Posts tagged ‘negative interest rates’
Missing the Financial Forest for the Political Trees
In the never-ending, 24/7, polarizing political news cycle, headlines of Ukraine phone calls, China trade negotiations, impeachment hearings, presidential elections, Federal Reserve monetary policy, and other Washington based stories have traders and news junkies glued to their phones, Twitter feeds, news accounts, blog subscriptions, and Facebook stories. However, through the incessant, deafening noise, many investors are missing the overall financial forest as they get lost in the irrelevant D.C. details.
Meanwhile, as many investors fall prey to the mesmerizing, but inconsequential headlines, financial markets have not fallen asleep or gotten distracted. The S&P 500 stock market index rose another +1.7% last month, and for the year, the index has registered a +18.7% return. As we enter the volatile fourth quarter, many stock market participants remain shell-shocked from last year’s roughly -20% temporary collapse, even though the S&P 500 subsequently rallied +29% from the 2018 trough to the 2019 peak.
Why are many people missing the financial forest? A big key to the significant rally in 2019 stock prices can be attributed to two words…interest rates. Unlike last year’s fourth quarter, when the Federal Reserve was increasing interest rates (i.e., tapping the economic brakes), this year the Fed is cutting rates (i.e., hitting the economic accelerator). Interest rates are a key leg to Sidoxia’s financial four-legged stool (see Don’t Be a Fool, Follow the Stool). Interest rates are at or near generational lows, depending where on the geographic map you reside. For example, interest rates on 10-year German government bonds are -0.55%. Yes, it’s true. If you were to invest $10,000 in a negative yielding -0.55% German bond for 10-years starting in 2019, if you held the bond until maturity (2029), the investor would get back less than the original $10,000 invested. In other words, many bond investors are choosing to pay bond issuers for the privilege of giving the issuers money for the unpalatable right of receiving less money in the future.
The unprecedented negative-yielding bond market is reaching epic proportions, having eclipsed $17 trillion globally (see chart below). This gargantuan and growing dollar figure of negative-yielding bonds defies common sense and feels very reminiscent of the panic buying of technology stocks in the late 1990s.
Source: Bloomberg
At Sidoxia Capital Management, we are implementing proprietary fixed income strategies to navigate this negative interest rate environment. However, the plummeting interest rates and skyrocketing bond prices only make our bond investing job tougher. On the other hand, declining rates, all else equal, also make my stock-picking job easier. Nevertheless, many market participants have gotten lost in the financial trees. More specifically, investors are losing sight of the key tenet that money goes where it is treated best (go where yields are highest and valuations lowest). With many bonds yielding low or negative interest rates, bond investors are being treated like criminals forced to serve jail time and pay large fines because future returns will become much tougher to accrue. In my Investing Caffeine blog, I have been writing about how the stock market’s earnings yield (current approximating +5.5%) and the S&P dividend yield of about +1.9% are handily outstripping the +1.7% yield on the 10-Year Treasury Note (see Going Shopping: Chicken vs. Beef ).
Unless our economy falls into a prolonged recession, interest rates spike substantially higher, or stock prices catapult appreciably, then any decline in stock prices will likely be temporary. Fortunately, the economy appears to be chugging along, albeit at a slower rate. For instance, 3rd quarter GDP (Gross Domestic Product) estimates are hovering around +2.0%.
Low Rates Aid Housing Market
Thanks to low interest rates, the housing markets remain strong. As you can see from the chart below, new home sales continue to ratchet higher over the last eight years, and lower mortgage rates are only helping this cause.
Source: Calafia Beach Pundit
The same tailwind of lower interest rates can be seen below with rising home prices.
Source: Calculated Risk
Consumer Flexes Muscles
At 3.7%, the unemployment rate remains low and the number of workers collecting unemployment is near multi-decade lows (see chart below).
Source: Calafia Beach Pundit
It should come as no surprise that the more employed workers there are collecting paychecks, the more consumer confidence will rise (see chart below). As you can see, consumer confidence is near multi-decade record highs.
Source: Calafia Beach Pundit
Although politics continue to dominate headlines and grab attention, many investors are missing the financial forest because the political noise is distracting the irrefutable, positive effect that low interest rates is contributing to the positive direction of the stock market and the economy. Do your best to not miss the forest – you don’t want your portfolio to suffer by you getting lost in the trees.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (October 1, 2019). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in 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.
Chinese Checkers or Chess?
There’s been a high stakes economic game of trade going on between the United States and China, but it’s unclear what actual game is being played or what the rules are? Is it Chinese checkers, chess, or some other game?
Currently, the rules of the U.S.-China trade war game are continually changing. Most recently, the U.S. has implemented 15% in added tariffs (on approximately $125 billion in Chinese consumer imports) on September 1st. The president and his administration appreciate the significance of trade negotiations, especially as it relates to his second term reelection campaign, which is beginning to swing into full gear. However, game enthusiasts also understand you can’t win or truly play a game, if you don’t know the rules? In that same vein, investors have been confused about the U.S.-China trade game as the president’s Twitter account has been blowing up with tariff threats and trade discussion updates. As a negotiating tactic, the current unpredictable trade talks spearheaded by the Trump administration have been keeping investors guessing whether there will be a successful deal payoff. Until then, market participants have been sitting on the sidelines watching the stock market volatility unfold, one tweet at a time.
Here’s what the president has planned for other tariffs:
- October 1: Tariffs on $250 billion in Chinese goods rise to 30%.
- November 17: Europe auto tariff deadline.
- December 15: 15% tariffs on $160 billion in Chinese goods.
This uncertain game translated into all the major stock market averages vacillating to an eventual decline last month, with a price chart resembling a cardiogram. More specifically, after bouncing around wildly, the S&P 500 decreased -1.8% last month (see chart below), the Dow Jones Industrial Average dropped -1.7%, and the tech-heavy Nasdaq fell -2.6%.
Politically, there is bipartisan support to establish new trade rules and there is acknowledgement that China has been cheating and breaking trade rules for decades. The consensus among most constituencies is especially clear as it relates to Chinese theft of our intellectual property, forced technology transfer, and barriers for U.S. companies to invest in China.
Beyond trade talks, China has been stirring the geopolitical pot through its involvement in the political instability occurring in Hong Kong, which is a Special Administrative Region (SAR) of China. For over five months Hong Kong has had to deal with mass demonstration and clashes with police primarily over a proposed extradition bill that Hong Kong people fear would give mainland China control and jurisdiction over the region. Time will tell whether the protests will allow Hong Kong to remain relatively independent, or the Chinese Communist party will eventually lose patience and use an authoritarian response to the protesters.
Inverted Yield Curve: Fed No Longer Slamming Breaks in Front of Feared Recession
Another issue contributing to recent financial market volatility has been the so-called “inverted yield curve.” Typically, an economic recession has been caused by the Federal Reserve slamming the breaks on an overheated economy by raising short-term interest rates (Federal Funds target rate). Historically, as short-term rates rise and increase borrowing costs (i.e., slow down economic activity), long-term interest rates eventually fall amid expected weak economic activity. When declining long-term interest rates fall below short-term interest rates…voila, you have an inverted yield curve. Why is this scary? Ever since World War II, history has informed us that whenever this phenomenon has occurred, this dynamic has been a great predictor for a looming recession.
What’s different this time? Unlike the past, is it possible the next recession can be averted or delayed? One major difference is the explosion in negative interest rate yielding bonds now reaching $17 trillion.
Yes, you read that correctly, investors are lining up in droves for guaranteed losses – if these bonds are held until maturity. This widespread perception as a move to perceived safety has not protected the U.S. from the global rate anchor sinking our long-term interest rates. United States interest rates have not turned negative (yet?), but rates have fallen by more than half over the last 10 months from +3.24% to +1.51% on the 10-Year Treasury Note. Will this stimulate businesses to borrow and consumers to buy homes (i.e., through lower cost mortgages), or are these negative rates a sign of a massive global slowdown? The debate continues, but in the meantime, I’m going to take advantage of a 0%-interest rate loan to buy me an 85″ big screen television for my new home!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 3, 2019). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Invest or Die
Seventy-six million Baby Boomers are earning near 0% (or negative rates) and aren’t getting any younger in the process, which is forcing them and others to decide…invest or die. The risk of outliving your savings is becoming a larger reality these days. Demographics and economics are dictating that our aging population is living longer and earning less due to generationally low interest rates.
Richard Fisher, the former Dallas Federal Reserve president, understands these looming dynamics. Fisher has identified how low-interest rates are increasing investor discontent by pushing consumers to save more in order to meet retirement needs. The unintended consequence from low rates, he said, is “you’re going to have to save a hell of a lot more before you consume.”
Besides saving, the other option investors have is to lower your standard of living. For example, you could continually eat mac & cheese and sleep in a tent – that is indeed one way you could save money. However, your kids and/or desired lifestyle may make this way of life unpalatable for all. Rather, the proper approach to achieving a comfortable standard of living requires you to invest more efficiently and prudently.
What a lot of individuals fail to understand is that accepting too much risk can be just as dangerous as being too conservative, over the long run. Case in point, depositing your savings into a CD at current interest rates (near 0%) is the equivalent of burning your cash, as any income produced is overwhelmed by the deleterious effects of inflation. It would take more than a lifetime of CD interest income to equal equity returns earned over the last seven years. Since early 2009, stocks have more than tripled in value.
Given the prevailing economic and demographic trends, investors are slowly realizing the attractive income-producing nature of stocks relative to bonds. It has been a rare occurrence, but stocks, as measured by the S&P 500, continue to yield more than 10-Year Treasury Notes (2.0% vs. 1.6%, respectively) – see chart below. The picture for bonds looks even worse in many international markets, where $13 trillion in bonds are yielding negative interest rates. Unlike bonds, which generally pay fixed coupon payments for years at a time, stocks overall have historically increased their dividend payouts by approximately 6% annually.
Source: Avondale Asset Management
With a scarcity of attractive investment alternatives available, investors will eventually be forced to adopt higher levels of equity risk, like it or not. However, this dynamic has yet to happen. Currently, actions are speaking louder than words, and as you can see, risk aversion reigns supreme with Americans tucking over $8 trillion dollars under their mattress (see chart below), in the form of savings accounts, earning next to nothing and jeopardizing retirements.
Source: Calafia Beach Pundit
Even if you fall into the camp that believes rates are artificially low by central bank printing presses, that doesn’t mean every company is recklessly leveraging their balance sheets up to the hilt. Many companies are still scared silly from the financial crisis and conservatively managing every penny of expense, like a stingy retiree living on a fixed income. Thanks to this reluctance to spend and hire aggressively, profit margins are at/near record highs. This financial stewardship has freed up corporations’ ability to pay higher dividends and implement discretionary stock buybacks as means to return capital to shareholders.
With the dovish Fed judiciously raising interest rates – only one rate hike of 0.25% over a decade (2006 – 2016) – there are no signs this ultra-low interest rate environment is going to turn aggressively higher anytime soon. Until economic growth, inflation, and interest rates return with a vengeance, and the persistent investor risk aversion abates, it behooves all the cash hoarders to….invest or die!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The New Abnormal: Living with Negative Rates
Pimco, the $1.5 trillion fixed-income manager located a stone’s throw distance from my office in Newport Beach, famously (or infamously) coined the phrase, “New Normal”. As former Pimco CEO (Mohamed El-Erian) described years ago, around the time of the Great Recession, the New Normal “reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high.”
As it turns out, El-Erian was completely wrong in some respects and shrewdly prescient in others. For instance, although the job recovery has been one of the slowest in a generation, 14.5 million private sector jobs have been added since 2010, and the unemployment rate has been more than halved from 10% in early 2009, to below 5% today. However, the pace of global growth has been relatively weak since the 2008-2009 financial crisis, which has forced central banks all over the world to lower interest rates in hope of stimulating growth. Monetary policies around the globe have been cut so much that almost 25% of global GDP is tied to countries with negative interest rates (see chart below).
Source: Financial Times
The European central banks started the sub-zero trend in 2014, and the Bank of Japan recently joined the central banks of Denmark, Sweden and Switzerland in negative territory. The negative short-term rate virus has spread further to long-term bonds as well, as evidenced by the 10-Year German Bund (sovereign bond) yield, which crossed into negative territory last week (see chart below).
Source: TradingEconomics.com
The New Abnormal
The unprecedented post-crisis move to a 0% Fed Funds rate target, along with the implementation of Quantitative Easing (QE) by former Federal Reserve Chairman Ben Bernanke, was already pushing the envelope of “normal” stimulative monetary policy. Nevertheless, central banks pushing rates to a negative threshold takes the whole stimulus discussion to another level because investors are guaranteed to lose money if they hold these bonds until maturity.
As we enter this new submerged rate phase, this activity can only be described as abnormal…not normal. Preserving money at a 0% level and losing value to inflation (i.e., essentially stuffing money under the proverbial mattress) is a bitter enough pill to swallow. Paying somebody to lend them money gives “insanity” a good name.
The stimulative objectives of negative interest policies established by central bankers may be purely intentioned, however there can be plenty of unintentional consequences. For starters, negative rates can produce too much of a good thing, in the form of excess borrowing or leverage. In addition, retirees and savers across a broad spectrum of ages are getting crushed by the paltry rates, and bank profit margins (net interest margins) are getting squeezed to boot.
Another unintended consequence of negative rate policies could be a polar opposite outcome to the envisioned stimulative design. Scott Mather, a co-portfolio manager of the $86 billion PIMCO Total Return Fund (PTTRX) is making the case that these policies could be creating more economic contractionary effects than invigorating expansion. More specifically, Mather notes, “It seems that financial markets increasingly view these experimental moves as desperate and consequently damaging to financial and economic stability.”
Eventually, the cheap money deliberately created by central banks will result in a glut of risk-taking and defaults. However, despite all the cries from hawks protesting money printing policies, cautious bank lending behavior coupled with regulatory handcuffs have yet to create widespread debt bubbles. Certainly, oceans of cheap money can create pockets of problems, as I have identified and discussed in the private equity market (see also Dying Unicorns), but supply and demand rule the day at some point.
In the end, as I have repeatedly documented, money goes where it is treated best. Realizing guaranteed losses while trapped in negative rate bonds is no way to treat your investment portfolio over the long-run. In the short-run, the safety and stability of short duration bonds may sound appealing, but ultimately rational and efficient behavior prevails. Why settle for 0% or negative rates when yields of 2%, 4%, and 6% can be found in plenty of other responsible investment alternatives?
Arguably, in this post financial crisis world we live in, we have transitioned from the New Normal to a New Abnormal environment of negative rates. Pundits and prognosticators will continue spewing fear-filled cautionary advice, but experienced, long-term investors will continue taking advantage of these risk averse markets by investing in a quality, diversified portfolio of superior yielding investments. For now, there are plenty of opportunities to choose from, until the next phase of this economic cycle… when the New Abnormal transitions to the New Normalized.
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 , but at the time of publishing had no direct position in PTTRX, 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.
Flat Pancakes & Dividends
Over the last 18 months, stock prices have been flat as a pancake. Absent a few brief China and recessionary scares, the Dow Jones Industrial Average index has spent most of 2015 and 2016 trading between the relatively tight levels of 17,000 – 18,000. Record corporate profits and faster growth than other developed and developing markets have created a tug-of-war with countervailing factors. A strong dollar, reversal in monetary policy, geopolitical turmoil, and volatile commodity markets have produced a neutralizing struggle among corporate executives with deep financial pockets and short arms. In this environment, share buybacks, stable profit margins, and growing dividends have taken precedence over accelerated capital investments and expensive new-hires.
With flat stock prices and interest rates at unprecedented low levels, it’s during times like these that stock investors really appreciate the appetizing flavor of stable, growing dividends. To this day, I still find it almost impossible to fathom how investors are burning money by irrationally speculating in $7 trillion in negative interest rate bonds (see Retire at Age 90).
Historically there are very few periods in which stock dividend yields have exceeded bond yields (2.1% S&P yield vs. 1.8% 10-Year Treasury yield). As I showed in my Dividend Floodgates article, for roughly 50 years (1960 – 2010), the yield on the 10-Year Treasury Notes have exceeded the dividend yield on stocks (S&P 500) – that longstanding trend does not hold today.
In the face of the competitive stock market, several trends are contributing to the upward trajectory in dividend payments (see chart below).
#1.) Corporate profits (ex-Energy) are growing and at/near record levels. Earnings are critical in providing fertile ground for dividend growth.
#2.) Demographics, plain and simple. As 76 million Baby Boomers transition into retirement, their income needs escalate. These shareholders whine and complain to corporate executives to share the spoils and increase dividends.
#3.) Low interest rates and disinflation are shrinking the available pool of income generating assets. As I pointed out above, when trillions of dollars are getting thrown into negative yielding investments, many investors are flocking to alternative income-generating assets…like dividend paying stocks.
Source: FactSet
The Power of Dividends (Case Studies)
Most people don’t realize it, but over the last 100 years, dividends have accounted for approximately 40% of stocks’ total return as measured by the S&P 500. In other words, using history as a guide, if you initially invested in a stock XYZ at $100 that appreciated in value to $160 (+60%) 10 years later, that stock on average would have supplied an incremental $40 in dividends (40%) over that period, creating a total return of 100%.
Rather than using a hypothetical example, here are a few stock specific illustrations that highlight the amazing power of compounding dividend growth rates. Here are two “Dividend Aristocrats” (stocks that have increased dividends for at least 25 consecutive years):
- PepsiCo Inc (PEP): PepsiCo has increased its dividend for an astonishing 44 consecutive years. Today, the dividend yield is 2.9% based on the current share price. But had you purchased the stock in June 1972 for $1.60 per share (split-adjusted), you would currently be earning a +188% dividend yield ($3.01 dividend / $1.60 purchase price), which doesn’t even account for the +6,460% increase in the share price ($104.96 per share today from $1.60 in 1972). Over that 44 year period, the split-adjusted dividend has increased from about $0.02 per share to an annualized $3.01 dividend per share today, which equates to a mind-blowing +16,153% increase. On top of the $103 price appreciation, assuming a conservative 5% dividend reinvestment rate, my estimates show investors would have received more than $60 in reinvested dividends, making the total return that much more gargantuan.
- Emerson Electric Co (EMR): Emerson Electric too has had an even more incredible streak of dividend increases, which has now extended for 59 consecutive years. Emerson currently yields a respectable 3.6% rate, but if you purchased the stock in June 1972 for $3.73 per share (split-adjusted), you would currently be earning a +51% dividend yield ($1.92 dividend / $3.73 purchase price), which doesn’t even consider the +1,423% increase in the share price ($53.31 per share today from $3.73 in 1972).
There is never a shortage of FUD (Fear, Uncertainty, and Doubt), which has kept stock prices flat as a pancake over the last couple of years, but market leading franchise companies with stable/increasing dividends do not disappear during challenging times. Record profits (ex-energy), demographics, and a scarcity of income-generating investment alternatives are all contributing factors to the increased appetite for dividends. If you want to sweeten those flat pancakes, do yourself a favor and pour some quality dividend syrup over your investment portfolio.
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 PEP, but at the time of publishing had no direct position in EMR 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.
Energizer Market… Keeps Going and Going
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 2, 2016). Subscribe on the right side of the page for the complete text.
Boom, boom, boom…it keeps going…and going…and going…
You’ve seen the commercials: A device operating on inferior batteries dies just as a drum-beating, battery operated Energizer bunny comes speeding and spiraling across the television screen. Onlookers waiting for the battery operated toy to run out of juice, instead gaze in amazement as they watch the energized bunny keep going and going. The same phenomenon is occurring in the stock market, as many observers eagerly await for stock prices to die. The obituary of the stock market has been written many times over the last eight years (see Series of Unfortunate Events). Mark Twain summed up this sentiment well, when after a premature obituary was written about him, he quipped, “The reports of my death are greatly exaggerated.”
With fears abound, stocks added to their annual gains by finishing their third consecutive positive month with the S&P 500 indexes and Dow Jones Industrial Average advancing +0.5% and +0.3%, respectively. Skeptics and worry-warts have been concerned about stocks plummeting ever since the Financial Crisis of 2008-2009. We experienced a 100 year flood then, and as a consequence, scarred investors now expect the 100 year flood to repeat every 100 days (see also 100 Year Flood). Given the damage created in the wake of the “Great Recession,” many individuals have become afraid of their own shadow. The shadows currently scaring investors include the following:
- Negative Interest Rates: The unknown consequences of negative interest rate policies by central banks (see chart below).
- U.S. Monetary Policy: The potential continuation of the Federal Reserve hiking interest rates.
- Sluggish Economic Growth: With a GDP growth figure up only +0.5% during the first quarter many people are worried about the vulnerability of slipping into recession.
- Brexit Fears: Risk of Britain exiting the European Union (a.k.a. “Brexit”) will blanket the airwaves as the referendum approaches next month
For these reasons, and others, the U.S. central bank is likely to remain accommodative in its stance (i.e., Fed Chairwoman Janet Yellen is expected to be slow in hitting the economic brakes via interest rate hikes).
Source: Financial Times. Central banks continue with attempts to stimulate with zero/negative rates.
Climbing the Wall of Worry
Despite all these concerns, stock prices continue climbing the proverbial “wall of worry” while approaching record levels. As famed investor Sir John Templeton stated on multiple occasions, “Bull markets are born on pessimism, and they grow on skepticism, mature on optimism, and die on euphoria.” It’s obvious to me there currently is no euphoria in the overall market, if you consider investors have withdrawn $2 trillion in stock investments since 2007. The phenomenon of stocks moving higher in the face of bad news is nothing new. A recent study conducted by the Financial Times newspaper shows the current buoyant bull market entering the second longest advancing period since World War II (see chart below).
Source: Financial Times
There will never be a shortage of concerns or bad things occurring in a world of 7.4 billion people, but the Energizer bunny U.S. economy has proven resilient. Our economy is entering its seventh consecutive year of expansion, and as I recently pointed out the job market keeps plodding along in the right direction – unemployment claims are at a 43-year low (see Spring Has Sprung). Over the last few years, these job gains have come despite corporate profits being challenged by the headwinds of a stronger U.S. dollar (hurts our country’s exports) and tumbling energy profits. Fortunately, the negative factors of the dollar and oil prices have stabilized lately, and these dynamics are in the process of shifting into tailwinds for company earnings. The -5.7% year-to-date decline in the Dollar Index coupled with the recent rebound in oil prices are proof that the economic laws of supply-demand eventually respond to large currency and commodity swings. With the number of rigs drilling for oil down by approximately -80% over the last two years, it comes as no surprise to me that a drop in oil supply has steadied prices.
The volatility in oil prices has been amazing. Energy companies have been reeling as oil prices dropped -76% from a 2014-high of $108 per barrel to a 2016-low of $26 per barrel. Since then, the picture has improved significantly. Crude oil prices are now hovering around $46 per barrel, up +76%.
Energy Bankruptcy & Recessionary Fears Abate
If you take a look at the borrowing costs of high-yield companies in the chart below (Calafia Beach Pundit), you can see that prior spikes in the red line (all high-yield borrowing costs) were correlated with recessions – represented by the gray periods occurring in 2001 and 2008-09. During 2016, you can see from the soaring blue line, investors were factoring in a recession for high-yield energy companies (until the oil price recovery), but the non-energy companies (red-green lines) were not anticipating a recession for the other sectors of the economy. Bottom-line, this chart is telling you the knee-jerk panic of recessionary fears during the January-February period of this year has quickly abated, which helps explain the sharp rebound in stock prices.
After a jittery start to 2016 when economic expectations were for a dying halt, investors have watched stocks recharge their batteries in March and April. There are bound to be more fits and starts in the future, as there always are, but for the time being this Energizer bunny stock market and economy keeps going…and going…and going…
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.
Want to Retire at Age 90?
Do you love working 40-50+ hour weeks? Do you want to be a Wal-Mart (WMT) greeter after you get laid off from your longstanding corporate job? Do you love relying on underfunded government entitlements that you hope won’t be insolvent 10, 20, or 30 years from now? Are you banking on winning the lottery to fund your retirement? Do you enjoy eating cat food?
If you answered “Yes” to one or all of these questions, then do I have a sure-fire investment program for you that will make your dreams of retiring at age 90 a reality! Just follow these three simple rules:
- Buy Low Yielding, Long-Term Bonds: There are approximately $7 trillion in negative yielding government bonds outstanding (see chart below), which as you may understand means investors are paying to give someone else money – insanity. Bank of America recently completed a study showing about two-thirds of the $26 trillion government bond market was yielding less than 1%. Not only are investors opening themselves up to interest rate risk and credit risk, if they sell before maturity, but they are also susceptible to the evil forces of inflation, which will destroy the paltry yield. If you don’t like this strategy of investing near 0% securities, getting a match and gasoline to burn your money has about the same effect.
Source: Financial Times
- Speculate on the Timing of Future Fed Rate Hikes/Cuts: When the economy is improving, talking heads and so-called pundits try to guess the precise timing of the next rate hike. When the economy is deteriorating, aimless speculation swirls around the timing of interest rate cuts. Unfortunately, the smartest economists, strategists, and media mavens have no consistent predicting abilities. For example, in 1998 Nobel Prize winning economists Robert Merton and Myron Scholes toppled Long Term Capital Management. Similarly, in 1996 Federal Reserve Chairman Alan Greenspan noted the presence of “irrational exuberance” in the stock market when the NASDAQ was trading at 1,350. The tech bubble eventually burst, but not before the NASDAQ tripled to over 5,000. More recently, during 2005-2007, Fed Chairman Ben Bernanke whiffed on the housing bubble – he repeatedly denied the existence of a housing problem until it was too late. These examples, and many others show that if the smartest financial minds in the room (or planet) miserably fail at predicting the direction of financial markets, then you too should not attempt this speculative feat.
- Trade on Rumors, Headlines & Opinions: Wall Street analysts, proprietary software with squiggly lines, and your hot shot day-trader neighbor (see Thank You Volatility) all promise the Holy Grail of outsized financial returns, but regrettably there is no easy path to consistent, long-term outperformance. The recipe for success requires patience, discipline, and the emotional wherewithal to filter out the endless streams of financial noise. Continually chasing or reacting to opinions, headlines, or guaranteed software trading programs will only earn you taxes, transaction costs, bid-ask spread costs, impact costs, high frequency trading manipulation and underperformance.
Saving for your future is no easy task, but there are plenty of easy ways to destroy your savings. If you want to retire at age 90, just follow my three simple rules.
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 WMT or 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.
Spring Has Sprung: Market Weather Turning
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).
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
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
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.
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.
Dolphin or Shark…Time for Concern?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2016). Subscribe on the right side of the page for the complete text.
Through the choppy stock market waters of February, investors nervously tried to stay afloat as they noticed a fin cutting through the water. The only problem is determining whether the fin approaching is coming from a harmless dolphin or a ferocious shark? The volatility in 2016 has been disconcerting for many, but a life preserver was provided during the month with the Dow Jones Industrial Average up a modest 50 points (+0.30%).
Remaining calm can be challenging when facing a countless number of ever-changing concerns. Stock investors have caught lots of fish since early 2009 (prices have about tripled), but here are some of the scary headlines (fins) floating out in the financial markets:
- Recession? Overall corporate profits have slowed in the face of plummeting energy prices and the headwind of a strong dollar. However, corporate profit margins remain near record levels and if you exclude the decline in the troubled oil patch, core profits keep chugging along. If an imminent recession were actually on the horizon, you wouldn’t expect to see a 4.9% unemployment rate (8-year low); record auto sales; an improving housing market; and stimulative national gasoline prices at $1.75/gallon (recent recessions have been caused by high energy prices).
- Negative Interest Rates: Would you like to get paid to borrow money? With $6 trillion dollars of negative interest rate bonds in the market (see chart below), that’s exactly what is happening. Just imagine walking into your local Best Buy, and asking the salesman, “Can I borrow $2,000 to buy that big screen TV there…and oh by the way, can you pay me interest every month after you give me the money?” Scary to think many people are panicked over the stock market when they should be more alarmed over negative interest rates. Would you rather earn 6.4% on the average stock (S&P 500 earnings yield) and a 2.2% dividend yield vs negative interest rate bonds? As I always caution investors, even though interest rates are at/near a generational low, diversified portfolios still need exposure to bonds, even if you’re at/near retirement because of the stability they provide. Bonds act like expensive pillows – they are necessary to sleep at night. Although some observers point to negative rates as a sign of a global collapse, low inflation, aggressive foreign central bank monetary policies, and a lingering risk aversion hangover from the 2008-09 financial crisis probably have more to do with the current strange status of interest rates.
Source: Financial Times
- Political Turbulence: Uncertainty abounds in another election year, just as is the case every other four years. As we head into Super Tuesday, the day in the presidential primary season when the largest number of states hold primary elections, the Republicans are set to battle for approximately half of the delegates necessary to secure the party nomination. The Democrats will be competing for about one-third of the delegates. While many individuals are placing paramount importance on the outcomes of the presidential elections, history teaches us otherwise. The ultimate person elected as president will certainly have a significant impact on the direction of the country, but there are other contributing factors as important (or more important) to economic growth, including the Federal Reserve, and the two houses of Congress. On numerous occasions, I have pointed out the irrelevance of presidential politics (see also Who Said Gridlock is Bad?). As the chart shows below, the past confirms there is no consistency to stock market performance based on political party affiliations. Stocks have performed strongly (and poorly) under both party affiliations.
- Brexit? After lengthy negotiations with EU leaders in Brussels, Britain’s Prime Minister David Cameron set June 23rd as the referendum date for voters to determine whether Britain stays in the European Union. Opinions remain divided (see chart below), but we have seen this movie before with Greece’s threat to leave the EU. As we experienced with the Greece exit (“Grexit”) drama, calmer heads are likely to prevail again. Nevertheless, until the end of June, regrettably we will be forced to listen to continued Brexit fears (see also Brexit article in the Economist for a more thorough review).
- Collapsing Oil Prices: The violent decline in oil prices over the last few years has been swift from about $100/barrel to $34/barrel today. However, the economic slowdown in China, coupled with a stronger U.S. dollar, has led to a broad downfall in commodity prices over the last five years as well. As much as declining demand has hurt commodities and been stimulative for buyers, over-building and excess supply has pressured prices equally. Fortunately, there are signs commodity prices could be in the process of bottoming (see CRB Index).
Financial market volatility in early 2016 has frayed some nerves, and the appearance of swirling fins has many investors wondering whether now’s the time to swim for shore or remain calm and catch the next growth wave. Despite the concerns over a potential recession, negative interest rates, bitter politics, Brexit fears, and depressed oil prices, our economy keeps slowly-but-surely powering forward. While U.S. corporations have been negatively impacted by a strong currency, compressed banking profits (i.e., lower interest rates), and a weak energy sector, S&P 500 companies are rewarding investors by returning a record $1 trillion in dividends and share buybacks (up from $500 million in 2005). When swimming in the current financial markets, you will be better served by swimming with the harmless dolphins rather than panicking over imaginary sharks.
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 BBY 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.
Thank You Volatility
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” -Warren Buffett
We’ve had some choppy markets and that’s fine by me. Great investors love uncertainty because volatility equates to opportunity. Selling or shorting into volatile euphoria and buying into panic is a time-tested, wealth creating strategy. On the other hand, when everything is consistently moving in one direction, either upwards or downwards, investing can be an easy and straight forward momentum game. Buy something and watch it go up…short something and watch it go down.
In tough, choppy, trendless markets, identifying trends by active traders becomes more challenging. During tricky markets like we’re in now is when the wheat gets separated from the chaff. Day traders and speculators act on a zig one day and are forced to zag the next. Because of the volatile, whippy market dynamics, this type of active trading by individuals rapidly destroys portfolios, not only because of the transaction costs and taxes, but also due to impact costs and spread losses (i.e., bid-ask).
Often, the greater losses come from the behavioral aspects of active trading. Performance chasing and/or the pursuit of overzealous loss mitigation frequently are driven by the destructively entrenched emotions of fear and greed. In the past, I can’t tell you how many times I have rushed into a highflying stock, only to see it pull back down -15-20%, in short order. On the flip side, how often have stocks bounced significantly, after I’ve made a panicked sale? Too many, unfortunately. Most investors don’t take to heart the fact that whenever you initiate a trade, you need to be right twice to optimize your profits. In other words, the security you initially sell needs to go lower (i.e., you should have kept the original investment), AND the security you subsequently buy needs to go higher (i.e., you shouldn’t have purchased the new investment in the first place).
Even in the cases in which the balance of the buy/sale trades becomes a wash, the trading costs and taxes will eat the active trader alive. Unfortunately, the other outcome of losing on both sides of the trade (the purchase goes lower and sale goes higher) is all too common. For example, the purchase you falls by -3%, and the investment you sold climbs +10%. Doing nothing would have been the best outcome!
All this investment tail-chasing inevitably results in a lot of portfolio bloodletting. There is plenty of academic research that shows practically all day traders lose money. Terrance Odean from Cal-Berkeley used 14 years of day trader data to conclude that more than 98% of day traders lose money. Even for those traders able to make a profit in the short run, usually the success doesn’t last very long:
- 40% of day traders quit within a month
- 87% of traders quit within 3 years
- 93% of traders quit within 5 years
Other sources besides Odean show the percentage of day trading losers as greater than 95%, and if you don’t trust the academic data, then simply ask your accountant what percentage of his/her active trading clients make a profit, after considering all taxes and trading costs.
While I may not necessarily fully rejoice in the pain and carnage of day traders, I am always thankful for these choppy markets. Without volatility, anybody can make money in upward trending markets (e.g., day traders did better in the mo-mo 1990s), but in those markets long-term opportunities become sparse. Without the transitory headlines of tightening Federal Reserve policy, negative interest rates, a strong dollar, and political dysfunction, I would not have a professional investing job. And for that blessing, I want to sincerely say, “Thank you volatility.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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