Stocks Finally Correct, What’s Next?

After an outstanding 15-month stock market advance, last week stocks experienced a significant pullback.  The S&P 500 declined 3.9% but all three major U.S. stock indexes remain in positive territory so far in 2018.  After outstanding performance in 2017, U.S. stocks started 2018 on an even more accelerated run with the Dow Jones Industrial Average gaining 7.6% during January, before last week’s pullback.  The stock market rally needed to slow down.

In terms of earnings, Factset reports as of February 2nd approximately 50% of the companies in the S&P 500 have reported actual results for Q4-2017.  Of those, 75% are reporting actual earnings-per-share above estimates compared to the five-year average.  In terms of sales, 80% are reporting actual sales above estimates; the sales and earnings health of U.S. publicly traded companies appears to be good.

The likelihood of additional interest rate hikes in 2018 may have been the trigger for last week’s stock market correction.  Jerome Powell is the new Fed Chair and futures markets are expecting another 75-basis point increase in Fed Funds in 2018, which would bring the rate to around 2%, still below the historical average.  Investors also saw declines in bond prices last week as the 10-year Treasury yield shot up to 2.92%.

The continued improvement in economic numbers along with the overall optimism and rapid pace of innovation currently underway could suggest we are a long way from interest rates causing a sustained decline in the stock market.

Don’t be surprised if stocks are up big on Monday.  We could see more selling but a lot of cash remains on the sidelines and some investors have been looking for an opportunity to enter this market; one of the reasons stocks have not given much ground since President Trump ushered in a new set of economic policies aimed at broad sustained economic growth.

I have said this before and I will repeat it here.  We could very well see the the Dow at 30,000, the Nasdaq at 10,000 and the S&P 500 at 5,000 before we see the next bear market.  For those that do not understand how this could be, let me remind you; stocks went nowhere for 14 years from 2000 – 2013.  In the four or so years since the S&P finally regained a new all-time high in 2013, the stock market spent 18 months in a trading range between 2015-16, as the U.S. teetered on the verge of falling into a recession.

We have a combination of conditions that are conducive to a continued market rally:

  • Low Interest Rates
  • Positive Economic Policy
  • An Innovation Renaissance

Unlike prior market cycles, this one may not last as long as those previously for a couple reasons.  First, this expansion comes on the heels of a recovery that started 8 years earlier.  Second, a tremendous amount of debt was created in the U.S. and globally as the primary policy for recovering from a debt crisis.  If you are shaking your head, you should be.  Eventually we will pay a price for policy mistakes used to address the 2008 financial crisis.  Until then it is a race between economic growth and debt growth.  The next crisis could very well come from a country needing to restructure their debt.

In terms of interest rates, it appears we have some breathing room.  The 10-year Treasury yield remains well below levels of the last 20+ years.

In terms of short-term rates, if the Fed Funds rate were to rise above 3% the economy should be doing exceedingly well.  However, government debt funding is more sensitive to short-term rates, so policy makers are likely to take funding costs into consideration as they move rates higher.  Fortunately, other broad economic factors appear to be holding inflation in check which should allow The Fed to keep short-term funding rates at or below normal levels.

Until The Fed has turn up interest rates to a point of slowing the economy, the stock market is likely to continue rallying…there are amazing investment opportunities in the next generation of biotechnology, materials, software, and much, much more.  It is truly an exciting time to be an investor which is another reason I believe more money will find its way into the stock market over the coming years.

Please let me know if you are interested in learning more about investment opportunities from innovations in finance, travel, technology and more in a risk-managed, proactive approach.

Stock Index Performance Calculations, Stockcharts.com

Yield data from Stockcharts.com, Investors Business Daily.

Tax Cuts and Jobs Act Overview

There are many changes to our current tax system with the recently signed, Tax Cuts and Jobs Act.  It is going to take more time for tax advisers to fully comprehend how the new act applies to individual situations.  In the meantime, the following Tax Cuts and Jobs Act Alert does a nice job of summarizing parts of the old and new law, as well as highlighting other changes.

 

 

Fed Rate Hikes & Bond Prices

After several interest-rate hikes this year, U.S. bond prices are looking for support and so far they have found it.

The iShares 7-10 Year Treasury ETF (IEF) closed today at $105.40.  Since June, $104.75 has provided price support.  Looking back to the start of 2016, a price of $101.50 has held ground.  The average yield* for this bond ETF is currently reported to be 2.36%.

Looking at interest rate sensitivity, the effective duration on IEF is 7.5.  This tells us it might only take a 50-basis point rate hike to move the price of IEF below $101, a real possibility next year.  Durations change and the surprising bond rally, along with stocks during most of 2017, may mean bond investors will be giving up a bit more if rates continue to rise.

With the Fed Funds rate already at 1.5%, the Fed may come up against the rate they are reluctant to cross, 2%.  It will be interesting to see how new Fed Chair, Jerome Powell, approaches rates next year.  It is highly likely the Fed is concerned bond price sensitivity (duration) may go up in 2018; something bond investors should keep in mind.  If you want to adjust your bond portfolio interest-rate sensitivity, now may be the time to do it.

There are a multitude of reason why the Fed needs to be more careful raising rates going forward; government-debt funding is at the top of the list.  And let’s not forget, the Fed has just started unwinding a balance sheet with billions in bonds.  There is no doubt Mr. Powell will have his hands full trying to appease the inflation hawks while selling bonds if the economy continues to grow.  It looks like next year could be very different for the bond market.

Here’s a quick look at where other bond ETF prices are trading.  As the charts below show, most of the bond market has taken this years’ rate hikes in stride.

Aggregate U.S. Bond, Average Yield* 2.68%

Corporate Bonds, Average Yield* 3.39%

High-Yield (Junk Bonds), Average Yield*  5.54%

Municipal Bonds, Average Yield* 2.16% (Tax Equivalent of 3.32% at 35% Rate)

* Average yield data provided by Blackrock at www.ishares.com.

Cryptocurrency Resources & Tools

I have received a lot of inquiries about Bitcoin and other “cryptocurrencies” recently.  As a finance related subject, I believe it is important to help individuals educate themselves so I offer the following learning resources.

I am not acting as an investment adviser in ANY capacity regarding information in this communication about  cryptocurrencies (CC).  As a finance topic, I am willing to pass along information to help people educate themselves further.  The information contained herein and referenced externally is not enough information for anyone  to enter the market for cryptocurrencies.  Anyone that does their own research and gets involved with CC will need to stay engaged in the subject as future developments may require their attention.  I am not offering any ongoing assistance in this area at this time.

THE FOLLOWING INFORMATION IS FOR EDUCATIONAL PURPOSES ONLY.

 

Warning, the cryptocurrency market is ripe for scams and there are likely many underway as I type these words.  Proceed with caution and consider working with friends, family members, colleagues, etc. to explore this area together.

Individuals interested in understanding Bitcoin and related CC might want to begin by watching the movie, Banking on Bitcoin.  It it also available on some on-demand networks.  The documentary may help an individual determine their interest level in this subject.  Another important video for understanding the ebbs and flows of the U.S. credit based economy can be found on YouTube, How The Economy Works, by Ray Dalio.

Phone App/Information Sources

A phone app, like HODL, can also be a great resource  where fundamentals, news, charts and posts for different CC can be reviewed.  A good app on your phone that tracks cryptocurrencies is a critical tool and next step for anyone interested in this market but you have to be careful, not all information is the same.  Here are the names of a few respected thought leaders on the subject of CC.

  • Andreas Antonopoulos (Mastering Bitcoin book)
  • Trace Mayer (Bitcoin knowledge podcast)
  • Jimmy Song (Twitter)

Read posts on Reddit/Medium for information and support on many CC subjects ( currencies, exchanges, and wallets).  There are also support forums for technical issues.  There have been many different types of technical issues in the past and they should be expected in the future.

There are also blogs and newsletters dedicated to this topic, some better than others; you should be able to find several dedicated information sources on CC to explore and compare.

Also, when comparing the different CC, you are well served to dig into detail around factors that may have a big impact on the future of a CC.  Here are a few additional topics to become familiar with overtime.

  • Governance – How are decisions made about the future of the CC?
  • Programmability – How easy it is to add features to the blockchain of the CC?
  • Development Funding – How is the CC funding future development, upgrades, marketing, research, etc?
  • Merchant/Payment Tools – How robust are their services and tools for merchants/ecommerce developers?

There are many other subjects to consider (Encryption Type, Hashing Power, Mining Reward, Transaction Validation, etc.) with cryptocurrency and the underlying blockchain supporting it.  This is a very fragmented and rapidly developing technology; the list of subjects above is incomplete but will help you dig into details you will want to understand if you are serious about CC.

Exchanges

A U.S. based exchange is most likely the best choice for U.S. residents although there appear to be some good exchanges in foreign countries.  Exchanges connect with a bank account or credit card and provide the ability to make a CC purchase.  Exchanges offer other features as well, like conversion to other CC.   Beware, transaction fees, trading costs and wide-price spreads can be costly.  Also, exchanges are not connected so the price listed at one exchange can vary dramatically from the price at another exchange, especially during periods of high volatility which have occurred frequently.

Reporting transactions is an important element of the CC market.  The Internal Revenue Service has already come out with notices on the subject referred to as “virtual currency”.  Participants in this market will want to keep good records and work with service providers that include accurate record keeping.

A quick internet search on U.S. cryptocurrency exchanges will provide more resources.  Some exchanges are more sophisticated than others.  One exchange that may be a good starting point for learning more about this service is Coinbase/GDAX but a full review of the competition should be completed before taking any action.

The website of some exchanges will operate on your phone.  Others are better from a tablet or computer.  Some exchanges offer a wallet but a different wallet provider from your exchange may be preferred.

Wallet

A wallet lets you take possession of the keys to your CC on a computer, phone or other personal device.  LOST OR STOLEN KEYS IS A BIG RISK FACTOR WITH CRYPTOCURRENCIES.  Some wallets may also allow you to convert to other types of CC inexpensively by using a feature like Shapeshift.  You don’t need a wallet right away or even at all but it can be nice to have for the reasons mentioned.

THE FOLLOWING INFORMATION IS INTENDED FOR EDUCATIONAL PURPOSES ONLY.  NO INVESTMENT RECOMMENDATIONS ARE BEING MADE.  CRYPTOCURRENCIES ARE HIGHLY SPECULATIVE.  INVESTING INVOLVES RISK, INCLUDING THE TOTAL LOSS OF CAPITAL INVESTED.

Cryptocurrencies

There are a lot of CC and the market is likely to change dramatically over time.  Below is a list of some of the more successful CC at this time and may be worth watching.  To keep track of CC winners and losers, individuals may want to pay attention to market cap, trading volume and price movements in addition to the subjects mentioned above.  The list below will likely change dramatically overtime but here are some of the leading CC at present.

  • BTC – BITCOIN
  • ETH – ETHEREUM
  • XRP – RIPPLE
  • BCH – BITCOIN CASH
  • LTC – LITECOIN
  • IOT – MIOTA
  • DASH – DASH
  • XMR – MONERO

It will be interesting to see how this market evolves.  There is a high likelihood CC will be with us for the foreseeable future; perhaps not in the present form.  The current environment is a little like the “DotCom” era of the 1990’s; the potential for massive change from the current market is high.

The Fallacy of Weak Productivity Growth

Models of the economy are pretty useful tools.  And simple models are some of he most useful.  They help people envision how the world works.  They help organize thinking.

For Example, the model that says the potential U.S. economic growth is determined by “population (labor force) growth” plus “productivity” is an elegant model that shows how adding workers, or having them become more productive, leads to more economic growth.

But, event an elegant model can lead people astray when the inputs are misunderstood.  As they say, [Click To Continue]

Why Inflation Has Stayed So Low

Globalization, demographics, technology have helped to keep inflation low

Key takeaways:

  • Globalization, demographics, technology have been helping to keep a lid on inflation.
  • Continued low inflation could be a headwind for the performance of Treasury Inflation-Protected Securities (TIPS).
  • Low inflation helps to justify above-average valuations for stocks.

In the wake of the financial crisis, the Federal Reserve kept rates low, waiting for unemployment to fall and inflation to rise to the Central Bank’s long-term target.  Several years ago, the unemployment rate passed the Fed’s target, but despite some [Click To Continue]

Personal Financial Vault

Today’s fasted pace world can make it difficult to keep track of all your financial information.  You might want to know your current mortgage balance and when it will be paid off.  Or your Net Worth and what retirement cash flows it is projected to generate.  There are many important questions I help wealth builders answer with today’s leading technology and our advanced wealth strategies.

Clearing a Path for Tax Reform – Brian Wesbury, First Trust

In the article linked below, Brian Wesbury – Chief Economist at First Trust, explains how U.S. tax policy over the last several decades has move from an environment where cutting taxes makes new spending difficult to a situation where government spending is so high tax cuts are hard to pass.

From a macro perspective, President Trump’s plan seems to do much of what Democrats have asked for by shifting a larger portion of the tax burden on individual high-earners while just about everyone in the bottom 60% gets a tax cut.  This is hardly an ideal supply side tax cut.  Republicans on the other hand, have lost their way.  Even with a majority in the house and senate, republicans have shown little enthusiasm for helping President Trump with his agenda.

This is a unique time in our history where a confluence of events have come together unexpectedly and produced an accelerating economic environment.  I believe tax reform could be another factor potentially leading us to the strongest economy so far in the 21st century.

Wesbury_Clearing a Path for Tax Reform