One of the problems with market volatility is I never know what may happen with the market between the time I write this little blurb and the time it posts. I usually write it on Thursday and it posts on Friday. Lately I have been waiting until Friday just in case the markets provide something I should address. Timing the writing is as futile as timing the markets. In both cases we have to be right twice. When writing the markets could change before posting. When posting the markets could change before the close on Friday. Same for investing. For market timers they have to get lucky on the timing of getting out of the market and then luck again on the timing of getting back in. We still don’t know if this market is headed back toward its previous upward trend or if we could be seeing the seeds of a bear market. Run from anyone who says they do know.
You are probably expecting this to be commentary on the markets but there is not much to say about the markets other than what a bounce back. This has been very reminiscent of 2016 when markets were off 15% to start they year and then recovered in less than a month. We could have witnessed the 4th correction during this bull market or maybe we are seeing the start of the next bear market. There is no way of knowing right now.
Tough times continue for Facebook. The first two links explain a lot of what everyone has been saying for a while now. They continue to claim they are not a media. They are and Europe is cracking down. This is neither a recommendation to buy or sell a stock.
We sent out a couple of notes to clients this week addressing the current market volatility. Here was the latest one…
Ralph Wanger, who used to run the Acorn Fund, used the following analogy to describe the stock market…
The market is like an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the market players, big and small, seem to have their eye on the dog, and not the owner.
We expect major volatility to continue for the foreseeable future. The markets are searching for something to cling to and until it finds it we could see strong movements up and down. There are a number of things that can be pointed to as the “cause” but the good news is as of now all of these causes are fairly normal. Interest rate fears. Margin calls. Algorithms. The list goes on but the list consists of what we would call cyclical issues.
We are not going to inundate your inboxes during this period of volatility unless something fundamentally changes. Instead we encourage you to keep up with our thoughts on our [blog], [Twitter] or [Facebook ]. If the volatility continues we will post to these places more often so you can follow our thoughts.
We urge you, however, to let us know if anything changes on your end. If you are anxious or your personal situation changes then please let us know so we can evaluate your strategy.
Here are a couple articles for you this weekend…
What a month. We addressed this in our monthly client letter this week. The last day of the month ended the euphoric trend but it was still quite a month. Just two articles this week. Take note that the second one is a true article. Everyone enjoy “the big game” this weekend.
So much for a market hangover. Equity markets have roared out of the gate. Historically, January has been a fairly accurate "indicator" as only 27% of the time since 1929 have the market and January parted ways. Of course this doesn't always hold up.
In the past 11 years, the S&P 500 has fallen six times in January and the market only ended down in two of those years. The most recent example was the brutal start to 2016, where markets had there worst start to a year since 1896 and saw the S&P 500 drop nearly 5% in January yet we still ended the year up nearly 10%. Even more eye opening was January of 2009 (global financial crisis). We experienced the worst January in history (-8.5%) but the S&P 500 finished the year up over 26%! There have also been some instances of a strong January that saw the market end the year in the negative.
Many active fund managers look to sell stocks with losses in December for tax purposes and then rebuy in January, which helps create momentum. While this may hold some weight, there has been a massive shift from active management to passive over the last decade and this could be part of the reason why the "January effect" has become less reliable lately. Also, since 2008, easy monetary policy prescribed by the Federal Reserve has helped push asset prices higher as witnessed by the S&P 500 posting positive returns nine straight years.
While U.S. equity markets seem to be grabbing all the headlines, foreign markets, specifically emerging markets, continue to outperform which is an encouraging sign for the global economy. The true test comes as the Federal Reserve starts to aggressively raise rates this year and next. This is when we will find out what shape the global economy is truly in.
It is always interesting to talk with clients and hear their takeaways from recent market news. Some clients don’t pay any attention to news while others are aware of the common themes we are seeing in the media. Sometimes I try to think how I would be as a client. Would I read financial news? Would I watch CNBC? Research investments? It is hard to say. Knowing what I know about markets I’d like to think I wouldn’t pay much attention. Its part of the reason to hire an advisor. Have a plan and trust and let it do its thing. Of course, some clients just enjoy it. Others probably feel like its a duty to know what’s going on. One thing I know I wouldn’t do is research stocks. Very smart people who spend 8+ hours a day researching stocks are wrong often. Why would I think I could do better?
I still maintain the Fed should have started unwinding their balance sheet and raising rates earlier than they did but so far its hard to argue with the results. Rates are rising and the market is not collapsing. Consumer balance sheets appear to be as health as ever. Consumer confidence is also up. Finally, the economy is growing healthily. The evidence supports the current market….until it doesn’t at which time the market could already be on a correction path. This is how it works and why timing markets does’t.
Unless you follow financial news you may have missed Jeremy Grantham’s latest viewpoint white paper. Grantham is highly respected in the financial world and his latest “warning” certainly caught the eyes of financial media. His warning is two fold. He things a “melt up” in the market may occur followed by a large “melt down”. He backs up his thesis very well. One of the things we have harped on when discussing bubbles with clients is there typically needs to be a period of euphoria before even considering something a bubble (see crypto currencies for example). Since this bull market has been met with so much skepticism the euphoric period has remained elusive. I have mentioned some anecdotal evidence of euphoric tendencies so maybe Grantham has a point. Could the “melt up” be 30%? 50% Who knows. One of the keys to making it through the next downturn, however, is to enjoy the gains leading up to it.
A few articles this week to start off the new year. Of note is the marijuana article. I share this as a reminder that a “sure thing” doesn’t exist. Is the legal weed market huge? Yes. Is it easy to make money in it? No and it may get harder. Investing in a “sure thing” doesn’t always mean money will be made. Economics of an industry plays a big role in investor success and an industry, sector or business can thrive without investors seeing large returns.
While bitcoin and cryptocurrencies are dominating the headlines lately, the S&P 500 is doing things it has never done in its history. In my 15 years in the industry I can't recall a run like we have had where every day is a repeat of the prior with new daily record highs in conjunction with record low volatility. Baring an enormous sell off the last week of December (I'm writing this On December 20th), the S&P 500 is going to set and break many records. Here are just some...
- The S&P 500 is on pace to finish 2017 without a single down month. You may be asking when was the last time that happened? NEVER. Even further, one has to go back to October of 2016 to find the last negative monthly return.
- The worst peak-to-trough drawdown in 2017 has been 2.8% while the average intra-year drawdown is ~16%. Even more stunning, the S&P 500 hasn't experienced one 2% move up or down close in all of 2017!
- The S&P 500's last negative quarter was in the 3rd quarter of 2015! In addition, 18 of the last 20 quarters have yielded positive returns. The last time that happened? NEVER.
The Federal Reserve increased interest by .25% in December and projected three hikes in 2018 and the markets rallied even harder. In years past, a mere mention of the words "rate hike" lead to panic and heightened volatility but today it's interpreted positively as it equates to a healthy and growing global economy. The markets seem to find the "good" in every piece of news.
Geopolitical tensions continue to rise but even this risk is being brushed off. It's interesting to watch how quickly sentiment changes as going into 2017 there was a cautious tone and analysts were anticipating extreme volatility. Even the most bullish analysts were calling for the S&P 500 to end 2017 in the 2,300 to 2,450 range. This goes to further solidify our opinion that trying to time markets should be avoided.
So what does all this mean for 2018? Well, in short, nothing. While these records are impressive, they are in the past and don't mean much going forward. While the global economy is growing and "major" tax reform is here, the question is how much of this have markets already factored in? It goes without saying that steady gains with low volatility are optimal for any investor, but not realistic long term. While the last fourteen months have defied the odds, I would not expect this going forward. If history is any guide, stock market volatility tends to accelerate after a one to two year dormant period and quite often market corrections start when it's least expected and when the economy seems to be humming along.
Have a safe and happy New Year!
Not much to share in the way of links this week. We’ve been reading stuff on the new tax code and getting our thoughts organized around it. Also I may not send anything out next week. Christmas Break.
I do however want to share something I have been ruminating on. I don’t want to leave the possible last post of the year on a negative note but I do want to briefly describe some thoughts on the markets as a whole. We have started to see investors starting to get bored with great returns. This scares us. Whether it is crypto currency, individual stocks or some other “investment” it seems people are now looking beyond the double digit market returns in search of something with more pizzaz. It is scary how much this reminds me of 2004-2007. Is this the spark of what could be the next market downturn? Possibly. It also could be the spark but the fire could be a year or so away. We don’t have to have a reaction to this feeling. We just have to acknowledge it. In the meantime we keep taking the great market returns and watch what happens with everything else.
I have my Star Wars tickets. It has become a holiday tradition I quite enjoy. When I opened my writing app this week I was shocked I had only saved one link so I added some Star Wars related links I read.
Bitcoin has gone full mania level and may continue its meteoric rise. It could go to 40k. Or it could crash to 1k. No one knows. On a scale from 1-10 my knowledge about crypto currency, smart contracts and blockchains is probably a 5 and that’s probably better than the average Bitcoin “investor” (speculator is a better term here). And I don’t know nearly as much as I would like and not quite enough to invest. Most money going into Bitcoin is not for investment. It’s for speculation and that’s fine. The trouble is many speculators of late probably don’t realize the difference. Either way, the technology behind all of this very intriguing and something I am learning more about. I think the future investments lie there.
I attended the Evidence based investing conference last week and was able to listen to some of the best and brightest in our industry.
They keynote presentation was given by Scott Galloway, Professor of Marketing at NYU and he spoke about digital advertising/marketing. One of the most startling takeaways was just how powerful the FOUR are (Google, Apple, Facebook & Amazon). In 2012, these four companies had market capitalization of $751 billion, equal to the size of Turkey's GDP. While today their market capitalization is $2,371 billion, equal to the size of India's GDP! Remember, India's population is approximately 1.324 billion. The way the world consumes has changed and by 2020 over 30% of searches will no longer involve a screen! They will come in the form of Alexa, Siri and Google Voice.
- The rest of the conference was focused on evidence based investing. Below are just some of my notes. I left the more analytical stuff out.
- There is a big misunderstanding between economic and stock market fundamentals. The stock market rarely follows economic fundamentals in the short term and can persist for years. In short, stop trying to time the market based on the fundamentals of the global economy.
- Volatility has come to a screeching halt as more people control a larger share (%) of the equity market vs. 10 years ago and the push to indexing and passive investing has largely replaced individual stock selection/day-trading which tend to be more volatile.
- Bitcoin was mentioned several times. The common theme was if you invest in it be prepared to lose it all. Introduction of government regulation or taxes could potentially cut the value by a third overnight. Until daily price fluctuations slow down, it is not a viable replacement for any currency.
- There are now over 110 hedge funds focused on cryptocurrency investing vs. 26 at the end of 2016. Too much speculation and this is fueling a massive bubble.
- Commodities are the most "hated" investment (comparable to Emerging Markets from mid 2011 to end of 2015). Given central bank involvement in manipulating interest rates trying to time when to invest in commodities is extremely difficult as they tend to outperform in period of high inflation.
- Emerging Markets are still "cheap" on a valuation basis compared to the United States and Europe with lower P/E and lower debt to GDP ratios. Emerging markets are becoming less reliant on commodities after the 2015 crash and placing higher emphasis on technology and manufacturing.
- Tensions between China and United States are beginning to flair up and come 2018-2019 could lead to a major trade war.
- Machine Learning/AI Investing has many worried. While it creates more options and variables with big data sets, initially it will be dealing with a very small sample size which can't be back-tested with much accuracy.
- Internal investment fees will continue to decline over the next decade
Here are some other facts I found interesting…
- Women now control more than half of US personal wealth!
- 1/6 queries entered into Google have never been asked before.
- Google and Facebook own 103% share of future digital advertising growth
- In 2016, Google advertising revenue compared to ad spend is larger than any single country in the world minus the United States.
- More American households (58%) are Amazon prime members than voted in 2016 election (55%)
- Apple's profit in 2016 ($45B) was nearly equal to Microsoft, Intel, IBM and Oracle combined! ($48B)
- Since 2008, Walmart has paid $64B in corporate income taxes while Amazon has paid $1B.
- Commodity Index has an annualized return of 2% the last 20 years with volatility of 14% while S&P500 has an annualized return of 10% last 20 years with the same level of volatility.
I hope everyone had a great Turkey Day and indulged in a lot of food. I sure did. A couple extra links this week but some really good reads. Non of the links are related to this weeks biggest news stories which are spread amongst many genres. North Korea tests another missile, Matt Lauer fired for sexual harassment, Tiger Woods returns to golf for his 4th post-back surgery comeback attempt, and Bitcoin gets volatile. The market seems to not be worried about the North Korea news. The Bitcoin story is something to watch as after Thanksgiving there was a dramatic increase in the number of accounts opened on some of the crypto exchanges and now a decline is occurring so a lot of new owners may be getting pummeled.
Sending links out early this week. Have a wonderful Thanksgiving weekend and thanks for reading.
A couple of times a year I block out all my reading time for a week to focus on knocking out a few books in a given subject. This has been one such week. I have tinkered around with meditation apps for a couple of years but I can’t really say they have helped me. So, I decided to review my list of books to read and see what I had saved regarding the subject of meditation and mindfulness. Below are the four books I read and a couple of others I plan to get to soon.
I always feel guilty tackling a subject that isn’t directly related to financial planning but a common theme I have come across from many great investors and leaders is some sort of mindfulness practice. I have long held that stoicism is important in helping people make investment decisions. Mindfulness fits into this as well.
The further away we get from the last major market decline the harder the next one will be to stomach. Guiding clients and ourselves through this will be as important as it was in 2008. It will be important as ever for advisors to make evidence based decisions with a sense of mindfulness and stoicism.
Thanks to all the Vets out there. If you have the day off then enjoy it and here is a longer than usual list of links.
We will have more details and further discussions with clients in the coming months but more details of the new tax plan are emerging. It looks like there will be big changes with mortgage interest deductions and business tax rates. There appears to be no changes to 401k and retirement accounts.
Ara is at the Evidence Based Investing Conference so look for details in his next market commentary.
Here are this week’s links...
In our April commentary we discussed how markets may have been driven higher in part because of the potential for tax reform. Since then, markets have continued to drift higher with no formal tax reform plan in place. While we wait for the details lets discuss "tax breaks" and the impact on the economy in general.
Currently the national debt exceeds $20 trillion and the 2017 fiscal year ended with a buget deficit of $666 billion. The national debt has been climbing as many government sponsored programs continue to experience higher outlays. Social Security and Medicare combine for about 40% of federal spending and this is only expected to increase. These are alarming numbers and it's estimated that President Trump's proposed tax cuts would add an additional $1.5 trillion to the deficit over the next 10 years.
Will economic expansion accelerate enough to offset the additional deficit?
Here is how a reduction in taxes is suppose to work...The cuts unleash investment and innovation which leads to more jobs, higher income and rapid economic expansion which help lower the deficit. There are many factors to measure the effectiveness of tax cuts but research done by Robert J. Barro and Charles J. Redlick found that historically cutting the average marginal tax rate on Americans by 1 percentage point raised the next year’s per-person economic output by about 0.5 percent. While positive, the concern is it's not enough to offset the additional deficit and could end up bloating the deficit even further. Others state that tax reform disproportionately benefits the wealthy and corporations, not the average taxpayer. In 2012, Kansas enacted tax reform and significantly cut rates with the hopes of economic expansion. Unfortunately the results showed that job growth, small business formation and overall economic growth lagged. This is not to say that tax cuts were the sole root of the problem, but it does show that a positive correlation of lower taxes and higher economic growth isn't always the case. In fact, we have experienced increased job growth in periods of both tax increases (Clinton, Obama) and tax cuts (Kennedy,Reagan). Factors such as age demographics, technology and normal economic cycles play a large role in shaping an economy. It should be stated that lowering taxes itself does not guarantee economic expansion as people could choose to work less to earn the same income.
Proponents of tax cuts argue that new business creation, which is considered to be the lifeblood of the U.S. economy is faltering in part because of high taxes and increased regulation. The numbers show new business creation is at a 40 year low. Starting a business is a risky and costly venture and proponents argue that without incentives such as lower taxes, write-offs on new capital purchases and less regulation, individuals are less inclined to take the steps necessary to start companies. It is argued that "wealthy" taxpayers pay more tax when marginal tax rates are slashed which means lower income earners bear a smaller share of the tax burden. It is also argued that private businesses use capital more efficiently than the government and tax revenues could rise even in the face of tax cuts as experienced in the 1920's. You can even point to a recent example where Indiana lowered state income taxes and corporate rates in 2013 and experienced a significant drop in unemployment (3.5%) and boost in GDP to 4%.
As you can see, tax reform is not an exact science and several factors shape an economy. The answer (as we often remind you) is probably somewhere in the middle but finding the right balance proves to be difficult. We think the government should look into alternate options with Social Security and Medicare benefits to help balance the budget but those are touchy subjects and would take time to hash out. While much of the attention is on tax reform, the bigger issue in our opinion is the Fed and ECB which are going to be attempting an unwinding of their balance sheets while raising rates. Financing a growing deficit with an increase in rates is a risky proposition unless economic expansion quickly follows. One thing is for sure, the economy will not thrive or collapse on tax reform alone.