Are Tech Stocks Going On Sale?

The U.S. stock market has come under pressure despite good Q2 earnings and the continuation of strong economic numbers.  The price declines are especially prevalent in tech industries while other sectors of the stock market have held up over the last week.  What is the market telling us?

In simple terms, technology stocks may be going on sale.

It is clear Facebook and Twitter face unique and systemic business challenges, but the massive declines they have experienced in the last few days seem to be taking down other tech related stocks.  The software industry, for example, is down nearly 5% from highs reached just 5 days ago.  More specifically, Cyber Security is down nearly 6% from highs it reached on July 18th.  Biotech is another example, down 6% since July 12th.

Company valuations are also a concern.  Technology stocks have become expensive and those companies with strong growth fundamentals, primarily sales and earnings growth, generally trade at a premium to the market during rising markets.  There’s little evidence business conditions for tech companies are contracting so the decline in price appears to be a typical correction bringing tech valuations closer to the broad market.

Other sectors of the stock market do not appear to be impacted by the tech selling, at least so far.  How can we tell?  For one thing, other stock market sectors have been able to avoid the selling:  Materials (XLB), Industrial (XLI), Consumer Staples (XLP), Energy (XLE), Healthcare (XLV) Utilities (XLU), Financial (XLF) have all generated positive returns over the last 5 trading days.  7 out of 11 sectors delivering positive returns.  These are not just defensive sectors either.  The Financial Sector participation is a bonus, suggesting these financial companies have not been impacted significantly by problems in the tech space and valuations in this sector are actually quite reasonable.

Other groups have also been able to side-step the selling over the last 5 days.  Transportation, Healthcare, and Consumer Staples, just to name a few.

Below is a look at the price performance over the last two months of the 11 SPDR Sectors, considered a good proxy for the entire U.S. stock market.  Recent selling appears to be focused on technology related companies;  However, talk of a government shutdown has the potential to aggravate the situation; it would be wise to proceed cautiously with any new investment.

(NOTE: The recently introduced eleventh “Communications Services Sector” (XLC), has an 18.5% allocation to Facebook, and 26% to Google.  The largest traditional “Telecommunications” holding is Verizon, which only represents 4.8% of the sector ETF.  A good example of why it is important to know the actual holdings of any mutual or exchange traded fund.)

As of July 30, 2018. StockCharts.com

2018 Investment Strategy Review

Stock and bond market performance has been more volatile in 2018.  After an amazing run in 2017 stocks have become more sensitive to interest rate hikes and potential disruptions in global trade because of ongoing trade negotiations by the Trump administration.

Bonds too have seen an increase in volatility as the Federal Reserve increases the Fed Funds rate and sell bonds from their balance sheet.

The start of the year was extremely volatile for both asset classes but over the last month U.S. stocks and bonds have settled down.  Other asset classes are still struggling.  Emerging market bonds are down over -4% and emerging market stocks have declined nearly 10% according to statistics from ETFReplay.com.

Over the years I have tracked the performance of 4 classical investment strategies from pillars in the industry. Here is a quick look at how they are doing so far in 2018.

Note:  This data is historical and does not reflect actual account performance.  Please see the performance disclosure below for additional detail.  The benchmark for each strategy is the iShares Moderate Growth ETF (AOM).  It is important to remember the CAGR (Compound Annual Growth Rate) for all these strategies are only  using approximately 6 months of data.  Year-To-Date (YTD) performance and volatility is provide below each summary.

We start with our baseline “Classic” Strategy Year-To-Date (YTD) performance.  This strategy is considered a blue-chip approach to investing by several well respected investors.  This mix of investments represents 60% U.S. stocks and 40% U.S. Bonds.

YTD:  Classic Return:  2.8% vs. AOM Return 0.0%     Volatility:  9.7% vs. AOM Volatility 6.0%

Next, we will look at the YTD performance 3-asset class strategy we call the “Cycle” strategy.  This strategy holds 5 investments from 3 asset classes.  It is the lowest volatility strategy I manage.  The benchmark for this portfolio is the iShares Moderate Growth ETF, AOM.

YTD:  Cycle Return:  0.6% vs. AOM Return 0.0%    Volatility:  5.5% vs. AOM Volatility 6.0%

Adding more asset class, next we feature a “risk parity” strategy YTD performance.  In this approach 7 asset classes are weighted based on their volatility (or risk) with lower volatility investments receiving a higher weight.  The benchmark for this portfolio is the iShares Moderate Growth ETF, AOM.

YTD:  Risk-Parity Return:  -1.7% vs. AOM Return 0.0%    Volatility:  4.1% vs. AOM Volatility 6.0%

Finally, the most diversified of the bunch, the 10-asset strategy YTD performance.  This approach invests equally in 10 asset classes.  The benchmark for this portfolio is the iShares Moderate Growth ETF, AOM.

YTD:  Ten Asset Return:  -0.4% vs. AOM Return 0.0%    Volatility:  5.8% vs. AOM Volatility 6.0%

It is clear 2018 has not favored highly diversified strategies.  Those strategies that focus on U.S. stocks have performed better.

For a real shocker, here is how 10 select industry groups I incorporate into my strategies have performed YTD.  This is an all stock selection, so the benchmark has been changed to the S&P 500 (SPY).

YTD:  Industry Group Stocks Return:  16.3% vs. SPY Return 5.6%    Volatility*:  19.5% vs. SPY Volatility 16.1%

*Note the significant increase in volatility associated with the portfolio of Industry Groups.  That is the trade-off for exposure to high-growth areas of the economy.

We don’t know what the future holds but as we embark on a new generation of product and service innovation, along with stronger economic performance in the U.S., I have been guiding clients to overweight U.S. stocks and incorporate industry groups from areas of the economy expected to grow faster than the general economy.  It has been working well and has the potential to add value for years to come.  In addition, I can include industry group exposure to any of the strategies above where risk-management characteristics should generally reduce volatility.

All the statistics provided by ETFReplay.com.

Past performance does not guarantee future results.  Investments and the income derived from them fluctuate both up and down.  Investments at Dightman Capital are subject to risks including loss of principal.  No specific investment recommendations have been made to any person or entity in this written material.  This presentation is for informational purposes only and is neither an offer to sell or buy any securities.  Benchmarks or other measures of relative market performance over a specified time period are provided for informational purposes only.  Dightman Capital does not manage any strategy toward a specific benchmark index.   A variety of sources we consider reliable have provided information for this presentation, but we do not represent that the information is accurate or complete.  Dightman Capital Group does not provide tax advice to its clients.  Conduct your own research or engage an investment professional before making any investment decision.  Investors are encouraged to discuss any potential investment with their tax advisors.  The material provided herein is for informational purposes only.  Data Sources:  IDC, Dightman Capital.

Trade Negotiations & LIBOR Spike

Another round of volatility hit stocks this week, but current support levels remain, and volume has been tamer. The Nasdaq 100’s outperformance YTD remains intact suggesting tech investors are still committed to the sector.

It’s one thing to see stocks under pressure but the recent spike in LIBOR (the rate banks lend to each other overnight) was my focus this week. Fortunately, the banking system remains stable and the rise in LIBOR appears to be the result of an increase in demand from short-term U.S. government funding needs for deficit spending and U.S. corporations pulling offshore money from corporate bonds and putting it into cash for spending. While the spike in LIBOR signals caution, banks impacted by the higher rate are not flashing other warning signs.

For those familiar with the TED Spread, the difference between interest rates on Eurodollar Contracts and T-bills, we are still well below levels that signaled problems in the banking sector back in 2008.

On balance the market is evaluating several concurrent events; higher interest rates, chronic deficit spending and trade policy adjustments are center stage. The economy and corporate sales/earnings are in good shape, so the bias remains to the upside. If a nasty trade war does break out, then we could see more downside pressure on stocks and the economy; we are a long way from that environment and it will be interesting to see how far President Trump will push the Chinese. They have far more to lose then we do in a trade war, but I don’t think the president wants to derail the overall growth environment in the U.S.

There is no such thing as “free trade”. What President Trump is trying to do with trade overall is reduce the concessions we provide our global partners (and reduce outright theft). The goal of spreading wealth via trade rules is a noble one, but the principles that make our country the success it is are free for the adopting too.

You may have heard, today the Dropbox IPO started trading and delivered a gained of 35%. An active IPO market is a sign this market may have more upside. Leading stocks are also holding up well, which is promising.

So far markets are correcting for trade uncertainties following interest rate concerns earlier this year. As uncomfortable as it can be, it’s a healthy process and should allow stocks to resume their uptrend once trade matters are resolved.

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.

North Korea Threat

There is no question the North Korea (NK) situation has deteriorated and could very well be headed to a conflict.  Outside of an offer of asylum for the Kim Jong Un regime there appear few options.  It is clear the current NK leadership is antagonistic and their arsenal now represents a clear and present danger.  President Trump has already demonstrated militarily he is not satisfied with appeasement in geopolitical negotiations.

When evaluating the potential impact on U.S. stocks it helps to look at these developments in context to the overall economy and stock market.  The economy continues a slow growth path with little threat of a rapidly rising interest rates, which combined represent a constructive environment for the stock market and helps explain its continued upward trend.  Corporate earnings are also healthy (Q2 earnings growth for the S&P 500 came in at 10.3% and projected earnings and revenue growth for Q3 are currently around 5%).  In addition, any positive developments on a Trump Tax Plan would most likely be viewed as bullish.  Taken as a whole, the market is going into this potential conflict in a positive environment.

The last time we experience a conflict like this was the Iraq ground war in March of 2003 (see chart below).  You may remember we were just coming out of a nasty recession and the market had started rallying as we moved into the new year.  2003 ended up being a strong year for the stock market.  Iraq did not represent a significant global economic component and the market was at the early stages of a recovery.

On the other hand, the 9-11 attack in 2001 hit the U.S. during a contraction in the economy and stock market after the dotcom bust (see chart below).  Because of the already weak state of economy and the direct hit to a global financial center, the implications were likely to be longer lasting and more severe.

Investors have to be very careful with defensive moves and a long-term perspective needs to be the dominant factor when making investment decisions.  Corrections are often short and markets can bounce back aggressively.  That being said, there are numerous periods historically where markets have not only sold off aggressively, they have done so over long period of time (multiple years).  Having a strategy in place for this type of environment will be helpful as you start to rely on your investment accounts for income.

The likelihood of a conflict with NK has increased significantly.  Kim Jong Un’s threats and acts are unacceptable and he seems unlikely to change his course.  NK economic impact globally is very limited and their military capabilities are antiquated.  I am not suggesting the possibility for significant damage resulting outside of NK doesn’t exist.  Each situation is different and the ICMB and nuclear capability of NK is a game changer, not to mention all their artillery on the DMZ aimed at Seoul.

The biggest issue now may be the U.S. having to calculate whether future ICBM “tests” are actually loaded with a nuke.  I won’t be surprised if we start shooting them down.

In summary, normally stocks have responded well to conflicts they believe will be resolved quickly and with little global economic impact when conditions are stable.  At present that appears how the market is responding to the NK situation.

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!

How Markets Reacted To A Trump Victory

stock-market-gainsInstead of a Brexit market reaction last week investors appeared to position for the impact a Trump presidency could have on the U.S. economy and asset markets. There is a limit to how much any administration can accomplish during the first couple of years but investors appear to be favoring some asset classes while avoiding others.

One of the most welcome surprises was the terrific performance of small cap stocks, up 2-3% on Wednesday, outperforming all the other broad U.S. stock indexes. For the week the Russell 2000 (IWM) was up 10%. The potential for a reduced regulatory burden appears to have given this group of companies a big boost.

International stocks, on the other hand, did not fare well last week based on potential changes to international trade. It does not sound like this is going to be an initial focus other than trying to bring trillions is cash from U.S. companies being held abroad. International developed market stocks (EFA) ended the week up just under 1% while emerging market stocks (EEM) took a hit, down -4%.

In addition to the stock market sending a positive message about future economic growth, the sentiment was echoed in the Bond market. A December rate hike was already priced in U.S. Aggregate Bonds (AGG), down just over 1% since highs this summer. They fell an additional 1% following election results. An expected fiscal stimulus package is likely the culprit sending bond prices lower. 10yr Treasury yields (IEF) have moved back above 2% and look headed higher.

Industry group rallies were also evident last week. One of the more promising may be the move in Community (QABA) and Regional Banks (KRE) both up about 15%. One of the biggest moves was in Biotech (XBI), up over 20%. Metals and Minerals (XME) had a big move as well, up nearly 11% on potential infrastructure spending. Retail (XRT) was also up over 8%.

In other asset classes, gold (GLD) was hammered indicating the rise in yields is based on rate normalization and not inflation. Gold has rallied strongly this year and remains above intermediate term support around $1,200 an OZ.

In currencies the U.S. Dollar (UUP) was a big winner, up 2% for the week. Interestingly, the British Pound (FXB) rallied in tandem with the dollar last week but is down significantly since Brexit. The Yen (FXY) and Euro (FXE) turned in losses for the week.

There are many remaining issues that could derail what looks like a market expecting positive developments from a Trump administration. With a considerable amount of capital on the sidelines investors can expect more money to come back into the market and push some investments still higher. Given the pre-election concern about a Trump victory, the market vote of confidence last week was a great way to get started.

The Stock Market Prepares for Higher Interest Rates

U.S. stocks have been stuck in a trading range since the middle of July. Q3 earnings and central bank policy are likely to be the factors driving near-term market direction but any number of wildcard events could derail a rally attempt. The market is currently priced for perfection but that does not mean it can’t go higher. In 10 years is it likely to be significantly higher.

SPY4mD101116

Q3 earnings expectations are not very high. Market consensus currently suggest this will be the sixth straight quarter of earnings declines. An earnings contraction of this duration has never happened before without a market correction. It is possible the two swift stock market sell-offs and recoveries over the last 12 months were all that was needed but the earnings picture has not improved suggesting a repeat is likely.

Talk of a Fed rate hike later this year (after the election) has pressured bond prices as well as gold. After a very strong rally earlier this year gold has corrected over 8%. Real estate and utilities have also been hit by potential rate hikes.

European stocks are starting to waver again but Asia and Latin America regions have been able to maintain the uptrends they started around the start of the year.

On the bond side of the market, the biggest surprise might be how well corporate junk bonds have held up. The recovery in crude oil prices appears to have taken some of the pressure off the highly leveraged energy market.

We have definitely seen a change in market character as we transitioned from summer to fall. To give you an idea here is how some asset classes have performed over the last 90 days.

90dayAssetClassPerf

The market appears to be telling us interest rates are going to adjust up which has caused most bonds, gold and real estate to fall after being darlings earlier this year, especially gold and real estate.

Money is still being put to work in high-growth stocks and markets which explains why the Nasdaq 100 and most emerging markets are outperforming developed market large-cap stocks. Also, in Europe and Japan central bank policy remains more active (although Japan has stepped back a bit), where stocks are still responding favorably.

What we are experiencing is a classic adjustment period where markets are taking into consideration the impact of higher interest rates on the short end of the yield curve and the potential impact to longer bond maturities.

Exposure to high-growth mid-large cap U.S. and emerging markets stocks has helped maintain portfolio value over the last few months. So far shorter maturity bonds have only experienced small declines but further weakness might indicate a market that expects the economic recovery to accelerate with more rate hikes to follow. Don’t count on it, there is sparse data suggesting anything of the sort.

As I have said before, margin debt is the one area where higher rates could aggravate stocks. Margin debt peaked 18 months ago so it is entirely possible the next ramp up on stock prices will be a function of levering up again assuming the costs are not prohibitive – we are likely a long way from that problem. Who really thinks 3-month T-bill rates will normalize at 2.6% anytime soon?

There are plenty of strategies for positioning your retirement assets in this market for long-term growth or a margin of safety. Let me know if this is a subject you would like to discuss in more detail.

The Stock Market After Brexit

Last week’s Brexit vote has cast a cloud of uncertainty over global markets.  The decisions direct impact is largely a regional one but as new information arrives we are learning the outcome calls into question the entire European Union concept and that has rattled markets globally.

It is unfortunate timing.  Stocks were starting to show some resilience after two brutal market declines in the last year, the IPO market was starting to warm again and international stocks rallied strongly into the vote.  The vote may also turn out to be just what is needed to bring back vibrant economic growth.

The challenge for European Union members is the ability to sustain rich social programs in the face of stagnating incomes and productivity.  We face similar problems here in the U.S. from local government pensions all the way up to Medicare and Social Security.

UKBrexitCentral banks have been in the driver’s seat since 2008 and their policies have pushed asset prices to levels where fundamentals are stretched.  Economic stimulus efforts to date have fallen short.  New programs designed to inject liquidity directly into consumers’ pockets are likely under active discussion although Europe may find it difficult to implement new policy at a time when many factions have proposed new agendas.  Central bankers no doubt have their work cut out.

At present the overall stock market environment contains far more negatives than positives.  Technical characteristics of the market have deteriorated significantly and now suggests more declines may follow.  It could also get worse if economic growth slows.  There has been little evidence that U.S. corporate sales and earnings have started a recovery after one of the longest periods of contraction on record without a recession.  Banks in Europe remain undercapitalized and slowing growth in China remains a concern.

Innovation and market expansion is alive and well and we can expect a more robust economic environment to return eventually.  The task at hand is to determine how much of an interruption to the global economy the Brexit saga likely to cause before we finally exit the malaise affecting this market.

Investment management has become more complex in the era of hyper-policy action lowering confidence intervals for decisions.  We have had a long market run, a mediocre economic recovery and a very long list of problems yet to be solved.  The likelihood of the market taking matters into its own hand and again serving up a steep correction has risen significantly.

A couple years from now we may look back on this event as a small blip in market history.  The innovation and market expansion on the horizon may need to take a pause as excesses are removed and reforms implemented.  While investing is a long-term pursuit there may be times where playing some defense pays off. This may be one of those times.