Posts tagged ‘emerging markets’

March Madness Leads to Gladness

jump ball

As usual, there was plenty of “madness” in March, and this year did not disappoint. Just as is the case with the annual NCAA basketball tournament, certain investors suffered the agony of defeat in the financial markets, but overall, the thrill of victory triumphed in March. So much so that the S&P 500 index posted its largest first-quarter gain in more than 20 years. Not only did the major indexes post gains for the month, but the winning record looks even better for the year-to-date results. For 2019, the S&P 500 index is up +13.1%; the Dow Jones Industrial Average +11.2%; and the tech-heavy NASDAQ index +16.5% for the year. The monthly gains in the major indexes were more muted, ranging from 0% for the Dow to +2.6% for the NASDAQ.

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While 2018 ended with a painful injury (S&P 500 -6.2% in Q4), on fears of a deteriorating China trade deal and a potentially overly aggressive Federal Reserve hiking interest rates, the stock market ultimately recovered in 2019 on changing perceptions. Jerome Powell, the Federal Reserve Chairman, indicated the Fed would be more “patient” going forward in increasing interest rates, and President Trump’s tweet-storm on balance has been optimistic regarding the chances of hammering out a successful trade deal with China.

With the new cautious Fed perspective on interest rates, the yield on the 10-Year Treasury Note fell by -0.28% for the quarter from 2.69% to 2.41%. In fact, investors are currently betting there is a greater than 50% probability the Fed will cut interest rates before year-end. Moreover, in testimony before Congress, Powell signaled the economic dampening policy of reducing the Fed’s balance sheet was almost complete. All else equal, the shift from a perceived rate-hiking Fed to a potentially rate-cutting Fed has effectively turned an apparent headwind into tailwind. Consumers are benefiting from this trend in the housing market, as evidenced by lower 30-year fixed mortgage rates, which in some cases have dropped below 4%.

Economy: No Slam Dunk

However, not everything is a slam dunk in the financial markets. Much of the change in stance by the Fed can be attributed to slowing economic growth seen both here domestically and abroad, internationally.

Here in the U.S., the widely followed monthly jobs number last month only showed a gain of 20,000 jobs, well below estimates of 180,000 jobs. This negative jobs surprise was the biggest miss in more than 10 years. Furthermore, the overall measure for our nation’s economic activity, growth in Gross Domestic Product (GDP), was revised downward to +2.2% in Q4, below a previous estimate of +2.6%. The so-called “inverted yield curve” (i.e., short-term interest rates are higher than long-term interest rates), historically a precursor to a recession, is consistent with slowing growth expectations. This inversion temporarily caused investors some heartburn last month.

If you combine slowing domestic economic growth figures with decelerating manufacturing growth in Europe and China (e.g. contracting Purchasing Managers’ Index), then suddenly you end up with a slowing global growth picture. In recent months, the U.S. economy’s strength was perceived as decoupling from the rest of the world, however recent data could be changing that view.

Fortunately, the ECB (European Central Bank) and China have not been sitting on their hands. ECB President Mario Draghi announced three measures last month that could cumulatively add up to some modest economic stimulus. First, it “expects the key ECB interest rates to remain at their present levels at least through the end of 2019.” Second, it committed to reinvesting all maturing bond principal payments in new debt “for an extended period of time.” And third, the ECB announced a new batch of “Targeted Long-Term Refinancing Operations” starting in September. Also, Chinese Premier Li Keqiang announced the government will reduce taxes, primarily Value Added Taxes (VAT) and social security taxes (SST). Based on the rally in equities, it appears investors are optimistic these stimulus efforts will eventually succeed in reigniting growth.

Volume of Political Noise Ratcheted Higher

While I continually try to remind investors to ignore politics when it comes to their investment portfolios, the deafening noise was especially difficult to overlook considering the following:

  • Mueller Report Completed: Robert Mueller’s Special Counsel investigation into potential collusion as it relates Russian election interference and alleged obstruction of justice concluded.
  • Michael Cohen Testifies: Former President Trump lawyer, Michael Cohen, testified in closed sessions before the House and Senate intelligence committees, and in public to the House Oversight Committee. In the open session, Cohen, admitted to paying hush money to two women during the election. Cohen called President Trump a racist, a conman, and a cheat but Cohen is the one heading to jail after being sentenced for lying to Congress among other charges.
  • Manafort Sentenced: Former Trump Campaign Chairman Paul Manafort was sentenced to prison on bank and tax fraud charges.
  • North Korea No Nuke Deal: In geopolitics,President Trump flew 21 hours to Vietnam to meet for a second time with North Korean leader Kim Jong Un on denuclearization of the Korean peninsula. The U.S. president ended up leaving early, empty handed, without signing an agreement, after talks broke down over sanction differences.
  • Brexit Drama Continues: The House of Commons in the lower house of the U.K. Parliament continued to stifle Prime Minister Theresa May’s plan to exit the European Union with repeated votes rejecting her proposals. Brexit outcomes remain in flux, however the European Union did approve an extension to May 22 to work out kinks, if the House can approve May’s plan.

Positive Signals Remain

March Madness reminds us that a big lead can be lost quickly, however a few good adjustments can also swiftly shift momentum in the positive direction. Although growth appears to be slowing both here and internationally, corporate profits are not falling off a cliff, and earnings remain near record highs (see chart below).

corp prof

Source: Calafia Beach Pundit

Similar to the stock market, commodities can be a good general barometer of current and future economic activity. As you can see from the chart below, not only have commodity prices remained stable in the face of slowing economic data, but gold prices have not spiked as they did during the last financial crisis.

gld v cmmd

Source: Calafia Beach Pundit

After 2018 brought record growth in corporate profits and negative returns, 2019 is producing a reverse mirror image – slow profit growth and record returns. The volatile ending to 2018 and triumphant beginning to 2019 is a reminder that “March Madness” does not need to bring sadness…it can bring gladness.

investment-questions-border

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 1, 2019). Subscribe on the right side of the page for the complete text.

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

April 1, 2019 at 1:37 pm Leave a comment

The Fed: Myths vs. Reality

Crystal Ball

Traders, bloggers, media talking heads, and pundits of all stripes went into a feverish sweat as they anticipated the comments of Federal Reserve Chairman Janet Yellen at the annual economic summit held in Jackson Hole, Wyoming. When Yellen, arguably the most dovish Fed Chairman in history, uttered, “I believe the case for an increase in the federal funds rate has strengthened in recent months,” an endless stream of commentators used this opportunity to spout out a never-ending stream of predictions describing the looming consequences of such a potential rate increase.

As I’ve stated before, the Fed receives both too much blame and too much credit for basically doing nothing except moving short-term interest rates up or down (and most of the time they do nothing). However, until the next Fed meeting in September (or later), we all will be placed in purgatory with non-stop speculation regarding the timing of the next rate increase.

The ludicrous and myopic analysis can be encapsulated by the recent article written by Pulitzer Prize-winning Fed writer Jon Hilsenrath, in his piece titled, The Great Unraveling: Fed Missteps Fueled 2016 Populist Revolt. Somehow, Hilsenrath is making the case that a group of 12 older, white people that meet eight times per year in Washington to discuss interest rate policy based on inflation and employment trends has singlehandedly created income inequality, and a populist movement leading to the rise of Donald Trump and Bernie Sanders.

While this Fed scapegoat explanation is quite convenient for the doom-and-gloomers (see The Fed Ate My Homework), it is way off base. I hate to break it to Mr. Hilsenrath, or other conspiracy theorists and perma-bears, but blaming a small group of boring bankers is an overly-simplistic “straw man” argument that does not address the infinite number of other factors contributing to our nation’s social and economic problems.

Ever since the bull market began in 2009, a pervasive skepticism and mistrust have kept the bull market climbing a wall of worry to all-time record levels. In the process, Hilsenrath et. al. have proliferated an inexhaustible list of myths about the Fed and its powers. Here are some of them:

Myth #1: The printing of money by the Fed has led to an artificially inflated stock market bubble and Ponzi Scheme.

  • As stock prices have more than tripled over the last eight years to record levels, I’ve reveled in the hypocrisy of the “money printers” contention. First of all, the money printing derived from Quantitative Easing (QE) was originally cited as the sole reason for low, declining interest rates and the rising stock market. The money printing community vociferously predicted once QE ended, as it eventually did in 2014, interest rates would explode higher and stock market prices would collapse. What happened? The exact opposite occurred. Interest rates have gone to record low levels, and stock prices have advanced to all-time record highs.

Myth #2: The Fed controls all interest rates.

  • Yes, the Fed can influence short-term interest rates through bond purchases and the targeting of the Federal Funds rate. However, the Fed has little-to-no influence on longer-term interest rates. The massive global bond market dwarfs the size of the Fed and U.S. stock market, and as such, large global financial institutions, pensions, hedge funds, and millions of other investors around the world have more influence on longer-term interest rates. The relationship between the 10-Year Treasury Note yield and the Fed’s monetary policy is loose at best.

Myth #3: The stock market will crash when the Fed raises interest rates.

  • Well, we can see that logic is already wrong because the stock market is up significantly since the Fed raised interest rates in mid-December 2015. It is true that additional interest rate hikes are likely to occur in our future, but that does not necessarily mean stock prices are going to plummet. Commentators and bloggers are already panicking about a potential rate hike in September. Before you go jump out a window, let’s put this potential rate hike into context. For starters, let’s not forget the “dove of all doves,” Janet Yellen, is in charge and there has only been one rate increase 0f 0.25% over the last decade. As I point out in one of my previous articles (see Fed Fatigue), stock prices increased during the last rate hike cycle (2004 – 2006) when the Fed raised  interest rates from 1.0% to 5.25% (the equivalent of another 16 rate hikes of 0.25%). The world didn’t end in 1994 either, when the Fed Funds rate increased from 3% to 6% over a short time frame, and stocks finished roughly flat for the period. Inflation levels remain at relatively low levels, and the Fed has moved less than 10% of recent hike cycles, so now is not the time to panic. Regardless of what the fear mongers say, the Fed and the bull market fairy godmother (Janet Yellen) will be measured and deliberate in its policies and will verify that any policy action is made into a healthy, strengthening economy.

Myth #4: Stimulative monetary policies instituted by the Fed and other central banks will lead to hyperinflation.

  • Japan has done QE for decades, and QE efforts in the U.S. and Europe have also disproved the hyperinflation myth. While commentators, pundits, and journalists like to all point and blame Janet Yellen and the Fed for today’s so-called artificially low interest rates, one does not need to be a genius to realize there are other factors contributing to low rates and inflation. Declining interest rates and inflation are nothing new…this has been going on for over 35 years! (see chart below) As I have discussed previously the larger contributors to declining interest rates and disinflation are technology, globalization, and emerging markets (see Why 0% Interest Rates?). By next year, over one-third of the world’s population is expected to own a smartphone (2.6 billion people), the equivalent of a supercomputer in the palm of their hands. Mobile communication, robotics, self-driving cars, virtual & augmented reality, drones, artificial intelligence, drones, biotechnology, and other technologies are dramatically impacting productivity (i.e., downward pressure on prices and interest rates). These advancements, combined with the billions of low-priced workers in emerging markets, who are lifting themselves out of poverty, are contributing to the declining rate/inflation trend.
Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

As the next Fed meeting approaches, there is no doubt the airwaves and internet will be filled with alarmist calls from the likes of Jon Hilsenrath and other Fed-haters. Fortunately, more informed financial market observers will be able to filter out this noise and be able to separate out the many Fed and interest rate myths from the reality.

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

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 27, 2016 at 8:15 pm 11 comments

E.M.s Want Cake & Eat It Too

Fancy Cake

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

Source: Financial Times

Source: Financial Times

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

Source: Financial Times

Source: Financial Times

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

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

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

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

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

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

investment-questions-border

www.Sidoxia.com 

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

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

Marathon Market Gets a Cramp

ganador maraton-02c

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

“Anyone can run a hundred meters, it’s the next forty-two thousand and two hundred that count.”

Investing is a lot like running a marathon…but it’s not a sprint to the retirement finish line. The satisfaction of achieving your long-term goal can be quite rewarding, but attaining ambitious objectives does not happen overnight. Along the hilly and winding course, there can be plenty of bumps and bruises mixed in with the elation of a runner’s high. While stocks have been running at a record pace in recent years, prices have cramped up recently as evidenced by the -2.6% decline of the S&P 500 stock index last month.

But the recent correction should be placed in the proper perspective as you approach and reach retirement. Since the end of the 2008 Financial Crisis the stock market has been racing ahead at a brisk rate, as you can see from the total return performance below (excluding 2015):

2009 - 2015 SP Performance

 

Long Term SP500 1925-2015

This performance is more indicative of a triumph than a catastrophe, but if you turned on the TV, listened to the radio, or surfed the web, you may come to a more frightening conclusion.

What’s behind the recent dip? These are some of the key concerns driving the recent price volatility:

  • China: Slowing growth in China and collapse in Chinese stock market. China is suffering from a self-induced slowdown designed to mitigate corruption, prick the real estate bubble, and shift its export-driven economy to a more consumer-driven economy. These steps diminish short-term growth (albeit faster than U.S. growth), but nevertheless the measures should be constructive for longer-term growth.
  • Interest Rates: Uncertainty surrounding the timing of a 0.25% target interest rate increase by the Federal Reserve. The move from 0% to 0.25% is like walking from the hardwood floor onto the rug…hardly noticeable. The inevitable move by the Fed has been widely communicated for months, and given where interest rates are today, the move will have a negligible impact on corporate borrowing costs. Like removing a Band-Aid, the initial action may cause some pain, but should be comfortably received shortly thereafter.
  • Politics: Potential government shutdown / sequestration. The epic political saga will never end, however, as I highlighted in “Who Said Gridlock is Bad?,” political discourse in Washington has resulted in positive outcomes as it relates to our country’s fiscal situation (limited government spending and declining deficits). The government shutdown appears to have been averted for now, but it looks like we will be blanketed with brinkmanship nonsense again in a few months.
  • Biotech/Pharmaceuticals: Politics over lofty drug prices and the potential impact of future regulation on the biotech sector. Given the current Congressional balance of power, any heavy-handed Democratic proposals is likely to face rigorous Republican opposition.
  • Emerging Markets: Emerging market weakness, especially in Latin America (e.g., Brazil). These developments deserve close monitoring, but the growth in the three largest economic regions (U.S., Europe, and China) will have a much larger effect on the direction of global economic expansion.
  • Middle East: Destabilized Middle East and Syria. Terrorist extremism and cultural animosity between various Middle East populations has existed for generations. There will be no silver bullet for a peaceful solution, so baby steps and containment are critical to maintain healthy global trade activity with minimal disruptions.

Worth noting, this current list of anxieties itemized above is completely different from six months ago (remember the Greece crisis?), and the list will change again six months into the future. Investing, like any competitive challenge, does not come easy…there is always something to worry about in the land of economics and geopolitics.

Here’s what the world’s top investor Warren Buffett said a few decades ago (1994) on the topic of politics and economics:

“We will continue to ignore political and economic forecasts which are an expensive distraction for investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.”

In a world of 7.3 billion people and 196 countries there will never be a shortage of fear, uncertainty, and doubt (F.U.D.) – see events chart in The Bungee Market. In an ever-increasing, globally connected world, technology and the media continually amplify molehills into mountains, thereby making the next imagined Armageddon a simple click of a mouse or swipe of a smartphone away.

Today’s concerns are valid but in the vast majority of cases the issues are completely overblown, sensationalized and over-emphasized without context. Context is an integral part to investing, but unfortunately context usually cannot be explained in a short soundbite or headline. On the flip side, F.U.D. thrives in the realm of soundbites and headlines.

While investors may feel fatigued from a strong flow of headline headwinds, financial market race participants should take a break at the water stop to also replenish themselves with a steady tailwind of positive factors, including the following:

  • Employment: The unemployment rate has been cut from a recession peak of 10.0% down to 5.1%, and the economy has been adding roughly +200,000 new monthly jobs on a fairly consistent basis. On top of that, there are a record 5.8 million job openings versus 3.7 million two years ago – a sign that the economy continues to hum along.
  • Housing/Commercial Real Estate/Mortgage Rates: Housing prices have rebounded by about +30% from the 2012 lows; Housing starts have increased by +25% in the past year and 120% in the past four years; and 30-Year Fixed mortgage interest rates sit at 3.85% – a highly stimulative level within a spitting distance from record lows.
  • Auto Sales: Surged to a post-recession record of 17.8 million units in August.
  • Interest Rates: Massively stimulative and near generational lows, even if the Fed hikes its interest rate target by 0.25% in October, December or sometime in 2016.
  • Capital Goods Orders: Up for three consecutive months.
  • Rail Shipments/Truck Tonnage: Both these metrics are rising by about 3-4%.
  • Retail Sales: Rising at a very respectable pace of 7% over the last six months.
  • Low Energy & Commodity Prices: Inflation has remained largely in check thanks to plummeting commodity prices. Low oil and gas prices are benefiting consumers in numerous ways, including the contribution to car sales, home sales, and/or debt reduction.

While the -10% dip in stock prices from mid-August might feel like a torn knee ligament, long-term investors know -10% corrections historically occur about one-time per year, on average. So, even though you may be begging for a wheelchair, the best course of action is to take a deep breath, stick to your long-term investment plan, rebalance your portfolio if necessary, and continue staying on course towards your financial finish line.

investment-questions-border

http://www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

October 3, 2015 at 9:55 am Leave a comment

Building Your All-Star NBA Portfolio

Player Attempting to Get Rebound --- Image by © Royalty-Free/Corbis

Image by © Royalty-Free/Corbis

You may or may not care, but the NBA (National Basketball Association) playoffs are in full swing. If you were an owner/manager of an NBA team, you probably wouldn’t pick me as a starting player on your roster – and if you did, we would need to sit down and talk. I played high school basketball (“played” is a loose term) in my youth, and even played in my early 40s against other over-aged veterans with knee braces, goggles, and headbands. Once my injuries began to pile up and my playing time was minimized by the spry, millennial team members, I knew it was time to retire and hang up my jockstrap.

The great thing about your investments is that you can create an All-Star NBA portfolio without the necessity of a salary market cap or billions of dollars like Mark Cuban. You can actually put the greatest professional players in the world (stocks/bonds) into your portfolio whether you invest $1,000 or $10,000,000. Sure, transactions costs can eat away at the smaller portfolios, but if investors are correctly managing their funds over years, and not months, then virtually everyone can create a cost-efficient elite team of stocks, bonds, and alternatives.

Now that we’ve established that anyone can create a championship caliber portfolio, the question then becomes, how does an owner go about selecting his/her team’s players? It may sound like a cliché, but diversification is paramount. Although centers Tim Duncan, Dwight Howard, Chris Bosh, Marc Gasol, and DeAndre Jordan may get a lot of rebounds for your team, it wouldn’t make sense to have those five starting centers on your team. The same principle applies to your investment portfolio.

Generally speaking, the best policy for investors is to establish exposure to a broad set of asset classes customized to your time horizon, risk tolerance, objectives, and constraints. In other words, it is prudent to have exposure to not only stocks and bonds, but other areas like real estate, commodities, alternatives, and emerging markets. Everybody has their own unique situation, and with interest rates and valuations continually changing, it makes sense that asset allocations across all individuals will be very diverse.

In basketball terms, the sizes and types of guards, forwards, and centers will be dependent on the objectives of the team’s owners/managers. For example,  it is very logical to have Stephen Curry (see great video) as the starting guard for the fast-paced, highest scoring NBA team, Golden State Warriors but Curry would not be ideally suited for the slow, grind-em-up offense of the Utah Jazz (one of the lowest scoring teams in the NBA).

In order to build a consistent winning percentage for your portfolio, you need to have a systematic, disciplined process of choosing your all-star-team, which can’t just consist of picking the hottest player of the day. Not only could it be too expensive, the consequences of over-concentrating your portfolio with an expensive position can be painful….just ask Los Angeles Laker fans how they feel about overpaying for Kobe Bryant’s $23.5 million 2014-2015 salary. Investors who chased the overpriced tech sector in the late 1990s, with stock prices trading at over 100 times trailing 12-month earnings, understand how painful losses can be in the subsequent “bubble” burst.

Having a strong bench of players is crucial as well. This requires a research process that can prioritize opportunities based on quantitative and fundamental processes (at Sidoxia we use our SHGR model). Sometimes your starters get injured, fatigued, or bought out by a competitor. Interest rates, valuations, exchange rates, earnings growth rates and other economic factors are continually fluctuating, so having a bench of suitable investment ideas is critical for different financial environments.

Beating the market is a challenging endeavor, not only for individuals, but also for professionals. If you don’t believe me, then check out what Dalbar had to say about this subject in its annual report entitled, Quantitative Analysis of Investor Behavior:

Dalbar found that in 2014, the average investor in a stock mutual fund underperformed the S&P 500 by a margin of 8.19 percent. Fixed-income investors underperformed the Barclays Aggregate Bond Index by a margin of 4.81 percent.

 

Ouch! If you want to generate winning returns matching the likes of the 1,000-win club, which includes Gregg Popovich, Phil Jackson, and Pat Riley then you need to avoid some of the most common investor mistakes (see also 10 Ways to Destroy Your Portfolio). Chasing performance, ignoring diversification, emotionally reacting to news headlines, paying high fees, and over-trading are sure fire ways to get technical fouls and ejected from the investment game. Avoiding these mistakes and following a systematic, objective process will make you and your investment portfolio a successful all-star.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

May 16, 2015 at 10:09 am Leave a comment

Here Comes the Great Rotation…Finally?

Carousel FreeImage

For decades interest rates have continually gravitated to zero like flies attracted to stink. For a split second in 2013, as long-term U.S. Treasury rates about doubled from 1.5% to 3.0% before reversing, it appeared the declining rate cycle could finally be broken. At the time, pundits of all types were calling for the “great rotation” out of bonds into stocks. Half of this forecast came to fruition as stocks grinded to record highs in 2014, but even I the big stock bull admittedly did not expect interest rates on 10-year Switzerland bonds to turn negative (see also Draghi QE Beer Goggles), especially after U.S. quantitative easing (QE) came to an end.

With rates already at a generational low, how could anyone be expected to accept a measly 0.3% annual return for a whole decade? Well, that’s exactly what’s happening in massive developed markets like Germany and Japan. While investors and retirees are painted into a corner by being forced to accept near-0% interest payments, savvy corporate borrowers are taking advantage of this once in a lifetime opportunity. Take for example the recently unprecedented $1.35 billion Switzerland bond issuance by Apple Inc. (AAPL), which included a tranche of bonds maturing in 2024 that yielded a paltry 0.25%.

With bonds offering lower and lower yield possibilities for investors of all stripes, at Sidoxia we are still finding plenty of opportunities in stocks, especially in high dividend-paying equity investments. In the U.S., the average S&P 500 stock is yielding approximately the same as the 10-Year Treasury Note (2.0%), but in other parts of the world, equity markets such as the following are offering significantly higher yields:

  • iShares MSCI Australia (Yield 5.0% – EWA)
  • Europe FTSE Europe (Yield: 4.6% – VGK)
  • Market Vectors Russia (Yield 4.6% – RSX)
  • iShares MSCI Brazil (Yield 4.0% – EWZ)
  • iShares MSCI Sweden (Yield 3.8% – EWD)
  • iShares MSCI Malaysia (Yield 3.8% – EWM)
  • iShares MSCI Singapore (Yield 3.4% – EWS)
  • iShares China (Yield 2.5% – FXI)

A New “Great Rotation” in 2015?

If you look at the 2014 ICI (Investment Company Institute) fund flow data, it becomes clear the great rotation out of bonds into U.S. stocks has not occurred. More specifically, despite the S&P 500 index reaching new record highs, -$60 billion flowed out of U.S. stock funds last year, and about +$44 billion flowed into all bond funds. Could the “great rotation” out of bonds into stocks finally happen in 2015? Certainly, this scenario is a possibility, but given the barren bond yield environment, perhaps the new “great rotation” in 2015 will be out of domestic equities into higher yielding international equity markets. In addition to the higher international market yields listed above, many of these foreign markets are priced more attractively (i.e., lower Price-Earnings (P/E) ratios) as you can see from the chart below created by strategist Dr. Ed Yardeni.

Source: Ed Yardeni - Dr. Ed's Blog

Source: Ed Yardeni – Dr. Ed’s Blog

Obviously, any asset shifting scenario is not mutually exclusive, and there could be a combination of investor reallocations made in 2015. It’s possible that previously unloved emerging markets and international developed markets could receive new investor capital from several areas.

With defensive sectors like utilities (up +25%) and healthcare (up +24%) leading the U.S. sector higher last year, it’s evident to me that “skepticism” remains the operative word in investors’ minds and there is no clear evidence of widespread euphoria hitting the U.S. stock market. Valuations as measured by trailing P/E ratios have objectively moved above historical averages, however this has occurred within the context of all-time record low interest rates and inflation. If you take into account the near-0% interest rate environment into your calculus, current stock prices (P/E ratios) are well within historical norms (see also The Rule of 20 Can Make You Plenty), which still leaves room for expansion.

If some of the half-glass full economic waters spill into the half-glass empty emerging markets/international markets, conceivably the eagerly anticipated “great rotation” out of bonds into U.S. stocks may also flow into even more attractively valued foreign equity opportunities.

Investment Questions Border

 

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL and certain exchange traded funds (ETFs) including VGK, EWZ, FXI,  but at the time of publishing SCM had no direct position in EWA, RSX, EWD, EWM, EWS, and 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 15, 2015 at 9:18 pm Leave a comment

Why 0% Rates? Tech, Globalization & EM (Not QE)

Globalization

Recently I have written about the head-scratching, never-ending, multi-decade decline in long-term interest rates (see chart below). Who should care? Well, just about anybody, if you bear in mind the structure of interests rates impacts the cost of borrowing on mortgages, credit cards, automobiles, corporate bonds, savings accounts, and practically every other financial instrument you can possibly think of. Simplistic conventional thinking explains the race to 0% global interest rates by the loose monetary Quantitative Easing (QE) policies of the Federal Reserve. But validating that line of thinking becomes more challenging once you consider QE ended months ago. What’s more, contrary to common belief, rates declined further rather than climb higher after QE’s completion.

10-Year Treasury Yields - Calafia 12-14

Source: Calafia Beach Pundit 

More specifically, if you look at rates during this same time last year, the yield on the 10-Year Treasury Note had more than doubled in the preceding 18 months to a level above 3.0%. The consensus view then was that the eventual wind-down of QE would only add gasoline to the fire, causing bond prices to decline and rates to extend an indefinite upwards march. Outside of bond guru Jeff Gundlach, and a small minority of prognosticators, the herd was largely wrong – as is usually the case. As we sit here today, the 10-Year Note currently yields a paltry 2.26%, which has led to the long-bond iShares 20-Year Treasury ETF (TLT)  jumping +22% year-to-date (contrary to most expectations).

The American Ostrich

Like an ostrich sticking its head in the sand, us egocentric Americans tend to ignore details relating to others, especially if the analyzed data is occurring outside the borders of our own soil. Unbeknownst to many, here are some key country interest rates below U.S. yields:

  • Switzerland: 0.33%
  • Japan: 0.34%
  • Germany: 0.60%
  • Finland: 0.70%
  • Austria: 0.75%
  • France: 0.88%
  • Denmark: 0.89%
  • Sweden: 0.98%
  • Ireland: 1.29%
  • Spain: 1.69%
  • Canada 1.80%
  • U.K: 1.85%
  • Italy: 1.93%
  • U.S.: 2.26% (are our rates really that low?)

Outside of Japan, these listed countries are not implementing QE (i.e., “Quantitative Easing”) as did the United States. Rather than QE being the main driver behind the multi-decade secular decline in interest rates, there are other more important disinflationary forces at work driving interest rates lower.

Technology, Globalization, and Emerging Market Competition (T.G.E.M.)

While tracking the endless monthly inflation statistics is a useful exercise to understand the tangible underlying pricing components of various industry segments (e.g., see 20 pages of CPI statistics), the larger and more important factors can be attributed to  the somewhat more invisible elements of technology, globalization, and emerging market competition (T.G.E.M).

CPI Components

Starting with technology, to put these dynamics into perspective, consider the number of transistors, or the effective horsepower, on a semiconductor (a.k.a. computer “chip”) today. The overall impact on global standards of living is nothing short of astounding. Take an Intel chip for example – it had approximately 2,000 transistors in 1971. Today, semiconductors can cram over 10,000,000,000 (yes billions – 5 million times more) transistors onto a single semiconductor. Any individual can look no further than their smartphone to understand the profound implications this has not only on pricing in general, but society overall. To illustrate this point, I would direct you to a post highlighted by Professor Mark J. Perry, who observed the cost to duplicate an iPhone during 1991 would have been more than $3,500,000!

There are an infinite number of examples depicting how technology has accelerated the adoption of globalization. More recently, events such as the Arab Spring point out how Twitter (TWTR) displaced costly military engagement alternatives. The latest mega-Chinese IPO of Alibaba (BABA) was also emblematic of the hunger experienced in emerging markets to join the highly effective economic system of global capitalism.

I think New York Times journalist Tom Friedman said it best in his book, The World is Flat, when he made the following observations about the dynamics occurring in emerging markets:

“My mom told me to eat my dinner because there are starving children in China and India – I tell my kids to do their homework because Chinese and Indians are starving for their jobs”.

“France wants a 35 hour work week, India wants a 35 hour work day.”

There may be a widening gap between rich and poor in the United States, but technology and globalization is narrowing the gap across the rest of the world. Consider nearly half of the world’s population (3 billion+ people) live in poverty, earning less than $2.50 a day (see chart below). Technology and globalization is allowing this emerging middle class climb the global economic ladder.

Poverty

These impoverished individuals may not be imminently stealing our current jobs and driving general prices lower, but their children, and the countless educated millions in other international markets are striving for the same economic security and prosperity we have. The educated individuals in the emerging markets that have tasted capitalism are giving new meaning to the word “urgency”, which is only accelerating competition and global pricing pressures. It comes as no surprise to me that this generational migration from the poor to the middle class is putting a lid on inflation and interest rates around the world.

Declining costs of human labor from emerging markets however is not the only issue putting a ceiling on general prices. Robotics, an area in which Sidoxia holds significant investments, continues to be an area of fascination for me. With human labor accounting for the majority of business costs, it’s no wonder the C-suite is devoting more investment dollars towards automation. Rather than hire and train expensive workers, why not just buy a robot? This is not just happening in the U.S. – in fact the Chinese purchased more robots than Americans last year. And why not? An employer does not have to pay a robot overtime compensation; a robot never shows up late; robots never sue for discrimination or harassment; robots receive no healthcare or retirement benefits; and robots work 24 hours/day, 7 days/week, and 365 days/year.

While newspapers, bloggers, and talking heads like to point to the simplistic explanation of loose, irresponsible monetary policies of global central banks as the reason behind a four decade drop in interest rates that is only a small part of the story. Investors and policy makers alike should be paying closer attention to the factors of technology, globalization, and emerging market competition as the more impactful dynamics systematically driving down long term interest rates and inflation.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions, including long positions in certain exchange traded fund positions and INTC (short position in TLT), but at the time of publishing SCM had no direct position in BABA, TWTR 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.

December 26, 2014 at 11:04 am 1 comment

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