Posts by PaulNolte:
Markets Present Chaos
November 9th, 2016
By Paul Nolte.
Our long national nightmare is over.” Gerald Ford would be incredulous to witness this year’s election efforts. It is not certain that come Wednesday morning, that it will be over. While the markets have declined nine straight days (longest since Reagan!), it has done so in a rather mild fashion. Surprising that it isn’t more, given the rhetoric and vitriol from everywhere. As far as the economy is concerned, the jobs report on Friday continued to show decent jobs gains, good wage growth and cemented a Fed increase when they next meet in December.
Their meeting last week could have been skipped, as little new information was passed along. The Fed officials will be out and about the next two weeks, chatting about monetary policy, especially in light of the election results. For all that has been thrown at the US economy, it continues to bump along, growing at a modest rate that should keep inflation, wage and earnings growth relatively low. All of which argues for a Fed to hike rates in December and sit back and watch…for a long time. The less they tweak, the better things may be for investors and corporations alike.
The market’s nine straight days of declines last happened late in 1980 and was a rather regular occurrence over the prior twenty years, happening nine times between 1961 and 1980. Save for a huge surge off of the October 1974 bottom, the average decline of the remaining eight is just over 2% for the following month with just two positive. More importantly the markets are once again hitting their long-term average level. Last time below the average (Aug’15-Feb’16) we saw volatility pick up as well as selling pressures. It also marked the last 10% decline from the peak to the February lows. For much of the past four years, the markets have been in a steady uptrend, but over the past 18 months the markets have moved sideways with much more volatility. It is too early to rule out another 10% decline in stock prices, but like February, it would present a very good buying opportunity for long-term investors.
The election and results this week could keep the markets volatile over the short-term, but the economic data does not yet suggest that this is “the big one”. Growth remains intact and larger declines should be seen more as buying than selling opportunities. The Fed did little to move the needle at their meeting last week, indicating that December is the most likely time for a rate increase. Of course, they will leave themselves an out if the global economy or US markets get squirrelly after the elections. Much as the British Central Bank did following the Brexit vote, we would expect the Fed to stand at the ready to keep the economy greased. It is unfortunately what we have come to expect from the Fed, injecting monetary policy for every ill that may be suffered, even though it may not be needed.
Rates have been rising for much of the past few months, and we are seeing an increasing likelihood that rates should continue to rise at a slow, but steady rate over the coming year. Of course that bars an economic calamity sometime in 2017! The “risk off” trade over the past two weeks came at the expense of some of the better performing asset classes over the past six months. As with much of the markets, we are expecting nothing more than a correction that could reset some of these asset classes for a good run in 2017. One part of the market that continues to decline is the REITs.
We highlighted the utilities last week as an interest rate sensitive sector that has suffered as interest rates have increased. REITs also tend to move with interest rates, as they distribute much of their earnings to shareholders in the way of dividends. As a result, they tend to have dividend yields similar to utilities, but with an added bonus of having some growth to the value of the underlying properties. They have been a great part of the market to invest in since the beginning of 2014, as investors clamored for income. The run up, similar to utilities, ended in June as investors realized that interest rates were indeed going higher and could pose “competition” to the dividends earned.
Their 15% decline since the end of the second quarter is well ahead of the still painful 10% decline in utility stocks over that same period. We are expecting the end of the election cycle to be on Wednesday, but given how the campaigns have gone, that may not be a foregone conclusion. Stocks are likely to react to the election news, but we expect that in a week or two, they will settle down and once again reflect the expectations for global economic growth and corporate earnings. Interest rates are likely to continue to rise, ever so slowly in the months ahead. As a result, we are shortening our maturity schedule as bonds come due and focusing on shorter term bond mutual funds as well.
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Market analysis
November 7th, 2015By Paul Note.
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Market update
April 17th, 2015
By Paul Nolte.
Wall Street is singing “It’s always better when we’re together”. From the Royal Dutch Shell buying BG Group to Mylan and
Perrigo hooking up, there have been over 120 mergers announced already this year totaling nearly $600 billion.
Some may argue that the deal flow is a result of a lousy economic environment, where many companies are trying to “buy growth” since they are not able to do so organically. Others will say that low interest rates make for an easy hurdle to clear when calculating potential returns from a merger.
Finally, still others will argue that this “frenzy” is a sure sign of the final act for a stock market that has risen very steadily over the past six years. Whether these mergers are deemed successful will only come with the benefit of hindsight and a few years of distance.
For its part the economy remains “ok”, neither showing robust growth nor falling into a recession. The now normal slowing during the first quarter may give way to a “spring” in the second quarter GDP figures released in July. The big event of the upcoming week will be a combination of corporate earnings and the end to the tax season that CPAs will be roundly celebrating on the 16th.
The release of the Fed minutes last week gave stocks a reason to rise, as it was evident that they remain very split on
when rates should rise and while not discussed, how quickly rates should rise. The last two months have been marked by
daily 100 point intra-day swings in the Dow, even though the markets may close relatively flat. When looking at many of
the short and long-term market indicators, they seem to be bunched toward the middle of their usual ranges, indicating
little buying or selling pressures.
Earnings season will be more company specific rather than broad market moving news. As usual, companies will do their best to beat already lowered estimates and talk poorly about the business to tamp future expectations. However, it will be instructive to hear their comments regarding overall business conditions and the effects of the higher dollar and lower energy prices on their businesses.
Keep an eye on revenues. It should not be surprising if many report relatively flat sales. Bonds have been called many things from a bubble to a sure fire loser. But bond investors continue to laugh as rates continue to decline.
Of course the trend will change, it has to at some point, right? Tell that to the Europeans, when Switzerland was the first country ever to issue 10 year bonds with a negative interest rate. It can’t, it won’t happen here, so it is thought. While our economy seems to be doing better than those around the world, allowing for the Fed to actually raise rates, the trend in rates around the world is lower not higher.
Are we leading the shift to higher rates or merely raising rates because we have promised to do so? It is a global economy and we are not an island. For the first time since mid-July last year, there are now six major asset classes trading above their long-term averages.
Emerging markets have generally done poorly since late 2010 in relationship to the SP500. Emerging markets has only been considered a distinct asset class since 1987. Over that time there have been four distinct performance periods to compare emerging markets to the SP500. From ’87 to late ’94, emerging markets did well.
From ’94 to ’01, the SP500 was king when compared to nearly any asset class. After the tech bubble burst, emerging markets did extremely well until late ’10. Since that time it has been the SP500. It may be a bit early to declare the time has arrived for emerging markets, but a strong dollar and very weak commodity prices are not likely to persist at their recent pace.
If the global economic train is indeed led by the US and we are “pulling out of the station”, it won’t be too much longer before emerging markets begin to gain momentum and begin besting the SP500. The dominance of the SP500 over many assets classes has been nearly unbroken for five years. It may finally be time to look outside of the SP500 for performance.
The economy will be taking a back seat over the coming weeks to earnings announcements. Corporate commentary
regarding the stronger dollar and lower oil prices will likely be pointed to as the culprits for weak earnings performance.
The path of least resistance seems to be higher, but for how much longer if earnings don’t improve. Bond investors will
continue to benefit from stock market volatility.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information
that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or
future financial market conditions.
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Despite decline, US GDP shows growth
March 2nd, 2015
By Paul Nolte.
“Full of sound and fury, signifying nothing.” While that is usually the only part of the quote that is used, the words
immediately in front are: “A tale told by an idiot”. The tale told last week was woven by the fools on the hill. From the
Congressional testimony by Fed Chief Yellen, to the passing of temporary funding for Homeland Security, to the veto of
the Keystone XL pipeline and the passing of net neutrality rules, it was a busy week in Washington.
While the legislative docket gets a pass here, the grilling of Yellen got a bit spirited as House members jousted with her regarding the Fed activities and hoping to impose additional rules. For her part, Yellen indicated that “at some point” the Fed will have to consider increasing rates, which means they could raise rates as soon as June or by yearend.
The better on Wall Street is still for a hike in June and little in her testimony indicated that is off the table. The next worry for investors is how rapidly the follow-on increases come and the impact of the hikes on the economy. The economy, according to the most recently revised GDP figures, showed growth barely above 2%. This week will have updates on manufacturing growth and the always highly anticipated employment figures. Rather than the unemployment level, we’ll be focused upon wage growth to see if last month’s jump can be sustained.
The strong rally in February more than reversed January’s decline and is reminiscent of the action from last year. As we
have highlighted before, in 2014, the bottom for the year was put in at the end of January. This year has followed that
pattern, just with a more aggressive February move. So what about March? If this year follows last, it will be rather
uninspiring with minimal gains. However once the weather warmed up, the fireworks started!
The extremely low volatility during the steady February rise has given way to complacent investors. When looking at various indicators of investor bullishness, many readings are at or near extreme levels. The characteristics of sentiment of late have been a sharp decline to scare investors to be followed by another rally to all-time highs. So March could be marked by an uninteresting market from beginning to end but a very volatile middle that shakes up investor confidence. Investors are certain rates will stay very low for very long, even as the Fed indicates otherwise. They are also certain that in a low rate environment the only investment to make is in stocks. As a result, valuations continue to get stretched. At some point it will snap back.
For the only the fourth week since the end of 2013 has the bond model flipped negative. Given the extremely low rate environment and the lower bound of zero for rates, at some point the model was going to move to a negative reading with just a minor move in rates. For an “official” change in the rate outlook, the model needs to be negative for more than two consecutive weeks, which was last achieved during the third quarter of 2013. Interestingly, since the model’s inception in 1989, the average length of a negative reading is merely six weeks. If we are to enter a long-term rising rate environment, many characteristics of the model will likely change and our investment stance will likewise change.
There is a disconnect between the price of energy on the futures market and at the pump. While the energy markets
remain near their lows, pump prices have increased 10-15%. Welcome to the annual changeover to “summer” blends.
Historically the spring is when pump prices normally rise as refiners are switching over and capacity is strained. Prices
should rise another 10% or so before peaking around April before resuming at least a modest decline. Everyone has been
focused on rig counts and pointing to the huge decline as a sign of terrible things to come.
Six period times rig counts dropped 25% or more in a year, but the economic and even energy price implication is spotty. The last two rig drops did coincide with a recession, however the four earlier periods saw either no recession or a lead time of over a year. Three of the periods followed price spikes and by the time rig counts were off 25%, energy prices were already on their way to stabilizing. Given the lack of consistency in the historical record, it is hard to make a generalization about the future of either the economy or oil prices based upon annual change in rig counts.
The markets are likely to take a breather for much of March while digesting the gains of February. We are noticing some
weakness in interest rate sensitive stocks (like utilities), but status quo for much of the rest of the market. Interest rates
may be in a broad trading range until we see signs of higher inflation. The economy is ok, but likely does not warrant
much higher rates between now and yearend.
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Market movement
October 9th, 2014
By Paul Nolte.
Housing prices continue to recover from their severe lows of 2009-2010, although foreclosure activity remains an issue in getting housing prices back to “normal”. Mortgage rates remain very close to historically low levels. So it shouldn’t be a surprise that someone with a good background, plenty of assets and income should be able to get a loan or at least refinance their existing loan. However, that is not the case for former Fed Chief Bernanke, who was turned down on a refinancing loan.
In a speech in Chicago last Thursday, he disclosed the recent loan rejection. While a reason was not cited, it may be that his change in job status to ex-Fed Chief may be at the heart of the matter. Although the jobs report last Friday was roundly applauded by Wall Street, Main Street is still wondering what all the celebrating is about. The lack of easy money (for loans) and additional regulation have kept a stranglehold on any real estate recovery. With home prices published daily on websites like Zillow, many are emotionally attached to the monthly wiggles on the value of their home. Buried in the jobs report is the average hourly wages paid, which showed a still meager 2% annual increase. The bull market continues on Wall Street, but Main Street isn’t feeling it.
The momentum of the markets has changed towards the negative side over the last few weeks. Even so, the decline in the averages remains well within a mild correction. The major question is whether the decline will morph into something major or just crash (as in 1987). There are a few things to note in the markets today that are a concern. First is the small stock index (Russell 2000) performance, relative to the SP500, has retraced all of the outperformance over the past three years.
Secondly, on just a price basis, the index is in jeopardy of making new lows for the year that would also break price levels. The next stopping point could be roughly 20% lower. The good news is that, so far, the weakness in the Russell has not spilled into the large stock indices. That could change if the SP500 breaks below 1900 (now at 1968), which would mark the first time in two years it has dipped below a trend. Our best guess is that stocks remain very volatile through much of October and potentially bottom out sometime around the mid-term elections in early November. The changes in the markets over the past six weeks are not getting many indicators close to areas that historically would have signaled turning points.
Bond investors continue to benefit from worries in the stock markets. Yields are once again close to the lows set early in the year, even though the Fed will be likely eliminating QE policy later this month. Low wage growth in the employment report, falling commodity prices and still tight credit conditions continue to keep a lid on yields. Credit growth has been much more robust in the commercial space, consistently above 5% growth over the past three years. For investors in the bond market, expect that yields will remain within a trading range, between 2.25% and 2.75% on the 10 year bond until we begin to see more inflationary pressures from incomes and commodity prices.
Quarter and month end is usually a good time to review some of the changes in the markets over the recent past and note changes that should be made to keep investors in the sweet spot of the markets. This month has seen many of the asset classes decline below their long-term averages, as highlighted by the Russell above.
The only two markets still above are the SP500 and bonds. Even the more conservative REIT market has suffered over the past two weeks. Based upon historical trends and similar declines as we have today, we may expect another 5 decline in stocks over the coming six months. The parts of the market that are holding up during the decline (like technology & healthcare) are likely to be leaders once this period ends. We have not yet cut equity exposure in a meaningful way. However given the deterioration of the past few weeks; we are keeping a close watch on the stock and bond relationship to help determine whether the decline is nearly over.
The decrease in small stocks holdings early in the year has proven to be the right decision. The concentration in large US stocks all year has been the right decision as well. What is next? As outlined above, further weakness is possible, but we are expecting another leg higher into mid-year 2015 as economic growth remains modestly strong. Bond investors will also benefit from a still “easy” Fed, keeping rates near zero well into 2015 and maybe beyond.
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Market watch
August 17th, 2014
By Paul Nolte.
With the various “skirmishes” around the world, it feels as though “we’re on the eve of destruction”. While the song was written nearly 50 years ago, it seems rather poignant today. Others scroll back 100 years to the series of events that pushed Europe and eventually the US into World War I. Whether it is Russia looking to regain some of their former states,
China rumbling in the east or the usual fighting in the Middle East, the lyrics are ringing truer today than maybe even back in 1965. The markets and the economies of the world have changed so much over the years, yet investors are held
hostage to each day’s events, impetuously buying or selling on each bit of news. Within a two week period, the SP500
has declined nearly 4%. But to hear the various pundits, the next major decline is now here and y’all better sell now. The
truth is market’s decline 5% at least once during the course of a year.
It has been two years since the last occurrence, so we are certainly due for one. But that doesn’t mean that impending doom will come to the stock market. For that we’ll need to see economic weakness, not record earnings, nor persistent growth in the labor market.
The underlying economy is growing, albeit at a slower than desired rate, but growing. Happy days are not quite here again, but neither is the eve of destruction.
The Wall Street adage that markets rise using the escalator but fall using the elevator is rather apt this year. There have
been three long periods of gains punctuated by rather short/sharp declines in the markets over the past eight months. In
each instance, the declines were eventually erased by the subsequent market advance. In each of the declines, investors
turned very quickly negative on stocks as measured by various sentiment readings. Such is the case today. The Individual
Investor Association survey has matched its most negative readings of the past year. Each of the prior instances was
within a week or two of the eventual price bottom in the SP500. A sharp turn in sentiment is also seen in various
professional surveys as well. Is this time different? There are many more stocks in decline phases than any time this year.
Volume has generally increased on market down days, which is not a very good sign. Bonds, the scourge of equity
investors, are also beginning to show better overall performance relative to stocks. So while we are not ready to back up
the truck and buy stocks, we view the recent decline as long-term healthy for the ongoing bull market.
Bond returns this year are fairly close to stocks so far this year. Similar to stocks, bonds have been pointed to as a bubble
and face big losses as the Fed stops their bond buying program in the fall. But the Fed remains in a box. The economy is
growing and rates should be boosted to avoid potential inflation down the road. However, if they raise rates too
much/quickly, then the still relatively fragile economy could sink into a recession. A
fter which the Fed will have to cut ratesagain to get it going. The only hole in this argument is that the economy is stronger than many believe and can withstand gradually higher rates. Our bet continues to be that rates remain between 2 and 4% as they have for the past six years.
The decline of the past two weeks has put the market back to roughly where it was mid-June. What is more instructive is
to see how the industry groups have performed over that two month period. Industrial stocks, which we highlighted two
weeks ago, are by far the worst performing group. It can be argued that poor industrial performance is a sign that
investors don’t believe economic growth will persist. If that were true, we would see other groups like basic materials and consumer related issues doing poorly.
However, joining industrials on the “bad” list is utilities, the bastion of safety when the world is falling apart. They are also a play on interest rates and have not done well as rates have declined over the past month. It is this dichotomy within the market that points to a corrective phase rather than investors shifting toward defensive stocks to cushion a huge market decline.
Energy stocks did make the “bad” list, however they were near the top last week, indicating investors were no completely abandoning this top sector just yet. The fighting seemingly around the world has made markets nervous and much more volatile over the last few weeks.
A correction of 5%+ is certainly overdue and very likely, however it is not enough to abandon quality stocks and hope to properly time a reentry into the market. The bond market has softened the blow of the equity decline. Given the very low
current yields it would not be surprising to see them a bit higher between now and year end.
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