Posts Tagged unemployment rate

It’s Official: Correction is Here

 

 

“Nature abhors a hero. For one thing, he violates the law of conservation of energy. For another, how can it be the survival of the fittest when the fittest keeps putting himself in situations where he is most likely to be creamed?” – Solomon Short (David Gerrold’s alter ego, a Star Trek writer)

 

The late September, early October market highs in stocks, may be this year’s all-time high in stock values. This is not due to the US economy doing poorly, or companies reporting dismal results. The stock market is forward looking, and so with rising input, financing and labor costs, along with a slowing down of global trade, European Union troubled with Brexit and Italy, China still on controlled slow down mode, equity investors are having a hard time finding bright spots. One thing is for sure, that the volatility is back and major indexes have touched the correction territory.

It’s a military tactic to know what not to do before everything else, because most importantly, you have to be alive to win battles and wars, and small mistakes can be deadly. In this market environment: don’t try be a hero. Unless you’re a thrill seeker, do not try to time a bottom and get in a concentrated position, because that low may be proven to be not low enough.

General Outlook

The US economy is currently doing well with a 3.5% GDP growth, but the World economy is pointing to a contraction in a year or two. The latest OECD Euro Area Composite Leading Indicator is at 99.6, and anything below 100 signals future negative growth. The US has been the lonely figure on the dance floor and usually when that happens, either the music stops, or more people join the dance. It seems like the former to play out coming into 2020. Or alternatively, growth may slow down to a 2% rate.

In the developed world, unemployment rates are below what would historically create inflation, and the US inflation rate is at 2.1%. Lower inflation rate is attributed to lower commodity prices, technological advancements and globalization, but the signs of a rising inflation have started to appear. This will be truer in the US, especially if the US dollar has peaked and commodities have bottomed.

The US bond prices are in a bear market with yields at current levels. The FED is no longer deemed accommodating, but rather on a neutral position. Combined, this puts pressure on stock prices as relative valuations become less attractive.

A recession in the next 6-12 months is a low probability, but is this good enough? Stocks tend to lead the economy by 6-12 months, so to say that the economy will survive next year may not be a compelling argument for equity investors.

In short, stock investors are confused about the future of corporate earnings. They haven’t given up on stocks yet, but there are serious questions and this doubt creates a tug of war. President Trump’s unwarranted comments on FED actions, and his tariff wars are only making things worse.

For those looking for a silver lining, here is a decent one: stocks typically climb a wall of worry. A case in point, in 1968, Martin Luther King Jr. and J.F. Kennedy were assassinated, USSR invaded Czechoslovakia, there were riots across the country, and the S&P 500 Index had risen 7%. The absence of worry, overly confident investors and frenzy usually is a better indicator of a waterfall decline. When investor worry about a bear market in stocks, that is usually a cause of volatility, but not a full out bear, especially during a time of strong economic growth. As mentioned before, this doesn’t mean go out and try to catch a falling knife, but rather adjust your portfolios for a volatile environment until the dust settles, which may take a few months.

More Warning Signs

There are other concerns for equity investors. The growth sector leaders have also been the leader of weakness, while defensive sectors have shown stronger resistance. This is a typical risk off move. The question is its sustainability. From here, the market usually either sees opportunities in growth areas and this trend reverses itself, or it turns into a bear market.

Rising bond yields, which since 2008 have been associated with a strengthening economy, started to spook stock investors. Globally yields are still low, there is still plenty of liquidity, so one might be skeptical of this analysis. The point I am trying to make, is that higher yields create a double whammy. Higher financing costs and rising relative valuations may have come to a point of hurting stocks.

Usually in a rising rate environment, bank stocks offer a place to hide, as a steepening yield curve translates into higher bank profits. Unfortunately, not this time, not so far. Global worries have been pressuring the long end of the yield curve while FED rates have been pushing up the short end, creating a flatter yield curve, and as a result hurting bank stocks.

Year End Rally and Elections

One action to look forward to in an annual cycle, is the year-end rally. Especially after the mid-term elections, the expectation of political certainty and a stimulus package push stock prices up. This year, the stimulus package, in the form of tax cuts, have already been priced in. In addition, the chance of political uncertainty with a divided government, is also a probable outcome. So, we may see a rather muted Santa Claus this year, if at all.

Tariffs

This is an easy one: tariffs are bad, period. It raises costs for everyone, and hurts economies. If you don’t believe me, ask the people it was supposed to help, like Ford and Harley Davidson. They are forced to lay off workers or go offshore as a result of higher input prices. This, if insisted, can wipe off all the benefits of tax cuts, and we would be stuck with a historic budget deficit with no upside. China is the second largest economy in the world, and the US exports to China is a little less than exports to Germany, UK and France combined. But more importantly, tariffs hurt business confidence, which may lower future capital expenditures, a key driver of economic activity.

Stock Buybacks and Capital Investments

A big supporter of stock prices has been corporate buy backs. How big you say? $560 billion big in the last 12 months trailing June 2018, an all-time high (Source: S&P Capital IQ). The question is, can or will it continue? For reasons shared above, corporations may put a halt to this, or slow it down. With the uncertainty created by tariffs, lower CEO confidence may elevate risk aversion and cash positions.

On the Plus Side

The good news is, a lot of this is already baked in the cake. The question is, how much more bad news is in the pipeline? Usually bear markets follow extreme optimism. Volatility index at 25, and when Nasdaq records daily 4% losses, that’s a hard one to argue for. The recent price action to the downside may be a process of shaking loose ends, creating better valuations and attracting new buyers. Let’s not forget; the FED may not be accommodating, but it is not restrictive either. Its neutral position is accompanied by still  easy central bank policies in Japan, UK and Europe. In addition, the credit conditions index, which is probably the most important factor in a debt driven economy, is not signaling capitulation to a level of a looming recession.

The US economy may extend its growth past 2019. The notion that this has been the longest expansion, is looking at the wrong side of the equation, as it also has been the slowest. The longest GDP growth period in the US was during 1991-2001, 120 months of straight growth. The current cycle is 113 months old, but much more importantly: the aggregate GDP growth during the longest cycle, was 42.6%. The current cycle GDP growth is 22.3%. So, there is still a lot of room to grow for a tie breaker.

Summary

Recessions start because of over investment and dropping demand as a result. Bear markets in equities lead recessions by a few quarters, and usually start with very few buyers left to invest. Both conditions occur during extreme optimism. Currently, we lack this ingredient to call for a full-on bear around the corner. But even still, for the reasons outlined above, equity prices may need to go through a re-balancing phase and create even more pessimism before igniting the next thrust to new highs. Until then, there is nothing wrong with playing defense.

Thanks for reading my commentary and as always, you can reach me at bbakan@shieldwm.com for questions and comments.

Disclosure

The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy. The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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2014

“Teach your tongue to say I do not know, and you shall progress.” – Maimonides (1135-1204 Spain)

 Investment management is the combination of science and intuition, anticipating what others anticipate, about a future set of events that are inherently unknowable.

 That’s what I will attempt to do in this market letter: Anticipate what others may anticipate about capital markets performance and behavior in 2014. Before I progress any further, I do need to disclose that I do not know. Having established some faith and confidence here, let’s pay a quick visit to 2013.

I prefer to look at returns on investable indexes (Exchange Traded Funds) rather than benchmarks because they are more realistic in the sense that they reflect management fees.

  • So according to iShares, Nasdaq Biotechnology Index was the top global performer with 65.61% return, followed by DJ US Select Investment Services Index 65.37%. The bottom feeders were Gold Miners Investable Markets Index -52.21% and Silver Miners Index -51.46%. Wow! Gold itself (GLD) brought a whopping -28.32% loss. So much for being a safe investment.

  • As you can tell, best results came from the US, as its S&P 500 Index returned 29.6% (capital gains only). The rest of the developed world such as Germany and rest of the Europe were also mostly positive as the Eurozone got out of recession in Q2.

  • Even though it was a good year for the residential housing market, the same can’t be said for the returns on Real Estate Investment Trusts (REITs).

  • Bonds? Ouch! 2013 was a markedly bad year for bonds. The 20 year treasury index lost over -15% due to the tapering and rate increase expectations.

I looked at my Jan 2013 market letter and the headline said it all; “A Ticking Time Bond?” In so many ways, it was anticipated, but the timing is always the toughest and the most important part of investment management. In 2011, most bond fund managers thought it would be a bad year for bonds, only to watch double digit returns to slip away. They were right, but early.

In short, the best performing capital markets in the world was the good old US equity markets with all else trailing it.

One hard to believe figure came from the Bureau of Economic Analysis on third quarter Gross Domestic Product (GDP) growth over second quarter: 4.1%! This was surely unexpected and underlines the sustainability of the recovery. We still don’t have the fourth quarter results so we can only estimate 2013 GDP growth rate to be around 2.5%. This is still below averages but surely above recessionary levels.

Inflation has been tame at 1.2% through November. This actually gives mixed signals. A low inflation is a good thing, but too low will waive the deflation flag (prices coming down) and it is a serious risk to the health of the economy. With falling prices, investors prefer to stay in cash, consumers wait as much as they can to get a better price and the whole economy can get in to a grid lock. This is one of the reasons the FED (I speculate) hasn’t been as aggressive as some anticipated in cutting their bond purchase program that is now referred to as the tapering.

According to the Bureau of Labor Statistics, the unemployment rate dropped to 6.7%, yes another surprising result. A year ago it was 7.9% and most analysts didn’t expect it to drop to these levels until the end of 2015, we are two years ahead of schedule so it seems. Now…some surely will argue that this is due to less available labor pool, people giving up on looking for a job, it’s a flawed statistic and so on and so forth. True, can’t say no but this rate is still important to watch closely as it’s one key metric the FED  pays attention to while making interest rate related decisions. This figure, once below 6.5%, may start pressuring wages to the upside, great news for the individuals and consumer stocks and potentially bad news for the overall corporate profitability.

So much could go wrong in 2013 and yet we came through: an economic recession, military action on Syria, tensions with Iran, fiscal cliff, debt ceiling, fights on Obamacare and tapering were some big risks we had faced in 2013. Now what? After an approximately 30% return in US equities, what to expect in 2014?

As I have said, I don’t know, but please read on!  I do think that there are some possibly probable events ahead of us in 2014 that may or may not happen and here they are:

I think two big words to pay attention this year are seasonality and earnings. I anticipate positive returns in the US equities, but certainly nothing like the ones we had in 2013, with a pull back or two during seasonally weak summer months.

Where would gains come from? Earnings growth. Yes, there is still room for growth in company earnings and if you can find the sectors that may benefit from global macro trends or if you are a bottom up stock picker, find those companies with healthy earnings (low accruals), you’re golden. Oh, don’t forget to buy them low and sell high, so easy!

Bonds may have another tough year in 2014 as interest rates may face upward pressure due to the recovery in the US and Europe. So stay with high yields and low duration bonds.

A great comeback story may be seen in the emerging markets following an upsetting 2013. They have been trailing the developed markets and a catch up is due at some point. Remember, not all emerging markets are equal and this year, pay attention to Asia rather than Eastern Europe and Middle East.

Europe is two years behind the US with the central bank giving away free money game. So, its equity markets may have more cards to play as they were late coming to the table.

Commodities could also be a comeback story, as they have been an area of the markets we all loved to hate in the past few years. Global economic recovery can trigger a run on industrial commodities and transportation stocks. Watch for themes supporting global recovery until summer months or the end of the bull run whichever comes sooner, go defensive if the anticipated pull back occurs, and go back to your seats in fall or the bounce back whichever is first.

With fracking, the US is turning into an oil exporting country, which translates into low energy and overall industrial production costs. Add the fact that the employment costs are rising in China, you get a reversal of the trend that had shipped jobs to overseas. I sincerely hope fracking won’t have lasting environmental damages that will prove true an old adage from an Indian Chief: Money won’t mean anything after the last fish is caught, but the economic future of the US is surely promising as a result of this and the demographic trends similar to the post World War II era. While the rest of the developed world population has been shrinking, the US has been able to manage population growth with the help of immigration. The cultural implications may keep some folks out of their comfort zone but the economic implications have been favorable.

Iran is being pulled back to the global system. I am not an international political science expert but one can call me a political junky and as far as what I’ve gathered, it seems like Asad’s presence in Syria will be tolerated by the US, as the alternatives have proven to be even worse options, like Al Queada dominance for instance. Can someone say unintended consequences? It’s a reversal of the US policy in Syria. The agreement it seems will result with Iran stopping the progress on the nuclear warhead development and being more transparent about it. In return, it will be allowed to keep its 40,000 troops in Syria to help Asad win his war while Iran continuing to sell oil to the international markets. An interesting twist in the conflict between the Sunni camp with the Saudis-Kuwait-Turkey-Katar-US coalition against the Shia camp with Russia-China-Iran-Syria coalition.

It seems like Putin has saved Obama from the Syrian dilemma by arranging this deal with Iran, which of course the neo-conservatives along with the Israelis are all up in arms about. I will leave politics to the experts but lower oil prices and a more stable Middle East in the short term are logical conclusions. Remember my thoughts on commodities? Well, keep oil out of that potential comeback story and if you are looking into buying baskets, make sure oil allocation is low.

Put your trust in the market itself more so than forecasts. Monitor market moves and be ready to react because 2014 will not be as easy as 2013, but again who thought 2013 was going to be easy? Just remember how troubling the fiscal cliff alone was, or fights on Obamacare and yet sometimes things did turn out to be better than expected.

One final thought before a suggestion for your New Year’s resolution. In my last market letter, I have suggested that a bull run is a possibility until the fiscal negotiations in February. I am reversing that statement as the Congress, thanks to Republicans’ realization of how damaging this can be to their political careers, has already shown signs of a much easier tone and some agreements have already been made. A pull back is still a possibility in that period but not as much as I have previously anticipated. The other big risk I have also talked about was tapering, FED’s reversal of the bond purchase program. This too is appearing to be of less concern as the FED has been doing a great job managing expectations around this issue. A decent part of this action is already priced in the markets. Tapering may slow the markets this year no doubt, but probably not as heavily as previously thought. Also, say hi to your new FED Chairwoman, first woman in that post, San Francisco’s own Janet Yellen.

2014’s Financial Resolution:

I don’t believe in New Year’s resolutions because I think meaningful change happens instantly when you’re ready and it’s impossible to schedule for it. Once you have had enough of the unwanted and you can’t accept it anymore, once the conditions are ripe for a change, that moment instantly shifts your gears towards the wanted.

All that said, I do think every year, you should have at least one financial goal to accomplish and I suggest you look into your estate planning this year.

Estate planning involves finding answers to questions such as: “If something happens to me, are my assets going to be handled exactly the way I want them to be and in the most tax efficient way? If I get into a coma, what happens then?”

I am a Certified Financial Planner and I understand estate planning enough to talk about them, but ultimately you should meet with a trust attorney and put everything in writing until it feels right. A good trust attorney will walk you through different kinds of scenarios and help you make the right decision. If you have further questions on this, I would be happy to answer or point you to the experts in this field.

Hope you have enjoyed reading my Newsletter. Please feel free to forward it to your friends and family and don’t forget to email your questions or comments to: bbakan@shieldwm.com

 Disclosure

The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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