Broker Check

7300 Wealth Connect – 7-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Fed and Trade Keep Investors on Their Toes

The Fed and international trade – these are the two headlines that dominated action in Q2.

Longer term, profits and profit forecasts are the leading driver of equities. Shorter term, sentiment can be influenced by various factors.

For much of the year, favorable headlines highlighting progress toward a trade deal between the U.S. and China aided equities. In addition, the Federal Reserve shifted gears, no longer talking about gradual rate hikes.

Coupled with modest economic growth, stocks have performed admirably.

In early May, the rally hit a roadblock when the president tweeted he would impose additional tariffs on China, injecting a new layer of uncertainty into the economic and stock market equation.

An unexpected tweet by the president in early June threatened Mexico with debilitating tariffs.

Yet, the peak-to-trough decline in the S&P 500 Index from April 30 thru June 3: a modest 6.8% (St. Louis Federal Reserve data). It’s nothing out of the ordinary.

Since 1980, the average annual maximum peak-to-trough pullback for the S&P 500 Index has been 14% (JP Morgan, LPL Research).

But shortly after Trump threatened Mexico, Fed Chief Powell shifted his stance. No longer was the Fed on hold. Instead, Powell implied the Fed would cut rates if the need arose, sparking a turnaround and lifting the S&P 500 Index to a new high.

The economy and Treasury yields

The steep drop in Treasury yields has surprised nearly everyone – see Figure 1.

In part, yields have fallen in developed nations, which encourages overseas investors to buy into higher-yielding U.S. Treasuries (bond prices and yields move in opposite direction).

Worries about a protracted trade war have increased economic uncertainty, which has encouraged a flight into safer U.S Treasury bonds.

And, odds of a rate cut or cuts this year have gone up significantly (CME Group FedWatch Tool), which also encourages investors to place cash into Treasury bonds.

If we read the tea leaves, the Treasury bond market is foreshadowing an economic slowdown. The same could be said from the Conference Board’s Leading Economic Index (LEI).

But the LEI isn’t suggesting the economy will contract this year. A quick peek at investment grade debt or yields in high-yield debt (junk bonds) aren’t suggesting a recession either.

You see, junk bonds are sometimes referred to as the canary in the coal mine. If investors expect a steep economic slowdown or recession, yields in junk debt can spike higher as investors flee shakier firms. That’s not happening right now. Investment grade debt can also come under pressure, though we typically see less volatility.

While the rally in stocks during June as not been as broad-based as we might like to see, action in the S&P 500 Index also suggests growth isn’t about to stall.

Rate cuts and stock market reaction

Since 1974, there have been nine rate-cut cycles by the Fed. Figure 2 illustrates the S&P 500’s reaction, from 1-month after to 12-months after the first rate cut in the cycle.

Over the last 45 years, a pattern has emerged, with stocks performing well when the economy side-stepped a recession, such as the mid-1980s, mid-1990s and the late 1990s. When the economy slid into profit-killing recession, rate cuts did little to bolster investor sentiment.

Ultimately, steady economic growth has historically been an important ingredient for stock market gains.

7300 Wealth Connect – 6-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Tweet Heard ‘Round the World

The U.S. and China were moving toward an historic trade agreement. It seemed as if the missing pieces of the puzzle were about to fall into place.

Then came a surprise tweet by President Trump on Sunday May 5th. Trump said he would raise tariffs on Chinese imports into the U.S.

Odds were low such an event would happen, but May’s Market Insights alluded to the possibility. “The U.S. and China have yet to reach a new trade agreement, and a setback could create unwanted volatility.” Unfortunately, that is what happened.

What came as a complete surprise – a month-end announcement by the president of new levies on all goods imported from Mexico, the 2nd largest U.S. trading partner (U.S. BEA), until “the illegal immigration problem is remedied.”

Investors are now grappling with the fallout of new trade tensions and the possible impact on the U.S. and global economy.

What happened with China? An apparent miscalculation by Chinese negotiators.

Here’s a May 9th headline in the Wall Street Journal: China Hardens Stance as Chinese Negotiators Emboldened by Perception U.S. was Willing to Compromise. A May 8th story by Reuters: China Backtracked on Almost All Aspects of U.S. Trade Deal.

From the vantage point of investors, renewed acrimony and ramped-up rhetoric on both sides have created a new round of volatility, though recent declines have been modest.

What might it mean for investors? Let’s review three possible scenarios.

1. The U.S. and China quickly come to terms – an enforceable trade deal is achieved. It’s the best outcome. Exporters benefit, U.S. intellectual property is protected, and any improvement in business confidence could translate into a new round of capital spending and hiring. Stocks likely rally. But look for Trump to set his sights on Europe and Japan.

2. Talks completely break down and we see more tit-for-tat retaliation – a full-blown trade war. Investors aren’t expecting this outcome. It’s the worst scenario. We would likely see more volatility as investors attempt to price in heightened economic uncertainty and any downside to U.S. and global economic growth.

3. Negotiations drag on for months, maybe through year end and beyond. The two sides appear to be far apart right now. Still, talks are better than no talks.

By month’s end, worries about the global and U.S. economy pushed longer-term Treasury bond yields to the lowest level since September 2017. (St. Louis Federal Reserve)

Yes, housing activity is down (Natl Assoc of Realtors, U.S. Census, U.S. BEA) and manufacturing has softened. But the economic slowdown isn’t as pronounced as the slowdown in 2015-16. And most leading economic indicators aren’t signaling a recession.

While short-term moves are difficult to precisely forecast, there are some important differences between today and the late 2018 selloff.

Risks never completely abate

The flare-up in trade tensions is the latest in a long list of risks and events that have buffeted stocks. Yet, shares have climbed the proverbial wall of worry – see Fig. 1.

The biggest risk to the bull market would be a profit-killing recession. Yet, the historical recipe for a recession isn’t in place – a credit squeeze, higher inflation that prompts higher rates from the Fed, or an asset bubble fueled by easy credit. Still, investors aren’t sure how to price a trade war’s impact on the economy. There isn’t a recent historical precedent.

Control what you can control. You can’t control the stock market, and timing the market isn’t a realistic tool. But, you can control the portfolio. Your plan should consider your time horizon, risk tolerance, and financial goals.

Risks never abate. The investment plan doesn’t eliminate risk but helps manage risk. Further, the plan is designed to capture the long-term upward market bias. It helps put you on a path towards your financial goals.

7300 Wealth Connect – 5-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Green Grass and High Tides

On April 23, the S&P 500 Index3 finished the day at 2,933.68, eclipsing its prior all-time closing high of 2,930.75. That was achieved on September 20, 2018 (St. Louis Federal Reserve).

We’ve experienced an impressive turnaround from the gloomy sentiment that pervaded the market late last year. It also marks an official milestone for the long-running bull market that began in March 2009.

Officially, the bull market, as measured by the S&P 500 Index, has extended its run past 10 years. Lengthwise, but not performance, it exceeds the 1990s (Figure 1). Note – bull markets come to an end when the index declines by 20% or more from a prior high. The three-month selloff in late 2018 came up just shy of 20% – down 17.77%.

Over the last 50 years, bear markets have coincided with profit-killing recessions. The one notable exception – the 1987 one-day selloff. It topped 20%.

Coincidently (or not), 1998 and 2011 came up just shy of the arbitrary 20% figure. In both cases, a recession did not materialize. While a bear market is inevitable, we’re not yet writing the obituary on the current bull market.

The latest rally to a new high has been marked with low volatility, similar to what we saw during 2017.

While the lack of a sharp downdraft is welcome, let’s also recognize that selloffs aren’t unusual.

Look at Figure 2. Since 1980, the average annual gain in the S&P 500 Index, including reinvested dividends, has been 12.6%. The index has finished in positive territory 32 times, or 82% of the time. Yet, the average intra-year pullback totaled nearly 14%.

If history is our guide, a pullback this year can’t be ruled out. But, we see that broad-market indexes have historically had a long-term upward bias. Keep in mind that the average annual change can vary by a substantial margin.

A look behind the rally

  1. The first read on Q1 Gross Domestic Product (GDP), which is the largest measure of U.S. economic activity, came in at an annual pace of 3.2% (U.S. BEA). The headline number may not reflect the underlying trend for the quarter as consumer and business spending eased, but it’s still a solid start to the year. More importantly, near-term recession fears have subsided.
  2. In addition, economic growth overseas appears to be stabilizing.
  3. And, the Federal Reserve has said it doesn’t expect to hike interest rates this year.

    It’s not that rate hikes, in response to stronger economic growth, will automatically trip up the bulls. Eight rate increases between December 2015 and September 2018 didn’t prevent new highs. But in October, investors began to suspect the Fed was on rate-hike autopilot.

    At the time, the Fed seemed less concerned with the economic data and more concerned about getting interest rates back to a more normal level.

    I get it. Money that’s too cheap during strong economic growth can create economic imbalances that rarely end well.

    However, the Fed’s posture appeared to be too aggressive. As growth slowed late last year and stocks fell, the Fed took a much more cautious stance. A slowdown in inflation is also helping reinforce the central bank’s more flexible attitude.

  4. The U.S. and China have yet to reach a new trade agreement, and a setback could create unwanted volatility. But cautiously upbeat headlines have aided sentiment.
  5. Finally, Q1 earnings are topping a low hurdle (Refinitiv). We’ve seen this before. Companies issue conservative forecasts, analysts pare back estimates, firms top a low bar, and investors react favorably.

Risks never completely abate. When the grass appears to be too green and lush, and the high tide covers what lurks on the ocean’s floor, reality usually returns. But, when that occurs, keep Figure 2 in mind.

7300 Wealth Connect – 4-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Strong Start to the Year

The first quarter feels as if it has been the mirror image of the final quarter of 2018. Economic conditions are far from robust, but investors have jumped back into stocks, brushing aside fresh concerns. In fact, the S&P 500 Index 3 turned in its best quarter since Q3 2009, per the Wall Street Journal.

The Fed’s newfound flexibility has played a big role in supporting the market, in my view. In December, the Fed was talking about two rate hikes this year. That has changed. The Fed is no longer on rate-hike autopilot. Instead, it is carefully looking at the economic data as it contemplates its next move.

Crosscurrents have developed at home and the global economy has slowed. We’re seeing it in the trade data and specific sectors of the economy, including housing and autos.

The latest Fed forecast projects no rate hikes this year, and Fed Chief Powell pushed back against talk of a 2019 rate cut at his March press conference.

Cautious optimism about a U.S.-China trade agreement has also lent support. Despite favorable headlines, the two economic powers have yet to conclude an agreement that opens Chinese markets to U.S. goods, protects intellectual property of U.S. companies, and prohibits forced technology transfers. Most reports suggest the enforcement mechanism of any deal has been the sticking point.

Yielding to the curve

While the data are not pointing to an economic contraction, the economy has entered into a slower orbit of growth. Coupled with slower economic growth around the globe, we witnessed an inversion of the yield curve for the first time in over a decade.

What is the yield curve? The yield curve plots the yields of a bond with the same credit quality (such as Treasuries) over various maturities. It’s illustrated in Figure 2.

A year ago (3/29/18) the curve was “normally” sloped – longer-dated maturities offered a higher yield. Today, we see a “kink” in the curve. As of 3/28/19, the 10-year bond yielded less than the 3-month T-bill.

Why do we care? Should we care? An inverted yield curve may restrict bank lending, but by itself, it does not cause a recession. Instead, it’s the bond markets signal that short-term interest rates may eventually fall in response to an economy that is expected to weaken.

Importance: the 10-year/3-month has inverted prior to each of the last seven recessions, according to data provided by the St. Louis Federal Reserve. The one glaring exception – the curve inverted in 1966 without an ensuing recession. But growth did slow considerably (St. Louis Fed GDP data).

On average a recession has occurred 11 months following the inversion of the 10-year/3-month T-bill.

That’s the bad news – any good news?

While the 10-year/3-month has inverted, not all signs point to a recession.

  • The Conference Board’s Leading Economic Index® has been flat since October, but it has not turned lower. Historically, it declines in front of recessions, with an average lead time of 7 to 20 months (Advisor Perspectives). That’s quite a range and highlights the difficulty in predicting and timing a recession. But we’re not currently getting a recessionary signal from the LEI.
  • During the last seven recessions, the 10-year/2-year Treasury yields inverted an average of 20 months before a recession (St. Louis Federal Reserve, NBER). It has yet to invert in this economic expansion.
  • Low yields around the world may be encouraging bond buys in the U.S., which could be artificially pushing U.S. yields lower (bond prices and bond yields move in the opposite direction).
  • Today, the Fed is on hold. Moreover, financial conditions have eased in the first quarter, according to the St. Louis Fed Stress Index and Chicago Fed National Financial Conditions Index. I get these aren’t household names, but they are followed closely by economists and Fed officials. Today’s levels signal access to credit isn’t restrictive and there is ample liquidity in the financial system.
  • Finally, the steep drop in longer-term Treasury yields has pushed mortgages rates down sharply. In October, the average 30-year fixed rate mortgage was 4.90%, according to Freddie Mac’s weekly survey. As of March 28, the weekly survey placed the average rate at 4.06%. It supports the struggling housing market.

Final thoughts

Let’s not dismiss what’s happened to the yield curve. It’s been a long-running economic expansion and U.S. growth has slowed. But other warning signals aren’t pointing to a contraction. Throw the government shutdown into the mix and Q1 is unlikely to deliver impressive results.

Historically, we have seen a bounce in the second quarter. The St. Louis Fed notes that in recent decades, Q1 GDP has been “substantially weaker than growth in other quarters.”

Recessions have typically been preceded by major economic imbalances, such as a stock market bubble or housing bubble. Or, a sharp rise in inflation forces the Fed to aggressively respond with rate hikes.

For the most part, neither conditions are currently present, lessening odds a near-term recession is lurking. Further, recent market action has been impressive. It’s not as if we haven’t seen some volatility, but year- to-date performance isn’t suggesting an economic contraction is imminent.

7300 Wealth Connect – 3-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Rising Stock Market, Housing’s Doldrums, and Animal Spirits

It’s been a strong start to 2019. In researching this month’s piece, I came across these stats that illustrate market strength.

Through Friday, February 24 —

  • The Dow Jones Industrial Average and the S&P 500 Index are off to their best starts in over 30 years, according to Dow Jones Market Data (MarketWatch).
  • We’ve had 8-straight weekly gains for the Dow in 2019, which is the best start since 1964 when the granddaddy of market averages logged 11-weekly gains.
  • The Russell 2000 Index^ has rung up its longest-ever weekly win streak to start a year – 8 in a row.

^The Russell 2000 Index is an unmanaged index of 2,000 smaller companies. The index cannot be invested into directly. Past performance does not guarantee future performance.

What’s behind the rally?

In part, the market was extremely oversold in late December, and markets tend to eventually bounce when the economic fundamentals don’t line up with a significant selloff.

But the snapback from oversold levels doesn’t completely explain recent gains.

  1. For starters, the Fed’s new-found flexibility is aiding shares. No longer are investors worried the Fed might push rates up too high and kill the economic expansion. Instead, the Fed said it can be patient as it eyes any changes in interest rates. While the Fed hasn’t defined exactly what it means by “patient,” broadly speaking, it means the Fed isn’t planning any near-term rate increases.

    Though sentiment can shift quickly, one measure of rate expectations published by the CME Group places odds the Fed won’t raise the fed funds rate this year at 90% (as of Feb 28).

  2. Continued progress on the trade front with China has also lifted spirits. And there have been no
    shortage of encouraging headlines.

    One from Reuters on February 20: Exclusive: U.S., China sketch outlines of deal to end trade war – sources. These included: forced technology transfer and cyber theft, intellectual property rights, services, currency, agriculture, and non-tariff barriers to trade, according to two sources familiar with the progress of the talks.

    As the month continued to progress, President Trump postponed a sharp increase in tariffs on Chinese imports, which had been scheduled for March 2. Still, sticking points remain. Reduced barriers to U.S. exports would be welcome. However, enforcement provisions that relate to forced technology transfers and structural changes that cut subsidies for state-owned businesses must be hammered out.

    The abrupt end to the U.S./North Korean summit adds an interesting wrinkle. Did China play a role in the failed talks. Or was Trump’s decision to walk out a signal to China that he could do the same on a trade agreement if it wasn’t to his liking? Early market reaction suggests it is not an issue.

  3. Though economic data have been mixed, the U.S economy continues to expand, albeit at more moderate pace. Note that GDP slowed from 3.4% in Q3 to 2.6% in Q4 (U.S. BEA). The path for housing and consumer attitudes is indicative of the mixed reports.

Housings shaky foundation

Housing has been in the doldrums. Prices have been rising for several years, inventory has been limited, especially for starter homes, and mortgage rates spiked last year.

Sifting through the data tells us that this leading economic indicator has fallen into a recession. Existing home sales and new home sales are down (Natl Assoc. of Realtor [NAR] and U.S Census Bureau). And the same can be said for housing starts and building permits – see Figure 1.

Single-family housing starts are clearly more volatile, but the trend has been to the downside. Permits, which are more forward-looking, have also floundered.

Lately, however, we may be seeing some stability amid the decline in mortgage rates (Freddie Mac weekly survey). Homebuilder confidence has improved per the NAHB monthly survey, and January’s NAR’s index of pending home sales rose at its fastest monthly pace since early 2017.

Animal Spirits

Mixed data is another way of saying that some reports are strong while others are weak. So, let’s end this update on a more favorable note. After sliding three-consecutive months, consumer confidence surged in February.

The end of the government shutdown and rising stock prices appeared to bolster sentiment.

This is a soft measure of the economy as sentiment isn’t a direct component of GDP. But it is a gauge that measures the “animal spirits” that can drive economic activity. A low level of confidence suggests animal spirits are dormant, while a high level suggests they are stirring.

While the level matters, the trend is just as important. Note in Figure 2 that confidence typically peaks in front of a recession, which makes February’s sharp gain encouraging as we push into 2019.

7300 Wealth Connect – 2-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Bright Start to the New Year

Stocks took a beating late last year, with key market indexes putting in their 2018 lows the day before Christmas (WSJ, various sources). For daily-market watchers – something that’s not recommended for longer-term investors – volatility and quick shifts in sentiment can be maddening. Besides, over a shorter period, markets can overshoot and can undershoot.

Since Christmas Eve, major U.S. market indexes have stabilized and posted strong gains. What’s behind the upturn in sentiment? Let’s review some of the factors behind the rally.

  1. Fed Chairman Jerome Powell is doing a better job of conveying the Federal Reserve’s intentions.

    Many variables flow into the stock market price equation, including interest rates and the expected direction of interest rates. In December, the Fed projected two rate increases in 2019 (down from four in 2018), and Powell highlighted the strength of the economy.

    However, investors took his upbeat remarks as a sign the Fed might hike rates too high and prematurely end the economic expansion.

    Enter January and Powell emphasized a different message. He said the Fed will be flexible going forward, carefully reviewing market signals and the economic data as it considers any rate increases.

    The Fed took an even more dovish turn at its end-of January meeting, eliminating language in its post-meeting statement that “gradual” rate hikes might be needed. Instead, the Fed said it could be “patient” on raising rates, which likely means no increases at least through June, and maybe through much of the year. It all depends on the economy.

  2. Trade frictions and acrimony with China took a toll on stocks last year. This year, cautiously optimistic headlines that some progress is being made on a new deal has lifted spirits. That said, the U.S. and China have plenty of ground to cover, and we may see short-term risks may pop up again.

    Still, both sides have a vested interest in reaching an agreement. China’s economy is slowing down, and new barriers will take a deeper bite. Failed talks may create a new cloud over U.S. growth and could create additional short-term market volatility.

  3. An early read on Q4 S&P 500 earnings haven’t been that bad. Definitive estimates (through 1/31/19) Q4 earnings will rise 15.0% vs a year ago. It’s down from Q3’s 28.4%, but commentary being issued has been respectable.

    Looking ahead, profit growth is projected to slow significantly in 2019 – see Figure 1. In part, 2018 was aided by a big cut in the corporate tax rate, so a slowdown was expected. Given some of the uncertainty over the U.S. and global economy, analysts have been ratcheting down 2019 estimates. Still, current forecasts are reasonable.

  4. Strong employment numbers from the U.S. BLS in December and January have alleviated fears that economic growth might be poised to slow too quickly.
  5. Oil prices have stabilized. A continue drop in oil prices might be welcome for drivers, but it could also be a sign world demand is faltering. Such a scenario might signal a recession.

Does global growth matter? The short answer – sort of

U.S. exports account for about 13% of total U.S. economic activity (U.S. BEA data), and S&P 500 companies gather an estimated 30% of sales from overseas (exports are products made at home and sold overseas; overseas sales may or may not have originated in the U.S.).

When global growth slows, sales from the larger multinationals may feel some of the pain. In January, Apple (AAPL $166) and Caterpillar (CAT $133) warned that weakness in China was pressuring sales. And the major stock market indexes reacted negatively on those days.

We sometimes experience volatility when bellwethers report unexpectedly bad news (the opposite can be true, too), but as Figure 2 illustrates, China does not account for a significant share of corporate revenues. U.S. exports to China make up about 1% of U.S. economic activity (U.S. BEA data).

The S&P 500’s advance last month was the best January in over 30 years, per the Wall Street Journal.

Continued weakness in the global economy and the inability to conclude a trade agreement with China that protects U.S. interests may inject volatility into short-term trading. But a more flexible Fed and continued economic and profit growth created tailwinds for stocks last month.

7300 Wealth Connect – 1-19


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Year Volatility Returned

The lack of volatility in 2017 was nearly unprecedented. We witnessed 310 trading days without two consecutive daily pullbacks in the S&P 500 Index3 of at least 0.5%, according to research firm Bespoke Group.

The unprecedented streak ended in late January. History tells us we “revert to the mean (average).” Timing such events, however, is nearly impossible.

In 2018, the broad-based index of 500 major companies rose or fell by at least 1% 64 times versus just eight in 2017. Yet, as Figure 1 highlights, last year’s volatility was not out of the range of what might be considered unusual.

The modern S&P 500 Index began in 1957; prior data using S&P 90. Both are unmanaged and cannot be invested into directly.

Note in Figure 1 that 2007 – 2011 and 2015 produced a greater number of 1% daily changes. Still, the Q4 selloff exacerbated concerns.

Figure 2 illustrates the late-year downturn, but it also highlights that year-end weakness was not out of the ordinary either.

Longer term, stocks react to the economic fundamentals. Short term, unpredictable events can quickly dampen sentiment, and pricing in uncertainty is difficult; hence, Q4’s decline and volatility.

What happened?

The global economy has been slowing and the US economy is showing signs of moderating. And with it, analysts have trimmed 2019 profit estimates (Refinitiv formerly Thomson Reuters). Consequently, some of the decline has been in reaction to the fundamentals. But was the selloff overdone?

Eight rate hikes by the Federal Reserve since the rate-hike cycle began didn’t hamper bullish sentiment, that is, until October. Communication faux pas by Fed Chief Jerome Powell in early October and late December took a toll on sentiment.

While trade frictions between the U.S. and China added to the souring mood, the issue extends beyond its direct impact on stocks. For starters, there is a bipartisan consensus on Capitol Hill that China doesn’t play fairly. Furthermore, Chinese theft of intellectual property and forced technology transfers are creating national security issues.

While many in the US and around the world share the president’s goal of fair and free trade with China, the current path to obtain the desired outcome has generated some of the tensions we’ve seen in the market. This is not meant to be a political statement, only a reflection of the reality that stocks have traded down on negative trade headlines.

Looking ahead

  1. The economic outlook will likely influence the direction of markets over the next year. A strong holiday shopping season last year (Wall Street Journal) aids growth. Falling gasoline prices may lend additional support to consumer spending. But manufacturing appears to be slowing and US leading economic indicators suggest growth will moderate in the first half of 2019.
  2. Earnings growth peaked in 2018 and growth will slow in 2019. Markets have been trying to price in some of the slowdown; hence, some of the late-year decline can be traced to the fundamentals. But markets can overshoot on both the upside and downside.
  3. What will the Federal Reserve do? Eight rate hikes tied to economic growth did little to discourage investors until early October (Fig. 3) amid concerns that rate increases might stifle economic activity and depress corporate profits. Currently, the Fed has projected two 0.25 percentage point rate increases in 2019. The number of increases will likely depend on how the economy performs.
  4. The Trump administration delayed a big hike in tariffs on Chinese imports until March (WSJ), pending a trade deal with China. Plenty of ground must be covered over a short period of time. However, progress over the next couple of months and a workable framework might further delay the imposition of higher tariffs, which would likely aid business confidence.
  5. US political instability did little to slow stocks in 2017, as optimism about the economy fueled gains and overshadowed political worries. Today, turnover in the administration has injected uncertainty into the mix, though it’s difficult to quantify its impact. Will Congress and the administration work together or will acrimony continue?
  6. Brexit and Italy’s financial troubles aren’t far from the front burner. Both issues had a minor impact on trading this year. While the European Union has approved a deal for the UK to exit the EU, it’s an agreement that can’t pass Parliament. It’s been a difficult split, but it’s not in either party’s interests for the UK to fall out of the EU without an agreement that establishes parameters going forward.

Just the facts

The broad market indexes can be unpredictable, and selloffs can and do occur. While we have yet to break the 20% threshold that marks a bear market, the peak to trough for the S&P 500 came within 0.20 percentage points of bear territory. We saw similar drops in 1998 and 2011 without a corresponding recession.

Since WWII, the S&P 500 has averaged a pullback of 31% every 5 years. Since 1980, the annual average drawdown in the S&P 500 Index has been 14%. Yet, the index, including reinvested dividends, has risen nearly 80% of the time.

Despite regular pullbacks, the S&P 500 has produced a compounded annual return of nearly 10% since 1928, all dividends reinvested. That means a $100 investment 90 years ago was worth $382,370 at year end. The same investment in the 3-month T-bill would have turned into $2,052 and $7,366 for the 10-year Treasury bond (Data sources: NYU Stern School of Business Stock, Bond Returns, S&P Dow Jones Indices, LPL, St. Louis Federal Reserve; past performance no guarantee of future performance).

Selling low and buying high isn’t a way to reach your financial goals. It is one reason we recommend an evidenced-driven, highly diversified investment plan. It’s not only a roadmap to your goals, it reduces volatility and helps separate the emotional component that may encourage decisions based on the sentiment of the day. You know, when euphoria encourages too much risk, and pessimism pushes us to sell after a decline.

Following a diversified plan that incorporates factors outside of market sentiment has historically been the best path to reach one’s financial goals.

If you have any questions or concerns, feel free to reach out to me. That is what I’m here for.

7300 Wealth Connect – 12-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

October’s Cool Breeze Flows into November

The midterm elections have ended, and stocks were supposed to resume their upward march, right? Did you know that since 1950, the S&P 500 Index has gained ground in every 12-month period that followed a midterm election? It’s an impressive 17 for 17, according to stats complied by the Wall Street Journal. The average increase has been 15.3%.

Well, we’re less than four weeks outside the election, and shares are struggling to follow the script.

The S&P 500 Index shed 10.2% from its September 20th high to the most recent low the day after Thanksgiving (St. Louis Fed). The decline wasn’t atypical and was likely related to the various economic fundamentals. Thanks to a late-month rally, major U.S. market indexes managed to end November in the green.

What’s been going on? For starters, the leaders for much of the bull market, high-flying technology stocks, have come under pressure due to regulatory and global growth concerns. Without leadership from some of the big-name tech stocks, we’ve witnessed selling in other sectors.

Still, a 10% correction in a major index isn’t out of the ordinary. In fact, since 1980, the average intra-year pullback for the S&P 500 has been just under 14% (LPL Research). We’ve yet to see a selloff of that magnitude.

Moderating U.S. economic growth

More recently, there have been growing signs the U.S. economy is slowing down from the fast pace witnessed earlier in the year.

Housing starts and housing sales are down from recent peaks (data from U.S Census and National Assoc of Realtors), and weekly first-time claims for unemployment insurance, a good leading indicator of economic activity, have edged up from the September low (Dept of Labor).

Moreover, global economic growth has been slowing for much of the year. It’s not enough to tip the U.S. economy into a recession, but it seems likely to create stiffer headwinds for U.S. exports and ding profits for firms that conduct a significant share of business overseas.

Given signs that growth is moderating at home, analysts have been trimming 2019 profits estimates (Thomson Reuters).

While trade tensions with China have created uncertainty, the U.S. announced at the end of the month it will postpone its threat to increase tariffs on $200 billion in Chinese goods to 25% from 10% (WSJ). But obstacles remain to a more permanent deal that protects U.S. interests and opens Chinese markets.

Rate Worries

Then, there have been rate worries. Eight rate hikes by the Federal Reserve since late 2015 did little to dent sentiment through September. Figure 1 illustrates that rates are off rock-bottom levels but aren’t far from historical lows.

We must go back to the 1950s to find a 10-year Treasury yield below 3% (excluding post-financial crisis yields). A fed funds rate at 2.0-2.25% is also at the low end of the 60-year range – see Figure 1.

While rates haven’t risen in response to an unwanted rise in inflation, investors have begun to fret the Fed might overshoot on the upside and slow growth too much.

Soothing comments from Fed Chief Jerome Powell in late November appeared to quiet concerns that the Fed was on “rate-hike autopilot.” In other words, the Fed suggested it is flexible and could slow any plans to boost interest rates in 2019.

Crude awakening

Oil prices have plunged – see Figure 2. The recent sharp decline in crude oil has its roots in several factors.

Slowing global growth, the stronger dollar (as oil is priced in dollars), and the Trump administration’s decision to allow some countries to purchase Iranian crude have played a role. Waivers from the sanctions that began in November were expected, but they were more generous than most had anticipated.

However, one of the biggest factors may be “Made in the USA.”

Thanks to price hikes earlier in the year, oil companies have been drilling for profits in the shale fields at home. Unlike conventional drilling, which can take years to produce oil, shale can be tapped much more quickly.

Based on estimates provided weekly by the Energy Information Administration, U.S. oil production has risen to 11.7 million barrels per day (Figure 3), ahead of number 2 Russia and number 3 Saudi Arabia.

It’s another way of saying the U.S. is now the largest oil producer in the world. Moreover, production has not only been rising, the pace has been accelerating.

Throw all the variables into the oil price equation and we’ve witnessed a steep decline in price.

Final Thoughts

Volatility is a normal part of investing. Stocks have a long-term upward bias, but the ascent has not been without pullbacks.

While moderation in U.S. growth may be temporary, recent uncertainty has encouraged investors to reprice risk, i.e., discount the slowdown in U.S. economic growth and profit growth. It’s an inexact science and markets can and do sometimes overshoot, both to the upside and the downside.

Yet, the odds of near-term recession remain are low, which has helped cushion the downside. In recent years, previous corrections have run their course when any economic fears turned out to be overblown and economic growth didn’t falter.

7300 Wealth Connect – 11-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Cool Wind Greets October

Last month’s update began with the headline, Strong Economic Fundamentals Drives Shares to New Highs. While I acknowledged that October has a ghoulish reputation, September is, on average, the weakest month for stocks (MarketWatch – Dow Jones Industrial going back to 1896).

This year, October, which historically sports a gain (St. Louis Fed data back to 1970), lived up to its supposedly undeserved reputation.

Let’s dive in and dissect October’s weakness, review the near-term outlook, and put October’s pullback in perspective.

Behind the decline

There wasn’t a specific catalyst that sparked the selloff but there were factors that influenced sentiment.

  1. Interest rates and a Fed policy mistake. Eight rate hikes by the Fed since December 2015 didn’t cause much concern until we entered October. Are investors getting anxious about an overshoot on rates that could put the brakes on economic growth? It’s not unusual for the cost of money to rise when the economy is expanding, and a growing economy is supportive of corporate profits.

    The Fed has yet to signal it may ease up on plans to gradually hike the fed funds rate. Expect one more 0.25 percentage-point increase in December. The Fed has penciled in three such hikes in 2019.

  2. China, slower global growth, and tariffs. This may be the biggest reason why we’re seeing the latest round of volatility. For firms that conduct a substantial amount of business overseas, we may see a moderation in earnings growth in Q4 and next year.

    And tariffs, which weren’t bothering investors a few weeks ago, have taken center stage. Fear—it will further slow economic growth among some industrial names and boost inflation at home.

    While Q3 earnings growth has been very strong – up over 26% per Thomson Reuters (estimate through Nov 1), various firms have commented that they are concerned about the impact of U.S. trade policy. Further, earnings growth is expected to moderate in 2019.

    The cut in the corporate tax rate is aiding results today. But let’s not discount U.S. economic growth. How the U.S. economy performs next year will play a key role in earnings.

  3. A U.S. economic slowdown? While U.S. GDP expanded at an annual rate of 3.5% in Q3 (preliminary data from the U.S. BEA), there was one notable soft spot – weakness in business spending.

Weakness in capital spending may be just a one-time slowdown, and consumer spending remains strong. Moreover, job growth and the gradual acceleration in wage gains are set to support consumer outlays.

The Fed’s Beige Book, which is an anecdotal review of the economic data, isn’t suggesting a near-term slowdown, and the Conference Board’s Leading Index hit another high in September.

While housing has stalled—an important leading indicator—and auto sales have moderated, odds of a near-term recession, which would likely send shares into bear market territory, remain low.

Taking the stairs up and the elevator lower

Stocks seems to take the stairs higher and the elevator lower. While we recognize that stocks don’t move up in a straight line, steep declines can sometimes be unnerving.

But trying to time the market and avoid surprises, well, it’s not a realistic option.

Benjamin Graham is not a household name, but he is well-recognized in the investment community. Best known as a mentor to Warren Buffett, he authored “Security Analysis” and “The Intelligent Investor,” two titles that influence financial planning today.

In the 1970s, he said, “If I have noticed anything over these sixty years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.” Agreed. Besides, a market timer must be successful twice – consistently and correctly forecasting the peak and trough.

While we may look for patterns that might provide insights, i.e., bear markets center around recessions and profit growth underpins longer-term stock market performance, former Fed Chief Ben Bernanke counseled, “These must be used with considerable caution and healthy skepticism.”

Even if a pattern emerges that may suggest a possible market turning point, if one is either early or late, it becomes exceedingly difficult to outperform the longer-term investment plan.

With that in mind, note in Figure 1 that market pullbacks are quite common. And so are annual advances.

The average intra-year decline in the S&P 500 Index since 1980 has been almost 14%. Yet, the total return on the S&P 500 Index, including dividends, averaged a healthy 12.6% annually since 1980. Moreover, we’ve only experienced six full-year declines.

This year the largest intra-year decline is 10%. That occurred in February. We came close to 10% last month. While the swiftness in October’s selloff may be disquieting, recent weakness isn’t out of the ordinary.

We’ve seen risks push their way onto the stage before. When anxieties failed to materially impact the economic outlook, stocks recovered. Stay tuned.

7300 Wealth Connect – 10-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Strong Economic Fundamentals Drives Shares to New Highs

October has a ghoulish reputation. Maybe it’s the October 1929 market crash or the one-day decline in October 1987 that exceeded 20%. Using data from the St. Louis Federal Reserve that goes back nearly 50 years, September has historically been the worst month for stocks.

There isn’t a plausible reason that might explain weakness in September, but this year, September saw new highs.

The Dow Jones Industrials, which is made up of 30 large companies, topped its January 26th high late last month. The S&P 500 Index, which is comprised of 500 large companies, pushed past its prior peak in August, added to its advance in September, and registered its best quarter since 2013 (CNBC).

Shorter term, risks never completely abate. Problems in developing markets are simmering, and we’ve been treated to a steady drumbeat of discouraging headlines on trade with China.

On September 18, the U.S. confirmed that tariffs on another $200 billion in Chinese imports will go into effect. China promptly slapped tariffs of $60 billion on U.S. exports. Market response: the Dow closed up 184 points that day (WSJ).

Retailers have begun to loudly complain that tariffs will boost prices. At a late September press conference, Fed Chief Jerome Powell said he’s “been hearing a rising chorus of concerns from businesses all over the country about disruption of supply chains, materials, cost increases, and loss of markets.”

But he was quick to point out that if you look at the data holistically, “It’s hard to see much happening at this point (slowing the U.S. economy).” That’s likely why investors aren’t fretting over trade frictions right now.

Maybe investors are underestimating the longer-term negative impact. That said, when new risks have failed to materially dent the economic outlook, investors refocused on the fundamentals.

It’s the upbeat economic data, rising corporate profits, and still-low interest rates that have helped push shares to new highs. This has been an ongoing narrative absent new headline risks.

Rates, the Fed, and new highs

Rates are no longer at rock-bottom levels as they were in the years that followed the 2008 financial crisis. Since the Federal Reserve began hiking interest rates in late 2015, the Fed has raised the fed funds rate eight times. Each hike has been in 0.25 percentage-point increments. Today, the target range for the fed funds rate is 2.00-2.25% – see Figure 2.

According to the Fed’s own projections, expect one more increase at the December meeting. The goal: slowly normalize interest rates without tipping the U.S. economy into a recession. But, raise rates too slowly in the face of solid economic growth and the Fed risks overheating the economy and lifting inflation.

When the Fed was about to begin lifting rates, some analysts worried it would be bad for stocks. A higher guaranteed return could diminish the appeal of equities.

Figure 2 suggests otherwise. Since the Fed first boosted the fed funds rate (blue line), the S&P 500 Index (red line) has risen 41% (through Sept 28).

You see, other factors also influence the overall level of closely-followed market indexes. The improving economy has played a significant role in lifting corporate profits, which has the biggest long-term influence on stock prices.

Besides, interest rates are still low, and the Fed has not been hiking rates in response to higher inflation, which could create a stiffer headwind for stocks. Instead, it has been gradually hiking interest rates in response to an improving economy.

Wrap up

We can’t discount the possibility that unexpected headlines could sway sentiment and create volatility.
We’ve seen it before.

A favorable outlook for profits is no guarantee stocks will be higher next month or by the end of the year. But strong fundamentals – rising corporate profits, solid economic growth, and still-low interest rates – have underpinned shares in the second half of the year.

7300 Wealth Connect – 09-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Milestone and Turkey Talk

It’s been a long-running bull market. Born in the depths of the Great Recession, the current bull market, as measured by the S&P 500 Index, has sidestepped a bear market since bottoming on March 9, 2009 at 676.53 (St. Louis Federal Reserve). A bear market is generally defined as a 20% drop or more. The widely followed index closed August 31 at 2,901.52 (WSJ).

On August 22, the current bull market extended its run to 3,453 calendar days (CNBC), taking the crown away from the previous champion, the run-up of the 1990s – see Figure 1. In some respects, it’s just a date. But it’s also a milestone.

As Figure 1 illustrates, lengthiest doesn’t necessarily mean best performing. That title still resides with the October 1990 – March 2000 bull market. It’s trough-to-peak return totaled 417% vs today’s run, which through August 31, has amounted to 329%.

More importantly, investors who have adhered to a disciplined approach that includes a diversified stock portfolio have been rewarded.

Sure, there have been times when the bulls have been knocked off balance. Greece, European financial woes, China anxieties, and the collapse in oil prices forced corrections of at least 10% since 2009.

An uptick in Treasury bond yields earlier this year pushed investors to the sidelines. What may have been a modest dip turned into a 10% correction when products tied to market volatility exacerbated selling.

While some sectors have suffered, trade frictions also caused jitters but have yet to trigger a significant slowdown in the U.S. Given strong profit and economic growth, low interest rates, and low inflation, investors have once again focused on the medium- and long-term drivers of stock prices – the favorable economic fundamentals.

Let’s talk Turkey

From time to time, a tremor from an overseas incident reaches our shores and impacts our markets. In most cases, when we look back at the event, it barely creates a ripple at home. It’s a footnote in market history few remember.

Russia’s invasion of Ukraine four years ago was a one-day market event. The U.K.’s Brexit vote in 2016 jarred investors for a couple of days, but that was about it. Europe’s financial turmoil in 2011 created waves. But in each case, none of these incidents caused significant harm to the U.S. economy.

In each case, cooler heads prevailed, and longer-term investors, those who stuck with a disciplined approach and avoided the temptation of an emotional response, were rewarded.

That leads us to the nation of Turkey. Problems have been simmering for a long time in Turkey. Last month, U.S. investors reacted when President Trump tweeted he wanted to double steel and aluminum tariffs on the struggling nation. It was like lighting a match in an already parched forest.

The lira, which has already begun to sag, quickly extended losses – see Figure 2. The Financial Times reported the European Union was concerned that some banks might have too much exposure to Turkey, and shorter-term investors were quick to react – at least for one day.

It’s not that a currency crisis can’t lead to what’s called “contagion,” when a financial crisis in one corner of the globe spreads. We saw that in 1998 when Russia defaulted. But odds of such an event are low.

Turkey’s problems have been in the making for years. It has borrowed too much money – much in dollars – to grow its economy. If borrowed in dollars, interest accrues in dollars, and loans must be repaid in dollars. Rising U.S. interest rates and rising inflation in Turkey conspired against the lira.

A lower lira means it’s costlier to convert lira into dollars, i.e., the debt level effectively rises, making repayment more difficult. In turn, a crisis of confidence develops, encouraging foreign investors to dump the lira, and a vicious downward cycle ensues.

Issues in other troubled areas also bear watching. Argentina comes to mind. But bottom line, it was a one-day selloff that amounted to less than one percent, and attention quickly returned to the positive economic fundamentals.

As we approached the end of August, the S&P 500 Index, the NASDAQ Composite, and a number of other key indexes rose to record highs (MarketWatch, various sources).

Given the negative headlines generated by trade frictions and emerging market woes, economic growth + profit growth + low interest rates have gone a long way in underpinning stocks.

7300 Wealth Connect – 08-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Entering the Second Half of the Year with Momentum

The U.S. economy just recorded its best quarter in nearly four years. Gross Domestic Product (GDP), which is the broadest measure of the value of a country’s economy, grew at an annual pace of 4.1%, according to the U.S. Bureau of Economic Analysis – see Figure 1.

We’ll get two more revisions over the next couple of months, but the early read is encouraging.

Without trying to minimize the good news, it’s important to point out that the GDP report is old data. It’s a snapshot of April – June. We’re entering August, which leads us to the next question. Was Q2 a one-time event, or are we entering a higher orbit of growth?

We’ve had false starts before – bursts of activity followed by a slowdown. And the trade war with U.S. trading partners is creating uncertainty.

Figure 2 illustrates that GDP, when measured on a year-over-year basis, has consistently and gradually accelerated for eight-consecutive quarters. It points to momentum.

Consumer and business confidence remains strong, and tax cuts, fiscal stimulus, and regulatory relief are likely to encourage economic activity.

While growth in Q3 and Q4 may not match Q2’s 4.1% pace, there are reasons for cautious optimism as we push into the second half of the year.

The big picture

Economic growth is beneficial in many ways. It creates jobs and new opportunities. While wage growth hasn’t been robust, a growing economy is necessary for wages to rise.

For savers, the expansion has finally started to lift interest rates, albeit at a gradual pace. For investors, economic growth is the engine of profit growth. And profit growth is the biggest factor that drives stocks higher over the longer term.

Q2 earnings season has been marked by several themes. Some companies have fretted about higher raw material costs, higher freight costs, and the negative impact of tariffs.

A couple of high-profile disappointments in the social media space generated recent volatility in the NASDAQ Composite, which for much of the year has been the beneficiary of tech outperformance. But these misses were mostly company-specific and not tied to economic weaknesses.

Thanks to the cut in the corporate tax rate, from 35% last year to 21% this year, Q2 earnings growth is very strong – see Figure 3. But let’s not discount U.S. economic growth either. By and large, forecasts being issued by companies for the rest of the year have generally been upbeat (Thomson Reuters).

Given the negative headlines generated by trade tensions, economic growth + profit growth + interest rates that remain near historic lows have gone a long way in propping up stocks.

It suggests that investors aren’t experiencing too much anguish over the ongoing trade war. Or, it’s possible investors are underestimating the economic impact. Possibly, they expect the U.S. to prevail, or they simply don’t believe a trade war, even if extended in length, will have that much of an economic impact.

It has created some day-to-day volatility, and additional choppy action can never be ruled out. But the economic fundamentals continue to lend support.

As July came to a close, the S&P 500 was up 5.34% since the end of last year. It’s not earth-shattering, and it almost feels puny compared to last year’s exceptional performance. But if it were possible to extend the year-to-date gain through December, the S&P 500’s return would end up near its long-term annual average.

7300 Wealth Connect – 07-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Nine Years Old

The economic recovery began in July 2009 – that according to the National Bureau of Economic Research, the official arbiter of recessions and economic expansions. A quick review of the math, and it means the current expansion just turned nine years old, or 108 months.

Let’s put that into perspective. We’ve surpassed the long-running expansion of the 1960s by two months. We’re within striking distance of the all-time longest expansion, which ran through the 1990s and lasted exactly ten years – see Figure 1.

It has not been an impressive economic recovery – see Figure 2. The graphic illustrates it has been the weakest since at least 1950 (the U.S. government began collecting quarterly data in 1947). But it’s probably one reason for its longevity.

You see, fast growth can sometimes force the Fed to quickly hike interest rates, which can stifle the economy. Or, it can create speculative excesses – economic booms – that sow the seeds of the next recession. We experienced that in the late 1990s.

Besides the general slowdown in growth post WWII, two things stand out.

First, recessions are typically short interruptions in what otherwise has been a long-term upward trajectory for the economy. Second, the 2001 recession was so shallow, it failed to produce a year-over-year (y/y) decline in GDP. In fact, the U.S. economy generated an uninterrupted period of y/y GDP growth that lasted nearly 17 years!

Still, growth stalled in 2001, the jobless rate rose, and the shallow recession was enough to prick the bubble in stocks, which had become extremely overvalued.

The current cycle is no longer young, and it generally leads to concerns that a recession could be lurking. Importance to investors: recessions and bear markets historically go hand in hand.

But is a recession in the next year inevitable? Not necessarily. Optimists, led by Byron Wien, the respected vice chairman of Blackstone, said in his July commentary be believes the current cycle “has at least several more years left to run.”

Bolstering his case, inflation is gradually moving higher but remains low, and wages are up but aren’t accelerating at a fast clip. Both factors are keeping the Federal Reserve from hiking interest rates too quickly. Moreover, fiscal stimulus, including the recently enacted tax cuts, is in the pipeline.

While Mr. Wien’s confidence isn’t shared by all analysts, most short-term leading economic indicators aren’t suggesting a recession will ensue this year or early next year.

Looking ahead and the upcoming election

Last year’s strong rally carried over into 2018 but quickly ran into a brick wall when longer-term Treasury yields tracked higher. The Dow Jones Industrials and the S&P 500 Index have failed to recapture January highs, but the tech-heavy NASDAQ Composite and closely followed measures of mid-sized and smaller-sized companies did set new highs in June (MarketWatch data).

As the month came to a close, escalating trade tensions have hampered sentiment, especially as it relates to large multinationals, whose reach extends around the globe.

An all-out global trade war would constitute a threat to U.S. and global economic growth and counter the economic stimulus from the tax cuts. So far, however, retaliatory actions have been measured.

While difficult to quantify the direct impact, the upcoming midterm elections may be creating headwinds. Yes, economic growth and corporate profits are a big factor in the longer-term direction of stocks, but political uncertainty can sometimes translate into shorter-term investor angst.

A recent study published in the Wall Street Journal found that since the creation of the Dow Jones Industrials in the late 1890s, the oldest and best known of the market indexes has produced “an annualized gain of just 1.4% in the six months before midterm elections, in contrast to a 21.8% annualized return in the six months thereafter.”

The study noted the pattern was not as pronounced during presidential elections. It didn’t repeat itself during non-election years. Of course, these are just averages. Economic and international factors may come into play, and each cycle has its own unique features.

We enter the second half of the year with a modest pullback in global economic momentum, but growth at home remains strong. Corporate profit growth is likely to remain strong this year and moderate in 2019, while low interest rates, and a low level of inflation – at least for now, have helped counter the headwinds created by the ongoing spat in trade.

7300 Wealth Connect – 06-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Shifting Winds of Sentiment

Market sentiment can be fragile. There are times when there is unbridled enthusiasm. Then, we may get a change in a key metric, and it’s as if everyone who was on one side of the boat runs to the other side.

In a way, that’s what happened when investor sentiment shifted between January, when shares were hitting new highs, and early February, when investors turned the tables.

If we look to the economy, nothing much has really changed. Sure, the winds of protectionism whipsawed sentiment earlier in the year, and tensions haven’t dissipated. But first quarter profits came in much better than expected (Thomson Reuters), and the jobless rate fell to 3.8% in May (U.S. BLS).

If we’re basing the outlook on the economy and profit growth, the fundamentals are sound.

Over the last month, larger company stocks have stabilized and moved away from recent lows. It’s another shift in sentiment.

It’s been even brighter for smaller-company stocks, with a key index hitting an all-time high in late May, according to MarketWatch.

There are times when it’s difficult to pinpoint the exact reason why shares drift in a particular direction. When investors implement buy or sell decisions, there isn’t a space on the ticket entitled, “reason for stock transaction.” But we can scan the investment landscape for signs.

Like a detective solving a riddle, we can gather clues and reach a reasonable hypothesis. For starters, investors appear to be adapting to the idea of a 10-year Treasury yield around 3%. The growing economy, which supports corporate profits, helps to offset any headwinds from higher rates.

Company stock buybacks, or companies that repurchase their shares on the open market, jumped to a record pace in Q1 (Figure 1). That’s expected continue in the current quarter (S&P Dow Jones Indices).

Additionally, legendary investor Warren Buffett said in a CNBC interview in early May that he was actively buying stocks in the first quarter.

It’s not that Mr. Buffett can’t make a mistake. He can as no one is infallible. Buffett has repeatedly said he doesn’t try to time the market, but an investor of his stature, and one whose long-term record of success speaks for itself, provided a degree of comfort and soothed anxious nerves.

Meanwhile, smaller companies don’t have as much international exposure, reducing potential damage from rising tariffs. Reduced exposure overseas limits any headwinds from the recent rise in the dollar.

As the winds of sentiment shift, it’s a good reminder that longer-term investors should be careful about being bounced around by short-term changes in investor psychology. Market timing is rarely a successful strategy.

Italy stirs

As the end of the month approached, a hiccup in Italy created tremors that reverberated through global markets.

First, a little bit of background – Europe has been dealing with various banking and financial problems since the beginning of the decade. We’ve seen flare-ups in Greece, Spain, Portugal and Cyprus. A couple of years ago, markets grappled with the short-term fall out when U.K. voters decided to exit the European Union, i.e., Brexit. Over the last year, faster growth in Europe has pushed anxieties to the backburner.

Over the Memorial Day weekend, the president of Italy rejected the appointment of the finance minister from the newly elected coalition government because of a perceived bias against Italy’s use of the euro as its currency. The newly chosen prime minister (not to be confused with the president) abruptly resigned.

While attempts are being made to salvage the current coalition, new elections can’t be ruled out.

The reaction in Italian bonds was swift, with yields surging (Bloomberg), while global markets temporarily took it on the chin. The overriding concern – Italy could dump the euro.

Unlike Greece, Italy is the eurozone’s third-largest economy. Though its debt is high, it’s not in need of a bailout as was the case with Greece. But a rejection of the euro would have huge ramifications in Italy. Cash would likely flee the country, collapsing Italian banks and roiling the European financial system.

It’s an unpleasant prospect, but rejection of the common currency is not something voters in Italy have been clamoring for. Cooler heads quickly prevailed.

The economic consequences strongly suggest that odds Italy will reject the euro are low. But the latest drama is a reminder that Europe’s financial struggles are simmering near the surface. At times, tensions in Europe can create volatility in U.S. markets.

Housing reclaims a prior peak

For some cities, home prices have been in record territory for quite a while. But this marks the first time a key measure of U.S. prices has surpassed the 2006 peak – see Figure 2 blue line. It took almost 12 years.

Unlike the prior decade, when speculators and easy lending standards helped create a buying frenzy that fueled price increases and home building, conditions are different today.

Underwriting standards are stricter and home builders have been reluctant to build smaller, starter homes. In some locales, bidding wars have broken out, especially at lower price points. Additionally, price increases (red line, Figure 2) have been reasonably steady. Gone are the days when prices were marching up at unsustainable, double-digit rates.

While rising mortgage rates could slow the housing market, today it is more about the lack of supply, as noted by statistics from the National Association of Realtors.

The lack of supply has created a challenge for buyers and has impeded sales in some markets. But overbuilding, which has historically been a prerequisite for a bubble, isn’t a problem right now. The problem in many markets is a lack of available homes for sale.

7300 Wealth Connect – 05-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Competing Forces

Since stocks rolled over near the end of January, there has been a sharp pickup in volatility – big gains on some days and big losses on others. But the selloff since the January 26th peak has been modest. Index April Return* 2018 YTD Return %

The Dow Jones Industrial Average®, which is the oldest and best known of the market averages (made of 30 large, well-known firms), is down 9.2% from its closing high as of April 30 (St. Louis Federal Reserve).

The S&P 500 Index®, which as its name implies consists of 500 larger companies, is down 7.8%. In both cases, the declines have been modest by historical standards. While markets trend higher over the longer term, we recognize that bumps in the road are normal.

Last year’s big advance left some investors with a false sense of security. Throw in very low volatility and it’s easy to forget that temporary pullbacks are the norm.

Successfully timing such selloffs – getting out at the top and back in at the bottom – is next to impossible.

We can mitigate risk, but not eliminate it. I understand that dips can sometimes be unpleasant, but they are incorporated into a long-term investment plan designed to reach your financial goals.

While shares aren’t far from all-time highs, we have, as noted above, experienced a much greater degree of volatility compared to 2017. Figure 1 highlights such volatility.

Through all of 2017 and the first month of 2018, the S&P 500 Index registered a daily change of 1% or more just 10 times. Over the next three months, the number of plus/minus daily changes accelerated to 29.

It’s another tangible measure that illustrates we’re seeing wider price swings.

China and the uptick in rates

Trade tensions subsided after China’s president gave a conciliatory speech last month. He didn’t offer much in the way of concessions, but his tone was designed to ratchet down the rhetoric. Still, the issue isn’t going away, and protectionism and the potential hit to U.S. exports remains a concern as deadlines loom.

Unlike the steel and aluminum tariffs, even free traders agree China’s trade practices, which include forced technology transfers and restricted access to Chinese markets, are undermining the trading system (Wall Street Journal).

Some will agree with Trump’s approach and others will not, but both agree on the desired outcome.

Stocks have also run into modest resistance amid an increase in interest rates, including the yield on the 10- year Treasury bond.

The yield on the benchmark Treasury breached 3% for the first time since late 2013 – see Figure 2. Most analysts point to forecasts of faster U.S. growth, forecasts that inflation may tick higher, and the belief the Fed will continue to gradually hike the fed funds rate. Projections that point to higher budget deficits may also be playing a role.

At about 3%, the 10-year bond remains at an historically low rate, but the recent rise has injected some uncertainty into the shorter-term outlook.

There is no shortage of academic theory to explain how rates may impact stocks. While an improving economy aids earnings and support shares, let’s avoid the academic weeds and keep things simple: rates that rise too quickly could slow economic growth and compete with stocks for the investors’ dollar.

The big winner – Q1 earnings…so why doesn’t it matter

Q1 S&P 500 profits are forecast to rise an astounding 25.0% from a year ago (Thomson Reuters I/B/E/S as of 5.1.18, with 60% for companies having reported). This compares with a forecast of a still-strong 18.5% on April 1. That’s a significant upward revision.

More firms are beating analyst expectations than ever before (Bloomberg) and are beating by a wider-than-average margin. While strong earnings growth is an underlying support, it’s not fueling further gains.

Trade tensions and rates may be creating some headwinds, but it appears the very strong profit season may have already been priced in. Further, Q1’s upbeat numbers aren’t sustainable into 2019.

For starters, we won’t be getting another reduction in the corporate rate next year. However, earnings growth going forward will be compounded from a higher base.

How that is being priced into shares is unclear, but it is likely supportive of stocks longer term. Still, as we head into May, competing forces are creating volatility and have been keeping shares in a range.

If you any questions or have any items you would like to discuss, please feel free to reach out to me.

7300 Wealth Connect – 04-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

A Tale of Two Cities

The first quarter of 2018 can be placed into two distinctive camps. Market action in January was a continuation of 2017, with investors pricing in sharp upward revisions to 2018 profit estimates (Thomson Reuters). But the tide shifted in February and March, with volatility replacing relative tranquility.

Did you know the S&P 500 Index snapped its longest streak without a back-to-back daily 0.5% decline at the end of January? That’s right – 310 trading days without two consecutive pullbacks of at least 0.5%, according to the research firm Bespoke Group. It was nearly double the prior streak.

The lack of volatility, which can create complacency, was nearly unprecedented. Yes, volatility sometimes leads to uneasiness. I get it. We take various precautions to reduce risk, but the return required to reach your financial goals requires some risk, or what might be called a calculated risk.

Figure 1 highlights the path of the broad-based S&P 500 Index since the bull market began. It has been a profitable trend for a diversified investor, but one that has included five market corrections of at least 10%.

That 10% pullback from the record-closing peak on January 26 took just nine trading days, the shortest such peak to 10% correction on record (LPL Research) – see Figure 1.

The initial selloff was sparked by a rise in the yield on the 10-year Treasury bond. The drop was exacerbated by investment products tied to market volatility. Without getting into all the minutia, too many speculators piled into a trade that bet the lack of market volatility would continue.

When stocks swooned in early February, the unwinding of the “volatility trade” aggravated what likely would have been a very modest decline. That trade eventually unwound, but we were treated to another round of instability when President Donald Trump surprised investors by announcing steep tariffs on steel and aluminum imports – tariffs designed to pry open foreign markets to U.S. goods.

Protectionism has always been a risk that could create instability, as Trump had campaigned on the issue. New barriers to imports had been placed on the backburner in 2017. That has changed.

The reason for worries—steel and aluminum tariffs raise U.S. manufacturing costs, hinder new projects, and may encourage some firms to move production offshore. Newly erected barriers can also spark a tit-for-tat trade war as other countries retaliate against U.S. exports, slowing economic and profit growth.

It’s a scenario that creates heightened uncertainty and has added to the volatile daily market swings.

The ebb and flow of risk

Stocks have a long-term upward bias that will be interrupted from time to time by various issues.

Early in the economic recovery, investors fretted about Greece, the expanding debt crisis in Europe, and the loss of the USA’s triple-A credit rating by Standard & Poor’s. During late 2015 and early 2016, a slowdown in China’s growth, an unexpected devaluation of China’s currency, and the collapse in oil prices threw investors a short-term curveball.

Volatility reentered the investment landscape in February after an unusually quiet period in 2017. Table 1 highlights the daily percentage changes in the S&P 500 Index over various periods.

In the 13 months that ended in January, the daily percentage change in the S&P 500 (up or down) was just 0.31%. That compares to a daily percentage change of 0.55% over the last five years.

Note the much larger average move in February and March. For comparison purposes, I’ve also included 2011, when stocks last experienced an extended period of volatility.

Final thoughts

Volatility can be unnerving, but recent action illustrates it is not unusual. The economic fundamentals remain solid, including economic growth, profit growth, still-low interest rates, and recent announcements of large stock buybacks by various firms (Wall Street Journal).

Stock market corrections of at least 10% are inevitable. But the fundamentals have helped to cushion the decline.

As a note by LPL Research recently pointed out, “Corrections (10% or greater declines) are never fun, but they also aren’t new territory for investors. Prior to the most recent example, we have experienced 36 corrections since 1980, and the S&P 500 fell by an average of 15.6% from peak to trough during these periods.

“Twelve months later, the index made up some ground, rising an average of 16.0% from the low, and after 24 months, the S&P 500 had climbed by an average of 28.0%, reinforcing the need for long-term investors to maintain their diversified strategies.”

Please feel free to reach out to me if you any questions or have any items you would like to discuss.

7300 Wealth Connect – 03-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Super Bowl and the Stock Market

Did you watch the Super Bowl last month? If you did, you were treated to a thrilling offensive contest that left the winner in doubt until the final seconds had ticked off the clock.

What may have been the deciding play in the game – a late fourth quarter assault by a Philadelphia Eagles defensive lineman, who managed to strip the ball from New England quarterback Tom Brady. In a game practically devoid of sacks, it proved to be a costly turnover, and one that came without warning.

The same can be said of the drop in the S&P 500 Index, which accumulated in a 10% decline in just nine-short trading days (St. Louis Federal Reserve). We know volatility is always possible. It’s something I explicitly alluded to in last month’s update—

Since 1950, the average intra-year pullback in the S&P 500 has been 13.6%, with 91% of intra-year declines of at least 5%, and 54% of at least 10%, according to LPL Research.

Like Brady’s fumble, timing such an event is practically impossible.

The initial selloff can likely be tied to an uptick in Treasury bond yields. But the selloff was exacerbated by computer-program trading AND complex trades that were highly leveraged and tied to investment products, which rise when market volatility is low.

Few understand the intricacies of these products (and risks), but regulators are reportedly investigating them, according to Bloomberg News.

The so-called “volatility trade” appears to have unwound, but, against the backdrop of economic momentum and modest inflation concerns, investors are turning their attention to interest rates and bond yields. Note: interest rates tend to rise when economic growth is stronger and/or inflation worries surface.

Stock performance in rising rate environments – an historical perspective

Past performance is not a guarantee of future performance, but what has occurred is the past is worthy of review as it may be used as an educational guide.

Conventional wisdom suggests rising interest rates are bad for stocks, because it decreases the relative attractiveness of equities. In other words, a rise in interest rates may siphon some funds away from stocks.

As Figure 1 highlights, on average, stocks have risen in both rising and falling rate environments, but rising yields on the 10-year Treasury bond have, on average, reduced gains.

Longer term, growth in corporate profits is a strong underlying support for stocks, helping to offset headwinds from rising yields, at least in most cases – see Figure 2.

So, let’s take our example one step further and break rising yields into four categories: big declines in rates, modest decline in rates, modest increases in rates, and big increases in rates.

As Figure 2 illustrates, stocks faced the stiffest headwinds when the 10-year Treasury yield recorded its biggest average monthly increases.

But, let’s add one more wrinkle to the empirical data. S&P Dow Jones Indices also pointed out, “Between 1954 and 1997, falling rates accompanied rising stock markets 80% of the time. Between 1998 and 2012, falling rates were associated with rising stocks only 27% of the time.”

In recent years, historically low interest rates have sometimes been associated with heightened uncertainty. And periods of heightened uncertainty created stronger headwinds for shares.

While we can never discount the possibility that rising rates, or other factors, might fuel shorter-term volatility, with the exception of steep rate increases, 60 years of data suggest that, on average, rising yields have not prevented longer-term stock market gains, as economic growth lent support to profit growth.

7300 Wealth Connect – 02-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Stock Roar in January

January came in like a lion. The broad-based S&P 500 Index registered 14 new closing highs while the Dow racked up 11 (St. Louis Federal Reserve). It’s an impressive start to the new year, but I believe it’s fair to say that the current pace is not sustainable.

Many of the factors that have supported stocks over the last year remain in place, including solid economic growth at home and overseas, an acceleration in profit growth (Thomson Reuters), still low interest rates, and low inflation as measured by the Consumer Price Index.

A remark in last month’s newsletter…

“Might we see a selloff early in the new year? It’s possible, if investors book 2017 stock profits in tax year 2018. Following 2013’s outsized 30% gain in the S&P 500 (St. Louis Federal Reserve), shares went sideways in the first three weeks of 2014, then slid 6% over the next couple of weeks.”

… did not materialize in January.

But the upward lurch in stocks was primarily driven by the dramatic reduction in the corporate rate from 35% in 2017 to 21% this year and beyond, in my view.

The chart below illustrates the almost unprecedented rise in quarterly profit estimates by analysts – Figure 1.

I’ll explain. Analysts were estimating an already-strong 12.2% increase in Q1 2018 S&P 500 profits on January 1 (Thomson Reuters). By month’s end, analysts had raised their forecast to 17.2%. That’s an astounding 5-percentage point increase in earnings estimates in just one month.

And we’re not simply witnessing the increase in Q1. It’s across the board.

With analysts sharply hiking profit forecasts, investors quickly priced in a much rosier earnings outlook. Hence, the sizable gains in stocks we saw as the year began.

Legendary investor Warren Buffett summed it up this way in a CNBC interview in the middle of last month. He called it the equivalent to a “silent shareholder,” in this case the U.S. government, giving up a claim to profits to other shareholders.

“You had this major change in the silent stockholder in American business, who has been content with 35%…and now instead of getting a 35% interest in the earnings (he noted foreign earnings from U.S. firms are more complicated) they get 21% and that makes the remaining stock more valuable,” he said.

Of course, one could ask – are analysts overestimating the impact from tax reform? Probably not, but it’s an open question because we haven’t had business tax reform of this magnitude in over 30 years.

One cloud on the horizon

Stocks may not be priced for perfection, but they are priced for many positive events. It leaves less room for disappointment.

As stocks have surged in January, we’ve experienced an upward creep in bond yields.

In particular, the 10-year Treasury bond is reacting to the possibility that inflation will gradually accelerate this year, economic growth will continue at a solid pace, and global central banks may become less accommodative. Note: Treasury bonds have historically performed well in low-inflationary, low-growth environments (bond prices and bond yields move in opposite directions).

A rise in the 10-year yield to its highest level in almost four years created modest jitters in shares as the month ended – see Figure 2.

It’s a reminder of something we already know—markets can experience bouts of volatility. Since 1950, the average intra-year pullback in the S&P 500 has been 13.6%, with 91% of intra-year declines of at least 5%, and 54% of at least 10%, according to LPL Research.

It’s simply a reminder that markets, which have a longer-term upward bias, do experience turbulence.

If you have any questions or concerns, I’d be happy to discuss them with you. I’m just an email or phone call away.

7300 Wealth Connect – 01-18


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Running of the Bulls

The bulls took charge the day after election day, keeping the bears on the defensive throughout 2017. A GOP that controlled all three branches of government ignited early optimism among investors, who had expected easy passage of economic-friendly policies. But instead, gridlock kept investors on pins and needles until year-end, when Congress enacted a dramatic cut in the corporate tax rate and modestly shaved tax brackets for individuals.

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC

Whatever your thoughts are about the president, investors are bipartisan. The long-term focus is on the economy and profits, i.e. the fundamentals. Investors really don’t care which party supports investor- friendly policies. Yes, there are important issues beyond the markets, and elections have consequences. But purely through the narrow prism of the market, it’s the economic fundamentals that matter.

For much of the year, improving economic fundamentals fueled bullish sentiment, sparking 71 closing daily highs for the Dow – a record (MarketWatch). Let’s review—

  1. Profit growth accelerated (Thomson Reuters).
  2. A synchronized global expansion created additional tailwinds for corporate profits.
  3. Global growth has accelerated, as noted by the IMF’s October outlook.
  4. Consumer confidence (the Conference Board) hit its best reading since late 2000.
  5. Small business confidence recorded its second-best reading in over 30 years (NFIB).
  6. The Unemployment Rate fell to 4.1% (U.S. BLS).
  7. Gross Domestic Product in the U.S. recorded two-straight quarters above 3.0% (U.S. BEA).
  8. Inflation in the U.S. remains low (Consumer Price Index—U.S. BLS).
  9. U.S. interest rates remain low, and are currently expected to rise gradually.
  10. Leading indicators put odds on a near-term recession at a low level.

Put another way, it’s the perfect receipt for last year’s impressive advance.

One more interesting aspect of last year’s rally: there was little volatility. The biggest dip of the year for the S&P 500 totaled 2.8%, the smallest since 1995’s 2.5% (LPL Research). Since 1950, the average intra-year pullback has been 13.6%. It’s a timely reminder that a modest pullback in 2018 can’t be ruled out.

A look ahead

The economic outlook heading into 2018 hasn’t been this upbeat in years, as the U.S economy finished 2017 with momentum.

Moreover, the synchronized upturn in global growth not only aids the U.S. economy, it has been a big support for earnings of U.S. multinationals, according to FactSet Research. A reduction in the corporate tax rate is set to support earnings longer term, but it’s unclear how much has been priced in by investors.

I’m never one to throw caution to the wind and perspective is in order. Figure 1 illustrates annual winning streaks for the broad-based S&P 500 Index. We’re one year away from tying the record for consecutive annual advances going back to 1947 – see Figure 1.

Figure 2 offers another comparison. It highlights the six longest bull markets since WWII and their respective advances.

The current bull market is the second longest in both longevity and performance.

By itself, the second longest bull market since WWII creates an air of caution, but bull markets don’t die of old age or enter a danger zone based only on past performance. The end of a bull market has historically correlated with the onset of a recession. Since the late 1960s, only one bear market – the 1987 Crash – did not align itself with a recession – see Figure 3.

Still, any number of events not directly tied to the economic fundamentals could spark a bout of volatility.

Might we see a selloff early in the new year? It’s possible, if investors book 2017 stock profits in tax year 2018. Following 2013’s outsized 30% gain in the S&P 500 (St. Louis Federal Reserve), shares went sideways in the first three weeks of 2014, then slid 6% over the next couple of weeks. Yet, the year finished higher.

Bigger concerns would surround the fundamentals. If inflation were to unexpectedly heat up, we could see a more aggressive Federal Reserve, one that deviates from its currently stated path of gradual rate increases. Odds of an unexpected jump in inflation are low, but keep an eye on oil prices, which have topped $60 per barrel for the first since June 2015 (St. Louis Federal Reserve).

However, a Fed that turns more aggressive in response to a spurt in economic growth is less of a concern, in my view, since a robust economy would lend added support to corporate profits. Of course, any unexpected economic slowdown would likely create a stiffer headwind for earnings and stocks.

For those who enjoy looking at probabilities, a 20%+ advance in the S&P 500 in one year does not necessarily mean we’ll see a pullback the following year.

Excluding 2017 (up 21.83% including dividends reinvested—S&P Dow Jones Indices), there have been 24 years in which the S&P 500’s annual performance has exceeded 20% (including dividends reinvested, New York School of Business S&P 500 data). The following year saw the S&P 500 rise 18 times and decline five times.

For long-term investors, it boils down to an investment plan that is rooted in a number of factors, including the economic fundamentals. Shorter term, the fundamentals may not always be positive. But discipline, patience, and investment decisions that don’t spring from an emotional response to disconcerting events have historically been the most efficient path to one’s goals.

7300 Wealth Connect – 12-17


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Around the World

Last month’s commentary opened with a summary of the number of daily all-time highs recorded by the S&P 500 Index3 – 50 closing all-time highs this year (LPL Research, St. Louis Federal Reserve) through October 31. We can add seven more now that November has come to a close.

Shorter term, improved odds the GOP tax bill will squeak through the Senate fueled gains at month end. But let me quickly add the bill still has hurdles that must be cleared before becoming law. Longer term, it’s still all about the economic fundamentals.

November’s commentary also highlighted more upbeat prospects for the U.S. economy. But that is only part of the narrative. To paraphrase the late Paul Harvey, “Now it’s time for the rest of the story.” And one that has an international flair.

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC, London Bullion Market Assoc
* Monthly: October 31, 2017 – November 30, 2017

“Growth in Global Economy is Robust,” said a November 29th story in the Wall Street Journal.

The Journal referenced the latest economic outlook provided by the Organization for Economic Cooperation
and Development (OECD) – an international group made up of 35 countries, including the U.S.

This year we’re seeing growth accelerate in the U.S., Europe, China and Japan, according to OECD data. While challenges remain, “Global growth is projected to improve slightly in 2018, but remain below the pace of previous recoveries,” the OECD said.

The October 2017 World Economic Outlook from the International Monetary Fund (IMF) concurs, adding that emerging and developing economies should see economic growth accelerate from 4.6% this year to 4.9% in 2018. Emerging and developing economies expanded by 4.3% last year. It’s an encouraging trend.

But let’s take a moment to dive a little bit deeper. Yes, it’s a brief dive into the weeds, but it illustrates an important point.

Figure 1 offers a great summary of what’s transpiring globally. Figure 1 illustrates whether fixed investment is rising or falling in 45 countries. A quick side note is in order: Fixed investment is a wonky term that primarily refers to spending by businesses on buildings and equipment.

The expansion or contraction in spending by businesses is significant because it is an important driver of economic growth. We see that spending plummeted during the 2009 recession. That’s not a surprise.

We also see a rebound as the global economy exited the recession. But heightened uncertainty following the financial crisis limited the economic upside, that is, until late last year (IMF data).

Currently, all but one country is expected to exhibit growth in 2017 and 2018. That’s impressive.

Put it in terms I understand

Okay, I get it. That was a wonky way of saying that prospects around the world are improving, but I felt it was important to use an obscure piece of economic data to graphically demonstrate the big picture.

From a more practical standpoint, faster global growth is translating into faster revenue and profit growth for U.S. companies that have more worldwide exposure – see Figure 2.

Figure 2 also offers us two takeaways. First, a thriving global economy creates a tailwind for earnings, which supports stocks. Second, the synchronized acceleration in activity around the world is a major factor in the upbeat performance of international stocks this year.

While we should never forget that unforeseen events have the potential to inject volatility into the market, including failure of tax reform, the economic fundamentals, both at home and abroad, have lent support to shares.

If you have any questions or concerns, I’d be happy to discuss them with you. I’m just an email or phone call away.

7300 Wealth Connect – 11-17


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.


The Dow Jones Industrial Average1 ended October near a record high. The same can be said of the broader-based S&P 500 Index3, which is a measure of 500 large publicly-traded U.S. companies.

Failing to end the month at a new high isn’t material. You see, through 10.31.17, the S&P 500 Index has recorded 50 closing all-time highs (LPL Research, St. Louis Federal Reserve). Notably, 20 have occurred since September 11, and eleven occurred in the month of October. It’s an impressive run.

Statistically speaking, September is the market’s weakest month (St. Louis Federal Reserve), while October has historically had a ghoulish reputation. Well, that didn’t happen this year.

Simply put, the fundamentals that have driven the rally remain in place – modest/moderate economic growth which is supporting corporate profit growth.

At the end of October, the U.S. BEA reported Gross Domestic Product (GDP), which is the largest measure of economic activity, grew at a 3.0% annualized pace in Q3. It was the second-straight quarter growth has met or exceeded 3%. It’s something we haven’t seen since 2014 – see Figure 1.

Just as important, we’re witnessing a synchronized acceleration in global economic growth. China is expanding at a brisk pace, while activity in Europe and emerging markets have accelerated. Even Japan’s much-maligned economy has been experiencing more consistent economic activity.

Why should U.S. centric investors care about the overseas economy? S&P Dow Jones Indices estimates that S&P 500 companies gathered 43.2% of sales from overseas in 2016.

S&P is quick to point out this is only an estimate because not all entities break out sales based on geography. Still, an estimate north of 40% is significant. So, it almost goes without saying that a brighter outlook overseas is a big benefit to U.S. multinationals, as we’ve seen from several Q3 earnings reports (CNBC, Bloomberg, various sources).

Need more convincing? FactSet Research estimated last month that companies with more than half of sales outside the U.S. were expected to post significantly higher Q3 profit growth than those that secure more than half their sales at home.

But North Korea hasn’t gone away

It hasn’t. But lately, headlines that might impact shares have been lacking. For that matter, missiles tests have had only a very limited and short-term effect on stocks. We don’t know when an alarming headline may surface, but investors have been discounting anything short of a crisis at the current time.

Discord in Washington? It’s failed to blunt bullish enthusiasm, as investors are rightfully keeping their eyes on the economic fundamentals.

About those new highs

That brings us back to the string of new highs we’ve experienced. One question that typically arises, “Is a new high the time to sell?” By itself, the short answer is “no.”

Nearly four years ago, Josh Brown, writing in the Reformed Broker, posted an inciteful piece that summed it up well. On January 15, 2014, he wrote—

“Just reading or hearing the term (new highs) itself engenders a certain kind of hysteria in people. It suggests that things are about to tip the other way any second, as we all carry within ourselves a cognitive defect known as the Gambler’s Fallacy. We innately believe that random occurrences are meant to balance out over short periods of time. That ten straight coin flips landing on heads virtually assures that a tails flip will be next – despite the fact that the next flip is its own event and nothing that came before it matters.”

The CNBC commentator added, “While our DNA and 100,000 years of evolutionary programming may lead us to believe that a new all-time high is a precarious perch and presages an imminent turn in the other direction, it isn’t ever quite that simple.”

That year, the S&P 500 Index went on to record 53 new, all-time closing highs – see Figure 2.

So, selling the day the market reaches a new high simply means you will probably receive a slightly higher price than if you had sold the day prior. But it doesn’t tell us about tomorrow – or, for that matter, a week, month, or year later.

In reality, anyone who shares his or her thoughts on where stocks are headed next month or next year is only offering a guess. No one owns a crystal ball. Many factors, both known and unknown, will determine share prices next year. The economic fundamentals and corporate profits play a big role, but emotions can sometimes sway sentiment in the shorter term.

A disciplined approach based upon a time-tested investment plan may not completely remove the anxiety we might experience, but historically it has been the best approach to reaching one’s financial goals.

7300 Wealth Connect – 10-17


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

Climbing a Wall of Worries to New Highs

The S&P 500 Index has risen 12.53% since the beginning of the year – pretty impressive. The S&P 500 not only ended the quarter at a record high, it extended its quarterly winning streak to eight-straight quarters (MarketWatch data). As far as September’s reputation for being a weak month, it didn’t happen.

It’s not uncommon to hear some folks credit this year’s runup to the performance of a few large stocks. You see, the S&P 500 Index is what is called a “market-capitalization” weighted index. That simply means that the larger stocks in the 500-company index have a greater influence than the smaller ones. So, strong gains by some large companies are driving most of the returns. Right?

Well, not exactly.

I recently came across a mid-September commentary by Blackstone that pointed out an equal-weighted version of the S&P 500 is up over 8% (at quarter-end, it’s up 10.38% year-to-date, per S&P Dow Jones Indices).

(The equal-weighted S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. The index includes the same firms as the capitalization-weighted S&P 500, but each company is allocated a fixed weight of 0.2% of the index at each quarterly rebalance. Past performance does not guarantee future results.)

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC
*Quarterly: June 30, 2017 – September 29, 2017

In other words, the good cheer from this year’s bull market isn’t concentrated in just a few large stocks.

Washington, North Korea and hurricanes

What’s interesting, and is surprising to some, is the continued lack of volatility in the market. Political gridlock in Washington hasn’t had much of an impact on investor psychology. The same holds true of rising tensions with North Korea and the devastating hurricanes that slammed into Texas, Florida and Puerto Rico.

Recall the jump in shares immediately following the election. Republicans controlled the White House and Congress.

Investors quickly seized the bullish reins amid expectations that tax cuts were a given, infrastructure spending and a ramp-up in defense spending would soon be in the pipeline, and pro-growth deregulation would be forthcoming. Think of it as a sugar and caffeine cocktail for economic activity.

Trump acted on the deregulation front, but the rest of his agenda seems to be mired in a quicksand known as Capitol Hill.

The rhetorical volley between North Korea and the U.S. has been unsettling, and more is likely forthcoming.

Prepare yourself for that. But it hasn’t had an impact on the U.S. economy.

Moreover, investors are beginning to price in the unpredictability of North Korea’s rogue leader. Taken together, a more meaningful market reaction has been lacking. Without a significant increase in tensions, recent history suggests market impact will likely remain limited.

Lastly, Hurricanes Harvey, Irma and Maria have devastated local communities. While relief efforts are under way and I encourage you to consider donating, the longer-term effect on the U.S. economy is likely to be minimal. Shorter term, it is affecting the data and gasoline prices are up, but rebuilding efforts are likely to lend support in the months ahead.

That said, Republican Congressional leaders and Trump released a blueprint for tax reform at the end of September, but it must wind its way around many Congressional hurdles before it can be enacted into law.

Keep an eye on the fundamentals

Longer term, I can’t put too much emphasis on what drives stock prices – corporate profits and expectations of how corporate profits will perform.

What’s been happening in Washington and North Korea has been barely more than a distraction for investors, as faster economic growth at home and overseas has lifted earnings.

In addition, interest rates remain near historic lows, which reduces competition with stocks. It’s been a powerful tonic that has kept volatility and the bears at bay.

Tax Reform

As September came to a close, the Trump administration unveiled its long-awaited plan to reform the tax code.

The plan is simply an outline, a blueprint that was the byproduct of negotiations between Trump officials and key Republican Senate and House leaders. It’s a framework that is likely to undergo several iterations as it winds its way through the House and the Senate.

With Congress tied to a tight schedule, details may not be finalized until early 2018, if then.

From an investment perspective, the outline was silent in regards to how it will treat dividends and capital gains. In addition, no mention was made of the 3.8% surtax on investment income that hits high-income Americans.

Retirement accounts could undergo changes. There has been some chatter about shifting retirement vehicles toward “Roth-style” accounts, which would eliminate the upfront deduction to income. But at this juncture, anything beyond that is simply speculation.

From a business perspective, the outline lowers the top corporate rate from 35% to 20%, which has been highly coveted by investors. It also allows for a top rate of 25% on business income. But specific language has yet to be written.

Simply put, tax planning becomes extremely tenuous given the high degree of uncertainty. If you have any questions or concerns, I’d be happy to discuss them with you. I’m just an email or phone call away.

7300 Wealth Connect – 9-17


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Stock Market and Earnings

For much of the year, the overall stock market has exhibited an unusual lack of volatility. In fact, one must go all the way back to the week ended September 9, 2016 before finding a Friday-to-Friday period in which the S&P 500 Index fell by more than 2% (MarketWatch closing data for the S&P 500).

At times, the upward climb in stocks has been exciting. At other times, it’s been pretty dull. And maybe that helps explain some of the shrill headlines that have been popping up on financial websites – websites that thrive on clicks and ad dollars.

Those who adhere to a disciplined investment plan, one that focuses on long-term performance, shouldn’t be too concerned.

But we did witness a little bit of volatility creep back into the major indices last month, even as many of these same indices finished the month near record highs.

A heated rhetorical exchange between President Donald Trump and North Korea’s rogue leader created a modest degree of instability earlier in August. But it was short-lived. Uncertainty emanating from Washington may have also rattled a few short-term traders.

What was noticeably absent was the lack of a meaningful market response when North Korea tested a missile that flew over Japan during the last week of August.

Two observations—
First, absent a serious crisis, investors appear to be pricing in North Korea’s unpredictable missile tests. Hence, we saw a muted reaction to what was a very provocative act of aggression.

Second, at least in the shorter term, investors don’t believe the situation will spiral out of control.

In no way am I trying to downplay the seriousness of what is going on. But from a short-term investment perspective viewed through the narrow lens of the market, geopolitical uncertainties just haven’t had much effect on shares.Yes, stocks opened lower the following day but quickly rallied to finish in positive territory.

Earnings, earnings, earnings

Any real estate agent will tell you it’s location, location, location. While short-term market sentiment can be swayed by any number of factors – both positive or negative – longer-term, it’s earnings, earnings, earnings for stock prices.

Sure, interest rates, corporate stock buybacks, the level of inflation, and more play a role, but profits and expectations of future profits are the biggest variable.

With Q2 earnings season set to conclude, companies posted sales and profits that were much better than analysts had expected, according to Thomson Reuters.

Thomson Reuters also reported that S&P 500 profits were up 12.1% from a year ago, the second consecutive double-digit increase. Profits were forecast to rise 8.0% as Q2 ended.

Notably, the four-quarter earnings (not to be confused with an economic recession) recession has ended.

Also, Figure 2 highlights the negative impact from the gyration in oil prices on S&P 500 earnings over the last two years. Still, even if energy is removed (the modest recovery in oil has aided earnings of energy companies), profit growth has been very respectable in recent quarters.

Bottom line – rising revenues and profits, in response to modest growth at home and an acceleration in economic growth around the world, has played a big role in supporting stocks. And it has occurred amid growing tensions with North Korea and dysfunction in Washington.

Simply put, investors have been focused on the fundamentals that drive stocks and have been looking past media-driven headlines.

Speaking of media headlines

Congress must pass and the president must sign a continuing resolution or pass a budget by September 30, or the government will shut down.

Of course, the government doesn’t completely shut down. Military, air traffic control, and other essential services continue, including checks for Social Security and Medicare. But non-essential government employees will stay at home and national parks would close.

Short-term traders get jittery, but the data going back to 1976 suggest any market impact is limited.

There have been 18 government shutdowns since 1976 (NBC News). The worst impact on the market: the S&P 500 Index fell 4.42% (1979). Number two and three, both in the 1970s, saw a drop of just over 3%.

One year following the shutdowns, the S&P 500 was up in 16 of the 18 closures. If we awaken to news on October 1 that we’ve entered the 19th government shutdown since 1976, my sympathies will go out to those who have planned October vacations to America’s beautiful monuments and national parks.

From a market perspective, historically it has had minimal short-term impact and virtually no long-term effect.

The debate over the debt ceiling is another matter. Congress must raise the debt ceiling or the Treasury could default. It’s something that has never happened before. Republican leaders in both the House and Senate have said the ceiling will be raised before the limit is breached, likely in early October.

Bottom line—both narratives could increase volatility in September. While history strongly suggests long-term investors would likely look past a government shutdown, a breach of the debt ceiling, which is unlikely, would send financial markets into uncharted waters.

7300 Wealth Connect – 8-17


The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.

The Tortoise and the Hare

Most are familiar with the Aesop’s Fable, The Tortoise and the Hare. It’s a story that teaches that a slow, steady, and deliberate pace ultimately produces success. Without a doubt, the current economic expansion has been slow and steady. There are many drawbacks to its dull pace, but it has one silver lining – longevity.

That brings us to the National Bureau of Economic Research (NBER)? Repeat that name. Just saying it could end a sleepless night. But stay with me, I’m going somewhere with this.

The NBER is the official arbiter of economic recessions and economic recoveries (also called expansions). The organization bases its decision on complex models that take employment, manufacturing, income, and retail and business sales into account.

For investors, recessions and recoveries matter.

The current economic expansion just entered its ninth year. Put another way, it just turned eight years old. How do we know? The NBER marked the end of what we now call the Great Recession as of June 2009.

As Figure 1 highlights, the current expansion is the third longest since WWII, and we’re not far from moving into second place, which brings up a natural question. Is a recession lurking just around the corner?

It’s an impossible question to answer with certainty, as the brightest economic minds have historically done a poor job of calling turning points in the business cycle.

Still, expansions don’t die of old age. They usually come to an end because speculative excesses build up in the economy, such as the tech/telecom boom of the 1990s or the housing bubble in the 2000s.

Or, the Fed cuts off the expansion via rate hikes. The shortest recovery, which lasted only one year, experienced an early demise when then Fed Chairman Paul Volker hiked interest rates in an effort to end years of high inflation. His recipe worked, but the cost was steep – a lengthy and deep recession.

While accurately forecasting the next recession is problematic at best, we can look to leading economic indicators for clues. And most leading indicators aren’t flashing red, suggesting a near-term recession is unlikely.

It’s not that cracks in the economic foundation haven’t appeared, but the lackluster recovery has helped prevent most speculative excesses from building in the economy.

A long running bull

A bear market is typically defined as a 20% drop in a major market index, like the S&P 500 Index. While we came close to a 20% selloff in 2011, we haven’t had a full-fledged bear market since the last recession.

In fact, the current bull market is the second longest since WWII, second only to the bull market of the 1990s, which coincided with the longest expansion on record – see Figure 2.

Given the age of the current run in stocks, it’s fair to ask the same question that might be asked of the current expansion. Is a bear market lurking around the corner?

A recession and the bear market

Figure 3 speaks volumes. Recessions are closely tied to bear markets, or declines in excess of 20%. Why? Longer term, stocks march to the tune of corporate profit growth, and nothing stymies profit growth and expectations of profit growth more than a recession.

We have had only one bear market since the mid-1960s that was not tied to a recession – the one-day Crash of 1987. The 22% decline in the mid-1960s, mild by bear standards, correlated with a sharp slowdown in the economy, though a recession did not ensue.


We can conclude that a recession will inevitably ensue, and we can reasonably conclude the economy will exit that recession. It’s been a pattern we’ve witnessed for over 200 years. We can’t say with certainty we’ll sidestep a 20% selloff absent a recession, but over 50 years of data suggest the odds we’ll experience a bear market outside of a recession are low.

We do see 10%+ selloffs from time to time (four since the bull market began per St. Louis Federal Reserve data), but the belief economic growth would continue prevented a more serious decline.

Based on the historical data, we can say that a steady and deliberate plan, i.e., one that eschews short-term emotional reactions that inevitably envelope investor psychology, enables investors to more effectively reach their long-term investment goals.

Put another way, it’s an alternative version of the tortoise and the hare.