Posts tagged ‘behavioral finance’

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

‘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

The Summer Heats Up

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

The temperature in the stock market heated up again this month. Like a hot day at the beach, the Dow Jones Industrial Average stock index burned +542 points higher this month (+2.5%), while scorching +2,129 points ahead in 2017 (or +10.8%).

Despite these impressive gains (see 2009-2017 chart below), overall, investors remain concerned. Rather than stock participants calmly enjoying the sun, breeze, and refreshingly cool waters of the current markets, many investors have been more concerned about getting sunburned to a geopolitical crisp; overwhelmed by an unexpected economic tsunami; and/or drowned by a global central bank-induced interest rate crisis.

Stock market concerns rise, but so do stock prices.

The most recent cautionary warnings have come to the forefront by noted value investor Howard Marks, who grabbed headlines with last week’s forewarning memo, “Here They Go Again…Again.” The thoughtful, 23-page document is definitely worth reading, but like any prediction, it should be taken with a pound of salt, as I point out in my recent article Predictions – A Fool’s Errand. The reality is nobody has been able to consistently predict the future.

If you don’t believe my skepticism about crystal balls and palm readers, just listen to the author of the cautionary article himself. Like many other market soothsayers, Marks is forced to provide a mea culpa on the first page in which he admits his predictions have been wrong for the last six years. His dour but provocative position also faces another uphill battle, given that Marks’s conclusion flies in the face of value investing god, Warren Buffett, who was quoted this year as saying:

“Measured against interest rates, stocks actually are on the cheap side compared to historic valuations.”

Rather than crucify him, Marks should not be singled out for this commonly cautious view. In fact, most value investors are born with the gloom gene in their DNA, given the value mandate to discover and exploit distressed assets. This value-based endeavor has become increasingly difficult as the economy gains steam in this slow but sustainably long economic recovery. As I’ve mentioned on numerous occasions, bull markets don’t die of old age, but rather they die from excesses. So far the key components of the economy, the banking system and consumers, have yet to participate in euphoric excesses like previous economic cycles due to risk aversion caused by the last financial crisis.

Making matters worse for value investors, the value style of investing has underperformed since 2006 alongside other apocalyptic predictions from revered value peers like Seth Klarman and Ray Dalio, who have also been proved wrong over recent years.

However, worth stating, is experienced, long-term investors like Marks, Klarman, and Dalio deserve much more attention than the empty predictions spewed from the endless number of non-investing strategists and economists who I specifically reference in A Fool’s Errand.

Beach Cleanup in Washington

While beach conditions may be sunny, and stock market geeks like me continue debating future market weather conditions, media broadcasters and bloggers have been focused elsewhere – primarily the nasty political mess littered broadly across our American shores.

Lack of Congressional legislation progress relating to healthcare, tax reform, and infrastructure, coupled with a nagging investigation into potential Russian interference into U.S. elections, have caused the White House to finally lose its patience. The end result? A swift cleanup of the political hierarchy. After deciding to tidy up the White House, President Trump’s first priority was to remove Sean Spicer, the former White House Press Secretary and add the controversial Wall Street executive Anthony Scaramucci as the new White House Communications Chief. Shortly thereafter, White House Chief of Staff Reince Priebus was pushed to resign, and he was replaced by Secretary of Homeland Security, John F. Kelly. If this was not enough drama, after Scaramucci conducted a vulgar-laced tirade against Priebus in a New Yorker magazine interview, newly minted Chief of Staff Kelly felt compelled to quickly fire Scaramucci.

While the political beach party and soap opera have been entertaining to watch from the sidelines, I continue to remind observers that politics have little, if any, impact on the long-term direction of the financial markets. There have been much more important factors contributing to the nine-year bull market advance other than politics. For example, interest rates, corporate profits, valuations, and investor sentiment have been much more impactful forces behind the new record stock market highs.

Federal Reserve Chair Janet Yellen may not wear a bikini at the beach, but nevertheless she has become quite the spectacle in Washington, as investors speculate on the future direction of interest rates and other Fed monetary policies (i.e., unwinding the $4.5 trillion Fed balance sheet). In the hopes of not exhausting your patience too heavily, let’s briefly review interest rates, so they can be placed in the proper context. Specifically, it’s worth noting the spotlighted Federal Funds Rate target is sitting at enormously depressed levels (1.00% – 1.25%), despite the fact the Fed has increased the target four times within the last two years. How low has the Fed Funds rate been historically? As you can see from the historical chart below (1970 – 2017), this key benchmark rate reached a level as high as 20.00% in the early 1980s – a far cry from today’s 1.00% – 1.25% rate.

There are two crucial points to make here. First, even at 1.25%, interest rates are at extremely low levels, and this is significantly stimulative to our economy, even after considering the scenario of future interest rate hikes. The second main point is that that Federal Reserve Chair Janet Yellen has been exceedingly cautious about her careful, data-dependent intentions of increasing interest rates. As a matter of fact, the CME Fed Funds futures market currently indicates a 99% probability the Fed will maintain interest rates at this low level when the Federal Open Market Committee (FOMC) meets in September.

Responsibly Have Fun but Use Protection

It’s imperative to remain vigilantly prudent with your investments because weather conditions will not always remain calm in the financial markets. You do not want to get burned by overheated markets or caught off guard by an unexpected economic storm. Blindly buying tech stocks exclusively without a systematic disciplined approach to valuation is a sure-fire way to lose money over the long-run. Instead, protection must be implemented across multiple vectors.

From a broader perspective, at Sidoxia we believe it’s essential to follow a low-cost, diversified, tax-efficient, strategy with a long-term time horizon. Rebalancing your portfolio as markets continue to appreciate will keep your investment portfolio balanced as financial markets gyrate. These investment basics have produced a winning formula for many investors, including some very satisfying long-term results at Sidoxia, which is quickly approaching its 10-year anniversary. You can have fun at the beach, just remember to bring sunscreen and a windbreaker, in case conditions change.

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.

August 1, 2017 at 12:16 pm Leave a comment

Hot Dogs, Political Fireworks, and Our Nation’s Birthday

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 3, 2017). Subscribe on the right side of the page for the complete text.

The 4th of July has arrived once again as we celebrate our country’s 241st birthday of independence. Besides being a time to binge on hot dogs, apple pie, fireworks, and baseball, this national holiday allows Americans to also reflect on the greatness created by our nation’s separation from the British Empire.

As our Founding Fathers fought for freedom and believed in a more prosperous future, I’m not sure if the signers of our Declaration of Independence (Below [left to right]: Roger Sherman, Benjamin Franklin, Thomas Jefferson, John Adams, and Robert Livingston) envisioned a world with tweeting Presidents, driverless Uber taxis, internet dating, biotechnology medical breakthroughs, cloud storage, and countless other innovations that have raised the standard of living for billions of people around the world.

(These Founding Fathers may use different pictures for their Facebook profile, if they were alive today.)

I tend to agree with the wealthiest billionaire investor on the planet, Warren Buffett, that being born in the United States is the equivalent of winning the “Ovarian Lottery.” The opportunities for finding success are exponentially higher, if you were born in America vs. Bangladesh, for example. Surprisingly, the U.S. only accounts for about 4% of the global population (325 million out of 7.5 billion world total). However, even though we Americans make up such a small portion of the of the people on the planet, we still manage to generate over $18 trillion in goods and services, which makes us the world’s largest economy. As the #1 economy, we account for almost 25% of the world’s total economic output (see table & graphic below).

Rank Country GDP (Nominal, 2015) Share of Global Economy (%)
#1 United States $18.0 trillion 24.3%
#2 China $11.0 trillion 14.8%
#3 Japan $4.4 trillion 5.9%
#4 Germany $3.4 trillion 4.5%
#5 United Kingdom $2.9 trillion 3.9%

Source: Visual Capitalist

How do we create six times the output of our population (i.e., 4% of world’s population producing 25% of the world’s output)? Despite the nasty, imperfect, mudslinging politics we live through daily, the U.S. has perfected the art of capitalism, which has landed us on top of the economic Mt. Everest. Although, there is always room for improvement, culturally, the winning “entrepreneurial” strain is born into our American DNA. The recent merger announcement between Amazon.com Inc. (AMZN) and Whole Foods (WFM), the leading natural and organic foods supermarket, is evidence of this entrepreneurial strain. Amazon has come a long way and gained significant steam since its founding in July 1994 by CEO Jeff Bezos. Consequently, the momentum of this internet giant has it steamrolling the entire retail industry, which has led to a flood of store closings, including department store chains, Macy’s, J.C. Penney, Sears and Kmart. The Amazon-Whole Foods merger announcement was not a huge surprise to my family because we actually order more than half of our groceries from AmazonFresh (Amazon’s food delivery program). What’s more, since I despise shopping, I continually find myself taking advantage of Amazon’s “Prime Now” 2-hour delivery option to my office, which is free to all Prime subscribers. It won’t be long before Amazon’s multi-channel strategy will allow me to make same-day orders for groceries, electronics, and general merchandise from my office, then pick up those items on my way home from work at the local Whole Foods store.

Leading the Pack

Replicating this competitive advantage around the world is a challenge for competing countries, and our nation remains leap years ahead of others, regardless of their efforts. However, the United States does not have a monopoly on capitalism. We are slowly exporting our entrepreneurial secret sauce abroad with the help of technology and globalization. Just consider these three Chinese companies alone are valued at almost $1 trillion (Alibaba Group $360B [BABA]; Tencent Holdings $340B [TCEHY]; and China Mobile $220B [CHL]), and the largest expected IPO (Initial Public Offering) in the world could be a Saudi Arabian company valued at $2 trillion (Saudi Aramco). When 96% of the world’s population lies outside of the U.S., this reality helps explain why exporting our advancements should not be considered a bad thing. In fact, a growing international pie means more American jobs and more dollars will flow back to the U.S., as we export more value-added products and services abroad.

Even if other countries are narrowing the entrepreneurial competitive gap with the United States, we still remain a beacon of light for others to follow. Despite what you may read in the newspaper or hear on the TV, Americans are dramatically better off financially over the last 20 years. Not only has net worth increased spectacularly, but consumers have also responsibly reduced debt leverage ratios (see chart below).

Source: Calafia Beach Pundit

If you were a bright CEO working for an innovative new start-up company, would you choose to launch your company in a closed, censored society like China? How about a fractured Britain that is pushing to break away from the European Union? Better yet, how about Japan with its exploding debt levels, a declining population, and a stock market that is about half the level it peaked at 28 years ago? Do emerging markets like Brazil with widespread corruption scandals blanketing a new president (after a recently impeached president) seem like the best location for a hot new venture? The answer to all these questions is a resounding “no”, even when compared to the warts and flaws that come with our durable democracy.

Political Pyrotechnics

Besides the bombs bursting in air during the 4th of July celebration, there were plenty of political fireworks blasting in our nation’s capital last month. No matter what side of the political fence you stand on, last month was explosive. Consider ousted FBI Director Jim Comey’s impassioned testimony relating to his firing by President Donald Trump; the contentious Attorney General Jeff Sessions Senate Intelligence Committee interview; the politically driven Republican baseball shooting; and the Special Counsel leader Robert Mueller’s investigation into Russian interference and potential Trump administration collusion into the 2016 elections.

Despite the combative atmosphere in Washington D.C., the stock market managed to notch another record high last month, with the Dow Jones Industrial Average index advancing another 340.98 points (+1.6%) for the month, and +8.0% for the first half of 2017. As I have written numerous times, the scary headlines accumulating since 2009 have prevented investors, strategists, economists, and even professionals from adequately participating in the almost quadrupling in stock prices since early 2009. Unfortunately, to the detriment of many, large swaths of investors who were burned by the 2008-2009 Financial Crisis have been scarred to almost permanent risk aversion. The fact of the matter is stock prices care more about economic factors than political / news headlines (see Moving on Beyond Politics).

The bitter, vitriolic political discourse is unlikely to disappear anytime soon, so do yourself a favor, and focus on the more important factors driving financial markets to new record highs – mainly corporate profits, interest rates, valuations, and sentiment (see Don’t Be a Fool). During this year’s 4th of July, partaking in hot dogs, apple pie, fireworks, and baseball are wholly encouraged, but please also take the time to celebrate and acknowledge the magnitude of our country’s greatness. That’s a birthday wish, I think we can all agree upon.

 

 

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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 WFM, BABA, TCEHY, CHL, 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.

July 3, 2017 at 12:24 pm Leave a comment

No April Fool’s Joke – Another Record

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 3, 2017). Subscribe on the right side of the page for the complete text.

Having children is great, but a disadvantage to having younger kids are the April Fool’s jokes they like to play on parents. Fortunately, this year was fairly benign as I only suffered a nail-polish covered bar of soap in the shower. However, what has not been a joke has been the serious series of new record highs achieved in the stock market. While it is true the S&P 500 index finished roughly flat for the month (-0.0%) after hitting new highs earlier in March, the technology-laden NASDAQ index continued its dominating run, advancing +1.5% in March contributing to the impressive +10% jump in the first quarter. For 2017, the NASDAQ supremacy has been aided by the stalwart gains realized by leaders like Apple Inc. (up +24%), Facebook Inc. (up +23%), and Amazon.com Inc. (up +18%). The surprising fact to many is that these records have come in the face of immense political turmoil – most recently President Trump’s failure to deliver on a campaign promise to repeal and replace the Obamacare healthcare system.

Like a broken record, I’ve repeated there are much more important factors impacting investment portfolios and the stock market other than politics (see also Politics Schmolitics). In fact, many casual observers of the stock market don’t realize we have been in the midst of a synchronized, global economic expansion, helped in part by the stabilization in the value of the U.S. dollar over the last couple of years.

Source: Investing.com

As you can see above, there was an approximate +25% appreciation in the value of the dollar in late-2014, early-2015. This spike in the value of the dollar suddenly made U.S. goods sold abroad +25% more expensive, resulting in U.S. multinational companies experiencing a dramatic profitability squeeze over a short period of time. The good news is that over the last two years the dollar has stabilized around an index value of 100. What does this mean? In short, this has provided U.S. multinational companies time to adjust operations, thereby neutralizing the currency headwinds and allowing the companies to return to profitability growth.

Source: Calafia Beach Pundit

And profits are back on the rise indeed. The six decade long chart above shows there is a significant correlation between the stock market (red line – S&P 500) and corporate profits (blue line). The skeptics and naysayers have been out in full force ever since the 2008-2009 financial crisis – I profiled these so-called “sideliners” in Get out of Stocks!.

As the stock market continues to hit new record highs, the doubters continue to scream danger. There will always be volatility, but when the richest investor of all-time, Warren Buffett, continues to say that stocks are still attractively priced, given the current interest rate environment, that goes a long way to assuage investor concerns.

Politically, a lot could still go wrong as it relates to healthcare, tax reform, and infrastructure spending, to name a few issues. However, it’s still early, and it’s possible positive surprises could also occur. More importantly, as I’ve noted before, corporate profits, interest rates, valuations, and investor sentiment are much more important factors than politics, and on balance these factors are on the favorable side of the ledger. These factors will have a larger impact on the long-term direction of stock prices.

With approval ratings of Congress and the President at low levels, investors have had trouble finding humor in politics, even on April Fool’s Day. Another significant factor more important than politics is the issue of retirement savings by Americans, which is no joke. As you finalize your tax returns in the coming weeks, it behooves you to revisit your retirement plan and investment portfolio. Inefficiently investing your money or outliving your savings is no laughing matter. I’ll continue with my disciplined financial plan and leave the laughing to my kids, as they enjoy planning their next April Fool’s Day prank.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, FB, 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.

April 3, 2017 at 12:03 pm Leave a comment

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