Category Archives: Market commentary

Foreign markets are soaring

The US markets are reaching new highs daily and many investors are happy with the returns their portfolios have generated.  According to the Wall Street Journal the S&P 500 is up 13.9% year-to-date.

 But some foreign markets are doing even better.

For example, the Hang Seng (Hong Kong) index is up 29.4%.

Chile is up 28%

Brazil up 27.3%

South Korea up 22.1%

Italy up 16.4%

Taiwan up 15.8%

Singapore up 14.7%

As part of our asset allocation strategy we always include a foreign component in our diversified portfolios.  Over long periods of time international diversification has had a positive effect on portfolio performance.  That’s because the US economy is mature.  It’s harder to generate the kind of economic growth that smaller, newer, and less developed economies can generate.

There is, however, a level of risk as well as reward to global diversification.  It’s said that when the US catches a cold, foreign markets get pneumonia.

The U.K. market is up only 5.8% this year, Shanghai +9.1%, Mexico +9.5%, Japan +9.6% and France +10.3%.  It’s difficult for the average investor to do the research to pick and choose their own foreign stocks.  So it’s even more important when investing overseas to use experienced portfolio managers with years of experience and an established track record.

We have done the research and we choose the best mutual funds with experienced managers to give our clients exposure to foreign markets.

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Time To Drain The Fed Swamp

The Panic of 2008 is widely misunderstood.  Part of this is due to the fact that financial issues are complicated.  How many people, after all, know what “mark to market accounting” is?  Part of it is due to politics.  Government policies encouraged home ownership by lowering lending standards, leading to NINA (“No Income No Assets”) loans.  At one time home prices were rising so fast that people believed that no matter what they paid for a house they could always sell it for more.

A thought-provoking article by Brian Wesbury of First Trust expands on this issue.

 Time To Drain The Fed Swamp

The Panic of 2008 was damaging in more ways than people think. Yes, there were dramatic losses for investors and homeowners, but these markets have recovered. What hasn’t gone back to normal is the size and scope of Washington DC, especially the Federal Reserve. It’s time for that to change.

D.C. institutions got away with blaming the crisis on the private sector, and used this narrative to grow their influence, budgets, and size. They also created the narrative that government saved the US economy, but that is highly questionable.

Without going too much in depth, one thing no one talks about is that Fannie Mae and Freddie Mac, at the direction of HUD, were forced to buy subprime loans in order to meet politically-driven, social policy objectives. In 2007, they owned 76% of all subprime paper (See Peter Wallison: Hidden in Plain Sight).

At the same time, the real reason the crisis spread so rapidly and expanded so greatly was not derivatives, but mark-to-market accounting.

It wasn’t government that saved the economy. Quantitative Easing was started in September 2008. TARP was passed on October 3, 2008. Yet, for the next five months markets continued to implode, the economy plummeted and private money did not flow to private banks.

On March 9, 2009, with the announcement that insanely rigid mark-to-market accounting rules would be changed, the markets stopped falling, the economy turned toward growth and private investors started investing in banks. All this happened immediately when the accounting rule was changed. No longer could these crazy rules wipe out bank capital by marking down asset values despite little to no change in cash flows. Changing this rule was the key to recovery, not QE, TARP or “stress tests.”

The Fed, and supporters of government intervention, ignore all these facts. They never address them. Why? First, institutions protect themselves even if it’s at the expense of the truth. Second, human nature doesn’t like to admit mistakes. Third, Washington DC always uses crises to grow. Admitting that their policies haven’t worked would lead to a smaller government with less power.

The Fed has become massive. Its balance sheet is nearly 25% of GDP. Never before has it been this large. And yet, the economy has grown relatively slowly. Back in the 1980s and 1990s, with a much smaller Fed balance sheet, the economy grew far more rapidly.

So how do you drain the Fed? By not appointing anyone that is already waiting in D.C.’s revolving door of career elites. We need someone willing to challenge Fed and D.C. orthodoxy. If we had our pick to fill the chair and vice chair positions (with Stanley Fischer announcing his departure) we would be focused on the likes of John Taylor, Peter Wallison, or Bill Isaac.

They would bring new blood to the Fed and hold it to account for its mistakes. It’s time for the Fed to own up and stop defending the nonsensical story that government, and not entrepreneurs, saved the US economy. Ben Bernanke and Janet Yellen have never fracked a well or written an App. We need a government that is willing to support the private sector and stop acting as if the “swamp” itself creates wealth.

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Recovery of Emerging Markets

The MSCI Emerging Markets Index, up 28.09%, is the best performing major index year-to-date – better than the DASDAQ, better than the S&P 500, better than the DJIA.  That’s an amazing reversal.

Emerging Markets have lagged the other major indexes over the last decade.

  • 2.21% for 3 years (vs. 9.57% for the S&P 500)
  • 5.56% for 5 years (vs. 14.36% for the S&P 500)
  • 2.76% for 10 years (vs. 7.61% for the S&P 500)

Why do we mention this?  A well diversified portfolio often includes an allocation to Emerging Markets.  Emerging Markets represent the economies of countries that have grown more rapidly than mature economies like the US and Europe.

Countries in the index include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, and the United Arab Emirates.  Some of these countries have economic problems but economic growth in countries like India, China, and Mexico are higher than in the U.S.

Between 2003 and 2007 Emerging Markets grew 375% while the S&P 500 only advanced 85%.  As a result of the economic crisis of 2008, Emerging Markets suffered major losses.  It is possible that these economies may now have moved past that economic shock and may be poised to resume the kind of growth that they have exhibited in the past.  Portfolios that include an allocation to Emerging Markets can benefit from this recovery.

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Market reacts to French election, tax cuts and earnings

The stock market had two back-to-back days with the Dow Jones Industrial Average (DJIA) up over 200 points.  On Monday the market was reacting to the first round of elections in France.

The French election for President is often a two step process.  If a candidate gets over 50% of the vote in the first round of voting he or she is declared the winner and becomes President.  If no one gets to 50%, the two top vote getters face a run-off election which decides the Presidency.

In the first round that just ended, the candidates of the major French parties that had run the country for decades did not make it to the run-off.  Instead, Marine Le Pen (usually described as “Far Right”) and Emmanuel Macron (usually described as a “centrist”) were the two top vote getters.  They will face off on May 7th with the winner becoming President of France.

Macron, age 39, received 23.8% of the vote while Le Pen scooped up 21.4%.  Macron formed his own party, splitting off from the Socialists.  Macron is best known for marrying his teacher, a woman 25 years his senior.

It is generally assumed that Macron will win the next round with the French establishment uniting against Le Pen who wants to stop immigration and wants France to pull out of the EU.  The results of the balloting caused a relief rally in expectation that France will stay the current course and remain in the EU.

The Tuesday market action was driven by exuberance over the Trump administration announcement that they were proposing a reduction in the corporate tax rate from 35% to 15%.  If this passes, next year’s corporate earnings would be higher.

On the earnings front some of the big names in the DJIA reported better-than-expected earnings.  Caterpillar, McDonald, Du Pont and Goldman Sachs were the biggest beneficiaries.

Stay tuned.

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The Trump Trade after three months.

The election of Donald Trump was followed by what many called “The Trump Trade.”  Based on the promises made by Trump during the campaign: to lower taxes and reduce regulations – two factors that inhibit economic growth – the stock market rose sharply.  But it’s going to take time and a lot of hard bargaining to actually get to the point where real economic benefits result.

Brian Wesbury, Chief Economist at First Trust:

As we wrote three months ago, it’s going to take much more than animal spirits to lift economic growth from the sluggish pace of the past several years. Measures of consumer and business confidence continue to perform much better than before the election. But where the economic rubber hits the road, in terms of actual production not so much.  It looks like real GDP growth will clock in at a 1.3% annual rate in the first quarter.

He says that we still have a “Plow Horse Economy” and it will take time to unhitch the plow and saddle up the “Racehorse.”

Trump has signed a number of executive orders that will have an impact on regulation, but the bureaucracy is still staffed with the last administration’s appointees and the pace of approving new appointments is glacially slow.

Waiting is the hardest part.

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The Plow Horse is Dead – Long Live the Race Horse

Race horse

We have referred to the economy over the last decade as the “Plow Horse Economy.”  There has been a huge increase in technology available to the economy over that period of time.  “Fracking” has unlocked huge oil and gas reserves in the energy sector.  The “Internet of Things” is tying our appliances together, automating our homes, even allowing us to control them with voice commands.  Self-driving cars are becoming a reality faster than I believed possible.  3D printing is revolutionizing production processes.  Yet despite this dazzling technological revolution, the economy is only managing 1.2% GDP growth.

Why?

Many analysts believe that if we compare the economy to a horse, we have a thoroughbred economy that’s plodding along like a Plow Horse.  The problem is that the rider is too heavy.    That rider is the government.  It’s holding growth down.  In the year 2000 government was 17.6% of Gross Domestic Product (GDP).  In 2016 it was 21.1% of GDP, an increase of 20%.  That’s a big move from the private sector to the public sector.

Keep in mind that government doesn’t manufacture anything.

On top of that, government today regulates virtually everything, generating a hidden cost to producers and consumers.  Some analysts think it’s a miracle that the economy actually grew despite increased borrowing, taxes and regulation.

The incoming Trump administration has a staunchly pro-business agenda.  The focus on jobs and economic growth is front and center.  A new executive order instructs federal agencies to halt the issuance of more regulations, and the new President has indicated a desire to reduce them by 75%.   Another executive order has frozen hiring of federal employees, opening the door to replacing government employees with technology, something that has happened in the private sector.  Yet other executive actions advance the approval of the Keystone XL and Dakota Access oil pipelines – using American steel – creating new high-paying construction jobs and indicating an interest in making America energy independent.  Reducing tax rates, especially the high corporate tax rate, is another Trump administration objective.  It’s the carrot to encourage companies to build here, even as he waves the stick of high tariffs for goods brought in from overseas.  It’s getting a respectful hearing from otherwise skeptical business leaders.

These actions are not going to be enough, but they are indications that the new administration is determined to streamline government and incentivize private industry to grow.  According to Brian Wesbury, Chief Economist of First Trust, the earning per share of the S&P 500 is estimated to be $130, an increase of 20% in 2017.  Growth in earnings of that magnitude can justify an increase in market valuations and add a few percentage points to the annual GDP.

To get back to our horse analogy, it looks as if the jockey riding the horse will be put on a diet.  If that happens the thoroughbred who was a “Plow Horse”  may become a “Race Horse.”

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Dow Breaks the 20,000 level

The Dow Jones Industrial Average reached another milestone today.  The Dow broke through 20,000 as traders cheered.

For a little perspective here’s how the market reached past milestones.

dow-jones-milestones

A few points to remember.  There have been long periods when the Dow treated investors like riders on a roller coaster:  lots of swoops and slides only to end up where you began.  During those periods people made money with astute stock selection, not by buying “Mr. Market.”  We believe that those times will come again.

  • It took from 1929 to 1954 for the Dow to regain its previous high.
  • It took ten years – from 1972 to 1982 – for the market to break through the 1,000 level.

Keep in mind that the 1,000 point move in the Dow at the current level is just a little over 5% and is therefore not nearly as meaningful as a move from 1,000 to 2,000, a move of 100%.  But it’s still an important psychological barrier that had to be broken for the market to move higher.

The move makes sense from both a technical and fundamental standpoint.  Both retail and institutional investors are positive, as we have noted in the past.

The incoming Trump administration has moved with amazing speed to demonstrate their desire to increase the level of economic growth as a way of increasing job and wage growth.  They have expressed policy preferences for lower taxes, reducing regulations that stifle business development, and have been encouraging companies to build their businesses in the United States rather than overseas.

The trend is clear.  The only thing that could derail this train is a massive change in consumer sentiment or an external factor such as a war or other calamity.  The latter are known as “Black Swan” events and we must always keep in mind that they can occur.  We manage our portfolios with those possibilities in mind.

Eventually, valuations will get too high and the inevitable correction will occur.  In the meantime, we enjoy the ride while keeping a close eye on events.

Market Perspectives and Outlook

In 2016, the general election dominated the news headlines while the economy continued its slow slog for most of the year.

Stocks began the year in a slump, losing 10% in the first six weeks and then meandering sideways until July.  The markets rallied in the third quarter, followed by another decline until the election.  That’s when Trump’s surprising win started a rally that has carried the market to nearly 20,000 on the Dow.

dji_chart1

U.S. equities have held their gains since the election, while definitive sector rotations indicate more confidence among investors.  We believe the bull market will continue, although the sharp gains seen recently may give way to more sideways movement and/or potential pullbacks.

Improving economic data alongside a perception that the incoming Trump administration will be more business-friendly has bolstered both stock and Treasury yields.

The Federal Reserve raised interest rates in December and indicated that they expect further rate increases in 2017.

While it remains to be seen how much of Trump’s populist agenda will be embraced by the Republican Congress, a survey of 177 fund managers the week following the elections found they were putting cash to work  at the fastest pace since August 2009.

We always want to be good stewards of our client assets.  As such, we are participating in the market’s growth while at the same time remaining aware that the future holds many uncertainties, especially with the change in government direction and policy as we head into 2017.

As always, we value our relationship with you and welcome your comments and suggestions.

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The Financial Planner as a Healer

[This is the most popular post we have published; it’s worth posting again]

Money is a significant source of stress for most people.  In many studies, it ranks above issues such as work, children and family.  Chronic financial stress is often the leading cause of family break-ups.

Chronic stress is also associated with all sorts of health problems, psychological problems, marriage conflicts and behavior issues such as smoking, excessive drinking, depression and overeating.

Men and women under stress have often relied on medical and mental health professionals.  However, financial planners are uniquely positioned to help people address what is likely the number one source of stress in their lives – their relationship with money.  Dealing with these issues head-on with a financial planner can lead to improved emotional and physical health, an improvement of work-related problems and improved relationships with family and friends.

A competent and caring financial planner does a great deal more than manage investments or create a financial roadmap.  He listens and empathizes with the conflicting issues that people face when attempting to manage their personal finances.

Discussing the issues that cause worry with a financial planner can lead to setting realistic goals, analyzing alternatives, prioritizing actions and implementing an easy-to-follow plan.  Just as important, it allows the client and the planner to review progress on a regular basis.

As a result the client gets a sense of personal control over his or her finances.  Someone who is in control of their life has much lower stress than someone who feels that events and outside agents control them.

For a relationship between a client and a financial planner to work well together, they must have shared views and expectations of financial planning, financial markets, investment philosophy, and managing risk.  An initial meeting between a client and a financial planner should establish a comfort level and determine whether the planner is actually interested in the client, or just the client’s money.

The planner’s goal should be to help their clients organize their financial affairs, and to discuss the client’s past, present and future – including death.  The planner should create a level of trust that allows him to keep the client from self-injury, which often results from fear surrounding money.  The financial planner should provide a sort of reality check to the client, reducing both excessive pessimism and irrational optimism.  A client should feel able to discuss money honestly and openly with their planner without a fear of judgment.

In many ways, a financial advisor can be the confidant to whom you can take your financial concerns … and make it all better.

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Dow 20,000? Not so Fast!

The “Trump Rally” has generated a lot of enthusiasm in the investing community.  Despite the cheerleading for the Dow to break through 20,000 before year-end, the market is meandering tantalizingly below that level.

We write this around noon on Wednesday, December 28th, and anything can happen between now and the end of the week.  There is, however, another factor in play that may keep the rally from breaking that magic number in 2016: pension fund rebalancing.

Pension funds have to have a balance between stocks and bonds to meet their risk tolerance targets and investment obligations.  That means as stocks go higher and tilt the portfolio weighting, pension funds will have to sell some of their stock holdings and buy bonds.

Jim Brown at Option Investor wrote this:

The pension fund rebalance for the end of December could see between $38 and $58 billion in equities sold according to Credit Suisse.  Stocks have rallied so much since the election the pension funds have to sell stocks and buy bonds to bring their mandatory ratios back into balance.  That suggests Thursday/Friday should have a negative bias.  Normal volume will be very low so that means even $38 billion in fund selling could have a significant impact.

This helps explain why the market seems to be stuck in neutral so far this week, and why it may stay that way until January.

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