Here is our monthly view of the financial markets and some of the thoughts that go into our investment decisions.
The Market: September 2022
The big news this week was not that the Federal Reserve raised the Fed Funds Rate by 0.75%. That was widely expected. What did surprise the market was the Fed’s forecast for how much they believe they need to raise rates to bring inflation down to their 2% target. Adding to the market angst was Chairman Powell’s resolute stance that there will be pain and higher unemployment to vanquish inflation. “Pain” is not a word the markets wanted to hear. Stocks and bonds sold off and interest rates rose sharply on the shorter end of the curve and more moderately on the long end. Not only do the markets need to deal with the Fed but the 3rd quarter is about to close and we will see how inflation, interest rates, and negative sentiment will affect corporate revenues and profits. Companies did reasonably well in the 2nd quarter. According to FactSet, 76% of companies in the S&P500 posted earnings that exceeded estimates. With oil prices high, it is no surprise that energy stocks led with year-over-year profit growth of a remarkable 293%. Can companies manage to pull off decent earnings in the 3rd quarter? There are a lot of headwinds. In addition to the ones mentioned already, the US dollar has been strong against major currencies. About 30% of S&P500 companies’ revenues are earned abroad. When the US dollar is strong, these non-US revenues are translated back into fewer dollars. Analysts have lowered 3rd quarter earnings estimates by about 5.5% since June 30th. About 20% of the 500 companies have issued 3rd quarter guidance. Of the 105, 65 have guided lower and 40 issued higher guidance than the 2nd quarter. Many market observers think that estimates are too high. We’ll have to see. The risk seems to be the downside. The forward price-to-earnings ratio for the S&P500 is just over 16 times. This is below the 5-year average of 18.6. Stocks are down 21% this year. Needless to say, there is uncertainty and a lot for investors to deal with. However, the market is a discounting mechanism. At 16 times earnings, has the market priced in the potential bad news? If it has and profits are better than expected or even stable, the market
The Market: July/August 2022
In the past week or so the markets, I suggest, have begun to question the prevailing conventional wisdom that inflation will remain persistently high and that the economy is likely to fall into a deep recession. Commodity prices have fallen sharply. Inventories, in some instances, especially in retail seem to be building as supply chains work through their bottlenecks and demand has softened. In the most recent payroll report, the labor market seems to be holding up with some reduction in the pace of wage increases. By looking at the markets, the expectation could be that inflation is moderating and the economy is slowing but perhaps not as dramatically as previously thought. Long-term interest rates have declined which may be evidence of lower inflation expectations and that the economy is slowing. Long-term rates are also not collapsing which may mean that the slowdown could be milder than thought. Rates at the short end of the curve have gone up but seem to not be as high as one would have expected if the markets believed that the Fed has to relentlessly raise rates to fight inflation. The market’s mood can change quickly so it may be too early to know for sure where inflation and the economy are going. Investors need to remember that stocks do not necessarily neatly follow the direction of the economy. Typically, the stock market will lead the economy lower and bottom ahead of the economy. While the economy certainly is a major factor in company profitability, there are other factors at play. We are not certain how inflation will impact the “bottom line”. Are companies able to pass on higher costs? We will find out more over the next few weeks as firms report their second-quarter earnings. Street analysts seem to have just begun to lower estimates. They may be late in this but shares have been significantly marked down based on macro forces. There may be a greater degree of company-specific profit pictures. In any case, volatility around earrings is likely to be high and requires a bottom-up approach to evaluating whether profits are stable.
The Market: June 2022
The earnings scorecard for the first quarter of 2022 is complete and the profit picture looked pretty good. According to FactSet, 77% of companies in the S&P500 reported earnings per share (EPS) that exceeded Wall Street estimates. S&P500 earnings rose 9.2% year-over-year. This increase was much better than what analysts thought at the beginning of March when expectations called for 4.6% earnings growth. Stock prices are a function of earnings times a “multiple”. While earnings increased, the S&P500 index nevertheless is down about 12.5% from the end of 2021. This is the result of a collapse in the price-to-earnings ratio (P/E), the multiple. The forward 12-month P/E of the S&P500 on January 1st, per FactSet, was approximately 21. It is now 17. The P/E ratio is a reflection of how investors value a company or index. The value is an estimate of the future stream of income and some end value for a company, either the result of a takeover or liquidation. For example, S&P500 estimated earnings for next year is about $245. Multiply this by 17 and you get the current price of the S&P500 index. The same calculation applies to individual stocks. The P/E is what investors are willing to pay above the expected level of profits. The P/E is influenced by interest rates and sentiment. In 2022 we have seen interest rates rise which, other things being equal, depresses the P/E. We have also seen a sharp decline in investor sentiment as worries about recession (a decline in profits) and geopolitics took center stage. Investors are cautious and not willing to pay much for future profits. Historically, we are below the 5-year average forward S&P500 P/E of 18.6. We are just about at the 10-year average of 16.9. It is impossible to know precisely what the “correct” P/E should be. Does a P/E of 17 discount, sufficiently, the future level of recession, inflation, and interest rates? If the factors that depressed P/Es – interest rates, sentiment – do not stabilize or reverse, it will be up to company profits to move the stock market higher or at least keep prices stable.
The Market: May 2022
Stock and bond prices have continued to stay in their bear markets. Rising rates, inflation, concerns that the Fed will push the economy into recession and the war in Ukraine continue to drag on prices and sentiment. The Federal Reserve last week raised the short-term funds’ rate 50 bps. Initially, the Dow Jones Industrials rallied almost 1,000 points, thinking that the Fed will not to throw the economy into recession. The following day, however, stocks sank more than they popped as the concern returned to the Fed’s move not being tough enough on inflation. That’s a bear market. No news is good news. Rallies don’t last. Volatility is higher than normal. It seems it will take a while for all the investors’ concerns to be priced into the market. There does not seem to be a resolution to the Ukraine situation anywhere on the horizon. COVID has shut down China so supply chains continue to be stressed. Consumers seem to have money and want to spend it. There seems to be no way out but for the Fed to dramatically slow the economy and perhaps cause a recession. We can’t even begin to think the “coast is clear” until the market can trade above its 200-day moving average, a widely regarded technical measure for a market with positive momentum. The S&P500 currently sits at 4,123. The 200-day moving average comes in around 4,447. We can’t even talk about a bull market until we make a new high which would be approx. 4,800. Having said this, when there seems to be no way out and sentiment is so negative, we may be well along to finding a bottom. On the earnings front, there is still good news. According to FactSet, with almost 90% of the S&P500 reporting, about 80% of companies reported profits that exceeded expectations. Profits are an important factor in stock prices and can perhaps lessen the negative aforementioned issues. Stock prices have fallen steadily and now the forward price/earnings ratio for the S&P500 is 17.6. This is the first time this valuation indicator is below 18 since April 2020. Again this indicates markets are
steadily discounting bad news and trying to find a bottom.
The Market: April 2022
Inflation and rising interest rates are still dominating the investment landscape. With the Ukraine conflict having no end in sight, sanctions are keeping commodity prices high. COVID is not gone and is still fueling inflationary pressure by disrupting local labor markets in the US and Europe and currently has shut down China. To control inflation, the Fed has embarked on a path to increase short-term interest rates and reverse the Quantitative Easing that has been policy since the Great Recession of 2008. Can the Fed thread the needle to moderate inflation but not throw the economy into recession? This is a real concern and is reflected in the interest rate yield curve. Rates have risen on the short-end of the curve faster than rates further out on the curve. This flattening means investors expect that, in the future, a recession could be in the cards. Bonds’ values have declined. The Vanguard Total Bond ETF (BND) is down about 6% this year. The Vanguard Long-Term Bond Fund ETF (BLV) is down almost 17%. That’s a dramatic decline. It is more than twice the decline in stocks as measured by the S&P500. Stocks have been stuck with the market seemingly having no memory from day to day. One day they are up on some news and down the next on a different piece of news or concern. Earnings season has just begun. Investors will find out the impact higher input prices will have on company profits. Ironically inflation helps improve nominal revenues. The question is whether this will offset higher costs. Investors have been steadily selling home builders and home improvement companies like Home Depot. The conventional
wisdom is that higher mortgage rates will hurt housing and related businesses. The sentiment is negative across the markets. The old adage on Wall Street is that stocks will turn up before the actual news flow
improves. It’s hard to know when stocks will bottom. How much do stocks need to fall to discount the impact of inflation, higher rates , and maybe a recession? The market is not monolithic. Some stocks
or industry groups will discount the news faster than others. The next few weeks of corporate profit reports will hold a lot of clues.
The Market: March 2022
The world is focusing on Ukraine. We acknowledge the human suffering as we monitor markets around the world. It is difficult to predict how this will play out. What is important for investors is that it WILL play out. At some point, there will be a resolution. For investors with patience, a long-term focus, and a portfolio that is durable, their holdings will recoup paper losses. For those with available cash, there will be even opportunities. What makes the conflict more unsettling is that it is here at a time when inflation is already rising and the Fed is at an inflection from massive accommodation to “normalization”. As Russia and Ukraine are commodity exporters, supply disruptions and sanctions are accelerating rising prices and making the Fed’s transition even more precarious. The Fed was relying on an expanding post-COVID economy to offset the impact of its plan to reduce its balance sheet and raise rates. However, higher commodity prices may drag on economic growth. The Fed wants to stop inflation but it doesn’t want to throw the economy into a recession. On the subject of the economy, it is important to remember that stock prices do not necessarily neatly follow the economy. Rates can rise and so can stocks. The economy can slow and stocks can rise. The reason for this is that economic data are snapshots of the past while stock prices look to the future. Points of maximum uncertainty often mark bottoms. We may be in that process now with respect to the Ukraine situation. Once we start worrying about a nuclear exchange between the US/NATO and Russia, we may be near the peak of uncertainty. Not that a resolution to the conflict will solve all problems, but any decrease in tensions will likely send stocks shooting higher until other concerns like inflation and the Fed will come back into focus. This is why it is so difficult to be 100% out of the market. The first few days of a stock rebound are typically the most ferocious up move of the cycle. Investors need to be careful. Only nibble. Be defensive. Have the ability to ride it out. No one knows when or how Ukraine will resolve itself. History suggests it will and stocks will recover.
The Market: February 2022
This week the markets got another hot inflation report. This sent interest rates shooting higher. The 10-year US Treasury yield broke above 2% for the first time since the summer of 2019. The persistent inflation raised the probability that the Federal Reserve will need to raise the Fed Funds rate by at least 25 bps at the March 16th meeting. The expectation is that the Fed will need to continue to raise rates throughout 2022 to combat higher prices. Raising rates is a tricky business. Raise them too little and inflation can stay stubbornly high. Raise them too much and the Fed could throw the economy into recession. The market is a discounting mechanism. Prices move in anticipation of a range of possible future outcomes. The S&P500 index, in response to inflation, rising rates, and the possibility of a recession, has fallen about 8% from its January high. The Nasdaq is down 14% from its November 2021 high. Investors clearly are making adjustments. High-flying stocks trading at ultra-high multiples of earnings have been taken down far more dramatically. Some are down 50%, 60%, or more. Those stocks probably should never have traded at those heights but with rates near zero and speculation abounding, prices were bid way up for companies with exciting plans but with no profits for years. In today’s environment, the appetite for such stocks is not there and prices have tumbled. On balance, it is probably a good thing that speculative excess is being wrung out of the market. Investors again are turning their attention to fundamentals and some sense of value. This week, geopolitics threw a wrinkle in the story. Fears of a Russian invasion of Ukraine sent investors selling risk assets and buying safe havens like US Treasuries. In fact, when reports circulated of a possible invasion over the weekend the 10-year rate reversed course and dropped back below 2%, to 1.91%. It’s hard to handicap whether Russia will move on Ukraine. If an invasion happens, in the short run, stocks will be under pressure. Treasuries will likely rally. Oil, natural gas, and other commodities will rally. Russia is a key producer of aluminum, nickel, oil, and natural gas. Ultimately, the impact will be muted. Not to ignore any loss of life but Ukraine is a small country. Its GDP is about $165 billion. As a comparison, Apple’s annual net income is about $100 billion.
The Market: January 2022
Welcome back. Happy New Year. Unfortunately, COVID is still with us as we start 2022. We all have been dealing with this pandemic for two years. A new year brings new possibilities and we hope we will not be writing about COVID in 2023. Like us humans, the markets and the economy have been dealing with COVID too. As vaccination and therapies were developed we all began to stir, resuming consumption and increasing demand for goods and services. While aggregate demand returned, the effects of COVID on the workforce did not allow for a commensurate supply response. The result is price inflation for goods and services. While we all seem shocked at the higher grocery and fuel bills, inflation did not appear overnight. Asset prices have been rising steadily and significantly for some time. Housing, stocks, cryptocurrency, art, and wine have been booming. While COVID kept us from spending on stuff, money flowed into all sorts of assets. Once we could start spending again, prices for our everyday items took off. This is ushering in a different dynamic. After the financial crisis, there were strong deflationary pressures that caused Central Banks to take “extraordinary” measures to try to raise prices and promote growth. Now, inflationary pressures are in the system and Central Banks are signaling a reverse in policy and a desire to move towards “normalization”. This means higher interest rates. An inflection in policy will likely create turbulence in the markets. Three important factors that determine stock prices are interest rates, company profits, and investor sentiment. The Fed has signaled that interest rates will go higher. All things being equal, this should depress equity prices. If we see COVID moving to a more manageable illness, company earnings should grow as consumers spend. In 2021, the government passed an infrastructure bill that should also support demand. A strong earnings environment can offset the downward pressure higher rates place on the stock market. If investors believe that “normalization” is good, that too could help support stocks. After all, if the Fed is not going to “normalize” now, then when?
The Market: November/December 2021
With over 90% of companies in the S&P500 reporting their 3rd quarter earnings, US corporate profits seem strong. According to FactSet, about 80% reported better than expected earnings per share, and about 75% posted revenues that beat estimates. For the S&P500 as a whole, earnings grew 39% as compared to the 3rd quarter of 2020. While this is the 3rd largest earnings growth rate since 2010, the number appears large as a result of a recovery from a COVID impaired 2020. The stock market has responded to the earnings bounce off of depressed 2020 levels. The S&P500 is up just over 26%. Even with the strong earnings surge, the S&P500 trades at a lofty forward 12-month P/E of 21. The 5-year average forward price-to-earnings ratio for the index is 18.4. When valuations are well-above average, investors need to be careful. There is much less of a margin of safety and disappointments can lead to significant price declines. Of course, earnings reports are backward-looking. The stock market looks ahead. The sectors where FactSet is reporting the greatest increases in earnings estimates since September 30 are financial stocks followed by healthcare. Overall, analysts expect year-over-year profit growth to moderate from the 39% rate in the 3rd quarter to about 21% in the 4th quarter. This is still solid growth. Not surprisingly the year-over-year growth comparisons are expected to continue to slow as the 2021 economy was better than in 2020. At present, analysts are calling for profit growth estimates in 1Q22 of 6%. Interesting to note, analysts see revenue growth for S&P500 companies slowing at a much lesser rate than profits. The reason is inflation cost pressures. Of the companies reporting 3rd quarter figures, 285 mentioned “inflation”. As we head into 2022, the big question for investors will be how can the market sustain a 20+ P/E in the face of slowing growth comparisons and inflation pressures which dampen profit margins and may cause the Fed to raise interest rates? I suggest that there are two ways the market can continue to support the current valuation. One would be that growth moderates less than estimated. This could happen if COVID subsides and/or becomes more manageable through greater vaccination and the development of therapeutics. An increase in productivity would help the profit picture, as well. This could happen as corporations reap the benefits of “work anywhere” technology. The other way to maintain the market’s P/E would be for inflation to moderate which would help margins and keep the Fed from raising rates too much. For this to happen, supply bottlenecks would need to be resolved, and some increase in the supply of key commodities like oil. It’s not impossible to see valuations maintained in 2022 but it is unlikely to be an easy accomplishment. Investors need careful stock selection to find companies that can maintain profit margins and growth.
The Market: October 2021
There is an important disconnect between the “advice”, “predictions” and “risks” people hear from market commentators and actual tactical moves an investor should make. Most market voices have no accountability, publish no track record, and are not responsible to clients with real-life portfolios to manage. There was a very popular observation made in August that September tends to be a poor month for stocks. While I heard this mentioned often, I did not hear actual recommendations on what to do. Let’s look at the month of September. According to Birinyi Associates, since 1945, on average, the S&P500 has declined 0.56% and yes, September is the worst month. So what does an investor do with this information? Does it pay to sell all of one’s holdings to avoid a possible -0.56%? Selling doesn’t seem to make sense, especially when considering taxes and transaction costs. Now, -0.56% is an average. Looking back 10 years, the S&P500 was down in 5 years and up in 5 years. The most the index was down in a year over the past 10 was 7% and the most it was up was 3%. Again, it is hard to make the case to bail out. Pundits also make it seem that investors should be all in or all out. They come with dire predictions and no probabilities associated with the possible outcomes. At any given time there could be a 50% decline in the markets but what is the probability of that happening? In the markets, there is a lot of noise. Investors need to focus on what is important and actionable and ignore what seems to be shaky correlations or axioms. Investors should follow their financial plans, make sure they have a robust decision-making process and rebalance accordingly. Now that September is behind us, it’s earning season and investors will get a look at actual consumer demand and the impact of higher input costs. It will be important to note which companies are able to pass on cost increases. This can provide insight to companies that have durable business models. Analysts have been increasing earnings estimates heading into the end of the 3rd quarter. This makes it more difficult for firms to beat their estimates. Disappointments are sure to happen. There are always some corporations that fail to make or beat estimates. Much will be made of these companies in the financial media but be careful not to draw conclusions about the broader market. This earnings season will likely be very company-specific.
The Market: September 2021
The Employment Report issued on Friday, September 3rd did little to clarify the direction of the economy or the Federal Reserve The number of jobs created in August was lackluster. While non-farm payrolls increased by 230,000 jobs, this was below expectations and well below the 586,000 monthly average job growth in 2021. The Bureau of Labor Statistics increased its July reading by 110,000 jobs, putting the revised July job increase at over 1 million. No doubt this was a weak report but the number of Americans working still increased. Hourly wages rose for the 5th straight month. It appears that the recovery is still happening but there is some sluggishness on the employment front. There was a thought that as the extended employment benefits ended, workers would seek work. The link of employment to extended relief benefits was never established and it appears there are other factors influencing employment. Of course, the Delta variant may be a significant reason the jobs report missed the mark. Companies closed or reduced activity as infections hit their operations. Workers may be afraid to go back to work. Parents may be reluctant to take positions without knowing for sure that schools will be open. Perhaps the reluctance of some workers to go back to work has given other workers some bargaining power, hence the steady rise in hourly wages. Where does leave the Federal Reserve? They have been signaling that they will be reducing (tapering) the number of bonds they purchase each month. This report probably does not change their objective. The recovery still seems intact and wages are rising. The case for the Fed supporting the economy seems less warranted than when the economy was in the throws of the pandemic. The Fed has been purchasing securities (quantitative easing) since the 2008 Financial Crisis. Now that there is a strong bounce post-pandemic and a new appetite in Washington for fiscal support in the form of infrastructure and social spending, there is probably no better time to taper. One might ask, “If not now, then when?” However, the stock market did not sell off and interest rates moved up only slightly after the employment report. Is there a thought that the employment picture is not so robust? Is the market concerned that the Delta variant will put a deeper drag on the economy? Will the taper be postponed or scaled back? Still lots of questions. Caution should be front and center for investors.
The Market: July/August 2021
The market seems to have no memory from one day to the next. On Thursday, July 8 stocks dropped on fears of the Delta COVID variant only to rally on Friday. The stock market has a lot to digest – COVID variants, political deadlock in Washington, higher commodity prices, Fed tightening, and second-quarter earnings about to be released. Markets always have a lot to worry about. However, it is one thing when stocks are trading at low multiples and another when the market is trading where it is now at 26 times earnings. At lofty multiples there is not a lot of cushion and prices are vulnerable to sharp sell-offs. No one wants to be stuck “holding the bag.” Some of this quick-to-sell attitude is justified but some of it I would suggest is the result of the residual effects of the 2008 financial crisis, amplified by cable TV. A large down day is described as if it is undeniably the start of a deep bear market. Despite all the recent worry, stocks are making new all-time highs. With new highs, it’s hard to see an end for this bull market. Market action is often a strong tell. The news was flooded with reports of run-away inflation and the inevitability of Fed action to raise rates. The bond market ignored all of that. Rates actually FELL, with the 10-year Treasury going to 1.25% and the 30-year T-bond below 2%. Does “Mr. Market” know best and inflation is really not a problem? We’ll see. Similarly, with stocks hitting new highs, is Mr. Market telling us that 2nd quarter earnings will be good and that the economy is in the midst of a strong recovery? According to FactSet, Q2 S&P500 earnings are estimated to grow 64% from a year ago (the large comparison is due to last year’s COVID shutdowns). This is the largest growth estimate in more than a decade. Expectations have been increasing. So far, 37 companies in the index have issued negative guidance while 66 have increased guidance, the highest number since FactSet began tracking in 2006. If you are watching oil and gasoline prices, it is not surprising that the energy sector has seen the largest increase in earnings estimates. The biggest market cap stocks, Apple and Microsoft have both had positive earnings revisions. If the two beat estimates it will certainly help to keep the bull market going.
The Market: June 2021
Inflation talk has been featured in the business news as well as in this newsletter for a few months now. This month, the Consumer Price Index, both total and core, came in higher than expected. Inflation was the highest since 2008 when the global economy began to bottom in the last crisis. The CPI rose 0.6% in May following a 0.8% rise in April. If one annualizes the May number, inflation was up 7.2%. With such a number, one might have thought that interest rates would have gone up – investors demanding higher rates to keep up with higher prices. However, the yield on the 10-year Treasury note went down. After the inflation report, the 10-year rate fell to 1.43%, the lowest level since early March. For context, the recent high was 1.745%. There are a couple of explanations for the break from conventional wisdom. First, the markets may believe that the increase in prices is temporary. As companies re-hire the supply of goods will increase. Similarly as more supply comes on line, any panic buying will subside. It has been said that the cure for higher prices is higher prices. As items get more expensive, quantity demanded will fall, easing inflation. The second possibility is that the Federal Reserve is actively buying bonds to keep rates low. Looking at the Fed balance sheet, there is consistent buying, about $22 billion in the week ended June 9 and another $54 billion for this past week. The stock market, like bonds, had a benign reaction to the inflation news. However, this week the Fed met. Chair Powell, said, “You can think of this meeting as the talking-about-talking about tapering meeting.” Stocks did not like that. Overall the stock market fell but if you look closely, not much was consistent. Bonds rallied pushing Treasury interest rates lower. Mortgage rates however went up. Industrial, financial, and energy stocks were weak. FAANGs and growth stocks did relatively well. Seems like the safety trade these days is to buy Treasuries and FAANGs. For all the talk of inflation, commodity-related stocks like miners dropped. While the Fed indicated that maybe two rate hikes might happen in late 2022 or into 2023, investors nevertheless used it as an excuse to sell sectors that have had substantial recent run-ups. Financials, miners, and materials stocks have been very strong as re-opening trades. The Fed cooled them off. The Fed is also trying to use its megaphone to move mortgage rates up a bit to try to alleviate some froth in the housing market. All in all, it looks like we may be in store for a choppy month or so as investors re-balance over-extended stocks.
The Market: May 2021
Markets saw increased volatility following first a disappointing jobs report and then a higher than expected level of inflation in the CPI release. During the week of May 10-14, the S&P500 at first fell 4% only to rally back 3%, from the week’s low. It was a fast roller-coaster but it left the week little changed. In the fixed income markets, the yield on the 10-year US Treasury Note also moved. First rates rose from a low of 1.616% to 1.695% before falling back to 1.637% at week’s end. In both markets, investors seemingly shrugged off the negatives and instead focused on the continuing economic recovery and belief that the recent rise in inflation will prove to be, as the Federal Reserve contends, “transitory”. Even without significant news, investors have seen “air pockets” where stocks experience a sharp drop and a subsequent fast rebound. In my opinion, this phenomenon is the result of a combination of algorithmic trading models that focus on momentum and a market structure (no uptick rule and no specialists required to commit to an orderly market) where liquidity can evaporate quickly. In addition, both the stock and bond markets are not cheap and expensive markets are vulnerable to “sell first, ask questions later” reactions. According to FactSet, with 88% of the S&P500 reporting, the market is selling at 21.6 times next year’s earnings estimates. That is well above the 5-year average of 17.9 times. The market is imputing not only a strong rebound to pre-COVID profits but also higher growth propelled by proposed infrastructure and other spending legislation. There is a lot that can make the path for both equities and fixed income bumpy. The markets are a discounting mechanism and now, Mr. Market is saying there is a higher probability that things break to the positive than to the negative. Expectations change quickly. From a technical point of view, investors will be paying attention to the 4,232.60 May 7 high for the S&P500. If the market can get above that, the upward path is still intact. If stocks fail or struggle at this level, it may mean the downward volatility is not over.
The Market: April 2021
The stock market has continued its march higher. New record closes were reached for the Dow Jones Industrials and the S&P500. The NASDAQ is very close to an all-time high. Many European exchanges and the TOPIX Japanese index hit fresh highs as well. Retail sales this week saw the biggest increase since the US began tracking the statistic. Corporate profits should be very good and look even better when compared to the pandemic-cratered second quarter of 2020. The market advance has been broad. Last week there were 721 “new highs” on the New York Stock Exchange and only 60 “new lows”. According to Barrons, last month’s weekly average cash inflow to equity mutual funds was $20 billion. The average weekly inflow to taxable fixed-income funds was $13.3B and money markets received $18.8B. These are solid figures indicating that there is a willingness for investors to put money to work. It’s hard to argue that we are not in a bull market. Of course, there are reasons for caution. There always are. The market has moved up significantly and is anticipating a strong recovery. The S&P500 now trades at a forward price-to-earnings ratio of 22.4. That is well above the 10-year average of about 16 times earnings and the 5-year average of about 18 times. Optimism is certainly here. According to Fact Set, the market is anticipating year-over-year earnings growth in the 1st quarter to be 24.5%. If this increase in corporate profits comes true it will be the highest since the recovery following the Great Recession of 2008-2009. Consumer discretionary and Financials are the two sectors expected to see the largest year-over-year increase in profits. If the actual earnings beat expectations, stock prices can rise. With high multiples, if companies disappoint, there will likely be downward price action. Investors can be selective and look for stocks that should have solid year-over-year comparisons that trade below the market multiple. The high flyers bring up the average multiple. Look for value. Look for growth at the right price. It is tricky to reach after the increase in stock prices we have seen
over the past year.
The Market: March 2021
With vaccinations under way and a new stimulus/relief package in the works, investors have begun to worry about inflation. The concern has manifested itself in a recent rise in longer-dated bond yields. There is some math involved but the simple short of it is that higher rates reduce the value of assets. We learn in Finance 101 that the value of any asset is the present value of all future cash flows. The flows that are the furthest out in time are the most sensitive to rising rates. As a result, the high flyer disrupter stocks that will not be profitable for years took a big hit this past week. The hot ARK Innovation ETF which invests in “disruptors” like Tesla and Roku, lost 10% of its value last week. The FAANGs were also under pressure this week as well. While the FAANGs have current profits, much of their perceived prospects lie in the future. With disruptors, new issues like SPACs, and mega-cap NASDAQ stocks rallying so hard in 2020 and into 2021, their valuations were in the stratosphere. At the same time that the darling tech stocks were falling, the old economy sectors like financials, energy, and industrials moved higher. Investors sold the high valuation stocks and bought the low valuation pockets of the market. Whether the re-allocation will continue will depend on how persistent inflation expectations will remain in the minds of investors. While input prices for commodities are rising, hours worked and wages have remained flattish. Even though a return of inflation is being talked about as a forgone conclusion, I am skeptical. The rapid decline in demand resulting from the pandemic caused supply chains to contract significantly. Farmers, miners, manufacturers, and service providers all cut back expecting a prolonged slump. However, the vaccine, along with prospects for expanded fiscal stimulus, brought demand back and new orders created a supply-demand imbalance. Prices for all sorts of commodities, including semiconductors, agricultural products, and crude oil, moved higher. John Dizard in the Financial Times described the situation as akin to “The Beer Distribution Game” developed at MIT in the 1950s to simulate the dynamics of a production-distribution system. Over-reaction by participants can, under certain circumstances, create big swings in supply and demand. In time, production is restored and supply comes up to meet demand. If this dynamic plays out, inflation pressures will ease. We will need more data points before we can really say inflation is back.
The Market: February 2021
The cartoon this month honors the lonely life of a contrarian investor. There are many flavors of investors. Some follow momentum. Some are broad asset allocators. Some are short-term traders. There are a lot of ways to make money in the market. There is no one answer. Even further, different strategies can be effective at different times. Contrarians take positions that go against the prevailing conventional wisdom and need to be patient while all the current news flow and market prices are telling them that they are wrong. The negatives are what interests contrarians. The foundational principle that can make money for contrarians is that the news is so bad and prices are so low that they are buying assets really cheap and eventually times will change and these assets will appreciate. Buying cheap gives them a “margin of safety” such that even if conditions get worse they will not lose a lot of money. In March 2020, the world looked pretty grim. The stock market and parts of the bond market experienced a sharp deep bear market in just a matter of weeks. Market declines like this are instances when contrarians place their bets. It took nine months and a vaccine to be developed but those bets paid off. During times of market stress, it’s important to keep perspective. The world doesn’t end very often. To continue the phrase, the saying goes, “…and if you bet against it there won’t be anyone to collect from anyway.” For a contrarian philosophy to work, an investor needs to have cash in order to buy when everyone else is selling. Believing in the optionality and benefits of holding cash also makes life tough for contrarians. When the market is moving up, holding cash hurts performance. The old saying, “Everything in moderation” probably applies to investing as well. An investor needs to be in the market to ride the long-run uptrend but also should keep some cash to be in a position to be a contrarian and not be afraid to take a position when the opportunity presents itself. Acting as a contrarian doesn’t only apply to market bottoms. Even more challenging than buying low, is selling when things look the best. Market trends end. Stocks get over-valued. A prudent investor needs to be willing to take money off the table when everyone is bullish and wait until assets get cheap again. Corrections happen relatively frequently and bear markets, while less frequent, seemingly come out of nowhere.
The Market: January 2021
As we say goodbye to 2020, despite all the turmoil and pain, the markets proved to be resilient beyond most people’s imagination. While debate should be had about the effectiveness and fairness of its distribution, there is little doubt that the massive monetary and fiscal government response gave a tremendous lift to financial assets. At first, the rally off the bottom was led by the FAANGs. Then, as vaccines were approved, the rally broadened out to include not only beaten-down travel-related stocks but also economically sensitive shares of industrials, financials, and energy. Now we are in earnings season waiting for the results from the 4th quarter. The setup going into earnings is not great. Stocks across the board have run up, potentially pricing in a lot of future good news. Case in point are the financial stocks which had explosive up moves in November and December. When the big banks reported last week, their stock prices dropped. I’m not saying the rally is over but investors need to be careful when buying stocks after big moves into events like Earnings Season. It would be very reasonable for stocks to have a cooling-off period as The Street assesses how much of the opening-up prospects are already reflected in stock prices. Many stocks are higher than they were before COVID hit. Wall Street seems comfortable with President Biden’s choice of Janet Yellen as Treasury Secretary. She’s a known quantity and is generally viewed as even-keeled. Many think of her as an easy-money economist but I’m not convinced. She did raise rates while she was Chair of the Federal Reserve. With her respected counterpart, Jay Powell at the Fed, it looks like accommodative monetary policy will stay for a prolonged time. This should be a tailwind for stock prices. As the new Congress convenes a lot of back and forth will happen over the size and scope of Biden’s relief package. The initial $1.9 trillion proposal is likely to be reduced. This too could impact the markets. The economy, despite the vaccine optimism, is still a ways away from returning to normal.
The Market: November/December 2020
As we look back on a year to both remember and to forget, some investment observations are worth examining. The first is the futility of forecasting. We are bombarded with market analysts, pundits, and prognosticators. In January, we were not hearing choruses warning of a furiously fast Covid-led bear market happening just 3 months into the year. Then at the bottom in late March, the Bears were in full force, missing a recovery in stock prices. Making money in the stock market requires patience, a long-term perspective, and a sense of knowing and valuing what you are buying. Successful investors avoid panic at bottoms and euphoria at tops. All this is easier said than done. Yesterday, I noticed a chart courtesy of Barry Ritholtz that illustrated the 28 years that had the largest intra-year declines in stock prices and how the market ended in each of those years. The end results to years where markets fell at some point were all over the place. Some years ended with big gains and in some years the market stayed down. At the bottom this year the S&P500 was down about 34%. More often than not (16 of 28years) stocks were down at least 19% at some point but closed the year down less than 10%. In five of the years, the S&P500 ended with double-digit gains. Perhaps the reason for the rebounds is government intervention. In 2020, Congress and the Federal Reserve injected more money into the system than they did during the 2008 Financial Crisis. The bottom line is that sticking with your long-term financial strategy and not reacting to short-term news flow is the best way to stay the course. Re-balancing and re-positioning are also helpful to manage risk, buying somewhat is low and selling somewhat is high. There are other observations to consider. The pandemic has pulled demand forward for many companies which means that some stocks may be over-valued. Having said that, other companies that have benefited from Covid may now be a part of new and lasting trends just beginning long revenue runways. Investors will need to think about this differentiation. The final thought I’d like to leave for the year is that the large valuation gap between those companies seemingly benefitting from Covid and those that were negatively impacted will narrow if we have an effective vaccination program. Similarly, parts of the world, like the US, have outperformed places like Europe and Emerging Markets. If the planet resumes to normal, markets in these areas could catch up.
The Market: October 2020
The stock market has remained resilient, hovering near highs. In some respects the markets have been held in suspending animation waiting for the election, waiting for Congress to pass another relief bill, and waiting for a Coronavirus vaccine. While we have seen some strength in the value and out of favor sectors like financials, energy, and industrials, the mega-cap growth names have been, for the most part, still the leaders. The economic data has been generally good. Of course, there are the haves and, very unfortunately, the have nots but in aggregate both corporate profits and broad economic measures have exceeded expectations. Some data has been showing signs that inflation has ticked up. The breakeven inflation rate reflected in Treasury TIPs is 1.7%, back to where it was before COVID hit. The breakeven rate had fallen to 0.50% in March. Whether or not inflation can sustain upward momentum is a topic of great debate. Supply chain disruptions have caused some increase in food and intermediate goods prices. One big commodity that has not seen upward price pressure is oil. COVID has dampened demand and there has been some increased supply coming from Libya. It’s hard to see sustained inflation without oil participating. Similarly, it’s unlikely that interest rates can move much higher as long as the Federal Reserve is willing to buy along the whole curve. What all this amounts to is that despite the long-awaited small moves in value stocks, inflation, and interest rates we have seen over the past weeks, this does not necessarily mean new trends are underway. It is very much a wait and see and until proved otherwise, conditions in the markets are likely to remain the same. On the topic of the election, despite the various opinions of market commentators, history has shown that it is very difficult to know how stocks will react to election results. The occupant of the White House is only one of many factors that influence stock prices.
The Market: September 2020
After one of the strongest Augusts on record, investors continue to shake their collective heads trying to figure out a market that is doing so well when the COVID economy is in recession. As we discussed in our previous letters, the monetary support that the Federal Reserve and the fiscal stimulus by the Congress and Administration have provided the fuel to keep the markets and consumers liquid. It’s worthy to note that these support and stimulus measures are significantly greater than those employed during the 2008 Financial Crisis. As an aside, if more were done then, it is my opinion that the recovery would have been much stronger. We still have a ways to go until we can determine a verdict on the government’s response but from a market’s perspective, investors are happy. As with everything in life there is more to it than meets the eye. While the S&P500 is back in the black for the year, this performance is skewed to the positive showing of the mega-cap technology and social media names. A majority of stocks are still far from even for the year. The top 10 companies in the S&P500 now make up approximately 30% of the index’s weighting. The implication is that investors may be less diversified than they think and as a result, risk is higher. Overall, with stock prices outpacing earnings, valuations in many parts of the market look stretched. Under these circumstances, the market is vulnerable to the downdrafts that we experienced this past week. Caution is warranted. With valuations high and an economy that, while improving, remains weak and reliant on government support, volatility will likely remain elevated. As the election is moving into the final two months, there will be a lot of talk about how the election will impact the markets. I caution investors that even the selection of a President is but one factor in the many informational inputs for the market. Far more important is to follow your financial plan, including appropriate re-balancing. — Ian Green, BrokerageSelect
The Market: July/August 2020
Twice in the past month, the bears took the S&P500 down to the 200 day moving average but both times failed to break the market lower. The buyers came in and bounced the S&P500 back up to 3130. This is about where stocks are now. The stock market seems to be trading in a range with the 200 day moving average at the lower bound and about 3200 at the top. The lower bound appears for now to be maintained by the expectation of the Federal Reserve doing “whatever it takes” to bridge the economy until a COVID vaccine is developed. The top is, for now, limited by a market that is trading at a high multiple with uncertain corporate profits. Next week, companies will begin to report their earnings for the 2nd quarter. I’m not sure what new information investors will get. We all know that business was down sharply for most industries. Investors are likely to look past the numbers in anticipation of better days. There are two sectors that may prove to be an exception. The first is the high fliers. Companies like the FAANGs. Stock prices for these companies have been strong and expectations high. If there are disappointments, there could be a correction in these names. The second group of stocks to watch is financials. Their reports should provide some insight into the health of “Main Street” and credit quality of loans in the banking system. Bank stocks have been performing poorly. With legitimate reasons, expectations are low. There are long memories of the 2008 financial crisis and there are presently a lot of loans in forbearance due to COVID. How many of these loans that are on pause that will ultimately go bad is a big question for the coming quarters. If there will be surprises it will be in the FAANGs (and the other COVID-era favorites) and in the banks. Will any earnings surprises move the market out of its trading range? A lot will depend on whether additional stimulus is provided by the government. A falling stock market would likely push Congress and the President to further open the coffers, especially in an election year. — Ian Green, BrokerageSelect
The Market: June 2020
The Market: May 2020
The stock market is caught in a tug-of-war between very bad economic data and the tremendous amount of fiscal and monetary stimulus. At his recent press conference Federal Reserve Chairman Powell reiterated his “whatever it takes” position. What that ultimately means is unknown but for now the Fed is buying government and corporate debt to keep interest rates low and maintain functioning debt markets in order to make it easier for companies to obtain financing to keep them going during the pandemic. This may mean that stocks could be stuck in a trading range until there is a vaccine or an effective therapy against COVID-19. The very low interest rates engineered by the Fed is making debt issuance affordable for companies. However, more debt on already heavily indebted companies is not a great situation for stockholders. Less cash flow available for shareholders should translate to lower equity values. This is not a universal case but it does mean investors need to be more careful than ever. Similarly, bond investors are facing more indebted companies with which to invest. Even worse, many troubled companies are issuing new debt that is secured by company assets (it may be the only way to attract buyers), shrinking the pool of assets available for subordinated debt (and equity) from which to make a claim. The term for this is known as”cramming down”. Not every investment case is destined for disaster. With the Fed supporting the corporate debt market, ideally companies can replace near term debt maturities with longer-dated bonds giving the enterprises time for a COVID solution to appear. With the Fed propping up bond prices, it’s hard to discern the health of a business from the company’s bond price. Company debt may well be over-priced vs the true underlying fundamentals and business risk. Investors should always examine each opportunity on its own merits. In the current environment, this rule is even more important. — Ian Green, BrokerageSelect
The Market: April 2020
The Market: March 2020
The Market: February 2020
The Market: November/December 2019
The Market: October 2019
The Market: September 2019
The Market: May 2019
The Market: April 2019
The stock market put up a tremendous quarter that brought prices within a few percentage points of all-time highs. Once the Fed convinced the markets it was not going to blindly hike rates to send the economy to oblivion, the market stabilized from its 4th quarter swoon and launched higher. The other fears that plagued stocks in December are still floating in the collective market consciousness – an inverted yield curve, slowing corporate profits and tariff wars. I’m not convinced that any of these three worries are about to derail the market. While there is a lot of talk about an inverted yield curve, one has not actually emerged. Yes, the very short-end of the yield curve is inverted. However, from 2 years to 30 years it is not. In fact, the curve recently has steepened a bit. When it comes to skepticism about corporate profits, this is not a new concern. In fact, bears have been talking about a weak economy and earnings for the entire bull market and it hasn’t prevented stocks from grinding higher. The ongoing trade war is the one that concerns me the most. Global trade has proven to be a key ingredient in global growth. The stocks that make up the S&P500 derive about 45% of their revenues from sources outside the US. Supply chains are global and barriers to the free flow of goods can cause disruptions that would drag on profits. Despite the downside, I believe there is a higher probability that the US and China reach some acceptable accord than the probability that a trade war erupts between the two. If a benign deal is announced, the markets will have a reason to rally. The bearish argument is aways the easiest to construct. In 2018 the stock market was down and for about a year and a half stock prices were flat. This is not unlike the 2014-2016 time period where stocks went nowhere and was a frustrating time for investors. The flat market proved to be just a pause in the upward market trend. This time could be similar. If the market manages to make a new high, investors who have been on the sidelines will be drawn in, refreshing the bull market and drive another upward leg in stock prices. First quarter earnings will be released over the next several weeks. Expectations have been lowered so it is possible that we may see profits beating expectations. The expectation game is a typical exercise on Wall Street. The market builds in a conventional consensus to what it thinks revenue and profit will be. Often the analysts tend to have relatively low estimates which helps companies “beat” their forecasts. Most of the time stocks react positively to the “beat”. Why do estimates tend to be lower? There are two possibilities. One is what was mentioned before. The bearish case is the easiest psychologically to build. The second possibility is that the industry prefers to set up a positive market surprise. In either case, the next few weeks will be important for investors. — Ian Green, BrokerageSelect
The Market: February 2019
The stock market has sharply moved higher, erasing about 60% of the September 20 to December 24 decline. While investors are breathing a bit easier, the mood on Wall Street is far from euphoric. There is a general feeling that the economy in 2019 will slow and corporate profits will decline. The conventional wisdom says that the impact of tax cuts that boosted 2018 profits will fade as we move into 2019. Wall Street estimates for earnings per share (EPS) growth have declined from a 10% increase to a 6 or 7% increase. Given the formula of EPS multiplied by the price-to-earnings (P/E) ratio equals the stock price, if EPS is going to rise less than previously forecast, unless the P/E ratio increases, stock prices will fall. Declining EPS estimates, however, are not new to this bull market. In fact, it has been more of the rule rather than the exception. From 2011 to 2016, analysts forecasted steady declines, each year, in earnings growth. As a result of the new tax law that lowered the corporate tax rate, in both 2017 and 2018, analysts forecasted accelerating earnings growth rates. Important to note, the earnings growth forecasts from 2011 to 2018 were not predictive indicators of future stock market returns. In 2011 the market was flat. From 2012 through 2014 it was up. Flat in 2015. The market returns for 2016 and 2017 were positive and despite rising growth expectations, returns were negative in 2018. With these figures in mind, we should hold the negative sentiment with some suspicion. What no doubt will influence the market in the first half of this year will be the resolution, if any, of the US trade negotiations with China and Brexit. The US has threatened to place a 25% tariff on Chinese imports if China does not come to a satisfactory agreement by March 1st. Raising tariffs to 25%, in my opinion, would be a disaster for global stocks. It would signal a new escalation in the trade war and thoroughly disrupt global supply chains. While the probability of a policy mistake is significant, my sense is that both sides are unlikely to want to risk their economies. As a result, I believe that some small agreement will be reached or there will be a delay in any action and negotiations will continue beyond the March 1st deadline. The impact on the US stock market of Great Britain crashing out of the European Union is harder to determine and will likely be less direct. A hard Brexit will be tough on UK-EU trade and markets but I’m not sure how much of an impact it will have on the US. Having said this, a bad Brexit outcome will no doubt place a drag on global GDP. The global bond markets are expressing some concern over Chinese trade and Brexit. There has been buying of sovereign bonds as a defensive play. US Treasury bonds have rallied and interest rates remain stubbornly low. Demand for German bonds has been strong as well. Despite the Bard’s warning, “Beware the Ides of March”, I’m cautious but hopeful. — Ian Green, BrokerageSelect
The Market: January 2019
2019 could not have arrived sooner for investors. The 4thquarter 2018 was terrible for stocks, culminating in the worst December since The Great Depression year, 1931. During the 4thquarter a combination of events tipped the market over after the new highs at the end of September. From October 1 to December 31, the S&P500 fell 14%. The risks that spooked the market were and maybe still are: 1) the Federal Reserve and its path of rate increases; 2) the China-US trade issue; and 3) Brexit. All three put into question the ability of the global economy to continue to grow. Stocks violently sold off to discount the possibility of recession. This response was incredibly fast and steep, possibly to degrees much greater than the risk of recession warranted. There is a good argument to be made that computerized, algorithmic trading exaggerated the response to recession fears. Year-end tax selling and light holiday trading volume also played a role in the sharp decline in stock prices. Stocks were not the only assets to go into a free-fall. Crude oil also experienced a massive price decline. Demand for oil falls in a recession, and the oil market moved quickly on fears that demand would dry-up. Here too computer trading is likely to have made the down move larger and quicker than it would have been before the advent of algorithmic trading. Despite all this negativity, the calendar changed over to 2019 and stocks and oil have rebounded. It helped that the Chairman of the Federal Reserve had soothing comments. He signaled the Fed is not tone deaf to market moves and will not blindly push the economy into a recession. With the Fed more conciliatory and stock valuations pushed lower by the 4Q18 correction (practically bear market), there is reason to look forward to 2019. Much will depend on how the China-US trade situation gets resolved. If a deal is reached that doesn’t include tariffs or supply chain disruptions, the market will feel global GDP can continue to grow. My guess is that a benign resolution will happen. If corporate earnings can continue to grow and interest rates remain low, stock prices can rise and 2019 will be a good year. Many stocks and sectors practically re-traced the upward swing created by the corporate tax cut. I’m not sure the market fully appreciates the benefits of the lower corporate tax rates. Other things being equal, companies have higher after-tax cash flows. Despite the positives, a lot can go wrong in 2019. The US budget deficit continues to grow. More government bonds will have to be issued and that could put upward pressure on interest rates. Further, the markets are still subject to the volatility inherent in computer/algo trading. Outflows from equity funds were similar to 4Q 2008 when we were in the grip of a financial crisis. Investor confidence needs to be restored for stocks to rise. — Ian Green, BrokerageSelect
The Market: November/December 2018
In the course of 2018, the US stock market hit a high at the end of January, then immediately suffered a quick 10% correction. This was followed by many months of recovery to achieve a new high in September only to once again immediately fall 10% into another correction. The year has been a roller-coaster of a ride leading us back to where we began. I suggest that the path of the market in 2018 is worth noting. Is it a sign of a tired bull market that is having trouble holding new highs or is the pattern a reflection of a market that is now dominated by index funds and computer algorithms? Perhaps it may be both. In either or both cases the prescription should be cautious stock selection and a somewhat increased allocation to cash. The cartoon on this page reflects the past few years where high multiple, momentum stocks were the darlings. I think that game may be over. As readers know, I have never been a fan of momentum investing and certainly one to stay away from high-fliers. In the market of recent years, prudent, traditional value investing has underperformed. I have argued that the explosion of index fund investing has distorted the market, giving momentum to high multiple stocks. I have also suggested that low interest rates fueled growth and made suspect business models appear sound. If some rationalization of P/E multiples are underway and interest rates are higher, 2018 might prove to be a year where we see a change in the way investors approach the market. The FAANG stocks may give way, allowing a broader set of leaders to emerge. If true, we could be standing on shifting ground. A lot of money has funneled into FAANGs and a repositioning takes time and is likely to be messy. After a long run, we forget that hot money flows out just as fast as it flows in, maybe even faster. This is where cash helps. It provides dry powder to take advantage of sudden market drops where quality names go on sale. Unlike a few years ago, short-term Treasuries at least now offer some yield. The drop in stocks from the end of September is very uncomfortable. Leaders like Amazon have been taken down. Confidence has been shaken. The speed of the decline is un-nerving. Worst of all, we are not out of it yet. The correction will be in place until the market makes a new high. Despite the present negativity and maybe because of it, I still think the market goes higher before we have the next bear market. It will take time for new market leaders to emerge. During this period, investors should be combing over their portfolios, selling weaker names to buy quality ones. Many stocks, country markets and sectors have already been in bear markets and represent fertile ground to find bargains. I wish everyone a warm, enjoyable holiday season and a happy, healthy, prosperous new year. — Ian Green, BrokerageSelect
The Market: October 2018
In the last issue of this newsletter, I made an observation that the stock market was seemingly ignoring a rise in interest rates. This week the market abruptly took notice. The 10-year US Treasury this week accelerated higher moving from 3.05% on Tuesday to 3.23% at the close of business on Friday. This broke the previous 2018 high of 3.12% set in mid-May. To many technical analysts, this represents a break-out and signals higher rates to come. The S&P 500 fell almost 40 points in two days. It does appear that the path of rates seems to be upward. For almost 40 years interest rates made a long succession of lower lows. On July 2016, the 10-year yield was 1.30%. Now we seem to be making higher highs in rates. It will be interesting to see how bond investors, if indeed rates will continue to rise, behave as their portfolio values decline. Recall that bond prices and rates move inverse to one another. Higher rates mean lower bond values. The Vanguard Total Bond Index Fund lost about 1% this week and is down 2.65% this year. The Vanguard Long-term Bond Index Fund is down almost 8% year-to-date. Market analysts used to talk about a “Great Rotation” meaning that when rates finally rise, investors will sell their bonds and buy stocks. I’m not hearing that anymore. I’m not sure why. Perhaps the increase in short-term rates – the 3-month Treasury bill now yields 2.2% means that investors will sell their bonds and go to either short-term notes, CDs or cash. A growing consensus should always be examined carefully. Momentum moves opinions and subsequently prices, too far in one direction. The mantra is for higher rates. While the US economy is running at a fine pace with GDP growth over 4% in the 2nd quarter. Europe seems to be slowing. Except for July, the European Purchasers Manager Index (PMI) has fallen in every month this year. Like Europe, China’s PMI has moved lower throughout 2018. In general, the Emerging Markets are experiencing similar trends. Can US growth continue at the same pace when the rest of the world seems to be slowing? If the answer is no, interest rates in the US may not rise as much as the growing consensus believes. A lot of economic data is to come over the next few weeks. The inflation reports are due next week. If recent wage increases and higher gasoline and oil prices begin to flow through into the inflation indices, there will be more upward pressure on interest rates. We have seen certain groups like FAANGs doing very well in 2018 while other sectors like Financials doing poorly. If interest rates continue to rise, we might see the performance gap between various sectors narrow. I’ve mentioned before that low-interest rates make suspect business models work. Easy money and low cost of funds help growth. Low rates also boost valuation multiples so that companies with low or no earnings can enjoy high stock prices. Times may be changing. — Ian Green, BrokerageSelect
The Market: September 2018
Investors came back from summer vacation and after a shaky start to September, rallied the market to new highs. The buying has occurred despite serious concerns over US trade policy with Mexico and Canada and a series of tariffs imposed on and retaliated by China. Bull markets are said to “climb walls of worry” and as such, stock prices have moved higher. Whether the market will begin to care about tariffs and trade remains to be seen. History seems to tell us that trade barriers are harmful to economic growth. The stock market is trading at 17 times earnings so there is definitely an expectation of growth. Should impediments to trade dampen growth, stock prices would be vulnerable. In addition to trade, the market seems to have ignored the rise of interest rates this month. The 10-year Treasury yield is back above 3%. Recently, the market has had “tantrums” when the 10-year has moved above this level. So far this time, there is little mention of the 10-year in the financial news. The market news, however, has continued to report on the Federal Reserve increasing the very short-term rates. The Fed Open Market Committee meets this coming week and the expectation is that another 25 basis point hike is in the cards. So far, the longer-end of the yield curve has not responded to increases on the shorter part of the curve. This has led to a flat-ish term structure of interest rates. A flat curve is a disincentive to banks to lend. Something to watch. Will tariffs, higher short-term rates, and a flat yield curve slow profit growth and create the disappointment that hurts a high P/E market? Remains to be seen. I suspect the Federal Reserve is aware that they can’t push too hard. If the Fed announces they will hold off after this week or after the December meeting, the market will likely take that as very good news. At present, this is the not the likely case. It is not the consensus view. Returning to stocks, bull markets can have explosive moves to the upside. However, there is a precedent that these moves lead to significant declines. I ran a simple regression of the S&P500 with a two standard deviation band going back to 1982, the beginning of the series of modern bull and bear markets. As a general rule, a two standard deviation move above a long-term average is a starting point for bubble territory. In my simple study, 3,300 on the S&P500 marks this area. That’s about 13% from current levels. I’m not saying that the bull market is about to end. Bull markets can go much further. There is no magic formula. What is important is that investors increase their caution. It’s easy to get sucked into the assets that are rocketing in the later innings of a bull market. Cannabis stocks are flying. We’ve seen Bitcoin run up and down. Private companies like WeWork are raising capital at big valuations. This is not a time for investors to lose their heads. Discipline is always an important quality to have, especially now. — Ian Green, BrokerageSelect
The Market: June 2018
The Federal Reserve raised rates this month. This was no surprise to the markets and continues the path the Fed has telegraphed. While the Fed and the stock market are behaving in a manner consistent with a belief that the economy is strong and inflationary pressures are building, the longer-end of the bond market, the 10-year to 30-year part of the curve, is apparently singing a different tune. Interest rates on the 10-year and 30-year Treasuries actually went down. Typically rates fall when the bond market expects an economic slowdown and low or falling inflation. It’s possible that the bond market is concerned about the global saber-rattling over trade. Trade wars have been shown to reduce economic activity. Tariff barriers in the 1930’s may not have started the Great Depression but research indicates that they certainly contributed to the global slump. The stock market seems to be taking the tariff situation somewhat in stride, trading in a relatively narrow range. Perhaps the stock market believes that the probability that trade issues ultimately get resolved is higher than the probability that a trade war develops. More important than the trade talk bluster, the European Central Bank outlined a timetable for tapering its quantitative easing program. The ECB stated that starting in September, it intends to reduce bond purchases and stop altogether by December. This news was largely overshadowed by trade talk. I believe that US rates long-term interest rates have been kept low, in part, by European investors buying US paper to get higher yields than what they can get at home. If Europe begins to “normalize” their rate structure, money should flow out of US bonds and into European bonds. Under this scenario, long-term rates in the US should go up. I think we will re-visit the tug of war between higher interest rates and positive fundamentals for stocks that we experienced earlier in the year. That is to say that higher rates hurt asset valuations but a strong economy, solid corporate profits, increased buybacks, and higher dividends help stock prices. Stock market watchers should note that while the S&P500 seems to be treading water, the small-caps have been moving up. The cumulative number of stocks advancing has been greater than the cumulative number of decliners. Companies are using the tax savings from the new code to yes, spend more on capital goods, but mostly to increase dividends and buy in shares. We will get a better picture of company profits as firms report their 2nd quarter numbers in a few weeks. Estimates are calling for a 19% quarterly year-over-year increase in S&P500 earnings. That’s pretty good. If the numbers come in, the market should be ok. So far, the evidence still supports The Bulls. However, keep an eye on trade. The bond market is. — Ian Green, BrokerageSelect
The Market: May 2018
The Market: April 2018
Corporate earnings season is under-way. Expectations for the 1st quarter are high as analysts look to new lower corporate tax rates and a fairly strong economy to deliver good results. The US dollar has been declining against other major currencies which also should provide a tailwind for companies which have signiﬁcant overseas revenues. As I
have written, over time, proﬁts drive stock prices. Unfortunately investors need to get through the short and intermediate term before they arrive at the long-run. While earnings may indeed come in strong, there are forces at work that may mitigate the positive impact. The ﬁrst is the phenomenon that markets anticipate and price-in expectations. It has been conventional wisdom since Donald Trump won the Presidency in November 2016 that there would be tax cuts and deregulation that would push corporate proﬁts higher. After Election Day, stocks soared and continued to rise steadily throughout 2017 and through to the March correction. How much of the upswing in stock prices has already discounted the positive news of higher proﬁts? If it already has, then stocks might not move up that much now that the proﬁts related to policy changes are actually coming in. The second force that could lean on stock prices is a return to rising interest rates and inﬂation. After all, it was concerns about rising rates and inﬂation that may have knocked stocks into the March correction in the ﬁrst place and there are no signs that either are heading lower. The rate on the 10-year Treasury note hit 2.92% on February 22nd and is at 2.87% now – almost the same. The rate on the 2-year Treasury note was at 2.25% on February 22nd and now is higher at 2.43%. On the inﬂation front, oil prices have found a bid and at almost $69 a barrel is already beyond what many pundits said oil could ever get to. Industrial metals, principally copper, nickel and zinc, are also strong. Will higher input prices dampen the beneﬁts of lower taxes on proﬁts? Whether stocks can continue to rise in the short-run remains an open question. The correction that began in Mid-March is not over yet. The S&P500 sits at 2,709. Not until a new high is made at 2,873 can we say the correction is over and that the bull market is still in-tact. I suspect the bull market continues but there are signs that risks are growing. In addition to interest rates and inﬂation there were two recent weak economic reports from Europe that surprised the markets given that the narrative has been that, for the ﬁrst time since the 2008 ﬁnancial crisis, there is across the board global economic growth. These reports may turn out to be outliers but nevertheless merit attention. Again, I think stocks will make new highs. The new tax code will allow companies to increase dividends and stock buy-backs. Corporate buying has been a powerful source of demand for equities. As the market recovers, a prudent approach is warranted and slowly building cash might also be a good idea. — Ian Green, BrokerageSelect
The Market: March 2018
After an up January, the long-awaited stock market correction happened in February. From the recent peak on January 26th to the low on February 8th, the S&P500 fell 10%. Finally a 10% correction! The previous 10% market correction began in November 2015 and ended in February 2016. Many have said we were long overdue. Of course we are not finished with the correcting process. That will not happen until if or when we post a new market high. My belief is that this phase of the market is not the beginning of a prolonged bear market and that we will make a new high. The rationale for this is that there are no immediate signs of a recession. This is to say that employment remains robust, consumer confidence is high, credit seems to be available and corporate profits still are rising. What is important to note about the February 2018 correction is the speed in which the market fell. The 10% decline we experienced this year took just 13 days to happen. In comparison, the November 2015-February 2016 drop occurred over the span of 100 days. The speed of the decline and the substantial swings within the decline is un-nerving and something that investors will need to get used to. Computer trading / algorithmic trading represents a large proportion of daily market activity. Some estimate that these strategies can comprise over half of the volume on a given trading day – all this without much human intervention. These systems react to subtle market moves or discrete pieces of information and by the sheer size of their trading power can move prices significantly. Amplifying the results of computerized trading is the proliferation of indexing where so much money is concentrated in the same set of stocks. You just need to move these market-weighted names and the overall market can move a lot. I’m afraid that February’s fast decline is a taste of things to come where corrections will be quick and relatively large. This is not particularly good for promoting market confidence but it should provide opportunities for patient, nimble investors. If one buys stocks that have good fundamentals and that sell at reasonable prices, these deep drops represent price “sales” and bargains for the taking. Conversely, it may mean that price surges represent chances to sell stocks as they are likely to move to investors’ target valuations faster than in the past. It’s not necessarily that computers and index funds are the cause of volatility. Many macro-economic trends may be in the process of changing direction and investors are struggling to find a path for dealing with a new backdrop for the markets. Central Banks are reducing their level of market intervention. Also, inflation, long absent, is showing some upward movement. If these developments continue, markets will have to adapt to a new interest rate structure and that may have consequences for P/E ratios and stock prices. — Ian Green, BrokerageSelect
The Market: January 2018
The market entered 2018 with the bulls in-charge. While such a strong start may be surprising, it is consistent with a strong global growth picture. US GDP in the 3rd quarter 2017, grew 3.2%, a pretty respectable rate. Anemic Europe managed to grow 2.5%. Even Italy, the weakest major European economy increased by 1.8%. Equally maligned Japan put in a much improved 1.8% GDP growth. China was up over 6%. With higher commodity prices, other emerging markets also improved. Late in the 4th quarter, the US voted in a new tax structure that greatly benefits US corporations. Lower corporate taxes increase corporate profits. Add a favorable tax policy to a landscape of better global economic growth and you have a strong argument for higher stock prices as corporate earningsis the long-term driver of stock prices. There is an argument that the market has priced in a good deal of the profit expectations. The S&P500 trades at a multiple of about 18 times 2018 earnings. That’s not cheap. It’s well above the 15 times experienced in 2007 but well below the 24 level before the Tech Wreck in 2000. During the current bull market which began in 2009, pessimism was consistently high. Sentiment is a contra-indicator and so long as there is pessimism concerning the market, stock prices are likely to go higher. Pessimism has been waning and more analysts are upgrading their opinions of the market. This is a concern. However, despite signs of speculation in Bitcoin, art, and some areas of technology, we are not yet in a state of euphoria. The next factor that is important to stock prices is liquidity. Global Central Banks have been pumping money into the system since 2009. Liquidity drives stock prices and all prices for that matter. Central Banks are beginning slowly to pull away from the punchbowl. The US Fed is raising rates and beginning to reduce its balance sheet. The European Central Bank has yet to do so but has hinted that “normalization” is not far off. Like sentiment, liquidity is moving from being market supportive to market negative. In summary, the likely path for stock prices remains upward. Small US companies may outperform as they will benefit more from tax reductions and US growth than large companies. What could surprise the markets in 2018? I think commodity prices and a pick up in inflation. From 2009 until the present, as a result of lackluster demand, capital expenditures and capacity in most commodities have declined. It takes time to restore lost capacity and supply can’t keep up with an increase in demand. We are seeing this in the oil market and in metals such as copper and iron ore. Unemployment is already low and with fiscal stimulus from tax cuts and possible infrastructure programs, wage rates may push up as well. If inflation expectations finally move up, long-term interest rates will rise. Could this trip up the bull market? Probably not for a while but I wouldn’t rule it out. — Ian Green, BrokerageSelect
The Market: November/December 2017
In the last issue, I wrote about the prospect of interest rates rising and the impact that would have on stock prices. After rising from 2.66% on September 8th to 2.96% on October 26, the 30-year rate on US Treasury bonds has moved back down. At the close on November 6, the 30-year T-bond had a yield of 2.80%. The long end of the interest rate curve remains stubbornly contained. Long-term rates are determined in the market, to a great extent, on the perceived rate of inflation. Right now inflation remains low. The Consumer Price Index is running about 2%. Wages are increasing at about a 2% rate. The price of gold, after rallying to a high of $1,346 per ounce on September 8 (curious that it peaked with the 30-year yield) has drifted lower to $1,267. These inflation indicators paint a very tame picture. Industrial metals prices and recently oil prices have increased, but so far these commodity prices have not translated into any inflation anxiety. My assertion that low rates are a fuel for the FAANG stocks did hold. Amazon’s recent low was on September 26. This was very close to the recent peakinlong term interest rates. As rates eased, Amazon rallied to a new all-time high. What makes asset prices move is very complicated and comprise of many variables – note the cartoon. It is dangerous to draw conclusions withsimpletwo factor correlations. Nevertheless, it would seem that keeping an eye on interest rates is a smart thing to do. While we are on the subject of interest rates, I’d like to discuss the shape of the interest rate curve. Most of the time, interest rates are higher the longer the term of a loan, a bond or a savings account. Banks, finance companies, certain real estate investments and other financial enterprises make a profit from borrowing short-term with lower rates and lending or investing longer-term with the corresponding higher rates. This “spread” is greater when the curve is steep and less so when the curve is flatter. A relatively flat curve is a dis-incentive to for banks to lend and investment vehicles to put money to work. Currently, the yield curve has been steadily flattening since 2014. The spread rallied from August 2016 to the end of 2016 but has fallen steadily since. The Federal Reserve has been on a path ofveryshort term rate hikes. This is pushing up yields on the short-end but the long-end has refused to move higher and the curve has flattened. The Federal Reserve has signaled another Fed Funds rate increase in December. It may well be that if the longer term rates do not rise, the Federal Reserve may not move to raise rates further. I don’t think the Fed wants a flat or perhaps an inverted yield curve. We’ll see. I think the Fed has to be careful that they do not create the very economic slowdown they are trying to avoid. Investors need follow not only the level of interest rates but the shape of the yield curve. I want to wish everyone a happy, meaningful holiday season. — Ian Green, BrokerageSelect
The Market: July/August 2017
Evocative of the saying, “You can’t keep a good man down”, you could easily say, “You can’t keep a bull market down.” Since the bottom in 2009, every time the market seemed to meet an insurmountable challenge, it found a way to power through. Over the past month, hopes for global economic growth combined with the view that Central Banks would be ending their easing programs gave a lift to interest rates. This, in turn, seemed to be giving the stock market some headwinds. However, Janet Yellen, last week indicated that the pace of rate increases would be moderate. Did Chairwoman Yellen just remove another obstacle to the ever resilient Bull Market? Maybe so. Stocks moved to new highs last week and again the Bulls are back in business. While the green light is on for stocks, we may have gotten a glimpse of what may end up being a factor that trips up the market one day. Investors should pay close attention to the impact of interest rates, especially on the legendary FAANG (Facebook, Amazon, Apple, Netflix, and Google) stocks that have led the market higher. The FAANGs performed much worse than the overall market when rates gave a hint of moving higher. Facebook, Amazon and Netflix trade at very high multiples. In part, this is due to expectations for future growth. However, I suspect that growth is not the only reason. While high multiples for growth are reasonable, I suspect that they would not have as high multiples as they presently exhibit if interest rates were normalized. Low rates create distortions. Interest rates are the price of money. With low rates, money is cheap. People and business use cheap money in inefficient ways. In China, they built too many factories and too many empty cities. Consumers bid up the prices of luxury homes in London, New York, and Miami. Investors may well be bidding up certain stocks, like FAANGs, to levels that they normally would not if money cost more. The situation becomes even more precarious given the large weighting these stocks have in the various index funds. If rates one day rise, the resulting decline in high flying stocks would be amplified by index funds. As I mentioned earlier, Janet Yellen may have placed the day of reckoning further out to the future. For now, it’s still a Bull Market until proven otherwise. However, it is important to consider interest rates as a “canary in the coal mine”. If rates move higher, more caution is needed. On a different note, there still remains sectors within the market that have lagged and are worth a look. Agriculture related stocks are one that I am viewing with great interest. Companies in the fertilizer, grain storage, and farm equipment areas have been struggling for years under pressure from low crop prices. This may be changing as agriculture prices have rallied. If the recent upturn proves to be the beginning of a longer-term move, these stocks could be big performers. — Ian Green, BrokerageSelect
The Market: June 2017
“It’s a Bull Market until proved otherwise” is an old Wall Street saying. From what we have experienced in recent history, this old adage makes sense. This 2009 to the present Bull has withstood negativity, fear, Greek crises, Brexit, elections, you name it and still makes its way higher. Many pundits say the Bull Market is long-in-the-tooth but I would answer, “Maybe, but it is still a Bull Market.”. While I believe the stock market will move higher, I still think a correction is in store. Last week on June 9th the market leading FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) suddenly fell about 5% during the trading day. They have recovered somewhat but the sharp move down may have exposed cracks in the market’s facade. The top 15 stocks in the S&P500 are responsible for about 1/2 of this year’s total return. Investors have piled into these large cap growth stocks mostly through index fund purchases. The concentration of returns signals a very crowded trade and as fast as money flows into certain stocks, money can just as quickly flow out. Despite the June 9th decline in the FAANGs, the overall volatility in the market was muted. Investor confidence in the government’s ability to pass favorable tax, regulatory and infrastructure legislation has created calm. Why sell when the policy will increase economic growth and corporate profits? This attitude is fine as long as “when” does not become “if”. The market has been very patient as to-date no such legislation has been passed. If doubts creep in, or if the bills that make it are less than expected, disappointment could take stocks down. Many investors since 2009 have made well thought out lists of why the market can’t go higher. They have, since 2009, been wrong. This is why I am still running with the Bulls. I am, however, very leery of crowded trades and right now investors seemingly can’t get enough bonds even when rates are so low. Investors can’t get enough of the S&P500 Index ETF and Index funds. Asset prices decline when the buying runs out. Until then, prices will move higher. While the FAANGs try to regain their upward climb, there are parts of the market that are struck with high levels of negativity. Energy stocks have been laggards as ample supplies of oil keep crude prices under $50 a barrel. Retailers have been taken down on fears that Amazon will put them all out of business. Similarly, low commodity prices have kept investors away from agriculture related companies. I once heard a well-known investor say that to be successful it is necessary to have a portion of your portfolio that is working today and a portion that will work tomorrow. There may be an opportunity in looking through forgotten stocks and maybe raising some cash as the stocks that are going up move higher. June 9th is telling me that near-term caution is warranted within a market that has room to move higher over the longer-term.— Ian Green, BrokerageSelect
The Market: May 2017
The seemingly widening question of Russian influence in the 2016 Presidential Election and in the current Trump administration has gripped the headlines and placed a new concern as to the continuation of the bull market. It is hard to predict where the investigations will lead. However, I don’t believe that even if impeachment lies at the end of a long investigation, the bull market is likely to end. Impeachment might cause a correction but not a bear market. If President Trump is removed, Vice-President Pence would succeed him. Politically Pence holds the same policies of tax cuts and possibly infrastructure spending. Even if the President and Vice-President were forced to resign, pro-business Paul Ryan, The Speaker of the House of Representatives would become President. The market would still get a pro-business President and at least until the 2018 Mid-Term Elections, a pro-business Republican Congress. Aside from politics, the economic news continues to come in positive. Manufacturing, consumer sentiment and employment all are registering solid numbers. Europe seems to be improving, China is hanging in there and emerging markets seem to be growing. Against this backdrop, without a recession or financial crisis, it’s hard to conclude a bear market is imminent. I have been writing that it is likely that we get a correction this year. We seem to experience one each year. With the political issues brewing, the probability of a correction has increased. At 17.5 times earnings, the market is not cheap. This explains why those companies that missed first quarter earnings estimates fell significantly more than the rise the in stock prices of firms that beat their estimates. The good news is that more companies beat their earnings estimates than average. Earnings growth was the highest since the 3rd quarter 2011. Over the long-term, profits drive stock prices. When stocks trade at the multiples they currently trade, earnings need to continue to come in strong to support the price levels. It’s a difficult treadmill and caution is warranted. Looking at the earnings reports, the companies that had global exposure had better earnings growth than domestic, US focused firms. With the rebound in oil prices, energy firms were the biggest contributors to the overall earnings growth. Given the back-drop of high price-to-earnings ratios and good earnings growth, there is even more reason to look for value. Screening investments for those companies with lower than average P/E ratios and earnings growth rates that are average to above average can provide some cushion should the markets correct. It will be interesting to watch how the OPEC and Russia oil production talks proceed and whether it will lead to an extension of the existing cuts. Saudi Arabia has a significant interest to move oil prices higher as the country seeks to sell 5% of its national oil company to the public. — Ian Green, BrokerageSelect
The Market: April 2017
Until the past two weeks, geopolitics is something that the market has ignored for quite some time. With North Korea saber-rattling with its missiles and the US firing off some of their own at Syrian targets, stock market volatility has increased. In addition, the fear-trade seems to be on again with investors buying gold and US Treasuries. A month ago, conventional wisdom was that interest rates would be on a more or less straight up trajectory. The flight to safety has put pressure on interest rates to move lower as fearful investors buy bonds. Additionally, the failure of the Trump Administration and Congress to come together to pass a new healthcare bill has called into question the ability to pass tax reform and infrastructure spending bills, both of which are thought to be key economic drivers. Despite all this, stocks have remained resilient and so far slight downward moves have been met with buyers who bid the indices back up. However, there now are questions where there once was certainty and I get a feeling that markets are nervous. This continues to play into my thesis that we will see some correction this year and caution is warranted. Europe seems to be improving and the deflation that was gripping the economy as well as the uncertainties of Brexit are less of a downward pull. The ECB has had its foot on the gas pedal to spark inflation and Brexit has gone from a question to a negotiation. European stocks trade at lower multiples compared to US firms and I think represent a compelling value. One piece to the Europe bull story is still missing and that is the result of the French election. If the center holds and LePen is defeated, the fear of Euro disintegration should go away (for now) and I think money will flow into European stocks. A center victory in France would allow the ECB to reduce its extraordinary measures and interest rates would likely rise in Europe. The scenario would be very positive for European banks – a sector that is almost universally hated as an investment. ECB policy change could move interest rates upward. US rates have been held down by Europeans buying US bonds for yield. If rates in Europe rise, money will flow back to Europe. Japan should also be on investors’ radar. The massive central bank intervention there, as well as some welcome fiscal measures, might be moving Japan to better economic results. Japan is a tough place to figure out. Its demographics are terrible for domestic consumption but it is a major exporter. Japan’s corporate sector has large surpluses. If the country can move some of these surpluses to domestic consumers, the deflation that has dragged down its economy for decades could be relieved. Again, Japan is difficult to understand but stocks are cheap there and have been for a long time. The Nikkei Index is still half of what it was at its peak in 1989. It is still lower than it was in 2000. Japan is a market to watch. — Ian Green, BrokerageSelect
The Market: March 2017
The economic news continues to come in reasonably good. Consumer sentiment, jobless claims, and manufacturing gauges are all continuing to be positive. Good data also continues to come in from China and Europe. European inflation for the first time since January 2013 hit 2%, a signal that the extraordinary actions the European Central Bank has been doing may be working. The Japanese economy is also showing good numbers. Inflation there turned positive in October and has remained positive. Inflation is a sign of positive economic activity. The global economy had been facing deflationary pressures for several years which are indicative of economic sluggishness. Positive inflation numbers are a good sign. With constructive economic data being reported around the globe, the prospects are good for the stock market to continue its path higher. Having said that, the markets do not move in a straight line. Each year there is a correction in the stock market. I suspect this year will be no different. In fact, the steep rise we have seen since the election makes it likely that the correction will come sooner rather than later. Elections in The Netherlands, France and Germany this Spring could also prove to be a speed bump for the markets. If anti-Euro candidates are able to form governments, the markets will get nervous. There is still Brexit looming out there. The UK is likely to invoke Article 50 on March 31 and begin the divorce from the European Union. It is always easier to make a list of bearish catalysts than a list of bullish ones. I get nervous when I begin to read headlines like “Dow 30,000” and other signs of market euphoria. There are still enough bears and enough money on the sidelines to outweigh the newly found exuberance but it’s important to keep eye on sentiment. The Federal Reserve seems to be indicating that they intend to raise rates at this month’s meeting. If the positive economic data continues, the Fed will be able to achieve their tentative goal of three rate hikes in 2017. More important than the number rate increases, is what the shape of the yield curve will look like. If growth remains robust, then the curve is likely to be steep, that is a large spread between short-term rates and long-term rates. If the Fed raises short-term rates and the economy is just so-so, then the yield curve could flatten. A steep yield curve is a help to the economy as it provides an incentive to lend and finance economic activity. Banks obtain deposits (borrow) at short-term rates and lend at long-term rates. The difference in yield is the gross profit. A flat yield curve is not supportive of economic growth. If the spread is narrow, banks are not rewarded for taking risk and tend to refrain from lending. There is a lot to play out in 2017. I think stock prices end the year higher but the road to get there will probably be marked with ups and downs. — Ian Green, BrokerageSelect
The Market: February 2017
As we move into February, stocks continue to show strength, albeit without the explosiveness we witnessed in January. Expectations for policy changes such as reduction in regulations, tax reform and increased spending continue to support the bulls. However, the optimism may be losing some of its luster. There seems to be greater interest in “safety trades”. Gold, US Treasuries and defensive stocks are attracting investor attention. Some of the caution is US-centric with concerns about erratic tweets, the ability of the President to produce a coherent pro-growth agenda and a concern that US policy may reduce global trade. The rest of the worries are focused on the upcoming elections in Europe and the start of Brexit talks. The Dutch anti-Euro party PVV, led by Geert Wilders, is leading in the polls and is likely to win the largest number of seats in the March 15th election. The Dutch election will be followed by a national election in France where the leading candidate, center-right Francois Fillon, has been hurt by scandal. With Fillon’s prospects in decline, the far-right, anti-EU candidate Marine Le Pen’s chances for victory increased. France goes to the polls on April 23rd. With anti-EU candidates having a good two weeks in their respective campaigns, it is little wonder why caution has crept back into the markets. Adding to the uncertainly, the UK parliament voted today to officially leave the European Union. While a break-up of the EU would have far reaching implications and likely would send the markets in a deep tailspin, eventually the world would go back to the pre-1999 Europe of different currencies and borders. It would take time but the world will adjust. It has long been said that the market “climbs a wall of worry”. The concerns about US policy and European elections might be providing the wall upon which the market will move higher. In some respects the recent whiffs of caution are comforting to a contrarian. Since the election, there has been more optimism than we have seen during this much-hated bull market. Bull markets end when everyone is in not when there are so many skeptical and on the sidelines. One area of the market that is very challenged is retail. Earnings reports out of Macy’s, Target, Under Armor and many others were weak due to competition from on-line firms like Amazon and from reduced margins in their own on-line channels. After an expansion fueled by low interest rates and the demands of Wall Street, retail companies are now saddled with too much square footage and overhead. Retail needs to shrink its footprint. Companies are doing so but it takes time. A knock-on effect is the drag on real estate firms. Mall operators especially are in trouble. It’s a lesson that even in a bull market, investors need to be selective. — Ian Green, BrokerageSelect
The Market: January 2017
I’d like to wish all of you a happy, healthy and prosperous new year. 2016 is gone and with it the tensions surrounding the US election. My guess is that the old saying that “one campaigns in poetry but governs in prose” is likely to hold true. The President-Elect has promised tough trade, reduced regulation, tough immigration, repeal ACA, lots of infrastructure spending and lots of tax cuts. We will see as the year unfolds how many of these campaign promises will come to fruition. Political realities, unforeseen events and the laws of economics turn election poetry into governing prose. The stock market has had a good run since the election on the hope that tax cuts and increased government spending will lead to higher corporate profits and more money in the pockets of consumers with which to buy more goods and services. As an aside, it will be interesting to see if concerns over deficits and debt which were used by Congressional Republicans as a rallying cry in their efforts to thwart spending by the Obama Administration, will fall away now that one of their own is in the White House. Back to the markets. The financial stocks led the post-election rally on not only hopes of better economic growth but also on the belief that the Trump Administration will pull back many of the more restrictive provisions of the Dodd-Frank Act. In fact 25% of the advance in the Dow Jones Industrials was due to the performance of Goldman Sachs. This might give some pause to the euphoria knowing the advance is not as broad as what has been publicized. Absent from the rally was technology and healthcare. Perhaps a sign of caution. If corporate profits and overall spending is going to increase, one would think technology stocks would respond. While I believe stock prices will rise, these inconsistencies remind me that caution is in order until we see the prose of this administration. Stocks were not the only asset class that moved post-election. Bonds went from being a top performer to ending the year with losses. The move was significant. The 10-year Treasury yield went from a low of 1.79% on November 4th to 2.45% at year-end. This increase translated into 10-year bond prices declining about 5%. That’s a large move in two months – especially for an asset class considered by many (I feel incorrectly so) to be a stable one. Bonds have had a tremendous run since Central Banks the world over embarked on “extraordinary measures” to combat the global slump. Bonds are over-owned by institutions and the public. This makes for jittery investors and big downside potential should bearish news develop and holders run for the exits. We saw an impact on bond funds, as well. As an example, the Vanguard Total Bond Market Index Fund was up 5.3% on November 4th and finished the year up 2.39%. Should interest rates continue to rise in 2017, the conversation may not be focused on stocks but rather with sharp declines in bonds. — Ian Green, BrokerageSelect
The Market: September 2016
I hope everyone’s summer was fun and an enjoyable break. This summer, unlike the recent past, did not bring a decline in the markets. The old proverb, “Sell in May and go away” was not the right call this year. For the most part, the markets managed to grind higher. The events that were supposed to pull the markets down over the summer like Brexit and the Fed, turned out, so far, to be benign. Having said that, the specter of a Fed Funds rate increase lurks around the markets. Many worry that the only reason for the 2009-present stock market rally (and bonds too) is the artificially low level of interest rates crafted by the world’s central banks. The Fed raised rates 1/4 of a point in December 2015 and the market had a tough 1st quarter of 2016 but rebounded to new highs. All else being constant, higher interest rates reduce the values of equities, bonds, real estate and commodities. Given that the current levels of rates are so low, it might take several rate increases to impact asset prices. The Bears may be relying on direction and ignoring magnitude when they are formulating their predictions. It doesn’t seem that the recent economic reports merit the Fed taking action at their September 20-21 meeting. There has been a tradition but not a fast rule that the Fed will not act immediately ahead of an election. If the economic data remains steady and the election tradition holds, the Fed would wait until the December 13-14 meeting to move rates upward. It’s my opinion that in a tie, the Fed will hold pat on rates. While the Fed has met its employment target, it has not met it’s inflation target and the economy is certainly not in “high gear”. Unless the latter two elements get closer to the Fed’s goals, I think the Fed would rather wait. The concern with waiting is that asset prices may well move higher and we could end up with bubbles like we did in 2000 with internet stocks or in 2007 with housing. The concern with moving too quickly and too much is that the Fed Governors could push the economy into the very recession they are trying to avoid. With a third of global government bonds, about $10 trillion, yielding a negative rate, the world is definitely in a strange place. I think (and hope) that policy makers are realizing that rock-bottom interest rates can not create a sustainable economic recovery. Personally, I think negative rates are interpreted by regular people with fear. Investors are afraid that their investments will not return enough to give them the pile of money they want or need to retire. In this situation, people cut back and save more in an attempt to keep their piles growing. This is Keynes’ popularized “paradox of thrift”. One person saving is noble, however a whole economy saving leads to reduced spending and low economic growth. Tools beyond monetary policy seem to be needed but tax reform, government spending and the like require political will which is, itself, in short supply. — Ian Green, BrokerageSelect
The Market: July/August 2016
I ended my commentary last month with the sentence, “Hopefully good economics will prevail this time around”. That sentiment became more of an open question following the unexpected decision by the British electorate to leave the European Union. The immediate market response was to run for cover. The British Pound fell precipitously, stocks around the world moved sharply lower, government bonds and gold rose. The “fear trade” was on. However, once again this stock bull market roared with the resilience that has been its hallmark since the lows of 2009. US stocks not only recovered from Brexit but sit just a whisker away from an all-time high. US stocks were helped by better than expected economic news. First the ISM Services report showed a bigger expansion in the service economy and then Friday’s employment report indicated a sharp rebound in jobs from May’s almost zero employment growth. Despite the sharp rebound in stocks, pessimism still abounds. Most commentators I saw on CNBC and Bloomberg, as well as in this week’s Barron’s still see stocks having difficulties sustaining these levels. On the CNBC show Fast Money, the pundits were tripping all over themselves trying to rationalize their bearish and wrong calls. Most of the reasons why the CNBC and other pros feel the market is headed lower are the same arguments that have persisted throughout this long bull market – high valuation, slow global growth, European crisis, China crisis, and declining bond yields. All these factors are in and of themselves real concerns. The problem for the bears is that the markets are extremely complicated with a large number of factors at work to determine prices. Making the task of predicting stock prices even harder is the fact that in determining prices, the market has to not only interpret the factors in the present but also make some guess as to the outcome of these and new factors in the future. Is the decline in interest rates signaling a recession or are the low rates a reflection of Central Bank buying and traders who keep buying in an attempt to front-run” the Central Bankers? Is then the sentiment in the market today too pessimistic about the future of the economy? So far, the pessimism has been too great and the market has climbed the “wall of worry”. Smart Indices or Factor-based Index Funds attempt to sort out the factors in such a way as to improve on the idea of a passive index. Again, is it really possible to 1) identify all the relevant factors, 2) pick the right combination of factors, and 3) properly assess their outcome in the future? The jury is still out on these products but they are nonetheless being heavily marketed to the public. Brexit added a new set of questions for the markets to deal with and resolution will probably take some time as the UK and EU negotiate a new path forward. Despite the news we can not discount the power of sentiment to be a contra-indicator. — Ian Green, BrokerageSelect
The Market: June 2016
The global markets are on pins and needles awaiting next week’s referendum on whether the United Kingdom will leave the European Union. The vote on June 23rd has significant ramifications for not only the British but may well set the tone for other EU nations to contemplate exiting the economic bloc. If the “Brexit” movement fails and the UK decides to remain in the EU, the markets will likely rally and could rally significantly. Markets like certainty (or at least the illusion of it) and a vote for the status quo would be re-assuring. Investor worries have pushed interest rates around the world to lower and lower levels as concerned players sell risky assets to buy US, Japanese, Swiss and German government bonds. I find it an ultimate irony that reports of a lack of faith in governments abound yet people continue to buy government debt hand over fist. These incredibly low interest rates are a function of slow economic growth, actions by the world’s central banks and investor fear. To show how extreme this is, last week interest rates on Swiss government debt were negative out to 30 years. Investors are so concerned about the economy and the UK political scene that they are willing to PAY the government to hold their money – for 30 years! Perhaps the Swiss case is a sign that the fear pendulum is swinging to the pessimistic extreme. We are seeing a flight from risk in many corners of the markets. Investors are buying, without a lot of concern for valuation, investments that are believed to be “safe”. In addition to government bonds, valuations for municipal bonds, real estate, utility stocks, consumer staples, and growth companies like Amazon all seem stretched. If the world turns out better or even marginally better than these investors anticipate, there is a chance for massive losses in bonds and a correction in the other so-called “safe” assets. We will know a lot more Thursday night and into Friday. My thought is that stock markets around the world will drop if the UK decides to leave the EU. The decline will not be so much about the UK. Britain is not the economic engine of the world and any differences in trade between it and the EU will affect the British. What will be foremost on investors mind is the question of which country will be next? The entire fabric of the EU could begin to unwind. Historically, challenging economic times have led to re-trenchment and an emphasis on the home-front at the expense of a more global view. Tariff restrictions and currency wars led to a rapid decline of global trade during the depression years of the 1930’s. Governments, in an attempt to protect their home industries, instituted barriers which most economists believe prolonged of the slump. The “every man for himself” knee-jerk reaction led to poor economic policy and one could argue led to the rise of hard-line to extreme political leaders. Hopefully good economics will prevail this time around. — Ian Green, BrokerageSelect
The Market: May 2016
The stock market has managed to grind higher throughout April. Oil prices rallied, the US dollar weakened and China showed signs that its economy is stabilizing. These three conditions are just what the market needed to breath easier and recover from the steep declines expressed in the first quarter. As usual, the market rallied in the face of high levels of investor pessimism. Over the past two weeks, US economic data has shown improvement. Factory orders, services sector data and manufacturing numbers all improved. This past week’s employment data, both the ADP private payrolls numbers and the Department of Labor’s statistics, revealed weaker numbers than the prior month but still ok. Interestingly, hourly wages showed a strong increase, rising at a 2.4% annualized rate from the prior year. Weak wage growth has been a chronic symptom of the US economy since the 2008-2009 financial crisis. Rising wages are a concern to those who believe higher labor costs will hurt corporate profits. However, others feel that since the US economy is 70% consumption, more money in household hands will lead to more spending. Personally, I am in the latter camp. Households need additional income to feel, as Keynes termed, “animal spirits”. More income and better sentiment leads to more spending and if demand for goods rise, businesses are more likely to invest in plant and equipment. Long-term business capital investment has been stubbornly weak since 2008. Europe saw better economic news as well. China’s news was positive but weaker than the prior month. Corporate earnings reports have been coming out and they are not particularly good. Many companies have beat their estimates but analysts have lowered the bar such that firms had much lower profits in the 1st quarter compared to last year but nevertheless still beat their estimates. Corporate earnings are backward looking numbers. Market bulls have to hope that April’s improved macro-economic reports will foretell better profits in the current quarter. If the US dollar keeps declining, oils stays above $45 a barrel and better economic reports continue, stocks should make their way to new highs this year – maybe sooner than later. I think there is a good chance that we will see new highs this year. Helping the bulls would be a Fed that does not raise rates until December. I think the Fed would like to get in one more 25bp rate hike in 2016. I think the Yellen Fed is very aware that a rate increase in June would send the US dollar soaring and as a result crimp US corporate profits. The Fed does not want a repeat of last summer and then this past quarter’s stock market declines. If rates do stay very low for longer then stock price-earnings multiples should expand and stocks could go a lot higher. Sentiment is still negative but we can’t rule out a positive surprise. — Ian Green, BrokerageSelect
The Market: April 2016
Last month I mused that what the market needs is good economic news from China and stability to oil prices. Since the last newsletter we actually got such data. Both government and independent data-gathering organizations reported an expansion in Chinese manufacturing for the first time in nine months. The service economy in China also showed expansion. Over the past month we have seen some stability in the oil market. While global crude remains oversupplied, there are signs that the glut may be stable to moderating. Global demand for energy is robust and Non-OPEC, Non-Russian production is declining. I’m cautiously optimistic about oil. Time is what commodities need to stabilize and we are well into the current down cycle. With these two pieces of good news, the S&P500 finished March up 6.6%. What a roller-coaster the first quarter was. January was down 5%. February was down 0.4% and March was up 6.6%. The ups and downs certainly strain investor patience. The market swings, amplified by the financial media, in my opinion makes it feel worse than it is. The S&P500 is only about 4% off its all-time high yet investors feel lousy. As I wrote last month, it is this pessimism that indicates the bull market is not over. According to the Investment Company Institute, since January 2014, there has been a cumulative net outflow from long-term stock mutual funds of approximately $49 billion. There are a lot of folks not participating in the stock market. As contrarians will point out, if the markets stay reasonably ok, these people will be the buyers that propel stocks higher. I listened to hedge fund manager, Doug Kass who on a Bloomberg Radio interview made the observation that until the individual long-term investor returns, the stock market will be left to the algorithmic traders and the volatility we have experienced will continue. In my mind, volatility is not a good thing but it is not a purely bad thing either. It is nerve-racking and trying but all it really means is that stocks move up and down more frequently and with higher amplitude. Looking at the glass half-full, this means that company shares go on sale more often. Nimble investors, if they can control their emotions and do their homework, can take advantage of the situation and buy what gets hit and sell what gets over-priced. I heard an analyst say that stocks are the only item that when they go on sale nobody wants to buy them. Volatility doesn’t mean that stocks only go down, it means they move significantly in both directions. We saw this in a January that is down 5% and a March up almost 7%. Moving back to the economics, the first quarter saw the US dollar decline against other major currencies. Throughout 2015, the strong dollar created a significant drag on the profits of US multinationals. It will be interesting to see how these companies fared with a weaker dollar when they report earnings this month. — Ian Green, BrokerageSelect
The Market: March 2016
US employment data continued to come in strong. February saw another 200,000+ getting jobs. What frustrates so many market participants is that the economic data shows such a mixed bag. Consistently strong employment data has come out despite recently weak manufacturing, service and GDP data. Auto sales have been robust as has loan growth yet railroads are seeing lower volumes across the board. There does not seem to be consistency in the data which makes it hard to paint a picture of how the economy is actually doing. It does seem inconsistent that GDP growth is so sluggish yet companies are willing to keep hiring people. Something is going to have to give. Either we will see GDP growth pick up as the year goes along or employment will weaken. The markets are divided as well. Stocks built on the turnaround that began in late February which would seem to signal some optimism. Having said that, money has been flowing into US Treasuries which are viewed to be safe-havens and the beneficiary of a weak economy. We have seen oil prices stabilize and manage to actually move higher. If oil can manage to claw its way to trade between $40 and $50 this year, it could create an ultimate “sweet spot.” At these levels, US companies can survive and muddle through which means that the fear of defaults and financial crisis will dissipate. At these moderate oil prices, the consumer will still have relatively low gasoline prices. Stocks don’t always take their cues from the economic data. Sentiment plays an enormous role. Before stocks began to move up in February, sentiment was incredibly negative. The “recession” word was being thrown around and the drop in the Chinese stock exchange reminded US investors of 2008. The Bears were in control and they were piling on the shorts in anything energy or materials related. Suddenly, talk of OPEC coming together with some sort of plan and production cuts by commodity producers spooked the Bears and we saw the result. Many commodity and energy companies were up 50% to 100% in a week, albeit from very low prices. I think we need to see more of this. The Bears will continue to pressure stocks and suffer sharp short-covering rallies. This has to go on until the bears are worn out. Only then will the Bulls be able to commit to stocks and we can see a sustainable rally to new highs. How long will this take? It is uncertain. Clearly better economic data out of the US and China would help. Continued stabilization in commodity prices would help as well. For investors, the key to navigating these volatile markets is having a long-term view. If one can look beyond the next week or next few months, the sharp declines will not look like like panics but rather will come into focus as opportunities. — Ian Green, BrokerageSelect
The Market: February 2016
Stocks and corporate bonds have continued to come under pressure. Low oil prices have called into question global growth and the ability of banks to absorb losses that may arise from companies going bankrupt in the low oil price environment. The weakness shows how important a role “confidence” plays in the financial markets. Without it, no one believes the validity of reported economic numbers, reported corporate profits, and bank bad loan reserves. George Soros has put forth a market concept called Reflexivity, which essentially means that declining prices can by themselves cause a lack of confidence which, in turn, brings about even lower prices. This is what we saw in 2008-2009 when concerns over sub-prime mortgages caused bank stock prices to drop and the fall in prices brought out fears of failure and nationalization. In 2015-2016, we have seen low oil prices cause concern about capital spending. Oil stocks and industrial stocks fell and this precipitated a doubt about the financial system, causing oil and bank stocks to fall even more. Whether or not fears are well-found, it doesn’t matter in the short-run. If everyone believes in lower prices, lower prices will be the result. I would suggest that in our current market structure with index funds, it is very easy to sell and when one sells, they are selling the entire market or the entire sector without regard to the differences among companies. The good gets thrown out with the bad and market moves seem to be quicker, and bigger than the moves that took place before the age of indexing. Regulators have further destabilized stocks by removing the Specialist on the exchanges who’s job it was to “keep an orderly market”. Regulators also removed the “uptick rule” which said that a short trade could only be done after the previous trade was up. Without these market controls, prices can drop quickly. So what will it take to turn confidence around? Continued good economic news out of the US helps. January US Retail sales came in decent and December was revised higher. The markets need some better news out of China. The transition of the Chinese economy from a manufacturing/export-based one to a consumer model has put pressure on emerging market and global growth. Given the turmoil in markets, the US Federal Reserve will be less likely to raise rates. Already, the Fed Funds Futures curve is predicting that the next Fed move will be a rate cut and not a raise. This has allowed the US dollar to weaken recently. A lower dollar takes pressure off emerging markets and helps US multinationals. The strong US dollar has been a major headwind for commodity, consumer and industrial stocks. Sentiment is very negative and it will take time for the market to find its footing. But rallies can come from nowhere, making it hard to be out of the market. Often, the biggest moves come at the start of a market recovery. — Ian Green, BrokerageSelect
The Market: January 2016
As I write, I am awaiting the December Jobs Report. The news release has a greater interest in light of the stock market having the worst start to a year on record. The S&P500 has fallen about 5% in the four trading days of 2016. Weak economic data out of China and the sharp decline in Chinese stocks has created a greater fear of global recession. The Chinese also lowered their currency exchange rate with the US dollar. Of course the decline has brought out the “bears”, many of whom are calling for steep declines in US stock markets and a US economic recession. Ok – the jobs number is out and it is a strong employment figure. In December 292,000 Americans found work, many more than the estimate of 200,000. Plus, more people moved into the job market and the prior two months were revised upward. I’m not sure how the US goes into recession when jobs are being created at such a strong pace. There are certainly a lot of negative pressures bearing down on the US economy and stock market. Falling commodity prices create worries about bankruptcies and defaults on the part of companies and countries that are dependent on these commodities. The strong dollar is crimping the competitiveness of US companies that export goods and services abroad. Thirdly, a slowdown in China puts into question global demand for goods, commodities and the internal ability of China to adjust its economy. By combining these negatives, one can easily put together a domesday scenario. Not all the new is bad. As we saw today, the US economy may not be going gangbusters but it is nevertheless moving along. There has been a steady stream of decent economic numbers out of Europe. Again not fantastic but not bad. India seems to be back on a growth path. China has been long described as an enigma. It is difficult to know how their transition from a capital intensive growth model to a consumption economy will develop. The Chinese government has many levers to pull and while it may be bumpy, it is too early to know how it will turn out. Much has been made of China’s currency devaluation. Remember, China pegs the Yuan to the US dollar and the dollar appreciated something like 20% over the past year. The US is not China’s only trading partner. While trade with the US amounts to about $500 billion, China’s trade with its neighbors – Japan, South Korea, Taiwan and Russia is a combined $872 billion. It is understandable that China would want to lower its exchange rate to compete with the rest of the world. While the news flow now is unsettling, beginning of the year predictions seldom come to be. A lot can happen in a year. There is a tendency to want to extrapolate the most recent data into the future. Just because 2015 was flat to down, many pundits are declaring 2016 will be flat to down as well. Bull markets end when there is euphoria and everyone is excited to be in stocks. — Ian Green, BrokerageSelect
The Market: November/December 2015
The market has given investors a roller-coast ride. The summer was sharply down with oil prices, a strong dollar and the prospect of a Fed interest rate hike weighing on the market. October saw a nice rebound as economic data showed that the US was performing well. Then came November and weakness returned as oil, the dollar and rates once again put a scare in the minds of investors. At this point I’m not too concerned with oil. As it is said, “Low prices are the cure for low prices.” At $35 per barrel, a good deal of world production is not viable. Rig counts are falling and at some point, supply will tighten and prices will rebound. In the meantime, I would suggest that there are many oil companies that could be longer-term bargains. The strong dollar has been problematic for companies that sell goods outside the US. Accounting rules require that US firms state their foreign earnings in US dollars. When the dollar is strong, the foreign earnings become a drag on profits. The reason that the US dollar is strong relative to other currencies is that the US economy has recovered faster than the rest of the world from the 2008 financial crisis. It is this stronger recovery that is leading the Federal Reserve to raise rates. While not a certainty, the markets are implying a 70-80% probability that the Fed will raise rates next week by 1/4%. This would be the first rate increase in over a decade. It has been so long since a rate hike that the mere idea of it brings anxiety. I don’t believe that a 25bp move in short-term rates will slow the economy. In fact, it appears that investors are hoping for a rise, which they believe is a signal from the Fed that the economy is fine. Continued zero rates, many would interpret as an admission by the Fed that the economy is faltering. A Fed rate increase has been widely telegraphed to the markets and I think has largely been priced in. Getting this, “Will they,? Won’t they?” tug-of-war behind us is probably a positive and the market might well rally. More important than the question of rates are some of the stresses we are seeing develop in the bond markets. Falling oil prices are putting pressure on smaller producers that issued junk bonds to finance their fracking operations. This, combined with worries that higher interest rates will slow the economy, has created a very nervous junk bond (high yield) market. This part of the bond market has always been relatively illiquid and was made even more so by the Dodd-Frank rules. When markets are nervous, reduced liquidity can lead to panics. The Third Avenue Credit Fund announced last week that it was closing. This is not a healthy sign for bonds. The bond markets warrants close attention. This week and the rest of the December is likely to be volatile as the market sorts out the Fed decision. Regardless of what the markets do, this time of the year is for giving thanks, generosity and cheer with family and friends
Happy Holidays – Ian Green, BrokerageSelect
The Market: October 2015
In the period July 1, 2015 to September 30, 2015, the S&P500 lost 6.9%. The index closed the quarter at 1,920, almost the same place it was in May 2014. Market turmoil led investors to move out of almost all asset classes. Nervous investors preferred bonds to stocks. Out of Municipal bonds, Taxable bonds, US stocks and International stocks, Municipal bonds were the best performing, rising 1.3% in the quarter. Taxable bonds fared next best with a -1.4% return. US stock funds, on average, declined 7.9% and the average International fund dropped 10%. Large-cap stocks outperformed mid-caps and small-caps. The best performing sector within the stock market was real estate. The worst was energy. Healthcare, which normally is a defensive place to be, performed poorly falling almost 14% in the quarter led down by the selling of biotech stocks. An observation with healthcare is that the Fidelity biotech fund was down almost 20% in the quarter which means that traditional healthcare like pharmaceuticals, were thrown out with biotech. Companies like big pharmaceuticals could be a buy.
In a time dominated by index and ETF investing, there can be opportunities if you dig through the detail. The quarter, with its August 24th min-crash, showed investors that more than ever indexers, ETFs and high-frequency traders are driving the broader markets. As a stock-picker and follower of the principles of value investing, I know I have a bias against indexing. But, I believe that the combination of index investing, ETFs and high-frequency trading brings out the worst in momentum investing. It can create a snowball that can move prices lower in a hurry without any consideration to the underlying fundamentals of individual stocks or the general market. We are in a world of quick, powerful moves. A strategy to take advantage of this needs to be developed. I don’t have it figured out but it seems that a combination of looking for stocks that have been unfairly trampled (the aforementioned healthcare example), keeping cash on-hand to buy the fierce drops, and a commitment to patience and a long-term view are the only ways to navigate the volatility that can appear.
Regardless of the poor performance and the downward pressures on the market, stocks did manage to re-group and bounce as the 3rd quarter ended. Last week was a strong one for stocks, which surprised many pundits. At the end of the quarter, pessimism was high, as evidenced by mutual fund outflows and the voices talking “bear market”. Maybe the bounce will prove to be short-lived, the result of an over-pessimistic market that was over-sold. Time will tell.
I’ll caution the bears that this bull market has weathered a lot and to underestimate it has been a bad trade. – Ian Green, BrokerageSelect
The Market: September 2015
Investors and traders will be back in full swing on Tuesday following the end of August and Labor Day Weekend holidays. Since our last newsletter the stock market took a hard and fast move down into correction territory. While we have been talking about a market correction for some time, they always seem to come from nowhere and are always unsettling. The problem with a correction is you never know until it is over whether it is just a correction or the start of a prolonged bear market. Over the past two weeks and especially after the market didn’t come shooting back, more voices were chanting the bear market chorus. Their reasoning is that as China goes so does the US and the Chinese stock market has dropped substantially. Falling oil and commodity prices, the persistently strong dollar and a Federal Reserve that may raise rates this month have led to some even predicting that the US will soon fall into a recession. I’m not in that camp and I think until proven otherwise, the economy remains ok and the stock market is still in a bull market. This doesn’t mean there are not concerns out there and constant evaluation is prudent. However, it seems premature to declare a recession when the US just posted a better than expected second quarter real GDP growth of 3.7%, wages and home prices are rising and unemployment is falling. The GDP number grew better than expected even considering that the energy sector has been hit hard by falling oil prices. If energy were better, the economy would presumably have been stronger. I also find it hard to believe that a 1/4 point increase (from zero) in short-term interest rates will bring the whole house down. We have not seen a rate increase in many years so it is understandable that there is uncertainty surrounding the outcome of the Fed’s decision, but I’m trying not to loose sight of the bigger context within which the Fed’s decision is being made. China may well be the biggest problem, but here too I think it is difficult to extrapolate a world wide recession coming from a slower China. These fears were ratcheted up by the recent decline in Chinese stock prices but those prices should not have been so high in the first place. We are talking about a market that doubled in a year’s time and now has gone back to essentially where it began 2015. Is it a harbinger of things to come? Maybe, but China is in a long term economic transition from being an exporter to being a consumer and that takes time, with many bumps like this along the way. Am I concerned about China? Yes. Will it derail the US bull market right now? I don’t think so. If the US market is in a correction then there are buying opportunities and chances to prune and adjust accounts. This is what I am doing now. When the bulls and bears hit the floor Tuesday, we will begin to see the picture a bit clearer. — Ian Green, BrokerageSelect
The Market: July/August 2015
Stocks hit an air-pocket in late June and early July over worries surrounding Greece and China. The latest round of the ever-present Greek financial drama continued with great spectacle. There were missed deadlines, intense rhetoric and a referendum where 61% of Greeks opposed more austerity. I suppose that’s not a tremendous revelation. After several years of cut-backs in a country known for generous state spending, the Greek people are in a beaten state. This weekend, the European leaders are trying to hammer out a package that will keep Greece in the Eurozone and provide another round of financial assistance. It looks unlikely that Greece can make its way out of its financial difficulties. The national debt is almost twice the level of annual GDP and with 25% unemployment, it is a big hole to get out of. It is not so much Greece itself that is worrying the market but rather the possibility that if Greece leaves the Euro, so may Italy, Spain, and Portugal. Unlike in the case of Greece, the private sector, especially banks, owns Italian, Spanish and Portuguese bonds. Leaving the Euro would certainly cause a crisis that could trip up the global financial system. For this reason, it is probable that the European leaders will work to keep Greece in the Euro. While the Greek tragedy was playing out, a new character walked onto the financial stage to cause more worry for investors. The Chinese market’s Shanghai Exchange, fell 30% since June 12. This steep decline in such a short time, sent out fears that the Chinese economy will slow more than anticipated and put more pressure on natural resource stocks and US industrial and consumer exporters. I have written in past issues of this letter that of the many concerns in the markets, China is the one that bothers me the most. The Chinese command economy has supported many inefficiencies that eventually will have to be sorted out and some amount of pain will have to be borne. The political regime is so concerned about domestic political stability that it intervenes to pour money into the economy instead of allowing the system to wring out excesses. Even in the recent Shanghai market decline, the government has intervened to try to keep stock prices from falling. The Chinese government has a lot of money to do what it will but nothing lasts forever. Expansion and recession are not pleasant but they are facts of economic life. Using the US as an example, during the rapid industrialization and urbanization in the 19th century there were many booms and busts. Despite the cycles, the US continued to grow and to develop. I don’t think this is the final act in China’s development and I don’t think the volatility in Shanghai shares will derail the global economy. Not yet, anyway. Remember the Shanghai market doubled from December 2014 to June 2015. I still suspect the US market will grind higher over the course of the year. — Ian Green, BrokerageSelect
The Market: June 2015
Friday’s Labor Department Employment Report came in much stronger than expected with 280,000 people finding new jobs in May. This report capped a string of solid economic reports that point to the US economy rebounding from a weak first quarter. The stock market doesn’t really know how to view the improvement. On one hand, an improving economy should lead to better corporate profits which should move stocks higher. On the other hand, a strong economy should push the US Federal Reserve to increase short-term interest rates. It reminds me of the story of a frustrated Harry Truman shouting, “Give me a one-handed economist!” The fear that investors have regarding a stronger economy and the possibility of resulting higher rates is not new. The S&P500 is trading at just over 18 times trailing earnings. That’s not cheap. No one is certain how much of this large multiple is due to short-term rates being zero and whether this premium will deflate if the Fed hikes the Fed Funds rate. It’s the multi-billion dollar question. Mathematically, higher rates reduce asset valuations. The only offset to this downward force is corporate earnings. Many factors came into play in the first quarter that hurt profits. Winter weather dampened economic activity in the northeast and midwest. The collapse in oil prices wrecked the energy sector. A West Coast port strike disrupted supply chains. The US dollar spiked which reduced profits earned overseas, a big component of S&P500 earnings. The good news is that all of these issues that crimped profits in the first quarter are either not present or lessened so far in the second quarter. Plus, the European economies have picked up this quarter which should benefit US companies doing business there. The pieces are in place for corporate profits to show an upside surprise this quarter. So how does the summer play out? Of course no one really knows and investors should not focus on the short-run. Having said that, I don’t think the bull run is over. Aside from the interest rate question, the Greece situation will likely be resolved with some accommodation on both sides and the can will get kicked down the road. This should give a boost to the stock market. I think earnings will come in better this quarter. The Fed is likely to wait until September to raise rates and the market could be weak come late July and into August. If the Fed moved in September the initial reaction will be for the market to sell off. However, I think the sell off will be short. One or two rate increases is not enough to significantly reduce the market multiple and stocks should resume their trend higher. Financial Services stocks look very good in an environment where rates are a bit higher and the economy is performing well. Bonds may have a rougher time than stocks as rates moving up from very low levels have a meaningful impact on bond values.— Ian Green, BrokerageSelect
The Market: May 2015
Yesterday’s employment report was “just right” – not too good as to send rate hike jitters through the markets and not too weak to bring out fears of low corporate profits. The middle of the road report brought out the buyers and the Dow Jones Industrials rose 267 points. The markets are a whisker away from all-time highs. Mind you that earlier in the week the market prognosticators were moving to the bearish camp and calls for the long-awaited correction were abundant. The resilience of this bull market is impressive. On pullbacks, buyers step in. Many have named this bull market “the most hated in history”. I’m not sure if that statement is true but certainly, the market has impressively climbed the “wall of worry”. I have felt and still do feel that the market will experience some form of correction this year, perhaps a 10-15% decline. Maybe my reasoning is too simple but given that in the recent past, seasonality seems to spook investors and given the quick sell reaction to hints of a Federal Reserve rate hike, there will be some period of decline this year. The conventional wisdom holds that the Fed will raise rates in September. This fits into the narrative that the market has a seasonally difficult time in late summer and early fall. Having said this, I do not think the bull market is over and I would suspect that any sell off would be met with buyers. What this means to my portfolios is that I still would like to slowly build cash in the accounts to have some dry powder to put to work in the event of a correction. I was of the mind to target 20% cash by the summer but that might be too much given the market’s resilience and my expectation that the economy is doing ok. Even if we get a rate increase, it will be small and more symbolic than an effort to tighten monetary policy.— Ian Green, BrokerageSelect
Over a beer at the Yankees game, an economist friend told me he believes the Fed will not raise rates until 2016. His reasoning is that the Fed’s own targets for doing so, 2% inflation, higher wage rates, and stronger GDP have not been met and are unlikely to be met this year. If he is right, there might not be a meaningful correction this year. On the corporate earnings front, the numbers came in better than many were expecting given the overall GDP weakness. According to FactSet, of the 447 companies in the S&P500 that have reported to date, 71% reported profits above estimates and 45% had revenues that exceeded expectations. Of course the estimates had been adjusted lower throughout the 1st quarter as the oil price decline, dollar strength, weather and port strikes on the West Coast put pressure on profits. 1Q15 earnings growth came in at a 0.1%, which is very weak, but nevertheless beat the expectations of -4.7%. Looking ahead, the negative pressures that hurt 1Q15 are receding. Plus Europe’s economy seems to be sending out “green shoots”. Again, evidence that the bull is still running. — Ian Green, BrokerageSelect
The Market: April 2015
Despite the sound and fury, the Dow Jones Industrials and S&P 500 were almost unchanged for the first quarter. The NASDAQ did better, turning in a 3.5% return for the quarter. Stocks were tossed around by a trifecta of worry. A rising US dollar, falling oil prices and the specter of the Fed hiking interest rates kept investors off balance. In March, the Dow Industrials moved up or down at least 100 points in 16 of the month’s 22 trading days. My view on these three concerns is that they might cause a correction but will not derail the bull market. The rising US dollar worries investors because US companies need to present their financial results in US dollars. Much of the S&P500 earns a majority of its profits overseas. If the dollar strengthens the profits earned overseas become reduced in translation. My view is that this is a short-term concern and doesn’t impact the long-term value of companies. I’m also not convinced that the impact is that severe in the short term. Multinational firms, like Coca-Cola, Procter & Gamble, and IBM have facilities and cost structures all over the globe, mitigating the US dollar impact. Despite the press, the evidence of a correlation between the US dollar and US stock prices is not convincing.— Ian Green, BrokerageSelect
Lower oil prices are a mixed bag as well and difficult to tell how they will impact the overall stock market. Surely, lower oil prices hurt oil producers and the companies that provide services to them. Energy companies make up about 16% of the S&P500. The flip side is that lower energy prices help consumers so there will be an offset with better earnings from consumer companies. Unfortunately, the impact of lower oil hits the energy companies before the benefits can work their way through to consumers. Over the next couple of quarters, oil will hurt overall S&P500 earnings. If oil prices stay low for a protracted period such that we see a good number of bankruptcies in the oil patch, a deep correction could well be in the cards. We are not there yet. This leaves the Fed. I am in the camp that when the Fed actually makes the first rate hike, the stock market will fall into a correction, maybe a deep one. There were jitters in the quarter that the first-rate increase could come as soon as June. — Ian Green, BrokerageSelect
The Market: March 2015
February saw the market recover from January’s losses. Despite the positive performance, February still frustrated investors. There were 11 down days and only 8 up days in the month’s trading. It certainly illustrates how hard it is to time the market. In February, an investor had to be in the whole month to achieve the upside. March has not started off well. Friday’s 279-point rout has left the market down 1.6% in March. We have a down January, an up February and so far a down March. It feels like the market is sensing constraints. I have written several times in this column that in the long-term, earnings and liquidity drive markets. There are real concerns with these two factors. The 50% decline in oil prices has caused a rapid decline in earnings estimates for oil producers and related oil service companies and vendors. Energy companies make up 16% of the S&P500. FactSet has estimated that for 2015, S&P500 energy companies will have an earnings decline of almost 54% from 2014 levels. The weakness in oil prices will undoubtedly put pressure on overall S&P500 profits. The market right now trades at 17 times 2015 earnings estimates. While not at greatly extended levels, a P/E of 17 is not cheap. A high P/E makes the market vulnerable to downward estimate revisions. If oil prices do not revive, and a prolonged slump is felt in the “Oil Patch”, the market will have difficulty moving upward. — Ian Green, BrokerageSelect
Yesterday’s Labor Department jobs report for February showed a much larger than expected increase in employment. Some 295,000 people found work. Wages also budged higher. The strength of the report has given investors concern that the Federal Reserve will increase short-term rates sooner and higher than previously expected. All else constant, higher interest rates are not good for stocks and especially not good for bonds. Fed Funds futures contracts are implying a 22% chance of a rate hike at the June 17th Fed meeting. There is now a 91% probability that rates will be higher by the end of the year by at least 0.25%. While earnings and interest rates are a concern, they do not necessarily mean a bear market is imminent. Nor does it mean that investors should sell all their positions. However, I do think that caution is warranted and perhaps an increase in cash in customer accounts should be considered.
The US economy, outside energy, appears to be doing well. Low oil prices and more jobs should be a plus when it comes to consumer spending, which is 70% of the economy. Bear markets usually do not appear when the economy is not heading to recession. As to interest rates, the speed and absolute level of rates matters most. Historically, the markets weather the first rate increase rather well. There is also the question of how long oil prices will remain depressed. I’m still in the bull camp but at a P/E of 17, the market is suspect in the short-term. — Ian Green, BrokerageSelect
The Market: February 2015
In January did as it did last year and gave investors a New Year’s hangover. The S&P500 was down 3% for the month. Smaller companies, as measured by the Russell 2000, were down 3.25%. Falling oil prices, concerns about Europe and whether the two would hurt corporate earnings dampened the “animal sprits” of the markets. February so far has seen a recovery in stock prices to levels just shy of where they began the year. Just as oil and Europe gave reasons for investors to sell in January, it was oil and Europe that brought buyers back to stocks. Oil prices have recovered a bit from their lows with both Brent and West Texas grades moving back above $50 a barrel.
European stocks moved higher as the European Central Bank announced plans to buy a variety of securities to flood the Eurozone with money. Overall the stock market in 2015 is struggling to find its footing. Today stock markets in Europe and in the US were down as focus has shifted back to that monster under the bed, Greece. This tiny country at the edge of the Eurozone has caused aggravation since the financial crisis began in 2008. The high debt and poor economic fundamentals made Greece the example of Eurozone faults and thrust the country square in the debate as to whether austerity works to solve financial crises. Greece held elections at the end of January and the far left party won. No surprise. After six years of depression, Greek voters want to cut a better deal with its creditors, namely the European Central Bank and the International Monetary Fund. The negotiations are afoot. The truth is the Greeks can not repay their debts and something has to give. Greece itself is very small and a default is not, in the grand scheme of things, that meaningful to the global economy. However, if Greece leaves the Euroland, a Pandora’s Box (ah, we owe so much to the Greeks) of issues will be opened. The most critical is if it means that Italy and Spain leave too. For now, my guess is that the unthinkable will remain the unthinkable and some compromise will be reached that keeps Greece in the Euro and changes some terms of the debt. There is a lot ahead for the market to digest.
Oil prices are going to be up and down as they try to find a bottom. We talked about Greece. There is still Russia. There are still questions about growth in China, Japan and Europe. My sense is that the market wants to go higher and will “climb the wall of worry” as the market always seems to do over time. Conflict, pessimism and points of maximum uncertainty are the sign posts of opportunities for careful investors. I think energy stocks, some Russian stocks and many European stocks are compelling values here. In these areas, there is great pessimism, uncertainty and very low expectations. Buying low and selling high is the name of the game. — Ian Green, BrokerageSelect
The Market: January 2015
January is the month for predictions and forecasts. While they are fun to read, the evidence shows that beginning of the year predictions seldom come true. All facets of life, including the financial markets, are the product of complex systems with many variables that lead to a wide range of outcomes. With a large number of potential results, it is useful when examining predictions to try and put a probability to the events predicted. This too is difficult and fraught with error but it does at least attempt to narrow down a strategy for the coming year.
If predictions are practically worthless, what is an investor to do? The answer is research with constant evaluation and adjusting of portfolios as time moves forward. It should be a dynamic process. Despite everything I just said about the limitations of predictions, I go back to the fun part. So let’s have some fun. I’m devoting this entire issue of the newsletter to my predictions regarding the most topical market subjects that we see today. As a test to see if you are reading the newsletter, let’s have a contest. Please send me your prediction for the closing value of the Dow Jones Industrial Average on December 31, 2015. I’ll figure out some prize or way that we can all pay homage to the winner for his/her clairvoyance, luck or skill. Before we get to 2015, I’d like to take a look back at 2014. I am constantly evaluating client accounts, especially at year-end to see what is working and what is not.
analysis of 2014 shows that it was a year with a bifurcated market where large company shares significantly outperformed small stocks. The S&P500 was up about 13.5% while the Russell 2000 (small company index) was up just under 5%. The S&P500 return was itself skewed to the largest of companies within the index. For example, Apple contributed to 9% of the rise in the S&P500. Similar results were present in the accounts I manage, with the larger holdings performing much better than the smaller positions. The concentrated 2014 rally made it tough for stock-pickers. I certainly was not happy with my performance but I was comforted somewhat by joining the likes of John Paulson and Leon Cooperman in having a less-than-stellar year. From my perspective, where I got it wrong was that I anticipated a stronger global economy in 2014. I was correct that the US economy would pick up in the second half of 2014, posting 5% growth in the 4th quarter. Where I was wrong was that Japan, Europe and China did not accelerate. The persisting weakness in these key economies cast a pall on the industrial names where I saw and still see compelling values. Certainly 2014 showed that these stocks were cheap for a reason. Where I was right was adding exposure to retail and keeping exposure to leisure stocks. Lower oil prices helped these names. Please read on for more reflection on 2014 and thoughts for 2015. — Ian Green, BrokerageSelect
The Market: November 2014
As discussed previously, September and October have reputations as volatile and down months. This year certainly proved the assertion true. The bears had plenty of ammunition to sell stocks. There was continued geopolitical turmoil, weak economic numbers out of Europe, and a Federal Reserve that discontinued quantitative easing. In addition to these concerns, there was a surprise move by Saudi Arabia to lower oil prices. That’s right – lower prices. There may be several motives for the Saudi strategy -an attempt to gain market share or to put economic pressure on its enemy, Iran. We may never really know. The most obvious impact was that oil stocks fell sharply, especially small-cap energy producers that are more sensitive to changes in oil prices than large, integrated companies. Energy companies comprise about 11% of the S&P 500, so the impact was felt beyond the energy sector to the broader indices. To further the October stock market woe, Mr. Market interpreted the Saudi price cut as a signal that the global economy is weakening, adding fuel to the bearish mood and put more downward pressure on stocks. The downdraft in stock prices was very uncomfortable. It was quick and deep. I think the exchange-traded funds and the algorithmic trading strategies assisted in creating the volatility. The current structure of the markets with the proliferation of index funds and electronic trading is going to make steep, fast drops and congruently quick recoveries, part of the normal life of the markets. We need to accept that and plan accordingly.
As I write this column we are in the midst of a recovery from the September/October correction. Throughout 2014, smaller companies’ shares have performed poorly compared to large companies. Consistent with this, shares in small companies fell further in September and October than large companies and in the recovery that began at the end of October, small stocks have not risen as much as the large ones. I think the relative under-performance of small-caps is due to the concern that the global economy is slowing and that small companies will have less wherewithal to maintain proﬁts. The question of global growth or lack thereof will be front and center as we move from 2014 to 2015. The US economy has been doing relatively well vis-a-vis other high income countries. As the third quarter earnings reports for the S&P 500 are almost all in, we see that 77% of the companies reported earning that were higher than estimates and 60% had revenues that exceeded estimates. This is good news for the bulls. If earnings continue to rise then the bull market should continue. It is unclear whether small-caps will catch up to larger ﬁrms. Small-caps need conﬁdence and that may come back only if investors see better growth in Europe and Japan and whether China can maintain its growth. — Ian Green, BrokerageSelect
The Market: October 2014
It seems to me that the geo-political world order runs like a casino blackjack table. There exists a set of game rules called The Basic Strategy, which you can buy at the casino gift shop to show you what to do when you have a certain hand and the dealer is showing a certain card. Even though the game’s odds are in the house’s favor, as long as all the players at the table abide by the rules laid out in The Basic Strategy, everyone is happy and the game moves along. Blackjack tables become acrimonious when one or more of the players fails to employ The Basic Strategy and begins to split 10’s, or hit when the dealer shows a six. A happy table quickly sours. The real world events of the past month are analogous to just such a card game. Players like Russia and ISIS not being rational, add to that some Ebola and nervous central bank watchers and the harmony of the global markets dissolves. Last month I wrote that September and October can be rocky periods for stocks, and so they have been. Stocks as well as commodity prices and interest rates have been in sharp decline as the events mentioned above create worries about the health of the global economy. Algorithmic trading and high frequency trading have added to the volatility. Regardless of the fears and maybe because of them, I still believe that the decline in stock prices represent a correction and not the start of a bear market. It is also amazing to me how the conventional wisdom can change. A few weeks ago oil prices were thought to be heading higher with analysts calling for prices to rise to $120 per barrel.
Today I heard an analyst calling for oil to fall to $40 per barrel. I have found that when you hear extreme predictions, the best trade is to go the opposite way. Falling oil, while bad for oil companies should be good for consumers: with gasoline prices at the pump below $3 per gallon, consumers’ disposable income increases, beneﬁtting retailers, restaurants and perhaps casinos. Interest rates have come down, pushing mortgage rates lower. Some banks are reporting an increase in reﬁnancing applications. This too should add to the money consumers have in their pockets to spend. Also helping consumers is the strength of the US dollar. The US dollar, despite the rhetoric about our central bank ruining our currency, has actually appreciated. In part this is due to actions by Japan and Europe to weaken their own currencies to stimulate their economies. A stronger dollar makes imports cheaper. As we all know the US imports more goods than it exports so a higher dollar results in a net savings to the country. As I wrote last month, a correction would, to me, be a buying opportunity I am looking at sectors that have been hit hard like energy but also at consumer stocks and US and non-US companies that would beneﬁt from a relatively stronger US dollar. — Ian Green, BrokerageSelect