Posts tagged ‘Stocks’
Wiping Your Financial Slate Clean
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”:
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.
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.
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.
Half Trump Empty, or Half Trump Full?
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.
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).
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)
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.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Waiting for the Fat Pitch
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.”
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
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.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page
Invest or Die
Seventy-six million Baby Boomers are earning near 0% (or negative rates) and aren’t getting any younger in the process, which is forcing them and others to decide…invest or die. The risk of outliving your savings is becoming a larger reality these days. Demographics and economics are dictating that our aging population is living longer and earning less due to generationally low interest rates.
Richard Fisher, the former Dallas Federal Reserve president, understands these looming dynamics. Fisher has identified how low-interest rates are increasing investor discontent by pushing consumers to save more in order to meet retirement needs. The unintended consequence from low rates, he said, is “you’re going to have to save a hell of a lot more before you consume.”
Besides saving, the other option investors have is to lower your standard of living. For example, you could continually eat mac & cheese and sleep in a tent – that is indeed one way you could save money. However, your kids and/or desired lifestyle may make this way of life unpalatable for all. Rather, the proper approach to achieving a comfortable standard of living requires you to invest more efficiently and prudently.
What a lot of individuals fail to understand is that accepting too much risk can be just as dangerous as being too conservative, over the long run. Case in point, depositing your savings into a CD at current interest rates (near 0%) is the equivalent of burning your cash, as any income produced is overwhelmed by the deleterious effects of inflation. It would take more than a lifetime of CD interest income to equal equity returns earned over the last seven years. Since early 2009, stocks have more than tripled in value.
Given the prevailing economic and demographic trends, investors are slowly realizing the attractive income-producing nature of stocks relative to bonds. It has been a rare occurrence, but stocks, as measured by the S&P 500, continue to yield more than 10-Year Treasury Notes (2.0% vs. 1.6%, respectively) – see chart below. The picture for bonds looks even worse in many international markets, where $13 trillion in bonds are yielding negative interest rates. Unlike bonds, which generally pay fixed coupon payments for years at a time, stocks overall have historically increased their dividend payouts by approximately 6% annually.
Source: Avondale Asset Management
With a scarcity of attractive investment alternatives available, investors will eventually be forced to adopt higher levels of equity risk, like it or not. However, this dynamic has yet to happen. Currently, actions are speaking louder than words, and as you can see, risk aversion reigns supreme with Americans tucking over $8 trillion dollars under their mattress (see chart below), in the form of savings accounts, earning next to nothing and jeopardizing retirements.
Source: Calafia Beach Pundit
Even if you fall into the camp that believes rates are artificially low by central bank printing presses, that doesn’t mean every company is recklessly leveraging their balance sheets up to the hilt. Many companies are still scared silly from the financial crisis and conservatively managing every penny of expense, like a stingy retiree living on a fixed income. Thanks to this reluctance to spend and hire aggressively, profit margins are at/near record highs. This financial stewardship has freed up corporations’ ability to pay higher dividends and implement discretionary stock buybacks as means to return capital to shareholders.
With the dovish Fed judiciously raising interest rates – only one rate hike of 0.25% over a decade (2006 – 2016) – there are no signs this ultra-low interest rate environment is going to turn aggressively higher anytime soon. Until economic growth, inflation, and interest rates return with a vengeance, and the persistent investor risk aversion abates, it behooves all the cash hoarders to….invest or die!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Politics & Your Money
Will you be able to retire, and what impact will the elections have on your financial future? Answering these questions can be a scary endeavor. And unless you have been living in a cave, you may have noticed we are in the middle of a heated U.S. presidential election campaign between Donald Trump and Hillary Clinton. Regardless of which side of the political fence you stand on, the prospects of your retirement are much more likely to be impacted by your personal actions than by the actions of Washington politicians.
Even if you despise politics and were living in a cave (with WiFi access), there’s a high probability you would be overloaded with detailed and dogmatic online editorials from overconfident Facebook friends. Besides offering self-assured predictions, these impassioned political pleas generally itemize the top 10 reasons your favorite candidate is a moron, and another 10 reasons why their candidate is the greatest.
Your friends’ opinions may have pure intentions, but unfortunately, rarely, if ever, do their thoughts alter your views. A reference from a recent Legal Watercooler article summed it up best:
“Political Facebook rants changed my mind…said nobody, ever.”
Nearly as ineffectual as political Facebook opinions on your politics is the ineffectual influence of presidential elections on your finances. For example, over the last four decades, stock prices have gone up and down during both Republican and Democrat presidential terms. The picture looks much the same, if you analyze the fiscal performance of conservatives and liberals since 1970 – debt burdens as a percentage of economic output have risen and fallen under both political parties. No matter who wins the presidency, many investors forget the ability of that individual to affect change is highly dependent upon the political balance of power in Congress. If Congress holds a split majority in the House and Senate, or the opposition party commands the entire Congress, then the winning presidential candidate will be largely neutered.
Rather than panic over a political loss or celebrate a candidate’s victory, here are some tangible actions to improve your finances:
- Organize. Typically individuals have investment and saving accounts scattered with no cohesive accounting or strategy. Get your financial house in order by gathering and organizing all your accounts.
- Budget. Spend less than you take in. Or in other words…save. You can achieve this goal in one of two ways – cut your spending, or increase your income.
- Create a Plan. When do you plan to retire? How much money do you need for retirement? What asset allocation and risk profile should you adopt to meet your financial goals?
If you have difficulty with any of these actions, then meet with an experienced financial professional to assist you.
Politics can trigger very emotional responses. However, realizing your actions have a much more direct impact on your finances than political Facebook rants and temporary elections will benefit you in achieving your long-term financial goals.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds and FB, 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.
EU Marriage Ends in Messy Brexit Divorce
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.
What Just Happened?
Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.
Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.
Source: Bloomberg
One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.
A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.
Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).
What Were Investors’ Reactions?
Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:
U.S. (S&P 500): -0.7%
U.K. (FTSE 100): +2.6%
Japan (Nikkei): -4.1%
Germany (DAX): -5.6%
Hong Kong (Hang Seng): +0.4%
China (Shanghai): +1.3%
India (BSE): -0.0%
Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.
Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.
To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).
Source: Calafia Beach Pundit
Why Did it Happen?
While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.
18-24: 75% Remain
25-49: 56% Remain
50-64: 44% Remain
65+: 39% Remain
While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.
At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).
Source: The Wall Street Journal
What happens next?
While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.
In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity. Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.
What does Brexit Mean for Global Markets?
The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:
1) What is the Brexit impact on the U.S. economy?
If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).
2) What is the Brexit impact on the global economy?
The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.
Source: The National Archives
What to Do Next?
Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).
If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Cleaning Out Your Investment Fridge
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2016). Subscribe on the right side of the page for the complete text.
Summer is quickly approaching, but it’s not too late to do some spring cleaning. This principle not only applies to your cluttered refrigerator with stale foods but also your investment portfolio with moldy investments. In both cases, you want to get rid of the spoiled goods. It’s never fun discovering a science experiment growing in your fridge.
Over the last three months, the stock market has been replenished after a rotten first two months of the year (S&P 500 index was down -5.5% January through February). The +1.5% increase in May added to a +6.6% and +0.3% increase in March and April (respectively), resulting in a three month total advance in stock prices of +8.5%. Not surprisingly, the advance in the stock market is mirroring the recovery we have seen in recent economic data.
After digesting a foul 1st quarter economic Gross Domestic Product (GDP) reading of only +0.8%, activity has been smelling better in the 2nd quarter. A recent wholesome +3.4% increase in April durable goods orders, among other data points, has caused the Atlanta Federal Reserve Bank to raise its 2nd quarter GDP estimate to a healthier +2.9% growth rate (from its prior +2.5% forecast).
Consumer spending, which accounts for roughly 70% of our country’s economic activity, has been on the rise as well. The improving employment picture (5.0% unemployment rate last month) means consumers are increasingly opening their wallets and purses. In addition to spending more on cars, clothing, movies, and vacations, consumers are also doling out a growing portion of their income on housing. Housing developers have cautiously kept a lid on expansion, which has translated into limited supply and higher home prices, as evidenced by the Case-Shiller indices charted below.
Source: Bespoke
Spoiling the Fun?
While the fridge may look like it’s fully stocked with fresh produce, meat, and dairy, it doesn’t take long for the strawberries to get moldy and the milk to sour. Investor moods can sour quickly too, especially as they fret over the impending “Brexit” (British Exit) referendum on June 23rd when British voters will decide whether they want to leave the European Union. A “yes” exit vote has the potential of roiling the financial markets and causing lots of upset stomachs.
Another financial area to monitor relates to the Federal Reserve’s monetary policy and its decision when to further increase the Federal Funds interest rate target at its June 14th – 15th meeting. With the target currently set at an almost insignificantly small level of 0.25% – 0.50%, it really should not matter whether Chair Janet Yellen decides to increase rates in June, July, September and/or November. Considering interest rates are at/near generational lows (see chart below), a ¼ point or ½ point percentage increase in short-term interest rates should have no meaningfully negative impact on the economy. If your fridge was at record freezing levels, increasing the temperature by a ¼ or ½ degree wouldn’t have a major effect either. If and when short-term interest rates increase by 2.0%, 3.0%, or 4.0% in a relatively short period will be the time to be concerned.
Source: Scott Grannis
Keep a Fresh Financial Plan
As mentioned earlier, your investments can get stale too. Excess cash sitting idly earning next-to-nothing in checking, savings, CDs, or in traditional low-yielding bonds is only going to spoil rapidly to inflation as your savings get eaten away. In the short-run, stock prices will move up and down based on frightening but insignificant headlines. However, in the long-run, the more important issues are determining how you are going to reach your retirement goals and whether you are going to outlive your savings. This mindset requires you to properly assess your time horizon, risk tolerance, income needs, tax situation, estate plan, and other unique circumstances. Like a balanced diet of various food groups in your refrigerator, your key personal financial planning factors are dependent upon you maintaining a properly diversified asset allocation that is periodically rebalanced to meet your long-term financial goals.
Whether you are managing your life savings, or your life-sustaining food supply, it’s always best to act now and not be a couch potato. The consequences of sitting idle and letting your investments spoil away are a lot worse than letting the food in your refrigerator rot away.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Cutting Losses with Fisher’s 3 Golden Sell Rules
Returning readers to Investing Caffeine understand this is a location to cover a wide assortment of investing topics, ranging from electric cars and professional poker to taxes and globalization. Investing Caffeine is also a location that profiles great investors and their associated investment lessons.
Today we are going to revisit investing giant Phil Fisher, but rather than rehashing his accomplishments and overall philosophy, we will dig deeper into his selling discipline. For most investors, selling securities is much more difficult than buying them. The average investor often lacks emotional self-control and is unable to be honest with himself. Since most investors hate being wrong, their egos prevent taking losses on positions, even if it is the proper, rational decision. Often the end result is an inability to sell deteriorating stocks until capitulating near price bottoms.
Selling may be more difficult for most, but Fisher actually has a simpler and crisper number of sell rules as compared to his buy rules (3 vs. 15). Here are Fisher’s three sell rules:
1) Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.
2) Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time. Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold according to Fisher.
3) Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then Fisher advises the sale of other securities to fund the purchase.
Reasons Not to Sell
Prognostications or gut feelings about a potential market decline are not reasons to sell in Fisher’s eyes. Selling out of fear generally is a poor and costly idea. Fisher explains:
“When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price.”
In Fisher’s mind, another reason not to sell stocks is solely based on valuation. Longer-term earnings power and comparable company ratios should be considered before spontaneous sales. What appears expensive today may look cheap tomorrow.
There are many reasons to buy and sell a stock, but like most good long –term investors, Fisher has managed to explain his three-point sale plan in simplistic terms the masses can understand. If you are committed to cutting investment losses, I advise you to follow investment legend Phil Fisher – cutting losses will actually help prevent your portfolio from splitting apart.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM 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.
Winning the Loser’s Game
During periods of heightened volatility like those recently experienced, it’s easy to get caught up in the emotional heat of the moment. I find time is better spent returning to essential investing fundamentals, like the ones I read in the investment classic by Charles Ellis, Winning the Loser’s Game – “WTLG”. To put my enthusiasm in perspective, WTLG has even achieved the elite and privileged distinction of making the distinguished “Recommended Reading” list of Investing Caffeine (located along the right-side of the page). Wow…now I know you are really impressed.
The Man, The Myth, the Ellis
For those not familiar with Charley Ellis, he has a long, storied investment career. Not only has he authored 12 books, including compilations on Goldman Sachs (GS) and Capital Group, but his professional career dates back prior to 1972, when he founded institutional consulting firm Greenwich Associates. Besides earning a college degree from Yale University, and an MBA from Harvard Business School, he also garnered a PhD from New York University. Ellis also is a director at the Vanguard Group and served as Investment Committee chair at Yale University along investment great David Swensen (read also Super Swensen) from 1992 – 2008.
With this tremendous investment experience come tremendous insights. The original book, which was published in 1998, is already worth its weight in gold (even at $1,384 per ounce), but the fifth edition of WTLG is even more valuable because it has been updated with Ellis’s perspectives on the 2008-2009 financial crisis.
Because the breadth of topics covered is so vast and indispensable, I will break the WTLG review into a few parts for digestibility. I will start off with the these hand-picked nuggets:
Defining the “Loser’s Game”
Here is how Charles Ellis describes the investment “loser’s game”:
“For professional investors, “the ‘money game’ we call investment management evolved in recent decades from a winner’s game to a loser’s game because a basic change has occurred in the investment environment: The market came to be dominated in the 1970s and 1980s by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with cautious custodians or amateurs who are out of touch with the market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to winning is to lose less than others lose.”
Underperformance by Active Managers
Readers that have followed Investing Caffeine for a while understand how I feel about passive (low-cost do-nothing strategy) and active management (portfolio managers constantly buying and selling) – read Darts, Monkeys & Pros. Ellis’s views are not a whole lot different than mine – here is what he has to say while not holding back any punches:
“The basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management – fees, commissions, market impact of big transactions, and so forth-85 percent of investment managers have and will continue over the long term to underperform the overall market.”
He goes on to say individuals do even worse, especially those that day trade, which he calls a “sucker’s game.”
Exceptions to the Rule
Ellis’s bias towards passive management is clear because “over the long term 85 percent of active managers fall short of the market. And it’s nearly impossible to figure out ahead of time which managers will make it into the top 15 percent.” He does, however, acknowledge there is a minority of professionals that can beat the market by making fewer mistakes or taking advantage of others’ mistakes. Ellis advocates a slow approach to investing, which bases “decisions on research with a long-term focus that will catch other investors obsessing about the short term and cavitating – producing bubbles.” This is the strategy and approach I aim to achieve.
Gaining an Unfair Competitive Advantage
According to Ellis, there are four ways to gain an unfair competitive advantage in the investment world:
1) Physical Approach: Beat others by carrying heavier brief cases and working longer hours.
2) Intellectual Approach: Outperform by thinking more deeply and further out in the future.
3) Calm-Rational Approach: Ellis describes this path to success as “benign neglect” – a method that beats the others by ignoring both favorable and adverse market conditions, which may lead to suboptimal decisions.
4) Join ‘em Approach: The easiest way to beat active managers is to invest through index funds. If you can’t beat index funds, then join ‘em.
The Case for Stocks
Investor time horizon plays a large role on asset allocation, but time is on investors’ side for long-term equity investors:
“That’s why in the long term, the risks are clearly lowest for stocks, but in the short term, the risks are just as clearly highest for stocks.”
Expanding on that point, Ellis points out the following:
“Any funds that will stay invested for 10 years or longer should be in stocks. Any funds that will be invested for less than two to three years should be in “cash” or money market instruments.”
While many people may feel stock investing is dead, but Ellis points out that equities should return more in the long-run:
“There must be a higher rate of return on stocks to persuade investors to accept risks of equity investing.”
The Power of Regression to the Mean
Investors do more damage to performance by chasing winners and punishing losers because they lose the powerful benefits of “regression to the mean.” Ellis describes this tendency for behavior to move toward an average as “a persistently powerful phenomenon in physics and sociology – and in investing.” He goes on to add, good investors know “that the farther current events are away from the mean at the center of the bell curve, the stronger the forces of reversion, or regression, to the mean, are pulling the current data toward the center.”
The Power of Compounding
For a 75 year period (roughly 1925 – 2000) analyzed by Ellis, he determines $1 invested in stocks would have grown to $105.96, if dividends were not reinvested. If, however, dividends are reinvested, the power of compounding kicks in significantly. For the same 75 year period, the equivalent $1 would have grown to $2,591.79 – almost 25x’s more than the other method (see also Penny Saved is Billion Earned).
Ellis throws in another compounding example:
“Remember that if investments increase by 7 percent per annum after income tax, they will double every 10 years, so $1 million can become $1 billion in 100 years (before adjusting for inflation).”
The Lessons of History
As philosopher George Santayana stated – “Those who cannot remember the past are condemned to repeat it.” Details of every market are different, but as Ellis notes, “The major characteristics of markets are remarkably similar over time.”
Ellis appreciates the importance of history plays in analyzing the markets:
“The more you study market history, the better; the more you know about how securities markets have behaved in the past, the more you’ll understand their true nature and how they probably will behave in the future. Such an understanding enables us to live rationally with markets that would otherwise seem wholly irrational.”
Home Sweet International Home
Although Ellis’s recommendation to diversify internationally is not controversial, his allocation recommendation regarding “full diversification” is a bit more provocative:
“For Americans, this would mean about half our portfolios would be invested outside the United States.”
This seems high by traditional standards, but considering our country’s shrinking share of global GDP (Gross Domestic Product), along with our relatively small share of the globe’s population (about 5% of the world’s total), the 50% percentage doesn’t seem as high at first blush.
Beware the Broker
This is not new territory for me (see Financial Sharks, Fees/Exploitation, and Credential Shell Game), and Ellis warns investors on industry sales practices:
“Those oh so caring and helpful salespeople make their money by convincing you to change funds. Friendly as they may be, they may be no friend to your long-term investment success.”
Unlike a lot of other investing books, which cover a few aspects to investing, Winning the Loser’s Game covers a gamut of crucial investment lessons in a straightforward, understandable fashion. A lot of people play the investing game, but as Charles Ellis details, many more investors and speculators lose than win. For any investor, from amateur to professional, reading Ellis’s Winning the Loser’s Game and following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, 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.
Going Shopping: Chicken vs. Beef
The headlines haven’t been very rosy over the last week, but when is that ever not the case? Simply put, gloom and doom sells. The Chinese stock market is collapsing; the Yuan is plummeting; there are rising tensions in the Middle East; terrorism is rising to the fore; and commodity prices are falling apart at the seams. This is only a partial snapshot of course, and does not paint a complete or accurate picture. Near record-low interest rates; record corporate profits (outside of energy); record-low oil prices; unprecedented accommodative central bank policies; and attractive valuations are but a few of the positive, countervailing factors that rarely surface through the media outlets.
At the end of the day, smart long-term investors understand investing in financial markets is a lot like grocery store shopping. Similarly to stocks and bonds, prices at the supermarket fluctuate daily. Whether you’re comparing beef (bonds) and chicken (stocks) prices in the meat department (stock market), or apple (real estate) and orange (commodities) prices in the produce department (global financial markets), ultimately, shrewd shoppers eventually migrate towards purchasing the best values. Since the onset of the 2008-2009 financial crisis, risk aversion has dominated over value-based prudence as evidenced by investors flocking towards the perceived safety of cash, Treasury bonds, and other fixed income securities that are expensively priced near record highs. As you can see from the chart below, investors poured $1.2 trillion into bonds and effectively $0 into stocks. Consumers may still be eating lots of steaks (bonds) currently priced at $6.08/lb while chicken (stocks) is at $1.48/lb (see U.S. Department of Labor Data – Nov. 2015), but at some point, risk aversion will abate, and consumers will adjust their preferences towards the bargain product.
Some Shoppers Still Buying Chicken
While the general public may have missed the massive bull market in stocks, astute corporate executives and investment managers took advantage of the equity bargains in recent years, as seen by stock prices tripling from the March 2009 lows. As corporate profits and margins have marched to record levels, CEOs/CFOs put their money where their mouths are by investing trillions of dollars into share buybacks and mergers & acquisitions transactions.
Despite the advance in the multi-year bull market, with the recent sell-off, panic has once again dominated rational thinking. We see this rare phenomenon (a few times over the last century) manifest itself through a stock market dividend yield that exceeds the yield on Treasury bonds (2.2% S&P 500 vs 2.1% 10-Year Treasury). But if we are once again comparing beef vs. chicken prices (bonds vs stocks), the 6% earnings yield on stocks (i.e., Inverse P/E ratio or E/P) now looks even more compelling relative to the 2% yield on bonds. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) is currently yielding a meager 2.3%.
For a general overview, Scott Grannis at Calafia Beach Pundit summarizes the grocery store flyer of investment options below:
While these yield relationships can and will certainly change under various economic scenarios, there are no concrete signs of an impending recession. The recent employment data of 292,000 new jobs added during December (above the 200,000 estimate) is verification that the economy is not falling off a cliff into recession (see chart below). As I’ve written in the past, the positively-sloped yield curve also bolsters the case for an expansionary economy.
Source: Calafia Beach Pundit
While it’s true the Chinese economy is slowing, its rate is still growing at multiples of the U.S. economy. As a communist country liberalizes currency and stock market capital controls (i.e., adds/removes circuit breakers), and also attempts to migrate the economy from export-driven growth to consumer-driven expansion, periodic bumps and bruises should surprise nobody. With that said, China’s economy is slowly moving in the right direction and the government will continue to implement policies and programs to stimulate growth (see China Leaders Flag More Stimulus).
As we have recently experienced another China-driven correction in the stock market, and the U.S. economic expansion matures, equity investors must realize volatility is the price of admission for earning higher long-term returns. However, rather than panicking from fear-driven headlines, it’s times like these that should remind you to sharpen your shopping list pencil. You want to prudently allocate your investment dollars when deciding whether now’s the time to buy chicken (6% yield) or beef (2% yield).
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including AGG, but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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