Posts tagged ‘GDP’
From Hard Landing to Soft Landing to No Landing?
I haven’t received my pilot’s license yet, but in trying to figure out whether the economy is heading for a hard landing, soft landing, or no landing, I’m planning to enroll in flight school soon! With the Federal Reserve approaching the tail end of an aggressive interest rate hiking cycle, investors have been bracing for a hard landing. However, with near record-low unemployment (3.4%) and multi-trillion dollars in government stimulus still working its way through the system, others see an economic soft landing. More recently, economic data has been flying in at an accelerating pace, which could mean the economy will stay in the air and have no landing.
For those waiting for an imminent recession, it looks like there could be a delay. In other words, bearish pessimists may be waiting at the gate longer than expected. As you can see in the chart below, economists at the Atlanta Federal Reserve are currently forecasting economic growth (GDP – Gross Domestic Product) to increase to a respectable +2.8% rate for the first quarter.
How have investors been interpreting this confusing array of landing scenarios? The stock market has stabilized and risen since last October (S&P +13.7%) but has also hit a temporary air pocket last month (-2.6%). Similarly, the Dow Jones Industrial Average has rebounded +13.9% since October, but pulled back further in February (-4.2%). As mentioned earlier, investors are having difficulty reading all the economic dials, instruments, and controls in the cockpit because there is no consensus on interest rates, inflation, economic growth, corporate earnings growth, and employment.
At the one end of the spectrum, you have a consumer who remains employed and willing to spend his/her savings accumulated during the pandemic. Case in point, air travel has hit pre-pandemic levels of 2019, despite business travelers staying at home conducting business on Zoom (see red line on chart below).
At the other end of the spectrum, we are witnessing the crippling effects that 7% mortgage rates can have on the $4 trillion real estate industry. As you can see from the chart below, sales of existing homes have plummeted at the fastest rate since the beginning of the 2008 Financial Crisis.
With all of that said, there is a consensus building that inflation is steadily coming down. Even the very skeptical and hawkish Federal Reserve Chairman, Jerome Powell, acknowledged that the “disinflationary process has begun.” We can see that in this inflation expectation chart below (green line), which measures the average anticipated inflation over the next five years by comparing the difference in yields between the five-year Treasury Notes and the five-year TIPS (Treasury Inflation Protection Securities).
Although, currently, there are many financial crosswinds swirling, the good news is that in the near-term, the economy has been maintaining its elevation and there is no imminent sign of a hard landing. We certainly could face the potential of turbulence and changing weather conditions, but that is always the case when you invest in the financial markets. If, however, inflation continues to move in the same direction, and growth continues to surprise on the upside, there may be no landing at all. Under this scenario of maintaining a comfortable altitude, I guess I can put my pilot training on hold.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Mar. 1, 2023). Subscribe Here to view all monthly articles.
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.
Recession Storm Fears Reign Supreme as Stocks Gain Steam
Commentators continue to shout the doom-and-gloom forecasts of a hard landing recession, but after an economic hurricane in 2022 there are some signs the financial clouds have begun to lift this year. The stock market has reflected this positive fundamental shift during January, as the S&P 500 catapulted +6.2%, NASDAQ +10.8%, and the Dow Jones Industrial Average +2.8%.
Last year, a major influencing cause to the -19% downdraft in the stock market (S&P 500) was due to the highest inflation readings experienced in four decades, compounded by a Federal Reserve hell-bent on slamming on the interest rate brakes. A big contributing factor to the surge in inflation was the spike in consumer spending fueled by trillions in government stimulus, coupled with widespread shortages in goods triggered by supply chain disruptions.
Fortunately, the headwinds of inflation now appear to be abating. Recently released inflation figures showed core inflation dropping from a peak of 9.1% last year to 3.5% in the fourth quarter (see chart below). Although the Fed will likely raise its interest rate target by 0.25% up to 4.75% this week, the downward reversal in inflation has raised the probabilities of the Federal Reserve “pausing” or “pivoting” on the direction of previous rate hikes. The odds of a halt or cut in rates will likely only increase if the descending trajectory of inflation persists and other upcoming economic data weaken further.
No Signs of Recession…Yet. Investors Waiting for Another Flood
While the calls for a hard economic landing remain, healthy GDP growth (+2.9% in Q4), generationally low unemployment (3.5%), and relatively stable earnings (see chart below) all point to a stable economy with the ability to navigate a soft landing. China’s new reopening of the economy and Europe’s seeming ability of dodging a recession provide additional evidence for a soft landing scenario.
As you can see further from the 25-year earnings chart above, the drop in S&P 500 earnings in recent months has been fairly modest compared to previous downturns, and the forecast for 2023 earnings is currently estimating a modest gain on a year-over-year basis. Over the last 25 years, we have arguably experienced three 100-year floods (2000 Tech Bubble, 2008 Financial Crisis, and 2020 COVID pandemic), so investors have been bracing for another enormous financial hurricane.
Although the bursting of the 2000 Tech Bubble had an outsized impact on the technology sector, the effect on the overall economy was more muted, as you can observe from the shallow decline in the earnings. As the earnings show, during the Financial Crisis (2008) and COVID (2020), the crash in earnings was much more severe. Thus far in 2023, there has been no earnings plummet or sign of recession, and if financial conditions continue to soften, there is no reason we couldn’t undergo a more vanilla, garden-variety recession like we did in 1990 and 2000.
Stairs & Elevators
While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023. However, as you can notice below, history over the last 70 years shows the duration of bull markets (average of about 6 years) are much longer than bear markets (approximately 1 year). I like to compare bull markets to walking up stairs in a tall building, and bear markets to going down an elevator. The main difference is that the stock market elevator generally never goes to the bottom floor and the stairs keep growing to record heights over the long-run. Since World War II, Americans have experienced 13 economic recessions (see also Recession or Mental Depression?). Not only are investors batting 1,000% in successfully surviving these recessions, they have thrived. From 1956 until the present, the S&P 500 has vaulted approximately 80-fold.
Presently, economic skies might not all be clear, blue, and sunny, but the fact that inflation is dropping, our economy is still growing, labor markets remain healthy, China has reopened for business, and Europe hasn’t cratered all leave room for optimism. It may not be time to bust out the sunscreen quite yet, but the dark economic clouds of 2022 appear to be lifting slowly.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Feb. 1, 2023). Subscribe Here to view all February articles.
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.
New Year, New Clean Slate
Stock and bond market returns in 2022 were disappointing, but we now get to start 2023 with a clean slate. Before we turned the page on another annual chapter, Santa Claus chose to finish last year by placing a lump of coal in investor stockings, as evidenced by the S&P 500 index decline of -5.9% during December.
Good News & Bad News
There is some good news and bad news as it relates to this year’s underwhelming stock market results (-19.4%). The bad news is last year turned out to be the 4th worst year in the stock market since World War II (1945) and also marked the worst year since 2008. Here’s a summary of the S&P 500’s worst years over the last eight decades:
2008: -38.5%
1974: -29.7%
2002: -23.4%
2022: -19.4%
Source: CNBC (Bob Pisani)
The good news is that the stock market is up 81% of the time in subsequent years following down years. The average increase in bounce-back years is +14%. In another study of down years, the analysis showed that after the stock market has fallen -20% or more, stock prices were higher on average by +15% one year later, +26% two years later, and +29% three years later. Nothing is guaranteed in life, but as Mark Twain famously stated, “History does not repeat itself, but it often rhymes.”
2022: The Year of No Shock Absorbers (Worst Bond Market Ever)
The stock market receives most of the media glory and reporting, however the bond market is the Rodney Dangerfield of asset classes, it “gets no respect.” Typically, during weak stock markets (i.e., “bear markets”), the bond or fixed income investments in a diversified portfolio act as shock absorbers to cushion the blow of volatile stock prices. More specifically, in a typical bear market, the economy generally slows down causing demand to decelerate, and interest rates to decline, which causes the values of bonds to increase. Therefore, as stock prices decline, the gains from bonds in your portfolio usually help offset stock losses. Unfortunately, this scenario didn’t happen in 2022, but rather investors experienced a double negative whammy. Not only did stocks experience one of its worst years in decades, the bond market also suffered what many pundits are describing as the “Worst Bond Market Ever” – see chart below.
Why in particular did bonds perform so poorly this year, when they commonly outperform in slow or recessionary economic conditions? For starters, interest rates spent most of 2022 increasing at the fastest pace in more than four decades (see chart below). An unanticipated rise in inflation was the main culprit, which was caused by spiking energy prices from Russia’s invasion of Ukraine; COVID-related supply chain disruptions; unprecedented fiscal stimulus (trillions of dollars in infrastructure spending and incentives); record monetary stimulus (QE – Quantitative Easing); and extended years of ZIRP (Zero Interest Rate Policy). For these reasons, and others, bonds collapsed in sympathy with deteriorating stock prices.
Room for Optimism in 2023
Last year was challenging, however, not all is lost. The Federal Reserve, inflation, interest rates, Ukraine, and cryptocurrency volatility (e.g., Bitcoin down -64% in 2022) dominated headlines this year, but many of these headwinds could abate or reverse in 2023. For example, there are numerous indicators pointing to peaking and/or declining inflation, which, if true, could create a tailwind for investors this year. Bolstering this argument are the current weakening trends we are witnessing in the housing market, which should ripple through the economy to cool inflation (see chart below).
And if it’s not declining home prices, lower energy prices have also filtered through the global economy to lower transportation and shipping costs (e.g., freight rates from China to West Coast are down -90%). What’s more, a stronger dollar has contributed to declining commodity prices as well.
Although inflation still has a long way to go before reaching the Federal Reserve’s 2% target rate, broad inflation measures, such as the GDP Deflator, are showing a significant decrease in inflation (see chart below). By analyzing the various disinflationary tea leave markers, we can gain some confidence regarding future interest rates. Observing the fastest rate hike cycle by the Fed in decades informs us that we are likely closer to an end of rate hikes (i.e., pause or cut), rather than the beginning. If correct, tamer inflation means 2023 could prove to be a better environment for both stock and bond investors.
In summary, last year was painful across the board, but investors are starting this year with a clean slate and signs are pointing to a potential reversal in inflation and interest rate headwinds. With the change of the calendar, a messy 2022 could turn into a spick-and-span 2023.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Jan. 3, 2023). 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.
Fed Ripping Off the Inflation Band-Aid
Inflation rates have been running near 40-year highs, and as a result, the Federal Reserve is doing everything in its power to rip off the Band-Aid of insidious high price levels in a swift manner. The Fed’s goal is to inflict quick, near-term pain on the economy in exchange for long-term price stability and future economic gains. How quickly has the Fed been hiking interest rates? The short answer is the rate of increases has been the fastest in decades (see chart below). Essentially, the Federal Reserve has pushed the targeted benchmark Federal Funds target rate from 0% at the beginning of this year to 3.25% today. Going forward, the goal is to lift rates to 4.4% by year-end, and then to 4.6% by next year (see Fed’s “dot plot” chart).
How should one interpret all of this? Well, if the Fed is right about their interest rate forecasts, the Band-Aid is being ripped off very quickly, and 95% of the pain should be felt by December. In other words, there should be a light at the end of the tunnel, soon.
The Good News on Inflation
When it comes to inflation, the good news is that it appears to be peaking (see chart below), and many economists see the declining inflation trend continuing in the coming months. Why do pundits see inflation peaking? For starters, a broad list of commodity prices have declined significantly in recent months, including gasoline, crude oil, steel, copper, and gold, among many others.
Outside of commodities, investors have seen prices drop in other areas of the economy as well, including housing prices, which recently experienced the fastest monthly price drop in 11 years, and rent prices as well (see chart below).
Anybody who was shopping for a car during the pandemic knows what happened to pricing – it exploded higher. But even in this area, we are seeing prices coming down (see chart below), and CarMax Inc. (KMX), the national used car retail chain confirmed the softening price trend last week.
Pain Spread Broadly
When interest rates increase at the fastest pace in 40 years, pain is felt across almost all asset classes. It’s not just U.S. stocks, which declined -9.3% last month (S&P 500), but it’s also housing -8.5% (XHB), real estate investment trusts -13.8% (VNQ), bonds -4.4% (BND), Bitcoin -3.1%, European stocks -10.1% (VGK), Chinese stocks -14.4% (FXI), and Agriculture -3.0% (DBA). The +17% increase in the value of the U.S. dollar this year against a basket of foreign currencies is substantially pressuring cross-border business for larger multi-national companies too – Microsoft Corp. (MSFT), for example, blamed U.S. dollar strength as the primary reason to cut earnings several months ago. Like Hurricane Ian, large interest rate increases have caused significant damage across a wide swath of areas.
But for those following the communication of Federal Reserve Chairman, Jerome Powell, in recent months, they should not be surprised. Chairman Powell has signaled on numerous occasions, including last month at a key economic conference in Jackson Hole, Wyoming, that the Fed’s war path to curb inflation by increasing interest rates will inflict wide-ranging “pain” on Americans. Some of that pain can be seen in mortgage rates, which have more than doubled in 2022 and last week eclipsed 7.0% (see chart below), the highest level in 20 years.
Now is Not the Time to Panic
There is a lot of uncertainty out in the world currently (i.e., inflation, the Fed, Russia-Ukraine, strong dollar, elections, recession fears, etc.), but that is always the case. There is never a period when there is nothing to be concerned about. With the S&P 500 down more than -25% from its peak (and the NASDAQ down approximately -35%), now is not the right time to panic. Knee-jerk emotional decisions during stressful times are very rarely the right response. With these kind of drops, a mild-to-moderate recession is already baked into the cake, even though the economy is expected to grow for the next four quarters and for all of 2023 (see GDP forecasts below). Stated differently, it’s quite possible that even if the economy deteriorates into a recession, stock prices could rebound smartly higher because any potential future bad news has already been anticipated in the current price drops.
Worth noting, as I have pointed out previously, numerous data points are indicating inflation is peaking, if not already coming down. Inflation expectations have already dropped to about 2%, if you consider the spread between the yield on the 5-Year Note (4%) and the yield on the 5-Year TIP-Treasury Inflation Protected Note (2%). If the economy continues to slow down, and inflation has stabilized or declined, the Federal Reserve will likely pivot to decreasing interest rates, which should act like a tailwind for financial markets, unlike the headwind of rising rates this year.
Ripping off the Band-Aid can be painful in the short-run, but the long-term gains achieved during the healing process can be much more pleasurable.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in MSFT, BND and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in KMX, XHB, VNQ, VGK, FXI, DBA 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.
Even Winning Teams Occasionally Lose
The stock market has been a winning team for years, generating outsized returns for investors. But so far this year, the winning streak appears to be coming to an end. For 2022, the S&P 500 index is down -21%, including -8% last month. However, since 2008, the stock market has generally been on a consistent tear racking up a record of 10 wins, 2 losses (2015 and 2018), and one tie (2011). In recent years, the U.S. stock market has been winning by a large margin (2019: +29%, 2020: +16%, 2021: +27%) and a significant contributor to the team’s win streak has been the Federal Reserve, or the designated hitter (DH).
Jerome Powell, the Fed Chair, has been a very effective clean-up hitter for the stock market, not only leading the stock market team to victories, but also appreciation in almost all global-risk asset classes. By keeping interest rates (the Federal Funds Rate target) essentially at 0% over the last few years, since the initial COVID pandemic outbreak, many investors are blaming Mr. Powell for elevated inflation rates. If that were truly the case, then we probably wouldn’t see the ubiquitous inflation globally, as we do now. Just as you would expect with any baseball team, any single player does not deserve all the credit for wins, nor should any single player receive all the blame for losses – the same principle applies to the Federal Reserve.
Regardless, the stock market’s best hitter is now injured. In addition to pushing interest rates higher, the Fed is hurting the team through its monetary policy of quantitative tightening or QT (i.e., selling bonds off the Fed’s balance sheet). Theoretically, QT should cause interest rates to move higher, all else equal, and thereby slow down growth in the economy, and help tame out-of-control inflation.
The stock market was also thrown a curve ball when Russia invaded Ukraine, which added gasoline to an already flaming inflation fire. Globally, consumers and businesses have witnessed exploding oil/gasoline prices, in addition to escalated food prices caused by a lack of grain and other commodity exports out of Ukraine.
Lastly, a wild pitch has been thrown at the U.S. stock market by China with its zero-COVID policy, which has essentially shut down the world’s 2nd largest economy and further delayed the full reopening of the global economic game. As a result of China’s hardline lockdown stance, global supply chain disruptions have intensified and import prices have mushroomed higher.
Although this all sounds like horrible news, in the game of investing, nobody wins all the time. As history teaches us, the stock market is generally up around 70% of the time. It just happens to be that we are in the middle of a 30% losing period.
Bad News Does Not Mean Bad Stock Market
The majority of economists, strategists, and talking heads on television are forecasting a recession in our economy, either this year or next. This should come as no surprise to any experienced investor, as history teaches us that recessions occur on average about twice every decade. Long-term investors also understand that stock prices do not always just go up on good news and down on bad news. Stocks can go down on good news, and up on bad news. In fact, over the last 13 years, since the bottom of the 2008-2009 financial crisis, the stock market has increased about six-fold (even after this year’s -21% correction) in the face of some horrendously scary headlines (also see chart below):
· Ukraine-Russia
· COVID
· Elections / Capitol Insurrection
· Exit from Afghanistan
· Impeachment
· China Trade War & Tariffs
· Inverted Yield Curves
· N. Korea Missile Launches
· Brexit
· ISIS in Iraq
· Ebola
· Russia Takeover of Crimea
· Double Dip Recession Fears
· Eurozone Debt Crisis
S&P 500 Index (1997 – 2022)
Despite the recent headwinds in the stock market, not all the news is bad. Here are some tailwinds:
- PROFITS: Corporate profits remain at or near record levels.
- INFLATION: Inflation appears to be cooling as evidenced by declining commodity prices (TR Commodities CRB Index).
CRB Commodities Index (2022)
- PRICES: Valuations have come down significantly – Price/Earnings ratio of 15.9 (i.e., stock prices are on sale).
- SENTIMENT: Sentiment remains fearful – a contrarian buy indicator (an elevated VIX – Volatility Index can signal buying opportunities). As Warren Buffett says, “Be fearful when others are greedy, and greedy when others are fearful.”
VIX – Volatility Index (2021 – 2022)
Even though the U.S. stock market has been a long-term winner, investors have been betting against the winning team by selling stocks. As mentioned earlier, recessions, if we get one, are common and nothing new. The -21% correction in stock prices is already factoring in a mild recession, so we have already suffered near-maximum pain. Could prices go lower? Certainly. But should you quit a 26-mile marathon at mile 25 because the pain is too intense? In most instances, the answer should absolutely be “no” (see also No Pain, No Gain). Eventually, the Fed will stop raising interest rates, inflation will cool, the Russia-Ukraine war will be resolved, and solid growth will return. While many people are betting the stock market will lose this year, many long-term investors recognize betting on stock market success is a winning strategy over the long-run, especially when prices are on sale.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
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 BRKA/B 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.
Bad Weather Coming: Hurricane or Drizzle?
It was a stormy month in the stock market, but the sun eventually came out and the Dow Jones Industrial Average rallied more than 2,300+ points before eking out a small gain (up +0.04%) and the S&P 500 index also posted an incremental increase (+0.005%). But there are clouds on the horizon. Although the economy is currently very strong (i.e., record corporate profits and a generationally low unemployment rate of 3.6% – see chart below), some forecasters are predicting a recession during 2023 as a result of the Federal Reserve pumping the brakes on the economy by increasing interest rates, in addition to elevated inflation, supply chain disruptions, COVID lockdowns in China, and a war between Russia and Ukraine.
UNEMPLOYMENT RATE (1997 – 2022)
But like weather forecasters, economists are perpetually unreliable. While some doomsday-er economists are expecting a deeply destructive hurricane (deep recession), others are only seeing a mild drizzle (soft landing) developing. The truth is, nobody knows for certain at this point, but what we do know is that the correction in stock prices this year (-13% now and -20% two weeks ago) has already significantly discounted (factored in) a mild recession. In other words, even if a mild recession were to occur in the coming months or quarters, there may be very little reaction or negative consequences for investors. Similarly, if inflation begins to be peaking as it appears to be doing (see chart below), and the Fed can orchestrate a soft landing (i.e., raise interest rates and reduce balance sheet debt without crippling the economy), then substantial rewards could accrue to stock market investors. On the flip side, if the economy were to go into a deep recession, history would suggest this stormy forecast might result in another -10% to -15% of chilliness.
INFLATION RATE (%)
Due to trillions of dollars in increased stimulus spending and Federal Reserve Quantitative Easing (bond buying), we experienced an explosion in the government deficit and surge in money supply growth (i.e., the root cause for swelling inflation). Arguably, some or all of these accommodations were useful in surviving through the worst parts of the COVID pandemic, however, we are paying the price now in sky-high food costs, explosive gasoline prices, and expanding credit card bills. The good news is the deficit is plummeting (see chart below) due to a reduction in spending (due in part to no Build Back Better infrastructure spending legislation) and soaring income tax receipts from a strengthening economy and capital gains in the stock market.
MONEY SUPPLY GROWTH% (M2) VS. GOVERNMENT DEFICIT
For many investors, getting used to large multi-year gains has been very comfortable, but interpreting downward gyrations in the stock market can be very confusing and counterintuitive. In short, attempting to decipher the reasons behind the short-term zigs and zags of the market is a fool’s errand. Not many people predicted a +48% gain in the stock market during a global pandemic (2020-2021), just like not many people predicted a short-lived -20% reduction in the stock market during 2022 as we witnessed record-high corporate profits and unemployment rates hovering near generational lows (3.6%).
Stock market veterans understand that stock prices can go down when current economic news is sunny but future expectations are too high. Experienced investors also understand stock prices can go up when the current economic news may be getting too cloudy but future expectations are too low.
Apparently, the world’s greatest investor of all-time thinks that all this gloomy recession talk is creating lots of stock market bargains, which explains why Buffett has invested $51 billion of his cash at Berkshire Hathaway as the stock market has gotten a lot more inexpensive this year. So, while the economy will likely face a number of headwinds going into 2023, it doesn’t mean a hurricane is coming and you need to hide in a bunker. If you pull out your umbrella and rain gear, just like smart investors do during all previous challenging economic cycles, the drizzle from the storm clouds will eventually pass and blue skies shall reappear.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2022). 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 BRK.B/A 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.
From Rocket Ship to Roller Coaster
The stock market has been like a rocket ship over the last three years 2019/2020/2021, advancing +90% as measured by the S&P 500 index, and +136% for the NASDAQ. After this meteoric multi-year rise, stock values started to come back to earth in 2022, and the rocket ship turned into a roller coaster during January. More specifically, the S&P 500 fell -5% for the month and the NASDAQ -9%. Yes, it’s true volatility has increased, and your blood pressure may have risen with all the ups and downs. However, the fact remains the economy remains strong, corporate profits are at record levels, unemployment is low, and interest rates remain at attractive levels despite nagging inflation (see chart below) and the removal of accommodative monetary policies by the Federal Reserve.
Math Matters
I did okay in school and was educated on many different topics, including the basic principle that math matters. This notion rings especially true when it comes to finance and investing. As I have discussed numerous times in the past, money goes where it is treated best, which is why interest rates, cash flows, and valuations play such a key role in ultimately determining long-term values across all asset classes. This concept of money seeking the best home applies equally to stocks, bonds, real estate, commodities, crypto-currencies, and any other asset class you can imagine because interest rates help determine the cost of holding and using money.
Normally, mathematics teaches us the lesson that more is better when discussing financial matters. And currently the stock market is compensating investors significantly more for investing in stocks relative to investing in bonds – I have reviewed this concept repeatedly on my Investing Caffeine blog (see Going Shopping: Chicken vs. Beef ). Currently, investors are getting paid about +5% to hold stocks based on the forward earnings yield (i.e., the inverse of the stock market’s Price-Earnings ratio of 20x) vs. the +2% yield on the 10-Year Treasury Note (1.78% more precisely on 1/31/22). What’s more, historically speaking, stock investors typically get rewarded with an earnings yield that doubles about every 10 years, whereas bond yields usually remain stagnantly flat, if bonds are held until maturity.
With that said, I am always quick to point out that diversification in a portfolio is important (i.e., most people should at least own some bonds), even if bonds are currently very expensive relative to other asset classes (see Sleeping on Expensive Financial Pillows). If bond yields climb significantly to the point where returns are more competitive with stocks, I will likely be buying significantly more bonds for me and my Sidoxia (www.sidoxia.com) clients.
Fed Jitters
The recent stock market volatility is reinforcing the idea that the Federal Reserve’s more aggressive stance regarding hiking interest rates is making many investors very anxious – just not me. I have lived through many tightening cycles in my lifetime and lived to tell the tale. It is true that all else equal, higher interest rates generally depress asset values, but it is also important to place the current interest rate environment in historical context. Although the Federal Funds interest rate target is expected to increase to 2.5% over the next few years (currently at 0%), this forecast is nothing new and there is no guarantee the Fed can successfully pull off this feat. Many people have short memories and forget the Fed hiked interest rates 10 times from the end of 2015 through 2018. In the face of this scary period, the stock market (S&P 500) still managed to approximately climb a respectable +22% (albeit with some volatility). Furthermore, if you give the Fed the benefit of the doubt of achieving this uncertain target, this 2.5% level is very appealing and still extremely low, historically speaking (see chart below).
When discussing interest rates and inflation, investors should also expand their views globally to the other 95% of the world’s population. Many investors are very myopic in their focus on U.S. interest rates. It is important to understand that rates are not just low here in the United States, but also low almost everywhere else as well. While international interest rates have bounced marginally higher in recent months, those countries’ long-term international rates, by and large, remain tremendously low too – in most cases even lower than rates in the U.S. (see chart below). Yes, the Fed has some control over short-term interest rates in the U.S., but considering other crucial forces that are depressing long-term global rates is worth pondering. Factors such as globalization and the pervading expansion of deflationary technology into our personal and work lives are contributing to disinflation. Valuable conclusions can be synthesized beyond digesting the pessimistic and nauseating analysis of Jerome Powell’s Congressional testimony, along with the needless wordsmithing of recent Fed minutes.
In order to earn above-average, financial returns in your portfolio over the long-run, experiencing unsettling volatility and corrections is the price of doing business. Flying on rocket ships might be fun, but sometimes the rocket can run out of gas, and you are forced to jump on a roller coaster. The ups-and-downs can be frustrating at times, but if you stay on for the full ride, you will almost always end with a smile on your face when it’s over.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2022). 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 PFE 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.
No Red Blood, Just Green Flood
Normally, investors equate the month of October with scary, blood-curdling screams because horrifying losses during the 1929 and 1987 crashes occurred during this month. Fortunately, for those invested in stocks, they experienced the opposite this last month – a flood of green (new all-time record highs), despite a whole host of frightening factors, including the following:
· Inflation
· Supply chain disruptions
· Federal Reserve monetary policy
· COVID variants
· Evergrande’s impact on China and commercial real estate
· Cryptocurrency volatility
· Expanding government deficits and debt (stimulus/infrastructure)
· Government debt ceiling negotiations
· Declining corporate profit margins
· Meme stocks
· And more…boo!
Even though this Halloween season has introduced these many spooky fears, investors still experienced a sugar-high during October. More specifically, the S&P 500 catapulted +6.9% this month (+22.6% Year-to-Date), Dow Jones Industrial Average +5.8% (+17.0% YTD); and NASDAQ +7.3% (+20.3% YTD). With the COVID Delta variant subsiding (see chart below), economic activity rising (Q4 GDP is estimated at +4.8%), and corporate profits going gang busters (33% growth and 84% of corporations are beating Q3 estimates), it should come as no surprise that stock market values continue to rise.
As I mention regularly to my readers, there is never a shortage of things to worry about when it comes to your investments, money, and savings. Emotions tend to highjack rational reasoning as non-existent boogeymen scare people into do-nothing decision-making or suboptimal choices. Investing for the long-run requires dedication and discipline, and if you do not have the time and fortitude to do so, it behooves you to find an experienced, independent professional to assist you.
Rather than getting spooked by supply chain fears and inflation plastered all over the newspapers and media outlets, the real way to compound wealth over the long-term is to do what Warren Buffett says, and that is “buy fear, and sell greed.” Unfortunately, our Darwinian instincts embedded in our DNA are naturally designed to do the contrary…”buy greed, and sell fear.” The goal is to buy low and sell high (not buy high and sell low).
Yes, it’s true that over the last year, semiconductor lead times have almost doubled to 22 weeks, and Chinese container shipping costs have about increased 10-fold to over $20,000 (see charts below). However, the economic laws of supply and demand remain just as true today as they did in 1776 when Adam Smith wrote Wealth of Nations (see also Pins, Cars, Coconuts & Chips). Chip makers are building new fabs (i.e., manufacturing plants) and worker shortages at the ports and truck driver deficiencies are slowly improving. Supply scarcity and higher prices may be with us for a while, but history tells us betting against capitalism isn’t a wise decision.
Not worrying about all the economic goblins and witches can be difficult when contemplating your investments and savings. Nevertheless, as I have consistently reminded my investors and readers, the key pillars to understanding the health of the investment environment are the following (see also The Stool):
· Interest rates
· Earnings (Corporate profits)
· Valuations (How cheap or expensive is the market?)
· Sentiment (How greedy or fearful are investors?)
The good news is that a) interest rates are near historically low levels; b) corporate profits are on a tear (+33% as mentioned above); c) valuations have come down because profits have grown faster than stock price appreciation; and d) sentiment remains nervous (a good thing) as measured by the massive inflows going into low (negative) yielding bonds. If you consider all these elements, one should not be surprised that we are at-or-near all-time record highs. Obviously, these investment pillars can reverse directions and create headwinds for investors. Until then, don’t be startled if there is more green flood rather than red blood.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 1, 2021). 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.
A Better Mousetrap
How do you earn better investment returns for your retirement? The short answer: You must find a better mousetrap.
In the current economic environment, finding a better mousetrap to prevent infestations inside your investment portfolio can be a challenge. Concerns over the COVID delta variant, rising inflation, Federal Reserve policy (i.e., “tapering”), and geopolitical tensions (Afghanistan) remain looming in the background. However, the economy continues to expand at a healthy pace (+6.6% Q2 – Gross Domestic Product growth has soared to record heights (see charts below).
The rising economic tide has lifted various stock market indices to new record highs. For the month, the S&P 500 and Dow Jones Industrial Average powered ahead +2.9% and +1.2%, respectively. For the year, these hot results are even more singeing – the S&P 500 has surged +20.4% and the Dow +15.5%.
All good things eventually come to an end, so protecting your financial home against damaging economic rodents is paramount. How you will defend your savings against an inevitable correction and insidious inflation is essential.
Investing with a better mousetrap will allow you to catch better returns, accelerate your retirement, and help avoid the infestation of inflation eating away at your nest egg. If you turn on any financial channel or click on an investment advertisement, chances are someone will attempt to sell you some overpriced, whiz-bang strategy or investment mousetrap that claims to capture amazing, quick results. More often than not, those assertions are complete lies. As Granny Slome always used to tell me, “If it sounds too good to be true, then it probably is.”
Mousetrap Characteristics
What should you be looking for in your investing mousetrap? Here are five characteristics to build upon:
1) Have a long-term time horizon. There is no reliable get-rich-quick scheme that will consistently make you money. Whereas, investing over the long-term in a diversified portfolio generally affords you the luxury of “compounding”, the phenomenon that Einstein called the “eighth wonder of the world.” Chasing the meme stock du jour, crypto currency flavor of the month, and/or the daily day-trading strategy parroted on TV will only lead to a pool of financial tears.
2) Invest in low-cost investment vehicles and strategies. The less you pay in fees, taxes, and transaction costs means the more you can keep for yourself. Investing in low-fee ETFs (Exchange Traded Funds), liquid low-spread securities, and $0 commission trading platforms, along with maintaining long-term holdings to minimize taxes, are all approaches to keeping more money for your growing retirement nest egg.
3) Obtain a customizable strategy to fit your risk tolerance and financial situation. Everyone has a unique financial profile and risk appetite. What’s more, everybody’s situation does not remain static. Circumstances change and life has a way of throwing curveballs at you. Finding a competent investment professional, who is also a fiduciary, is easier said than done, but if you are able to work with an advisor like Sidoxia Capital Management (www.Sidoxia.com), this will afford you the benefit of making prudent adjustments to your situation as it changes.
4) Find an understandable and transparent investment strategy. If your advisor or investment manager cannot explain the strategy and outline the specific costs/fees, then you should look elsewhere. Understanding the objective and strategy of your investments is critical, otherwise volatility can lead to emotional, sub-optimal decision-making. Hidden costs compromise the integrity of the investment advisor, so do not associate yourself with these sketchy people.
5) Rely on proven results. Past results do not guarantee future returns, however, aligning your investment strategy with time-tested results can provide you peace of mind. At the end of the day, your investments need to perform, and having an experienced investment manager is a valuable asset for you.
There is never a shortage of concerns in the financial markets, in both good and bad times. Rather than lose sleep and nervously chew down your fingernails, relax and spend your time finding a better mousetrap.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2021). 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.
Consumer Confidence Flies as Stock Market Hits New Highs
As the economy starts reopening from a global pandemic that is improving, consumers and businesses are beginning to see a light at the end of the tunnel. The surge in the recently reported Consumer Confidence figures to a new one-year high (see chart below) is evidence the recovery is well on its way. A stock market reaching new record highs is further evidence of the reopening recovery. More specifically, the Dow Jones Industrial Average catapulted 2,094 points higher (+6.2%) for the month to 32,981 and the S&P 500 index soared +4.2%. A rise in interest rate yields on the 10-Year Treasury Note to 1.7% from 1.4% last month placed pressure on technology growth stocks, which led to a more modest gain of +0.4% in the tech-heavy NASDAQ index during March.
Comeback from COVID
With a combination of 150 million vaccine doses administered and 30 million cumulative COVID cases, the U.S. population has creeped closer toward herd immunity protection against the virus and pushed down hospitalizations dramatically (see chart below).
Also contributing to investor optimism have been the rising values of investments and real estate assets thanks to an improving economy and COVID case count. As you can see from the chart below, the net worth of American households has more than doubled from the 2008-2009 financial crisis to approximately $130 trillion dollars, which in turn has allowed consumers to responsibly control and manage their personal debt. Unfortunately, the U.S. government hasn’t been as successful in keeping debt levels in check.
Spending and Paying for Infrastructure Growth
Besides focusing on positive COVID trends, investors have also centered their attention on the passage of a $1.9 trillion stimulus bill last month and a new proposed $2.3 trillion infrastructure bill that President Biden unveiled details on yesterday. At the heart of the multi-trillion dollar spending are the following components (see also graphic below):
- $621 billion modernize transportation infrastructure
- $400 billion to assist the aging and disabled
- $300 billion to boost the manufacturing industry
- $213 billion to build and retrofit affordable housing
- $100 billion to expand broadband access
With over $28 trillion in government debt, how will all this spending be funded? According to The Fiscal Times, there are four main tax categories to help in the funding:
Corporate Taxes: Raising the corporate tax rate to 28% from 21% is expected to raise $730 billion over 10 years
Foreign Corporate Subsidiary Tax: A new global minimum tax on foreign subsidiaries of American corporations is estimated to raise $550 billion
Capital Gains Tax on Wealthy: Increasing income tax rates on capital gains for wealthy individuals is forecasted to raise $370 billion
Income Tax on Wealthy: Lifting the top individual tax rate back to 39.6% for households earning more than $400,000 per year is seen to bring in $110 billion
Besides the economy being supported by government spending, growth and appreciation in the housing market are contributing to GDP growth. The recently released housing data shows housing prices accelerating significantly above the peak levels last seen before the last financial crisis (see chart below).
Although the economy appears to be on solid footing and stock prices have marched higher to new record levels, there are still plenty of potential factors that could derail the current bull market advance. For starters, increased debt and deficit spending could lead to rising inflation and higher interest rates, which could potentially choke off economic growth. Bad things can always happen when large financial institutions take on too much leverage (i.e., debt) and speculate too much (see also Long-Term Capital Management: When Genius Failed). The lesson from the latest, crazy blow-up (Archegos Capital Management) reminds us of how individual financial companies can cause billions in losses and cause ripple-through effects to the whole financial system. And if that’s not enough to worry about, you have rampant speculation in SPACs (Special Purpose Acquisition Companies), Reddit meme stocks (e.g., GameStop Corp. – GME), cryptocurrencies, and NFTs (Non-Fungible Tokens).
Successful investing requires a mixture of art and science – not everything is clear and you can always find reasons to be concerned. At Sidoxia Capital Management, we continue to find attractive opportunities as we strive to navigate through areas of excess speculation. At the end of the day, we remain disciplined in following our fundamental strategy and process that integrates the four key legs of our financial stool: corporate profits, interest rates, valuations, and sentiment (see also Don’t Be a Fool, Follow the Stool). As long as the balance of these factors still signal strength, we will remain confident in our outlook just like consumers and investors are currently.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 1, 2021). 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 GME 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.
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