Posts tagged ‘Tax Increases’
2014: Here Comes the Dumb Money!
Before this year’s gigantic rally, I wrote about the unexpected risk of a Double Rip. At that time, all the talk and concern was over the likelihood of a “Double Dip” recession due to the sequestration, tax increases, Obamacare, and an endless list of other politically charged worries.
Perma-bear Nouriel Roubini has already incorrectly forecasted a double-dip in 2009, 2010, 2011, and 2012, and bond maven Bill Gross at PIMCO has fallen flat on his face with his “2013 Fearless Forecasts”: 1) Stocks & bonds return less than 5%. 2) Unemployment stays at 7.5% or higher 3) Gold goes up.
Well at least Bill was correct on 1 of his 4 predictions that bonds would suck wind, although achieving a 25% success rate would have earned him an “F” at Duke. The bears’ worst nightmares have come to reality in 2013 with the S&P up +25% and the NASDAQ climbing +33%, but there still are 11 trading days left in the year and a Hail Mary taper-driven collapse is in bears’ dreams.
Source: Scott Grannis
For bulls, the year has brought a double dosage of GDP and job expansion, topped with a cherry of multiple expansion on corporate profit growth. As we head into 2014, at historically reasonable price-earnings valuations (P/E of ~16x – see chart above), the new risk is no longer about Double-Dip/Rip, but rather the arrival of the “dumb money.” You know, the trillions of fear capital (see chart below) parked in low-yielding, inflation-losing accounts such as savings accounts, CDs, and Treasuries that has missed out on the more than doubling and tripling of the S&P and NASDAQ, respectively (from the 2009 lows).
Source: Scott Grannis
The fear money was emboldened in 2009-2012 because fixed income performed admirably under the umbrella of declining interest rates, albeit less robustly than stocks. The panic trade wasn’t rewarded in 2013, and the dumb money trade may prove challenging for the bears in 2014 as well.
Despite the call for the “great rotation” out of bonds into stocks earlier this year, the reality is it never happened. I will however concede, a “great toe-dip” did occur, as investor panic turned to merely investor skepticism. If you consider the domestic fund flows data from ICI (see chart below), the modest +$28 billion inflow this year is a drop in the bucket vis-à-vis the hemorrhaging of -$613 billion out of equities from 2007-2012.
Will I be talking about the multi-year great rotation finally coming to an end in 2018? Perhaps, but despite an impressive stock rally over the previous five years in the face of a wall of worry, I wonder what a half trillion dollar rotation out of bonds into stocks would mean for the major indexes? While a period of multi-year stock buying would likely be good for retirement portfolios, people always find it much easier to imagine potentially scary downside scenarios.
It’s true that once the taper begins, the economy gains more steam, and interest rates begin rising to a more sustainable level, the pace of this stock market recovery is likely to lose steam. The multiple expansion we’ve enjoyed over the last few years will eventually peak, and future market returns will be more reliant on the lifeblood of stock-price appreciation…earnings growth (a metric near and dear to my heart).
The smart money has enjoyed another year of strong returns, but the party may not quite be over in 2014 (see Missing the Pre-Party). Taper is the talk of the day, but investors might pull out the hats and horns this New Year, especially if the dumb money comes to join the fun.
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 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.
Surviving a Series of Unfortunate Events
My children grew up reading a Series of Unfortunate Events by Lemony Snicket’s (the pseudonym for Daniel Handler). The award winning 13 book series began at the turn of the century (1999) with the Bad Beginning and seven years later, Handler ended the stories with The End (2006). The books chronicle the stories of three orphaned children (Violet, Klaus, and Sunny Baudelaire) who experience increasingly terrible events after the alleged death of their parents and burning of their house by a man named Count Olaf.
Crime, violence and hardships not only occur in novels, but also in real life. Stock market investors are no strangers to unfortunate events either. Within the last five years alone, investors have endured an endless stream of bad news, including the following:
- Flash Crash
- Debt Ceiling Debate
- U.S. Debt Downgrade
- European Recession
- Arab Spring
- Potential Greek Exit from EU
- Uncertain U.S. Presidential Elections
- Sequestration
- Cyprus Financial Crisis
- Tax Increases
- Fed Talks of Stimulus Tapering
- Syrian Civil War / Military Threat
- Gov. Shutdown
- Obamacare Rollout Glitches
- Iranian Nuclear Threat
This is only a partial list, but wow, this never ending crises list sounds pretty ominous, right? I wonder how stocks have fared amidst this horrendous avalanche of negative headlines? The short answer is stocks are up a whopping +170% since the March 2009 lows as measured by the S&P 500 index, and would be significantly higher once accounting for reinvested dividends. A bit higher return than your CD, money market, or savings account rate.
As you can see from the chart above, the gargantuan returns achieved over this period have not occurred without some volatility. Investors have consumed massive quantities of Tums during the five highlighted corrections (averaging -13%) to counteract all the heartburn. As I’ve written in the past, with higher risk comes higher rewards. Those investors who cannot stomach the volatility shouldn’t go cold turkey on stocks though, but rather diversify their holdings and reduce the portfolio equity allocation to a more palatable level.
Doubting Thomases
Many people I bump into remain “Doubting Thomases” as it relates to the stock market recovery and they expect an imminent crash. Certainly, the rocket-like trajectory of the last year (and five years) is not sustainable, and historically stocks correct significantly twice a decade – equal to the number of recessions occurring each decade. There is no denying that this economic recovery has been the slowest since World War II, but could this be good news? From the half-full glass lens, a slower recovery may actually equate to a longer recovery.
Just like skeptical investors, business executives have been slow to hire and slow to accelerate spending as well. Typically business cycles come to an end when overinvestment happens – recall the 2000 tech bubble and 2007 housing bubble. There may be pockets of investment bubbles (e.g., Twitter Inc [TWTR] and other money-losing speculative stocks), but as you can see from the chart below, corporate profits have skyrocketed and are at record highs. It should therefore come as no surprise that record profits have coincided with record stock prices (see also It’s the Earnings Stupid)
Over the period of 2003-2013 stock prices largely followed the slope of earnings, and excluding the enormous losses in the banking sector, non-financial stocks suffered much less.
History is on Your Side
If you are in the camp that says this last five years has been an anomaly, history may beg to differ. Over the last 50 years we have experienced wars, assassinations, currency crises, banking crises, terrorist attacks, recessions, SARs, mad cow disease, military engagements, tax hikes, Fed rate hikes, and yes, even political gridlock. As the chart below shows, the stock market is volatile over the short-run, but quite resilient and lucrative over the long-run (+6,863% over 49 years). In fact, from January 1960 to October 2013 the S&P 500 index has catapulted +14,658%, including reinvested dividends (Source: DQYDJ.net).
Rather than getting caught up in the political or CNBC headline du jour, investors will be better served by creating a customized, long-term diversified portfolio that can meet long-standing goals and objectives. If you don’t have the discipline, interest, or time to properly create a personalized investment plan, then find an independent investment advisor like Sidoxia Capital Management (www.Sidoxia.com), so you can experience a series of fortunate (not unfortunate) events.
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 SCM 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. Chart construction done by Kevin D. Weaver.
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