Stock Market Anxious & Vulnerable

This was one of the most fascinating weeks in my career as a portfolio manager. Stocks were under aggressive selling pressure most of the week but ended the session on Friday recovering most of the days’ declines. Especially encouraging was the impressive advance Friday from the tech sector and small caps. Overall trading on Friday was supportive but action for the week is another reminder to investors, we have entered a new phase of increased market volatility.

Here is how the S&P 500 traded on Thursday and Friday.

The biggest issue at hand is not President Trump’s steel and aluminum tariff announcement. Time will tell how the policy unfolds. The biggest challenge has more do to with the new Fed Chair, Jerome Powell, providing both houses of congress his first testimony. Unlike prior Fed chairs, Chair Powell appears less concerned about what Wall Street thinks and more focused on executing his monetary policy. Here is what one of my Wall Street trading contacts had to say about the Donny & Jay Team…

“If you think Donny is going to pull back on this major announcement just because the mkt sells off a bit – think again……Like Jay Powell – Donny will not be led around by the nose when traders on Wall St. throw a hissy fit.” Kenny Polcari, Oneil Securities

The market was already anxious and vulnerable so testimony from Chairman Powell on interest rates, which are headed higher, and import tariff policy by President Trump, is bound to rattle markets. From elevated levels in a prolonged bull market, stocks are vulnerable to steep corrections.

I would suggest the interest rate and inflation dynamic is what is driving markets today. My ongoing research has caused me to change my view of whether an increase in rates from current levels can negatively impact the economy and stock market. I have suggested that interest rates rising from such low levels are not likely to have a negative impact our economy or the stock market until they move past normal levels. Most rate hikes in the past that have slowed the economy have occurred at much higher levels. However, a closer look at three different factors facing most central banks in the world has changed my thinking.

Those factors are:

1- Refinancing costs by treasuries (issuing new debt to retire maturing debt)
2- Treasuries issuing new debt to fund budget deficits
3- Central banks selling bonds from their balance sheets

Collectively these three factors represent a massive impact on the bond market. Central bankers and treasury officials do have options for managing these challenges. The Fed will increase their available tools after a few more hikes in the Fed Funds Rate. The playbook seems pretty clear for 2018, the Fed lifts the Fed Fund Rate to around 2% while the economy strengthens on Trump’s economic policies. 2019 is where it will get interesting and the stock and bond markets are already anticipating the environment 6-9 months in the future.

For reference, here is a quick look at the Prime Lending Rate, Consumer Price Index and the S&P 500 over the last 20 years.

Much of the recovery from 2008 involved bond buying by central banks: Bank of Japan, European Central Bank and the Federal Reserve. The Federal Reserve was the first to start selling bonds from their balance sheet last fall. Keep in mind, the bonds on a central bank balance sheet are in addition to bonds a treasury department may issue to fund government operations. Central bank balance sheet bonds are already issued bonds, treasury bonds are newly issued bonds. As I have communicated many times, the world is swimming in debt from decisions made during the last financial crisis and a consumption driven economy.

Japan has even hinted they may stop purchasing government bonds soon. Once a central banks shift to selling bonds from their balance sheets, while government treasuries continue to issue new bonds to fund operations, the supply of bonds very well may push prices down further and interest rates higher. Some traders are expecting the U.S. Treasury to issue substantially more 30-year bonds around this time next year. Combined with ongoing sales from The Fed (which holds several trillion dollars’ worth), some traders believe bond prices will have to be much lower to get new bonds sold, driving interest rates higher. Higher interest rates mean government debt servicing costs are going to rise which will increase the deficit (which shows no end in sight). As I have said before, I would not be surprised if the next crisis comes once again from the bond market. What policy makers are dealing with now is the other side of Quantitative Easing, the strategy used to address the last financial crisis.

The White House is hoping economic growth accelerates and tax revenues increase to cover costs and reduce the deficit. If the economy grows too fast The Fed will be under pressure to raise short-term interest rates, where most of government debt is financed. This will cause debt servicing costs to shoot up. This is another concern I have mentioned in prior commentary. Debt servicing costs as a percent of the Federal Government expenditures is a risk to the economy. Unfortunately there are not many good options for policy makers.

Markets have pretty much priced in 3-4 increases in the Fed Funds rate for 2018. Now the attention is focused on 2019. It should be clear President Trump and Fed Chair Powell have a very delicate balance to maintain but their style of communicating their policy is decidedly different than previous administrations. They can’t really afford to let markets dictate their moves (many analysis and commentators believe The Fed waited to long to raise rates). They have to take actions based on what they believe will be the best path for navigating the U.S. economy through the current challenges.

The key appears to be maintaining a steadily improving economy of moderate GDP growth around 3%. Here is where Economic Cheerleader Trump may run into problems. The harder he pushes for 4% growth the more trouble he may create in debt markets. The good news here is innovation is alive and well at a time where money is plentiful, financing relatively cheap and government policy is generally favorable.

From a portfolio management perspective, there are clearly better areas of the stock market to be invested in right now and even some undervalued assets to consider bringing into portfolios to reduce risk levels. 2018 appears to be delivering a market where investors may be rewarded for making the right changes to their portfolio. Let me know if you are interested in discussing how I handled the 2008 bear market and how I am addressing the current set of challenges and opportunities.

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.

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.

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]

Digital Currency & Blockchain Technology

NO RECOMMENDATIONS ARE BEING MADE IN THIS VIDEO.  THE DIGITAL CURRENCY MARKETPLACE IS HIGHLY SPECULATIVE. YOU COULD LOSE YOUR ENTIRE INVESTMENT.

The Digital Currency Market has created quite a stir with some of the biggest names in the finance weighing in while the price of some Digital Currencies continues to rise.  The underlying Blockchain Technology of Digital Currencies is also being herald as a new exiting software development system.  In this short value I touch on both subjects including the two aspects of Digital Currency that help us understand its potential value.

Hey Government: It’s Time To Get Serious!

Brian Wesbury, Chief Economist at First Trust Portfolios, does a nice job in the commentary below comparing and contrasting the difference between the private sector (which is doing well) and the public sector (with governments of all sizes in precarious financial positions).  This divergence is a risk factor; the next crisis could erupt from the public sector.  Fortunately it is likely a decade or more away at the Federal level although the upcoming debt ceiling debate could create some pain.  In the meantime, the private sector looks poised to keep making progress and driving stock prices higher in the process.

Hey Government: It’s Time to Get Serious!

At eight years, the current economic recovery is the third longest on record.  Personal income, consumer spending, household assets, and net worth, are all at record highs.  Stock markets are at record highs.  Corporate profits are within striking distance of their all-time highs.  Federal tax receipts are at record highs.

So, how is it possible that the federal budget, along with some state and local budgets, still look like they’re in the middle of a nasty recession?

The answer: Government fiscal management is completely out of control.  Politicians find time to fret about Amazon’s purchase of Whole Foods and won’t stop bashing banks, but they’ve lost their ability to deal with their own fiscal reality.

The federal government is projected to run a nearly $700 billion deficit this year, and long-term forecasts suggest trillion dollar deficits as far as the eye can see.  Illinois and the City of Chicago are running chronic deficits, while New Jersey and New York are fiscal basket cases.

This makes the politicians of the 1990s look downright responsible.  In 1999, after a 10-year recovery, these entities were all running surpluses. But even if this recovery lasts 12 years, deficits will persist.  And what happens if there’s another recession?

Politicians have claimed intellectual support for their fiscal irresponsibility from John Maynard Keynes.  He believed in deficit-spending to help cure the problems of weak consumer spending in a recession.  As a result, the Panic of 2008 gave cover to grow government, and they did so in spectacular fashion.  But that “emergency” spending then morphed into permanent overspending and chronic deficits.

Tax rates are higher today than in 1999, and the economy is bigger, but governments have consistently outspent the ability of taxpayers to fund it.

Even Keynes thought the government should roll back spending and get budget deficits under control in better economic times.  But politicians are long past seeking his intellectual support.  They love to lecture business-people about greedy human nature, yet can’t turn that analysis on themselves.

Businesses and entrepreneurs create new things and build wealth.  Politicians redistribute that wealth.  And while some of what government does can help the economy, like providing defense or supporting property rights, the U.S. government has expanded well beyond that point.  Politicians have never been this reckless or fiscally irresponsible.

Whenever we say this, people ask; “what would you cut from the budget?”  And then, if you are actually brave enough to answer, you get attacked for “not caring.”

This needs to stop.  Illinois is in a death spiral.  Tax rate increases will chase more productive people out of the state, while ratcheting spending higher.  And just like Detroit and Puerto Rico, the state will go bankrupt.

The U.S. government is on this path, but, because it has the ability to fund itself with the best debt in the world, a true fiscal day of reckoning is still 15-20 years away.

Government spending needs to be peeled back everywhere.  It’s no longer a case of picking and choosing.  And until that happens, the fiscal irresponsibility of the government is the number one threat to not only America, but the world.

No matter what politicians tell us, any pain caused by private sector greed will pale in comparison to the mayhem that collapsing governments can create.  Just look at Venezuela or Greece!  It’s time to reset America’s fiscal reality.  And if that means debt ceiling brinkmanship, shutting down the government, or moving to a simple majority on spending decisions, so be it.  It’s time to get serious!

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist

Approved for public use.  Thanks and have a great week!

Q1 Earnings Surprise

Q1 earnings are expected to come in much better than expected and upside revisions and upside earnings surprises are the primary drivers for Q1’s earnings growth rate.  The blended rate (combines actual results with estimated results not yet reported) of 12.5% as of Friday, April 28th for the S&P 500 is coming in well ahead of the 9% expected at the end of March.  Take a look at the report from Factset for more details.

Q1 earnings reports contrast with economic data for Q1 which remained soft in some areas.  The Big Four Economic Indicators was updated Monday, May 1st with the most recent (and very important) Personal Income data.  After adjusting for inflation the real number for Personal Income during March rose 2.8% year over year, which is near the high end for the last year.  The biggest improvement in the Big Four Indicators over the last year, however, has come from Industrial Production.  After peaking just over two-years ago the indicator entered a prolonged slide that flatlined 13-months back.  Only in the last 4-months have we seen it reverse course and move higher.

There was no question the economy was at risk of slipping into a recession as we approached the fall elections and it is reasonable to point out the economic improvements have been mild.  A soft Q1 real GDP growth of just 0.7% was disappointing.  It wasn’t all bad, looking at Core GDP which removes inventories, government spending and trade with the rest of the world, grew at 2.2% in Q1 and is up 2.8% from a year ago.

In terms of stock market performance, the last week of March was the strongest since January which sent the Nasdaq index to a new all-time high which is now over 6,000.  The race may be on for the Nasdaq to break-through the 10,000 level or the Dow to top 30,000. Maybe it will be the S&P hitting 3,000 first.  It will take some time and there is a chance we will have a recession or some other surprise event that will send stocks much lower before we reach the next big milestone for these indexes; it is also entirely possible that market will only experience normal corrections between now and new target levels.

We are also hearing a lot about an expensive and “toppy” stock market.  For those that hold this view they may find themselves watching this market move much higher before prices fall to “attractive” levels.  There is little evidence suggesting we are on the verge of a 2000 or 2008 type event.  There are issues with credit markets to be mindful of and there is always the risk a black swan event could materialize but a big market correction does not appear imminent.  That does not mean there aren’t clouds on the horizon.

What is apparent is the inability for Washington DC to get its act together.  There are huge problems with the U.S. Federal debt level and ongoing deficit spending is unsustainable.  Eventually something is going to give unless they get their house in order which seems more unlikely with each passing congress.  The percent of federal expenditures needed to make interest payments is an important area to watch.  The Wall Street Journal recently published an article highlighting how rising interest payments are already showing up in the federal fiscal year.  We are a long way from them being problematic but with ongoing deficit spending and interest rates slowly moving higher the clock is counting down.

Negligent politicians aside, one of the more exciting driving force in today’s economy and stock market is the amazing array of new innovation and scientific discoveries.  Entrepreneurs are busy delivering new solutions to our health, travel, and entertainment needs and creating new business in the process.  There is a new innovation index out that may be a promising investment for those looking to invest in companies targeting high-growth areas like web-based data & services, IT infrastructure software, consumer data and services, finance software & services, specialized semiconductors and more.  The investment currently holds 100 companies delivering a nice combination of diversification and focus and has a weighted market cap of only $30 billion which, compared to the $169 billion weighted average market cap of investments tied to the S&P 500 index, represents much smaller companies but still primarily in the large cap category.   Let me know if you are interested in learning more.

While the stock market is rising some categories of stocks might represent better long-term opportunities based on structural changes in the economy.  If this is something you have thought about but not acted on, let’s have a conversation.

Inside The Secret Meeting Where Apple Revealed The State Of Its AI Research

Apple is working on technology that will allow iPhones and iPads to identify faces and locations in photos, or understand changes in a user’s heart rate, without needing to rely on remote servers. Keeping these processes on the phone makes the features available anywhere, and also ensures data doesn’t need to be encrypted and sent over wireless networks.  Check out more of Apples’s future projects dealing with AI here.

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