Posts tagged ‘Janet Yellen’

The Scary Blip

I hated it when my mom reminded me when I was a younger, but now that I’ve survived into middle-aged adulthood, I will give you the same medicine she gave me:

“I told you so.”

As I cautioned in last month’s newsletter, “It’s important for investors to remember this pace of gains cannot be sustainable forever.” I added that there were a whole bunch of scenarios for stock prices to go down or “stock prices could simply go down due to profit-taking.”

And that is exactly what we saw. From the peak achieved in late January, stock prices quickly dropped by -12% at the low in early February, with little-to-no explanation other than a vague blame-game on rising interest rates – the 2018 yield on the 10-Year Treasury Note rose from 2.4% to 2.9%. This explanation holds little water if you take into account interest rates on the 10-Year increased from roughly 1.5% to 3.0% in 2013 (“Taper Tantrum”), yet stock prices still rose +20%. The good news, at least for now, is the stock correction has been contained or mitigated. A significant chunk of the latest double-digit loss has been recovered, resulting in stock prices declining by a more manageable -3.9% for the month. Despite the monthly loss, the subsequent rebound in late February has still left investors with a gain of 1.5% for 2018. Not too shabby, especially considering this modest return comes on the heels of a heroic +19.4% gain in 2017.

As you can see at from the 22-year stock market chart below for the S&P 500, the brief but painful drop was merely a scary blip in the long-term scheme of things.

Whenever the market drops significantly over a short period of time, as it did this month, conspiracy theories usually come out of the woodwork in an attempt to explain the unexplainable. When human behavior is involved, rationalizing a true root cause can be very challenging, to say the least. It is certainly possible that technical factors contributed to the pace and scale of the recent decline, as has been the case in the past. Currently no smoking gun or fat finger has been discovered, however some pundits are arguing the popular usage of leveraged ETFs (Exchange Traded Funds) has contributed to the accelerated downdraft last month. Leveraged ETFs are special, extra-volatile trading funds that will move at amplified degrees – you can think of them as speculative trading vehicles on steroids. The low-cost nature, diversification benefits, and ability for traders to speculate on market swings and sector movements have led to an explosion in ETF assets to an estimated $4.6 trillion.

Regardless of the cause for the market drop, long-term investors have experienced these types of crashes in the past. Do you remember the 2010 Flash Crash (down -17%) or the October 1987 Crash (-23% one-day drop in the Dow Jones Industrial Average index)? Technology, or the lack thereof (circuit breakers), helped contribute to these past crashes. Since 1987, the networking and trading technologies have definitely become much more sophisticated, but so have the traders and their strategies.

Another risk I highlighted last month, which remains true today, is the potential for the new Federal Reserve chief, Jerome Powell, to institute a too aggressive monetary policy. During his recent testimony and answers to Congress, Powell dismissed the risks of an imminent recession. He blamed past recessions on previous Fed Chairmen who over enthusiastically increased interest rate targets too quickly. Powell’s comments should provide comfort to nervous investors. Regardless of short-term inflation fears, common sense dictates Powell will not want to crater the economy and his legacy by slamming the economic brakes via excessive rate hikes early during his Fed chief tenure.

Tax Cuts = Profit Gains

Despite the heightened volatility experienced in February, I remain fairly constructive on the equity investment outlook overall. The recently passed tax legislation (Tax Cuts and Job Act of 2017) has had an undeniably positive impact on corporate profits (see chart below of record profit forecasts – blue line). More specifically, approximately 75% of corporations (S&P 500 companies) have reported better-than-expected results for the past quarter ending December 31st. On an aggregate basis, quarterly profits have also risen an impressive +15% compared to last year. When you marry these stellar earnings results with the latest correction in stock prices, historically this combination of factors has proven to be a positive omen for investors.

Source: Dr. Ed’s Blog

Despite the rosy profit projections and recent economic strength, there is always an endless debate regarding the future direction of the economy and interest rates. This economic cycle is no different. When fundamentals are strong, stories of spiking inflation and overly aggressive interest rate hikes by the Fed rule the media airwaves. On the other hand, when fundamentals deteriorate or slow down, fears of a 2008-2009 financial crisis enter the zeitgeist. The same tug-of-war fundamental debate exists today. The stimulative impacts of tax cuts on corporate profits are undeniable, but investors remain anxious that the negative inflationary side-effects from a potential overheating economy could outweigh the positive economic momentum of a near full-employment economy gaining steam.

Rather than playing Goldilocks with your investment portfolio by trying to figure out whether the short-term stock market is too hot or too cold, you would be better served by focusing on your long-term asset allocation, and low-cost, tax-efficient investment strategy. If you don’t believe me, you should listen to the wealthiest, most successful investor of all-time, Warren Buffett (The Oracle of Omaha), who just published his annual shareholder letter. In his widely followed letter, Buffett stated, “Performance comes, performance goes. Fees never falter.” To emphasize his point, Buffett made a 10-year, $1 million bet for charity with a high-fee hedge fund manager (Protégé Partners). As part of the bet, Buffett claimed an investment in a low-fee S&P 500 index fund would outperform a selection of high-fee, hot-shot hedge fund managers. Unsurprisingly, the low-cost index fund trounced the hedge fund managers. From 2008-2017, Buffett’s index fund averaged +8.5% per year vs. +3.0% for the hedge fund managers.

During scary blips like the one experienced recently, lessons can be learned from successful, long-term billionaire investors like Warren Buffett, but lessons can also be learned from my mother. Do yourself a favor by getting your investment portfolio in order, so my mother won’t have to say, “I told you so.”

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2018). Subscribe on the right side of the page for the complete text.

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

March 1, 2018 at 3:08 pm Leave a comment

The Summer Heats Up

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 1, 2017). Subscribe on the right side of the page for the complete text.

The temperature in the stock market heated up again this month. Like a hot day at the beach, the Dow Jones Industrial Average stock index burned +542 points higher this month (+2.5%), while scorching +2,129 points ahead in 2017 (or +10.8%).

Despite these impressive gains (see 2009-2017 chart below), overall, investors remain concerned. Rather than stock participants calmly enjoying the sun, breeze, and refreshingly cool waters of the current markets, many investors have been more concerned about getting sunburned to a geopolitical crisp; overwhelmed by an unexpected economic tsunami; and/or drowned by a global central bank-induced interest rate crisis.

Stock market concerns rise, but so do stock prices.

The most recent cautionary warnings have come to the forefront by noted value investor Howard Marks, who grabbed headlines with last week’s forewarning memo, “Here They Go Again…Again.” The thoughtful, 23-page document is definitely worth reading, but like any prediction, it should be taken with a pound of salt, as I point out in my recent article Predictions – A Fool’s Errand. The reality is nobody has been able to consistently predict the future.

If you don’t believe my skepticism about crystal balls and palm readers, just listen to the author of the cautionary article himself. Like many other market soothsayers, Marks is forced to provide a mea culpa on the first page in which he admits his predictions have been wrong for the last six years. His dour but provocative position also faces another uphill battle, given that Marks’s conclusion flies in the face of value investing god, Warren Buffett, who was quoted this year as saying:

“Measured against interest rates, stocks actually are on the cheap side compared to historic valuations.”

Rather than crucify him, Marks should not be singled out for this commonly cautious view. In fact, most value investors are born with the gloom gene in their DNA, given the value mandate to discover and exploit distressed assets. This value-based endeavor has become increasingly difficult as the economy gains steam in this slow but sustainably long economic recovery. As I’ve mentioned on numerous occasions, bull markets don’t die of old age, but rather they die from excesses. So far the key components of the economy, the banking system and consumers, have yet to participate in euphoric excesses like previous economic cycles due to risk aversion caused by the last financial crisis.

Making matters worse for value investors, the value style of investing has underperformed since 2006 alongside other apocalyptic predictions from revered value peers like Seth Klarman and Ray Dalio, who have also been proved wrong over recent years.

However, worth stating, is experienced, long-term investors like Marks, Klarman, and Dalio deserve much more attention than the empty predictions spewed from the endless number of non-investing strategists and economists who I specifically reference in A Fool’s Errand.

Beach Cleanup in Washington

While beach conditions may be sunny, and stock market geeks like me continue debating future market weather conditions, media broadcasters and bloggers have been focused elsewhere – primarily the nasty political mess littered broadly across our American shores.

Lack of Congressional legislation progress relating to healthcare, tax reform, and infrastructure, coupled with a nagging investigation into potential Russian interference into U.S. elections, have caused the White House to finally lose its patience. The end result? A swift cleanup of the political hierarchy. After deciding to tidy up the White House, President Trump’s first priority was to remove Sean Spicer, the former White House Press Secretary and add the controversial Wall Street executive Anthony Scaramucci as the new White House Communications Chief. Shortly thereafter, White House Chief of Staff Reince Priebus was pushed to resign, and he was replaced by Secretary of Homeland Security, John F. Kelly. If this was not enough drama, after Scaramucci conducted a vulgar-laced tirade against Priebus in a New Yorker magazine interview, newly minted Chief of Staff Kelly felt compelled to quickly fire Scaramucci.

While the political beach party and soap opera have been entertaining to watch from the sidelines, I continue to remind observers that politics have little, if any, impact on the long-term direction of the financial markets. There have been much more important factors contributing to the nine-year bull market advance other than politics. For example, interest rates, corporate profits, valuations, and investor sentiment have been much more impactful forces behind the new record stock market highs.

Federal Reserve Chair Janet Yellen may not wear a bikini at the beach, but nevertheless she has become quite the spectacle in Washington, as investors speculate on the future direction of interest rates and other Fed monetary policies (i.e., unwinding the $4.5 trillion Fed balance sheet). In the hopes of not exhausting your patience too heavily, let’s briefly review interest rates, so they can be placed in the proper context. Specifically, it’s worth noting the spotlighted Federal Funds Rate target is sitting at enormously depressed levels (1.00% – 1.25%), despite the fact the Fed has increased the target four times within the last two years. How low has the Fed Funds rate been historically? As you can see from the historical chart below (1970 – 2017), this key benchmark rate reached a level as high as 20.00% in the early 1980s – a far cry from today’s 1.00% – 1.25% rate.

There are two crucial points to make here. First, even at 1.25%, interest rates are at extremely low levels, and this is significantly stimulative to our economy, even after considering the scenario of future interest rate hikes. The second main point is that that Federal Reserve Chair Janet Yellen has been exceedingly cautious about her careful, data-dependent intentions of increasing interest rates. As a matter of fact, the CME Fed Funds futures market currently indicates a 99% probability the Fed will maintain interest rates at this low level when the Federal Open Market Committee (FOMC) meets in September.

Responsibly Have Fun but Use Protection

It’s imperative to remain vigilantly prudent with your investments because weather conditions will not always remain calm in the financial markets. You do not want to get burned by overheated markets or caught off guard by an unexpected economic storm. Blindly buying tech stocks exclusively without a systematic disciplined approach to valuation is a sure-fire way to lose money over the long-run. Instead, protection must be implemented across multiple vectors.

From a broader perspective, at Sidoxia we believe it’s essential to follow a low-cost, diversified, tax-efficient, strategy with a long-term time horizon. Rebalancing your portfolio as markets continue to appreciate will keep your investment portfolio balanced as financial markets gyrate. These investment basics have produced a winning formula for many investors, including some very satisfying long-term results at Sidoxia, which is quickly approaching its 10-year anniversary. You can have fun at the beach, just remember to bring sunscreen and a windbreaker, in case conditions change.

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 had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 1, 2017 at 12:16 pm Leave a comment

The Sky is Falling?

sky-red-freeimages

Investors reacted like the sky was falling on Friday. Commentators mostly blamed the -400 point decline in the Dow on heightened probabilities for a September rate hike by Janet Yellen and her fellow Federal Reserve colleagues. Geopolitical concerns over a crazy dictator in North Korea with nuclear weapons were identified as contributing factors to frazzled nerves.

The real question should be, “Are these stories complete noise, or should I pay close attention?” For the vast majority of times, the response to questions like these should be “yes”, the media headlines are mere distractions and you should simply ignore them. During the last rate hike cycle from mid-2004 to mid-2006, guess how many times the Fed raised rates? Seventeen times! And over those 17 rate hikes, stocks managed to respectably rise over 11%.

So far this cycle, Yellen and the Fed have raised interest rates one time, and the one and only hike was the first increase in a decade. Given all this data, does it really make sense to run in a panic to a bunker or cave? Whether the Fed increases rates by 0.25% during September or Decemberis completely irrelevant.

If we look at the current situation from a slightly different angle, you can quickly realize that making critical investment decisions based on short-term Federal Reserve actions would be foolish. Would you buy or sell a house based solely on this month’s Fed policy? For most, the answer is an emphatic “no”. The same response should hold true for stocks as well. The real reason anyone should consider buying any type of asset, including stocks, is because you believe you are paying a fair or discounted price for a stream of adequate future cash flows (distributions) and/or price appreciation in the asset value over the long-term.

The problem today for many investors is “short-termism.” This is what Jack Gray of Grantham, Mayo, Van Otterloo and Company had to say on the subject, “Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth.” I couldn’t agree more.

Many people like to speculate or trade stocks like they are gambling in Las Vegas. One day, when the market is up, they buy. And the other day, when the market is down, they sell. However, those same people don’t wildly speculate with short-term decision-making when they buy larger ticket items like a lawn-mower, couch, refrigerator, car, or a house. They rationally buy with the intention of owning for years.

Yes, it’s true appliances, vehicles, and homes have utility characteristics different from other assets, but stocks have unique utility characteristics too. You can’t place leftovers, drive inside, or sit on a stock, but the long-term earnings and dividend growth of a diversified stock portfolio provides plenty of distinctive income and/or retirement utility benefits to a long-term investor.

You don’t have to believe me – just listen to investing greats like Warren Buffett:

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”

 

The common sense test can also shed some light on the subject. If short-term trading, based on the temperature of headlines, was indeed a lucrative strategy, then the wealthiest traders in the world would be littered all over the Forbes 100 list. There are many reasons that is not the case.

Even though the Volatility Index (aka, “Fear Gauge” – VIX) spiked +40% in a single day, that does not necessarily mean stock investors are out of the woods yet. We saw similar volatility occur last August and during January and June of this year. At the same time, there is no need to purchase a helmet and run to a bunker…the sky is not falling.

Other related article: Invest with a Telescope…Not a Microscope 

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper. 

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

September 10, 2016 at 12:00 pm 1 comment

The Fed: Myths vs. Reality

Crystal Ball

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

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

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

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

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

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

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

Myth #2: The Fed controls all interest rates.

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

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

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

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

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

Source: Calafia Beach Pundit

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

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper. 

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

August 27, 2016 at 8:15 pm 11 comments

Pulling the Band-Aid Off Slowly

Bandaid

Federal Reserve monetary policy once again came to the forefront as the Fed released its April minutes this week. After living through years of a ZIRP (Zero Interest Rate Policy) coupled with QE (Quantitative Easing), many market participants and commentators are begging for a swifter move back to “normalization” (a Federal Funds Rate target set closer to historical averages). The economic wounds from the financial crisis may be healing, as seen in the improving employment data, but rather than ripping off the interest rate Band-Aid quickly and putting the pain behind investors, the dovish Fed Chair Janet Yellen has been signaling for months the Fed will increase rates at a “gradual” pace.

Despite the more hawkish tone regarding the possibility of an additional rate hike in June, Fed interest rate futures are currently still only factoring in about a 26% probability of a rate increase in June. As I have been saying for years (see “Fed Fatigue”), there has, and will likely continue to be, an overly, hyper-sensitive focus on monetary policy and language disseminated by members of the Feral Reserve Open Market Committee.

For example, in 1994, despite the Fed increasing target rates by +2.5% in a single year (from 3.0% to 5.5%), stock prices finished roughly flat for the year, and the market resumed its decade-long bull market run the subsequent year. Today, the higher bound of Fed Funds sits at a mere 0.5%, and the Fed has announced only one target increase this cycle (equaling a fraction of the ’94 pace). Even if investors are panicking over another potential quarter point in June or July, can you say, “overkill?”

While the Fed is approaching the lower-end of the range for its employment mandate (unemployment currently sitting at 5%), despite the recent bounce in oil prices, core inflation remains in check (see Calafia Pundit chart below). This long-term benign pricing trend gives the Fed a longer leash as it relates to the pace of future rate hikes.

Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

Sure, ripping off the Fed Band-Aid with a small handful of +0.5% (50 bps) hikes might appease hawkish investors, but Janet Yellen, the “Fed Fairy Godmother,” has made it abundantly clear she is in no hurry to raise rates. Whether there is zero, one, or two additional rate hikes this year is much less important than other fundamental factors. Adding fuel to the Fed-speak fire in the short-run will be Yellen speeches on May 27th at Harvard University and on June 6th at the World Affairs Council of Philadelphia. And then following that, we will have the “Brexit” referendum (i.e., the vote on whether Britain should exit the EU); a steady stream of election noise; and many other unanticipated economic/geopolitical headlines.

As I continually state, the key factors driving the direction of long-term stock prices are profits, interest rates, valuations, and sentiment (see Follow the Stool). Profits (ex-energy) are growing near record levels; interest rates are near record lows (even with potential 2016 hikes); valuations remain near historical averages; and sentiment regarding stock ownership is firing strongly as a positive contrarian indicator.

While many pundits have been calling for and predicting the Fed to rip the Band-Aid off with a swift string of rate increases, persistently low inflation, coupled with a consistently dovish Fed Chair are likely to lead to a slow peeling of the monetary policy Band-Aid. Unfortunately, the endless flow of irrelevant monetary policy guesswork regarding the timing of future rate hikes will be more painful than the actual hikes themselves. In the end, any future hikes should be justified with a stronger economic foundation, which should represent future strength, rather than future weakness.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

May 21, 2016 at 10:21 pm Leave a comment

Spring Has Sprung: Market Weather Turning

Ox-eye daisies

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 1, 2016). Subscribe on the right side of the page for the complete text.

It was a cold winter for stocks, but as we approached the spring season in March, the flowers have begun to bloom. More specifically, during the month of March, the Dow Jones Industrial index catapulted +7.1% and the S&P 500 index jumped +6.6%. While this roughly +80% annualized rate is unlikely to sustain itself, this flurry of strong performance could be the sign of warmer weather conditions in the economic forecast.

What started out as a cold and blustery January, with stocks posting one of the worst beginning months in history (S&P 500 down -5.1%), quickly thawed out in February and March. Fears over deteriorating economic conditions in the U.S., China along with plummeting oil prices proved fleeting. In fact, as Scott Grannis at Calafia Beach Pundit  pointed out, there is no sign of recession in the U.S. as evidenced by a 43-year low in unemployment claims and a 4.9% unemployment rate (see chart below).

Unemployment Claims 3-16

As I’ve stated for many years, focusing on the never-ending hurricane of pessimistic headlines is a wasteful use of time and destructive force on performance, if acted upon. Offsetting the downpour of negative news stories are the record low interest rates (now incomprehensibly negative in parts of the globe), which serve as a protective umbrella against the short-term stormy volatility. When investors face the soggy reality of earning a near-0% return on their bank savings and a sub-2% Treasury bond market for 10-year maturities, suddenly a 6-7% earnings yield on stocks certainly looks pretty sunny. There have been very few times in history when dividends earned on stocks have exceeded the payments received on a 10 year Treasury bond, but that is exactly the extreme environment we are living in today. No doubt, if the interest rate climate changes, and rates spike higher, stocks will face a more thunderous environment.

However, fortunately for stock market investors (and unfortunately for savers), this week Federal Reserve Chair Janet Yellen reiterated her forceful view of maintaining interest rates at a low, stimulative level for an extended period of time.

If It Bleeds It Leads – At the Expense of Your Portfolio

Even in the face of European terrorist attacks in Brussels and a turbulent (but entertaining) political presidential election season, the four pillars of earnings, interest rates, valuations, and sentiment are still protecting stock investors from an economic flood (see also Don’t Be a Fool, Follow the Stool). Scary news headlines may sell newspapers and attract advertising dollars, but the real money is made by following the four investing pillars.

Also contributing to a clearer outlook this spring is the steadying value of the U.S. dollar and stabilizing trend realized in oil prices.

For most of 2015, multinational corporations saw their profits squeezed due to a 20-25% spike in the dollar. For example, an auto manufacturer selling a car for $20,000 in the U.S. could suddenly see the price of the same car changed to $25,000 in Europe. Meanwhile, a different German competitor could price a similar car manufactured in their country at the lower $20,000. This all translates into diminished sales and profits for American companies. Mercifully, we are beginning to see these currency headwinds abate, and even begin to shift into a slight tailwind (see 5-year chart below).

Source: barchart.com

Source: barchart.com

From copper and corn to silver and soy beans, commodity prices have been in a downward death spiral over the last five years. And crude oil hasn’t escaped the commodity collapse either…until recently. The supply glut, created by factors like the U.S. shale revolution and new added Iranian post-sanction reserves, led to price declines from a 2009 high of $147 per barrel to a 2016 low of $26. With China and U.S. dollar fears abating, oil prices have bounced about +45% from the 2016 lows to about $38 per barrel.

While the weather has been improving on our shores, not everyone appreciates the fact the U.S. has been the “best house in a bad global neighborhood.” As the chart below shows (February 2016), international stock markets have gone into a bear market (down > -20%) since the 2011 and 2014 peaks, while the U.S. has performed about 100% better. Even in the U.S. market, small-midcap stocks (small & midsize companies) fell about -22% from their 2015 peak before recouping much of the losses.

Source: Financial Times

Source: Financial Times

Whether large companies, as measured by the S&P 500 index, which fell about -15% from the peak, suffer a true, technical -20% “bear market” or continue the current seven-year bull market is debatable. Regardless, what we do know is investors survived another cold winter and spring has produced a weather forecast that is currently predicting warmer weather and sunnier economic skies.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

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

April 3, 2016 at 11:59 pm Leave a comment

Shoot Now, Ask Later

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Since the start of 2016, investor sentiment has led to a shoot now, ask questions later mentality. In the court of economic justice, all stocks have been convicted guilty of recession despite the evidence and defense that proves the economy innocent. Even the Federal Reserve Chair Janet Yellen did not prove to be a great public defender of the economy with her comments that negative interest rates are on the table.

With large cap stocks down -13% and small cap stocks losing -25% from 2015, there are a mixture of indicators suggesting a looming recession could be coming. For example, banking stocks, the beating heart of the U.S. economy, saw prices collapse almost -30% from the 2015 highs this week. As CNBC pointed out, “American Airlines (AAL), United Continental (UAL), General Motors (GM) and Ford (F) all sell for five times 2016 earnings” – about a 70% discount to the average S&P 500 stock. As a group, these economically sensitive cyclical stocks grew earnings per share greater than 50%, while their stock prices are down by more than -30% from their 52-week highs. In general, the cyclicals are serving jail time, even though growth has been gangbusters and the current valuations massively discounted.

On the flip side, defensive stocks with little-to-no revenue growth like “Campbell Soup (CPB) trade at 20 times earnings, Kimberly-Clark (KMB) is at 21 times earnings, Procter & Gamble (PG) is at 22 times earnings and Clorox (CLX) is at 25 times earnings. All of these stocks are near 52-week highs.”

Confused? Well, if we are indeed going into recession, than this valuation dichotomy between cyclicals and staples makes sense. Stocks can be a leading indicator (i.e., predictor) of future recessions, but as the famed Nobel Prize winner in economics Paul Samuelson noted, “The stock market has forecast nine of the last five recessions.”

On the other hand, if this current correction is a false recession scare, then now would be a tremendous buying opportunity. In fact, over the last five years, there have been plenty of tremendous buying opportunities for those courageous long-term investors willing to put capital to work during these panic periods (see also Groundhog Day All Over Again):

  • 2011: Debt Downgrade/Debt Ceiling Debate/European PIIGS Crisis (-22% correction)
  • 2012:Arab Spring/Greek “Gr-Exit” Fears (-11% correction)
  • 2013: Fed Taper Tantrum (-8% correction)
  • 2014: Ebola Outbreak (-10% correction)
  • 2015: China Slowdown Fears (-13% correction in August)
  • 2016 (1st Six Weeks): Strong Dollar, Collapsing Oil, interest Rate Hikes/Negative Rates, Weakening China (-15% correction)
  • 2016 (Next 46 Weeks): ??????????

Today’s threats rearing their ugly heads have definite recession credibility, but if you think about the strong dollar, collapsing oil prices, Fed monetary policies, weakening Chinese economy, and negative global interest rates, all of these threats existed well before stock prices nose-dived during the last six weeks. If the economic court is judging the current data for potential recession evidence, making a case and proving the economy guilty is challenging. It’s tough to find a recession when we witness a low unemployment rate (4.9%); record corporate profits (ex-energy); record car sales (17.5 million); an improving housing market; a positively sloped yield curve; healthy banking and consumer balance sheets; sub-$2/gallon gasoline; and a flattening U.S. dollar, among other factors.

Could stock prices be clairvoyantly predicting Armageddon? Sure, anything is possible…but this scenario is unlikely now. Even if the U.S. economy is headed towards a recession, the -20% plunge in stock prices is already factoring in most, if not all, of a mild-to-moderate recession. If the economic data does actually get worse, there is still room for stock prices to go down. Under a recession scenario, the tremendous buying opportunities will only get better. While weak hands may be shooting (selling) first and asking questions later, now is the time for you to use patience and discipline. These characteristics will serve as bullet proof vest for your investment portfolio and lead to economic justice over the long-term.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and non-discretionary positions in PG, and KMB, but at the time of publishing had no direct position in AAL, CLX, CPB, F, GM, UAL,  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.

February 13, 2016 at 1:09 pm Leave a comment

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