Broken Records or Records Broken?

Rearrange the two words “broken” and “record” and combined they have two totally different meanings. A broken record is akin to your financial planner repeating over and over again about saving more and spending less. A record broken conjures up images of olympic athletes taking their craft to higher, never before achieved heights.  We also hear it often when referring to never-seen before stock market levels.

We’ve all heard it said: “Records are made to be broken.” We celebrate record-breaking winning streaks from our favorite teams and athletes. Conversely, we hope to avoid a long string of losses.

The bull (up-trending) market that began in 2009 is not the best performing since World War II (WWII). That title still resides with the long-running bull market of the 1990s. But it is the longest running since WWII (St. Louis Federal Reserve, Yahoo Finance, LPL Research–as measured by the S&P 500 Index).

In the same vein, the current economic expansion is poised to become the longest running expansion since WWII. For that matter, it’s about to become the longest on record. According to the National Bureau of Economic Research, which is considered the official arbiter of recessions and economic expansions, the current expansion began in July 2009. It has run exactly 10 years, or 120 months, matching the 1990s expansion (see below table).

Economic Scorecard

Expansions Length in Months
July 2009 -? 120
Mar 1991 – Mar 2001 120
Feb 1961 – Dec 1969 106
Nov 1982 – Jul 1990 92
Nov 2001 – Dec 2007 73
  Average 64
Mar 1975 – Jan 1980 58
Oct 1949  – Jul 1953 45
May 1954 – Aug 1957 39
Oct 1945 –  Nov 1948 37
Nov 1970 – Nov 1973 36
Apr 1958  – Apr 1960 24
Jul 1980  –  Jul 1981 12

Source: NBER thru June 2019

Barring an unforeseen event, the current period is headed for the record books.

While the economic recovery is about to enter a record-setting phase, it has been the slowest since at least WWII, according to data from the St. Louis Federal Reserve. For example, starting in the second quarter of 1996, U.S. gross domestic product (GDP), the broadest measure of economic growth, exceeded an annualized pace of 3% for 14 of 15 quarters. It exceeded 4% in nine of those quarters (St. Louis Federal Reserve). Growth was much more robust in the 1960s, and we experienced a strong recovery from the deep 1981-82 recession.

Economic booms and long-running expansions can encourage risky behavior. People forget the lessons learned in prior recessions and overextend themselves. Consumers can take on too much debt. Businesses may over-invest and build out too much capacity. We saw euphoria take hold in the stock market in the late 1990s and speculation run wild in housing not too long ago.

That brings us to the silver lining of the lazy pace of today’s economic environment.

Slow and steady has prevented speculative excesses from building up in much of the economy. In other words, a mistaken realization that the good times will last forever has not taken hold in today’s economic environment.

Causes of recessions

In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). The long-running expansions of the 1960s, 1980s, and 1990s led to a mistaken belief that various policy tools could prevent a recession.

Yet, expansions don’t die of old age. A downturn can be triggered by various events. So, let’s look at the most common causes and see where we stand today.

  1. Rising inflation leads to rising interest rates. In the early 1980s, the Federal Reserve pushed interest rates to historically high levels in order to snuff out inflation. The Fed’s policy prescription succeeded, but led to a deep and painful recession.
  2. The Federal Reserve (The Fed) screws up. A policy mistake can be the trigger, for instance if the Fed raises interest rates too quickly and restricts business and consumer spending. This is a derivative of point number one. There were fears the Fed was headed down this road late last year. Credit markets tightened, and investors revolted until the Fed reversed course after the markets swooned nearly 20% in the 4th quarter of 2018.
  3. A credit squeeze can snuff out growth. In 1980, the Fed temporarily implemented credit controls that briefly tipped the economy into a recession.
  4. Asset bubbles burst. The 2001 and 2008 recessions were preceded by speculative excesses in stocks and housing.
  5. Unexpected financial and economic shocks jar economic activity. The OPEC oil embargo in the 1970s exacerbated inflation and the 1974-75 recession. The tragedy of 9/11 jolted economic activity in 2001. Iraq’s invasion of Kuwait pushed oil up sharply, contributing to the 1990-91 recession. Such events don’t occur often, but their possibility should be acknowledged.

Where are we today?

Inflation is low, the Fed is signaling its first possible rate cut this week, and credit conditions are easy as measured by various gauges of credit. For the most part, speculative excesses aren’t building to dangerous levels.

While stock prices are near records, valuations remain well below levels seen in the late 1990s (I’m using the forward price-to-earnings ratio for the S&P 500 index as a guide). Besides, interest rates are much lower today, which lends support to richer valuations. That doesn’t mean that swaths of stocks or sectors are not over-valued. That’s also not to say we can’t see market volatility. Stocks have a long-term upward (bullish) bias, but the upward march has never been and never will be a straight line higher.

As I’ve repeatedly stressed, your financial plan is designed, in part, to keep you grounded during the short periods when volatility may tempt you to make a decision based on emotions. Such reactions are rarely profitable.

A sneak peek at the rest of the year

The Conference Board’s Leading Economic Index, which has a good record of predicting (if not timing) a recession, isn’t signaling a contraction through year end. But one potential worry: a protracted trade war and its impact on the global/U.S. economy, business confidence, and business spending.

Exports account for almost 14% of U.S. GDP per the U.S. Bureau of Economic Analysis (BEA). It’s risen over the last 20 years, but we’ve never experienced a U.S. recession caused by global weakness.

By itself, trade barriers with China are unlikely to tip the economy into a recession. Per U.S. BEA and U.S. Census data, total exports to China account for just under 1% of U.S. GDP. Even with higher tariffs, exports to China won’t grind to a halt and erase 1% of GDP.

What’s difficult to model is the impact on business confidence and business spending, which in turn could slow hiring, pressuring consumer confidence and consumer spending. Simply put, there isn’t a modern historical precedent to construct a credible model. Hence, the heightened uncertainty we’ve seen among investors.

Is a recession inevitable?

It has been in the U.S., but other countries have more enviable records.

Earlier in June, the Wall Street Journal highlighted, “Australia is enjoying its 28th straight year of growth. Canada, the U.K., Spain and Sweden had expansions that reached 15 years and beyond between the early 1990s and 2008. Without the Sept. 11, 2001 terrorist attacks, the U.S. might have, too.”

If trade tensions begin to subside (a big “if”) and if the fruits of deregulation and corporate tax reform kick in, we could see economic growth well into 2020 (and with some luck, into 2021 and beyond). But, I’ll caution, few have accurately and consistently called economic turning points.

The Fed to the rescue?

Rising major market indexes for much of the year can be traced to positive U.S.-China trade headlines (at least through early May), a pivot by the Fed from tightening monetary policy to loosening, and general economic growth at home.

We witnessed a modest pullback in May after trade negotiations with China hit a snag. The threat of tariffs against Mexico added to the uncertain mood until June 4th, when Federal Reserve Chief Jerome Powell signaled the Fed would consider cutting interest rates to counter any negative economic headwinds.

While Powell is not exactly promising to deliver any rate cuts, one key gauge from the CME Group that measures fed funds probabilities puts odds of a rate cut at the July 31st meeting at around 100% (as of July 28 – probabilities subject to change).

I’ll keep it simple and spare you the academic theory explaining why lower interest rates are a tailwind for equities. In a nutshell, stocks face less competition from interest-bearing assets.

But let’s add one more wrinkle–economic growth.

Falling rates in 2001 and 2008 failed to stem the outflow out of stocks as economic growth faltered. And, rising rates between late 2015 and September 2018 didn’t squash the bull market.

During the mid-1980s, mid-1990s, and late 1990s, rate cuts by the Fed, coupled with economic growth, fueled market gains.

It’s not a coincidence that bear markets coincide with recessions and the bulls are inspired by economic expansions. Ultimately, steady economic growth has historically been an important ingredient for stock market gains.

Final thoughts

Control what you can control. You can’t control the stock market, you can’t control headlines, and exactly timing the market turns isn’t a realistic tool. But, you can control your portfolio.

While I would expect the market to continue higher over the intermediate term, it would not surprise me to have a mid-summer pullback as August-September tend to be weaker months of the year. Don’t let volatility shake you out of your positions, but if you haven’t done anything to take some money off the table up to this point, it would be prudent to consider taking some profits on certain positions and add some defensiveness to your portfolio. This is not a recommendation to buy or sell any stocks or other securities.

Your plan should consider your time horizon, risk tolerance, and financial goals. There is always risk when investing, but we tailor our recommendations with your financial goals in mind. If you’re unsure or have questions, let’s have a conversation. That’s what we’re here for.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

 

 

 

What’s Going on in the Markets: April 28, 2019

It’s no surprise to anyone paying attention to financial news that the stock market, as measured by the S&P 500 index, closed at an all-time high last Friday. It was one measly point away from the all-time intra-day high set on September 21, 2018 (2940.91). The technology heavy NASDAQ indexes have already surpassed their all-time 2018 highs.

You’d think at new all-time highs, the masses would be euphoric and pouring money into the stock market hand-over-fist. But alas, that’s not the case at all. The rise from what I like to call the “Christmas Eve Stock Market Massacre of 2018” has been one of the most distrusted and hated rallies I’ve ever seen in my over forty years of following the stock markets. Ironically, that’s what might keep the market from falling over and moving higher, at least temporarily.

I’ll be the first to admit that I personally haven’t fully embraced the 24% rally from the Christmas Eve bottom. It’s been a torrent advance that has given latecomers (as well as early sellers) very few low-risk opportunities to jump in. That’s to say, pullbacks since Santa Claus came calling have been shallow and fleeting. Bull markets tend to be that way. Virtually every portfolio manager and investor I talked to was over-invested going into the 4th quarter 2018 swoon, and under-invested during the 1st quarter 2019 relentless advance.

Such is life investing in the stock markets.

Pundits would say that it was the Federal Reserve Chairman’s walking back talk of planned interest rate hikes in 2019 as the proximate cause for the rally. Markets love low interest rates (cheap money) as companies borrow even more money to buy back their own stock. Lower interest rates for longer have always meant corporate earnings can grow a bit faster with less drag from servicing (paying down) debt and financing expansion plans.

If the promise of lower interest rates for longer is the proximate cause for the rally, then recent positive economic news might cause the “data dependent” federal reserve to rethink the interest rate pause. A federal reserve board meeting is scheduled for this week, though the chance of an interest rate hike announcement at this meeting is virtually nil.

Just this past Friday, what was widely forecast as a coming dismal 1st quarter 2019 gross domestic product figure (under 1%), turned out to be more than thrice as good, coming instead at 3.2%.

Also this past week, while existing home sales came in 4.9% below expectations, new home sales came in almost 4.5% above expectations. In addition, durable goods orders also came in much better than expected. Finally, weekly jobless claims continue to be low. The March monthly jobs report will be announced on Friday May 3.

Expected to be dismal as well, first quarter 2019 corporate earnings reports have also continued to surprise to the upside. So far, 230 of the S&P 500 have now reported Q1 2019 earnings, and the reported Earnings Per Share (EPS) growth rate for the index is up about 2%. Granted, when companies lower expectation ahead of time, beating them becomes the norm (games companies play!)

So should we throw caution to the wind, set aside all hedges and invest all idle cash since so little seems to derail this charging bull market (e.g., the still unsettled trade wars, the Mueller Report, rising debt levels, the never-ending Brexit debacle, slower global growth, higher gas prices, etc.)?

In a word, no.

While it appears that the markets will continue to move higher in the near term, the risk-reward ratio at these levels does not favor heavy deployments of capital. Getting to a previous market high doesn’t necessarily mean we’re going to smash through those old highs and rally another 5-10% immediately. After all, there are many regretful buyers from the 2018 highs who can’t wait to get out at even-money if given that opportunity (exclaiming the famous phrase anyone unexpectedly caught in a nearly 20% stock market drop “never again!”).

That incoming supply of shares from regretful buyers will likely cause a long battle around last year’s highs, making for a pause in the upward momentum. Besides, after a nearly 25% run, the market is way overdue for a break.

A Wall of Worry?

In addition to the still unresolved trade wars and ongoing Brexit discussions, we have the following worries on the table (acknowledging that the market likes to climb a wall of worry):

  1. Recession Fears: an inverted interest rate curve, where short term rates are higher than longer term rates, has historically been a warning flag for the economy, though the lead time to a recession has been 11 months on average. In fact, there has been only one instance where the yield curve inverted without a U.S. recession, in January 1966. It is worth noting, however, that there was still a bear market during that period, which began just one month after inversion.
  2. Inflation Fears: as inflation indicators have eased since the middle of 2018, investors and economists alike have pushed this all-important economic barometer to the back of their minds. However, inflationary pressures, in the form of wage hikes, could reemerge in the near future, forcing the Federal Reserve to again take action when they least want to do so.
  3. Corporate Debt: over the course of this economic cycle, business debt has skyrocketed as U.S. corporations have issued record amounts of debt.  Non-Financial Business Debt as a percentage of GDP is close to an all-time high, and well in excess of the levels reached at the beginning of the last three recessions. If the economy slips into recession, marginally profitable companies will be unable to pay back interest on their debt, let alone the principal.
  4. Small Business Optimism: both small business owners and CEOs are not as enthusiastic as consumers or investors. Small business confidence fell sharply in the closing months of 2018 and has shown little propensity to recover. Corporate CEO confidence experienced an even bigger hit, with the same inability to rebound from these depressed levels. Business owners are most likely feeling the pressures of a tight labor market, rising wages, and squeezed profit margins. That could spell trouble for earnings and business spending ahead.

So What To Do Now?

The economy is stable and employment is strong. At this point, blue chip indexes have surpassed or are very close to surpassing their previous highs, tempting investors to climb aboard for another potential leg upward. But should you?

The financial planning answer to that question is that it depends on your goals, time-frame and risk tolerance. But the more realistic answer is that it really depends on your current investment level and your confidence that we’re just going to sail higher. While in the long run the market trends higher, no one I know of is a fan of investing at a potential top.

I suggest that you think back to how you were feeling in December of 2018, and if you felt that you were over-invested, or were surprised or uncomfortable reading the balances on your year-end account statements, take this gift the market has given you and reduce exposure to the markets. Even if you weren’t, ask yourself this: should I be taking some profits off the table? This is not a recommendation to buy or sell anything; only you and your financial planner can make that decision (we can help!)

I’m personally not so confident we’re going to just continue to rally without a near term pullback, and therefore I continue to position client and my personal portfolios with a defensive tilt. Mind you, I see nothing in the price action to tell me that a pause is imminent, but severe downside action can change that and repossess weeks’ worth of gains in a matter of a day or two. This, however, should be meaningless to investors with a long-term investing horizon.

While we have participated robustly in this rally since 2018, I believe that the market’s ability to achieve notably stronger gains from here is somewhat questionable. And from a safety-first strategy viewpoint, the longer-term outlook is more ominous.

The recent inversion of the yield curve is a classic warning flag, regardless of whether it remains inverted over the intermediate term. And the simmering wage inflation pressures are not going to subside anytime soon, especially when initial claims for unemployment are hitting 50 year lows. That means the Federal Reserve might have to renege on their “no rate hike” promise before this year is over. Few on Wall Street are anticipating that the Fed might take away the low interest rate punch bowl again.

As Jim Stack of InvesTech Research warns, “One of the most difficult aspects of negotiating the twists and turns of a late stage bull market is keeping one’s feet objectively planted on firm ground. It’s hard to argue against positive economic reports, except with the historical knowledge that bull markets peak when economic news is rosiest. And with consumer confidence near the highest levels of the past 50 years, one would have to think that we are approaching a peak. That inherently leaves a lot of room for potential disappointment.”

Even if it means leaving a few dollars of market profits on the table, my safety-first approach leaves me cautious/defensive with an abundant level of cash and hedges for the time being. Now is a good time to take stock of your investment level, and decide for yourself whether you’re prepared for the next downturn.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Believe it Or Not

A longtime favorite line that I like to use when people ask me what the market or economy are going to do in the near future, is to say “Sorry, my crystal ball is in the shop.”  Or I’ll repeat what famed baseball manager Yogi Berra once said: “It’s tough to make predictions, especially about the future.”

That doesn’t stop others from trying to be a broken clock by predicting early and often. And so we’re into that exciting time of year when all sorts of market predictions are made by people who are mostly claiming that they knew the future and have accurately predicted it over a great track record.  But if you’re smart, you’ll turn off the TV/radio or move on to the next article.

The truth is that none of us can accurately predict the movements of the markets.  If we could, then we would always make trades ahead of market moves, and it wouldn’t take long before that amazing prognosticator with the working crystal ball would have amassed billions off of his or her stock market trades.  Have you read about anybody doing that lately?

Most of these people are employed at think tanks or sell their predictions to credulous investors.  Would they need that paycheck or your hard-earned subscription dollars if they had the ability to make billions just by checking the ‘ole crystal ball a couple of times a day?

A recent article by frequent blogger and wealth manager Barry Ritholtz offers some rather amazing data on people in the prediction business.  You may know that the cryptocurrency known as “bitcoin” is now worth about $3,500—way WAY down from the start of 2018.  So how well did the people in the prediction business foresee that downturn?

Not well.  In his article, Ritholtz noted that Pantera Capital predicted that Bitcoin would be selling for $20,000 by the end of 2018.  Tom Lee of Fundstrat was more bullish, forecasting that bitcoin would breach $25,000 by then.  Prognostications by Anthony Pompliano, of Morgan Creek Digital Partners, were still more bullish, predicting bitcoins would be worth $50,000 by the end of last year.  John Pfeffer, who describes himself online as “an entrepreneur and investor,” anticipated $75,000 bitcoins by now, and Kay Van-Petersen, Global Macro-Strategist at Saxo Bank, one-upped everybody with his prediction that bitcoins would be worth $100,000 by December 31st of last year.

Ritholtz offers other examples, like radio personality Peter Schiff telling listeners since 2010 that the price of gold has been heading toward $5,000 an ounce.  (It’s riding around $1,300 currently.). Jim Rickards, former general counsel at Long-Term Capital Management, is more ambitious, telling his followers that he has a $10,000 price target for an ounce of gold.

If you happen to follow former Reagan White House Budget Director David Stockman, you have been told that stocks are going to crash in 2012, 2013, 2014, 2015, 2016, 2017, 2018 and 2019.  Someday he’s going to be right, and will no doubt be touting his amazing prediction abilities (that broken clock is right twice a day).

When you read about a prediction, instead of reaching for the phone to call your financial advisor, try writing the prediction down on a calendar or reminder program like the app followupthen.com, and come back to it a year later.  Chances are you’ll be less impressed then than you might be now.

The three things that work best for investors: time in the market, portfolio diversification, and risk management. Soothsayers need not apply.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source:

https://ritholtz.com/2018/12/fun-with-forecasting-2018-edition/

TheMoneyGeek thanks guest writer Bob Veres for his contribution to this post

What’s Going on in the Markets: November 25, 2018

Here’s hoping your Thanksgiving holiday and weekend spent with loved ones were reasons to be thankful for the past year of blessings. Certainly, the markets didn’t give us much to be thankful or joyful for as all major market indexes dropped between 2.5% and 4.4% last week. Normally, Thanksgiving week can be counted on for an upside bias, but instead we got the worst Thanksgiving week since 2011 as the correction that began in early October rolls on.

As bad as the week was, we could be setting up for a pretty good rally into year end, if we could just get a positive spark of some sort this week. Some possible good news could be forthcoming on the trade war front from the G20 Summit, scheduled for November 30 and December 1, where President Donald Trump and China President Xi Jinping are scheduled to meet and have a discussion. This may bring hope for some type of agreement on the tit-for-tat tariffs imposed.

To be clear, the price action in the markets to-date has shown no evidence of a robust bounce coming, but there are some signs that a market reversal (upward) is brewing.

Market corrections, defined as a decline from the top of 10% or more, are always gut-wrenching and difficult to “watch”.  In fact, this past week, the S&P 500 index finally closed 10.1% below the all-time high made in September.  Under the surface, some stocks, specifically the technology and infamous FAANG stocks (Facebook, Apple, Amazon, Netflix and Google), have been hit hard with declines of up to 40% from their highs seen earlier this year. I could list a ton of stocks and market sectors that are in their own bear markets (20% below their recent highs), but you already know them because you probably own them.

Why the Long Face Mr. Market?

So what has the market in such a tizzy, seemingly all of a sudden, especially after a great 3rd quarter performance and record quarterly corporate earnings reported? A few things actually:

  1. Trade Wars & Tariffs: Initially thought to be immune to the trade wars, the markets have succumbed to the thought that the current trade war may be drawn out, not just for months, but for years. While a minority of companies that reported earnings this past quarter pointed to tariffs as a concern, the ones that did, were very vocal about how a dragged out tariff war will significantly drag on future earnings. Needless to say, China features prominently in this picture, so a resolution next week would give Wall Street a reason to cheer.
  2. Interest rates: There’s nothing like cheap money to keep the money flowing and the stock market buoyant, as companies issue bonds (debt) to buy back their shares in the open market and finance capital expansion plans. Home buying obviously works better with lower rates. So higher interest rates curb the debt appetite by companies and potential homeowners. In addition, investors, with the availability of lower risk and higher interest rate government bonds, will cash in their stocks for the safety of Uncle Sam’s treasury notes and bills. Why take all the stock market risk for an extra potential 1%-2% returns?
  3. Economic Data Slowing: While gross domestic product, employment, consumer confidence and housing data have been near their highest levels, there are emerging signs of growth slowing in many areas of the economy. For example, home builder confidence dropped 8 points in November – now confirming the message that the housing market is slowing. The Conference Board’s Leading Economic Index barely eked out a gain of 0.1pts, which suggests that next month could see the first decline in over 29 months. Finally, durable goods (e.g., appliances, aircraft, machinery and equipment) orders for October came in worse than expected. While none of the data signifies an imminent recession, a slowdown in growth looks to continue, hardly surprising given the long slow economic recovery we’ve been in for almost ten years.
  4. Oil Prices Crashing: Oil prices have lost over 35% from their highs in the first week in October. While lower oil prices mean more money in consumers’ pockets and higher profits for oil consumers such as airlines, the swift decline in prices unnerves investors and traders. Questions arise as to the robustness of the economy and worldwide demand for oil if the price can lose 1/3rd of its value in a period of less than two months.

When you consider that stock markets trade on future company profit expectations, all of the above worries weigh on prices investors are willing to pay for those future earnings. Companies may start to alert Wall Street that their initially published profit expectations may not be met. So, as a forward looking mechanism, the market starts to price in those worries 6-12 months before companies actually start to report those earnings.

Will Santa Claus Visit Wall Street This Year?

As mentioned above, there are some “green shoots” of hope that a rally may be near:

  1. Investor Sentiment has been decimated in this correction. Any number of investor surveys, professional or retail (that’s you or me), has shown them to be despondent and sure this bull market is done and over with. In this business, excessive investor pessimism or optimism tends to act as a contrary indicator (when so many are sure the market will do one thing, the market tends to do another).
  2.  The markets are oversold in the short-term. When the selling has been as persistent as it has, without much in the way of a rally, the markets tend to reverse and rally up, if only for a day, a week, a month, or two.
  3. Seasonality favors a rally. The period from mid-November through the following May tend to be very positive from a market standpoint. I should be clear in mentioning that seasonality has not worked very well at all in 2018 (e.g., August and September are usually down months but were up big this year).
  4. We haven’t made a new market low in this correction since October 29. With the exception of some technology and NASDAQ stocks/indexes, the overall market has not made any new lows. While this could change when the markets open on Monday morning, the fact that the market didn’t push to new lows last week when it had the chance, means that we may be running out of sellers. In addition, some positive technical signs, one in the form of small capitalization stock strength on Friday, bode well for a potential near-term rally.
  5. Although an interest rate increase of 0.25% is a 78% certainty in December, it’s possible that the federal reserve, when it meets in mid-December will signal a willingness to pull back on it’s plan for three interest rate hikes in 2019, given the apparent slow-down in economic growth.
  6. Announced today (Sunday), the European Union and the United Kingdom have reached an agreement on Brexit. The removal of that uncertainty can help spark a rally.

So What Do We Do Now?

The weight of the evidence at the moment gives the benefit of doubt to the bears and the evident short-term downtrend. Therefore, caution is still warranted, even if a short-term rally emerges.  Although the odds of a recession over the next 6-9 months remain very low, things can change in a hurry if the global slowdown continues or accelerates downward.

If you haven’t sold or trimmed any positions to-date, and you’re losing sleep over the market action, then you should take advantage of any rally to reduce your exposure to the markets to the “sleeping point” or add some hedges.  It may be too late to sell right now, or into any further decline, but you should have your own plan for your investments that matches your risk tolerance, investment goals and time-frame. If you’re not a client, then I cannot possibly advise you, so this should not be construed as investment advice. Of course, if you would like to become a client, we’d love to talk to you.

For our clients, we lightened up on positions, raised cash and increased our hedges over the past several months as short-term signs pointed towards a bit of over-exuberance to the upside. We have tried dipping our toes lightly into a few positions during this correction, but mostly the market told us we were too early.  Of course, stocks become more attractive as their prices decline, so dipping your toes into this decline is not a bad idea; just be sure you know your time-frame for holding, and be sure to keep it light until the trend changes upward, and the overall market acts as a tailwind rather than a headwind.

While markets are acting bearishly at this time, we remain alert to a switch in trend and hopeful that Santa comes to Wall Street, bringing a robust rally. Remember that a rally always comes around, so if your portfolio is down, there will be better days ahead if you want to buy or sell. Until then, remember that investing in stocks is great…as long as you don’t get scared out of them.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets October 7, 2018

Last week was one of the “worst” for the stock markets in many months, even though the S&P 500 index was barely down 1%, and the Dow Jones Industrial average remained virtually unchanged. However, the tech-heavy NASDAQ lost 3.2% and small capitalization stocks were down 3.8%. International stocks declined about 2.35%.

The proximate “cause” of the weekly decline was blamed on fast rising bond yields (when bond yields go up, that means bond prices go down). The ten-year treasury note yield rose 0.16% to 3.2%, while the 30-year treasury bill rose 0.20% to 3.4%.  These are their highest levels since July 2011 and August 2014 respectively.

Despite a weaker than expected September monthly jobs report, with 134,000 jobs added in September (185,000 were expected), we are seeing wages grow 2.8% year-over-year, while the unemployment rate has declined to match the low of 3.7%, last seen in 1969. Wage inflation is the biggest threat to stable prices, and portends more aggressive interest rate hikes by the federal reserve in the future.

Too Much of a Good Thing?

With the economy hitting on all cylinders, jobs are plentiful and consumers are extraordinarily confident. In fact, the latest survey from the Conference Board puts the September reading of the Consumer Confidence Index at the highest reading since September 2000. Paradoxically, frothy confidence and complacency typically coincide with a run up to a final bull (up-trending) market peak.  With five out of the last seven bull market tops over the last 52 years, exceptionally bright consumer outlooks peaked coincidentally with the S&P 500, and declined with the onset of a bear (down-trending) market. The only exceptions were 1980 and 1987, when the bear declines were driven by an abrupt monetary shock.  So even though we are in the midst of a “Goldilocks” economy, a significant downturn in consumer confidence could negatively impact the economic outlook.

Since the financial crisis of 2009, the Federal Reserve has kept interest rates abnormally low, and is currently committed to a gradual path to normalization. There is a fear, however, that the Fed might fall behind the curve and could be forced to move faster than expected. That increases concerns that interest rates might push the economy into a recession.

Time to Get Defensive?

Over the past couple of weeks, as the number of stocks that were advancing (versus those that were declining) saw deterioration (despite the indexes setting new all-time highs),  we started getting more defensive in client (and my personal) investment portfolios by selling some partial positions and increasing market hedges. This past week, we saw some further stalling and heavier volume selling in the markets than we have seen in quite a few months. For client portfolios, we already had reduced exposure to the markets, and with the recent increased institutional selling, I plan to slightly further reduce exposure on rallies in the coming weeks.

Everybody seems to be expecting a 4th quarter (November/December) post-mid-term election rally, which makes me a bit suspicious that we might not get one. The 3rd quarter of a mid-term election year is usually biased to the downside, but instead, this time around, we went on to make new all-time highs. Did we pull forward 4th quarter returns into the 3rd quarter? We’ll soon find out.

If you’re not inclined to sell anything, thereby recognizing capital gains this year, you could consider 1) making use of inverse funds (also referred to as bear market funds); 2) buy put options to hedge your portfolio; and/or 3) sell call options against stock and ETF positions on bounce-backs, the first of which I expect to see early this coming week.

But don’t let the tax “tail” wag the investment “dog”; take some chips off the table while you can, not when you’re forced to. In these algorithmic and high-frequency trader driven markets today, the velocity to the downside, as we saw in January earlier this year, can be stunning. Also, don’t forget that if you sell something in your IRA or 401(k), you won’t be generating any taxable capital gains.

With interest rates clearly headed higher, I wouldn’t be moving money from stocks to bonds as a defensive measure right now. As this past week attests, both bonds and stocks can go down at the same time, leaving cash or inverse funds as a couple of feasible places to “hide out” on a fraction of your overall investment portfolio. A buy point in bonds will be coming soon, but one should wait until they stabilize. If you find yourself overweight in bond exposure, a rally is sure to come, which you should take advantage of to reduce exposure.

Know Your Risk

To be clear, I may be early & wrong, but growth and bellwether names have been getting hit hard of late. Any measure of risk management over the last 9-1/2 years has reduced overall returns to be sure. And if you have a very long term time horizon, this may turn out to be a garden variety 5-15% pullback on our way to new highs, so you may choose to do nothing.

With interest rates finally rising meaningfully, institutions showing some inclinations towards selling (which we haven’t seen since January-February), some key sectors  faltering (such as financials and housing), and consumer confidence at all-time highs, this is a time to protect market profits and capital. If you’re fully invested, it can’t hurt to take some of your bull market gains off the table.

As mentioned above, the current period around mid-term election years is usually a strong one, and economic and corporate profit strength are at record highs, so this may be a normal correction on our way to new stock market highs. The last quarter of this year and first quarter of next year have historically been very strong, and that’s what I’m expecting. But just in case it isn’t, it may be prudent to somewhat reduce exposure here.

I am not calling for a bear market or market crash. I see nothing out there to panic about right now. You can bet that if I see anything like that brewing, you’ll be hearing from me again, urging you to drastically reduce market exposure.

As always, this article is not a recommendation to buy or sell any securities. I may not be your portfolio manager or financial planner, know little to nothing about your risk tolerance, time-frame or financial goals, so I can’t really advise you. I am only sharing what I’m seeing after a prolonged run in a persistently accommodative monetary environment, which is getting less so (central banks, federal reserve tightening monetary policy and raising rates). This might turn out to be the pull-back to buy instead of sell, but if you don’t have cash ready on the side to invest, can you really take advantage of it?

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets February 5, 2018

It’s been a long time, more than a year, since I’ve posted an article about what’s going on in the markets. Market volatility, until last week, has been mostly subdued. For what seems like years now, markets seemed immune from any meaningful drop. But this still young month of February has seen volatility return with a vengeance.

This means that the U.S. stock market will finally get something that happens, on average, about once a year: a 10+ percent drop—the definition of a market correction.  The last time this happened, better known as a bear market, was a whopper: the Great Recession drop that caused U.S. stocks to drop more than 50%–so most people today probably think that corrections are catastrophic.  They aren’t.  More typically, they last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%).  Corrections are unnerving, but they’re a healthy part of the economy and the markets—for a couple of reasons.

Reason #1: Because corrections happen so frequently, and are so unnerving to the average investor, they “force” the stock market to be more generous than alternative investments.  People buy stocks at corporate earnings multiples which are designed to generate average future returns considerably higher than, say, cash or municipal bonds—and investors require that “risk premium” (which is what economists call it) to get on that ride.  If you’re going to take on more risk, you should expect at least the opportunity to get considerably more reward.

Reason #2: The stock market roller coaster is too unsettling for some investors, who sell when they experience a market lurch.  This gives long-term investors a valuable—and frequent—opportunity to buy stocks “on sale.”  That, in turn, lowers the average cost of the stocks in your portfolio, which can be a boost to your long-term returns.

The current market downturn relates directly to the first reason, where you can see that bonds and stocks are always competing with each other.  Monday’s 4.1% decline in the S&P 500 coincided with an equally-remarkable rise in the yields on U.S. Treasury bonds last Friday.  Treasuries with a 10-year maturity are now providing yields of 2.85%–hardly generous, but well above the record lows that investors were getting just 18 months ago.  People who believe that they can get a decent, relatively risk-free return from bond investments are tempted to abandon the bumpy ride provided by stocks for a smoother course that involves clipping coupons.  Bond rates go up and the very delicate supply/demand balance shifts, at least temporarily, in their direction, and you have the recipe for a stock market correction.

This provides us all with the opportunity to do an interesting exercise.  It’s possible that the markets will drop further—perhaps even, as we saw during the Great Recession, much further.  Or, as is more often the case, they may rebound after giving us a correction that stops short of the technical definition of a bear market, which is a 20% downturn.  The rebound could happen as early as tomorrow, or some weeks or months from now as the correction plays out.

Most bear markets coincide with the onset or expectation of a recession. Some even debate whether a recession causes the bear market or vice versa. The good news is that all indications are such that a recession is not on the horizon. Jobs, housing and many other manufacturing and services data are quite strong, retail sales are healthy, and most importantly, consumer confidence is near all-time highs. While this could all change, it would take at least 9-12 month for conditions to deteriorate enough and make the probabilities of a recession more likely than not. That’s why I believe that a bear market is not imminent.

A correction or even a bear market, once they’re over (no matter how long or hard the fall) you’ll hear people say that they predicted the extent of the drop.  So now is a good time to ask yourself: do I know what’s going to happen tomorrow?  Or next week?  Or next month?  Is this a good time to buy or sell?  Does anybody seem to have a handle on what’s going to happen in the future?

Record your prediction, and any predictions you happen to run across, and pull them out a month or two from now.

Chances are, you’re like the rest of us.  Whatever happens will come as a surprise, and then look blindingly obvious in hindsight.  All we know is what has happened in the past.  Today’s market drop is nothing more than a data point on a chart that doesn’t, alas, extend into the future.

Markets have become very oversold, a market technical term that indicates that we’ve sold off too far too fast. That means a bounce is near, and it may be a big one. If you’re worried about what the markets are doing, and overexposed on your risk, you should use these bounces to hedge your portfolio or sell some portions thereof to the “sleeping point”; that is, the point where you can sleep or get through your day without worrying about your portfolio declining. Think about putting some spare cash in the markets after you see some signs of the markets stabilizing, feeling good about picking them up on sale (Disclaimer: this is not a recommendation to buy or sell any security).

For our clients, over the past several weeks, we have reduced market exposure through sales of certain positions, and have increased our hedges. But we are not preparing for an all-out bear market. In fact, we have been looking to pick up some positions that are much more attractive after this latest selloff. After all, the stock markets are still in an uptrend, the economy is hitting on all cylinders, and there are no signs of an impending recession.

If you are worried or would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.fool.com/knowledge-center/6-things-you-should-know-about-a-stock-market-corr.aspx

https://www.yardeni.com/pub/sp500corrbear.pdf

https://finance.yahoo.com/news/stocks-getting-smashed-143950261.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

A Strawberry Alarmist?

“Good sense, innocence, cripplin’ mankind
Dead kings, many things I can’t define
Occasions, persuasions clutter your mind
Incense and peppermints, the color of time

Who cares what games we choose?
Little to win, but nothin’ to lose”

— Song Lyrics from the 1967 hit single “Incense & Peppermints” written by Tim Gilbert & John S. Carter and performed by the group known as The Strawberry Alarm Clock

Suppose somebody came up to you and shouted: “I have terrible news about the economy. I think you should sell your stocks!”
Alarmed, you say: “Oh, my God. Tell me more!”
And this mysterious stranger shouts: “Run for the hills! The American economy just added 200,000 more jobs—more than expectations—and the U.S. jobless rate now stands at 4.1%, the lowest since 2000!”
You blink your eyes. So?
“There’s more,” you’re told. “The average hourly earnings of American workers have risen a more-than-expected 2.9% over a year earlier, the most since June of 2009! You should sell your stocks while you can!”

Chances are, you don’t find this alarmist stranger’s argument very persuasive, but then again, you don’t work on Wall Street. After hearing these benign government statistics, traders rushed for the exits from the opening bell to the closing on Friday, and at the end of the day the S&P 500 stocks are, in aggregate, worth 2.13% less than they were last Thursday. The NASDAQ Composite index fell 1.96% and the Dow Jones Industrial Average, a somewhat meaningless but well-known index, was down 2.54%.

To understand why, you need to follow some tortuous logic. According to the alarmist view, those extra 200,000 jobs might have pushed America one step closer to “maximum employment”—the very hard-to-define point where companies have trouble filling job openings, and therefore have to start offering higher wages. No, that’s not a terrible thing for most of us, but the idea is that if companies have to start paying more, then they’ll be able to put less in their pockets—and the rise in the hourly earnings of American workers totally confirmed the theory.

If you’re an alarmist, it gets worse. If American workers are getting paid more, then companies will start charging more for whatever they produce or do, which might raise the inflation rate. “Might” is the operative word here. There hasn’t been any sustained sign of higher inflation, which is still not as high as the Federal Reserve Board wants it to be. But if you’re a Wall Street trader who thinks the market is in a bubble phase, you aren’t necessarily looking at facts to confirm your beliefs.

Suppose you’re not an alarmist. Then you might notice that 18 states began the new year with higher minimum wages, which might have nudged up that hourly earnings figure that looked so alarming a second ago. And some companies have recently announced bonuses following the huge reduction in U.S. corporate tax rates, whose amortized amounts are also finding their way into wage statistics.

Meanwhile, those same government statistics are showing a resurgence in factory activity and a rebound in housing, which together, account for more than 50,000 of those new jobs.

So the question we all have to ask ourselves is: are we alarmists? Selling everything in anticipation of a bear market has never been a great strategy, even though stocks are admittedly still priced higher than they have been historically. Trimming some positions and perhaps putting on some hedges into one of the greatest bull runs of our time makes a lot of sense. But panicking never paid worthwhile benefits to anyone.

If you are not an alarmist, then you have something to celebrate. The S&P 500 has now officially ended its longest streak without a 3% drop in its history—as you can see from the below chart. It’s an historic run not likely to be seen by any of us again. The truth about the markets is that short, sharp pullbacks are inevitable and routine—unless you were living in the past year and a half, when we seemed to be immune from normal market behavior.

Strawberry Alarmist

Although the drop on Friday was a bit “jarring”, and technical indicators point to some internal deterioration, I don’t believe that this is the start of a bear market. Employment, housing and the overall economic environment are way too strong to give way to a recession, at least not in the next six to nine months.

I’ve been saying for months now that the market is way past due for a normal correction, as evidenced by the above chart. A pullback of 10-15% in the markets would be normal and healthy, to allow this market to “rest up” for the next move higher. If you think you’re nimble enough to get out of the markets now, and know when to get back in to catch the next wave higher, then I and 90% of the masses out there can probably learn from you. But as the great fund legend Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” 

If you’re concerned about the markets and you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:
https://www.bloomberg.com/news/articles/2018-02-02/u-s-added-200-000-jobs-in-january-wages-rise-most-since-2009

https://www.bloomberg.com/news/articles/2018-02-01/asia-stocks-to-slide-as-tech-stumbles-bonds-drop-markets-wrap?

https://www.theatlantic.com/business/archive/2018/02/market-dow-drop/552254/?utm_source=atltw

TheMoneyGeek thanks guest writer Bob Veres for his contribution to this post

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