Posts tagged ‘Stocks’

Stocks: Be My Long-Term Valentine

hearts-1254000

With Valentine’s Day just around the corner, stock bulls remain in love as the major indexes once again hit another new, all-time record high this week (Dow 20,269). Unfortunately, however, there are many other investors afraid of going through another 2008-2009-like break-up, so they remain single as they watch from the sidelines. In a recent post, I point out, as repeated record highs continue to be broken, the skeptics remain fearful of divorcing their cash. While it is indeed true that since the end of the 2016 presidential election, some investors are beginning to date stocks again, there are still wide swaths of conflicted observers very afraid of potential rejection.

As I’ve documented on numerous occasions, the skepticism is evident in the depressing long-term trends found in the weekly fund flows data and the disheartening record-low stock ownership statistics.

Long-Term Relationships

For some, casually dating can be fun and exciting. The same principle applies to short-term traders and speculators. In the short-run, the freedom to make free-wheeling, non-committal stock purchases can be exhilarating. Unfortunately, the fiscal and emotional costs of short-term dating/trading often outweigh the fleeting benefits.

How can you avoid the relationship blues? In short…focus on the long-term. Like any relationship, investing takes work, and there will always be highs, lows, and bumps in the road. It is better to think in terms of a marathon, rather than a sprint. The important lesson is to maintain a systematic, disciplined approach that you can apply irrespective of the changing investment environment. In other words, that means not loosely reacting (buying or selling) to presidential tweets of the day.

Famed investor Peter Lynch spoke about long-term stock fund investing in this manner

“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”

 

No relationship survives without experiencing wild swings, and stocks are no exception. Establishing deep roots to your investments via intensive fundamental analysis provides stability, especially if you are managing your portfolio personally. Even if you are outsourcing your investment management to an advisor like Sidoxia Capital Management, it is still important to understand your advisor’s investment process and philosophy. That way, when the economic and political winds are blowing fiercely, you won’t overreact emotionally and see your gains fly away.

Investing legend Warren Buffett has discussed the importance of intensive research on long-term investment performance through his “20-Hole Punch Card” rule:

“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”

 

Patience is a Virtue

In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down regardless of the daily headlines.

Explaining this randomness, Peter Lynch said the following:

“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”

 

Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually dating your investments, perhaps you should commit to a long-term relationship and divorce your bad short-term centric habits. Now that sounds like a sweet Valentine’s Day kiss your investment portfolio would enjoy.

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, T, FB 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 11, 2017 at 10:42 pm Leave a comment

Super Bowl Blitz – Dow 20,000

team

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 3, 2017). Subscribe on the right side of the page for the complete text.

If you have been following the sports headlines, then you know the Super Bowl 51 NFL football championship game between the four-time champion New England Patriots and the zero-time champion Atlanta Falcons is upon us. It’s that time of the year when more than 100 million people will congregate in front of big screen TVs across our nation and stare at ludicrous commercials (costing $5 million each); watch a semi-entertaining halftime show; and gorge on thousands of calories until stomachs bloat painfully.

The other headlines blasting across the media airwaves relate to the new all-time record milestone of 20,000 achieved by the Dow Jones Industrials Average (a.k.a., “The Dow”). For those people who are not glued to CNBC business television all day, the Dow is a basket of 30 large company stocks subjectively selected by the editors of the Wall Street Journal with the intent of creating an index that can mimic the overall economy. A lot of dynamics in our economy have transformed over the Dow’s 132 year history (1885), so it should come as no surprise that the index’s stock components have changed 51 times since 1896 – the most recent change occurred in March 2015 when Apple Inc. (AAPL) was added to the Dow and AT&T Inc. (T) was dropped.

20,000 Big Deal?

The last time the Dow closed above 10,000 was on March 29, 1999, so it has taken almost 18 years to double to 20,000. Is the Dow reaching the 20,000 landmark level a big deal in the whole scheme of things? The short answer is “No”. It is true the Dow can act as a fairly good barometer of the economy over longer periods of time. Over the 1998 – 2017 timeframe, economic activity has almost doubled to about $18 trillion (as measured by Gross Domestic Product – GDP) with the added help of a declining interest rate tailwind.

In the short-run, stock indexes like the Dow have a spottier record in correlating with economic variables. At the root of short-term stock price distortions are human behavioral biases and emotions, such as fear and greed. Investor panic and euphoria ultimately have a way of causing wild stock price overreactions, which in turn leads to poor decisions and results. We saw this firsthand during the inflation and subsequent bursting of the 2000 technology bubble. If that volatility wasn’t painful enough, last decade’s housing collapse, which resulted in the 2008-2009 financial crisis, is a constant reminder of how extreme emotions can lead to poor decision-making. For professionals, short-term volatility and overreactions provide lucrative opportunities, but casual investors and novices left to their own devices generally destroy wealth.

As I have discussed on my Investing Caffeine blog on numerous occasions, the march towards 20,000 occurred in the middle of arguably the most hated bull market in a generation or two (see The Most Hated Bull Market). It wasn’t until recently that the media began fixating on this arbitrary new all-time record high of 20,000. My frustration with the coverage is that the impressive phenomenon of this multi-year bull market advance has been largely ignored, in favor of gloom and doom, which sells more advertising – Madison Avenue execs enthusiastically say, “Thank you.” While the media hypes these stock records as new, this phenomenon is actually old news. In fact, stocks have been hitting new highs over the last five years (see chart below).

dji-07-17

More specifically, the Dow has hit consecutive, new all-time record highs in each year since 2013. This ignored bull market (see Gallup survey) may not be good for the investment industry, but it can be good for shrewd long-term investors, who react patiently and opportunistically.

Political Football

In Washington, there’s a different game currently going on, and it’s a game of political football. With a hotly contentious 2016 election still fresh in the minds of many voters, a subset of unsatisfied Americans are closely scrutinizing every move of the new administration. Love him or hate him, it is difficult for observers to accuse President Trump of sitting on his hands. In the first 11 days of his presidential term alone, Trump has been very active in enacting almost 20 Executive Orders and Memoranda (see the definitional difference here), as he tries to make supporters whole with his many previous campaign trail promises. The persistently increasing number of policies is rising by the day (…and tweet), and here’s a summarizing list of Trump’s executive actions so far:

  • Refugee Travel Ban
  • Keystone & Dakota Pipelines
  • Border Wall
  • Deportations/Sanctuary Cities
  • Manufacturing Regulation Relief
  • American Steel
  • Environmental Reviews
  • Affordable Care Act Requirements
  • Border Wall
  • Exit TPP Trade Deal
  • Federal Hiring Freeze
  • Federal Abortion Freeze
  • Regulation Freeze
  • Military Review
  • ISIS Fight Plan
  • Reorganization of Security Councils
  • Lobbyist Bans
  • Deregulation for Small Businesses

President Trump has thrown another political football bomb with his recent nomination of Judge Neil Gorsuch (age 49) to the Supreme Court in the hopes that no penalty flags will be thrown by the opposition. Gorsuch, the youngest nominee in 25 years, is a conservative federal appeals judge from Colorado who is looking to fill the seat left open by last year’s death of Justice Antonin Scalia at the age 79.

Politics – Schmolitics

When it comes to the stock market and the economy, many people like to make the president the hero or the scapegoat. Like a quarterback on the football field, the president certainly has influence in shaping the political and economic game plan, but he is not the only player. There is an infinite number of other factors that can (and do) contribute to our country’s success (or lack thereof).

Those economic game-changing factors include, but are not limited to: Congress, the Federal Reserve, Supreme Court, consumer sentiment, trade policy, demographics, regulations, tax policy, business confidence, interest rates, technology proliferation, inflation, capital investment, geopolitics, terrorism, environmental disruptions, immigration, rate of productivity, fiscal policy, foreign relations, sanctions, entitlements, debt levels, bank lending, mergers and acquisitions, labor rules, IPOs (Initial Public Offerings), stock buybacks, foreign exchange rates, local/state/national elections, and many, many, many other factors.

Regardless to which political team you affiliate, if you periodically flip through your social media stream (e.g., Facebook), or turn on the nightly news, you too have likely suffered some sort of political fatigue injury. As Winston Churchill famously stated, “Democracy is the worst form of government except for all the other forms that have been tried from time to time.”

When it comes to your finances, getting excited over Dow 20,000 or despondent over politics is not a useful or efficient strategy. Rather than becoming emotionally volatile, you will be better off by focusing on building (or executing) your long-term investment plan. Not much can be accomplished by yelling at a political charged Facebook rant or screaming at your TV during a football game, so why not calmly concentrate on ways to control your future (financial or otherwise). Actions, not fear, get results. Therefore, if this Super Bowl Sunday you’re not ready to review your asset allocation, budget your annual expenses, or contemplate your investment time horizon, then at least take control of your future by managing some nacho cheese dip and handling plenty of fried chicken.

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, T, FB 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 4, 2017 at 8:02 am Leave a comment

Become the Landlord of Your Stocks

modern-apartments-1203635

“Why do you buy stocks?” Unfortunately, many people do not truly understand how to answer that particular question. If they were honest with themselves, many stockholders would respond by saying, “Because they are going up in price,” or maybe, “My neighbor told me to buy stock XYZ.” However, if somebody asked the same question regarding the purchase of a real estate property or an apartment building, would the answer be the same? The short answer is…probably not. There certainly could be some people who answer the stock versus real estate valuation question in the same way, but in general, real estate investors understand the tangibility and relevant factors of a property better than equity investors understand the jargon and abstract nature of most stocks.

There are many ways to value an asset, but in many cases, the value of an asset is spontaneously left in the eye of the beholder. Nevertheless, there is one common approach, applicable across asset classes, which is the net present value or discounted cash flow approach. This valuation methodology basically states any asset is worth the cumulative value of cash inflows minus the value of cash outflows, after adjusting that netted figure for time and interest rates.

In the case of an apartment building, a layman generally understands the basic valuation concept behind adding up the relevant cash inflows and cash outflows. For example, being a landlord of an apartment building involves simple rent collection (cash inflows) in addition to maintenance, repairs, construction costs, employee wages, taxes, and other payments (cash outflows). After making additional assumptions about future rent increases, occupancy levels, wage inflation, and a few other variables, many outside observers could probably come up with a decent estimated value of the property.

The variables relating to an apartment building may be more stable, predictable, and understandable, if compared with the variables of a stock, but the same exact principles apply to both asset classes. Wal-Mart may not collect stable rent checks, but it does collect money from product sales in its 11,500 stores around the world (cash inflows). Wal-Mart’s cash inflows are much less predictable than real estate rent check inflows due to the many retail-specific variables, such as store openings/closings, online competition, promotions, seasonality, inventory levels, and geographic economics. Expenses (cash outflows) are challenging to predict as well due to wage fluctuations, energy cost variability, capital project timing, erratic raw material prices, and other factors. In the end, stock variables may be more volatile and less predictable, but the valuation process should be the same. Valuing stocks requires estimating the cumulative value of cash inflows minus the value of cash outflows, and then adjusting those results for time and interest rates.

Real estate has its own industry language, but the language of stocks has an endless number of acronyms, which can be quite challenging if you consider the dozens of industries and thousands of stocks. Here are a few of my favorite obscure acronyms used across the technology, healthcare, energy, and retail sectors:

Technology: 4G, CDMA, DSLAM, LTE, MPLS, SaaS, SRAM

Energy: BCF, BOE, BTU, EIA, Gwh, kWh, LNG, MWh, WTI

Healthcare: AARP, CRM, DRG, EENT, FDA, HIPAA, MI, SARS

Retail: B2B, EDI, EDLP, GMROI, POS, RFID, SCM, SKU, UPC

As noted earlier, the language and complexity for valuing stocks may be more complicated than valuing other more straightforward asset classes, but the methodology is essentially the same.

The opportunities and rewards stemming from stock ownership are almost endless. While it’s true that successful long-term stock investing is rarely easy, anything worthwhile in life is never simple. If you are able to understand the principal concepts of how to become an effective landlord of real estate, then applying the same principles on how to become an effective landlord of your stock portfolio is highly achievable.

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

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 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 21, 2017 at 2:15 pm Leave a comment

Wiping Your Financial Slate Clean

slate

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 3, 2017). Subscribe on the right side of the page for the complete text.

The page on the calendar has turned, and we now have a new year, and will shortly have a new president, and new economic policies. Although there is nothing magical about starting a fresh, new year, the annual rites of passage also allow investors to start with a clean slate again and reflect on their personal financial situation. Before you reach a desired destination (i.e., retirement), it is always helpful to know where you have been and where are you currently. Achieving this goal requires filtering through a never-ending avalanche of real-time data flooding through our cell phones, computers, TVs, radios, and Facebook accounts. This may seem like a daunting challenge, but that’s where I come in!

Distinguishing the signals from the noise is tough and there was plenty of noise in 2016 – just like there is every year. Before the S&P 500 stock index registered a +9.5% return in 2016, fears of a China slowdown blanketed headlines last January (the S&P 500 fell -15% from its highs and small cap stocks dropped -26%), and the Brexit (British exit) referendum caused a brief 48-hour -6% hiccup in June. Oil was also in the news as prices hit a low of $26 a barrel early in the year, before more than doubling by year-end to $54 per barrel (still well below the high exceeding $100 in 2014). On the interest rate front, 10-Year Treasury rates bottomed at 1.34% in July, while trillions of dollars in global bonds were incomprehensibly paying negative interest rates. However, fears of inflation rocked bond prices lower (prices move inversely to yields) and pushed bond yields up to 2.45% today. Along these lines, the Federal Reserve has turned the tide on its near-0% interest rate policy as evidenced by its second rate hike in December.

Despite the abbreviated volatility caused by the aforementioned factors, it was the U.S. elections and surprise victory of President-elect Donald Trump that dominated the media airwaves for most of 2016, and is likely to continue as we enter 2017. In hindsight, the amazing Twitter-led, Trump triumph was confirmation of the sweeping global populism trend that has also replaced establishment leaders in the U.K., France, and Italy. There are many explanations for the pervasive rise in populism, but meager global economic growth, globalization, and automation via technology are all contributing factors.

The Trump Bump

Even though Trump has yet to accept the oath of Commander-in-Chief, recent investor optimism has been fueled by expectations of a Republican president passing numerous pro-growth policies and legislation through a Republican majority-controlled Congress. Here are some of the expected changes:

  • Corporate/individual tax cuts and reform
  • Healthcare reform (i.e., Obamacare)
  • Proposed $1 trillion in infrastructure spending
  • Repatriation tax holiday for multinational corporate profits
  • Regulatory relief (e.g., Dodd-Frank banking and EPA environmental reform)

The chart below summarizes the major events of 2016, including the year-end “Trump Bump”:

16-sp-sum

While I too remain optimistic, I understand there is no free lunch as it relates to financial markets (see also Half Trump Full). While tax cuts, infrastructure spending, and regulatory relief should positively contribute to economic growth, these benefits will have to be weighed against the likely costs of higher inflation, debt, and deficits.

Over the 25+ years I have been investing, the nature of the stock market and economy hasn’t changed. The emotions of fear and greed rule the day just as much today as they did a century ago. What has changed today is the pace, quality, and sheer volume of news. In the end, my experience has taught me that 99% of what you read, see or hear at the office is irrelevant as it relates to your retirement and investments. What ultimately drives asset prices higher or lower are the four key factors of corporate profits, interest rates, valuations, and sentiment (contrarian indicator) . As you can see from the chart below, corporate profits are at record levels and forecast to accelerate in 2017 (up +11.9%). In addition, valuations remain very reasonable, given how low interest rates are (albeit less low), and skeptical investor sentiment augurs well in the short-run.

16-eps

Source: FactSet

Regardless of your economic or political views, this year is bound to have plenty of ups and downs, as is always the case. With a clean slate and fresh turn to the calendar, now is a perfect time to organize your finances and position yourself for a better retirement and 2017.

investment-questions-border

www.Sidoxia.com 

Wade W. Slome, CFA, CFP®

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

January 3, 2017 at 12:17 pm Leave a comment

Half Trump Empty, or Half Trump Full?

glass

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

It was a bitter U.S. presidential election, but fortunately, the nastiest election mudslinging has come to an end…at least until the next political contest. Unfortunately, like most elections, even after the president-elect has been selected, almost half the country remains divided and the challenges facing the president-elect have not disappeared.

While some non-Trump voters have looked at the glass as half empty, since the national elections, the stock market glass has been overflowing to new record highs. Similar to the unforeseen British Brexit outcome in which virtually all pollsters and pundits got the results wrong, U.S. experts and investors also initially took a brief half-glass full view of the populist victory of Donald Trump. More specifically, for a few hours on Election Day, stock values tied to the Dow Jones Industrial Average index collapsed by approximately -5%.

It didn’t take long for stock prices to quickly reverse course, and when all was said and done, the Dow Jones Industrial Average finished the month higher by almost +1,000 points (+5.4%) to finish at 19,124 – a new all-time record high (see chart below). Worth noting, stocks have registered a very respectable +10% return during 2016, and the year still isn’t over.

dji-2016

Source: Investors.com (IBD)

Drinking the Trump Egg Nog

Why are investors so cheery? The proof will be in the pudding, but current optimism is stemming from a fairly broad list of anticipated pro-growth policies.

At the heart of the reform is the largest expected tax reform since Ronald Reagan’s landmark legislation three decades ago. Not only is Trump proposing stimulative tax cuts for corporations, but also individual tax reductions targeted at low-to-middle income taxpayers. Other facets of the tax plan include simplification of the tax code; removal of tax loopholes; and repatriation of foreign cash parked abroad. Combined, these measures are designed to increase profits, wages, investment spending, productivity, and jobs.

On the regulatory front, the President-elect has promised to repeal the Obamacare healthcare system and also overhaul the Dodd-Frank financial legislation. These initiatives, along with talk of dialing back other regulatory burdensome laws and agencies have many onlookers hopeful such policies could aid economic growth.

Fueling further optimism is the prospect of a trillion dollar infrastructure spending program created to fix our crumbling roads and bridges, while simultaneously increasing jobs.

No Free Lunch

As is the case with any economic plan, there is never a free lunch. Every cost has a benefit, and every benefit has a cost. The cost of the 2008-2009 Financial crisis is reflected in the sluggish economic growth seen in the weak GDP (Gross Domestic Product) statistics, which have averaged a modest +1.6% growth rate over the last year. Scott Grannis points out how the slowest recovery since World War II has resulted in a $3 trillion economic gap (see chart below).

us-real-gdp

Source: Calafia Beach Pundit

The silver lining benefit to weak growth has been tame inflation and the lowest interest rate levels experienced in a generation. Notwithstanding the recent rate rise, this low rate phenomenon has spurred borrowing, and improved housing affordability. The sub-par inflation trends have also better preserved the spending power of American consumers on fixed incomes.

If executed properly, the benefits of pro-growth policies are obvious. Lower taxes should mean more money in the pockets of individuals and businesses to spend and invest on the economy. This in turn should create more jobs and growth. Regulatory reform and infrastructure spending should have similarly positive effects. However, there are some potential downside costs to the benefits of faster growth, including the following:

  • Higher interest rates
  • Rising inflation
  • Stronger dollar
  • Greater amount of debt
  • Larger deficits (see chart below)

trumpdeficit

Source: The Wall Street Journal

Even though President-elect Trump has not even stepped foot into the Oval Office yet, signs are already emerging that we could face some or all of the previously mentioned headwinds. For example, just since the election, the yield on 10-Year Treasury Notes have spiked +0.5% to 2.37%, and 30-Year Fixed Rate mortgages are flirting with 4.0%. Social and economic issues relating to immigration legislation and Supreme Court nominations are likely to raise additional uncertainties in the coming months and years.

Attempting to anticipate and forecast pending changes makes perfect sense, but before you turn your whole investment portfolio upside down, it’s important to realize that actions speak louder than words. Even though Republicans have control over the three branches of government (Executive, Legislative, Judicial), the amount of control is narrow (i.e., the Senate), and the nature of control is splintered. In other words, Trump will still have to institute the “art of the deal” to persuade all factions of the Republicans (including establishment, Tea-Party, and rural) and Democrats to follow along and pass his pro-growth policies.

Although I do not agree with all of Trump’s policies, including his rhetoric on trade (see Free Trade Boogeyman), I will continue paying closer attention to his current actions rather than his past words. Until proven otherwise, I will keep on my rose colored glasses and remain optimistic that the Trump glass is half full, not half empty.

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper.

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

December 3, 2016 at 8:00 am Leave a comment

Waiting for the Fat Pitch

baseballfreeimages

Fall is here and the leaves are beginning to change, which means it’s baseball playoffs time and the World Series is quickly approaching. Investing in some respects is similar to baseball because they both require discipline and patience. One investing legend who embodies those characteristics is Warren Buffett, and he has repeatedly spoken about Ted Williams and waiting for the “fat pitch.”

John Huber, over at BHI, did a great job summarizing Ted Williams’ hitting philosophy here:

“Ted Williams was famous for “waiting for the fat pitch”. He would only look to swing at pitches in the part of the strike zone where he knew he had a higher probability of getting a hit. There were parts of his strike zone where he batted .230 and there were other parts of the strike zone where he batted .400. He knew that if he waited for a pitch over the heart of the plate and didn’t swing at pitches in the .230 part of the strike zone—even though they were strikes—he would improve his odds of getting a hit and increase his overall batting average.”

 

ted-williams

This lesson of patience and discipline is critical for your investment portfolio. Too many people speculate by chasing a hot tip or good stock story, or on the flip side, panic by selling based upon transitory negative news headlines. Today, we see risk aversion happening on steroids. Consider there is over $8 trillion sitting in savings accounts earning effectively nothing – the equivalent of stuffing money under the mattress (see also Invest or Die). In other words, investors are paying extremely high prices (chasing) for safer (less volatile) securities – bonds and cash, while equities are yielding a much higher rate as measured by the earnings yield of the S&P 500 (S&P operating profits / index value). Scott Grannis at Calafia Beach Pundit calls this dynamic the equity risk premium (chart below).

Source: Scott Grannis

Source: Scott Grannis

As you can see from the chart, ever since the financial crisis occurred, stocks have been compensating investors at significantly higher levels (almost 4% currently) than the yields on 10-Year Treasury Notes, a phenomenon not experienced for the previous three decades.

When will this equity premium revert back towards the mean? There are number of factors that could correct this disparity.

1). The economy enters recession and profits decline to a point at which bonds offer a more compelling risk-reward ratio than stocks.

2). Interest rates rise (bond prices decline) to a point at which bonds offer a more compelling risk-reward ratio than stocks.

3). Investors bid stocks significantly higher to a point at which bonds offer a more compelling risk-reward ratio than stocks.

Most people are worried about scenario #1, but there is plenty objective data that splashes cold water on that view. Consider the unemployment rate has been chopped in half since 2009 with about 15 million jobs added; corporate profits are at/near record highs; auto sales are at/near record highs; home sales continue on an improving trajectory; and the yield curve remains positive, among other factors. If you absorb that information, it clearly doesn’t resemble a recessionary environment, but that doesn’t prevent  people from worrying.

Regarding scenario #2, rising rates are an eventuality, but an absence of meaningful inflation, coupled with sluggish global growth are likely to keep a lid on interest rates for some time. Any casual observer would realize that interest rates have been on a downward trend for more than 35 years (see also Fall is Here: Change is Near). Even with a potential second rate increase in a decade initiated by the Fed this upcoming December, the long-term downward trend in rates will likely remain intact.

While the media likes to focus on the half-glass full scenarios (#1 & #2), very little time has been expended on the possibility of scenario #3, which contemplates a rise in stock prices to erase the discount in stock prices relative to bond prices (i.e., elevated equity risk premium).

While many people are ignoring the probability of scenario #3 occurring, like a disciplined hitter in baseball, successful investing requires patience while you wait for your fat investment pitch.

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper.

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

October 22, 2016 at 8:00 am 1 comment

Invest or Die

China Executes Wall Street Solution

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.

div-vs-treas-2016

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

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!

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper. 

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

September 24, 2016 at 8:11 am 1 comment

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