Posts tagged ‘stock market’

Fed Ripping Off the Inflation Band-Aid

Inflation rates have been running near 40-year highs, and as a result, the Federal Reserve is doing everything in its power to rip off the Band-Aid of insidious high price levels in a swift manner. The Fed’s goal is to inflict quick, near-term pain on the economy in exchange for long-term price stability and future economic gains. How quickly has the Fed been hiking interest rates? The short answer is the rate of increases has been the fastest in decades (see chart below). Essentially, the Federal Reserve has pushed the targeted benchmark Federal Funds target rate from 0% at the beginning of this year to 3.25% today. Going forward, the goal is to lift rates to 4.4% by year-end, and then to 4.6% by next year (see Fed’s “dot plot” chart).

Source: Trading Economics

How should one interpret all of this? Well, if the Fed is right about their interest rate forecasts, the Band-Aid is being ripped off very quickly, and 95% of the pain should be felt by December. In other words, there should be a light at the end of the tunnel, soon.

The Good News on Inflation

When it comes to inflation, the good news is that it appears to be peaking (see chart below), and many economists see the declining inflation trend continuing in the coming months. Why do pundits see inflation peaking? For starters, a broad list of commodity prices have declined significantly in recent months, including gasolinecrude oilsteelcopper, and gold, among many others.

Source: Trading Economics

Outside of commodities, investors have seen prices drop in other areas of the economy as well, including housing prices, which recently experienced the fastest monthly price drop in 11 years, and rent prices as well (see chart below).

Source: Calculated Risk

Anybody who was shopping for a car during the pandemic knows what happened to pricing – it exploded higher. But even in this area, we are seeing prices coming down (see chart below), and CarMax Inc. (KMX), the national used car retail chain confirmed the softening price trend last week.

Source: Calafia Beach Pundit

Pain Spread Broadly

When interest rates increase at the fastest pace in 40 years, pain is felt across almost all asset classes. It’s not just U.S. stocks, which declined -9.3% last month (S&P 500), but it’s also housing -8.5% (XHB), real estate investment trusts -13.8% (VNQ), bonds -4.4% (BND), Bitcoin -3.1%, European stocks -10.1% (VGK), Chinese stocks -14.4% (FXI), and Agriculture -3.0% (DBA). The +17% increase in the value of the U.S. dollar this year against a basket of foreign currencies is substantially pressuring cross-border business for larger multi-national companies too – Microsoft Corp. (MSFT), for example, blamed U.S. dollar strength as the primary reason to cut earnings several months ago. Like Hurricane Ian, large interest rate increases have caused significant damage across a wide swath of areas.

But for those following the communication of Federal Reserve Chairman, Jerome Powell, in recent months, they should not be surprised. Chairman Powell has signaled on numerous occasions, including last month at a key economic conference in Jackson Hole, Wyoming, that the Fed’s war path to curb inflation by increasing interest rates will inflict wide-ranging “pain” on Americans. Some of that pain can be seen in mortgage rates, which have more than doubled in 2022 and last week eclipsed 7.0% (see chart below), the highest level in 20 years.

Source: Calculated Risk

Now is Not the Time to Panic

There is a lot of uncertainty out in the world currently (i.e., inflation, the Fed, Russia-Ukraine, strong dollar, elections, recession fears, etc.), but that is always the case. There is never a period when there is nothing to be concerned about. With the S&P 500 down more than -25% from its peak (and the NASDAQ down approximately -35%), now is not the right time to panic. Knee-jerk emotional decisions during stressful times are very rarely the right response. With these kind of drops, a mild-to-moderate recession is already baked into the cake, even though the economy is expected to grow for the next four quarters and for all of 2023 (see GDP forecasts below). Stated differently, it’s quite possible that even if the economy deteriorates into a recession, stock prices could rebound smartly higher because any potential future bad news has already been anticipated in the current price drops.

Worth noting, as I have pointed out previously, numerous data points are indicating inflation is peaking, if not already coming down. Inflation expectations have already dropped to about 2%, if you consider the spread between the yield on the 5-Year Note (4%) and the yield on the 5-Year TIP-Treasury Inflation Protected Note (2%). If the economy continues to slow down, and inflation has stabilized or declined, the Federal Reserve will likely pivot to decreasing interest rates, which should act like a tailwind for financial markets, unlike the headwind of rising rates this year.

Ripping off the Band-Aid can be painful in the short-run, but the long-term gains achieved during the healing process can be much more pleasurable.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in MSFT, BND and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in KMX, XHB, VNQ, VGK, FXI, DBA 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.

October 3, 2022 at 2:24 pm Leave a comment

Heartburn Pains After Digesting Market Gains

After gorging on +9% gains in the stock market (S&P 500 index) during July, investors suffered some heartburn pain in August (-4%). The indigestion really kicked in after Federal Reserve Chairman, Jerome Powell, gave a frank and candid outlook during his annual monetary policy speech at Jackson Hole, Wyoming. His key takeaways were that further interest rate increases are necessary to control and bring down inflation. And these economically-slowing measures, coupled with the Fed’s $95 billion in quantitative tightening policies (QT), will according to the Fed Chairman, “bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

But not everything is causing stomach pains. Yes, inflation is elevated (the rate declined to 8.5% in July from 9.1%), but there are multiple signs that overall prices are peaking. For example, gasoline prices have declined for 11 consecutive weeks to pre Russia-Ukraine invasion levels around $3.81/gallon nationally. There are also signs that housing prices, rent, used car prices, and other commodities like wheat, beef, and copper are all declining in price, as well. Even Bitcoin and other cryptocurrencies are joining in the deflation parade.

And while the Fed is doing its darnedest to bring a halt to gut-wrenching inflation, the job market remains on fire (see chart below). The unemployment rate registered in at a near a generational-low of 3.5% last month, but we will receive a fresh, new figure this week to see if this trend continues.

Source: Trading Economics

The economy’s ravenous appetite for workers can also be found in the just-released JOLTS job opening data (see chart below), which shows there are 11.2 million job openings, a total that is almost double the number of available workers (5.7 million).

Source: Calculated Risk

Stimulus – Trillion Style

The subject of politics is not my strong suit, so perhaps only time will tell whether the net result of two large pieces of government legislation totaling more than $1 trillion (Inflation Reduction Act and Student Loan Forgiveness) will accelerate growth in the economy (Real GDP) or hasten the pace of inflation.

More specifically, the $565 billion Inflation Reduction Act is designed with the intent of investing in clean energy and healthcare initiatives, while negotiating lower pharmaceutical prices with drug companies, and raising tax revenues. The key measures planned in the legislation to fund the spending and forecasted deficit reduction are a minimum corporate tax, the termination of the carried interest tax loophole, and a doubling of the IRS (Internal Revenue Service) budget to hunt down tax dodgers.

With respect to the Student Loan Forgiveness Plan, the cost of the bill is estimated to be between $469 billion to $519 billion over a 10-year budget window, according to the University of Pennsylvania. The debt cancellation will apply to lower income individuals (earning less than $125,000 annually) with the potential of erasing debt of $10,000 – $20,000 per eligible person.

While the government passes various investing, spending, and tax-raising initiatives, corporations continue to crank out record results (see profit charts below), despite talks of an impending recession (see last month’s article, Recession or Mental Depression?).

Source: Yardeni.com

Pessimists point to the economic strength as only temporary, as they brace for the Fed’s interest rate hiking medicine to take larger effect on the patient. Optimists point to the durability of corporate profits, relatively low interest rates (3.13% yield on the 10-Year Treasury Note), positive Q3 – GDP growth estimates of +1.6%, and reasonable valuations (17x Forward Price/Earnings ratio), given the evidence of peaking and declining inflation.

In view of all the current countervailing factors, the near-term volatility will likely create a lot of stomach-churning uneasiness. However, in the coming months, if it becomes clearer the Fed is closer to the end of its rate-hiking cycle and inflation subsides, you might be gleefully enjoying your tasty gains rather than complaining of financial heartburn and headache pains.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

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 BRKA/B 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.

September 1, 2022 at 5:48 pm Leave a comment

Recession or Mental Depression?

Recession is when your neighbor loses his job. Depression is when you lose yours.” -Ronald Reagan

So far, 2022 has been a volatile year in the financial markets, and as a result, investors have been on an emotional rollercoaster, questioning whether we are going into a recession, or are already in one? Rampant inflation caused by COVID, supply chain disruptions, the Russia-Ukraine conflict, monetary policy, fiscal policy, wage increases, and other factors have been contributing to all the anxiety. Economic data (GDP – Gross Domestic Product) just released last week showed the economy contracting by -0.9% in the 2nd quarter after declining -1.6% in the first quarter of 2022 (see chart below).

Source: The Wall Street Journal

Typically, economists have defined a recession by two consecutive quarters of negative GDP growth, which we have now technically achieved, as shown in the chart above. But, not so fast. The official, mutually agreed upon arbiter of a U.S. “recession” is the NBER (National Bureau of Economic Research), which defines a recession more broadly. In order to prevent recession declaration mistakes, the NBER typically waits until long after the fact before making a definitive recession proclamation, in part because the recently released data could eventually be revised higher to a positive level. Revisions, both positive and negative, are commonplace in the never-ending flood of economic data. In addition to negative GDP output figures, the NBER committee considers other factors. For example, household income and unemployment, which by many measures remains white hot and currently remains at generationally low levels (3.6% unemployment rate) are considered when classifying a recession (see the historically low unemployment claims chart below). 

Source: CalculatedRisk.com

So, this begs the question, “Does it really matter whether we are in a recession or not?” The short answer is “no”. The dynamics that really matter are the ones relating to the future. Ultimately, the stock market is forecasting how much worse or better will the economy become? And how long will the pain last? Getting correct answers to these questions is always challenging, but what we do know is that we have had 12 recessions since World War II, and our country is batting 1,000% on recoveries. And the economy has grown stronger coming out of each recession, every time. Therefore, now is not the time to get depressed and climb under a rock. Rather, it’s time to sharpen your pencil and go bargain hunting for opportunities during these corrections.

Well, investors (at least the ones still remaining) came out of their caves this month and actually bought stocks. For the month, the S&P 500 impressively climbed by +9.1% and the NASDAQ index soared by +12.4%. How did we suddenly go from gloom and doom to boom and zoom this month? For starters, although inflation has remained stubbornly high, there are signs of a disinflation light at the end of the tunnel. Anecdotally, we see gasoline prices coming down, while housing prices are softening and various food prices are beginning to come down from the stratosphere. On the economic data front, the Federal Reserve’s inflation measure of choice (Core PCE) appears to be stabilizing as well (see chart below). Core PCE for June rose by 4.8%, but this metric was down from 5.2% in March, and it is up a smidge from the 4.7% figure reported during May.

Source: The Wall Street Journal

Another factor contributing to investor optimism this month revolves around the Fed’s monetary policy. Just last week, Fed Chairman Jerome Powell and the members of the FOMC (Federal Open Market Committee) decided to set the Fed Funds target higher by +0.75% to a range of 2.25% – 2.50%, the fourth increase this year (see chart below). For many traders, they interpreted this move as getting one step closer to a terminal rate in the 3.0% – 4.5% range by next year. In other words, a broad number of market participants are beginning to view the rapid escalation of rates this year as a way of accumulating dry powder for potential stimulative interest rate cuts in 2023, if the economy continues to weaken or stagnates further.

Source: The Wall Street Journal

There are plenty of challenging forces surrounding us, including an overhanging recession, that could push you into a depression, however the ability to invest in certain areas of the market where prices are on sale should bring plenty of happiness. As investing legend Peter Lynch stated, “I’m always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession.” Said differently, no matter what transpires in the coming months, “This too shall pass.”

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

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 BRKA/B 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.

August 4, 2022 at 6:29 pm Leave a comment

Even Winning Teams Occasionally Lose

The stock market has been a winning team for years, generating outsized returns for investors. But so far this year, the winning streak appears to be coming to an end. For 2022, the S&P 500 index is down -21%, including -8% last month. However, since 2008, the stock market has generally been on a consistent tear racking up a record of 10 wins, 2 losses (2015 and 2018), and one tie (2011). In recent years, the U.S. stock market has been winning by a large margin (2019: +29%, 2020: +16%, 2021: +27%) and a significant contributor to the team’s win streak has been the Federal Reserve, or the designated hitter (DH).

Jerome Powell, the Fed Chair, has been a very effective clean-up hitter for the stock market, not only leading the stock market team to victories, but also appreciation in almost all global-risk asset classes. By keeping interest rates (the Federal Funds Rate target) essentially at 0% over the last few years, since the initial COVID pandemic outbreak, many investors are blaming Mr. Powell for elevated inflation rates. If that were truly the case, then we probably wouldn’t see the ubiquitous inflation globally, as we do now. Just as you would expect with any baseball team, any single player does not deserve all the credit for wins, nor should any single player receive all the blame for losses – the same principle applies to the Federal Reserve.

Regardless, the stock market’s best hitter is now injured. In addition to pushing interest rates higher, the Fed is hurting the team through its monetary policy of quantitative tightening or QT (i.e., selling bonds off the Fed’s balance sheet). Theoretically, QT should cause interest rates to move higher, all else equal, and thereby slow down growth in the economy, and help tame out-of-control inflation.

The stock market was also thrown a curve ball when Russia invaded Ukraine, which added gasoline to an already flaming inflation fire. Globally, consumers and businesses have witnessed exploding oil/gasoline prices, in addition to escalated food prices caused by a lack of grain and other commodity exports out of Ukraine.

Lastly, a wild pitch has been thrown at the U.S. stock market by China with its zero-COVID policy, which has essentially shut down the world’s 2nd largest economy and further delayed the full reopening of the global economic game. As a result of China’s hardline lockdown stance, global supply chain disruptions have intensified and import prices have mushroomed higher.

Although this all sounds like horrible news, in the game of investing, nobody wins all the time. As history teaches us, the stock market is generally up around 70% of the time. It just happens to be that we are in the middle of a 30% losing period.

Bad News Does Not Mean Bad Stock Market

The majority of economists, strategists, and talking heads on television are forecasting a recession in our economy, either this year or next. This should come as no surprise to any experienced investor, as history teaches us that recessions occur on average about twice every decade. Long-term investors also understand that stock prices do not always just go up on good news and down on bad news. Stocks can go down on good news, and up on bad news. In fact, over the last 13 years, since the bottom of the 2008-2009 financial crisis, the stock market has increased about six-fold (even after this year’s -21% correction) in the face of some horrendously scary headlines (also see chart below):

·       Ukraine-Russia

·       COVID

·       Elections / Capitol Insurrection

·       Exit from Afghanistan

·       Impeachment

·       China Trade War & Tariffs

·       Inverted Yield Curves

·       N. Korea Missile Launches

·       Brexit

·       ISIS in Iraq

·       Ebola

·       Russia Takeover of Crimea

·       Double Dip Recession Fears

·       Eurozone Debt Crisis

S&P 500 Index (1997 – 2022)

Source: TradingEconomics.com

Despite the recent headwinds in the stock market, not all the news is bad. Here are some tailwinds:

  • PROFITS: Corporate profits remain at or near record levels.
Source: Yardeni.com
  • INFLATION: Inflation appears to be cooling as evidenced by declining commodity prices (TR Commodities CRB Index).

CRB Commodities Index (2022)

Source: TradingView
  • PRICES: Valuations have come down significantly – Price/Earnings ratio of 15.9 (i.e., stock prices are on sale).
Source: Yardeni.com
  • SENTIMENT: Sentiment remains fearful – a contrarian buy indicator (an elevated VIX – Volatility Index can signal buying opportunities). As Warren Buffett says, “Be fearful when others are greedy, and greedy when others are fearful.”

VIX – Volatility Index (2021 – 2022)

Source: Macrotrends

Even though the U.S. stock market has been a long-term winner, investors have been betting against the winning team by selling stocks. As mentioned earlier, recessions, if we get one, are common and nothing new. The -21% correction in stock prices is already factoring in a mild recession, so we have already suffered near-maximum pain. Could prices go lower? Certainly. But should you quit a 26-mile marathon at mile 25 because the pain is too intense? In most instances, the answer should absolutely be “no” (see also No Pain, No Gain). Eventually, the Fed will stop raising interest rates, inflation will cool, the Russia-Ukraine war will be resolved, and solid growth will return. While many people are betting the stock market will lose this year, many long-term investors recognize betting on stock market success is a winning strategy over the long-run, especially when prices are on sale.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

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 BRKA/B 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.

July 1, 2022 at 3:47 pm Leave a comment

Bad Weather Coming: Hurricane or Drizzle?

It was a stormy month in the stock market, but the sun eventually came out and the Dow Jones Industrial Average rallied more than 2,300+ points before eking out a small gain (up +0.04%) and the S&P 500 index also posted an incremental increase (+0.005%). But there are clouds on the horizon. Although the economy is currently very strong (i.e., record corporate profits and a generationally low unemployment rate of 3.6% – see chart below), some forecasters are predicting a recession during 2023 as a result of the Federal Reserve pumping the brakes on the economy by increasing interest rates, in addition to elevated inflation, supply chain disruptions, COVID lockdowns in China, and a war between Russia and Ukraine.

UNEMPLOYMENT RATE (1997 – 2022)

Source: TradingEconomics.com

But like weather forecasters, economists are perpetually unreliable. While some doomsday-er economists are expecting a deeply destructive hurricane (deep recession), others are only seeing a mild drizzle (soft landing) developing. The truth is, nobody knows for certain at this point, but what we do know is that the correction in stock prices this year (-13% now and -20% two weeks ago) has already significantly discounted (factored in) a mild recession. In other words, even if a mild recession were to occur in the coming months or quarters, there may be very little reaction or negative consequences for investors. Similarly, if inflation begins to be peaking as it appears to be doing (see chart below), and the Fed can orchestrate a soft landing (i.e., raise interest rates and reduce balance sheet debt without crippling the economy), then substantial rewards could accrue to stock market investors. On the flip side, if the economy were to go into a deep recession, history would suggest this stormy forecast might result in another -10% to -15% of chilliness.

INFLATION RATE (%)

Source: TradingEconomics.com

Due to trillions of dollars in increased stimulus spending and Federal Reserve Quantitative Easing (bond buying), we experienced an explosion in the government deficit and surge in money supply growth (i.e., the root cause for swelling inflation). Arguably, some or all of these accommodations were useful in surviving through the worst parts of the COVID pandemic, however, we are paying the price now in sky-high food costs, explosive gasoline prices, and expanding credit card bills. The good news is the deficit is plummeting (see chart below) due to a reduction in spending (due in part to no Build Back Better infrastructure spending legislation) and soaring income tax receipts from a strengthening economy and capital gains in the stock market.

MONEY SUPPLY GROWTH% (M2) VS. GOVERNMENT DEFICIT

Source: Calafia Beach Pundit

For many investors, getting used to large multi-year gains has been very comfortable, but interpreting downward gyrations in the stock market can be very confusing and counterintuitive. In short, attempting to decipher the reasons behind the short-term zigs and zags of the market is a fool’s errand. Not many people predicted a +48% gain in the stock market during a global pandemic (2020-2021), just like not many people predicted a short-lived -20% reduction in the stock market during 2022 as we witnessed record-high corporate profits and unemployment rates hovering near generational lows (3.6%).

Stock market veterans understand that stock prices can go down when current economic news is sunny but future expectations are too high. Experienced investors also understand stock prices can go up when the current economic news may be getting too cloudy but future expectations are too low.

Apparently, the world’s greatest investor of all-time thinks that all this gloomy recession talk is creating lots of stock market bargains, which explains why Buffett has invested $51 billion of his cash at Berkshire Hathaway as the stock market has gotten a lot more inexpensive this year. So, while the economy will likely face a number of headwinds going into 2023, it doesn’t mean a hurricane is coming and you need to hide in a bunker. If you pull out your umbrella and rain gear, just like smart investors do during all previous challenging economic cycles, the drizzle from the storm clouds will eventually pass and blue skies shall reappear.

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 (June 1, 2022). 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 BRK.B/A 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.

June 1, 2022 at 1:21 pm Leave a comment

No Pain, No Gain

Long-term success is rarely achieved without some suffering. In other words, you are unlikely to enjoy gains without some pain. Last month was certainly painful for stock market investors. On the heels of concerns over the Russia-Ukraine war, Federal Reserve interest rate hikes, China-COVID lockdowns, inflation/supply chain disruptions, and a potential U.S. recession, the S&P 500 index declined -8.8% for the month, while the technology-heavy NASDAQ index fell -13.3%, and the Dow Jones Industrial Average weakened by -4.9%.

For long-term stock investors who have reaped the massive +520% rewards from the March 2009 lows, they understand this gargantuan climb was not earned without some rocky times along the way. As you can see from the chart below, there have been no shortage of issues and events to worry about over the last 15 years (2007 – 2022):

  • 2008-2009: Financial Crisis
  • 2010: Flash Crash (electronic trading collapse)
  • 2011: Debt Ceiling – Eurozone Collapse
  • 2012: Greek Debt Crisis – Arab Spring (anti-government protests)
  • 2012: Presidential Elections – Sequestration (automatic spending cuts) – Cyprus Financial Crisis
  • 2013: Federal Reserve Taper Tantrum (threat of removing monetary policy accommodation)
  • 2014: Ebola Virus Outbreak
  • 2015: China Economic Slowdown
  • 2018: China Trade Tariffs – Federal Reserve Interest Rate Hikes
  • 2020: COVID-19 Global Pandemic – Recession
  • 2022: Russia-Ukraine War -Federal Reserve Interest Rate Hikes – Inflation/Supply Chain – Slowing China
Source: TradingView chart with Sidoxia notations

So, that’s the bad news. The good news is that after the stock market eventually bottomed (S&P 500) around each of these events, one year later, stock prices rebounded on average approximately +32%, and prices moved even higher in the following two years. Suffice it to say, in most instances, patiently waiting and taking advantage of heightened volatility usually results in handsome rewards for investors over the long-run. As Albert Einstein stated, “In the middle of every difficulty lies an opportunity.”

There have been plenty of false recession scares in the past, and this could prove to be the case again. Although I have noted some of the key headwinds the economy faces above, it is worth noting that current corporate profits remain at/near all-time record highs (see chart below) and the 3.6% unemployment rate effectively stands at/near generationally record low levels. What’s more, housing remains strong, and consumer balance sheets remain very healthy as a result of elevated savings rates that occurred during COVID.

Source: Ed Yardeni

The S&P 500 is already off -14% from its highest levels experienced at the beginning of the year. Although there are no clear signs of a looming recession presently, if history is a guide, much of the pessimism is likely already discounted in current stock prices. Stated differently, even if the economy were to suffer a garden-variety recession, we may already be closer to a bottom than the potential gains from a subsequent rebound. The 15-year chart shows that stock prices have become significantly more attractively valued in recent months.

Source: Ed Yardeni

Panic is rarely a profitable strategy, so now is probably not the best time to knee-jerk react to the price declines. Peter Lynch, arguably one of the greatest all-time investors (see Inside the Brain of an Investing Genius), said it best when he stated, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Market corrections are never comfortable, but successful, long-term investing comes with a price…no pain, no gain!

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 2, 2022). 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.

May 2, 2022 at 7:48 pm 1 comment

Insane Gain After Fed & Ukraine Pain

After a painful start to 2022, the stock market surged last month, with the S&P 500 index gaining a respectable +3.6%, while the technology-heavy NASDAQ index rose by +3.4%. With volatility on the rise, getting caught up in the emotions of the headlines can be challenging for some investors. At Sidoxia, we are determined to objectively stick to the facts and migrate investments to the areas of the market that provide the best risk-reward opportunities to our clients, based on their unique objectives and constraints. There certainly are some headwinds for investors to contend with, but for long-term investors, it’s also important to recognize the positive tailwinds and not miss the forest for the trees.

As I pointed out last month, we are coming off a heroic advance over the last three years (2019/2020/2021) with the S&P 500 soaring +90%. The hangover from COVID has created significant supply chain disruptions and widespread economic shortages. Adding the Russian invasion of Ukraine to the mix has been like pouring gasoline on the flames of inflation, especially when it comes to the energy and food sectors. As you can see from the CRB index below (a basket of 19 commodities ranging from aluminum to orange juice and live cattle to wheat), in recent years the index has been highly volatile in both directions, but is up +27% this year. Since the COVID-driven trough, prices have about tripled over the last two years, but that does not mean prices will fly to the moon forever.

Source: Trading Economics

Many traders have short-term memories. People forget that commodity prices approximately doubled after the 2008 Financial Crisis, only to experience a subsequent slow bleed over the next decade until prices were essentially chopped in half. As the saying goes, “price cures price.” In other words, as prices skyrocket, greedy capitalists and businesses then decide to take advantage of the high pricing environment by investing to produce more supply, which eventually leads to deflation. This supply expansion process takes time and will not happen overnight.

With gasoline prices exceeding $4/gallon nationally, and breaching $6/gallon in my Southern California backyard (see chart below), it should come as no surprise that oil companies are taking advantage of the lucrative environment by drilling for more oil.

Source: GasBuddy.com

The rising Baker Hughes drilling rig count below reflects the miracle of supply-demand economics operating in full force. As prices rise and accelerate during geopolitical shocks like we have experienced in Ukraine, naturally supply rises, which eventually depresses prices until an equilibrium is reached. Even our government is now attempting to increase supply by releasing up to 180 million barrels of oil from our country’s Strategic Petroleum Reserve (the largest release in the almost 50-year history of the reserve), while also pushing for penalties on those energy companies sitting on unused permits (i.e., not producing oil on leased oil land). High energy prices will most certainly become a hot-button political issue in the upcoming midterm elections.

Source: Trading Economics

Adding to investor anxiety, our Federal Reserve is embarking on an interest rate hiking cycle that is expected to take the targeted Federal Funds interest rate from effectively 0% to a range around 2.5% over the next couple of years. The Fed’s goal is to increase the cost of borrowing, thereby slowing down the economy and reducing inflation. On the surface this sounds scary, but do you remember what happened the last time the Fed tapped the interest rate brakes during 2015 – 2018? Despite the Fed raising interest rates from 0% to 2.5%, the stock market increased dramatically over that timeframe. The current Fed interest rate cycle may more closely resemble 1994 when the Fed aggressively hiked rates from 3% to 6%. Similar to now, back then stock prices swung wildly throughout the year to eventually finish the year flattish.

If Things Are So Bad, Why Are Prices Going Up?

In the face of such horrible and scary headlines, how can prices still go up? The short answer is that companies are making money hand over fist and the economy remains strong (3.6% unemployment rate; record 11.3m job openings3% forecasted growth in 2022 GDP) in a post-COVID recovery world, where consumers remain financially healthy and are now looking to spend their shelter-in-place savings on vacations, houses, and cars (all healthy industries).

Not only are corporate profits at record levels, they are also expected to grow at a healthy rate (+10% in 2022, +10% in 2023) after mind-boggling growth of +50% in 2021 (see chart below).

Source: Yardeni.com

Could the headwinds previously described cause prices to go lower? They certainly could, but valuations remain attractive given where interest rates currently stand. If interest rates rise dramatically, all else equal, then that will be challenging for all asset pricing. Moreover, discounting or forecasting future Russian military actions is a difficult chore as well, which could also potentially throw a curve ball at investors.

In the meantime, what are companies doing with this flood of growing cash? Well, besides combing the job boards in search of hiring a scarce number of qualified workers, investing in technology to improve productivity, and expanding geographically to grow revenues, companies are also returning gobs of cash to investors in the form of record, swelling dividends and share buybacks (see charts below).

Darling Dividends

The gift that keeps on giving. Dividends now amount to more than half a trillion dollars and they are still growing.

Source: Yardeni.com

Beautiful Buybacks



As you can see, the trajectory of buybacks are more volatile and discretionary than dividends, but record profits are driving more than $1 trillion in share buybacks on an annualized basis – not too shabby.

Source: Yardeni.com

Although there are plenty of reasons for investors to rationalize a run for the hills, there remains some extraordinarily strong fundamental tailwinds intact. In spite of the economic pain caused by Ukraine, the Fed, and inflation, there are plenty of reasons to remain optimistic. The strong economy, impressive profit growth, historically low interest rates (even though slowly rising), cash-rich corporations, and attractive valuations mean there is still ample room for future market gains.

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 (April 1, 2022). 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.

April 1, 2022 at 1:37 pm Leave a comment

End of the World or Status Quo?

If you were the chief executive of a newspaper, television, or magazine company, what headline stories would you run to generate the most viewers and readers? Which subjects will you choose to make me impulsively grab a magazine in the grocery line, keep me glued to the television news, or suck me in to click-bait advertisements on the web? For example, what topics below would you select to grab the most attention?

·      Hurricane or Sunshine?

·      High Speed Car Chase or Cat Saved from Tree?

·      Bloody Murder or Baby’s Birthday?

·      Messy Divorce or Wedding Celebration?

·      Impeachment or Bipartisan Legislation

·      End of the World or Status Quo?

If you selected the first subject in each pair above, you would likely gain much more initial interest. In choosing a winning topic, the saying goes, “what bleeds, leads.” In other words, scary or controversial stories always grab more attention than feel-good or status quo narratives. And that is why the vast majority of media outlets are drawn to negativity, just as mosquitos are attracted to bug zappers. This phenomenon can be explained in part with the help of Nobel Prize winner Daniel Kahneman and his partner Amos Tversky, who conducted research showing the pain from losses is more than twice as painful as are the pleasures experienced from gains (see chart below).

The significant volatility seen in the stock market recently from the Russian war/invasion of Ukraine is further evidence of how this fear dynamic can create short-term panics.

Although the stock market as measured by the S&P 500 index has gone gangbusters over the last three years, almost doubling in value (2019: +29%, 2020: +16%, 2021: +27%), the S&P 500 has hit an air pocket during the first couple months of 2022 (-8%), including down -3% in February. The year started with turbulence as investors became fearful of a Federal Reserve that is entering the beginning stages of interest rate hikes while cutting stimulative bond purchases. And then last month, the Russian-Ukrainian incursion made investors even more skittish. Like always, these geopolitical events tend to be short-lived once investors realize the impact turns out to be less meaningful than initially feared. As you can see below, the worst economic impact is forecasted to be felt by Russia (consensus on 2/24/22 of approximately a -1.0% hit to economic growth), more than twice as bad as the -0.2% to -0.4% knock to growth for the U.S., Europe, and the world (see chart below). The Russian hit will likely be worse after accelerated sanctions.

Source: The Financial Times (2/24/22)

As it relates to Ukraine, many Americans don’t even know where the country is located on a map. Ukraine accounts for about only 0.14% of total global GDP (i.e., a rounding error and less than 1% of total global economic activity). Russia, although larger than Ukraine, is still a relative small-fry and represents only about 3% of total global economic activity. If you live in Europe during the winter, you might be a little more concerned about Vladimir Putin’s recent activities because a lot of Europe’s energy (natural gas) is supplied by Russia through Ukraine. For example, Germany receives about half of its natural gas from Russia (see chart below).

Source: The Financial Times

Russia, on the other hand, is larger than Ukraine, but the red country is still a relative small-fry representing only about 3% of total global economic activity. When it comes to energy production however, Russia is more than a rounding error because the country accounts for about 11% of global energy production (#3 country globally behind the United States and Saudi Arabia). By taking all these factors into account, we can confidently state that Russia and Ukraine have a very low probability of solely pulling the global economy into recession.

If history repeats itself, this conflict will turn out to be another garden variety decline in the stock market and an opportunity to buy at a discount. It’s virtually impossible to predict a short-term bottom in stock prices has been reached, but over the long-run, stock investors have been handsomely rewarded for not panicking and staying invested (see chart below).

Source: Marketsmith

At the end of the day, the daily headlines will continually attempt to sell the negative story that the world is coming to an end. If you have the fortitude and discipline to ignore the irrelevant noise, the status quo of normal volatility can create more exciting opportunities and better returns for long-term investors.

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, 2022). 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.

March 1, 2022 at 4:52 pm 1 comment

From Rocket Ship to Roller Coaster

The stock market has been like a rocket ship over the last three years 2019/2020/2021, advancing +90% as measured by the S&P 500 index, and +136% for the NASDAQ. After this meteoric multi-year rise, stock values started to come back to earth in 2022, and the rocket ship turned into a roller coaster during January. More specifically, the S&P 500 fell -5% for the month and the NASDAQ -9%. Yes, it’s true volatility has increased, and your blood pressure may have risen with all the ups and downs. However, the fact remains the economy remains strong, corporate profits are at record levels, unemployment is low, and interest rates remain at attractive levels despite nagging inflation (see chart below) and the removal of accommodative monetary policies by the Federal Reserve.

Source: Calafia Beach Pundit

Math Matters

I did okay in school and was educated on many different topics, including the basic principle that math matters. This notion rings especially true when it comes to finance and investing. As I have discussed numerous times in the past, money goes where it is treated best, which is why interest rates, cash flows, and valuations play such a key role in ultimately determining long-term values across all asset classes. This concept of money seeking the best home applies equally to stocks, bonds, real estate, commodities, crypto-currencies, and any other asset class you can imagine because interest rates help determine the cost of holding and using money.

Normally, mathematics teaches us the lesson that more is better when discussing financial matters. And currently the stock market is compensating investors significantly more for investing in stocks relative to investing in bonds – I have reviewed this concept repeatedly on my Investing Caffeine blog (see Going Shopping: Chicken vs. Beef ). Currently, investors are getting paid about +5% to hold stocks based on the forward earnings yield (i.e., the inverse of the stock market’s Price-Earnings ratio of 20x) vs. the +2% yield on the 10-Year Treasury Note (1.78% more precisely on 1/31/22). What’s more, historically speaking, stock investors typically get rewarded with an earnings yield that doubles about every 10 years, whereas bond yields usually remain stagnantly flat, if bonds are held until maturity.

With that said, I am always quick to point out that diversification in a portfolio is important (i.e., most people should at least own some bonds), even if bonds are currently very expensive relative to other asset classes (see Sleeping on Expensive Financial Pillows). If bond yields climb significantly to the point where returns are more competitive with stocks, I will likely be buying significantly more bonds for me and my Sidoxia (www.sidoxia.com) clients.

Fed Jitters

The recent stock market volatility is reinforcing the idea that the Federal Reserve’s more aggressive stance regarding hiking interest rates is making many investors very anxious – just not me. I have lived through many tightening cycles in my lifetime and lived to tell the tale. It is true that all else equal, higher interest rates generally depress asset values, but it is also important to place the current interest rate environment in historical context. Although the Federal Funds interest rate target is expected to increase to 2.5% over the next few years (currently at 0%), this forecast is nothing new and there is no guarantee the Fed can successfully pull off this feat. Many people have short memories and forget the Fed hiked interest rates 10 times from the end of 2015 through 2018. In the face of this scary period, the stock market (S&P 500) still managed to approximately climb a respectable +22% (albeit with some volatility). Furthermore, if you give the Fed the benefit of the doubt of achieving this uncertain target, this 2.5% level is very appealing and still extremely low, historically speaking (see chart below).

Source: Federal Reserve Economic Data (FRED)

When discussing interest rates and inflation, investors should also expand their views globally to the other 95% of the world’s population. Many investors are very myopic in their focus on U.S. interest rates. It is important to understand that rates are not just low here in the United States, but also low almost everywhere else as well. While international interest rates have bounced marginally higher in recent months, those countries’ long-term international rates, by and large, remain tremendously low too – in most cases even lower than rates in the U.S. (see chart below). Yes, the Fed has some control over short-term interest rates in the U.S., but considering other crucial forces that are depressing long-term global rates is worth pondering. Factors such as globalization and the pervading expansion of deflationary technology into our personal and work lives are contributing to disinflation. Valuable conclusions can be synthesized beyond digesting the pessimistic and nauseating analysis of Jerome Powell’s Congressional testimony, along with the needless wordsmithing of recent Fed minutes.

Source: Edward Yardeni

In order to earn above-average, financial returns in your portfolio over the long-run, experiencing unsettling volatility and corrections is the price of doing business. Flying on rocket ships might be fun, but sometimes the rocket can run out of gas, and you are forced to jump on a roller coaster. The ups-and-downs can be frustrating at times, but if you stay on for the full ride, you will almost always end with a smile on your face when it’s over.

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 (February 1, 2022). 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 PFE 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.

February 1, 2022 at 4:07 pm Leave a comment

The Rocket Science of Investing – Armageddon Yet to Arrive

In the face of an incredibly scary global pandemic, the stock market completed a phenomenal year (S&P 500 rocketed +27%) closing at a new all-time monthly record high, after also posting incredible results in 2020 (+16%) and 2019 (+29%). Naturally, the follow-on question I get most is, “What about next year?” And to this question, I annoyingly provide the same answer as the most successful long-term investor of all-time, Warren Buffett, “I have no idea.”

But with that said, despite lacking the skill of 100% clairvoyance, my investment firm Sidoxia Capital Management and our strategies have performed quite well over the long-run for numerous reasons. As it turns out, the power of compounding, coupled with low-cost, tax-efficient investing can produce quite spectacular results. Throw in some good stock picking, and that is frosting on a cake recipe of success. Thank you Amazon.com Inc. +5,544%, Apple Inc. +2,394%, and Alphabet Inc. 880%, among many other fruitful investments since Sidoxia’s inception in 2008.

Lessons Learned Over 30 Years

I’ve been doing this thing called investing for about three decades now and I’ve learned a few things over the years, most prominently that investing is not rocket science. Warren Buffett has correctly described investing as similar to dieting. In other words, both are easy to understand but difficult to execute because they require discipline.

If you want your investments to succeed, consider some of these investing nuggets:

  • Invest for the Long-Run: Markets move in all directions, but if you can avoid myopia and short-termism, you will be much better positioned for investment success.
  • Avoid Investment Fads: Invest where you get the most bang for your buck – stick to sound investments selling at reasonable prices. Stay away from expensive, speculative, frothy areas, or at least keep that exposure of your portfolio to a minimum.
  • Turn off the TV and Silence your Phone: Regardless of what you hear, the world is not ending. COVID, inflation, and Federal Reserve monetary policies may dominate the headlines du jour but this is nothing new. The stock market has increased more than 7-fold in value since the 2009 stock market lows, even in the face of many frightening news stories (see Ed Yardeni’s list of panic attacks since 2009).
  • Understand Stock Prices Do Go Down: We have been spoiled in recent years with above-average returns, but that does not mean you need to panic when prices do decline or that you need to try to time the market. There can be years when stock prices do not appreciate (reference the post-2000 and post-2008 periods), however, those who wisely rebalanced and dollar-cost-averaged positions in their portfolio were handsomely rewarded for their discipline and patience over the long-run.
  • Volatility Can Be a Good Thing: Periods of volatility offer you the ability to rebalance your portfolio and take advantage of opportunities that disruption creates.
  • Optimize Your Investments Based on Your Time Horizon and Risk Tolerance: At Sidoxia, we customize investment portfolios to meet our clients’ unique circumstances and risk appetite. It’s important to have your investments diversified across a broad array of asset classes in a low-cost, tax efficient manner.
  • Get Assistance: If you don’t have the time, discipline, or interest to manage your investments, find an experienced professional who is a fiduciary (i.e., someone who legally places your interests first) and implements time-tested investment strategies. Sidoxia should be able to assist you in identifying an appropriate investment manager. 😉

What Now for 2022?

As I made clear earlier, at Sidoxia, we do not attempt to predict the directions of markets, but rather we look to opportunistically take advantage of many different dynamic areas that we believe provide the best risk-adjusted return potential for our clients.

However, although we freely admit we are not Nostradamus, we do closely follow a wide spectrum of areas in financial markets to best position our investments. Here are some thoughts on some hot-button issues that are top-of-mind as we enter 2022.

Stocks Remain Attractive: Stocks are still attractively priced broadly considering where interest rates stand today. Most people don’t realize that stock prices are actually cheaper today than they were a year ago because earnings will be up roughly +50% in 2021 (see chart below) and stock prices are only up +27%. Stated differently, the price of the market as measured by the forward price-earnings ratio (P/E) has declined, even though the stock market has melted up. Under a different lens, stocks are also attractively priced if you consider bonds are generally yielding 1-2% versus the 4-5% on stocks as measured by the earnings yield of the S&P 500 index (corporate earnings/price of the index), which can be calculated as an inverse P/E ratio. Regardless, if stock prices do indeed decline this year, while bond yields remain in the same general ballpark, then stocks will only become even more attractive.

Source: Yardeni Research

Federal Reserve Tightening Doesn’t Mean Game Over for Stocks: We have seen this movie before (see chart below). What happened the last time quantitative easing (QE) stopped and the Fed raised its Federal Funds interest rate target? Ten-year interest rate yields went down, and stock prices went up – not necessarily immediately, but ultimately investors were compensated for not knee-jerk selling.

Source: Yardeni Research

Inflation Does Not Appear to Be Spiraling Out of Control: Just take a look at the paltry yield of the 10-year Treasury Note, currently at 1.51%. And please do not just consider the low interest rates here in the U.S., but also internationally in markets like Germany with negative 10-year interest rates (-0.18%) or near-0% interest rates in Japan (0.07%). If inflation were indeed considered a systemic risk, global yields in large developed markets would not be hovering around 0%. Furthermore, COVID-related supply chain bottlenecks appear to be abating. As you can see from the chart below, the average business delivery times have been coming down in recent months as supply disruptions subside – an improving trend for overall prices.

Source: Yardeni Research

The Global Pandemic Deserves Watching: There are plenty of reasons to remain concerned, however science and natural immunity may have brought us closer to neutralizing this health crisis. A worldwide focus on creating vaccines, antiviral drugs, monoclonal antibodies, and other COVID treatments has allowed the global health community to more effectively treat those infected with COVID, while simultaneously lowering the number of related hospitalizations and deaths. There is even hope for areas that have lower vaccination rates than the U.S., for example India (see chart below), which you can see has experienced a dramatic fall-off in COVID cases in part because of the large number of previous infections and subsequent natural immunity created.

Source: Google

There are always talking heads and so-call pundits predicting Armageddon in the stock market, but as you can see from the facts presented, record highs in the stock market aren’t currently painting this picture for 2022. Profits have been gargantuan, interest rates remain near generational lows, valuations remain reasonable, and there are reasons to be optimistic regarding the COVID pandemic. Investing is never easy, but it is not rocket science, if you remain disciplined and patient. Follow this advice and your portfolio should benefit in 2022 and beyond.

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 (January 3, 2022). 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 PFE 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.

January 3, 2022 at 3:42 pm 1 comment

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