Weekly Commentary March 23rd, 2015

The Markets

Financial markets gave the Federal Reserve a standing ovation last week. At least, that was Barron’s interpretation. What did the Fed do to deserve it?

“…the Fed did what everyone expected, signaling that it could raise interest rates at any meeting starting in June. Yet, Yellen and team still found a way to assure the market that it wouldn’t do anything rash, insisting that the labor market would need to strengthen further, and that inflation would have to be heading for its 2 percent target before they make a move. Even then, the projected path of interest-rate hikes would be slow and steady – and unlikely to undermine the market.”

Stock markets in the United States weren’t the only ones heading toward, or surpassing, new highs. The Fed’s reassurances about the pace at which it would normalize monetary policy pushed markets across the Eurozone higher, too. Reuters reported global investors were feeling confident a weaker euro could goose the region’s economy.

There is some optimism about shorter-term market potential. Experts cited by Barron’s suggested the chance for a stock “melt-up,” which would lift the Standard & Poor’s 500 Index (S&P 500) higher, were pretty good.

However, others believe the longer-term outlook for stocks, as a whole, may temper investors’ enthusiasm. Barron’s explained earnings growth for the S&P 500 is well below its 30-year average, dividend yields are well below their 20-year average, and the index’s valuation is “so high that it is projected to subtract 2.6 percent annualized from returns. Put it together and investors are likely to earn just 0.4 percent after inflation.”

One thing is for sure: It’s awfully difficult to predict the future with any accuracy. Barron’s warned about the quirks of market forecasts, offering an example from a decade ago. “In January 2005, expected returns were just 0.4 percent, yet the S&P 500 gained 5.6 percent annualized during the next 10 years.”

It may seem like a good idea today... If anyone needs more evidence that focusing on short-term corporate performance can be detrimental to longer-term outcomes, look no further than the effect of the strengthening U.S. dollar on companies outside the United States that issued debt denominated in U.S. dollars. The Economist explained:

“Dollar borrowing is everywhere, but the biggest growth has been in emerging markets. Between 2009 and 2014 the dollar-denominated debts of the developing world, in the form of both bank loans and bonds, more than doubled, from around $2 trillion to some $4.5 trillion, according to the Bank for International Settlements (BIS)… Recent months have seen… an Indian property developer… a South African power generator, and… a Turkish firm that makes TV dinners, sell dollar-denominated bonds. By borrowing dollars at several percentage points below the prevailing interest rate in their domestic currency, CEOs have pepped up profits in the short term.”

As it turns out, dollar-denominated debt may not work out so well in the long run. In recent weeks, the value of currency in many countries has declined relative to the U.S. dollar which has been strengthening. As a result, the amount of interest owed on bonds issued and loans taken in U.S. dollars has increased significantly when measured in local currency terms. Unless a company has U.S. dollar earnings to help offset the expense, the higher cost of its debt can hurt the company.

The New York Times cited a leading electric utility in India that is selling facilities and renegotiating debt after its debts increased thirty-fold in just a few years. In Brazil, some sugar producers have declared bankruptcy, in part, because of U.S. dollar debt and falling sugar prices.

The Times also pointed out, “…the rising dollar and falling emerging-market currencies cut both ways for the economies in question. Even as companies that gorged on dollar debt run into trouble, falling currency values make exporters more competitive on global markets.” In January, the International Monetary Fund projected economic growth in emerging countries will increase from 4.3 percent in 2015 to 4.7 percent in 2016.

 

Weekly Focus – Think About It

“If you obey all the rules you miss all the fun.”

--Katharine Hepburn, Actress

Weekly Commentary March 30th, 2015

The Markets

So, when is the Federal Reserve going to increase the rate for overnight borrowing?

It’s a question that has plagued bond investors throughout the first quarter of 2015. In January, 10-year Treasury yields fell as low as 1.6 percent. Early in March, they rose to about 2.2 percent before falling back below 2.0 percent. The Financial Times reported:

“Higher volatility is typical when markets are on the cusp of a major turning point, and that has been the story so far this year for U.S. Treasury debt… The year has already been characterized by big swings in bond yields, which move inversely with prices… The lack of a clear signal over when policy shifts towards a tightening phase may provide the central bank with greater flexibility but does not quell the uncertainty facing investors.”

In recent weeks, Fed Chairwoman Janet Yellen indicated the timing and pace of a rate change would be determined by economic data. In general, the Fed considers a variety of employment and inflation measures when determining policy. The Times suggested bond markets have priced out the possibility of a June rate hike, although several Federal Reserve officials recently said a June increase is still under consideration.

U.S. stock markets reflected investor uncertainty last week, too. Turmoil in the Middle East sparked concern an oil price reversal could occur if supply is disrupted. In addition, investors’ worried weaker-than-expected economic data might indicate U.S. economic growth was slowing. The Commerce Department reported business investment spending plans fell for the sixth straight month. That could result in reduced expectations for first quarter growth, as well as delay a Fed rate increase. Stock markets showed signs of life late in the week but finished lower.

Your grandparents and great-grandparents saw a lot of things change during their lifetimes… During the 20^th century, the first Nobel prizes were awarded. The first license plates were issued. The first World Series was played. Americans lived through McCarthyism, the Great Depression, and Orson Welles’ ‘The War of the Worlds’ broadcast. Rock and roll became popular. The first theme parks opened, NASA was formed, and Earth Day was introduced. Two World Wars were fought as well as the Vietnam, Korean, and Gulf Wars. The Gold Standard ended and the tech revolution arrived.

Many of these events had immediate or eventual implications for industries – automobiles, sports, communications, entertainment, defense, technology, and others – as well as financial markets. The last decade has seen some significant changes, too. Here are a few milestones we’ve witnessed:

2006: The United States population passed 300 million. (100 million in 1915; 200 million in 1967)

2007: More babies were born in the United States than in any other year in American history.

2008: Nielsen reported texting had become more popular than calling.

2009: More people lived in urban areas than in rural areas across the globe.

2010: This was the hottest year since 1880 – until the record was broken again in 2014.

2011: Digital music sales overtook physical music sales for the first time ever.

2012: China became the world’s biggest trading nation and largest pork producer.

2013: The United States overtook the Saudis to become the world’s biggest oil producer.

2014: China’s economy surpassed that of the United States.

2015: Millennials (born 1980 to late 1990s) became our nation’s largest living generation.

When considering investment opportunities, it can be helpful to ponder the ways in which demographic and economic shifts may affect the future and what types of businesses may benefit (or not benefit) from the changes.

 

Weekly Focus – Think About It

“Friendship is always a sweet responsibility, never an opportunity.”

--Khalil Gibran, Lebanese poet and writer

Happy Belated Birthday Bull Market

The financial crisis of 2008 seems like such a long time ago. During the crisis, we saw the collapse of Lehman Brothers, bank bailouts and forced mergers, massive federal stimulus, and extraordinary Federal Reserve (Fed) policy. We experienced near unprecedented stock market volatility when daily stock market moves of 5% or more were not uncommon. Despite these extreme conditions, one of the greatest six-year bull markets emerged from this crisis.

Now, we are celebrating another (belated) birthday of the bull market that began on March 9, 2009. (A bull market is defined as a prolonged period of stock market gains without a 20% or more decline.) Not only has this bull market for stocks lasted a long time from a historical perspective (it is the third-longest since World War II), it has also been the strongest six-year-old bull.

As the bull market enters its seventh year, many are wondering whether this bull has another year left to run. As should not be surprising given its age and the strong returns it has produced, this bull market may be due for a modest correction. But, that does not necessarily mean that a downturn is imminent. Risks always loom somewhere and, right now, they are in the form of terrorism, the Russia-Ukraine conflict, the possibility of a nuclear Iran, the energy downturn, and the Eurozone’s struggles.

However, there seem to be enough factors supporting this bull that it could continue its charge:

·         Bull markets do not die of old age, they die of excesses, and there does not seem to be any evidence today that economic excesses are emerging in the U.S. economy.

·         The Fed typically reacts to built-up excesses with multiple rate hikes, contributing to the start of recessions. The slow economic recovery we have experienced has delayed the formation of excesses and the start of the Fed’s rate hike campaign.

·         Though valuations are slightly expensive by historical standards, prior bull markets have shown that corporate earnings gains can lift stocks for quite a while even after valuations exceed long-term averages and stop expanding. Valuations have proven to be good indicators of long-term stock performance; they have not been reliable shorter-term indicators.

·         Low inflation persists, which helps increase the value of future earnings and dividends.

·         Economic and market indicators that have been found to be effective in signaling recessions and stock market downturns suggest the economic expansion and bull market have the potential to continue through 2015.

Given this backdrop, I believe remaining fully invested in a diversified portfolio is prudent. The outlook continues to be positive for modest gains in stocks based on the underlying strength of the U.S. economy, a rapidly improving employment backdrop, and accommodating global central bank policies. Thus, we can be optimistic that we may be blowing out seven candles on this bull market’s birthday cake next year.   

As always, if you have any questions, I encourage you to contact me.

Weekly Commentary March 16th, 2015

The Markets

Franklin D. Roosevelt’s first inaugural address was delivered in 1933 in the midst of the Great Depression. He said, “This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself – nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.”

Last week, some were speculating fear and uncertainty were behind U.S. stock market performance. The root of the problem was the word ‘patient,’ which Barron’s reported is likely to be removed from the Federal Open Market Committee’s statement this week, paving the way for an increase in interest rates. The publication cautioned that investors may throw a tightening tantrum and:

“That could make 2015 look a lot like 2013, the year of the so-called taper tantrum. Remember when Ben Bernanke first mooted the possibility that the Fed would curtail its bond purchases in testimony to Congress on May 22, 2013? The markets reacted with, well, horror. The S&P 500 fell 5 percent in just over a month of trading. Tapering itself, however, went off without a hitch; the S&P gained 9.1 percent from December 2013 to October 2014 as the Fed slowly cut its bond purchases.”

Continued strengthening of the U.S. dollar also affected markets last week. Reuters reported stock prices fell, in part, because of concerns about corporate profitability in the face of a stronger dollar. Sources cited by Barron’s pointed out, in the long run, a strong dollar is better for American companies. After all, a strong dollar increases the buying power of consumers and companies. However, investors currently seem to be focused on short-term consequences rather than long-term results.

#make it happen! International Women’s Day (IWD) was on March 8. It celebrated the economic, social, and political achievements of women in countries around the world. The United Nations explained IWD “is a time to reflect on progress made, to call for change, and to celebrate acts of courage and determination by ordinary women who have played an extraordinary role in the history of their countries and communities.”

Although IWD is not a recognized holiday in the United States, American women have made great strides, particularly in the workplace. If you look back to the 1890s, when the U.S. government first began gathering detailed information about working people, there were about 63 million Americans. Twenty-three million were working-age women. (The working age, whether you were male or female, was 10 or older.) Women were a relatively small part of the paid work force – just 17 percent – as most labored in the home or alongside their families on farms, producing food and goods.

How times have changed!

The 2013 U.S. Census Bureau American Community Survey estimated there were more than 316 million Americans in 2012. About 103 million were working age women (ages16 to 64) and more than 73 million women were part of the paid work force.

Women have become an integral part of American companies. In early 2015, Catalyst reported women who worked at Standard & Poor’s 500 companies held:

·         25.1 percent of executive/senior-level management positions

·         19.2 percent of the board seats

·         4.8 percent of chief executive officer positions

In addition, the inclusion of women on corporate boards appears to correlate with better performance. The Bottom Line: Corporate Performance and Women’s Representation on Boards compared the performance of companies which included the most women on their boards to those with fewest by measuring return on equity (ROE), return on sales (ROS), and return on invested capital (ROI). Companies with more women sitting on their boards had, on average, 53 percent higher ROE, 42 percent higher ROS, and 66 percent higher ROI.

 

Weekly Focus – Think About It

“No matter what message you are about to deliver somewhere, whether it is holding out a hand of friendship, or making clear that you disapprove of something, is the fact that the person sitting across the table is a human being, so the goal is to always establish common ground.”

--Madeleine Albright, Former U.S. Secretary of State

Weekly Commentary March 9th, 2015

The Markets

If you looked at last week from the perspective of the children’s book, If You Give a Mouse a Cookie, it might have gone like this:

If you give the United States a positive employment report,

Investors are going to ask whether interest rates will move higher.

When they conclude the Federal Reserve may increase rates sooner rather than later,

American stock markets may dip lower…

Yes, last week was one of those weeks: When good news triggered not-so-good news. According to Barron’s:

“The February jobs report, showing a 295,000 gain in nonfarm payrolls, about 60,000 more than predicted by economists, plus a dip in the unemployment rate to 5.5 percent from 5.7 percent in January, evidently was enough to convince the markets that a June Fed rate hike is now likely. The June fed-funds futures contract was pricing in a 70 percent probability of a move to 0.25 percent to 0.5 percent at Friday’s settlement, up from 48 percent the day before, according to the CME.”

Reuters reported the good news: A stronger U.S. economy is better for U.S. stock markets over the long term. It also gave the not-so-good news: Investors’ worries the Fed could choke economic growth by raising rates too soon led to a market selloff.

As investors agitate, it may prove worthwhile to spend some time thinking about economic indicators. The Conference Board produces leading, coincident, and lagging economic indices which are comprised of individual leading, coincident, or lagging indicators. These indices are intended to provide insight to U.S. economic change and help identify turning points in economic data. For example:

·         The leading index is an early indicator. It is intended to mark turning points before economic change occurs.

·         The coincident index tends to mirror current economic performance, turning up or down along with GDP (gross domestic product) growth. One component of the coincident index is the number of employees on nonfarm payrolls.

·         The lagging index tends to reflect what has already happened.

In its most recent report, The Conference Board Leading Economic Index increased which suggests a positive short-term outlook for 2015. However, the pace of increase slowed month-to-month which indicates downside risks remain.

 

 

do you know who irving fisher was? The Library of Economics and Liberty described him as:

 

“…one of America’s greatest mathematical economists and one of the clearest economics writers of all time. He had the intellect to use mathematics in virtually all his theories and the good sense to introduce it only after he had clearly explained the central principles in words. And he explained very well. Fisher’s Theory of Interest is written so clearly that graduate economics students can read – and understand – half the book in one sitting, something unheard of in technical economics.”

 

Unfortunately, he is also known for saying, “Stocks have reached what looks like a permanently high plateau,” on October 15, 1929. Just a few weeks later, the market crashed along with Fisher’s credibility.

 

This is but one tale of our dismal ability to forecast. Regardless, we continue to try. Consider 2014. The Wall Street Journal’s survey of economists predicted 10-year Treasury rates would move higher (a unanimous opinion). There was good reason for analysts to forecast higher rates, but markets are complex and rates fell during the year. Survey participants predicted 10-year Treasury rates would finish at 3.52 percent. They finished at 2.17 percent.

 

Survey participants also anticipated crude oil would finish the year at about $95 a barrel. There was little reason for anyone to suspect a significant drop in oil prices when demand for energy is relatively strong around the world. Regardless, the final closing price per barrel was about $53.

 

So, when people whose jobs involve tracking economic events and financial markets find it difficult to interpret how markets may perform, what are investors supposed to do? It is felt they should remain committed to investing best practices, which include prioritizing financial goals, maintaining well-allocated portfolios, managing risk, and talking with financial advisors.

 

Weekly Focus – Think About It

“Start with what is right rather than what is acceptable.”

--Franz Kafka, Novelist

 

 

Weekly Commentary March 3rd, 2015

The Markets

“Well, I never heard it before,” said the Mock Turtle; “but it sounds uncommon nonsense.”

It was an Alice in Wonderland week. European countries, companies, and entrepreneurs were getting paid to borrow money, and ordinary Joes with money in some European banks got letters saying the banks would be charging to hold their money. The New York Times reported:

“The most profound changes are taking place in Europe’s bond market which has been turned into something of a charity, at least for certain borrowers. The latest example came on Wednesday when Germany issued a five-year bond worth nearly $4 billion with a negative interest rate. Investors were essentially agreeing to be paid back slightly less money than they lent.

Bonds issued by Switzerland, the Netherlands, France, Belgium, Finland, and even fiscally challenged Italy also have negative yields. Right now, roughly $1.75 trillion in bonds issued by countries in the eurozone are trading with negative yields which are equivalent to more than a quarter of the total government bonds…”

At the end of February, many European stock markets were showing high single-digit to low double-digit gains for the year.

Meanwhile, back in the United States, the background report that supported Fed Chair Janet Yellen’s semi-annual testimony before Congress highlighted the effects of the Fed’s EAT ME cake – also known as quantitative easing – which left its balance sheet at about $4.5 trillion (up from about $1 trillion in 2008). Barron’s speculated the effect of an unexpected rise in interest rates could negatively affect the Fed’s bond holdings with maturities greater than 10-years. “If long-term rates do rise faster than anyone now anticipates, the Fed may run into difficulties of navigation that could prove a tad destabilizing to the economy.”

A manufacturing renaissance in america... really? In the 1950s, manufacturing accounted for 30 percent of America’s gross domestic product (GDP), which is the value of all goods and services produced in the United States. Today, it comprises about 12 percent of GDP. That’s a big change and it was accompanied by a big shift in employment. In its heyday, manufacturing companies employed about 20 million people in America. Today, that number has fallen to about 12 million.

For decades, companies moved production facilities away from the United States to countries like China which offered lower manufacturing costs. Now, the trend is beginning to reverse. Lower energy prices and rising wages in emerging countries have companies moving manufacturing back to the United States. However, they’re running into a stumbling block – a shortage of skilled labor. A BBC report asked:

“…will Americans really contemplate going back to work on the factory floor? The companies all worried about a shortage of skilled workers. So, I went to meet students from the University of Tennessee. They told me they didn't see their future in manufacturing. Some wanted to finance those plants while others said that they weren't good enough at mathematics to work in advanced industries.”

The 2015 Manufacturing Institute and Deloitte Skills Gap study confirmed the shortage of skilled manufacturing labor here in the United States and reported little is expected to change during the next decade. Through 2025, close to 3.5 million manufacturing jobs are likely to open but just 1.4 million will be filled because there are not enough workers with the right skill sets. The study found:

·         60 percent of available skilled production positions remain open

·         80 percent of manufacturing companies are willing to pay more than the going rates to attract skilled workers

·         82 percent of executives believe the skilled labor shortage will affect their ability to meet customers’ needs

The Economist was skeptical about a renaissance in U.S. manufacturing. It reported for the industry to flourish, America needs investment in research and development, improved schools and colleges, and changes to the tax system.

Weekly Focus – Think About It

“Learn from yesterday, live for today, hope for tomorrow. The important thing is not to stop questioning.”

--Albert Einstein, Theoretical physicist