Here is our monthly view of the financial markets and some of the thoughts that go into our investment decisions.

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 stock market had a big up week as an economy that is re-opening, hopes for a vaccine and the fear of missing the rebound motivated investors to buy. While the initial rally off the March low was led by social media stocks, the FAANGs and technology, the past two weeks have seen a broadening of the advance. The optimism over the rebound brought the buyers to the banks, travel stocks and cyclical industrials. Last week was really a catch up trade for many of the hardest hit areas of the market. The small-caps performed well last week with the Russell 2000 Index up 7.1%, outpacing the S&P500’s 4.6% gain. Even with an impressive week, small-caps are significantly behind large-caps for 2020, by about nine percentage-points. There are valid arguments for the laggards to continue to catch up. An important one is investment manager career risk, meaning that for those managers who have missed the recovery rally, stocks that have lagged are reasonable ways to catch up to peers. Managers don’t want to miss their benchmarks for fear of being fired. The Nasdaq-100 has already recovered to it’s pre-lockdown levels. The Financial ETF is still 15% off its high. The Regional Bank and Industrial ETFs are 20% and 12% off their 2020 highs, respectively. As we move forward, the market will have to continue to climb a wall of worry. New cases of COVID are likely to rise as the states re-open. Whether the public or the authorities will care is another question. We’ll find out soon enough if our society has lost interest in the Coronavirus. While momentum is on the side of the bulls, the market has moved up very quickly. Right now, over 90% of stocks are above their 50-day moving average. How much fuel is left in the tank? With all the central bank liquidity, maybe a lot. Investors should be cautious and keep to their discipline and allocation targets. Trimming positions that have gone up a lot and resisting the temptation to reach for returns are valid. Nothing goes up in a straight line.— Ian Green, BrokerageSelect

 

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

From its high on February 19 to its recent low on March 23rd the S&P500 dropped 35.6%.  Not only was the decline of significant magnitude, the speed of the fall was the fastest since the 1987 Crash.  The deep and quick drop in stocks was accompanied by disruptions in most asset classes. Corporate bonds declined as investors feared defaults.  This was especially true in the High Yield market.  All this was in anticipation of what will likely be a signifiant recession brought on by Coronavirus and the intentional shutting down of economies around the world to save lives.  In the US, to mitigate the economic impact of the virus, there has been a massive monetary and fiscal response.  In all likelihood, there will be more stimulus to come.  The Federal Reserve has essentially said it will do whatever it takes to keep liquidity in the various markets and buy most classes of debt instruments to allow companies to continue to fund themselves.  The Congress, through the Treasury, will send out money to individuals and whole industries in an attempt to make up for lost income. It is truly a massive effort to meet the crisis head on.  After the moves by the Fed and Treasury, the high yield and corporate bond markets stabilized and stocks rallied, bouncing 20-25% off the lows.  The rally has been led by the mega-cap companies.  Small stocks have lagged.  On Friday, however, small-cap stocks, led by banks joined the relief party. With much of the stimulus flowing through the banks, there will be fee income to be had and money for borrowers to repay existing debts.  The relief rally has given the market a shot of optimism. I remain cautious. No matter how much the government throws into the economy, it will not create a cure or vaccine to neutralize the Coronavirus.  It will take at least a year, maybe two, for a vaccine to be available. No medicine has yet been shown to work.  Until then, the economy will continue to be fragile. Even when the economy emerges from lockdown, will people in large numbers return so quickly to restaurants, airplanes, and workplaces? I can easily see stocks and bonds slipping lower from current levels.  Could stocks to fall below the March 23rd low? Possibly.  However, that would likely be a short-term phenomenon. As time moves forward, the vaccine and/or an effective treatment will be closer at hand.  As the recovery process continues, investors should selectively add quality stocks to their portfolio, keep to their long-term strategies and maintain appropriate asset allocations.  After the crisis has abated, there will be massive amounts of liquidity  in the system. It will take time before the Fed can or will drain the pool of liquidity. Money finds its way everywhere and financial assets could rally significantly. — Ian Green, BrokerageSelect

The Market: March 2020

First, before any commentary, it is important that while this newsletter deals with dollars and cents, when discussing global crises we keep in our minds and hearts the human cost, difficulties and sometimes tragedies that go along with events.  We are not experts in health or politics. We have some insight into how investors behave and how investments may be priced or mis-priced.  It’s apparent that the Coronavirus infection rate will continue to rise.  There is little doubt that the measures to contain the virus such as working from home, closed facilities, canceled events and a general sense of caution will have a negative impact on the global economy.  This is not to say that these measures are not correct and necessary, it is just a fact.  Markets discount the impact of events before the actual numbers appear.  The decline in stocks and corporate bonds is the market discounting future negative economic news. The question is whether these markets have discounted enough or is more to go. I might suggest that the markets may have priced in one to two quarters of flat to negative economic growth.  If the contagion lasts longer, the economy will be in a slump for longer and I think the markets will have to continue to adjust.  During these conditions the two preeminent competing urges that are present in the minds of investors are at their peak.  One is fear.  The other is greed.  One can make a case that investors should sell everything and wait for the virus to dissipate.  The correction in stocks we’ve had could easily become a 40% bear market.  Conversely, many stocks have fallen sharply and now have low P/E ratios and/or high dividend yields.  As Warren Buffett likes to quote from the book Reminiscences Of A Stock Operator, “be greedy when others are fearful”.  I think there is a middle path.  Market declines are a chance to evaluate a portfolio. It’s hard to sell everything. You may need the income. It’s also impossible to come back in at the bottom and you could  miss a big rally when the coast is clear.  What may work is pruning the portfolio – selling positions you really are “so-so” about and trading up to better quality names.  Buy the stocks you always wanted to own but you thought you missed them.  Smart investors focus on the long-term.  Taking a short-term loss to buy shares of a company that will work for the long haul makes sense.  Investors shouldn’t panic but rather occupy their minds with the idea that they are being strategic.  Asset allocation should also be addressed. Are you over-weight a sector or an asset class?  Make adjustments but don’t, in a panic, change your long-term investment plan unless your needs and goals have really changed. — Ian Green, BrokerageSelect

The Market: February 2020

After a strong run-up to the end of 2019, the market began in 2020 with an upward bias that stalled as the Coronavirus began to spread in China. In response to the contagion, China has sealed off cities and transport to and from China has been reduced. The Coronavirus situation will reduce global GDP which will certainly put pressure, in general, on corporate profits. Certain industries like airlines, casinos, and technology will see a greater impact. The news surrounding the virus is not good but the markets have a way of discounting information. After a few down trading days, stocks rebounded. The stock market is either anticipating that the impact of the virus will be limited and/or investors believe the world’s central banks will add stimulus to their economies to help offset the dampening effects of the Coronavirus. Whatever the reason, for now, stocks want to move higher. Until proven otherwise, the Bull Market remains intact. Events like the Coronavirus usually are buying opportunities. Regardless of the trade issues of 2019 or the Coronavirus of 2020, China will continue to grow and continue transitioning from manufacturing-centered to a service-centered economy. The consumer markets in China have enormous potential led by giant internet/technology platforms with a scale much larger than the US. This is a good place for the patient, long-term investors to find buys. Similarly, companies in Asian economies that trade with China like South Korea, Japan, and Taiwan also will be places to look for opportunities as those stock prices have also been impacted by the situation in China. Setting aside China, the massive run-up in “disruptor” companies like Tesla, Amazon, and Shopify and in “big tech” like Apple and Microsoft should give even the most ardent Bulls some pause. Asset prices get riskier the higher they are valued. The market’s price to earnings ratio is moving up faster than profits. With a P/E of 19 and overall corporate earnings down for the past few quarters, the stock market is vulnerable to downdrafts. — Ian Green, BrokerageSelect

The Market: November/December 2019

As we look back on 2019, the headlines were terrible.  “Trade Wars”, “Impeachment”, “Iran”, “Brexit” and “China” dominated the news cycle.  Add to this the cacophony of pundits talking about “recession” and it is no wonder that investors pulled $135.5 billion out of equity mutual funds and ETFs during the year.  It has been the largest withdrawal from stocks since 1992.  Yet, the US stock market performed well in 2019.  Who was buying? Corporations continued to buy their own shares and non-US investors flocked to the safer shores of the US.  Some lessons were learned.  First, when it comes to the stock market, the conventional wisdom is often wrong.  Second, the headlines are not good barometers of the right time to invest.  If you have a long investment horizon, trying to time the market or “waiting until the coast is clear” can cause investors to miss good years.  Steady, continuous investing through the ups and downs and through the uncertainties has shown to be the best long-term strategy.  The market is difficult to predict because there are so many factors that go into stock prices.  For instance, a reasonable criticism of the market is that corporate profits have been down for three consecutive quarters.  Lower earnings should mean lower stock prices.  However, earnings, while critical are not the only input.  The level of interest rates are also important.  In 2019, declining rates have offset profit concerns allowing stocks to rise.  In addition to the many factors, markets reflect the future.  Stock prices anticipate future events.  Some say 6 months in advance. Perhaps the stock rally over the past week is telling us that the recent streak of lower corporate profits is about to end.  The commentators will fill in the blanks with reasons after the market moves.  So what’s in store for next year?  The pundits will once again throw out their “Up 10% Forecast” which almost never happens.  I won’t attempt to make any predictions but I will make some observations. There are parts of the market that have underperformed for some time, namely financials, small-caps, and emerging markets. Recently we have seen these sectors pick up.  They are under-owned by Wall Street.  Seems like this could be a set up for these areas to do well.  Along with financials, energy and retail are very unloved.  We know the reasons.  Fossil fuels are destined to go away.  Amazon will destroy all retail.  As we noted earlier, given the conventional wisdom is often wrong, these corners of the market might be worth looking into. Oh; let’s not forget about the $135.5 billion that abandoned stocks?  Will some or all of it come back?  As the Presidential Election moves into earnest, all sorts of fears will swirl in the press.  I encourage investors to stick to their financial plans and asset allocations and stay on track. I wish everyone a meaningful, quiet, peaceful and fun season of holidays. — Ian Green, BrokerageSelect

The Market: October 2019

It’s hard to believe 3/4 of 2019 is already in the books.  The lingering trade war with China and the prospect of more trade wars with Europe and any other comers has created uncertainty in corporate boardrooms and with investors.  As a result, the US economy has not been able to sustain the momentum it had following the revamping of the corporate tax code.  In fact, some of the recent data is more concerning than just a loss of momentum.  Last month the ISM Manufacturing Index came in at about 47, the worst reading since 2009.  A reading below 50 means that US manufacturing is contracting. In response to weakening signals in the economy, the Federal Reserved cut interest rates for the second month in a row.  Fed action and continuing signals from The White House that a resolution to the trade issue is imminent, has kept the stock market from falling.  Having said that, following the ISM Manufacturing report the Dow Jones Industrial Average declined over 300 points.  This begs the question, “How long will the market remain patient with the back-and-forth over trade?”  While trade is most likely the primary concern for stocks, there are two other factors that I am concerned about.  The first is Brexit. On one hand, the UK economy is not nearly as big nor as important to global growth as the US or China. Any damage from a UK “crash out” should in the intermediate and long-term be relatively benign to the global economy. However, economic activity is set on the margin and any fall-off in global demand will be felt in the short-run.  The second bearish observation to note is the failure of WeWork, a darling of the private equity unicorns, to garner enough investor interest at the desired price to pull off an IPO.  While much as been written of the high valuations of the FAANGs, the most over-valued space in the marketplace looks to be in private companies that have gripped the private equity and venture capital world with the promise of “disruption”.  Each new round of private financing brought, on paper and within the private capital world, higher and higher valuations despite little or no profits. The public markets are more discerning. Recently, when the private investment world has ventured into public offerings, the results have not been good. Uber, Lyft, Slack and others have seen their stock prices drop significantly since their IPOs. Public investors want to see a path to profitability. They also are not happy with stock offerings where the proceeds go to the private owners, not the company itself. Why buy from an insider who is selling? Bull markets end when excesses become extreme and investors finally pull back. It is possible we are witnessing the beginnings of a re-pricing of companies. I’m not suggesting the end is here. I think a trade deal will come and the market will rally. However, I am concerned that the late innings of this bull market are close if not here. — Ian Green, BrokerageSelect

The Market: September 2019

We are back from the summer and the stock market is, despite some big up and down days, pretty much at the level where it began the summer.  The bond market is a different story, interest rates in the US and Europe steadily declined throughout July and August.  More than $14 trillion of bonds yield negative interest rates. Rates and bond prices move in opposite directions and as rates have fallen, returns on bonds have been stellar.  From July 1 to August 30, the US long-bond was up just over 11%. This compares with a 1% decline over the same period for the S&P500.  Globally, investors are clamoring for “safe” assets.  Government bonds, gold, consumer staples stocks, utilities and REITS have seen positive inflows and prices that have been bid up.  The markets are trying to grapple with several factors and investor appetite for “safe” assets is a reflection of the concerns.  The global economy has been slowing, causing many to fear that a recession is inevitable.  Whether the escalated trade war is the cause of the slowdown or whether the conflict has just increased the pressure on the brakes, trade is nonetheless an important factor. Any positive resolution would be bullish for stocks and would likely cool off the bond rally.  Perhaps an under-rated concern is Brexit.  Maybe the markets were desensitized given that Brexit has been in the news for so long.  However, as the October 31 deadline is rapidly approaching, the separation of the UK from the EU has become real.  It’s understandable how investors have been behaving.  Trade and Brexit add great uncertainty for businesses and consumers. Both hold back expenditures which slows the economy and puts a question mark over future corporate earnings.  The uncertainties may ultimately lead to recession and the “safe” assets that have been so popular will continue to work well.  However, a word of caution.  As an asset’s price goes up, so does the risk.  What is “safe” today might become “risky” tomorrow.  If there is a resolution on trade and Brexit, investors will exit the “safe” assets all at once and the prices of these assets will tumble.  With this in mind, the important lesson for investors is that they should stick with their financial plan and asset allocation regardless of emotion and fear or greed.  Similarly, investors should maintain a balanced asset allocation that incorporates “safe” assets and “risk” assets, consistent with long-term goals.  Rebalancing becomes essential so as to not let certain asset classes or sectors become too great a percentage of total assets.  It’s also important to not let fear keep you out of the markets.  Missing the big up days can reduce returns dramatically.  Fidelity looked at the growth of $10,000 invested in the stock market from 1980 to 2018.  If an investor missed the five best days the growth of $10,000 was reduced from $708,143 to $458,476.  It is time not timing that matters.   — Ian Green, BrokerageSelect

The Market: May 2019

The stock market is gripped once again by the US-China trade negotiations.  The US has upped the ante by increasing tariffs on $200 billion of goods imported from China.  President Trump has threatened to expand the list.  China has retaliated and could consider other measures.  It may well be that the threats and negotiations will go on longer than most have been expecting.  At this point it is unclear what a win looks like to either side.  While most believe it is in the best interest of both countries to get a deal done as quickly as possible, the two sides may not be able to deliver.  The markets have been down in response to the escalating trade tensions but this is after the market hit fresh highs. It seems that the trade issue will hang over the market, dampening any good news.  Earnings for the 1st quarter came in better than most feared.  According to FactSet, with 90% of S&P500 companies reporting, 76% of S&P500 firms beat their earnings estimates and 59% reported positive revenue surprises.  The markets are a game of expectations. The earnings beats drove stock prices higher but it is important to note that earnings were actually down 0.5% when compared to the same period last year. This is the first decline in earnings since the 2nd quarter 2016.  Analysts forecasted that earnings would be down 4% from a year ago.  Being less bad than expected is good. The S&P500 trades at 16.5 times earnings which is about the average for the past five years. The market is not cheap but also is not extremely overvalued, especially considering interest rates are so low.  The earnings picture  for the second quarter isn’t shaping up to be great.  Sixty-five of the 500 companies have offered lower profit guidance versus just 17 companies guiding higher.  This makes the trade issue more concerning. It’s one thing to introduce some profit uncertainty when earnings are rising.  It’s another when earnings are soft.  While 16.5 times earnings is within the market’s recent average, if the earnings component to the calculation declines, the price-to-earnings ratio will increase, adding to the precariousness of the market.  I would suggest that investors today need to be more cautious than in the past because the computer algorithms can take hold and sell programs can be triggered.  As we have seen in today’s market structure, without an uptick rule or market-making specialists, selling can become relentless.  This is what happened in the 4th quarter 2018.  With computer-driven trading taking up an ever-larger portion of daily volume, it seems like the markets move around in the short-run irrespective of the fundamentals. Despite the fierce ups and downs, the stock market has not really gone anywhere in 15 months.  Investors need a robust portfolio with quality growth, value and cash reserves to withstand the downdrafts, to take advantage of buying opportunities and to participate in the upswings.   — Ian Green, BrokerageSelect

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

I chose the cartoon for this month to provide not only humor but also a clue to figure out when this bull market will end.  Market cycles, to a large extent, are based on psychology and participation.  Bottoms occur when everyone is pessimistic and no one wants to own the particular asset.  Conversely, when everyone is excited and everyone has crowded into an asset class, a top is near.  Recall not long ago oil prices were falling and analysts were calling for a protracted bear market with prices per barrel potentially going into the teens. One popular commentator said that oil, “Would not go above $50 in my lifetime.” Well, a year after this prediction, oil is now $75-$80 per barrel.  Our squirrel friends are examples of when we should be worried about stocks. It’s when investors and pundits start saying that stocks will go up forever and predictions like Dow 100,000 hit the headlines, the bear is coming.  When you read stories of more and more people quitting their jobs, like Mr. Squirrel, to trade the market, clouds are on the horizon. In late bull markets, investors clamor for ever more risky stocks a la dot-com companies in 1999 where companies with no revenues and often no employees were richly valued.  I don’t think we are there yet. Since the 2008 financial crisis, investors may have been buying stocks but have done so warily and without enthusiasm.  There have been some high profile IPO’s but nothing close to a mania. There is data that shows that many have not gotten back into the markets even though 10 years have passed since the 2008 debacle.   The Crisis is still fresh in people’s minds. Now one could argue that there are other assets that have absorbed the market’s speculative tendencies. The cryptocurrency phenomenon comes to mind as do the high prices in commercial real estate and in the large flows to private equity and venture capital partnerships. There may be an argument that there are more asset classes than in the past for speculative money to flow and that stocks are less exciting and therefore the bull market in stocks can last longer.  In the first instance, markets go down not due to selling pressures but rather the result of everyone who is going to enter the market being in, leaving no one left to buy more.  The rock begins its roll down the hill due to its own weight. Once the market heads down, then the selling comes in.  As long as there is  appetite for stocks and there are buyers to come in, the bull run can last.  The Nasdaq Index gained 22% in 1997, 40% in 1998 and surged 86% in 1999 before the 2000-2002 bear market.  History may be a guide and we will see a big, blow off top like we did in the late 1990’s where buyers get sucked into the surging markets in big numbers before we reach the top of this bull market. If a big move up does occur, it may not be of the magnitude we witnessed in 1999 but it may nevertheless serve as a warning. — Ian Green, BrokerageSelect

 

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 earn a majority of their 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. The 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 the evidence of 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 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 undoubtably 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-tern 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