Tag Archives: Market commentary

Does Volatility Make You Nervous?

One of our favorite economists, Brian Wesbury, has some comments on recent volatility and the economy.

When Volatility is Just Volatility

Stock market volatility scares people. But, volatility itself isn’t necessarily bad. Only if there are fundamental economic problems, something that could cause a recession, would we think volatility itself is a warning sign.

So, we watch the Four Pillars. These Pillars – monetary policy, tax policy, spending & regulatory policy, and trade policy – are the real threats to prosperity. Right now, these Pillars suggest that economic fundamentals remain sound.

Monetary Policy: We’re astounded some analysts interpreted last Wednesday’s pronouncements from the Federal Reserve as dovish. The Fed upgraded its forecasts for economic growth, projected a lower unemployment rate through 2020 and also expects inflation to temporarily exceed its long-term inflation target of 2.0% in 2020.

As recently as December, only four of sixteen Fed policymakers projected four or more rate hikes this year; now, seven of fifteen are in the more aggressive camp. Some analysts dwell on the fact that the “median” policymaker still expects only three hikes in 2018, ignoring the trend toward a more aggressive Fed.

But all of this misses the real point. Monetary policy will still be loose at the end of 2018, whether the Fed raises rates three or four times this year. The federal funds rate is about 120 basis points below the yield on the 10-year Treasury (which will rise as the Fed hikes), and is also well below the trend in nominal GDP growth. Meanwhile, the banking system still holds about $2 trillion in excess reserves. Monetary policy is a tailwind for growth, not a headwind.

Taxes: The tax cut passed last year is the most pro-growth tax cut since the early 1980s, particularly on the corporate side. Some analysts argue that the money is just going to be used for share buybacks, but we find that hard to believe. A lower tax rate means companies have more of an incentive to pursue business ideas that they were on the fence about.

And there is a big difference between who cuts a check to the government and who truly bears the burden of a tax, what economists call the “incidence of a tax.”

Cutting the tax rate on Corporate America will lift the demand for labor, meaning workers and managers share the benefits with shareholders. Yes, some of the tax cut will be used for share buybacks, but that’s OK with us; it means shareholders get money to reinvest in other companies. Buybacks also move capital away from corporate managers who might otherwise squander the money on “empire building,” pursuing acquisitions for the sake of growth, when returning it to shareholders is more efficient.

Spending & Regulation: This pillar is a little shaky. On regulation, Washington has moved aggressively to reduce red tape rather than expand it. That’s good. But, Congress can’t keep a lid on spending. That’s bad.

Back in June, the Congressional Budget Office was projecting that discretionary spending in Fiscal Year 2018 would be $1.222 trillion. (Discretionary spending doesn’t include entitlements like Social Security, Medicare, or Medicaid, or net interest on the federal debt.) Now, the CBO says that’ll reach $1.309 trillion, a gain of 7.1% in just nine months.

Assuming the CBO got it right back in June on entitlements and interest, that would put this year’s federal spending at 20.9% of GDP, a tick higher than last year at 20.8% – despite faster economic growth. This extra spending represents a shift in resources from the private sector to the government. The more the government spends, the slower the economy grows.

Trade: Trade wars are not good for growth. And the US move to put tariffs in place creates the potential for a trade war. We aren’t dismissing this threat, but a “full blown” trade war remains a low probability event.

The bottom line: taxes, regulation and monetary policy are a plus for growth, spending and new tariffs are threats. Things aren’t perfect, but, in no way do the fundamentals signal major economic problems ahead. The current volatility in markets is not a warning, it’s just volatility.

 

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Why unwinding QE is not a threat to the bull market.

Brian Wesbury has a new Monday Morning Outlook out that is worth considering.

On March 9, 2018, the bull market in U.S. stocks will celebrate its ninth anniversary. And, what we find most amazing is how few people truly understand it. To this day, in spite of massive increases in corporate earnings, many still think the market is one big “sugar high” – a bubble built on a sea of Quantitative Easing and government spending.

While passing mention is given to earnings (because they are impossible to ignore), conventional wisdom has clung to the mistaken story that QE, TARP, and government spending saved the economy from the abyss back in 2008-09.

A review of the facts shows the narrative that “Wall Street” – meaning capitalism and free markets – failed and government came to the rescue is simply not true.

Wall Street was not the driving force behind subprime mortgages. In his fabulous book, Hidden in Plain Sight, Peter Wallison showed that by 2008 Fannie Mae, Freddie Mac and other government programs had sponsored 76% of all subprime debt – not “Wall Street.” Everyone was playing with rattlesnakes and government was telling them it was OK to do so. But, when the snakes started biting, government blamed the private sector, capitalism and free markets.

At the same time, Wall Street did not cause the market and economy to collapse; it was overly strict mark-to-market accounting. Yes, leverage in the financial system was high, but mark-to-market accounting forced banks to write down many performing assets to illiquid market prices that had zero relationship to true value. Mark-to-market destroyed capital.

QE started in September 2008, TARP in October 2008, but the market didn’t bottom until March 9, 2009, five months later. On that day in March, former U.S. Representative Barney Frank, of all people, promised to hold a hearing with the accounting board and SEC to force a change to the ill-advised accounting rule. The rule was changed and the stock market reversed course, with a return to economic growth not far behind.

Yes, the Fed did QE and, yes, the stock market went up while bond yields fell, but correlation is not causation. Stock markets fell after QE started, and rose after QE ended. Bond yields often rose during QE, fell when the Fed wasn’t buying, and have increased since the Fed tapered and ended QE.

A preponderance of QE ended up as “excess reserves” in the banking system, which means it never turned into real money growth. That’s why inflation never took off. Long-term bond yields fell, but this wasn’t because the Fed was buying. Bond yields fell because the Fed promised to hold short-term rates down for a very long time. And as long-term rates are just a series of short-term rates, long term rates were pushed lower as well.

We know this is a very short explanation of what happened, but we bring it up because there are many who are now trying to use the stock market “correction” to revisit the wrongly-held narrative that the economy is one big QE-driven bubble. Or, they use the correction to cover their past support of QE and TARP. If the unwinding of QE actually hurts, then they can argue that QE helped in the first place.

So, they argue that rising bond yields are due to the Fed now selling bonds. But the Fed began its QE-unwind strategy months ago, and sticking to its plans hasn’t changed a thing.

The key inflection point for bond yields wasn’t when the Fed announced the unwinding of QE; it was Election Day 2016, when the 10-year yield ended the day at 1.9% while assuming the status quo, which meant more years of Plow Horse growth ahead. Since then, we’ve seen a series of policy changes, including tax cuts and deregulation, which have raised expectations for economic growth and inflation. As a result, yields have moved up.

Corporate earnings are rising rapidly, too, and the S&P 500 is now trading at roughly 17.5 times 2018 expected earnings. This is not a bubble, not even close. Earnings are up because technology is booming in a more politically-friendly environment for capitalism. And while it is hard to see productivity rising in the overall macro data, it is clear that profits and margins are up because productivity is rising rapidly in the private sector.

The sad thing about the story that QE saved the economy is that it undermines faith in free markets. Those who argue that unwinding QE is hurting the economy are, in unwitting fashion, supporting the view that capitalism is fragile, prone to bubbles and mistakes, and in need of government’s guiding hand. This argument is now being made by both those who believe in big government and those who supposedly believe in free markets. No wonder investors are confused and fearful.

The good news is that QE did not lift the economy. Markets, technology and innovation did. And this realization is the key to understanding why unwinding QE is not a threat to the bull market.

 

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Don’t Time a Correction

Brian Wesbury, Chief Economist, First Trust:

The stock market is on a tear. The S&P 500 rose 19.4% in 2017 excluding dividends, and is already up over 4% in 2018. It’s not a bubble or a sugar high. Our capitalized profits model, says the broad U.S. stock market, is, and was, undervalued.

We never believed the “sugar high” theory that QE was driving stocks. So, slowly unwinding QE and slowly raising the federal funds rate, as the Fed did in 2017, was never a worry. But, now a truly positive fundamental has changed – the Trump Tax Cut, particularly the long-awaited cut in business tax rates. With it in place, we think our forecast for 3,100 on the S&P 500 by year-end is not only in reach, but could be eclipsed.

Before you consider us overly optimistic, we did not expect the stock market to surge like it has so early in the year. In fact, we would not have been surprised if the market experienced a correction after the tax cut. There’s an old saying; “buy on rumor, sell on fact.” So, with tax cuts approaching, optimism could build, but once they became law, the market would be left hanging for better news.

We would never forecast a correction, because we’re not traders. We’re investors. Anyone lucky enough to pick the beginning of a bear market never knows exactly when to get back in. In 2016, it happened twice and we know many investors are still bandaging up their wounds from being whipsawed.

The market got off to a terrible start in 2016, one of the worst in years. The pouting pundits were talking recession and bear market, only to experience a head-snapping rebound. Then, during the Brexit vote, the stock market fell 5% in two days – which was seen as another indicator of recession. But, it turned out to be a great buying opportunity, like every sell-off since March 2009.

The better strategy for most investors is don’t sell. Some sort of correction is inevitable but no one knows for sure when it will happen and few have the discipline to take advantage of the situation.

This is particularly true when risks to the economy remain low and the stock market is undervalued, which is exactly how we see the world today.

Earnings are strong (even with charge-offs related to tax reform), and according to Factset, since the tax law passed analysts have lifted 2018 profit estimates more rapidly than at any time in the past decade. Even the political opponents of the tax cuts are saying it will likely lift economic growth for at least the next couple of years.

Continuing unemployment claims are the lowest since 1973, payrolls are still growing at a robust pace, and wages are growing faster for workers at the lower end of the income spectrum than the top. Auto sales are trending down, but home building has much further to grow to keep up with population growth and the inevitable need to scrap older homes. Consumer debts remain very low relative to assets, while financial obligations are less than average relative to incomes.

In addition, monetary policy isn’t remotely tight and there is evidence that the velocity of money is picking up. Banks are in solid financial shape, and deregulation is going to increase their willingness to take more lending risk. The fiscal policy pendulum has swung and the U.S. is not about to embark on a series of new Great Society-style social programs. In fact, some fiscal discipline on the entitlement side of the fiscal ledger may finally be imposed.

Bottom line: This is not a recipe for recession.

It’s true, rising protectionism remains a possibility, but we think there’s going to be much more smoke than fire on this issue, and that deals will be cut to keep the good parts of NAFTA in place.

Put it all together, and we think the stock market, is set for much higher highs in 2018. If you’re brave enough to attempt trading the inevitable ups and downs of markets, more power to you, but as hedge fund performance shows, even the so-called pros have a hard time doing this. Stay bullish!

 

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Investing vs. Trading

Market commentary from Brian Wesbury of First Trust.
Are you an investor or a trader? Investors think long-term, while traders focus on short-term price movements.
Trading furs, cloth, commodities, or tulips, has gone back centuries, if not millennium, but was about adding value and moving goods to markets. In other words, through trading many ran businesses that looked a great deal like investing.
The “ticker tape” allowed the trading of financial products, but after the Great Depression many wouldn’t touch stocks for decades. Now, financial market news and quotes are on TV all-day and pushed out over smartphones. This can encourage “trading” over “investing.” Or another way of saying the same thing, the short-term over the long-term.
For example, many people have zero idea what Bitcoin is, why it is needed, or what gives it value, but they are mesmerized by it nonetheless. It’s just digital scrip – an alternative to sovereign currency. It pays no dividend and isn’t widely accepted. No one knows if it will last.
In the meantime, there are monumental events taking place that get missed if one focuses on the trees and not the forest. Horizontal drilling and fracking are one of those.
Remember when the world was about to run out of natural gas and oil? Remember when the Middle East and Russia, because of their energy reserves, could dominate geopolitics?
Well, all that has changed. The US is now the world’s biggest energy producer and, by 2020, the US is likely to become a net energy exporter to the rest of the world. This explains the political upheaval in Saudi Arabia as the royal family moves slowly toward a more free-market friendly environment. Russia faces similar forces that, in the end, will create more global stability.
Because of US supplies, Europe can become less dependent on Russian oil and natural gas. In addition, just like when Ronald Reagan was president of the US, as the pendulum swings toward less regulation, lower tax rates and smaller government, Europe must follow suit.
The combination of these developments causes stronger global economic growth, which is great news for investors. However, the dominance of governments in recent decades, and the reporting of every utterance of Federal Reserve or foreign central bankers, creates anxiety among many investors. Some investors are worried about a flattening, or inversion, of the yield curve as the Fed tightens.
But these concerns are overdone. It’s true that an inverted yield curve signals tight money, but inversions typically don’t happen until the Fed pulls enough reserves out of the system to push the federal funds rate above nominal GDP growth. Right now, that’s about 3.5%, which means the Fed is likely at least two years away. And, the banking system is still stuffed with over $2 trillion in excess bank reserves. Monetary policy, by definition, is not tight until those excess reserves are gone.
Focusing on trading, and not investing, misses these longer-term developments and highlights short-term fears.  Patience, persistence and optimism help avoid the pitfalls of short-term thinking. The current environment will continue to reward those who stay focused on investing.
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The Weekly Market Review

Week of 10/30/17 – 11/03/17:
Last week wrapped up the busiest part of the earnings season with most companies having now reported.  Large caps continued the recent stretch of gains extending the streak of new record highs for the S&P 500, Dow, and Nasdaq.
The Nasdaq led the way last week adding nearly 1% while the S&P and Dow a gained 0.29% and 0.45% respectively.  Small stocks didn’t fair quite as well, own 0.87% as benchmarked by the Russell 2000.
Global stocks recorded gains led by emerging markets, which rallied back from a couple lackluster weeks to add 1.45%.  The ACWI and EAFE closed the week up 0.67% and 0.92%
respectively.
While headlines were primarily focused on earnings releases, investors also continued to monitor the political landscape, especially the announcement of a new Fed chairman –
Jerome Powell.
Rates decreased for the first time in several weeks while the dollar added to it’s recent rally.
The 10 year closed just north of 2.3% while munis and corporates also rallied.  Energy and Technology stocks responded the best to last week’s earnings releases,
while telecoms saw a major decline.
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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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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 Economy” Keeps Plowing

The stock market defied the bears again and rose despite mixed economic news. We are in the camp that believes that the economy and the market will continue its slow and plodding rise despite a brutal winter and government policies that make doing business more complicated.

That being said, we would not be surprised us if the stock market experienced a correction. In fact, we construct our portfolios with this possibility in mind. The world is full of surprises and events – either local or global – can cause a temporary disruption. One of the things that surprised many bond traders is that interest rates actually declined in the last year, catching many pundits off guard.

Moving ahead, conditions appear to favor actively managed portfolios. We constantly review our manager line-up and re-balance your portfolios on a regular basis to keep you – and all the rest of our clients – within the risk bands that you have established.

Year-to-date, most of the broad global market indexes are positive. In the U.S., the NASDAQ was the best performing stock index. Interest rates remain low by historical standards, meaning that money in savings and checking accounts is losing purchasing power. The rise of food and energy prices is causing a problem for those who bailed out of the market in 2008 and never re-entered.

If you have not yet visited our new website, please take this opportunity to go to www.korvingco.com and invite your friends to check us out. We welcome your comments and suggestions for ways we can be of greater service to you.

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