The Rising Rate Bull Case
October 12, 2018
The 10-year treasury rate is rising. For the first time in 37 years, it set a higher high….The rise in the 10-year interest rate, if not driven by inflation, could be the result of a positive change in economic growth expectations. US GDP growth has notched higher this year (from 2% to 3%) and global PMIs are expanding. If this is indeed the case, rising interest rates are not necessarily bearish for stocks.
October 5, 2018
When climbing a mountain, it is fairly common to look up and see what appears to be the summit. Upon arriving at this high point, it becomes apparent that the actual peak is further ahead. As a tired climber, this can be disappointing. For an investor, higher highs are a positive.
Stepping Up (Fed, Rates, Stocks, Economy…)
September 28, 2018
Investor awareness of a flattening yield curve has been heightened by media coverage over the past year. A flattening yield curve precedes an inverted yield curve which historically has been a robust recession indicator. Our definition of an inverted yield curve is when the two-year U.S. treasury rate is higher than the ten-year rate.
Since the beginning of 2017, the yield curve has flattened.
Crowded Trade: Target Date Funds
September 21, 2018
One of the most important things we have learned over our years in the financial markets is beware of the crowd.
We follow the money to determine where a crowd is building.
Another Quarter, Same Old Story
September 14, 2018
S&P 500 earnings in 2018 are about 25% higher than they were in 2017. Stock prices are responding to this advance. The next round of earnings announcements (third quarter) begins in October. We should expect a continuation of better than expected earnings news.
50-Year Record Set!
September 7, 2018
Last week, the S&P 500 and NASDAQ reached new all-time highs. The S&P 500 advanced by about 3.2% in August and the NASDAQ appreciated 5.9%. These gains followed gains in July of 3.7% and 2.2%, respectively. The strength can be attributed to strong earnings and a red-hot Apple – and we are not talking about the heat at the U.S. Open in New York. The largest company on the planet appreciated 20%+ from the end of July to the beginning of September.
The Rise of the Global Middle Class
August 31, 2018
The S&P 500 is at new highs. 25% earnings growth this year is a significant driver of the bullish price action. Although earnings are expected to continue to grow in 2019, the rate of growth is expected to slow. Is the economic growth cycle approaching its natural end or are there underlying changes occurring in the global economy which could extend cycle longevity?
The World According to Brian Cornell
August 24, 2018
Who is Brian Cornell? He was the chief marketing officer of Safeway. He has been the CEO of Michaels, Sam’s Club and PepsiCo Americas Foods. He has been on the board of directors of OfficeMax, The Home Depot, Polaris Industries and Yum! Brands. He is the chairman of the Retail Industry Leaders Association Board. Brian Cornell knows retail.
Crisis Du Jour: Turkey Melt
August 17, 2018
The Turkish currency (lira) is melting. It is down about 40 percent this year versus the U.S. dollar. Much of Turkey’s debt is owed in U.S. dollars. As its currency falls, it becomes increasingly expensive and difficult for Turkish indebted entities to make debt payments owed to foreign banks. The strengthening dollar and weakness in emerging market currencies (including Indonesia, South Africa, Russia, Argentina, Malaysia and China) is increasing fears of contagion risk.
Is 2018 Going to Be a Good Year for Stocks?
August 10, 2018
As of this date, all indications are we will have a good year. 81% of the S&P 500 companies have reported earnings through Friday of last week. 80% beat the earnings estimates and 74% reported revenue upside. Earnings are on pace to grow this quarter by 24%. Revenues are up 9.8% year-over-year. This is great performance in a roughly 4% GDP growth economy.
A New Bull Market Record
August 3, 2018
Since reaching an all-time-record high of 2,872.87 on January 26th, the S&P 500 has spent the past six-plus months correcting, consolidating, trading sideways. From the January 26 high to the low on February 5, the index dropped 11.8%. Through the beginning of April, stocks hovered -10% from the high and -3.5% on the year and retested the February low. Strong economic growth coupled with great corporate earnings have lifted stocks. The index is grinding higher and is now less than 2% from making new highs.
Mid-Year 2018 Observations
July 27, 2018
New home sales convey a lot more information about economic growth than existing home sales. New homes need to be built driving employment and commodity demand (lumber, flooring, roofing, insulation, concrete, etc.) higher. New homes need furniture, appliances, washer/dryers, gardening services, insurance, etc. – all additive to economic activity.
Generally, when the year-over year change in new home sales falls by about 20%, a recession follows. In 1966, there was an exception and government spending on the Vietnam War buildup kept the economy out of recession. The recession eventually arrived in the early 1970s. The “double” decline in 2010 is considered a part of the housing bust and was driven by the housing tax credit policy in 2009.
Insider Views: Price versus Value
July 20, 2018
There is a saying that a person can know the price of everything and the value of nothing. With Netflix stock this year, it would be understandable to have one’s thoughts filled with price rather than value. The stock more than doubled year-to-date from $191.96 to a high of $423.21 through last week prior to earnings.
The Bareback Bull
July 13, 2018
Since March 6, 2009, the S&P 500 is up roughly 400%. The 10-year average annual return through Wednesday of this week is 10.6%. The S&P 500 index is within about 4% of its all-time high. The U.S. stock is enjoying a multi-year bullish run.
Although the stock market is experiencing a major bull move, many individual investors have not participated fully. The chart below shows that the cumulative fund flows into U.S. equity mutual funds and ETFs since 2007 is negative.
Making the Jump to Earnings Season
June 29, 2018
Roughly two weeks from now on July 16, second quarter earnings season will begin with Bank of America (BAC) and BlackRock (BLK). That week, we will hear from many of the largest banks and many of the largest industrial firms including Lockheed Martin (LMT), Textron (TXT) and Danaher (DHR). We will also hear results from notable companies like Netflix (NFLX), Microsoft (MSFT), Johnson & Johnson (JNJ) and Grainger (GWW). By July 20, we should have a much better understanding of the health of corporate earnings and the impact of tariff actions and Fed Fund rate hikes on profit outlooks.
Trade War Score Card
June 22, 2018
The trade war is impacting markets. The range of impact varies by the extent of the exposure to international trade.
The U.S. represents about 5% of the world’s population but consumes about 24% of the world’s energy. Americans eat 815 billion calories of food each day, roughly 200 billion more than needed. We throw out 200,000 tons of edible food daily. The average American generates 52 tons of garbage by age 75. We use one-third of the world’s paper…etc. When the U.S. imposes tariffs, it hurts foreign producers more than domestic producers in aggregate.
Movement of Goods Reveals Positive Movement in the Economy
June 15, 2018
Intermodal freight transport involves the movement of freight in a container that can be carried by a ship, train and/or truck. Intermodal containers carry a wide range of products from electronics to refrigerated products, building materials to farm equipment and almost all other materials and products produced today. It provides a fundamental and extensive measure of economic activity.
Is The Fed Facing a Rate Ceiling?
June 8, 2018
How high can they go? Since November 2015, the Fed has raised the Fed Funds rate from roughly zero to about 1.75%.
Next week on Wednesday, the Federal Reserve is expected to raise the Fed Funds rate once again by 0.25% to 2%. When the Fed raises the Fed Funds rate, the two-year treasury usually rises in lock-step. The two-year treasury rate at 2.52% is roughly 0.75% above the Fed Funds rate. If the Fed raises rates next week, we should not be surprised to see the two-year treasury rate to climb to about 2.75%.
Trouble With The Curve
June 1, 2018
In a 2012 movie “Trouble with the Curve”, Clint Eastwood stars as a professional baseball scout who is able to recognize that a highly sought after prospect is unable to hit a curve ball. The 2018 stock market year-to-date has been unable to connect on a pitch. With just a 1.9% gain for the year, the S&P 500 remains stuck at home plate, unable to advance to first base.
The stock market is having trouble with the curve. Curve balls this year have included the volatility spike of the VIX to 50, ping-pong peace talks with North Korea, potential global trade wars, Fed rate hikes and most recently refreshed concerns about the euro with a potential Italian exit (“Itexit”).
Stock Market “Selfies”
May 25, 2018
When evaluating the stock market, sometimes it helps to take a step back and simply observe. What we see today is encouraging.
Stocks are risk assets. They generally have higher volatility than bonds and there is no guarantee they will not trade down to zero. Large company stocks are considered less risky than small company stocks. Large companies like Apple and Exxon are not likely to fail anytime soon. Little companies are more vulnerable. When small company stocks are doing well, it suggests investors have an appetite for risk assets. This is bullish for the overall stock market. The chart below shows the Russell 2000 Index (IWM), small company stock index breaking out to the upside through a triple top.
This Aging Bull Is Still Attractive
May 18, 2018
The stock bull market is entering its Golden Years. Since March 2009, the stock market climbed out of its hole and has been making new highs since 2013. The market continues to be bullish, but tailwinds are turning into headwinds.
When the bull was younger, interest rates were reduced to historical lows. Oil prices declined by roughly 73% from July 2014 through February 2016. This was a stimulus for consumer spending. From 2010 through 2014, the U.S. dollar was relatively low spurring international trade. Corporate profits more than doubled from the end of 2009 through 2017.
No Gutter Balls
May 11, 2018
It is hard to throw a gutter ball when the bumpers are up. Having the bumpers up will help us avoid the frustration of our investments rolling into the gutter but does not necessarily grant us a PBA (Pro Bowlers Association) type score.
Nestle announced last week that it has agreed to pay $7.2 billion for the right to sell Starbucks’ packaged coffees and teas. Starbucks says it will use the $7.2 billion to accelerate share buybacks. Starbucks expects to return to shareholders $20 billion
through repurchases and dividends through fiscal 2020. This return of value represents roughly 25% of the total market capitalization of the company today.
Looking Down From the Peak
May 4, 2018
What do Procter & Gamble (PG), Coca-Cola (KO), PepsiCo (PEP), Walmart (WMT) and Philip Morris (PM) have in common? They are blue-chip stocks. They all have “A” investment-grade credit ratings. They are the top five holdings of the S&P 500 Consumer Staples ETF (XLP). They are slow-growth stocks. They are down year-to-date an average of -16.5% through May 2. They help explain why the broader market is not rising on record first quarter earnings.
Sensitivity Training; Higher Interest Rates
April 27, 2018
Interest rates are rising. From the all-time low of 1.33% reached on July 6, 2016, the 10-year U.S. treasury rate is now 3.02%.
Rising rates are a negative for bond values. During the 23 year period from 1958 to 1981, the 10-year treasury rate rose from about 4.2% to 15.8%. The average annual real return from corporate bonds was -2%.
This Market Has To Earn It!
April 20, 2018
Because of high levels of investor skepticism (AAII investor sentiment is 43% Bearish and only 26% Bullish) for the stock market to rise, it is going to have to earn it!
Factset Research is predicting the market will. Through Friday of last week, 70% of the S&P 500 companies that have reported earnings (about 6% of the index) beat earnings estimates. This week through Thursday, the beat rate jumped up to 83%. Factset is already postulating that earnings growth in the first quarter is more likely to be 20%+ than the 17% they had been predicting roughly a week ago.
Float Like a Butterfly, Sting Like a Bee
April 13, 2018
“The Greatest” (Muhammad Ali) followed this approach in the boxing ring with some success. In the fixed income investment ring, floating like a butterfly is also a viable approach when interest rates are rising.
Of the twelve bond types listed in the chart above, only three appreciate in a rising rate environment. Of the three, two are somewhat dependent on a rising stock market and an improving economy to show solid returns. Only one, floating rate, is a winner simply by the fact that rates are rising.
The Hidden Risks of “Safe” Assets
April 6, 2018
Money managers often advise clients who would like more safety in their portfolios to increase the weighting of bonds versus stocks. Historically, bonds have experienced lower volatility than stocks. Volatility (standard deviation) is one way risk is measured in finance.
Just as the S&P 500 Index is often used as the benchmark for performance by stock investors, the Bloomberg Barclays US Aggregate Bond Index (AGG) is a common benchmark for bond investors. The AGG is an investment grade corporate bond index.
Stormy Times for Leadership During Quiet Period
March 29, 2018
Seventeen days ago on March 12 the NASDAQ reached an all-time closing high of 7,588.32. Over the prior twelve months, the NASDAQ led the broader stock market higher advancing by about 28% versus the S&P 500 advance of about 18%.
Twenty days from now, Alcoa (AA) will kick-off first quarter earnings season on April 18. First quarter earnings are expected to be up 17% year-over-year.
Stock Market Spring Has Yet To Arrive
March 23, 2018
What do hotel occupancies, chemical sales activity, job openings, stock buybacks and intermodal freight loadings have in common? They are all booming and have accelerated from 2017 levels. Some of these measures are at all-time highs. First quarter earnings to be reported next month are expected to be up about 17% year-over-year. On December 31, analyst expectations were for just 11.4% earnings growth in Q1.
Stocks Consolidate Under Trade War Shadow
March 16, 2018
In August of 2017, President Trump asked ambassador to China, Robert Lighthizer, to perform a Section 301 review of Chinese trade practices which may be harming American intellectual property rights, innovation, or technology development. Section 301 of the U.S. Trade Act of 1974 allows the President to act unilaterally and retaliate against unfair trade practice. Lighthizer has until August 2018 to complete the study.
Although the China 301 trade study has not been officially completed, Trump is actively considering imposing a set of tariffs and investment restrictions on China in the near term. Most economists believe the consequences of such action would have an adverse impact on the U.S. economy.
Stock Market Responds to Tariffs and Growth
March 9, 2018
The market is not a singular entity. It is comprised of thousands of individual stocks which are organized by size, style (growth versus value) and industry sector. For example, the Dow Jones Industrial Average index (DJIA) measures the performance of 30, very large companies. The weighted average market cap of the DJIA stocks is $230 billion. By contrast, the Russell 2000 growth index (IWO) measures the price performance of 1,162 stocks with earnings expected to grow at an above-average rate relative to the market. The weighted average market cap of the Russell 2000 growth index is one tenth the size of the DJIA at $2.3 billion. The P/E of the DJIA is 16.9x versus the P/E of the Russell 2000 growth of 24.7x.
Interest Rate Sensitivity
March 2, 2018
The stock market has had a touchy relationship with bond yields in the past few weeks. On Friday of last week and Monday of this week, stocks rallied on a successful auction of $258 billion worth of treasury bonds which lowered the 10-year treasury yield. On Tuesday, the new Federal Reserve Chairman, Jerome Powell, spoke to Congress and said his economic projections strengthened since the December Federal Open Market Committee (FOMC) meeting. The market interpreted this remark as an indication the Fed may raise rates four (rather than three) times this year. Bond yields rose and stocks declined.
When Will Rising Interest Rates Be a Problem for Stocks?
February 23, 2018
Are rising interest rates negative for the stock market? The answer is yes and no. It depends on how high rates are while they are rising.
As long as the 10-year U.S. treasury rate is below 5%, rising interest rates have a positive correlation with a rising S&P 500. Said simply, rates go up and stocks go up. Above 5%, rising rates have a negative correlation with the direction of the S&P 500. Today, the 10-year treasury is about 2.9%.
Investment Batting Average Peril
February 16, 2018
In baseball, batting average is a useful statistic. It indicates how frequently the batter gets on base. The downside of not getting on base is waiting for the next turn at bat. The risk/reward of taking a turn at bat in baseball is good even with a low batting average. In investing, batting average can be deceptive because risk may be asymmetric.
In investing, you can have a high batting average. But one losing trade can wipe out all of the accumulated gains. This would be the equivalent of a baseball batter being called out on three strikes and then being permanently banned from the game as a result. The downside is much greater than the upside. This is asymmetric risk.
On November 24, 2017 the CBOE Volatility Index (VIX) reached an all-time low of 8.56. Of the 20 lowest VIX closes, 18 occurred in 2017 and 2018. Of the 68 times the VIX has closed below 10 over the past 27 years, 59 of these occurrences were in 2017 and 2018. Volatility has been very, very low over the past year.
Volatility is a Two-Way Street
February 9, 2018
In finance, volatility is a bad word. It is measured as standard deviation and is how risk is defined. Investors hardly ever complain about upside volatility. At the high in January, the S&P 500 was up 7% for the year. Stocks were short-term overbought. Short-term overbought markets correct by price or time.
In February, volatility reversed course and the S&P 500 depreciated by nearly 10% from high to low. A 10% decline is often labeled a “correction.”
The Next Frontier: Healthcare
February 2, 2018
In the Unites States, our healthcare system suffers from two fundamental problems: 1) it is very expensive and 2) partly because it is so expensive, it is unclear how all Americans can have access to quality healthcare.
Roughly 18% of the U.S. GDP is spent on healthcare. For purposes of comparison, Canada spends about 10%, France 11.5%, Germany 11.3%, and the UK 9%.
Stocks Have Positive Momentum
January 26, 2018
Stocks just won’t seem to go down lately. Through Thursday of this week, there have been 12 S&P 500 record high closings month-to-date. The all-time record for S&P 500 record closing highs was set in June, 1955 at 16. On the four days the S&P 500 has traded down in 2018, the cumulative decline was less than 19 points (~0.7%).
Part of the reason for the strong market is the economy is performing well and accelerating. The Leading Economic Index (LEI) came in at up 0.6% for December which makes 16 consecutive positive LEI monthly reports.
Worried About Rising Rates? Get Active
January 19, 2018
The Fed is scheduled to raise rates three times this year. The possibility of upside to four increases has entered conversations. The reason: a hotter labor market and price pressures due to expansive fiscal or accomodative financial conditions.
The Fed target rate range is 1.25 – 1.50%. Three “gradual” increases would bring the range to 2.00% – 2.25%. Raising the rate makes it more expensive to borrow and lowers the supply of money. The Fed meets eight times a year. Market participants expect the next rate hike to be at the March 21st meeting.
January 12, 2018
There has been a seismic shift in the way investors are investing since the 2000. Investors have been moving money from active to passive management. Passive, index investing has quadrupled since 2000. The primary arguments for passive, index investing are lower fees and a belief that an investor cannot consistently outperform the market indexes.
When the price movement of all stocks is very similar (highly correlated), passive investing makes a lot of sense. If all stocks move in the same direction by the same amount, it does not matter which stock you buy. From 2000 to 2009, correlation between stocks increased. In September 2009, the average correlation between stocks globally was 0.89. This is only 0.11 away from perfect correlation of 1:1.
Power of Positive Thinking
January 4, 2018
All else equal, the optimist lives on average seven years longer than the pessimist. My 14-year-old son did not believe me at our dinner table discussion. I was actually glad to get the pushback. I enlisted a scientist friend who worked in the labs at University of California Berkeley to convince my adolescent son with some science. There have been several studies showing positive thinking can extend our telomeres.
Telomeres are the protective caps on the ends of the strands of DNA. The longer our telomeres are and the slower they shorten, the longer we live. Telomeres like positive thinking.
2018 Stock Market Outlook
November 17, 2017
Our 2018 S&P 500 Index outlook is up. If the P/E remains constant as it has for the past two years, the S&P 500 should be up in-line with earnings or about 11%.
The following ten factors support our 2018 bullish investment thesis:
- Global Economic Expansion – No U.S. Recession In Sight
The global stock market (MSCI AC World Index) has posted a gain for 12 consecutive months (a record) and is on track for every single month in a year for the first time in the 30-year history of the index. Every one of the world’s 45 largest economies tracked by the Organization for Economic Cooperation and Development (OECD) is expanding. Economists are forecasting acceleration in world GDP in 2018 from 2017 levels.
Predicting a Recession – Avoiding Major Loss – LEI and the Yield Curve
The Leading Economic Index (LEI) and the U.S. Treasury Yield Curve have been accurate predictors of recessions. This is important because:
1. Major stock market pull-backs (-40% or greater) that require years to recover occur during recessions.
2. As stock investors, we would like to reduce exposure to stocks in advance of major pull-backs.
3. If we can reliably predict when the next recession will be, we will be alerted to an elevated risk of an impending major bear market.
Click Here for Delta’s analysis of the LEI
Click Here for Delta’s analysis of the Yield Curve