Posts tagged ‘interest rates’
Glass Half Full or Half Empty?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 1, 2017). Subscribe on the right side of the page for the complete text.
We live in a time of confusing dichotomies, which makes deciphering the flood of daily data quite challenging. In that context, determining whether the current economic fundamentals should be viewed from a glass half empty of glass half full perspective can be daunting.
More specifically, stock markets have again recently hit new all-time record highs, yet if you read the newspaper headlines, you might think we’re in the midst of Armageddon. Last month, the Dow Jones Industrial Average stock index eclipsed 21,000 and the technology-heavy NASDAQ index surpassed the psychologically important 6,000 threshold. In spite of the records, here’s a sampling of the steady stream of gloomy feature stories jamming the airwaves:
- French Elections – Danger of European Union Breakup
- Heightened Saber Rattling by U.S. Towards North Korea
- Threat of U.S. Government Shutdown
- First 100 Days – Obamacare repeal failure, tax reform delays, no significant legislation
- NAFTA Trade Disputes
- Russian Faceoff Over Syrian Civil War & Terrorism
- Federal Reserve Interest Rate Hikes Could Derail Stock Market
- Slowing GDP / Economic Data
Given all this doom, how is it then that stock markets continue to defy gravity and continually set new record highs? Followers of my writings understand the crucial, driving dynamics of financial markets are not newspaper, television, magazine, and internet headlines. The most important factors are corporate profits, interest rates, valuations, and investor sentiment. All four of these elements will bounce around, month-to-month, and quarter-to-quarter, but for the time being, these elements remain constructive on balance, despite the barrage of negative, gut-wrenching headlines.
Countering the perpetual flow of gloomy, cringe-worthy headlines, we have seen a number of positive developments:
- Record Breaking Corporate Profits: Profits are the chief propellant for higher stock prices, and so far, for the 1st quarter, S&P 500 company profits are estimated to have risen +12.4% – the highest rate since 2011, according to Thomson Reuters I/B/E/S. As I like to remind my readers, stock prices follow profits over the long-run, which is evidenced by the chart below.
Source: Trading Economics
- Interest Rates Low: With interest rate levels still near generational lows (10-Year Treasury @ 2.28%), and inflation relatively stable around 2%, this augurs well for most asset prices. For U.S. consumers there are many stimulative effects to lower interest rates, whether you are buying a house, purchasing a car, paying off a school loan, and/or reducing credit card debt. Lower rates equal lower payments.
- Potential Tax Reform: There are numerous stimulative components to the largest planned tax-cut in history. First of all, cutting the tax rate from 35% to 15% for corporations and small businesses (i.e. pass-through entities like LLCs and S-Corps) would place a lot of dollars back in the pockets of taxpayers and should stimulate economic growth. Other components of the White House proposal include the termination of the estate tax, the elimination of the AMT (Alternative Minimum Tax) targeted at wealthier households, and the doubling of the standard deduction to help middle-income families. All of this sounds great on paper, but not a lot of details have been provided yet on how these benefits will be paid for – removing state tax deductions alone is unlikely to fully offset revenue declines. The chart below highlights how high U.S. corporate income tax rates are relative to other foreign counterparts.
Source: The Wall Street Journal
- Business Spending & Confidence on the Rise: Ever since the 2008-09 Great Recession, the U.S. has been a better house in a bad neighborhood relative to other global developed economies. However, the recovery has been gradual and muted due to tight-fisted companies being slow to hire and invest. Although recent Q1 GDP economic data came in at a sluggish +0.7% growth rate, the bright spot embedded in the data was a +12% annualized increase in private fixed investment. This is consistent with the spike we’ve seen in recent business and consumer confidence surveys (see chart below). Although this confidence has yet to translate into an acceleration in broader economic data, the ramp in capital spending and positive business sentiment could be a leading indicator for faster economic growth to come. Stimulative legislation enacted by Congress (i.e., tax reform, infrastructure spending, foreign repatriation, etc.) could add further fuel to the economic growth engine.
Source: Trading Economics
- Economy Keeps Chugging Along: As the wealthiest country on the planet, we Americans can become a little spoiled with success, which helps explain the media’s insatiable appetite for growth. Nevertheless, the broader economic data show a continuing trend of improvement. Simply consider the trend occurring in these major areas of the economy:
- Unemployment – The jobless rate has been chopped by more than half from a 10.0% cycle peak to 4.5% today.
- Housing – The number of annual existing home sales has increased by more than +60% from the cycle low to 5.7 million units, which still leaves plenty of headroom for growth before 2006 peak sales levels are reached.
- Consumer Spending – This segment accounts for roughly 70% of our country’s economic activity. Although we experienced a soft patch in Q1 of 2017, as you can see from the chart below, we Americans have had no problem spending more to keep our economy functioning.
Source: Trading Economics
While key economic statistics remain broadly constructive, there will come a time when prudence will dictate the pursuit of a more defensive investment strategy. When will that be? In short, the time to become more cautious will be when we see a combination of the following occur:
- Sharp increase in interest rates
- Signs of a significant decline in corporate profits
- Indications of an economic recession (e.g., an inverted yield curve)
- Spike in stock prices to a point where valuation (prices) are at extreme levels and skeptical investor sentiment becomes euphoric
To date, there is no objective evidence indicating these dynamics are in place, so until then, I will remain thirsty and grab my half glass full of water.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
You Can’t Kiss All the Beauties
When I was in high school and college, kissing all the pretty girls was not a realistic goal. The same principle applies to stock picking – you can’t buy all the outperforming stocks. As far as I’m concerned, there will always be some people who are smarter, better looking, and wealthier than I am, but that has little to do with whether I can continue to outperform, if I stick to my systematic, disciplined process. In fact, many smart people are horrible investors because they overthink the investing process or suffer from “paralysis by analysis.” When it comes to investing, the behavioral ability to maintain independence is more important than being a genius. If you don’t believe me, just listen to arguably the smartest investor of all-time, Warren Buffett:
“Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
Even the best investors and stock pickers of all-time are consistently wrong. When selecting stocks, a worthy objective is to correctly pick three outperforming stocks out of five stocks. And out of the three winning stocks, the rationale behind the outperformance should be correct in two out of those three stocks. In other words, you can be right for the wrong reason in one out of three outperforming stocks. The legendary investor Peter Lynch summed it up when he stated, “If you’re terrific in this business you’re right six times out of 10.”
Yes, it’s true, luck does play a role in stock selection. You just don’t want luck being the major driving force behind your success because luck cannot be replicated consistently over the long-run. There are so many unpredictable variables that in the short-run can work for or against the performance of your stock. Consider factors like politics, monetary policy, weather, interest rates, terrorist attacks, regulations, tax policy, and many other influences that are challenging or impossible to forecast. Over the long-run, these uncontrollable and unpredictable factors should balance out, thereby allowing your investing edge to shine.
Although I have missed some supermodel stocks, I have kissed some pretty stocks in my career too. I wish I could have invested in more stocks like Amazon.com Inc. (AMZN) that have increased more than 10x-fold, but other beauties like Apple Inc. (AAPL), Alphabet Inc. (GOOG), and Facebook Inc. (FB), haven’t hurt my long-term performance either. As is the case for most successful long-term investors, winning stocks generally more than compensate for the stinkers, if you can have the wherewithal to hold onto the multi-baggers (i.e., stocks that more than double), which admittedly is much easier said than done. Peter Lynch emphasized this point by stressing a focus on the long-term:
“You don’t need a lot of good hits every day. All you need is two to three goods stocks a decade.”
Sticking to a process of identifying and investing in well-managed companies at attractive valuations is a much better approach to investing than chasing every beauty you see or read about. If you stick to this simple formula, you can experience lovely, long-term results.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, FB, GOOG, AMZN, and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
No April Fool’s Joke – Another Record
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 3, 2017). Subscribe on the right side of the page for the complete text.
Having children is great, but a disadvantage to having younger kids are the April Fool’s jokes they like to play on parents. Fortunately, this year was fairly benign as I only suffered a nail-polish covered bar of soap in the shower. However, what has not been a joke has been the serious series of new record highs achieved in the stock market. While it is true the S&P 500 index finished roughly flat for the month (-0.0%) after hitting new highs earlier in March, the technology-laden NASDAQ index continued its dominating run, advancing +1.5% in March contributing to the impressive +10% jump in the first quarter. For 2017, the NASDAQ supremacy has been aided by the stalwart gains realized by leaders like Apple Inc. (up +24%), Facebook Inc. (up +23%), and Amazon.com Inc. (up +18%). The surprising fact to many is that these records have come in the face of immense political turmoil – most recently President Trump’s failure to deliver on a campaign promise to repeal and replace the Obamacare healthcare system.
Like a broken record, I’ve repeated there are much more important factors impacting investment portfolios and the stock market other than politics (see also Politics Schmolitics). In fact, many casual observers of the stock market don’t realize we have been in the midst of a synchronized, global economic expansion, helped in part by the stabilization in the value of the U.S. dollar over the last couple of years.
Source: Investing.com
As you can see above, there was an approximate +25% appreciation in the value of the dollar in late-2014, early-2015. This spike in the value of the dollar suddenly made U.S. goods sold abroad +25% more expensive, resulting in U.S. multinational companies experiencing a dramatic profitability squeeze over a short period of time. The good news is that over the last two years the dollar has stabilized around an index value of 100. What does this mean? In short, this has provided U.S. multinational companies time to adjust operations, thereby neutralizing the currency headwinds and allowing the companies to return to profitability growth.
Source: Calafia Beach Pundit
And profits are back on the rise indeed. The six decade long chart above shows there is a significant correlation between the stock market (red line – S&P 500) and corporate profits (blue line). The skeptics and naysayers have been out in full force ever since the 2008-2009 financial crisis – I profiled these so-called “sideliners” in Get out of Stocks!.
As the stock market continues to hit new record highs, the doubters continue to scream danger. There will always be volatility, but when the richest investor of all-time, Warren Buffett, continues to say that stocks are still attractively priced, given the current interest rate environment, that goes a long way to assuage investor concerns.
Politically, a lot could still go wrong as it relates to healthcare, tax reform, and infrastructure spending, to name a few issues. However, it’s still early, and it’s possible positive surprises could also occur. More importantly, as I’ve noted before, corporate profits, interest rates, valuations, and investor sentiment are much more important factors than politics, and on balance these factors are on the favorable side of the ledger. These factors will have a larger impact on the long-term direction of stock prices.
With approval ratings of Congress and the President at low levels, investors have had trouble finding humor in politics, even on April Fool’s Day. Another significant factor more important than politics is the issue of retirement savings by Americans, which is no joke. As you finalize your tax returns in the coming weeks, it behooves you to revisit your retirement plan and investment portfolio. Inefficiently investing your money or outliving your savings is no laughing matter. I’ll continue with my disciplined financial plan and leave the laughing to my kids, as they enjoy planning their next April Fool’s Day prank.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, FB, AMZN, and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Wiping Your Financial Slate Clean
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 3, 2017). Subscribe on the right side of the page for the complete text.
The page on the calendar has turned, and we now have a new year, and will shortly have a new president, and new economic policies. Although there is nothing magical about starting a fresh, new year, the annual rites of passage also allow investors to start with a clean slate again and reflect on their personal financial situation. Before you reach a desired destination (i.e., retirement), it is always helpful to know where you have been and where are you currently. Achieving this goal requires filtering through a never-ending avalanche of real-time data flooding through our cell phones, computers, TVs, radios, and Facebook accounts. This may seem like a daunting challenge, but that’s where I come in!
Distinguishing the signals from the noise is tough and there was plenty of noise in 2016 – just like there is every year. Before the S&P 500 stock index registered a +9.5% return in 2016, fears of a China slowdown blanketed headlines last January (the S&P 500 fell -15% from its highs and small cap stocks dropped -26%), and the Brexit (British exit) referendum caused a brief 48-hour -6% hiccup in June. Oil was also in the news as prices hit a low of $26 a barrel early in the year, before more than doubling by year-end to $54 per barrel (still well below the high exceeding $100 in 2014). On the interest rate front, 10-Year Treasury rates bottomed at 1.34% in July, while trillions of dollars in global bonds were incomprehensibly paying negative interest rates. However, fears of inflation rocked bond prices lower (prices move inversely to yields) and pushed bond yields up to 2.45% today. Along these lines, the Federal Reserve has turned the tide on its near-0% interest rate policy as evidenced by its second rate hike in December.
Despite the abbreviated volatility caused by the aforementioned factors, it was the U.S. elections and surprise victory of President-elect Donald Trump that dominated the media airwaves for most of 2016, and is likely to continue as we enter 2017. In hindsight, the amazing Twitter-led, Trump triumph was confirmation of the sweeping global populism trend that has also replaced establishment leaders in the U.K., France, and Italy. There are many explanations for the pervasive rise in populism, but meager global economic growth, globalization, and automation via technology are all contributing factors.
The Trump Bump
Even though Trump has yet to accept the oath of Commander-in-Chief, recent investor optimism has been fueled by expectations of a Republican president passing numerous pro-growth policies and legislation through a Republican majority-controlled Congress. Here are some of the expected changes:
- Corporate/individual tax cuts and reform
- Healthcare reform (i.e., Obamacare)
- Proposed $1 trillion in infrastructure spending
- Repatriation tax holiday for multinational corporate profits
- Regulatory relief (e.g., Dodd-Frank banking and EPA environmental reform)
The chart below summarizes the major events of 2016, including the year-end “Trump Bump”:
While I too remain optimistic, I understand there is no free lunch as it relates to financial markets (see also Half Trump Full). While tax cuts, infrastructure spending, and regulatory relief should positively contribute to economic growth, these benefits will have to be weighed against the likely costs of higher inflation, debt, and deficits.
Over the 25+ years I have been investing, the nature of the stock market and economy hasn’t changed. The emotions of fear and greed rule the day just as much today as they did a century ago. What has changed today is the pace, quality, and sheer volume of news. In the end, my experience has taught me that 99% of what you read, see or hear at the office is irrelevant as it relates to your retirement and investments. What ultimately drives asset prices higher or lower are the four key factors of corporate profits, interest rates, valuations, and sentiment (contrarian indicator) . As you can see from the chart below, corporate profits are at record levels and forecast to accelerate in 2017 (up +11.9%). In addition, valuations remain very reasonable, given how low interest rates are (albeit less low), and skeptical investor sentiment augurs well in the short-run.
Source: FactSet
Regardless of your economic or political views, this year is bound to have plenty of ups and downs, as is always the case. With a clean slate and fresh turn to the calendar, now is a perfect time to organize your finances and position yourself for a better retirement and 2017.
Wade W. Slome, CFA, CFP®
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in FB and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in 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.
Half Trump Empty, or Half Trump Full?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2016). Subscribe on the right side of the page for the complete text.
It was a bitter U.S. presidential election, but fortunately, the nastiest election mudslinging has come to an end…at least until the next political contest. Unfortunately, like most elections, even after the president-elect has been selected, almost half the country remains divided and the challenges facing the president-elect have not disappeared.
While some non-Trump voters have looked at the glass as half empty, since the national elections, the stock market glass has been overflowing to new record highs. Similar to the unforeseen British Brexit outcome in which virtually all pollsters and pundits got the results wrong, U.S. experts and investors also initially took a brief half-glass full view of the populist victory of Donald Trump. More specifically, for a few hours on Election Day, stock values tied to the Dow Jones Industrial Average index collapsed by approximately -5%.
It didn’t take long for stock prices to quickly reverse course, and when all was said and done, the Dow Jones Industrial Average finished the month higher by almost +1,000 points (+5.4%) to finish at 19,124 – a new all-time record high (see chart below). Worth noting, stocks have registered a very respectable +10% return during 2016, and the year still isn’t over.
Source: Investors.com (IBD)
Drinking the Trump Egg Nog
Why are investors so cheery? The proof will be in the pudding, but current optimism is stemming from a fairly broad list of anticipated pro-growth policies.
At the heart of the reform is the largest expected tax reform since Ronald Reagan’s landmark legislation three decades ago. Not only is Trump proposing stimulative tax cuts for corporations, but also individual tax reductions targeted at low-to-middle income taxpayers. Other facets of the tax plan include simplification of the tax code; removal of tax loopholes; and repatriation of foreign cash parked abroad. Combined, these measures are designed to increase profits, wages, investment spending, productivity, and jobs.
On the regulatory front, the President-elect has promised to repeal the Obamacare healthcare system and also overhaul the Dodd-Frank financial legislation. These initiatives, along with talk of dialing back other regulatory burdensome laws and agencies have many onlookers hopeful such policies could aid economic growth.
Fueling further optimism is the prospect of a trillion dollar infrastructure spending program created to fix our crumbling roads and bridges, while simultaneously increasing jobs.
No Free Lunch
As is the case with any economic plan, there is never a free lunch. Every cost has a benefit, and every benefit has a cost. The cost of the 2008-2009 Financial crisis is reflected in the sluggish economic growth seen in the weak GDP (Gross Domestic Product) statistics, which have averaged a modest +1.6% growth rate over the last year. Scott Grannis points out how the slowest recovery since World War II has resulted in a $3 trillion economic gap (see chart below).
Source: Calafia Beach Pundit
The silver lining benefit to weak growth has been tame inflation and the lowest interest rate levels experienced in a generation. Notwithstanding the recent rate rise, this low rate phenomenon has spurred borrowing, and improved housing affordability. The sub-par inflation trends have also better preserved the spending power of American consumers on fixed incomes.
If executed properly, the benefits of pro-growth policies are obvious. Lower taxes should mean more money in the pockets of individuals and businesses to spend and invest on the economy. This in turn should create more jobs and growth. Regulatory reform and infrastructure spending should have similarly positive effects. However, there are some potential downside costs to the benefits of faster growth, including the following:
- Higher interest rates
- Rising inflation
- Stronger dollar
- Greater amount of debt
- Larger deficits (see chart below)
Source: The Wall Street Journal
Even though President-elect Trump has not even stepped foot into the Oval Office yet, signs are already emerging that we could face some or all of the previously mentioned headwinds. For example, just since the election, the yield on 10-Year Treasury Notes have spiked +0.5% to 2.37%, and 30-Year Fixed Rate mortgages are flirting with 4.0%. Social and economic issues relating to immigration legislation and Supreme Court nominations are likely to raise additional uncertainties in the coming months and years.
Attempting to anticipate and forecast pending changes makes perfect sense, but before you turn your whole investment portfolio upside down, it’s important to realize that actions speak louder than words. Even though Republicans have control over the three branches of government (Executive, Legislative, Judicial), the amount of control is narrow (i.e., the Senate), and the nature of control is splintered. In other words, Trump will still have to institute the “art of the deal” to persuade all factions of the Republicans (including establishment, Tea-Party, and rural) and Democrats to follow along and pass his pro-growth policies.
Although I do not agree with all of Trump’s policies, including his rhetoric on trade (see Free Trade Boogeyman), I will continue paying closer attention to his current actions rather than his past words. Until proven otherwise, I will keep on my rose colored glasses and remain optimistic that the Trump glass is half full, not half empty.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
What Do You Worry About Next?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 1, 2016). Subscribe on the right side of the page for the complete text.
Boo! Halloween has just passed and frightened investors have still survived to tell the tale in 2016. While most people have gotten spooked by the presidential election, other factors like record-high corporate profits, record-low interest rates, and reasonable valuations have led to annual stock market gains. More specifically, values have risen in 2016 by approximately +4% (or +6% including dividend payments). Despite last week’s accelerating 3rd quarter GDP economic growth figure of +2.9%, which was the highest rate in two years and more than doubled the rate of the previous quarter (up +1.4%), there were still more tricks than treats during October. Recently, scary politics have shocked many Halloween participants into a zombie-like state, as evidenced by stock values declining around -1.7% during October.
This recent volatility is nothing new. Even though financial markets are significantly higher in recent years, that has not prevented repeated corrections over the year(s) as shown below in the 2009 – 2015 chart.
In order to earn higher long-term returns, investors have to accept a certain amount of short-term price movements (upwards and downwards). With a couple months remaining in the year, stock investors have achieved gains through a tremendous amount of economic and geopolitical uncertainty, including the following scares:
- China: A significant fallout from a Chinese slowdown at the beginning of the year (stocks fell about -14%).
- Brexit: A 48-hour Brexit vote scare in June (stocks fell -6%).
- Fed Fears: Threatening comments in September from the Federal Reserve about potentially hiking increasing interest rates (stocks fell -4%).
With the elections just a week away, political anxiety has jolted Americans’ adrenaline levels. The polls continue to move up and down, but as I have repeatedly pointed out, the only certain winner in Washington DC is gridlock. Sure, in a Utopian world, politicians should join hands and compromise to solve all our country’s serious problems. Unfortunately, this is not the case (see Congress’s approval rating). However, there is a silver lining to this dysfunction…gridlock can lead to fiscal discipline.
Our country’s debt/deficit financial situation has been spiraling out of control, in large measure due to rapidly rising entitlement spending, including Medicare, and Social Security. Witnessing all the political rhetoric and in-fighting is very difficult, but as I highlighted in last month’s newsletter, gridlock has flattened the spending curve significantly since 2009 – a positive development.
And although the economic recovery has been one of the slowest since World War II and global growth remains anemic, the U.S. remains a better house in a bad global neighborhood (e.g., Europe and Japan continue to suck wind), as evidenced by a number of these following positive economic indicators:
- Employment Improvement: Unemployment has fallen from 10% to 5% since 2009, and more than 15 million jobs have been added over that period.
- Housing Recovery Continues: Home sales and prices continue their multi-year rise; housing inventories remain tight; and affordability remains strong, given generationally low interest rates.
- Record Auto Sales: Car sales remain near record levels, hovering around 17 million units per year.
- Consumer Confidence on the Rise: Ever since the financial crisis, consumer sentiment figures have rebounded by about 50%.
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Record Consumer Sales: Consumer spending accounts for approximately 70% of our economy, and as you can see from the chart below, despite consumers saving more, stronger employment and wages are fueling more spending.
Source:Calculated Risk
Absent a clean sweep of control by the Democrat or Republican Presidential-Congressional candidates, our democratic system will retain its healthy status of checks and balances. Based on all the current polling data, a split between the White House, Senate, and House of Representatives remains a very high likelihood scenario.
The political process has been especially exhausting during the current cycle, but regardless of whether your candidate wins or loses, much of the current uncertainty will likely dissipate. As the saying goes, at least it is “Better the devil you know than the devil you don’t know.”
After the November 8th elections are completed, there will be one less election to worry about. Thankfully, after 25 years in the industry, I’m not naïve enough to believe there will be nothing else to worry about. When the financial media and blogosphere get bored, at a minimum, you can guarantee yourself plenty of useless coverage regarding the next monetary policy move by the Federal Reserve (see also Fed Fatigue).
Whatever the next set of worries become, U.K. Prime Minister Winston Churchill said it best as it relates to American politics and economics, “You can always count on Americans to do the right thing – after they’ve tried everything else.” If Churchill’s words don’t provide comfort and you had fun getting spooked over the elections on Halloween, feel free to keep wearing your costume. Behind any constructive economic data, the prolific media machine will continue doing their best in manufacturing plenty of fear, uncertainty, and doubt to keep you worried.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Fall is Here: Change is Near
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 1, 2016). Subscribe on the right side of the page for the complete text.
Although the fall season is here and the leaf colors are changing, there are a number of other transforming dynamics occurring this economic season as well. The S&P 500 index may not have changed much this past month (down -0.1%), but the technology-laden NASDAQ index catapulted higher (+1.9% for the month and +6.0% for 2016).
With three quarters of the year now behind us, beyond experiencing a shift in seasonal weather, a number of other changes are also coming. For starters, there’s no ignoring the elephant in the room, and that is the presidential election, which is only weeks away from determining our country’s new Commander in Chief. Besides religion, there are very few topics more emotionally charged than politics – whether you are a Republican, Democrat, Independent, Libertarian, or some combination thereof. Even though the first presidential debate is behind us, a majority of voters are already set on their candidate choice. In other words, open-minded debate on this topic can be challenging.
Hearing critical comments regarding your favorite candidate are often interpreted in the same manner as receiving critical comments about a personal family member – people often become defensive. The good news, despite the massive political divide currently occurring in the country and near-record low politician approval ratings in Congress , politics mean almost nothing when it comes to your money and retirement (see also Politics & Your Money). Regardless of what politicians might accomplish (not much), individuals actually have much more control over their personal financial future than politicians.
While inaction may rule the day currently, more action generally occurs during a crisis – we witnessed this firsthand during the 2008-2009 financial meltdown. As Winston Churchill famously stated,
“You can always count on Americans to do the right thing – after they’ve tried everything else.”
Political discourse and gridlock are frustrating to almost everyone from a practical standpoint (i.e., “Why can’t these idiots get something done in Washington?!”), however from an economic standpoint, gridlock is good (see also Who Said Gridlock is Bad?) because it can keep a responsible lid on frivolous spending. Educated individuals can debate about the proper priorities of government spending, but most voters agree, maintaining a sensible level of spending and debt should be a bipartisan issue.
From roughly 2009 – 2014, you can see how political gridlock has led to a massive narrowing in our government’s deficit levels (chart below) – back to more historical levels.This occurred just as rising frustration with Washington has been on the rise.
The Fed: Rate Revolution or Evolution?
Besides the changing season of politics, the other major area of change is Federal Reserve monetary policy. Even though the Fed has only increased interest rates once over the last 10 years, and interest rates are at near-generational lows, investors remain fearful. There is bound to be some short-term volatility if interest rates rise to 0.50% – 0.75% in December, as currently expected. However, if the Fed continues at its current snail’s pace, it won’t be until 2032 before they complete their rate hike cycles.
We can put the next rate increase into perspective by studying history. More specifically, the Fed raised interest rates 17 times from 2004 – 2006 (see chart below). Fortunately over this same time period, the world didn’t end as the Fed increased interest rates from 1.00% to 5.25% (stocks prices actually rose around +11%). The same can be said today – the world won’t likely end, if interest rates rise from 0.50% to 0.75% in a few months.
The next question becomes, why are interest rates so low? There are many reasons and theories, but a few of the key drivers behind low rates include, slower global economic growth, low inflation, high demand for low-risk assets, technology, and demographics. I could devote a whole article to each of these factors, and indeed in many cases I have, but suffice it to say that there are many reasons beyond the oversimplified explanation that artificial central bank intervention has led to a 35 year decline in interest rates (see chart below).
Change is a constant, and with fall arriving, some changes are more predictable than others. The timing of the U.S. presidential election outcome is very predictable but the same cannot be said for the timing of future interest rate increases. Irrespective of the coming changes and the related timing, history reminds us that concerns over politics and interest rates often are overblown. Many individuals remain overly-pessimistic due to excessive, daily attention to gloomy and irrelevant news headlines. Thankfully, stock prices are paying attention to more important factors (see Don’t Be a Fool) and long-term investors are being rewarded with record high stock prices in recent weeks. That’s the type of change I love.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Invest or Die
Seventy-six million Baby Boomers are earning near 0% (or negative rates) and aren’t getting any younger in the process, which is forcing them and others to decide…invest or die. The risk of outliving your savings is becoming a larger reality these days. Demographics and economics are dictating that our aging population is living longer and earning less due to generationally low interest rates.
Richard Fisher, the former Dallas Federal Reserve president, understands these looming dynamics. Fisher has identified how low-interest rates are increasing investor discontent by pushing consumers to save more in order to meet retirement needs. The unintended consequence from low rates, he said, is “you’re going to have to save a hell of a lot more before you consume.”
Besides saving, the other option investors have is to lower your standard of living. For example, you could continually eat mac & cheese and sleep in a tent – that is indeed one way you could save money. However, your kids and/or desired lifestyle may make this way of life unpalatable for all. Rather, the proper approach to achieving a comfortable standard of living requires you to invest more efficiently and prudently.
What a lot of individuals fail to understand is that accepting too much risk can be just as dangerous as being too conservative, over the long run. Case in point, depositing your savings into a CD at current interest rates (near 0%) is the equivalent of burning your cash, as any income produced is overwhelmed by the deleterious effects of inflation. It would take more than a lifetime of CD interest income to equal equity returns earned over the last seven years. Since early 2009, stocks have more than tripled in value.
Given the prevailing economic and demographic trends, investors are slowly realizing the attractive income-producing nature of stocks relative to bonds. It has been a rare occurrence, but stocks, as measured by the S&P 500, continue to yield more than 10-Year Treasury Notes (2.0% vs. 1.6%, respectively) – see chart below. The picture for bonds looks even worse in many international markets, where $13 trillion in bonds are yielding negative interest rates. Unlike bonds, which generally pay fixed coupon payments for years at a time, stocks overall have historically increased their dividend payouts by approximately 6% annually.
Source: Avondale Asset Management
With a scarcity of attractive investment alternatives available, investors will eventually be forced to adopt higher levels of equity risk, like it or not. However, this dynamic has yet to happen. Currently, actions are speaking louder than words, and as you can see, risk aversion reigns supreme with Americans tucking over $8 trillion dollars under their mattress (see chart below), in the form of savings accounts, earning next to nothing and jeopardizing retirements.
Source: Calafia Beach Pundit
Even if you fall into the camp that believes rates are artificially low by central bank printing presses, that doesn’t mean every company is recklessly leveraging their balance sheets up to the hilt. Many companies are still scared silly from the financial crisis and conservatively managing every penny of expense, like a stingy retiree living on a fixed income. Thanks to this reluctance to spend and hire aggressively, profit margins are at/near record highs. This financial stewardship has freed up corporations’ ability to pay higher dividends and implement discretionary stock buybacks as means to return capital to shareholders.
With the dovish Fed judiciously raising interest rates – only one rate hike of 0.25% over a decade (2006 – 2016) – there are no signs this ultra-low interest rate environment is going to turn aggressively higher anytime soon. Until economic growth, inflation, and interest rates return with a vengeance, and the persistent investor risk aversion abates, it behooves all the cash hoarders to….invest or die!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Huh… Stocks Reach a Record High?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2016). Subscribe on the right side of the page for the complete text.
The stock market hit all-time record highs again in August, but despite the +6.2% move in 2016 S&P 500 stock prices (and +225% since early 2009), investors continue to scratch their heads in confusion. Individuals continue to ask, “Huh, how can stocks be trading at or near record levels (+6% for the year) when Brexit remains a looming overhang, uncertainty surrounds the U.S. presidential election, global terrorist attacks are on the rise, negative interest rates are ruling the day, and central banks around the globe are artificially propping up financial markets (see also Fed Myths vs. Reality)? Does this laundry list of concerns stress you out? If you said “yes”, you are not alone.
As I’ve pointed out in the past, we live in a different world today. In the olden days, terrorist attacks, natural disasters, currency crises, car chases, bank failures, celebrity DUIs, and wars happened all the time. However, before the internet existed, people either never heard about these worries, or they just didn’t care (or both). Today, we live in a Twitter, Facebook, Instagram, Snapchat, society with 500+ cable channels, and supercomputers in the palm of our hands (i.e., smartphones) with more computing power than existed on the Apollo mission to the moon. In short, doom-and-gloom captures human attention and sells advertising, the status quo does not.
- Record corporate profits are on the rise
- Stabilizing value of the dollar
- Stabilizing energy and commodity prices
- Record low interest rates
- Skeptical investing public
Fortunately, the stock market pays more attention to these important dynamics, rather than the F.U.D. (Fear, Uncertainty, Doubt) peddled by the pundits, bloggers, and TV talking heads. Certainly, any or all of the previously mentioned positive factors could change or deteriorate over time, but for the time being, the bulls are winning.
Let’s take a closer look at the influencing components that are driving stock prices higher:
Record Corporate Profits
Source: Yardeni.com
Profits are the mother’s milk that feeds the stock market. During recessions, profits are starved and stock prices decline. On the flip side, economic expansions feed profits and cause share prices to rise. As you can see from the chart above, there was a meteoric rise in corporate income from 2009 – 2014 before a leveling off occurred from 2015 going into 2016. The major headwinds causing profits to flatten was a spike of 25% in the value of the U.S. dollar relative to the value of other global currencies, all within a relatively short time span of about nine months (see chart below).
Why is this large currency shift important? The answer is that approximately 40% of multinational profits derived by S&P 500 companies come from international markets. Therefore, when the value of the dollar rose 25%, the cost to purchase U.S. products and services by foreign buyers became 25% costlier. Selling dramatically higher cost goods abroad squeezed exports, which in turn led to a flattening of profits. Time will tell, but as I showed in the first chart, the slope of the profit line has resumed its upwards trajectory, which helps explain why stock prices have been advancing in recent months.
Besides a strong dollar, another negative factor that temporarily weakened earnings was the dramatic decline in oil prices (see chart below) Two years ago, WTI oil prices were above $100 per barrel. Today, prices are hovering around $45 per barrel. As you can imagine, this tremendous price decline has had a destructive impact on the profits of the energy sector in general. The good news is that after watching prices plummet below $30 earlier this year, prices have since stabilized at higher levels. In other words, the profits headwind has been neutralized, and if global economic growth recovers further, the energy headwind could turn into an energy tailwind.
Record Low Interest Rates
Stocks were not popular during the early 1980s. In fact, the Dow Jones Industrial Average traded at 2,600 in 1980 vs 18,400 today. The economy was much smaller back then, but another significant overhang to lower stock prices was higher interest rates (and inflation). Back in 1980, the Federal Funds target rate set by the Federal Reserve reached a whopping 20.0% versus today the same rate sits at < 0.5%.
Why is this data important? When you can earn a 16.99% yield in a one-year bank CD (see advertisement below), generally there is a much smaller appetite to invest in riskier, more volatile stocks. Another way to think about rates is to equate interest rates to the cost of owning stocks. When interest rates were high, the relative cost to own stocks was also high, so many investors liquidated stocks. It makes perfect sense that stocks in that high interest rate environment of 1980 would be a lot less attractive compared to a relatively safe CD that paid 17% over a 12-month period.
On the other hand, when interest rates are low, the relative cost of owning stocks is low, so it makes sense that stock prices are rising in this environment. Just like profits, interest rates are not static, and they too can change rapidly. But as long as rates remain near record lows, and profits remain healthy, stocks should remain an appealing asset class, especially given the scarcity of strong alternatives.
Skeptical Investing Public
The last piece of the puzzle to examine in order to help explain the head-scratching record stock prices is the pervasive skepticism present in the current stock market. How can Brexit, presidential election, terrorism, negative interest rates, and uncertain Federal Reserve policies be good for stock prices? Investing in many respects can be like navigating through traffic. When everyone wants to drive on the freeway, it becomes congested and a bad option, therefore taking side-streets or detours is a better strategy. The same principle applies to the stock market. When everyone wants to invest in the stock market (like during the late 1990s) or buy housing (mid-2000s), prices are usually too inflated, and shrewd investors decide to choose a different route by selling.
The same holds true in reverse. When nobody is interested in investing (see also, 18-year low in stock ownership and two trillion of stocks sold), then generally that is a strong sign that it is a good time to buy. Currently, skepticism is plentiful, for all the reasons cited above, which is a healthy investment indicator. Many individuals continue reading the ominous headlines and scratching their heads in confusion over today’s record stock prices. In contrast, at Sidoxia, we have opportunistically benefited from investors’ skepticism by discovering plenty of attractive opportunities for our clients. There’s no confusion about that.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and FB, but at the time of publishing had no direct position in 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.
The Fed: Myths vs. Reality
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
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.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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