Rio, Rubio, and Your Portfolio
Dear Valued Clients and Friends,
I could practically skip this week’s market commentary to talk about Michael Phelps. That is how much I have enjoyed watching this first week of the Olympics and particularly the incredible story of this simply dominant athlete. In a year where the election has taken so much energy and joy out of me at times, these Olympic games have been the embodiment of patriotism and commitment to excellence that I love. Speaking of the election, we got a visit at our offices from Sen. Marco Rubio of Florida who came and talked to a group of us about the election, economy, national security, and various other issues.
We learn a lot from candidates and thoughts leaders from all sides of the aisle and perspectives. So from Phelps to Rubio to the basic conclusion of earnings season, let’s get into it…
Watch this Video Executive Summary at this link (unique content).
- Markets rallied big on Thursday behind a big move up in oil prices and strong results from some key department store retailers.
- Chinese Yuan depreciation is the story that died this year – the press quit talking about it, and too many investors have let it go. We feel the need to keep watching.
- Oil is suddenly on a tear and markets have come up with it.
- It is harder to find good companies that are able to sustain and grow their dividends in an environment like the one we are in now.
- Gold is being bought by speculators, not users, and not central banks.
In the News Last Week
- There has not been a lot of data to look at the sentiment in the U.K. economy since BREXIT passed, but we did get July data. Not only were retail sales 1.9% higher this July than last July, it was the highest monthly total in six months!
- Both Presidential candidates announced economic plan agendas last week. Markets didn’t respond as there was little new or unexpected information in there, and the polls are still widening for a Hillary Clinton victory in November.
- China – Both imports and exports fell more than expected in July. The reserves fell to $3.2 trillion, which is what was expected, but still declining. Is further weakening of the Yuan on the horizon? Let’s look at the Yuan to dollar over last year and see if we notice anything else that correlates to this? If you guessed that the Yuan and the S&P 500 seem to have a high correlation, you would have guessed correctly.
- Oil – Crude hit $39 two weeks ago, and hit $43.50 on Thursday of last week (a +11% move in a few days). Our view continues to be that while we do not want to take a direct position in the commodity price itself, we recognize it directionally has much impact in the overall state of risk markets (both in cause and effect). The reason is up for debate about the drop from just above $50 to just below $40 did not seem to have the same impact these last few weeks that it did across the risk markets spectrum in January and February. We believe it was more speculation-driven, and that market actors are more aware that it is unlikely to stay down for long. As we have discussed in the last few weeks, the “contagious” effect of declining oil prices (if there were one) would show up in High Yield bond spreads; the exact opposite has been the case in recent weeks!
- Recession – The jobs report from July not only caused a big rally in markets two weeks ago, but it reinforced the basic theory that the U.S. economy is not in recession, and has enough octane to stay in positive growth for the second half of 2016. Average hourly wages are now up 2.6% year-over-year, as well. Our guess is that there is virtually no chance of a rate hike in September, and yes that is because of the election, but December is roughly 50/50.
- Earnings – So now with 90% of the S&P 500 having reported their Q2 results, 71% have beaten in earnings expectations and 53% have beaten revenue/sales expectations. We don’t believe earnings will continue to drop quarter-over-quarter to the extent that almost all of the earnings decline we have seen over the last year has been related to low energy prices and the previously rising dollar, both of which have now stabilized or reversed.
- Election – We will primarily be looking for threats to the market in terms of potential Congressional shifts for the next few months. Our projection is still, at this point, that the GOP will keep the House, and the Senate is up for grabs. Polls are indicating that some GOP incumbent Senate seats are more vulnerable than they were a few weeks ago.
Questions from Readers
- What exactly is the situation in Italy this fall and what do we need to know about it?
Italy is not holding a vote to “exit” the European Union as Britain did; rather, they are voting on a referendum to change their own Constitution. The issue to watch is that if this “reform” bill does not pass, the present leadership has said they will step down, and the replacement party has said they want to hold a vote on leaving the European Union. The polls are quite close right now, and we are a couple steps away from all of this, but can we say that there is no scenario by which Italy would seek to leave the EU? No, we cannot. But it is hardly imminent, and is still unlikely. How this situation plays out will either heighten volatility in the Eurozone or perhaps reduce it.
- If I think the election results are going to be terrible for the market should I go to all cash now?
No, I would not consider it. It’s what people do when they want to blow up their financial well being. It never, ever, ever, ever, ever works. No one gets the exit right. No one gets the re-entry right. Mitigate volatility with asset allocation. Understand this reality of the markets: They are always and forever discounting mechanisms, pricing in today what they believe about tomorrow.
- What has hurt hedge funds the most this year?
Easy, the shorts. Hedge funds don’t have “equal-to-market” risk – they often bet against various securities (“go short”) to lower risk etc. What shorts could have made money this year? If you thought interest rates were going up (or at least wanted to hedge against it), they not only didn’t go up – they collapsed (pushing bond prices higher). Globally low interest rates have pushed asset price valuations around the globe higher. It’s been a tough road for investment strategies that try to reduce market risk. We haven’t gone into a recession, and we haven’t entered a bear market. Many investors bemoaning hedge funds during times like this may sing a different tune during the next sustained market distress.
Deep End of the Pool
Do not dismiss this as just heady “deep end” stuff for the sake of advancing the vocabulary… The LIBOR rate has advanced .15% back to levels not seen since May 2009. Why would this short-term reference rate be rising when most country bond yields are not? Why should we care? 15-20% of household borrowing is connecting to the LIBOR rate and over 25% of business debt is… This increase could potentially help profitability at banks but does increase cost of borrowing for a lot of actors. We watch these things (short-term LIBOR rate; the TED spread; etc.) because we want to see if underneath the hood there are different signals being sent about the market than meets the eye with central bank set rates. When lending and liquidity dry up (and obviously we are not even in the stratosphere of that happening with this LIBOR rate move), it is a huge deal for markets. In this case, we believe the move is the result of changes in money market regulations coming up in a couple months that are causing disruptions within short-term capital allocations. But we’re watching…
Weekly Reinforcement of a Permanent Principle
For those who missed it, we want to re-direct you to the piece we put out thursday on ABSOLUTE, goal-oriented investing, vs. RELATIVE, peer-oriented investing. We believe in investing around the specific needs of clients, with a continued focus on their own unique goals and objectives. We do not believe in the continued, and silly, distraction of playing a game with other random and incomparable indexes. Read the piece at this link: What Michael Phelps Teaches Us About Absolute Return Investing
Comments from the Bull in Us (What We Like)
If someone says, “Do you like India?” or, “Do you like Brazil?” Then the answer needs to be, “Are you talking about the weather or the food?,” because you cannot invest in the country as a whole. It does not work that way with Emerging Markets — not with hundreds of reasonably illiquid companies, a plethora of different accounting and regulatory frameworks, and totally different impacts from currency, etc. What we DO like are operating companies with higher Return on Invested Capital, high Return on Equity, and high pricing power. We find these companies all over the world. For that reason, we like the Emerging Markets, if one means these types of companies!
Comments from the Bear in Us (What We Don’t Like)
We are frequently told that gold goes higher because central banks such as in China and India are buying more and more of it, presumably because they know something we don’t know and we ought to follow suit. We are agnostic (and will continue to be so) about whether or not gold will go higher or lower, but we are anything but agnostic about what actually drives its price. It is speculation. Period. That speculation may result in higher prices, and it may be lower, but it is simply untrue that gold moves because of central bank buying, let alone central bank irresponsibility. We saw a 40% drop from 2013-2015. I don’t think those years will go down as the golden years (no pun intended) of central bank responsibility. This chart tells us where the extra buying has come from in this 2016 higher move.
Switching Gears (Outside the World of Investments)
One area which seems quite outside of the portfolio management world, but is well within the area of concierge services we direct, relates to clients building, remodeling, or designing a new home or their current home. This is near and dear to Joleen and I, as we just completed a 15-month project building our new family home (the “we” there is a little disingenuous). Clients in the Orange County area looking for an introduction to a general contractor or interior design lead are welcome to reach out. Our referrals here not only have gone through the traditional Bahnsen Group vetting – they just built my own house!
Chart of the Week
The investible universe of companies who have the sustainable dividend growth outlook and culture we believe in is a small universe, so it makes our job harder when it appears that there is a benign environment for dividend growth. More companies are paying a dividend now than any point since the crisis, and S&P 500 dividend growth has been robust. So we as dividend growth investors, should be thrilled, right? Sadly, no. For now there are more companies who have unsustainable dividends, and we have to work extra hard to avoid them. The reality is that the work of finding companies who have the characteristics needed to keep paying and growing dividends can never be “passive.” This chart shows the burden that active managers like us face:
Quote of the Week
“There are two types of economists – those who don’t know, and those who don’t know they don’t know.”
~John Kenneth Galbraith
Originally posted on HighTower Advisors.