Markets and College Football: A Time For Serious Focus
Dear Valued Clients and Friends,
Okay, I’m not actually going to be talking about college football, though as I am sure all of you know, the season is upon us. =) This time, we are going to talk markets, and I think this past Labor Day weekend and the transition out of August into the final trimester of 2016 is a great time to do so. By a little whisker, the Dow and S&P avoided their sixth consecutive positive month, though they went into the final day of the month in positive territory. May you find this “Welcome to College Football Season Edition” stimulating and informative…
Watch the Video Executive Summary at this link (unique content).
Never Fear, the Fed is Here
One of the most jarring parts of Fed Chairwoman Janet Yellen’s speech in Jackson Hole, WY last week was her action plan for dealing with the next recession. Her basic thesis implies that by the time the next recession comes, the Fed Funds rate will be back to 3%, and that $2 trillion of Quantitative Easing (QE4?) would do the trick to stave off the recession. The reality is that adding to the Fed balance sheet was never an American way of dealing with a recession until the aftermath of the Great Recession of 2008. While QE has been effective at holding down long term interest rates, it certainly has not been productive at creating job growth or economic productivity. It seems impossible to believe the Fed will have gotten the Fed Funds rate back to 3% before the next recession, when a simple .25% increase seems to require the movement of heaven and earth. The Fed’s talk was more hawkish than many thought it would be a couple weeks ago.
Just give it to me once, then repeat it again and again
While prognosticating on what the Federal Reserve will do (or not do) has been one of the easiest things to do in my career these last eight years, it is not really something we want to base our investment outlook or client allocations on. With that said, it bears repeating that our broad perspective on the Fed’s pickle is this: They may or may not raise a quarter point here and a quarter point there, and we recognize that there are optics important to them that they not lose all credibility; however, global central bank monetary realities are so widely different from our own that anything the Fed does to increase hawkishness forces our policy to be even more divergent from the rest of the world. This inevitably means huge impact on the dollar vs. foreign currencies, and that essentially means de facto tightening. In other words, and maybe this should be my only sentence here: Mario Draghi and other such global bankers are keeping the Fed in a holding pattern, and we cannot fathom anything changing that for quite some time.
Profit as Prophet
The very understandable rule-of-thumb is that “as earnings go, so goes the market.” Declining profits are often a precursor to a declining market. Since earnings growth has been declining, shouldn’t that mean declining stock prices into the future? Quite possibly, yes, but there is one very legitimate reason to do more homework before we make a vanilla conclusion about this hyper-nuanced subject. That reason is the role energy played in the decline since 2014. Put differently, the declining profits in energy from mid-2014 through mid-2016 explain all of the profits slowdown, and then some, across the S&P 500. Therefore, if, and it is a big if, the energy earnings slowdown has run its course and is in fact due for a rebound, we may see the exact opposite consequence – meaning, profits expansion.
Reports of Oil’s Demise were Greatly Exaggerated
At this time last year I was reading reports, hearing media pundits, and yes, even having clients suggest, that the oil sector was permanently broken – that demand was collapsing – that fossil fuels were not part of our future – and that the end was near. Last week a report came out showing $11 billion of oil and gas transactions (mergers and acquisitions), the highest monthly total this year. Over $30 billion of deals have happened since May. A robust energy sector is alive and well in our country.
Write this number down!
$12.6 trillion. That is the dollar amount worldwide of bonds that currently have a negative yield. And people are buying then. People do want them. And understanding why will be perhaps the key to investing for the next two years.
As easy as predicting the weather, in 2026
One of the things I have seen prove most dangerous, un-doable, unreliable, and unrepeatable, is anyone’s ability to forecast interest rates (and I do not mean the fed funds rate, but the real rate like a 10-year treasury yield). People get wrong what affects it, get wrong how the things that affect it will go, and then get wrong how rates will respond to the wrong reaction they didn’t anticipate about the wrong events they wrongly labeled. Other than all that, it’s a lay-up… So I guess my point is that (a) The 10-year is going to determine so much of what happens, and (b) I haven’t the foggiest what the 10-year will do.
I’m waiting until you’re done waiting
What would make us increase our allocations to equities at this time? Well, I suppose a P/E in the S&P of 16 and a VIX of 18 would be nice. That, of course, would mean that many were rejecting equities, which would be the time that buying more equities was most out of favor. Right now we have a market multiple above 18 and a VIX around 13, meaning it feels good to be buying. We are moderating but not eliminating equity weightings, prudently, intelligently, and selectively (not all valuation stories are created equal). But we remind our clients and readers – there is no better time to be buying than when it feels terrible to be buying. And vice versa.
It’s not what you see; it’s what you don’t see
We believe history will record this bull market and when it inevitably ends as a time that many signals became quite distorted vs. historical readings. On one hand, we are totally of the opinion that bull markets end when the last dumb, euphoric, greedy dollar comes into the market. And we agree with many bulls that such “tip-top” euphoria has been absent… A decline of margin buying is another and more compelling argument for this side lately. However, the selling in stock mutual funds is distorted by very unreliable data about what has been bought in Exchange Traded Funds, and we believe there are people who literally are not coming back in post-dotcom, post-2008, ever. So we see retail skepticism in mutual funds that makes us think this bull market is not toppy, but we also do not see ETF action with enough reliability to read it.
Reports of my death were exaggerated, again
Few stories made bigger fools of certain pundits in 2009-2010 than the idea that the U.S. faced an imminent death. The reasons why that analysis were flawed then and now can be discussed another time, but no one can dispute that rather than talking about the death of the dollar, we are now inundated with stories about what to do in the face of a strong dollar – an irony that should never be lost on any of us. I read a piece last week that said Korean companies selling televisions in Brazil will generally ask for payment in U.S. dollars only, and I had to grin. 90% of global trade transactions involve dollars, even when there is no U.S. party involved, and we are supposed to think that the dollar is going the way of Zimbabwee. Ay yi yi.
Chart of the Week
This chart is another sort of “nutshell” about current voter angst. Politicians are claiming we are approaching full employment, and yet we have 6 million people out of the labor force who do indeed want a job. The percentage of people employed compared to the whole population is quite low, and as this chart shows, while it has improved, it tells more of the complete story than the mere unemployment rate does (which treats these 6 million people like they do not exist).
Quote of the Week
“All models are wrong. But some are useful.“
~ George Box
Originally posted on HighTower Advisors.