Tariff, Fed, & Facebook Fears but No Easter Bunny Tears

After an explosive 2017 (+19.4%) and first month of 2018 (+5.6%), the Easter Bunny came out and laid an egg last month (-2.7%). It is normal for financial markets to take a breather, especially after an Energizer Bunny bull market, which is now expanding into its 10th year of cumulative gains (up +296% since the lows of March 2009). Investors, like rabbits, can be skittish when frightened by uncertainty or unexpected events, and over the last two months, that’s exactly what we have seen.

Fears of Tariffs/Trade War: On March 8th, President Trump officially announced his 25% tariffs on steel and 10% on aluminum. The backlash was swift, not only in Washington, but also from international trading partners. In response, Trump and his economic team attempted to diffuse the situation by providing temporary tariff exemptions to allied trading partners, including Canada, Mexico, the European Union, and Australia. Adding fuel to the fire, Trump subsequently announced another $50-$60 billion in tariffs placed on Chinese imports. To place these numbers in context, let’s first understand that the trade value of steel (roughly $300 billion – see chart below), aluminum, and $60 billion in Chinese products represent a small fraction of our country’s $19 trillion economy (Gross Domestic Product). Nevertheless, financial markets sold off swiftly this month in unison with these announcements. The selloff did not necessarily occur because of the narrow scope of these specific announcements, but rather out of fear that this trade skirmish may result in large retaliatory tariffs on American exports, and ultimately these actions could blow up into a full-out trade war and trigger a spate of inflation.

Source: Bloomberg

These trade concerns are valid, but at this point, I am not buying the conspiracy theories quite yet. President Trump has been known to use fiery rhetoric in the past, whether talking about building “The Wall” or threats to defense contractors regarding the pricing of a legacy Air Force One contract. Often, the heated language is solely used as a first foray into more favorable negotiations. President Trump’s tough tariff talk is likely another example of this strategy.

Interest Rate/Inflation Phobia: Beginning in early February, anxiety in the equity markets intensified as interest rates on the benchmark 10-year Treasury note have now risen from a September-low yield of 2.40% to a 2018-high of 2.94%. Since that short-term high this year, rates have moderated to +2.74%. Adding to this month’s worries, Fed Chairman Jerome Powell hiked interest rates on the Federal Funds interest rate target by +0.25% to a range of 1.50% to 1.75%. While the direction of rate increases may be unnerving to some, both the absolute level of interest rates and the level of inflation remain relatively low, historically speaking (see 2008-2018 inflation chart below). Inflation of 1.5% is nowhere near the double digit inflation experienced in the late-1970s and early 1980s .

Source: Dr. Ed’s Blog

It is true that rates on mortgages, car loans, and credit cards might have crept up a little, but from a longer-term perspective rates still remain significantly below historical averages. Even if the Federal Reserve increases their interest rate target range another two to three times in 2018 as currently forecasted, we will still be at below-average levels, which should still invigorate economic growth (all else equal). In car terms, if the current strategy continues, the Fed will be moving from a strategy in which they are flooring the economic pedal to the medal, to a point where they will only be going 10 miles per hour over the speed limit. The strategy is still stimulative, but just not as stimulative as before. At some point, rising interest rates will slow down (or choke off) growth in the economy, but I believe we are still a long way from that happening.

Why am I not worried about runaway interest rates or inflation? For starters, I believe it is very important for investors to remove the myopic blinders, so they can open their eyes to what’s occurring with global interest rate trends. Although, U.S. rates have more than doubled from July 2016 to 2.74%, as long as interest rates in developed markets like Japan, the European Union, and Canada, remain near historically low levels (see chart below), the probabilities of runaway higher interest rates and inflation are unlikely to transpire.

Source: Ed Yardeni

With the Japanese 10-year government bond yielding 0.04% (near-zero percent), the German 10-year bond yielding 0.50%, and the U.K. 10-year bond yielding 1.35%, one of two scenarios is likely to occur: 1) global interest rates rise while U.S. rates decline or remain stable; or 2) U.S. interest rates decline while global rates decline or remain stable. While either scenario is possible, given the lack of rising inflation and the slack in our employment market, I believe scenario #2 is more likely to occur than scenario #1.

Privacy, Politics, and Facebook: A lot has recently been made of the 50 million user profiles that became exposed and potentially exploited for political uses in the 2016 presidential elections. How did this happen, and what was the involvement of Facebook Inc. (FB)? If you have ever logged into an internet website and been given the option to sign in with your Facebook password, then you have been exposed to third-party applications that are likely mining both your personal and Facebook “friend” data. The genesis of this particular situation began when Aleksandr Kogan, a Russian American who worked at the University of Cambridge created a Facebook quiz app that not only collected personal information from approximately 270,000 quiz-takers, but also extracted information from about 50 million Facebook friends of the quiz takers (data scandal explained here).

Mr. Kogan (believed to be in his early 30s) allegedly sold the Facebook data to a company called Cambridge Analytica, which employed Steve Bannon as a vice president. This is the same Steve Bannon who eventually became a senior adviser for the Trump Administration. Facebook has defended itself by blaming Aleksandr Kogan and Cambridge Analytica for violating Facebook’s commercial data sharing policies. Objectively, regardless of the culpability of Kogan, Cambridge Analytica, and/or Facebook, most observers, including Congress, believe that Facebook should have more closely monitored the data collected from third party app providers, and also done more to prevent such large amounts of data to be sold commercially. Now, the CEO (Chief Executive Officer) of Facebook, Mark Zuckerberg, faces an appointment in Washington DC, where he will receive tongue lashings and be raked over the coals, so politicians can better understand the breakdown of this data breach.

It is certainly possible that a large amount of data was compromised for political purposes relating to the 2016 presidential election. There has been some backlash as evidenced by a few high profile users threatening to leave the Facebook platform like actor/comedian Will Ferrell, Tesla CEO Elon Musk, and singer Cher, but since the data scandal was unearthed, there has been little evidence of mass defections. Even considering all the Facebook criticism, the stickiness and growth of Facebook’s 1.4 billion (with a “b”) monthly active users, coupled with the vast targeting capabilities available for a wide swath of advertisers, likely means any negative impact will be short-lived. Even if there are defectors, where will all these renegades go, Instagram? Well, if that were the case, Instagram is owned by Facebook. Snapchat, is another Facebook alternative, however this platform is skewed toward younger demographics, and few people who have invested years of sharing/saving memories on the Facebook cloud, are unlikely to delete these memories and migrate that data to a lesser-known platform.

Financial markets move up and financial markets down. The first quarter of 2018 reminded us that no matter how long a bull market may last, nothing money-related moves in a straight line forever. The fear du jour constantly changes, and last month, investors were fretting over tariffs, the Federal Reserve’s monetary policy, and a Facebook data scandal. Suffice it to say, next month will likely introduce new concerns, but one thing I do not need to worry about is an empty Easter basket. It will take me much longer than a month to work through all the jelly beans, chocolate bunnies, and marshmallow Peeps.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 2, 2018). Subscribe on the right side of the page for the complete text.

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

April 2, 2018 at 3:10 pm Leave a comment

The Scary Blip

I hated it when my mom reminded me when I was a younger, but now that I’ve survived into middle-aged adulthood, I will give you the same medicine she gave me:

“I told you so.”

As I cautioned in last month’s newsletter, “It’s important for investors to remember this pace of gains cannot be sustainable forever.” I added that there were a whole bunch of scenarios for stock prices to go down or “stock prices could simply go down due to profit-taking.”

And that is exactly what we saw. From the peak achieved in late January, stock prices quickly dropped by -12% at the low in early February, with little-to-no explanation other than a vague blame-game on rising interest rates – the 2018 yield on the 10-Year Treasury Note rose from 2.4% to 2.9%. This explanation holds little water if you take into account interest rates on the 10-Year increased from roughly 1.5% to 3.0% in 2013 (“Taper Tantrum”), yet stock prices still rose +20%. The good news, at least for now, is the stock correction has been contained or mitigated. A significant chunk of the latest double-digit loss has been recovered, resulting in stock prices declining by a more manageable -3.9% for the month. Despite the monthly loss, the subsequent rebound in late February has still left investors with a gain of 1.5% for 2018. Not too shabby, especially considering this modest return comes on the heels of a heroic +19.4% gain in 2017.

As you can see at from the 22-year stock market chart below for the S&P 500, the brief but painful drop was merely a scary blip in the long-term scheme of things.

Whenever the market drops significantly over a short period of time, as it did this month, conspiracy theories usually come out of the woodwork in an attempt to explain the unexplainable. When human behavior is involved, rationalizing a true root cause can be very challenging, to say the least. It is certainly possible that technical factors contributed to the pace and scale of the recent decline, as has been the case in the past. Currently no smoking gun or fat finger has been discovered, however some pundits are arguing the popular usage of leveraged ETFs (Exchange Traded Funds) has contributed to the accelerated downdraft last month. Leveraged ETFs are special, extra-volatile trading funds that will move at amplified degrees – you can think of them as speculative trading vehicles on steroids. The low-cost nature, diversification benefits, and ability for traders to speculate on market swings and sector movements have led to an explosion in ETF assets to an estimated $4.6 trillion.

Regardless of the cause for the market drop, long-term investors have experienced these types of crashes in the past. Do you remember the 2010 Flash Crash (down -17%) or the October 1987 Crash (-23% one-day drop in the Dow Jones Industrial Average index)? Technology, or the lack thereof (circuit breakers), helped contribute to these past crashes. Since 1987, the networking and trading technologies have definitely become much more sophisticated, but so have the traders and their strategies.

Another risk I highlighted last month, which remains true today, is the potential for the new Federal Reserve chief, Jerome Powell, to institute a too aggressive monetary policy. During his recent testimony and answers to Congress, Powell dismissed the risks of an imminent recession. He blamed past recessions on previous Fed Chairmen who over enthusiastically increased interest rate targets too quickly. Powell’s comments should provide comfort to nervous investors. Regardless of short-term inflation fears, common sense dictates Powell will not want to crater the economy and his legacy by slamming the economic brakes via excessive rate hikes early during his Fed chief tenure.

Tax Cuts = Profit Gains

Despite the heightened volatility experienced in February, I remain fairly constructive on the equity investment outlook overall. The recently passed tax legislation (Tax Cuts and Job Act of 2017) has had an undeniably positive impact on corporate profits (see chart below of record profit forecasts – blue line). More specifically, approximately 75% of corporations (S&P 500 companies) have reported better-than-expected results for the past quarter ending December 31st. On an aggregate basis, quarterly profits have also risen an impressive +15% compared to last year. When you marry these stellar earnings results with the latest correction in stock prices, historically this combination of factors has proven to be a positive omen for investors.

Source: Dr. Ed’s Blog

Despite the rosy profit projections and recent economic strength, there is always an endless debate regarding the future direction of the economy and interest rates. This economic cycle is no different. When fundamentals are strong, stories of spiking inflation and overly aggressive interest rate hikes by the Fed rule the media airwaves. On the other hand, when fundamentals deteriorate or slow down, fears of a 2008-2009 financial crisis enter the zeitgeist. The same tug-of-war fundamental debate exists today. The stimulative impacts of tax cuts on corporate profits are undeniable, but investors remain anxious that the negative inflationary side-effects from a potential overheating economy could outweigh the positive economic momentum of a near full-employment economy gaining steam.

Rather than playing Goldilocks with your investment portfolio by trying to figure out whether the short-term stock market is too hot or too cold, you would be better served by focusing on your long-term asset allocation, and low-cost, tax-efficient investment strategy. If you don’t believe me, you should listen to the wealthiest, most successful investor of all-time, Warren Buffett (The Oracle of Omaha), who just published his annual shareholder letter. In his widely followed letter, Buffett stated, “Performance comes, performance goes. Fees never falter.” To emphasize his point, Buffett made a 10-year, $1 million bet for charity with a high-fee hedge fund manager (Protégé Partners). As part of the bet, Buffett claimed an investment in a low-fee S&P 500 index fund would outperform a selection of high-fee, hot-shot hedge fund managers. Unsurprisingly, the low-cost index fund trounced the hedge fund managers. From 2008-2017, Buffett’s index fund averaged +8.5% per year vs. +3.0% for the hedge fund managers.

During scary blips like the one experienced recently, lessons can be learned from successful, long-term billionaire investors like Warren Buffett, but lessons can also be learned from my mother. Do yourself a favor by getting your investment portfolio in order, so my mother won’t have to say, “I told you so.”

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2018). Subscribe on the right side of the page for the complete text.

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

March 1, 2018 at 3:08 pm Leave a comment

Glass Moving from Half-Empty to Half-Full

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2018). Subscribe on the right side of the page for the complete text.

Economic growth accelerated in 2017, the unemployment rate is sitting at a 17-year low, housing prices are up significantly, Consumer Confidence is near the highs of 2000, corporations are doing cartwheels thanks to tax cut legislation, and the stock market has recently set new records. Not a bad start to the year, eh?

Fat Wallets & Stuffed Purses

The strength of the economy, coupled with the optimism of business and consumers, has resulted in a financial boon for Americans, as shown in the chart below. Not only have financial assets and real estate gone up significantly since the 2008-2009 Financial Crisis, but household debt has also remained relatively stable. The combination of these factors have American households sitting on almost $1 trillion in household value, a new record.

Source: Calafia Beach Pundit

As we move ahead through the first month of 2018, the +5.8% gain in the Dow Jones Industrial Average, and the +5.6% advance in the S&P 500 index have further fattened wallets and stuffed the purses of equity investors. On an annual basis, the results only look even better, with the Dow up +32% and the S&P +24%. Given the sharp appreciation in value, casual observers might expect a flood of new investors to pile into stocks and equity mutual funds…not true. Actually, this buying phenomenon has yet to occur. However, it is true investor sentiment has begun shifting to a “glass half-full” perspective due to the vast number of positive economic headlines. Nevertheless, it’s important for investors to remember this pace of gains cannot be sustainable forever.

There is no theoretical limit on the number of potential market moving events. The stock market could temporarily get rattled by another North Korean nuclear test, a terrorist attack, a geopolitical standoff, an inflammatory tweet, an infinite number of other unforeseen events, or stock prices could simply go down due to profit-taking (i.e., investors sell to lock-in gains). Regardless, the economic momentum is palpable and the president did not waste any time at the recent State of the Union address to remind Americans.

Currently, there are limited signs of euphoric stock buying, but there will be a point in time, as in all economic cycles, when investment excesses will overwhelm demand and will therefore lead to a recession. Let’s not forget, an overzealous monetary policy (i.e., too many rate increases), led by a new Federal Reserve chief (Jerome Powell), is another scenario which could slam the breaks on an overheated economy.

Follow the Money

In attempting to read the tea leaves about the future direction of the stock market, we are inspired by the famous quote from the 1976 film All the President’s Men, “Follow the money.” Actions speak louder than words in our book, which is why at Sidoxia Capital Management (www.Sidoxia.com), we track the money buying and selling actions of investors. There is never a shortage of information, and the professionals at the ICI (Investment Company Institute) are kind enough to publish the Weekly Fund Flows data  (see chart below), which details the amount of dollars funneling in and out of stock and bond funds. Despite the stock market more than tripling in value, and contrary to common belief, more than -$200 billion has poured out of domestic stock funds and ETFs (Exchange Traded Funds) from 2015 through early 2018.

Source: ICI through 1-17-18

How can this counterintuitive money exodus transpire during a bull market? Quite simply, corporations have been using record piles of cash to buy trillions of dollars in stock through “stock buybacks” and “mergers & acquisitions” activity. All this corporate stock purchase activity has offset the money flowing out of funds, which has helped catapult stock prices higher. History tells us, that before this long-term bull market that started in 2009 ends, flows into U.S. stock mutual funds and ETFs will turn significantly positive after years of hemorrhaging.

Many speculators and traders waste time on a plethora of unreliable sentiment surveys and indicators (e.g., CBOE Volatility Index, AAII Sentiment Survey, Put-Call Ratio, etc), but my 25+ years of investment experience tells me the fund flows data works much better as a longer-term contrarian indicator. To put “contrarian” investing in English, famed billionaire investor, Warren Buffett, summed it up best when he said, “Be fearful when others are greedy and greedy when others are fearful.”

Sharing the Wealth

Speaking of greed, corporations have been greedy capitalists as they have watched profits surge to record levels. Yet many of these greedy corporations have decided to share some of the spoils garnered from the recent tax legislation with rank and file employees. For instance, consider the small sampling of the following large corporations that have decided to pay their employees bonuses:

Overall, even though trillions of savings remain in cash and money is still flowing out of US stock funds, the investment glass is shifting from a glass half-empty perception to a glass half-full impression. A time will come when the masses will believe the glass half-full will turn to a glass over-flowing. I don’t think anyone can predict with any certainty when that time will arrive, but I will continue doing my best to drink as much water as possible before it spills.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

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

February 1, 2018 at 12:22 pm Leave a comment

Celebrating Another Year, Another Decade for Sidoxia

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 2, 2018). Subscribe on the right side of the page for the complete text.

Not only is New Year’s the time to celebrate the year that has just passed, but it is also the time to set new resolutions for the year to come. For financial markets, especially the stock market, 2017 was a special year of celebration. In addition to the S&P 500 index rejoicing a +19% gain, the more narrowly focused Dow Jones Industrial Average (consisting solely of 30 stocks) partied to an even more impressive +25% advance. Out of the three major stock indexes, the icing on the cake can be savored by the technology-heavy NASDAQ index, which soared +28% in 2017.

Can the mojo of this festive bull market continue into its 10th year after the financial crisis? The short answer is “yes”, but there are numerous variables that can cause the performance gusts to swirl into a headwind or a tailwind. While many Americans are glued to the topic of politics and get caught up in the continual mudslinging, followers of Sidoxia Capital Management’s writings (see also Politics & Your Money) understand there are much more important factors impacting the long-term performance of your investments. More specifically, the following four factors I track on Sidoxia’s financial dashboard (Don’t Be a Fool)  have continued to act as significant tailwinds for positive stock performance:

  • Corporate profits
  • Interest rates
  • Valuations
  • Sentiment

Sidoxia’s 10-Year Anniversary

The year 2018 also happens to be a special year that marks a significant milestone in my professional career. A decade ago in late 2007, I ventured off from managing one of the largest multi-billion growth funds in the country (see How I Managed $20,000,000,000.00 by Age 32) and launched my own company, Sidoxia Capital Management in Newport Beach, California. At the time of the launch (December 2007), and subsequent to the bursting of the 2000 technology bubble, stock prices had about doubled over a five year period, starting in early 2003 (see chart).

On top of having the leading investment credentials (CFA, MBA, and CFP) and the experience of successfully managing a multi-billion fund, I also held the youthful confidence and optimism of a 30-something year-old (Trivia fact: the name Sidoxia is derived from the Greek word for “optimism”). What could possibly go wrong? How about the worst financial collapse in a generation (79 years)!

Suffice it to say, the global panic and recession that resulted in stock prices crumbling -50% (see chart below) temporarily bruised my youthful confidence and briefly punched my optimistic enthusiasm in the gut. In hindsight, what felt like a disaster at that point turned out to be a perfect time to start Sidoxia. The advantage of starting with virtually no clients meant that most of my early clients have enjoyed participating in a near quadrupling in stock prices to the near-record highs of today.

However, it wasn’t all rainbows and unicorns over Sidoxia’s first ten years (2007 – 2017). Despite the Dow advancing to 24,719 today from the 2009-low of 6,470, there were at least 11 substantial corrections (price drops) ranging from -5% to -22%. The extraordinary climb up the financial mountain included a “Flash Crash”, U.S. debt downgrade, eurozone economic crisis, Ebola scare, Brexit vote, multiple presidential elections, and China recession scares, among numerous other fear-grabbing headlines.

What Now?

As I have described on numerous occasions (see also Fool’s Errand), predicting short-term directions in the stock market is a fruitless effort. With that said, our correctly positioned positive stance over the years can be clearly documented on my blog (see InvestingCaffeine.com).

For example, 2017 was one of Sidoxia’s best years thanks in large part to our positive outlook (see Wiping Slate Clean), even though headlines were dominated by mass shootings, natural disasters, terrorist attacks, White House politics, Bitcoin/cryptocurrencies, and let’s not forget the sexual harassment revelations. But in going back to my previous comments, the key follow-up question becomes, “Do these headlines negatively impact the four key pillars of corporate profits, interest rates, valuations, and sentiment?” And the short answer is “No”.

On the positive side of the ledger, we have a newly minted tax legislation that dramatically loweres corporate tax rates from 35% to 21%. This move should significantly stimulate corporate profits, thereby creating extra cash for shareholder friendly actions like increased dividends and stock buybacks, not to mention more cash in corporate coffers for further acquisitions. Worth also noting, the global synchronized economic recovery continues to buoy the stellar U.S. performance. Evidence of the rising international tide lifting all global boats can be seen in the 2017 performance of various international equity markets*:

  • Vietnam: +48%
  • Hong Kong: +36%
  • Asia (Overall): +30%
  • India: +27%
  • Brazil: +26%
  • Europe (VGK): +23%
  • Japan: +17%

Source: CNBC 12/29 & Sidoxia

What could negatively impact investment results in 2018? For starters, overly aggressive (“hawkish”) monetary policy by the Federal Reserve could potentially slam the brakes on the economy. In my view this scenario is unlikely given the rhetoric and new composition of the Federal Open Market Committee, including new chief Jerome Powell. Regardless of the historically low Federal Funds rate, interest rate policy is definitely worth following in the coming months.

Another wildcard that could slow down the 10-year bull market is a spike in the value of the U.S. dollar. As we saw in 2015-2016, a higher valued dollar makes American goods more expensive abroad, which will crimp corporate profits. Beyond these known unknowns, there are always what Donald Rumsfeld likes to call unknown unknowns“. These unknowns can include things like terrorist attacks, currency crises, foreign bank defaults, natural disasters, etc. Short-term volatility typically ensues after these uncontrollable events, but history has proven our country’s resilience.

With the new tax legislation voted into law and shift of IRS calendar, a cohort of investors may now choose to temporarily sell stocks during January, which could briefly lower stock prices. I fully understand stock prices cannot go up forever, but as long as the previously discussed four key pillars remain positive on balance, the New Year’s celebration can continue.

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.

January 2, 2018 at 1:12 pm 2 comments

‘Tis the Season for Giving

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2017). Subscribe on the right side of the page for the complete text.

Holiday season is in full swing, and that means it’s the primetime period for giving. The stock market has provided its fair share of giving to investors in the form of a +2.7% monthly return in the S&P 500 index (up +18% in 2017). For long-term investors, stocks have been the gift that keeps on giving. As we approach the 10-year anniversary of the 2008 Financial Crisis, stocks have returned +68% from the October 2007 peak and roughly +297% from the March 2009 low. If you include the contributions of dividends over the last decade, these numbers look even more charitable.

Compared to stocks, however, bonds have acted more like a stingy Ebenezer Scrooge than a generous Mother Theresa. For the year, the iShares Core Aggregate bond ETF (AGG) has returned a meager +1%, excluding dividends. Contributing to the lackluster bond results has been the Federal Reserve’s miserly monetary policy, which will soon be managed under new leadership. In fact, earlier this week, Jerome Powell began Congressional confirmation hearings as part of the process to replace the current Fed chair, Janet Yellen. As the Dow Jones Industrial Average rose for the 8th consecutive month to 24,272 (the longest winning streak for the stock index in 20 years), investors managed to take comfort in Powell’s commentary because he communicated a steady continuation of Yellen’s plan to slowly reverse stimulative policies (i.e., raise interest rate targets and bleed off assets from the Fed’s balance sheet).

Because the pace of the Federal Funds interest rate hikes have occurred glacially from unprecedented low levels (0%), the resulting change in bond prices has been relatively meager thus far in 2017. In that same deliberate vein, the Fed is meeting in just a few weeks, with the expectation of inching the Federal Funds rate higher by 0.25% to a target level of 1.5%. If confirmed, Powell plans to also chip away at the Fed’s gigantic $4.5 trillion balance sheet over time, which will slowly suck asset-supporting liquidity out of financial markets.

Economy Driving Stocks and Interest Rates Higher

Presents don’t grow on trees and stock prices also don’t generally grow without some fundamental underpinnings. With the holidays here, consumers need money to fulfill the demanding requests of gift-receiving individuals, and a healthy economy is the perfect prescription to cure consumers’ empty wallet and purse sickness.

Besides the Federal Reserve signaling strength by increasing interest rates, how do we know the economy is on firm footing? While economic growth may not be expanding at a barn-burning rate, there still are plenty of indications the economy keeps chugging along. Here are a few economic bright spots to highlight:

  • Accelerating GDP Growth: As you can see from the chart below, broad economic growth, as measured by Gross Domestic Product (GDP), accelerated to a very respectable +3.3% growth rate during the third quarter of 2017 (the fastest percentage gain in three years). These GDP calculations are notoriously volatile figures, nevertheless, the recent results are encouraging, especially considering these third quarter statistics include the dampening effects of Hurricane Harvey and Irma.

Source: Bloomberg

  • Recovering Housing Market: The housing market may not have rebounded as quickly and sharply as the U.S. stock market since the Financial Crisis, but as the chart below shows, new home sales have been on a steady climb since 2011. What’s more, a historically low level of housing inventory should support the continued growth in home prices and home sales for the foreseeable future. The confidence instilled from rising home equity values should also further encourage consumers’ cash and credit card spending habits.

Source: Calculated Risk

  • Healthy Employment Gains: Growth in the U.S. coupled with global synchronous economic expansion in Europe, Asia, and South America have given rise to stronger corporate profits and increased job hiring. The graph highlighted below confirms the 4.1% unemployment rate is the lowest in 17 years, and puts the current rate more than 50% below the last peak of 10.0% hit in 2009.

Source: Calculated Risk

Turbo Tax Time

Adding fuel to the confidence fire is the prospect of the president signing the TCJA (Tax Cuts and Jobs Act). At the time this article went to press, Congress was still feverishly attempting to vote on the most significant tax-code changes since 1986. Republicans by-and-large all want tax reform and tax cut legislation, but the party’s narrow majority in the House and Senate leaves little wiggle room for disagreement. Whether compromises can be met in the coming days/weeks will determine whether a surprise holiday package will be delivered this year or postponed by the Grinch.

Unresolved components of the tax legislation include, the feasibility of cutting the corporate tax rate from 35% to 20%; the deductibility of state and local income taxes (SALT); the potential implementation of a tax cut limit “trigger”, if forecasted economic growth is not achieved; the potential repeal of the estate tax (a.k.a., “death tax”); mortgage interest deductibility; potential repeal of the Obamacare individual mandate; the palatability of legislation expanding deficits by $1 trillion+; debates over the distribution of tax cuts across various taxpayer income brackets; and other exciting proposals that will heighten accountants’ job security, if the TCJA is instituted.

Bitcoin Bubble?

If you have recently spent any time at the watercooler or at a cocktail party, you probably have not been able to escape the question of whether the digital blockchain currency, Bitcoin, is an opportunity of a lifetime or a vehicle to crush your financial dreams to pieces (see Bitcoin primer).

Let’s start with the facts: Bitcoin’s value traded below $1,000 at the beginning of this year and hit $11,000 this week before settling around $10,000 at month’s end (see chart below). In addition, blogger Josh Brown points out the scary reality that “Bitcoin has already crashed by -80% on five separate occasions over the last few years.” Suffice it to say, transacting in a currency that repeatedly loses 80% of its value can pose some challenges.

Source: CoinMarketCap.com  

Bubbles are not a new phenomenon. Not only have I lived through numerous bubbles, but I have also written on the topic (see also Sleeping and Napping through Bubbles). I find the Dutch Tulip Bulb Mania that lasted from 1634 – 1637 to be the most fascinating financial bubble of all (see chart below). At the peak of the euphoria, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation-adjusted basis), and one historical account states 12 acres of land were offered for a single tulip bulb.

Forecasting the next peak of any speculative bubble is a fool’s errand in my mind, so I choose to sit on the sidelines instead. While I may be highly skeptical of the ethereal value placed on Bitcoin and other speculative markets (i.e. ICOs – Initial Coin Offerings), I fully accept the benefits of the digital blockchain payment technology and also acknowledge Bitcoin’s value could more than double from here. However, without any tangible or intellectual process of valuing the asset, history may eventually place Bitcoin in the same garbage heap as the 1630 tulips.

For some of you out there, if you are anything like me, your digestion system is still recovering from the massive quantities of food consumed over the Thanksgiving holiday. However, when it comes to your personal finances, digesting record-breaking stock performance, shifting Federal Reserve monetary policy, tax legislation, and volatile digital currencies can cause just as much heartburn. In the spirit of “giving”, if you are having difficulty in chewing through all the cryptic economic and political noise, “give” yourself a break by contacting an experienced, independent, professional advisor. That’s definitely a gift you deserve!

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.

December 2, 2017 at 6:30 am Leave a comment

Markets Fly as Media Noise Goes By

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 1, 2017). Subscribe on the right side of the page for the complete text.

That loud pitched noise is not a frightening scream from Halloween, but rather what you are likely hearing is the deafening noise coming from Washington D.C or cries from concerned Americans watching senseless acts of terrorism. Thanks to the explosion of real-time social media and smart phones, coupled with the divisive politics and depressing headlines blasted across all media outlets, it is almost impossible to ignore the daily avalanche of informational irrelevance.

As I have been writing for some time, the good news for long-term investors is the financial markets continue to plug their ears and ignore poisonous politics and the spread of F.U.D. (Fear, Uncertainty & Doubt). There is a financial benefit to turning off the TV and disregarding political rants over your Facebook feed. Regardless of your political views, President Trump’s approval ratings have objectively been going down, but that really doesn’t matter…the stock market keeps going up (see chart below).

Source: Bespoke

While politicians on both sides scream at each other, investment portfolios have been screaming higher. Stock prices are more focused on the items that really matter, which include corporate profits, interest rates, valuations (price levels), and sentiment (i.e., determining whether investors are too optimistic or too pessimistic). The proof is in the pudding. Stock prices continue to set new records, as witnessed by the 7th consecutive monthly high registered by the Dow Jones Industrial Average to a level of 23,377. For the month, these results translate into an astonishing +4.3% gain. For the year, this outcome equates to an even more impressive +18.3% return. This definitely beats the near-0% rate earned on your checking account and cash stuffed under the mattress.

On the surface, 2017 has been quite remarkable, but over the last decade, stock market returns have proved to be even more extraordinary. Bolstering my contention that politics rarely matter to your long-term pocketbook, one can simply observe history. We are now approaching the 10-year anniversary of the 2008-2009 Financial Crisis – arguably the worst recession experienced in a generation. Over the last decade, despite political power in Washington bouncing around like a hot potato, stock performance has skyrocketed. From early 2009, when the Dow briefly touched a low of 6,470, the index has almost quadrupled above the 23,000 threshold (see chart below).

Source: Barchart.com

To place this spectacular period into better context, one should look at the political control dynamics across Congress and the White House over the same time frame (see the right side of the chart below). Whether you can decipher the chart or not, anyone can recognize that the colors consistently change from red (Republican) to blue (Democrat), and then from blue to red.

More specifically, since the end of 2007, the Democrats have controlled the Senate for approximately 80% of the time; the Republicans have controlled the House of Representatives for 60% of the time; and the Oval Office has switched between three different presidents (two Republicans and one Democrat). And if that is not enough diversity for you, we have also had two Federal Reserve Chairs (Ben Bernanke and Janet Yellen) who controlled the world’s most powerful monetary system, and a Congressional mid-term election taking place in twelve short months. There are two morals to this story: 1) No matter how sad or excited you are about your candidate/political party, you can bank on the control eventually changing; and 2) One person alone cannot save the economy, nor can that same person singlehandedly crater the economy.

Source: Wikipedia

Waterfall of Worries

If you simply read the newspapers and watched the news on TV all day, you would be shocked to learn about the magnificent magnitude of this equity bull market. Reaching these new highs has not been a walk in the park for most investors. There certainly has been no shortage of issues to worry about, including the following:

  • Special Counsel Indictments: After the abrupt firing of former FBI Director James Comey by President Donald Trump, Deputy Attorney General Rod Rosenstein established a special counsel in May and appointed ex-FBI official and attorney Robert Mueller to investigate potential Russian meddling into the 2016 presidential elections. Just this week, Mueller indicted Paul Manafort, the former Trump campaign chairman, and Manafort’s business partner and Trump campaign volunteer, Rick Gates. The special counsel also announced the guilty plea of George Papadopoulos, a former foreign policy adviser for the Trump campaign who admitted lying to the FBI regarding interactions between Russian officials and the Trump campaign.
  • Terrorist Attacks: Senseless murders of eight people in New York  by a 29-year-old man from Uzbekistan, and 59 people shot dead by a 64-year-old shooter from a Las Vegas casino  have created a chilling blanket of concern over American psyches.
  • New Money Chief? The term of current Federal Reserve Chair, Janet Yellen, ends this February. President Trump has fueled speculation he will announce the appointment of a new Fed chief as early as this week. Although the president has recently praised Yellen, a registered Democrat, many pundits believe Trump wants to select Jerome Powell, a Republican, who currently sits on the Federal Board of Governors.
  • North Korea Rocket Launches: So far in 2017, North Korea has launched 22 missiles and tested a hydrogen bomb, while simultaneously threatening to fire missiles over the US territory of Guam and conduct an atmospheric nuclear test. Saber rattling has diminished somewhat in recent weeks since the last North Korean missile launch took place on September 15th. Nevertheless, tensions could rise at any moment, if missile launches resume.

Although media headlines are often depressing, F.U.D. will never go away – it’s only the list of worries that change over time. As noted earlier, the entrepreneurial DNA of the financial markets is focused on more important economic factors like the economy, rather than politics or terrorism. One barometer of economic health can be gauged by the chart below – Consumer Confidence is at the highest level since 2000.

Source: Bespoke

This trend is important because consumers make up approximately 70% of our nation’s economic output. Therefore, it should come as no surprise that Americans are feeling considerably better due to the following factors:

  • Strong Job Market: The 4.2% unemployment rate is at the lowest level in 16 years.
  • Strong Economy: Despite the dampening effect of the hurricanes, the economy is poised to register its best six-month performance of at least 3% growth in three years.
  • Strong Housing Market: Just-released data shows an acceleration in national home price appreciation by +6.1% compared to a year ago.
  • Low Interest Rates: Inflation has been low, credit has been cheap, and the Federal Reserve has been cautious in raising interest rates. These low rates have improved the affordability of credit, which has been stimulative for the economy.

Tax Reform Could be the Norm

The icing on the stock market cake has been the optimism surrounding the potential passage of tax reform, likely in the shape of corporate & personal tax cuts, foreign profit repatriation, and tax simplification. The process has been slow, but by passing a budget, the Republican-led Congress was able to pave the way for substantive new tax reform, something not seen since the Ronald Reagan administration, some 30-years ago. Everybody loves paying lower taxes, but victory cannot be claimed yet. Democrats and some fiscally conservative Republicans are not interested in exploding our country’s already-large deficits and debt levels. In order to achieve responsible tax legislation, Congress is looking to remove certain tax loopholes and is negotiating precious tax breaks such as mortgage interest deductibility, state/local tax deductibility, 401(k) tax incentives, and corporate interest expense deductibility, among many other possible iterations. Although corporate tax discussions have been heated, the chart below demonstrates individual income tax legislation is much more important for tax reform legislation because the government collects a much larger share of taxes from individuals vs. corporations.

Source: Calafia Beach Pundit

In spite of all the deafening political noise heard over social media and traditional media, it’s important to block out all the F.U.D. and concentrate on how to achieve your long-term financial goals. If you don’t have the time, energy, or emotional fortitude to follow a disciplined financial plan, I urge you to find an experienced investment advisor who is also a fiduciary. If you need assistance finding one, I am confident Sidoxia Capital Management can help you with this endeavor.

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) and FB, 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.

November 1, 2017 at 4:57 pm 1 comment

The September to Remember

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 2, 2017). Subscribe on the right side of the page for the complete text.

Given the volume of recent memorable events, it appears September will become a month to remember. Not only did we witness horrific natural disasters in Texas, Florida, Puerto Rico, and Mexico but Americans have also had to digest the saber rattling by the North Korean Rocket Man leader, Kim Jong Un*. If that wasn’t enough, there were a slew of headlines detailing the Washington gridlock and dysfunction over healthcare legislation / tax reform; hackings at Equifax affecting up to 143 million credit accounts; the planned unwinding of the Federal Reserves $4.2 trillion bond portfolio; and a controversy over NFL football players kneeling during the national anthem.

Despite all these notable events, the Dow Jones Industrial Average just posted its 8th consecutive quarter of advances. For the three months ending in September, the Dow impressively climbed more than 1,000 points (+4.7%) to a new record high of 22,381. For the year, the Dow remarkably has risen approximately +13%, excluding dividends, which translates into a total 2017 return of more than +15%, thus far.

However, not everybody has participated in the financial party. Negative political headlines have by and large paralyzed the hearts and minds of the general public, but as I have been writing for some time, stocks do not care much about governmental affairs – stock prices care about fundamentals. There have been two critical, fundamental components fueling the repetitive new highs experienced in the stock market: 1) The extraordinarily persistent surge in corporate profits (see chart below); and 2) The stubbornly declining interest rates,  which are near generationally-low levels. When investors are offered next-to-nothing interest rates in their bank accounts, and coupon payments on Treasury bonds remain paltry (10-Year Treasury closed month at a yield of 2.33%), suddenly stock opportunities can look much more attractive in a scarce investment environment.

Source: Yardeni.com

And geographically speaking, the rise in corporate profits has not been limited to the U.S. There has also been a synchronized escalation in corporate earnings globally. Whether we are talking about Europe, China, or emerging markets, in general, the economic recovery in these regions is now occurring coincidentally with the U.S. Case in point is the Purchasing Managers Index (PMI), which serves as a broad indicator of the economic health of the manufacturing sector. The chart below highlights the clear recovery that has been ongoing in the global manufacturing sector over the last year and a half.

Source: Yardeni.com

In addition to these numerous positive factors, a cheaper (weaker) U.S. dollar has also contributed to our nation’s economic tailwind. More specifically, a lower valued dollar makes American goods sold abroad cheaper for foreign buyers. This currency exchange rate dynamic is important because 43% of Fortune 500 sales (S&P 500) are derived from American products and services sold in foreign countries.

Tax Reform to be Born?

You probably don’t need me to tell you that gridlock in Washington D.C. is alive and well, but new details surrounding potential tax reform legislation that surfaced last week has lifted short-term investor optimism. As you can see from the chart below, the U.S. has the highest corporate tax rate among 35 developed countries in the OECD (Organisation for Economic Co-operation and Development), thereby making U.S. business less competitive globally. In hopes of reversing this trend, a basic framework was introduced by the President that proposed a top corporate rate of 20%, top small business rate of 25%, and streamlined personal tax brackets of 12%, 25%, and 35% (down from 7 brackets). Other key elements of the tax plan include, a doubling of the standard deduction for middle-class Americans; the elimination of the estate tax for the wealthy; the repeal of the alternative minimum tax; and immediate tax write-offs for business capital investments.

Source: The Financial Times

Many other important details have yet to be released and further specifics remain to be negotiated on Capitol Hill. For example, the removal of deductions for state and local taxes was announced, however additional information explaining how the estimated $2.2 trillion in tax cuts will be funded has yet to surface.

Regardless of the tax reform outcome, the economy continues to chug along at a healthy clip. Most recently, Gross Domestic Product (GDP), the central statistic in measuring the health of the U.S. economy, was revised higher to a respectable +3.1% rate in the second quarter. The latest natural disasters may clip third quarter growth temporarily, however, the consensus remains the economic expansion stands on firm ground, despite the financial drag of the hurricanes.

While geopolitical, meteorological, and athletic anthem headlines have made this a “September to Remember,” fundamental strength and other factors have contributed to this enduring and unforgettable bull market. There will be many more noteworthy headlines to occur in coming months and years, but placing these events in the proper context and investing wisely will lead to a much more positive, memorable existence.

*The article was written before the Las Vegas tragedy on October 1, 2017.

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 EFX 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

 

October 2, 2017 at 1:08 pm Leave a comment

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