Posts tagged ‘Iranian Nuclear Threat’

Ignoring Economics and Vital Signs

As stock prices sit near all-time record highs, and as we enter year nine of the current bull market, I remain amazed and amused at the brazen disregard for important basic economic concepts like supply & demand, interest rates, and rising profits.

If the stock market was a doctor’s patient, over the last decade, bloggers, pundits, talking heads, and pontificators have been ignoring the improving, healthy patient’s vital signs, while endlessly predicting the death of the resilient stock market.

However, let’s be clear – it has not been all hearts and flowers for stocks – there have been numerous -10%, -15%, and -20% corrections since the Financial Crisis nine years ago. Those corrections included the Flash Crash, debt downgrade, Arab Spring, sequestration, Taper Tantrum, Iranian Nuclear Threat, Ukrainian-Crimea annexation, Ebola, Paris/San Bernardino Terrorist Attacks, multiple European & Chinese slowdowns and more.

Despite the avalanche of headlines and volatility, we all know the net result of these events – a more than tripling of stock prices (+259%) from March 2009 to new all-time record highs. With the incessant stream of negative news, how could prices appreciate so dramatically?

Over the years, the explanations by outside observers have changed. First, the recovery was explained as a “dead cat bounce” or a short-term cyclical bull market within a long-term secular bear market. Then, when stock prices broke to new records, the focus shifted to Quantitative Easing (QE1, QE2, QE3, and Operation Twist). The QE narrative implied the bull advance was temporary due to the non-stop, artificial printing presses of the Fed. Now that the Fed has not only ended QE but reversed it (the Fed is actually contracting its balance sheet) and hiked interest rates (no longer cutting), outsiders are once again at a loss. Now, the bears are left clinging to the flawed CAPE metric I wrote about three years ago (see CAPE Smells Like BS), and using political headlines as a theory for record prices (i.e., record stock prices stem from inflated tax cut and infrastructure spending expectations).

It’s unfortunate for the bears that all the conspiracy theory headlines and F.U.D. (fear, uncertainty, and doubt) over the last 10 years have failed miserably as predictors for stock prices. The truth is that stock prices don’t care about headlines – stock prices care about economics. More specifically, stock prices care about profits, interest rates, and supply & demand.

Profits

It’s quite simple. Stock prices have more than tripled since early 2009 because profits have more than tripled since 2009. As you can see from the Macrotrends chart below, 2009 – 2016 profits for the S&P 500 index rose from $6.86 to $94.54, or +1,287%. It’s no surprise either that stock prices stalled for 18 months from 2015 to mid-2016 when profits slowed. After profits returned to growth, stock price appreciation also resumed.

Source: Macrotrends

Interest Rates

When you could earn a +16% on a guaranteed CD bank rate in the early 1980s, do you think stocks were a more or less attractive asset class? If you can sense the rhetorical nature of my question, then you can probably understand why stocks were about as attractive as rotten milk or moldy bread. Back then, stocks traded for about 8x’s earnings vs. the 18x-20x multiples today. The difference is, today interest rates are near generational lows (see chart below), and CDs pay near +0%, thereby making stocks much more attractive. If you think this type of talk is heresy, ignore me and listen to the greatest investor of all-time, Warren Buffett who recently stated:

“Measured against interest rates, stocks are actually on the cheap side.”

 

Source: Trading Economics

Supply & Demand

Another massively ignored area, as it relates to the health of stock prices, is the relationship of new stock supply entering the market (e.g., new dilutive shares via IPOs and follow-on offerings), versus stock exiting the market through corporate actions. While there has been some coverage placed on the corporate action of share buybacks – about a half trillion dollars of stock being sucked up like a vacuum cleaner by cash heavy companies like Apple Inc. (AAPL) – little attention has been paid to the trillions of dollars of stock vanishing from mergers and acquisition activities. Yes, Snap Inc. (SNAP) has garnered a disproportionate amount of attention for its $3 billion IPO (Initial Public Offering), this is a drop in the bucket compared to the exodus of stock from M&A activity. Consider the trivial amount of SNAP supply entering the market ($3 billion) vs. $100s of billions in major deals announced in 2016 – 2017:

  • Time Warner Inc. merger offer by AT&T Inc. (T) for $85 billion
  • Monsanto Co. merger offer by Bayer AG (BAYRY) for $66 billion
  • Reynolds American Inc. merger offer by British American Tobacco (BTI) for $47 billion
  • NXP Semiconductors merger offer by Qualcomm Inc. (QCOM) for $39 billion
  • LinkedIn merger offer by Microsoft Corp. (MSFT) for $28 billion
  • Jude Medical, Inc. merger offer by Abbott Laboratories (ABT) for $25 billion
  • Mead Johnson Nutrition merger offer by Reckitt Benckiser Group for $18 billion
  • Mobileye merger offer by Intel Corp. (INTC) for $15 billion
  • Netsuite merger offer by Oracle Corp. (ORCL) for $9 billion
  • Kate Spade & Co. merger offer by Coach Inc. (COH) for $2 billion

While these few handfuls of deals represent over $300 billion in disappearing stock, as long as corporate profits remain strong, interest rates low, and valuations reasonable, there will likely continue to be trillions of dollars in stocks being purchased by corporations. This continued vigorous M&A activity should provide further healthy support to stock prices.

Admittedly, there will come a time when profits will collapse, interest rates will spike, valuations will get stretched, sentiment will become euphoric, and/or supply of stock will flood the market (see Don’t be a Fool, Follow the Stool). When the balance of these factors turn negative, the risk profile for stock prices will obviously become less desirable. Until then, I will let the skeptics and bears ignore the healthy economic vital signs and call for the death of a healthy patient (stock market). In the meantime, I will continue focus on the basics of math and offer my economics textbook to the doubters.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own AAPL, ABT, INTC, MSFT, T, and certain exchange traded funds, but at the time of publishing SCM had no direct position in SNAP, TWX, MON, KATE, N, MBLY, MJN, STJ, LNKD, NXPI, BAYRY, BTI, QCOM, ORCL, COH, RAI, Reckitt Benckiser Group,  any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

May 14, 2017 at 12:27 am Leave a comment

Surviving a Series of Unfortunate Events

Disaster

My children grew up reading a Series of Unfortunate Events by Lemony Snicket’s (the pseudonym for Daniel Handler). The award winning 13 book series began at the turn of the century (1999) with the Bad Beginning and seven years later, Handler ended the stories with The End (2006). The books chronicle the stories of three orphaned children (Violet, Klaus, and Sunny Baudelaire) who experience increasingly terrible events after the alleged death of their parents and burning of their house by a man named Count Olaf.

Crime, violence and hardships not only occur in novels, but also in real life. Stock market investors are no strangers to unfortunate events either. Within the last five years alone, investors have endured an endless stream of bad news, including the following:

  • Flash Crash
  • Debt Ceiling Debate
  • U.S. Debt Downgrade
  • European Recession
  • Arab Spring
  • Potential Greek Exit from EU
  • Uncertain U.S. Presidential Elections
  • Sequestration
  • Cyprus Financial Crisis
  • Tax Increases
  • Fed Talks of Stimulus Tapering
  • Syrian Civil War / Military Threat
  • Gov. Shutdown 
  •  Obamacare Rollout Glitches
  •  Iranian Nuclear Threat

This is only a partial list, but wow, this never ending crises list sounds pretty ominous, right? I wonder how stocks have fared amidst this horrendous avalanche of negative headlines? The short answer is stocks are up a whopping +170% since the March 2009 lows as measured by the S&P 500 index, and would be significantly higher once accounting for reinvested dividends. A bit higher return than your CD, money market, or savings account rate.

CLICK TO ENLARGE

SP500 History 2009-2013

As you can see from the chart above, the gargantuan returns achieved over this period have not occurred without some volatility. Investors have consumed massive quantities of Tums during the five highlighted corrections (averaging -13%) to counteract all the heartburn. As I’ve written in the past, with higher risk comes higher rewards. Those investors who cannot stomach the volatility shouldn’t go cold turkey on stocks though, but rather diversify their holdings and reduce the portfolio equity allocation to a more palatable level.

Doubting Thomases

Many people I bump into remain “Doubting Thomases” as it relates to the stock market recovery and they expect an imminent crash. Certainly, the rocket-like trajectory of the last year (and five years) is not sustainable, and historically stocks correct significantly twice a decade – equal to the number of recessions occurring each decade. There is no denying that this economic recovery has been the slowest since World War II, but could this be good news? From the half-full glass lens, a slower recovery may actually equate to a longer recovery.

Just like skeptical investors, business executives have been slow to hire and slow to accelerate spending as well. Typically business cycles come to an end when overinvestment happens – recall the 2000 tech bubble and 2007 housing bubble. There may be pockets of investment bubbles (e.g., Twitter Inc [TWTR] and other money-losing speculative stocks), but as you can see from the chart below, corporate profits have skyrocketed and are at record highs. It should therefore come as no surprise that record profits have coincided with record stock prices (see also It’s the Earnings Stupid)

SP500 Earnings 2003-2014

Over the period of 2003-2013 stock prices largely followed the slope of earnings, and excluding the enormous losses in the banking sector, non-financial stocks suffered much less.

History is on Your Side

If you are in the camp that says this last five years has been an anomaly, history may beg to differ. Over the last 50 years we have experienced wars, assassinations, currency crises, banking crises, terrorist attacks, recessions, SARs, mad cow disease, military engagements, tax hikes, Fed rate hikes, and yes, even political gridlock. As the chart below shows, the stock market is volatile over the short-run, but quite resilient and lucrative over the long-run (+6,863% over 49 years). In fact, from January 1960 to October 2013 the S&P 500 index has catapulted +14,658%, including reinvested dividends (Source: DQYDJ.net).

SP500 History 1960-2008

Rather than getting caught up in the political or CNBC headline du jour, investors will be better served by creating a customized, long-term diversified portfolio that can meet long-standing goals and objectives. If you don’t have the discipline, interest, or time to properly create a personalized investment plan, then find an independent investment advisor like Sidoxia Capital Management (www.Sidoxia.com), so you can experience a series of fortunate (not unfortunate) events.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in 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. Chart construction done by Kevin D. Weaver.

November 16, 2013 at 10:52 pm 4 comments


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