Weekly Commentary November 24th, 2014

The Markets

Pioneer. Trendsetter. Trailblazer. Whatever term you decide to use, there’s no debate about the fact central banks around the world are taking a page or two from the U.S. Federal Reserve’s playbook. The Fed may have ended quantitative easing (QE) – its program of buying government bonds to keep interest rates low and increase money supply – in October, but that doesn’t mean QE hasn’t become popular elsewhere. Barron’s reported:

“…virtually every other major central bank is maintaining or stepping up its pace of money printing – even where the success in spurring growth is questionable. On October 31, Japanese authorities doubled down on asset purchases by the Bank of Japan, and the nation’s pension fund, to spur flagging growth… In a surprise move on Friday, China cut interest rates for the first time in two years in an effort to spur slowing growth… That was followed by European Central Bank President Mario Draghi’s signal the ECB would expand its stimulus plan, leading observers to expect large-scale, Fed-style purchases of government debt.”

Although some Americans remain skeptical about the health of the U.S. economy, growth in the United States stands in sharp contrast to growth elsewhere. The U.S. Department of Commerce reported real gross domestic product (GDP) – the value of goods and services produced in the United States – increased by 3.5 percent during the third quarter of 2014 after growing by 4.6 percent in the second quarter. For the same period, the Eurozone’s GDP grew by 0.6 percent, which is well below its 2 percent pre-crisis growth rate, and Japan’s GDP declined by 1.6 percent during the third quarter after a 7.3 percent drop in the second quarter.

While Japan has been mired in economic stagnation for some time, it’s a relatively new experience for the Eurozone where unemployment hovers around 11.3 percent – a record high. Aggression in Ukraine is complicating matters in Europe. An expert cited by The New York Times explained, “We are at most one or two rounds of sanctions and countersanctions away from pushing Russia into a deep recession, and Europe into a recession.”

While concerns remain about the health of the global economy, markets generally were pleased about central banks’ easy money policies and most global stock markets finished the week higher.

looking for some money for college? Then you may want to stop limiting the time your children spend playing video games, or you may want to focus their efforts. Robert Morris University (RMU) in Chicago, Illinois, has a new scholarship program – $500,000 for 30 scholarships that will go to League of Legends (LOL) players. The chosen few receive up to 50 percent of tuition and 50 percent of room and board.

Where do the Robert Morris Eagles find candidates? As it turns out, more than 750 schools in the United States and Canada participate in the League of Legends High School Starleague. At the collegiate level, the LOL league boasts more than 100 colleges and universities, including Carleton, Texas A&M, George Washington, University of Minnesota, Northwestern, University of Michigan, and Harvard. E-athletes participating in the college Starleague vie for $100,000 in scholarship money offered by the company that publishes League of Legends.

According to WNYC’s New Tech City, LOL is a complex and difficult-to-master game. Players choose one of more than 120 characters, each with various magical powers that must be memorized. “Teams of five take on other teams of five and basically try to destroy each other. It’s called a ‘multiplayer online battle arena game’ or MOBA for short.”

So, what’s in it for the school? E-sports are not covered by the NCAA, “so the school's team can compete for cash prizes and, if it wins, the school keeps the take.” You may recall, from a late-July commentary, the League of Legends (LOL) championship is an international video game competition with $1 million in prize money.

If you’re amazed there are scholarships for video game play, you’re not alone. One of the Robert Morris Eagles’ players told NPR, “I told my mom about [the RMU scholarship]. She didn't believe me. She's like, you're crazy and there's no way… She thought I was like, making it up 'cause she personally doesn't even like me playing the game, but when she realized I was going to get a scholarship for it, she accepted it, you know? She tells all of her friends.”

Parental support is probably pretty important. E-athletes at RMU practice five hours a day in their ‘arena,’ which is a room decked out with sponsored gear. They play tournaments on weekends. Critics worry that encouraging intensive play is a poor idea when countries, like Korea (where the game is exceptionally popular), have begun screening children for gaming and Internet addiction.

In mid-November, the RMU Eagles were undefeated in LOL collegiate play.

Weekly Focus – Think About It

“Empathy is really the opposite of spiritual meanness. It's the capacity to understand that every war is both won and lost. And that someone else's pain is as meaningful as your own.”

--Barbara Kingsolver, American novelist

Weekly Commentary November 17th, 2014

The Markets

“Is all this stock market optimism a red flag?”

Contrarians – investors who bet against prevailing market trends – were probably nodding along as they read that headline in The Wall Street Journal back on January 18, 2013. The Journal cited the American Association of Individual Investor’s (AAII’s) Sentiment Survey, which showed about 46 percent of participants were feeling bullish. As it turned out, the bulls were right. The Standard & Poor’s 500 Index rose from about 1486 to about 2040 through the end of last week.

You may recall, two weeks ago, the AAII Sentiment Survey showed investor pessimism at a nine-year low with just 15 percent of participants growling like bears. Well, last week, pessimism rebounded and optimism moved higher, too. The survey results were:

·         Bullish:  57.9 percent, up 5.2 percentage points from the prior week

·         Neutral: 22.8 percent, down 9.5 percentage points from the prior week

·         Bearish: 19.3 percent, up 4.3 percentage points from the prior week

The historic average for the survey is bullish 39.0 percent, neutral 30.5 percent, and bearish 30.5 percent.

Americans are feeling pretty confident about the stock market’s potential and that’s not always a positive sign. Expectations of Returns and Expected Returns, a paper published by Robin Greenwood and Andrei Shleifer of Harvard University, compared investors’ expectations for returns to what financial economists call expected returns (which are calculated using dividends, consumption, and market valuations). They crunched numbers for data collected between 1963 and 2011 and found expectations for returns and expected returns tend to be negatively correlated. “…Both expectations of returns and [financial economists’ expected returns] predict future stock market returns, but with opposite signs. When [financial economists’ expected returns] are high, market returns are on average high; when [investors’] expectations of returns are high, market returns are on average low.”

So, since investor expectations are high, will U.S. stock markets returns be low? There is no way to know. Whether you’re a bull or a bear, in times like these, it’s good to have a well-diversified portfolio.

'THE NEW HIRE' is the name of a September survey published by PwC. It’s not about how to make newly-hired people more comfortable and productive. It’s about how the R generation – the latest iteration of industrial robots – is transforming manufacturing. More than one-half of the 120 manufacturing firms surveyed already have adopted robotics technologies. Auto manufacturers employ robots, as do food; consumer goods; life sciences, pharmaceutical, and biomedical; and metals companies.

PwC predicts the shift to robots will create new jobs for engineers specializing in robots and robotics operating systems. It also is likely to result in the displacement of a fair number of human workers. Currently there are about 1.5 million ‘intelligent industrial work assistants’ laboring around the world. About 230,000 are employed in the United States. According to The New Hire report:

“Industrial robots are on the verge of revolutionizing manufacturing. As they become smarter, faster and cheaper, they’re being called upon to do more – well beyond traditional repetitive, onerous, or even dangerous tasks such as welding and materials handling. They’re taking on more “human” capabilities and traits such as sensing, dexterity, memory, trainability, and object recognition. As a result, they’re taking on more jobs – such as picking and packaging, testing or inspecting products, or assembling minute electronics.”

That may be a little optimistic. Last month, Popular Mechanics reported engineers have been working on mechanical first-responders, like bomb-defusing and investigator robots, to help with threats like Ebola and the Fukushima nuclear power plant disaster. The magazine found robots competing in the DARPA Robotics Challenge were more like toddlers and less like capable adults. “For a typical task in the event, turning a valve, a team of several people required an hour or more to prep the robot, and that same team had to stand at the ready to catch their bot when it stumbled (which happened often).”

 

Weekly Focus – Think About It

“All the world's a stage, and all the men and women merely players: they have their exits and their entrances; and one man in his time plays many parts, his acts being seven ages.”

--William Shakespeare, English playwright and poet

Weekly Commentary November 10th, 2014

The Markets

Is it a melt-up?

You’re familiar with the word melt. Ice cream melts. Snow melts. You may have seen someone melt down (or have done it yourself). Right now, markets may be experiencing a melt-up, according to Barron’s. Melt-up is a counterintuitive term which describes a sharp, emotion-driven improvement in market performance. Last June, The Wall Street Journal blog described the melt-up phenomenon like this:

“Money managers and analysts are beginning to talk about an idea that dates from the roaring ’90s: a rapid stock gain known as a melt-up. In the late ’90s, people thought a melt-up, or a sudden double-digit percentage rise, was a fine thing. Set off by some exciting event, melt-ups feed on their own gains as people rush to avoid missing out. In late 1999 and early 2000, the Nasdaq Composite Index surged to 5000 from 3000 amid the Internet frenzy. It then collapsed. Melt-ups, investors learned, can lead to meltdowns.”

Markets did move higher last week. In fact, several major U.S. indices finished at record highs on the same day. That’s a rare occurrence and one that hasn’t happened since 1998. What was behind the move? Barron’s reported investors were encouraged by mid-term election results, strong third-quarter earnings, and the European Central Bank’s promise to spend $1.25 trillion on quantitative easing.

Investor optimism also gained ground. Last week’s American Association of Individual Investor’s (AAII’s) Sentiment Survey found a majority of investors were feeling bullish. Almost 53 percent believed stock prices would increase during the next six months. The bears were in retreat with pessimism about market performance falling to a nine-year low. “At current levels, optimism is unusually high and pessimism is unusually low. Historically, such occurrences have been followed by lower-than-average levels of market gains,” reported the AAII’s blog.

So, is it a melt-up? It’s difficult to know. What’s really important is this: Melt-ups are buy first, think later situations which sometimes lead to melt downs, which are sell first, think later situations. Needless to say, it’s always better to think first.

Let’s hear it for family businesses! Family-owned and family-controlled businesses are a pretty important part of the global economy. McKinsey & Company recently noted:

“In many ways, family businesses are stronger, more vital, and more important than they have ever been. Various estimates peg their share of global GDP [gross domestic product] at between 70 and 90 percent. While many family businesses are private, about a third of the Fortune Global 500 companies are founder or family controlled, as are 40 percent of the major listed companies in Europe. Family businesses are especially important in emerging markets accounting for about 60 percent of private-sector companies with revenues of $1 billion or more.”

According to The Economist, the largest family firms in the world span industries ranging from retail to automobiles to electronics to pharmaceuticals. The top 10 include four companies in the United States, along with firms based in Switzerland/United Kingdom, Germany, Italy, Russia, South Korea, and Taiwan.

One of the most important challenges for family firms is succession. McKinsey & Company reported many businesses falter as they transition from the founder to the next generation, and most perish before the third generation can take the reins. Successful succession requires founders to look ahead, formulate a vision, and plan to that vision. In general, family-owned businesses have three basic options. The founder can:

·       Give the business away and start a foundation.

·       Sell the business and invest or divide the proceeds.

·       Keep the business and pass it on to the next generation.

McKinsey & Company predicts family companies are likely to become even more influential over time, especially in emerging markets.

 

Weekly Focus – Think About It

“Total spending by political parties in the British general election was £31.5m ($49.9m). Total spending by outside groups was £2.8m ($4.4m). So all in all: $54.3m. With 45.6m registered voters in Britain, that comes out at $1.19 per voter… That is less than the seventh most-costly Senate race (Arkansas), which cost $56.3m, or $26.47 per Arkansas voter. So the seventh costliest Senate race cost more than the entire 2010 general election in Britain.”

--The Economist

November Election Results and the Stock Market

The months of polls, punditry, and posturing are finally over. After months of uncertainty and waiting, the midterm elections are done, and there is a resolution.

As expected, the Republican Party regained control of the U.S. Senate and added to its majority in the U.S. House of Representatives. Although a few Senate races have yet to be decided, the Republicans control at least 52 seats—and  could control as many as 54. The important numbers in the Senate are 51, 60, and 67. The Republicans are over 51, which gives them a simple majority, but they are still short of the filibuster-proof 60, and far short of the 67 needed to override a veto, making sweeping legislative change unlikely.

Republicans made major gains, and the House has not been so dominated by one party since 1946. This is an interesting development, but does it mean that significant changes are on the horizon? Does change in the Congress mean change for you? Not really. The business environment might be slightly friendlier after the midterms, but I do not expect significant changes. 

The next key date in Washington, D.C. comes in mid-December 2014, when the continuing resolution to fund the government expires. The subsequent key date will be mid-March 2015, when the U.S. Treasury will hit the debt ceiling once again. At the margin, the Republicans’ control of Congress raises the risk they will demand concessions for passing a funding resolution for next year, or for raising the debt limit. However, given the backlash following last year’s government shutdown, as well as initial comments from likely Senate Majority Leader Mitch McConnell (R-KY), it is likely that Congress will avoid such a standoff.

Although major changes from the new Congress are not expected, we are watching possible movement on several key legislative issues. Republican control of the Senate and House could have positive implications for energy and financial services companies by easing the regulatory landscape. For the energy sector, Republicans may be able to speed up permits for oil and gas exploration and gain approval for the construction of the Keystone XL pipeline, providing a potential boost to energy and industrial sector growth. Regulatory pressures on banks, including capital requirements, may be eased. Tax reform is possible, although more likely to happen at the corporate level than an individual level. And although Republicans will not be able to repeal the Affordable Care Act, changes to the law are likely, including the probable elimination of the medical device tax.

Clearly, elections have implications for policy and the direction of the country. Ultimately, however, we believe stock market performance will depend more heavily on economic growth, corporate earnings, and valuations in the months ahead. In the end, these factors will weigh more heavily on the direction of stock prices than modest legislative changes. We continue to believe these factors may support further stock market gains. 

Stay tuned for our upcoming Outlook 2015 event, for a closer look at policy considerations and the forecast on the economy, stock market, and bond market for investors next year.

Weekly Commentary November 3th, 2014

The Markets

Are central banks throwing a progressive party?

You know, the kind of party where folks travel from house to house feasting and drinking and enjoying the proffered hospitality. For years pundits have speculated about what will happen to the U.S. stock market party when the spiked punch bowl of quantitative easing is gone. Last week, they got an unexpected answer: Come on over to Japan’s house.

On Wednesday, the U.S. Federal Reserve announced October marked the end of its third round of quantitative easing (QE). Since late 2008, the Fed has purchased trillions of dollars of government and mortgage-backed bonds in an effort to spur economic growth (by increasing liquidity and lending) and head off deflation. In October, The New York Times reported, “The good news is that economy has been growing remarkably steadily since the middle of 2009… Still, the pace of growth has been perpetually disappointing for anyone expecting or betting on a return to the pre-crisis trend.”

Not long after the Fed announced QE closing time, Japan’s central bank, Bank of Japan (BOJ), startled stock markets with a Godzilla-sized surprise – it was expanding an already significant quantitative easing program. As if that weren’t enough, the President of Japan’s Government Pension Investment Fund (the world’s largest pension fund) said the fund’s assets were being reallocated. Instead of having 60 percent invested in bonds, it would keep 35 percent in bonds and move the balance to stocks. The news electrified stock markets. Barron’s reported:

“Stocks soared around the globe while the yen plunged against the dollar and the euro. Extending the previous week’s surge, the major U.S. equity gauges ended at records on Friday, while stocks in Tokyo jumped more than 7 percent on the week to the highest level since November 2007. Not to be left out, European stocks gained 3 percent, their best weekly showing since last December.”

Barron’s also pointed out the real effect of a falling yen was to export deflation to Japan’s trade partners. The drop in the value of the yen on Friday translated into a $1,500 price cut on a $60,000 Lexus or Acura, increasing competition for luxury German automobiles.

So, what’s the next stop for revelers at the central bank fête? The New York Times speculates it may be the Eurozone.

 

 

Why are people worrying about deflation? Deflation is a general decline in prices. For anyone who has been struggling to make ends meet that may not sound all bad. In fact, it’s not always bad. According to the Federal Reserve Bank of St. Louis, between 1876 and 1879, prices in the United States fell by about 5 percent per year, on average, while the economy grew at a 7.6 percent clip.

Of course, deflation is not always good either. Financial crises in the United States during 1890, 1893, 1907, and the early 1930s were followed by periods of lower economic growth and deflation. The Economist described the harmful effects of deflation like this:

 

“It is a pernicious threat, all the more so because, at its onset, it seems almost benign… The belief that money made tomorrow will be worth less than money today stymies investment; the belief that goods bought tomorrow will be cheaper than goods bought today chokes consumption… Wages, incomes, and tax revenue all stall, undermining the ability of households, businesses, and governments to pay their debts – debts which, in real terms, will grow more burdensome under deflation.”

 

Deflation is a greater threat in Europe than in the United States. The European Central Bank’s most recent bulletin distinguished between deflation (a significant and persistent decline in prices that becomes entrenched in expectations) and disinflation (a process of decelerating inflation that may lead to negative inflation rates but is a temporary state of affairs). Italy, Spain, Greece, Sweden, and Israel experienced negative inflation in September, according to The Economist. It reported, “The IMF [International Monetary Fund] recently put the odds of deflation in the euro zone – defined as two quarters of falling prices in a 12-month span – at 30 percent in the coming year.”

 

Weekly Focus – Think About It

 

“And so it began: a growing realization that the vampire genre is positively swollen with economic questions. And the zombie genre? Maybe more so. Economic issues take center stage in many undead narratives – and when they don’t, they’re still lurking in the shadows.”

--Economics of the Undead, A collection of essays