Posts tagged ‘interest rates’
Marathon Market Gets a Cramp
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 1, 2015). Subscribe on the right side of the page for the complete text.
“Anyone can run a hundred meters, it’s the next forty-two thousand and two hundred that count.”
Investing is a lot like running a marathon…but it’s not a sprint to the retirement finish line. The satisfaction of achieving your long-term goal can be quite rewarding, but attaining ambitious objectives does not happen overnight. Along the hilly and winding course, there can be plenty of bumps and bruises mixed in with the elation of a runner’s high. While stocks have been running at a record pace in recent years, prices have cramped up recently as evidenced by the -2.6% decline of the S&P 500 stock index last month.
But the recent correction should be placed in the proper perspective as you approach and reach retirement. Since the end of the 2008 Financial Crisis the stock market has been racing ahead at a brisk rate, as you can see from the total return performance below (excluding 2015):
This performance is more indicative of a triumph than a catastrophe, but if you turned on the TV, listened to the radio, or surfed the web, you may come to a more frightening conclusion.
What’s behind the recent dip? These are some of the key concerns driving the recent price volatility:
- China: Slowing growth in China and collapse in Chinese stock market. China is suffering from a self-induced slowdown designed to mitigate corruption, prick the real estate bubble, and shift its export-driven economy to a more consumer-driven economy. These steps diminish short-term growth (albeit faster than U.S. growth), but nevertheless the measures should be constructive for longer-term growth.
- Interest Rates: Uncertainty surrounding the timing of a 0.25% target interest rate increase by the Federal Reserve. The move from 0% to 0.25% is like walking from the hardwood floor onto the rug…hardly noticeable. The inevitable move by the Fed has been widely communicated for months, and given where interest rates are today, the move will have a negligible impact on corporate borrowing costs. Like removing a Band-Aid, the initial action may cause some pain, but should be comfortably received shortly thereafter.
- Politics: Potential government shutdown / sequestration. The epic political saga will never end, however, as I highlighted in “Who Said Gridlock is Bad?,” political discourse in Washington has resulted in positive outcomes as it relates to our country’s fiscal situation (limited government spending and declining deficits). The government shutdown appears to have been averted for now, but it looks like we will be blanketed with brinkmanship nonsense again in a few months.
- Biotech/Pharmaceuticals: Politics over lofty drug prices and the potential impact of future regulation on the biotech sector. Given the current Congressional balance of power, any heavy-handed Democratic proposals is likely to face rigorous Republican opposition.
- Emerging Markets: Emerging market weakness, especially in Latin America (e.g., Brazil). These developments deserve close monitoring, but the growth in the three largest economic regions (U.S., Europe, and China) will have a much larger effect on the direction of global economic expansion.
- Middle East: Destabilized Middle East and Syria. Terrorist extremism and cultural animosity between various Middle East populations has existed for generations. There will be no silver bullet for a peaceful solution, so baby steps and containment are critical to maintain healthy global trade activity with minimal disruptions.
Worth noting, this current list of anxieties itemized above is completely different from six months ago (remember the Greece crisis?), and the list will change again six months into the future. Investing, like any competitive challenge, does not come easy…there is always something to worry about in the land of economics and geopolitics.
Here’s what the world’s top investor Warren Buffett said a few decades ago (1994) on the topic of politics and economics:
“We will continue to ignore political and economic forecasts which are an expensive distraction for investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.”
In a world of 7.3 billion people and 196 countries there will never be a shortage of fear, uncertainty, and doubt (F.U.D.) – see events chart in The Bungee Market. In an ever-increasing, globally connected world, technology and the media continually amplify molehills into mountains, thereby making the next imagined Armageddon a simple click of a mouse or swipe of a smartphone away.
Today’s concerns are valid but in the vast majority of cases the issues are completely overblown, sensationalized and over-emphasized without context. Context is an integral part to investing, but unfortunately context usually cannot be explained in a short soundbite or headline. On the flip side, F.U.D. thrives in the realm of soundbites and headlines.
While investors may feel fatigued from a strong flow of headline headwinds, financial market race participants should take a break at the water stop to also replenish themselves with a steady tailwind of positive factors, including the following:
- Employment: The unemployment rate has been cut from a recession peak of 10.0% down to 5.1%, and the economy has been adding roughly +200,000 new monthly jobs on a fairly consistent basis. On top of that, there are a record 5.8 million job openings versus 3.7 million two years ago – a sign that the economy continues to hum along.
- Housing/Commercial Real Estate/Mortgage Rates: Housing prices have rebounded by about +30% from the 2012 lows; Housing starts have increased by +25% in the past year and 120% in the past four years; and 30-Year Fixed mortgage interest rates sit at 3.85% – a highly stimulative level within a spitting distance from record lows.
- Auto Sales: Surged to a post-recession record of 17.8 million units in August.
- Interest Rates: Massively stimulative and near generational lows, even if the Fed hikes its interest rate target by 0.25% in October, December or sometime in 2016.
- Capital Goods Orders: Up for three consecutive months.
- Rail Shipments/Truck Tonnage: Both these metrics are rising by about 3-4%.
- Retail Sales: Rising at a very respectable pace of 7% over the last six months.
- Low Energy & Commodity Prices: Inflation has remained largely in check thanks to plummeting commodity prices. Low oil and gas prices are benefiting consumers in numerous ways, including the contribution to car sales, home sales, and/or debt reduction.
While the -10% dip in stock prices from mid-August might feel like a torn knee ligament, long-term investors know -10% corrections historically occur about one-time per year, on average. So, even though you may be begging for a wheelchair, the best course of action is to take a deep breath, stick to your long-term investment plan, rebalance your portfolio if necessary, and continue staying on course towards your financial finish line.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Oxymoron: Shrewd Government Refis Credit Card
With the upcoming Federal Reserve policy meetings coming up this Wednesday and Thursday, investors’ eyes remain keenly focused on the actions and words of Federal Reserve Chairwoman Janet Yellen.
If you have painstakingly filled out an IRS tax return or frustratingly waited in long lines at the DMV or post office, you may not be a huge fan of government services. Investors and liquidity addicted borrowers are also irritated with the idea of the Federal Reserve pulling away the interest rate punch bowl too soon. We will find out early enough whether Yellen will hike the Fed Funds interest rate target to 0.25%, or alternatively, delay a rate increase when there are clearer signs of inflation risks.
Regardless of the Fed decision this week, with interest rates still hovering near generational lows, it is refreshing to see some facets of government making shrewd financial market decisions – for example in the area of debt maturity management. Rather than squeezing out diminishing benefits by borrowing at the shorter end of the yield curve, the U.S. Treasury has been taking advantage of these shockingly low rates by locking in longer debt maturities. As you can see from the chart below, the Treasury has increased the average maturity of its debt by more than 20% from 2010 to 2015. And they’re not done yet. The Treasury’s current plan based on the existing bond issuance trajectory will extend the average bond maturity from 70 months in 2015 to 80 months by the year 2022.
If you were racking up large sums of credit card debt at an 18% interest rate with payments due one month from now, wouldn’t you be relieved if you were given the offer to pay back that same debt a year from now at a more palatable 2% rate? Effectively, that is exactly what the government is opportunistically taking advantage of by extending the maturity of its borrowings.
Most bears fail to acknowledge this positive trend. The typical economic bear argument goes as follows, “Once the Fed pushes interest rates higher, interest payments on government debt will balloon, and government deficits will explode.” That argument definitely holds up some validity as newly issued debt will require higher coupon payments to investors. But at a minimum, the Treasury is mitigating the blow of the sizable government debt currently outstanding by extending the average Treasury maturity (i.e., locking in low interest rates).
It is worth noting that while extending the average maturity of debt by the Treasury is great news for U.S. tax payers (i.e., smaller budget deficits because of lower interest payments), maturity extension is not so great news for bond investors worried about potentially rising interest rates. Effectively, by the Treasury extending bond maturities on the debt owed, the government is creating a larger proportion of “high octane” bonds. By referring to “high octane” bonds, I am highlighting the “duration” dynamic of bonds. All else equal, a lengthening of bond maturities, will increase a bond’s duration. Stated differently, long duration, “high octane” bonds will collapse in price if in interest rates spike higher. The government will be somewhat insulated to that scenario, but not the bond investors buying these longer maturity bonds issued by the Treasury.
All in all, you may not have the greatest opinion about the effectiveness of the IRS, DMV, and/or post office, but regardless of your government views, you should be heartened by the U.S. Treasury’s shrewd and prudent extension of the average debt maturity. Now, all you need to do is extend the maturity and lower the interest rate on your personal credit card debt.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Bungee Market
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2015). Subscribe on the right side of the page for the complete text.
Are you an adrenaline junkie? You may be one and not even know it. If you are an investor in the stock market, you may have noticed a sinking feeling in your investment portfolio before a sharp bounce-back, much like a bungee jump. Before the recent drop of -6.6% in the Dow during August, some stock investors got lulled into a state of complacency, considering a tripling in stock prices over the last six years.
Almost any current or future news headline has the capability of potentially triggering a short-term bungee jump in stock prices. Now, worries over the health of the Chinese economy and financial markets, coupled with concerns of an impending rate hike by the Federal Reserve have created some tension for global financial markets. The slowdown in China should not be ignored, but as famed investor Bill Nygren pointed out, its impact should be placed in the proper context. China only represents 15% of global economic activity and U.S. exports to China only account for 0.7% of our GDP.
- 5% market corrections, 3 times per year on average (“correction” = price decline);
- 10% market corrections, 1 time per year on average; and
- 20% market corrections, 1 time every 3.5 years on average.
Welcome Back Volatility! Mini Flash Crash
- Economic growth revised higher (Q2 GDP raised to +3.7% from +2.3%)
- Unemployment rate continues to drop ( at 5.3%, a 7-year low)
- Interest rates near historic lows (3.95%, 30-year mortgage rate), which will remain massively stimulative even if the Fed modestly increases short-term rates
- U.S. corporate profits are near record highs (despite dampening effect of the strong U.S. dollar on exports)
- Reasonable valuations (improved after latest index price declines)
- Housing market on a steady recovery (existing home sales at multi-year highs and pricing up +6% vs. July of last year)
- Massively accommodative central banks around the globe (e.g., European Central Bank and People’s Bank of China)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
The Art of Catching Falling Knives
“In the middle of every difficulty lies an opportunity.” ~Albert Einstein
It was a painful week for bullish investors in the stock market as evidenced by the -1,018 point drop in the Dow Jones Industrial Average, equivalent to approximately a -6% decline. The S&P 500 index did not fare any better, and the loss for the tech-heavy NASDAQ index was down closer to -7% for the week.
The media is attributing much of the short-term weakness to a triple Chinese whammy of factors: 1) Currency devaluation of the Yuan; 2) Weaker Chinese manufacturing data registering in at the lowest level in over six years; and 3) A collapsing Chinese stock market.
As the second largest economy on the planet, developments in China should not be ignored, however these dynamics should be put in the proper context. With respect to China’s currency devaluation, Scott Grannis at Calafia Beach Pundit puts the foreign exchange developments in proper perspective. If you consider the devaluation of the Yuan by -4%, this change only reverses a small fraction of the Chinese currency appreciation that has taken place over the last decade (see chart below). Grannis rightfully points out the -25% collapse in the value of the euro relative to the U.S. dollar is much more significant than the minor move in the Yuan. Moreover, although the move by the People’s Bank of China (PBOC) makes America’s exports to China less cost competitive, this move by Chinese bankers is designed to address exactly what investors are majorly concern about – slowing growth in Asia.
Although the weak Chinese manufacturing data is disconcerting, this data is nothing new – the same manufacturing data has been very choppy over the last four years. On the last China issue relating to its stock market, investors should be reminded that despite the massive decline in the Shanghai Composite, the index is still up by more than +50% versus a year ago (see chart below)
Fear the Falling Knife?
Given the fresh carnage in the U.S. and foreign markets, is now the time for investors to attempt to catch a falling knife? Catching knives for a living can be a dangerous profession, and many investors – professionals and amateurs alike – have lost financial fingers and blood by attempting to prematurely purchase plummeting securities. Rather than trying to time the market, which is nearly impossible to do consistently, it’s more important to have a disciplined, unemotional investing framework in place.
Hall of Fame investor Peter Lynch sarcastically highlighted the difficulty in timing the market, “I can’t recall ever once having seen the name of a market timer on Forbes‘ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”
Readers of my blog, Investing Caffeine understand I am a bottom-up investor when it comes to individual security selection with the help of our proprietary S.H.G.R. model, but those individual investment decisions are made within Sidoxia’s broader, four-pronged macro framework (see also Don’t be a Fool, Follow the Stool). As a reminder, driving our global views are the following four factors: a) Profits; b) Interest rates; c) Sentiment; and Valuations. Currently, two of the four indicators are flashing green (Interest rates and Sentiment), and the other two are neutral (Profits and Valuations).
- Profits (Neutral): Profits are at record highs, but a strong dollar, weak energy sector, and sluggish growth internationally have slowed the trajectory of earnings.
- Valuation (Neutral): At an overall P/E of about 18x’s profits for the S&P 500, current valuations are near historical averages. For CAPE investors who have missed the tripling in stock prices, you can reference prior discussions (see CAPE Smells Like BS). I could make the case that stocks are very attractive with a 6% earnings yield (inverse P/E ratio) compared to a 2% 10—Year Treasury bond, but I’ll take off my rose-colored glasses.
- Interest Rates (Positive): Rates are at unambiguously low levels, which, all else equal, is a clear-cut positive for all cash generating asset classes, including stocks. With an unmistakably “dovish” Federal Reserve in place, whether the 0.25% interest rate hike comes next month, or next year will have little bearing on the current shape of the yield curve. Chairman Yellen has made it clear the trajectory of rate increases will be very gradual, so it will take a major shift in economic trends to move this factor into Neutral or Negative territory.
- Sentiment (Positive): Following the investment herd can be very dangerous for your financial health. We saw that in spades during the late-1990s in the technology industry and also during the mid-2000s in the housing sector. As Warren Buffett says, it is best to “buy fear and sell greed” – last week we saw a lot of fear.
In addition to the immense outflows out of stock funds (see also Great Rotation) , panic was clearly evident in the market last week as shown by the Volatility Index (VIX), a.k.a., the “Fear Gauge.” In general, volatility over the last five years has been on a declining trend, however every 6-12 months, some macro concern inevitably rears its ugly head and volatility spikes higher. With the VIX exploding higher by an amazing +118% last week to a level of 28.03, it is proof positive how quickly sentiment can change in the stock market.
Not much in the investing world works exactly like science, but buying stocks during previous fear spikes, when the VIX level exceeds 20, has been a very lucrative strategy. As you can see from the chart below, there have been numerous occasions over the last five years when the over-20 level has been breached, which has coincided with temporary stock declines in the range of -8% to -22%. However, had you held onto stocks, without adding to them, you would have earned an +84% return (excluding dividends) in the S&P 500 index. Absent the 2011 period, when investors were simultaneously digesting a debt downgrade, deep European recession, and domestic political fireworks surrounding a debt ceiling, these periods of elevated volatility have been relatively short-lived.
Whether this will be the absolute best time to buy stocks is tough to say. Stocks are falling like knives, and in many instances prices have been sliced by more than -10%, -20%, or -30%. It’s time to compile your shopping list, because valuations in many areas are becoming more compelling and eventually gravity will run its full course. That’s when your strategy needs to shift from avoiding the falling knives to finding the bouncing tennis balls…excuse me while I grab my tennis racket.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including emerging market/Chinese ETFs, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Who Gives a #*&$@%^?!
The stock market is just a big rigged casino, fueled by a reckless money printing Fed that is artificially inflating a global asset bubble, right? That seems to be the mentality of many investors as evidenced by the lack of meaningful domestic stock fund buying/inflows (see also Digesting Stock Gains). Underlying investor skepticism is a foundation of mistrust and detachment caused by the unprecedented 2008-09 financial crisis, when regulators fell asleep at the switch.
Making matters worse, the proliferation of the Internet, smart phones, and social media, has forced investors to digest a never-ending avalanche of breaking news headlines and fear mongering. Here is a partial list of the items currently frightening investors:
- Interest Rates: Will the Federal Reserve raise interest rates in June or September?
- Volatility: The Dow is up 200 points one day and then down 200 the next day. Keep me away.
- Greece: One day Greece is going to exit the eurozone and the next day it’s going to reach a deal with the IMF (International Monetary Fund) and European leaders.
- Terrorism / Middle East: ISIS is like a cancer taking over the Middle East, and it’s only a matter of time before they invade our home soil. And if ISIS doesn’t get us, then the Iranian boogeyman will attack us with their inevitable nuclear weapons.
- Inflation: The economy is slowing improving and as we approach full employment in the U.S., wage pressure is about to kick inflation into high gear. After falling significantly, oil prices are inching higher, which is also moving inflation in the wrong direction.
- Strong Dollar: Now that Europe is copying the U.S. by implementing quantitative easing, domestic exports are getting squeezed and revenue growth is slowing.
- Bubble? Stocks have had a monster run over the last six years, so we must be due for a crash…correct?
Seemingly, on a daily basis, some economist, strategist, analyst, or talking head pundit on TV articulately explains how the financial markets can fall off the face of the earth. Unfortunately, there is a problem with this type of analysis, if your evaluation is solely based upon listening to media outlets. Bottom line is you can always find a reason to sell your investments if you listen to the so-called experts. I made this precise point a few years ago when I highlighted the near tripling in stock prices despite the barrage of bad news (see also A Series of Unfortunate Events).
While I am certainly not asking anyone to blindly assume more risk, especially after such a large run-up in stock prices, I find it just as important to point out the following:
“Taking too much risk is as risky as not taking enough risk.”
In other words, driving 35 mph on the freeway may be more life threatening than driving 75 mph. In the world of investing, driving too slowly by putting all your savings in cash or low-yielding securities, as many Americans do, may feel safe. However this default strategy, which may feel comfortable for many, may actually make attaining your financial goals impossible.
At Sidoxia, we create customized Investment Policy Statements (IPS) for all our clients in an effort to optimize risk levels in a Goldilocks fashion…not too hot, and not too cold. Retirement is supposed to be relaxing and stress free. Do yourself a favor and create a disciplined and systematic investment plan. Being apathetic due to an infinite stream of worrisome sounding headlines may work in the short-run, but in the long-run it’s best to turn off the noise…unless of course you don’t give a &$#*@%^ and want to work as a greeter at Wal-Mart in your mid-80s.
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 WMT, 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 ICContact page.
Will Rising Rates Murder Market?
After an obituary of Mark Twain had been mistakenly published in the United States, Twain sent a cable from London stating, “The reports of my death have been greatly exaggerated.” Similar reports about the death of the stock market have been prematurely published as well. If you were to listen to the talking heads on TV or other self-proclaimed media pundits, the prevailing opinion is that rising interest rates will murder the stock market. In reality, the benchmark 10-Year Treasury Note has risen a whopping 0.23% so far this year. Could this be a start of a more prolonged increase in interest rates? It is certainly possible. Most investors have a very short memory because we have seen this movie before. It was just two short years ago that we witnessed a near doubling of 10-Year Treasury yields exploding from 1.76% to 3.03% in 2013. Did the stock market crater? In fact, quite the contrary. The S&P 500 index catapulted higher by a whopping +30%.
Even if we go back a litter further in recent history, interest rates were quite a bit higher. For example in early 2010, 10-Year Treasury yields breached 4.0%. Where was the Dow Jones Industrial index then? A mere 11,000 vs 17,850 today. Or in other words, when interest rates were significantly higher than today’s 2.40% yield, the stock market managed to climb +62% higher. Not too shabby, eh? As I have talked about in the past (see Don’t Be a Fool, Follow the Stool), there are other factors besides interest rates that are contributing to positive stock returns – primarily profits, valuations, and sentiment are the other key factors in determining stock prices. Suffice it to say, over the last five years, stocks have survived quite well in the face of multiple interest rate spikes; the 2013 “Taper Tantrum”; and the subsequent completion of quantitative easing – QE (see chart below).
Underlying Chart: Yahoo Finance!
Yield Curve on the Side of Bulls
Despite the trepidation over a series of potential Fed rate hikes, stocks continue to grind higher. If the fears are based on the expectation of a slowing economy on the horizon, then we would generally see two things happening. First, rising short-term interest rates would cause the yield curve to flatten, and then secondly, the yield curve would invert (typically a leading indicator for a recession). Currently, there are no signs of flattening or inverting. Actually, the recent better than expected jobs report for May (280,000 jobs added vs. estimate of 226,000) created a steeper yield curve – long-term interest rates increased more than short-term interest rates. Just as I wrote in 2009 about the recovery (see Steepening Yield Curve Recovery), right now the bond market is flashing recovery…not slowdown.
In the face of the mini-interest rate spike, bank stocks are also signaling economic recovery – evidenced by the 2.75% surge in the KBW Bank Index (KBX) last week. If there were signs of dark clouds on the horizon, a flattening yield curve would squeeze bank net interest margins and profits, which ultimately would send bank investors to the exit. That phenomenon will eventually happen later in the economic cycle, but right now investors are voting in the opposite direction with their dollars.
The media, economists, strategists, and other nervous onlookers will continue fretting over the Federal Reserve’s eventual rate increases. As long as dovish Janet Yellen is at the helm of the Fed, future rate increases will be measured, and rather than murdering the stock market, the policies will merely reflect a removal of the economy from artificial life support.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on ICContact page.
U.S. Takes Breather in Windy Economic Race
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (May 1, 2015). Subscribe on the right side of the page for the complete text.
Looking back, in the race for financial dominance, the U.S. economy sprinted out to a relatively quick recovery from the 2008-2009 financial crisis injury compared to its other global competitors. The ultra-loose monetary policies implemented by the Federal Reserve (i.e., zero percent Fed Funds rate, quantitative easing – QE, Operation Twist, etc.) and the associated weakening in the value of the U.S. dollar served as tailwinds for growth. The low interest rate byproduct created cheaper borrowing costs for consumers and businesses alike for things like mortgages, refinancings, stock buybacks, and infrastructure investments. The cheaper U.S. dollar also helped domestically based, multinational companies sell their goods abroad at more attractive prices.
However, those positive dynamics have now changed. With the end of stimulative bond buying (QE) and threats of imminent interest rate hikes coming from the Federal Reserve and its Chairwoman Janet Yellen, the tailwinds for the U.S. economy have now transitioned into headwinds. The measly +0.2% growth recently reported in the 1st quarter – Gross Domestic Product (GDP) results are evidence of an economy currently sucking wind (see chart below).
As it relates to the stock market, the Dow Jones crept up +0.4% for the month of April to 17,841, and is essentially flat for all of 2015. Small Cap stocks in the Russell 2000® Index (companies with an average value of $2 billion – IWM), pulled a muscle in April as shown by the index’s -2.6% tumble. A slight increase in the yield of the 10-Year Treasury to 2.05% caused bond prices to contract a modest -0.5% for the month.
Beyond a strengthening dollar and threats of rising interest rates, debilitating port strikes on the West Coast and abnormally cold weather especially back east also contributed to weak trade data and sub par economic performance. Although a drop in oil and gasoline prices should ultimately be stimulative for broader consumer and industrial activity, the immediate negative impacts of job losses and declining drilling in the energy sector added to the drag on 1st quarter GDP results.
Source: Scott Grannis (Calafia Beach Pundit)
The good news is that many of the previously mentioned negative factors are temporary in nature and should self-correct themselves as we enter the 2nd quarter. One positive aspect to our country’s strong currency is cheaper imports. So, as the U.S. recovers from its temporary currency cramps, foreigners will continue pumping out cheap exports to Americans for purchase. If this import phenomenon lasts, these lower priced goods, coupled with discounted oil prices, should keep a lid on broader inflation. The benefit of lower inflation means the Federal Reserve is more likely to postpone slamming the brakes on the economy with interest rate hikes. The decision of when to lift interest rates will ultimately be data-dependent. Due to the lousy 1st quarter numbers, it will probably take some time for economic momentum to reemerge, and therefore the Fed is unlikely to raise interest rates until September, at the earliest.
The great thing about financial markets and economics is many of these swirling monetary winds eventually self-correct themselves. And during April, we saw these self-correcting mechanisms up close and in person. For example, from March 2014 to March 2015 the U.S. dollar appreciated in value by about +25% versus the euro currency (FXE). However, from the peak exchange rate seen this March, the value of the U.S. dollar declined by about -7%. The same self-correcting principle applies to the oil market. From the highs reached in mid-2014 at about $108 per barrel, crude oil prices plunged by about -60% to a low of $42 per barrel in March. Since then, oil prices have recovered significantly by spiking over +40% to about $60 per barrel today.
Competitors Narrow the Gap with the U.S.
Source: Dr. Ed Yardeni
As I’ve written many times in the past, one of the ultimate arbiters of stock price performance is the long-term direction of corporate profits. And as you can see from the chart above, profits have hit a bump in the road after a fairly uninterrupted progression over the last six years. The decline is nowhere near the collapse of 2008-2009, but given the rise in stock prices, investors should be prepared for the bears and skeptics to become more vocal.
And while the U.S. has struggled a bit, European and Asian shares have advanced significantly. To that point, Asian equities (FXI) spiked an impressive +16% in April (see chart below) and European stocks jumped a respectable +4% (VGK) over the same timeframe.
Source: Dr. Ed’s Blog
Bolstering the advance in China’s shares has been the Chinese central bank’s move to cut the amount of cash that banks must hold as reserves (“reserve requirements”). The action by the central bank is designed to spur bank lending and combat slowing growth in the world’s second largest economy. The Europeans are not sitting idly on their hands either. European central bankers have taken a cheat sheet page from the U.S. playbook and have introduced their own form of trillion dollar+ quantitative easing (see Draghi Provides Beer Goggles) in hopes of jump starting the European economy. Given the moves, how is the European business activity picture looking? Well, based on the Eurozone Purchasing Managers’ Index (PMI), you can see from the chart below that the region is finally growing (readings > 50 indicate expansion).
Source: Dr. Ed’s Blog
The economic winds in the global race for growth have been swirling in all directions, and due to temporary headwinds, the dominating lead of the U.S. has narrowed. Fortunately for long-term investors, they understand investing is a marathon and not a sprint. Holding a globally balanced and diversified portfolio will help you maintain the stamina required for these volatile and windy economic times.
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), FXI, VGK, and a short position in FXE, but at the time of publishing, SCM had no direct position in IWM, 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.
“Patient” Prick Proves More Pleasure than Pain
I will be the first one to admit I hate needles. In fact, I’ve been known to skip my annual flu shots out of cowardice simply to avoid the harmless prick of the syringe. The mere thought of a long needle jabbing into my arm, or other fleshy part of my body, has had the chilling effect of generating irrational decisions (i.e., I forgo flu shot benefits for no logical reason).
For months the talking heads and so-called pundits have speculated and fretted over the potential removal of the term “patient” from the periodically issued Federal Open Market Committee (FOMC) statement. Since the end of 2014, the statement read that the Fed “can be patient in beginning to normalize” monetary policy.
For investors, the linguistic fear of the removal of “patient” is as groundless as my needle fears. In the financial markets, the consensus view is often wrong. The stronger the euphoric consensus, the higher the probability the consensus will soon be wrong. You can think of technology in the late 1990s, real estate in the mid-2000s; or gold trading at $1,800/oz in 2011. The reverse holds true for the pessimistic consensus. Value guru, extraordinaire, Bill Miller stated it well,
“Stocks do not get undervalued unless somebody is worried about something. The question is not whether there are problems. There are always problems. The question is whether those problems are already fully discounted or not.”
Which brings us back to the Fed’s removal of the word “patient”. Upon release of the statement, the Dow Jones Industrial index skyrocketed about 400 points in 30 minutes. Considering the overwhelming consensus was for the Fed to remove the word “patient”, and given the following favorable factors, should anyone really be surprised that the market is trading near record highs?
FAVORABLE FACTORS:
- Queen Dove Yellen as Fed Chairwoman
- Declining interest rates near generational low
- Stimulative, low oil prices that are declining
- Corporate profits at/near record highs
- Unemployment figures approaching cyclical lows
- Core inflation in check below 2% threshold
While the short-term relief rally may feel good for the bulls, there are still some flies in the ointment, including a strong U.S. dollar hurting trade, an inconsistent housing recovery, and a slowing Chinese economy, among other factors.
Outside the scandalous “patient” semantics was the heated debate over the Fed’s “Dot Plot,” which is just a 3rd grader’s version of showing the Fed members’ Federal Funds rate forecasts. While to a layman the chart below may look like an elementary school dot-to-dot worksheet, in reality it is a good synopsis of interest rate expectations. Part of the reason stocks reacted so positively to the Fed’s statement is because the “Dot Plot” median interest rate expectations of 0.625% came down 0.50% for 2015, and by more than 0.60% for 2016 to 1.875%. This just hammers home the idea that there are currently no dark clouds looming on the horizon that would indicate aggressive rate hikes are coming.
Source via BusinessInsider
These sub-2% interest rate expectations over the next few years hardly qualify as a “hawkish” stance. As I’ve written before, the stock market handled a 2.5% hike in stride when the Fed Funds rate increased in 1994 (see also 1994 Bond Repeat or Stock Defeat?). What’s more, the Fed Funds rate cycle peaked at 5.0% in 2007 before the market crashed in the Great Recession of 2008-2009.
Although volatility is bound to increase as the Federal Reserve transitions out of a six-year 0% interest rate policy, don’t let the irrational fear of a modest Fed hike prick scare you away from potential investment benefits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Here Comes the Great Rotation…Finally?
For decades interest rates have continually gravitated to zero like flies attracted to stink. For a split second in 2013, as long-term U.S. Treasury rates about doubled from 1.5% to 3.0% before reversing, it appeared the declining rate cycle could finally be broken. At the time, pundits of all types were calling for the “great rotation” out of bonds into stocks. Half of this forecast came to fruition as stocks grinded to record highs in 2014, but even I the big stock bull admittedly did not expect interest rates on 10-year Switzerland bonds to turn negative (see also Draghi QE Beer Goggles), especially after U.S. quantitative easing (QE) came to an end.
With rates already at a generational low, how could anyone be expected to accept a measly 0.3% annual return for a whole decade? Well, that’s exactly what’s happening in massive developed markets like Germany and Japan. While investors and retirees are painted into a corner by being forced to accept near-0% interest payments, savvy corporate borrowers are taking advantage of this once in a lifetime opportunity. Take for example the recently unprecedented $1.35 billion Switzerland bond issuance by Apple Inc. (AAPL), which included a tranche of bonds maturing in 2024 that yielded a paltry 0.25%.
With bonds offering lower and lower yield possibilities for investors of all stripes, at Sidoxia we are still finding plenty of opportunities in stocks, especially in high dividend-paying equity investments. In the U.S., the average S&P 500 stock is yielding approximately the same as the 10-Year Treasury Note (2.0%), but in other parts of the world, equity markets such as the following are offering significantly higher yields:
- iShares MSCI Australia (Yield 5.0% – EWA)
- Europe FTSE Europe (Yield: 4.6% – VGK)
- Market Vectors Russia (Yield 4.6% – RSX)
- iShares MSCI Brazil (Yield 4.0% – EWZ)
- iShares MSCI Sweden (Yield 3.8% – EWD)
- iShares MSCI Malaysia (Yield 3.8% – EWM)
- iShares MSCI Singapore (Yield 3.4% – EWS)
- iShares China (Yield 2.5% – FXI)
A New “Great Rotation” in 2015?
If you look at the 2014 ICI (Investment Company Institute) fund flow data, it becomes clear the great rotation out of bonds into U.S. stocks has not occurred. More specifically, despite the S&P 500 index reaching new record highs, -$60 billion flowed out of U.S. stock funds last year, and about +$44 billion flowed into all bond funds. Could the “great rotation” out of bonds into stocks finally happen in 2015? Certainly, this scenario is a possibility, but given the barren bond yield environment, perhaps the new “great rotation” in 2015 will be out of domestic equities into higher yielding international equity markets. In addition to the higher international market yields listed above, many of these foreign markets are priced more attractively (i.e., lower Price-Earnings (P/E) ratios) as you can see from the chart below created by strategist Dr. Ed Yardeni.
Source: Ed Yardeni – Dr. Ed’s Blog
Obviously, any asset shifting scenario is not mutually exclusive, and there could be a combination of investor reallocations made in 2015. It’s possible that previously unloved emerging markets and international developed markets could receive new investor capital from several areas.
With defensive sectors like utilities (up +25%) and healthcare (up +24%) leading the U.S. sector higher last year, it’s evident to me that “skepticism” remains the operative word in investors’ minds and there is no clear evidence of widespread euphoria hitting the U.S. stock market. Valuations as measured by trailing P/E ratios have objectively moved above historical averages, however this has occurred within the context of all-time record low interest rates and inflation. If you take into account the near-0% interest rate environment into your calculus, current stock prices (P/E ratios) are well within historical norms (see also The Rule of 20 Can Make You Plenty), which still leaves room for expansion.
If some of the half-glass full economic waters spill into the half-glass empty emerging markets/international markets, conceivably the eagerly anticipated “great rotation” out of bonds into U.S. stocks may also flow into even more attractively valued foreign equity opportunities.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL and certain exchange traded funds (ETFs) including VGK, EWZ, FXI, but at the time of publishing SCM had no direct position in EWA, RSX, EWD, EWM, EWS, and any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Is Good News, Bad News?
The tug-of-war is officially on as investors try to decipher whether good news is good or bad for the stock market? On the surface, the monthly January jobs report released by the Bureau of Labor Statistics (BLS) appeared to be welcomed, positive data. Total jobs added for the month tallied +257,000 (above the Bloomberg consensus of +230,000) and the unemployment rate registered 5.7% thanks to the labor participation rate swelling during the month (see chart below). More specifically, the number of people looking for a job exceeded one million, which is the largest pool of job seekers since 2000.
Source: BLS via New York Times
Initially the reception by stocks to the jobs numbers was perceived positively as the Dow Jones Industrial index climbed more than 70 points on Friday. Upon further digestion, investors began to fear an overheated employment market could lead to an earlier than anticipated interest rate hike by the Federal Reserve, which explains the sell-off in bonds. The yield on the 10-Year Treasury proceeded to spike by +0.13% before settling around 1.94% – that yield compares to a recent low of 1.65% reached last week. The initial euphoric stock leap eventually changed direction with the Dow producing a -180 point downward reversal, before the Dow ended the day down -62 points for the session.
Crude Confidence?
The same confusion circling the good jobs numbers has also been circulating around lower oil prices, which on the surface should be extremely positive for the economy, considering consumer spending accounts for roughly 70% of our country’s economic output. Lower gasoline prices and heating bills means more discretionary spending in the pockets of consumers, which should translate into more economic activity. Furthermore, it comes as no surprise to me that oil is both figuratively and literally the lubricant for moving goods around our country and abroad, as evidenced by the Dow Jones Transportation index that has handily outperformed the S&P 500 index over the last 18 months. While this may truly be the case, many journalists, strategists, economists, and analysts are nevertheless talking about the harmful deflationary impacts of declining oil prices. Rather than being viewed as a stimulative lubricant to the economy, many of these so-called pundits point to low oil prices as a sign of weak global activity and an omen of worse things to come.
This begs the question, as I previously explored a few years ago (see Good News=Good News?), is it possible that good news can actually be good news? Is it possible that lower energy costs for oil importing countries could really be stimulative for the global economy, especially in regions like Europe and Japan, which have been in a decade-long funk? Is it possible that healthier economies benefiting from substantial job creation can cause a stingy, nervous, and scarred corporate boardrooms to finally open up their wallets to invest more significantly?
Interest Rate Doom May Be Boom?
Quite frankly, all the incessant, never-ending discussions about an impending financial market Armageddon due to a potential single 0.25% basis point rate hike seem a little hyperbolic. Could I be naively whistling past the graveyard? From my perspective, although it is a foregone conclusion the Fed will have to increase interest rates above 0%, this is nothing new (I’m really putting my neck out there on this projection). Could this cause some volatility when it finally happens…of course. Just look at what happened to financial markets when former Federal Reserve Chairman Ben Bernanke merely threatened investors with a wind-down of quantitative easing (QE) in 2013 and investors had a taper tantrum. Sure, stocks got hit by about -5% at the time, but now the S&P 500 index has catapulted higher by more than +25%.
Looking at how stocks react in previous rate hike cycles is another constructive exercise. The aggressive +2.50% in rate hikes by former Fed Chair Alan Greenspan in 1995 may prove to be a good proxy (see also 1994 Bond Repeat?). After suffering about a -10% correction early in 1994, stocks rallied in the back-half to end the year at roughly flat.
And before we officially declare the end of the world over a single 0.25% hike, let’s not forget that the last rate hike cycle (2004 – 2006) took two and a half years and 17 increases in the targeted Federal Funds rate (1.00% to 5.25%). Before the rate increases finally broke the stock market’s back, the bull market moved about another +40% higher…not too shabby.
Lastly, before writing the obituary of this bull market, it’s worth noting the yield curve has been an incredible leading indicator and currently this gauge is showing zero warnings of any dark clouds approaching on the horizon (see chart below). As a matter of fact, over the last 50 years or so, the yield curve has turned negative (or near 0%) before every recession.
Source: StockCharts.com
As the chart above shows, the yield curve remains very sloped despite modest flattening in recent quarters.
While many skeptics are having difficulty accepting the jobs data and declining oil prices as good news because of rate hike fears, history shows us this position could be very misguided. Perhaps, once again, this time around good news may actually be good news.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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