become too addicted to the Chinese, Europeans, and Japanese loans, financial risks can/will grow to unmanageable levels. Guess what happens once our borrowings swell to a level that forces foreigners to question our ability of repaying their debt? Interest rates will accelerate upwards, our interest payments will balloon, and our deficits will widen. The consequences of these unfavorable outcomes will be devastating budget cuts and/or tax increases.

For the time being, we will gladly accept the charitable donations of foreign investors to help lower funding costs for our sorely needed infrastructure projects. Fortunately, for now fiscal sanity is prevailing. The post financial crisis political environment has scared municipalities from borrowing too much, as explained here by the FT:

“For local and state politicians grappling with pension reforms, new healthcare programs and — in Alaska, Texas and Oklahoma — a drag on finances from lower energy prices, the looming presidential election is also diminishing the appeal of [municipal debt] issuance.”

 

In a near-zero/negative rate environment, there certainly will be incentives for irresponsible governments and corporations to extend themselves too far with cheap debt. However, in the short-run, as starving foreigners hunt for yield in the U.S. municipal bond market, Americans have the opportunity of exploiting this foreign generosity for the benefit our country’s long-term infrastructure.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

May 14, 2016 at 3:30 pm Leave a comment

Want to Retire at Age 90?

sleep sit 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.

negative bonds apr 16

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.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

April 16, 2016 at 11:00 am 1 comment

Bargain Hunting for Doorbuster Discounts

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

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

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

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

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

Source: Calafia Beach Pundit

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

Source: Calculated Risk Blog

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

Source: Calculated Risk Blog

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

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

Source: Wikipedia

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

Shopping Without My Rose Colored Glasses

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

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

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

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

Source: Yardeni.com

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

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AMZN and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

December 1, 2015 at 1:06 pm 1 comment

More Treats, Less Tricks

pumpkin ornament

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

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

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

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

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

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

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

fed cycles

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

debt limit

Source: Wall Street Journal

Remain Calm – Not Frightened

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

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

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

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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

E.M.s Want Cake & Eat It Too

Fancy Cake

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

Source: Financial Times

Source: Financial Times

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

Source: Financial Times

Source: Financial Times

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

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

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

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

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

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

investment-questions-border

www.Sidoxia.com 

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including EWZ, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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

The Art of Catching Falling Knives

Knife Falling FreeImages

“In the middle of every difficulty lies an opportunity.”  ~Albert Einstein

It was a painful week for bullish investors in the stock market as evidenced by the -1,018 point drop in the Dow Jones Industrial Average, equivalent to approximately a -6% decline. The S&P 500 index did not fare any better, and the loss for the tech-heavy NASDAQ index was down closer to -7% for the week.

The media is attributing much of the short-term weakness to a triple Chinese whammy of factors: 1) Currency devaluation of the Yuan; 2) Weaker Chinese manufacturing data registering in at the lowest level in over six years; and 3) A collapsing Chinese stock market.

As the second largest economy on the planet, developments in China should not be ignored, however these dynamics should be put in the proper context. With respect to China’s currency devaluation, Scott Grannis at Calafia Beach Pundit puts the foreign exchange developments in proper perspective. If you consider the devaluation of the Yuan by -4%, this change only reverses a small fraction of the Chinese currency appreciation that has taken place over the last decade (see chart below). Grannis rightfully points out the -25% collapse in the value of the euro relative to the U.S. dollar is much more significant than the minor move in the Yuan.  Moreover, although the move by the People’s Bank of China (PBOC) makes America’s exports to China less cost competitive, this move by Chinese bankers is designed to address exactly what investors are majorly concern about – slowing growth in Asia.

Yuan vs Dollar 2015

Although the weak Chinese manufacturing data is disconcerting, this data is nothing new – the same manufacturing data has been very choppy over the last four years. On the last China issue relating to its stock market, investors should be reminded that despite the massive decline in the Shanghai Composite, the index is still up by more than +50% versus a year ago (see chart below)

Shanghai Composite 8-2015

Fear the Falling Knife?

Given the fresh carnage in the U.S. and foreign markets, is now the time for investors to attempt to catch a falling knife? Catching knives for a living can be a dangerous profession, and many investors – professionals and amateurs alike – have lost financial fingers and blood by attempting to prematurely purchase plummeting securities. Rather than trying to time the market, which is nearly impossible to do consistently, it’s more important to have a disciplined, unemotional investing framework in place.

Hall of Fame investor Peter Lynch sarcastically highlighted the difficulty in timing the market, “I can’t recall ever once having seen the name of a market timer on Forbes‘ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”

Readers of my blog, Investing Caffeine understand I am a bottom-up investor when it comes to individual security selection with the help of our proprietary S.H.G.R. model, but those individual investment decisions are made within Sidoxia’s broader, four-pronged macro framework (see also Don’t be a Fool, Follow the Stool). As a reminder, driving our global views are the following four factors: a) Profits; b) Interest rates; c) Sentiment; and Valuations. Currently, two of the four indicators are flashing green (Interest rates and Sentiment), and the other two are neutral (Profits and Valuations).

  • Profits (Neutral): Profits are at record highs, but a strong dollar, weak energy sector, and sluggish growth internationally have slowed the trajectory of earnings.
  • Valuation (Neutral): At an overall P/E of about 18x’s profits for the S&P 500, current valuations are near historical averages. For CAPE investors who have missed the tripling in stock prices, you can reference prior discussions (see CAPE Smells Like BS). I could make the case that stocks are very attractive with a 6% earnings yield (inverse P/E ratio) compared to a 2% 10—Year Treasury bond, but I’ll take off my rose-colored glasses.
  • Interest Rates (Positive): Rates are at unambiguously low levels, which, all else equal, is a clear-cut positive for all cash generating asset classes, including stocks. With an unmistakably “dovish” Federal Reserve in place, whether the 0.25% interest rate hike comes next month, or next year will have little bearing on the current shape of the yield curve. Chairman Yellen has made it clear the trajectory of rate increases will be very gradual, so it will take a major shift in economic trends to move this factor into Neutral or Negative territory.
  • Sentiment (Positive): Following the investment herd can be very dangerous for your financial health. We saw that in spades during the late-1990s in the technology industry and also during the mid-2000s in the housing sector. As Warren Buffett says, it is best to “buy fear and sell greed” – last week we saw a lot of fear.

In addition to the immense outflows out of stock funds (see also Great Rotation) , panic was clearly evident in the market last week as shown by the Volatility Index (VIX), a.k.a., the “Fear Gauge.” In general, volatility over the last five years has been on a declining trend, however every 6-12 months, some macro concern inevitably rears its ugly head and volatility spikes higher. With the VIX exploding higher by an amazing +118% last week to a level of 28.03, it is proof positive how quickly sentiment can change in the stock market.

Not much in the investing world works exactly like science, but buying stocks during previous fear spikes, when the VIX level exceeds 20, has been a very lucrative strategy. As you can see from the chart below, there have been numerous occasions over the last five years when the over-20 level has been breached, which has coincided with temporary stock declines in the range of -8%  to -22%. However, had you held onto stocks, without adding to them, you would have earned an +84% return (excluding dividends) in the S&P 500 index. Absent the 2011 period, when investors were simultaneously digesting a debt downgrade, deep European recession, and domestic political fireworks surrounding a debt ceiling, these periods of elevated volatility have been relatively short-lived.

Whether this will be the absolute best time to buy stocks is tough to say. Stocks are falling like knives, and in many instances prices have been sliced by more than -10%, -20%, or -30%. It’s time to compile your shopping list, because valuations in many areas are becoming more compelling and eventually gravity will run its full course. That’s when your strategy needs to shift from avoiding the falling knives to finding the bouncing tennis balls…excuse me while I grab my tennis racket.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including emerging market/Chinese 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.

August 22, 2015 at 7:40 pm Leave a comment

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