On Tuesday my Weather Underground app said we could see 9” of snow on Saturday. Luckily the threat has decreased to potentially nothing. We need Spring to arrive on the East Coast if nothing else to make people feel better. The recent convergence of politics and the markets is exhausting. With Amazon and China in the President’s crosshairs we continue to see the market give back gains. Even this week after a couple of great days, more tariff threats have led to another sell-off to close the week.
Though we have experienced extreme volatility in 2018, every sell off has been short lived. In fact, the past five years has been this way. The S&P 500 has experienced only two negative quarters since 2013. One constant throughout has been the elevated levels of stock buybacks. While buybacks play a role in markets, the question is how much is too much and what are the risks associated?
Prior to 1982, stock buybacks were a rare occurrence as corporations ran the risk of being prosecuted by the SEC. After a few regulatory tweaks, stock buybacks became the norm. Corporations turn to buybacks when they feel their stock is undervalued and attempt to put a floor on the price. They can use cash on their balance sheet or borrow money (debt) to do so. Leading up to the financial crisis, buybacks were steadily increasing year over year. All that changed in 2008 when the global economy came to a screeching halt. After the Federal Reserve stepped in and reduced interest rates and began quantitative easing, corporations took advantage of low interest rate and once again began to ramp up buybacks. Just recently, as part of President Trump's tax overhaul, corporate taxes were reduced from 35% to 21%, which lead to a new surge in buybacks. Through February 15th, corporations had announced over $170 Billion of buybacks. This surpasses the $147.2 billion in the first six weeks of 2015 and nearly double the first six weeks of each year since 2011 (minus 2016). Over the past decade, the corporations that comprise the S&P 500 have spent 54% of their profit on stock buybacks. This is a jaw-dropping amount and makes one wonder how sustainable it is.
The question is, are stock buybacks healthy or more a temporary solution? Proponents argue that too much is harmful as it mainly enriches shareholders and corporate executives and does not focus on capital investment, spending or boosting wages, which help all, not just the few. History has shown that achieving sustainable economic growth is extremely difficult without a growing lower and middle class. Also, oftentimes struggling corporations issue buybacks in an attempt to stop the bleeding while ignoring their fundamental problems which leads to a poor use of resources. While buybacks may help boost corporations' earnings per share, it has no material impact on bottom line growth. This is important to remember as many stocks experienced phenomenal gains leading up the financial crisis when in reality their growth was already slowing but buybacks were helping cover up the root of the corporations problems. Stock buybacks are rarely subject to shareholder approval which means the board of directors has the final decision. To be clear, buybacks serve a purpose (similar to dividends) and make sense when implemented properly but just like most thing, too much of it could be detrimental the same way too much lending or debt can be harmful.
On one extreme we now have lawmakers proposing bills to ban buybacks completely. While this seems extreme it is something we may start hearing more about. A majority of voters don't have investments and in some ways love the idea of "hurting Wall Street" in whatever way possible.
Facebook, Amazon, Netflix and Google (now Alphabet) are so large that the can affect the market, especially over the short term. This week tech stocks took a beating, recovered some and could be up or down for the week by the time you read this. As I am writing this the NASDAQ jumped up over 1.5% in about 30 minutes since I last checked. Its the nature of tech stocks and the market at large these days. Make no mistake, however, these four stocks are always in the crosshairs both positively and negatively. It seems Trump has an ax to grind with Amazon but seeing how there are more Amazon Prime subscribers than the number of people who voted in the last presidential election it isn’t a big concern in our opinion.
Enjoy this week’s links.
I hope everyone in the Mid-Atlantic and Northeast are digging out of this late season snow storm. Warmer times are ahead. For Facebook, however, their ongoing storm has only worsened. And a new storm is now brewing in global markets as fears of a Trade War with China has led to sell-offs this week. “Trade War” will continue to be the buzzword of choice in the financial media so try not to get to bogged down in it.
New Fed Chair Powell presided over his first rate hike this week but what may be a more interesting thing to watch moving forward is it appears he will diverge from the philosophy of using models and forecasts and instead react to the current state of the economy.
Kudos to all the kids who walked out of school this week. Regardless of your opinion on guns the fact these kids peacefully protested across the nation (with many facing detention for doing so) is a testament to their generation.
I’ve heard this generation of kids called Generation Z but who knows if that name will stick. One thing is for sure, they are deciding to do things differently from their elder Millennials. These are the kids born to the “forgotten generation” termed Generation X who grew up in the 80s. Though they are sandwiched between the larger Boomer and Millennial generations they are raising what may end up being the most important generation since WWII.
Oscar ratings were their worst ever on Sunday. There seems to be a great debate as to why. Personally, I saw very few of the movies nominated. This wasn’t without trying. We went to binge them iTunes only to find they either weren’t out yet or you could only buy them. If your movies aren’t accessible leading up to the Oscars then don’t be surprised when no one watches. And don’t be surprised when no one remembers your movies a week later when we all get back to whatever TV show we are currently binging.
You may have seen the $1B acquisition of Ring by Amazon. You may have also seen the story of how in 2013 Ring was on Shark Tank and failed to acquire a deal. Most of the “Sharks” would likely tell you this isn’t their only miss. They would also likely tell you they don’t beat themselves up about missing out on companies or investments. They made the best decision for them at the time. With the rise (and subsequent fall) of Bitcoin and other crypto currencies the feeling of “missing out” popped into many peoples minds. Worse, the fear of missing out drove many to invest at the top and subsequently see their money cut in half.
Warren Buffet’s annual letter is a must read in our industry and I linked it below but the last link is a very quick summation also.
In our January Market Commentary we mentioned that the low levels of volatility experienced in 2017 were not likely to continue. Sure enough, volatility spiked from late January into February with the S&P 500 experiencing several 3-4% single day declines and as much as 5-6% intraday moves! February is going to end up as one of the most volatile months in the last decade while 2017 was one of the lowest in the last 60 years.
Rising interest rates is one of the reasons given by many as the culprit of the recent sell off. Historically, however, stocks tend to increase during periods of rising interest rates. Of course it is important to point out this time could be different since we are experiencing rising rates coming out of a period of unprecedented levels of quantitive easing and low rates. But, it is also possible higher rates may simply reflect the rising pace of economic activity. Economic expansion is typcially identified as a catalyst of long-term stock returns.
I feel interest rates are not the place to look for blame right now.
The area that should be receiving more attention is inflation. Inflation is currently a little over 2% which is still relatively low (at at the targeted number for the Federal Reserve) but has been on the rise since 2015. With the U.S. economy being near full employment along with increased wages (all seemingly "good" things) the added tax "stimulus" could overheat the economy leading to a large spike in inflation which would provide markets a major reason to pull back. Rising inflation tends to lead to an increase in wages and production costs, which typically has a negative impact on corporate earnings and economic output. Too much inflation (hyper inflation) can cripple an economy. The U.S. experienced 14% inflation in the 80's, although I'm not suggesting the U.S. faces nearly the same threat today, I am merely pointing out that rising inflation poses a bigger threat to stocks than rising rates, although admittedly often these things do go hand in hand.
There have been inflation worries in the past that never came to fruition. This could be another one of those cases or it could just be the next thing to deal with. Central banks will once again be playing a crucial role.
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.