Friday, November 27, 2015

Investing is a Funny Business... AND... Your Weekly Update (video)

The Fed's readiness to raise its benchmark rate (make money more expensive) signals its members' optimistic view of the economy and, therefore, means good times are ahead for the U.S. stock market---or so goes the mantra of the ever-optimistic market pundit.

Makes sense, right? I mean if the economy is growing at a pace that warrants a little break-tapping by the Fed, business must be about to boom to ultimately a capacity-straining enough point where inflation (beyond some desirable level) becomes a legitimate concern. And---until inflation (at some undesirable level) rears its ugly head---booming business has to mean a booming stock market, right? Well, hmm...

Investing is a funny business. As you're about to read, doing what makes perfect sense all too often makes for uninspiring investment results. Let's start with commodities:

Three conversations come to mind: One, from a few years ago, with a client who informed me that he had been maintaining an online account where he would speculate at the behest of an old friend who happened to be an astute market-watcher/predictor. Another with a neighbor. And another with a guy who did a pest inspection for me last winter.

My client's friend would feed him tips that he'd implement in said account (apparently he had experienced enough winners to keep him engaged for the previous few years). For whatever reason, my client wasn't entirely comfortable with his friend's counsel in circa mid-2010: He wanted to know what I thought about going all commodities with his, let's call it gambling, money (his friend had assured him that the Fed's QE [which by then had become a household acronym] program would result in so much new money supply that inflation would run rampant and commodities would be far-and-away the best game in town). I explained that his friend was, on the surface, making a logical assumption, however, there was substantially more to be considered:

First of all, QE (the Fed buying treasuries and mortgage-backed securities from banks---i.e., placing billions of cash on bank balance sheets that could be lent into the economy), by itself, creates no inflation: The cash has to be put to use---at a pace that exceeds the economy's ability to produce compensating goods and services---to increase the rate of inflation. If all it does is sit on banks' balance sheets nothing---other than keeping interest rates very low---happens. Plus, you have to consider the supply of commodities in storage, the current rate of their production, and their demand in the global marketplace before coming to any conclusions as to where their near-term prices may be headed.

My neighbor, circa 2013, told me how he went heavy commodities, thinking that, yep, all that money printing had to lead to high inflation.

The pest inspector, in December 2014, after asking me what I do for a living, explained how he's been getting creamed in commodities---but remained certain that it was just a matter of time before he'd be able to cash in on huge profits.

I gave essentially the same lecture to the neighbor and the exterminator that I did my client.

With (I swear) no prodding from me, what remained of my client's online gambling account now rests in his portfolio with us, my neighbor has yet to again broach the subject, and I'm guessing, alas, that the determined exterminator has yet to exterminate his commodity positions.

Again, successful investing is all too often unintuitive. A point that I'll expound in the following, sticking with Fed policy as my backdrop:

What does it say about the economy when the Fed embarks on expansionary monetary policy? Well, it says that the economy is in trouble and the Fed feels it needs to make money really cheap so people will put it to use and rescue (expand) the economy. I.e., it means times are tough. And tough times are anything but synonymous with rising stock prices, right?

And, to reiterate paragraph two above, what does it say about the economy when the Fed embarks on restrictive monetary policy? Well, it says that the economy is robust enough to warrant the Fed making money more expensive in an effort to cool (restrict) the growth rate enough to keep the economy humming along at a non-too-inflationary pace. And robust times are indeed synonymous with rising stock prices, right?

Well, nope and nope! History, believe it or not, offers convincing evidence that one should expect strong market gains when the Fed signals that the economy is, well, weak, and weak gains (if not losses) when the Fed signals that the economy is strong.

Here's the proof:

In their excellent 2015 book Invest with the Fed, Robert Johnson, Gerald Jensen and Luis Garcia-Feijoo chart the performance of the S&P 500 from 1966 through 2013 during periods of expansive and restrictive monetary policy. As it turns out, stocks tend to perform spectacularly (average annual return of 15.2%) when the Fed signals that the economy needs major help, and scantily (average annual return of 5.9%) when the Fed signals that the economy's running hot. Hmm...

So how could that be? How could it be that stock prices, which by their nature are economically sensitive, rise faster when the Fed signals trouble, and slower (if at all) when the Fed signals economic growth? Actually, if we really stop and think about it, it's not all that unintuitive after all. You see when the Fed engages in expansive monetary policy it's pulling its levers to inject money into the economy. Astute investors---believing that more money means more capital (job producing) investment on the part of business and more spending on the part of consumers---bid stock prices (particularly those of companies in the cyclical sectors) higher in anticipation of greater profits down the road. Conversely, when the Fed engages in restrictive policy it's pulling liquidity out of the economy. Astute investors---believing that less money means less investment and less spending---then sell stocks (within the cyclical sectors) in anticipation of lower profits down the road.

Hence, we have the angst (I've been reporting on all year) about when the Fed is finally going to embark on a restrictive monetary policy. And, hence, you can understand why I'm not entirely on board with the popular notion that the market's just going to rally right through the first Fed rate hike. Although it just might---or at least not fall completely apart (which, at this juncture, would be my best guess)---if the Fed can convince astute investors that the glide path for rates going forward is going to be the flattest---or least steep---on record.

And, hence, you can understand why, for some time now---being that the European Central Bank is presently engaged in an aggressive QE campaign---I've been constructive on the stocks of Euro Zone companies.

Lastly, what about commodities? Shouldn't commodity prices do the same for all the same reasons? Well, you might think so, but no! In fact, they tend to do the opposite. Remember, inflation is the rising of the price of stuff. Commodities are stuff. When the Fed is engaged in expansive policy, it isn't the least bit worried about inflation. In fact it's signaling that their ain't any. When it's engaged in restrictive policy, it's reacting to the looming threat of inflation. And, typically, it's justified.

Here's the proof (that commodities tend to move opposite the broad market):

According to Johnson, Jensen and Garcia-Feijoo, the GSCI Commodity Index---which is comprised of 24 commodities within the energy, industrial metals, agriculture, livestock and precious metals sectors---has produced an average annual return of minus 0.19% during periods of expansive monetary policy (when inflation was the least of the Fed's worries) versus a whopping 17.66% during periods of restrictive policy (when inflation was at the top of the Fed's worry list).

Hence, you now understand why I've begun talking more about commodities as the Fed gets closer to lift off...

As for your weekly update, I'm thinking this week's TV segment should suffice:

Saturday, November 21, 2015

Your Weekly Update...

In a post last week I offered up three charts that illustrated the ills of recency bias: which, in the context I use here, is the basing of one's investment decisions on recent past performance.

Here's another illustration:

It's September 30, 2015 and John and Jane (both in their early 60s) recently contributed (but not really) to the political narrative that says the U.S. economy is going to hell in a hand basket because the labor force participation rate is shrinking. I.e., they, oops!---(doesn't quite fit the glass-half-empty narrative)---retired. I know, I just angered at least half of you!

Anyways --- the newly-retired couple have to do something with the zillions they saved in their 401(k) plans over all those years of toil and sweat.

So John---or please pretend I said Jane if my gender bias disturbs you... or if your name is John pretend I said Jim... if your name is Jim pretend I said....umm.... Bartholomew! (I don't counsel any Bartholomews)---is the analytical sort. Well, kinda: let's just say John, I mean Bart, considers himself the analytical sort. (I'm thinking my condescension toward Bart just won me back the feminists I offended in the previous sentence)... So Bart does his due diligence and assembles the sector performance spreadsheet below (click to enlarge):


Bart, having eyes that do not deceive---and limited (having been confined to his old 401(k) options) investment experience---knows one thing for certain: he ain't touching energy, materials or industrials with the 60% of the family portfolio he's devoting to the stock market. He'll play it safe (as most retirees should) and divide it amongst the top 6 performing sectors.

Well, we're now 7 weeks into the fourth quarter, and Bart, the analytical sort---with gobs of time on his hands---updates his sector spreadsheet to see what's what since they rolled over their zillions. Here's what he saw:


It's not like they lost any money (it's been a very good Q4), but Bart, being competitive (folks who consider themselves the analytical sort generally are.... i.e., they like to be right), is feeling a bit frustrated. The 3 sectors he shunned have delivered impressive top 5 results since day one of his foray into the world outside the old 401(k).

I know, that's too short-term an example to get excited about, but it is perhaps a hint that the constructiveness on commodity-related equities that I've expressed in recent audios might bear some fruit---if, that is, we're anywhere near embarking on that later inflationary-phase of the economic cycle. That said, while we're beginning to dribble in (where we deem client portfolios to be underweight), I can make a bearish very-near-term case for commodity stocks if, as so many expect, the dollar appreciates further as a result of the Fed raising interest rates (while other central banks are taking opposite measures). I.e., commodities tend to correlate negatively to the U.S. dollar. As I've previously expressed, however, while the logic is textbook, history doesn't entirely support today's consensus on the dollar. Good thing we don't concern ourselves with the very near-term when making sector allocation decisions.

Since we're on commodities, let's take a peek at some data you'll seldom, if ever, hear discussed on CNBC. When they're talking commodities, they're talking oil, copper and the like. And they're generally assessing the prospects for taking speculative positions in the commodities and/or their futures contracts. A common refrain of late has been that the horrendous bear market in commodities says something, well, horrendous about the global economy. I've sung a bit of a different tune: China's evolution, if not orchestration, from an industrial-driven economy to one that's geared toward consumption has been the primary catalyst for a major bear market in commodities. Now, while, indeed, supply and demand impact the price of copper and a barrel of oil, speculator sentiment plays into the mix as well. But when we're talking nontradable, nonmetalic, commodities, the ones---such as cement, clay, glass, lime and gypsum---whose prices are captured in the U.S. PPI Commodities Nonmetalic Minerals Index, there are no speculators pushing prices around while trying to make a buck. Nope, the only players are the suppliers and the users.

The following chart (click to enlarge) shows the one-year move of said index (red) along with the index for brick and structural clay tile (purple).   

Nonmetalic Minerals and Brick and Clay Tile Indices

While the above should in no way be considered conclusive that things are going gangbusters and that the bear market in tradable commodities is due primarily to speculative fervor (it absolutely isn't!), it does offer some support for the notion that the prospects for the global economy (not to mention the U.S. housing market) aren't nearly as bad as some would have us believe.

The Fed:

Can't close a market commentary these days without touching on the Fed: The punditry seems to have fallen into alignment on the market sentiment toward a December rate hike. Last week's impressive rally amid Fed chatter that December may be the month was greeted by virtually every commentator I paid attention to as proof positive that the market is a-okay with higher rates. I get it, but I'm not convinced. Last week saw France go hard after suspected terrorists, it saw Dow-component Nike announce a $12 billion share buyback, a hike in its dividend and a two-for-one stock split (now tell me again how bad the global economy is [55% of Nike's sales occur outside of North America]), and it saw the likes of Lowes and Home Depot post impressive results (now tell me again how awful life is these days for the American consumer). Those events---not to mention the season [November and December tend to be very good months for stocks]---by themselves were enough to spark a rally, especially after the previous week's dismal showing.

2-year treasury yields, as well as Fed funds futures, are pricing in a December hike---and the pundits may very well have it right (it'd sure be nice) on how the stock market views it. But I'll need a little more time---and to see the market react to a few more economic data points---before joining the consensus.

I do believe---particularly since we just got our 10+% correction---there's a good chance the Fed can pull off the first rate hike without turning the market completely upside down. They'll do it with a firm promise that they'll go most tenderly in their efforts to "normalize" interest rates during the months to come. But I struggle with the notion---as so much of last week's commentary suggested---that the market will actually accelerate right through it, being, they say,  that it'll confirm the Fed's confidence that the economy's in good enough shape to withstand higher rates (I actually believe it is). Which implies that the market has complete confidence in the Fed's forecasting ability. I don't believe it does...

I'll keep you posted...

Sunday, November 15, 2015

It ain't easy predicting bear markets!

My charge as counselor to the folks who entrust their portfolios to our firm is to teach them how to think like long-term investors. Which, in today's media-rich world, can be quite the task. When pundits who---by nature of their media exposure---have to know what they're talking about tell us that there's a "99.7% chance we are in a bear market", that "the S&P may fall further 10-15%", that we should go "long bonds and short stocks", that there's "danger ahead", that "equities have another 10% to fall" and that "now is not the time to buy", it can be tough for little old me to convince our clients to buy and/or hold stocks through the inevitable fluctuations that are part and parcel to the business of long-term investing.

In showing this chart (click to enlarge) exposing the recent miscalculations of today's media darlings, I in no way want to suggest that these chaps are always wrong. I have no doubt that they've made some very impressive calls during their careers that have ascended them to their present perches.


When Carl Icahn (arguably one of the world's best investors) issued his "danger ahead" warning, he said that experts like himself should've helped the little guy by sounding the alarm ahead of the 2008 bear market. Problem is, he didn't see it coming either, the hedge fund he managed took a 35% hit that year.

It's gotta be tough being a prognosticator. Especially when notoriety only comes when you accurately predict a bear market. The visual below (click to enlarge) tells why predicting higher stock prices doesn't garner much attention, it's easy. Stocks tend to rise over the long run. Guessing the red, on the other hand, is hard.

bull & bear market chart

Friday, November 13, 2015

Your Weekly Update

Tell me you're not at least a little nerve-wracked over the stock market these days. I'm not hearing anything because you can't tell me that. As much as we know that equity investing is a long-term affair---and that volatility is inevitable---let's face it, when it's "bad" it stinks!

When the stock market's "bad" we wish we weren't in it. When it's "bad" we're sad.

When our clients take a look at their monthly statements---or, worse yet, when they daily pull up their accounts online, they, save for a few, don't see the individual companies they hold. They see the names of funds that  assemble the stocks of the individual companies they hold; names that aren't what you'd call "household"---names that don't engender any pride of ownership.

So, while we may be sad when the market's "bad", would we indeed be as sad if we knew we owned a company that has a couple hundred billion in cash and utterly dominates the world of wireless devices---even when it's share price is in decline? Well, we might, but we shouldn't. How about if we owned the retailer that is largely responsible for the pain dealt to the market this week by the likes of Macys and Nordstrom? We might, but we shouldn't. How about if we owned the world's largest and most profitable banks? The chip maker that dominates cloud technology? The leader in home improvement goods? The place where you connect with hundreds of friends you didn't know you had? The company run by the world's most successful investor? Again, we might, but surely we shouldn't.

If you're our client, here---in order of their weighting (taken from a representative client account)---are the top 25 companies (out of hundreds) you hold.

Apple Inc
Microsoft Corp Inc
General Electric Co
Wells Fargo & Co
Chevron Corp
JPMorgan Chase & Co
Exxon Mobil Corporation
Alphabet Inc Class A (Google)
Comcast Corp Class A
Home Depot Inc
Citigroup Inc
Facebook Inc Class A
Monsanto Co
Cisco Systems Inc
Oracle Corporation
Berkshire Hathaway Inc Class B
Alphabet Inc Class C Capital Stock
Bank of America Corporation
Medtronic PLC
Visa Inc Class A
Procter & Gamble Co
Intel Corp
Boeing Co

Being in a position to own 25 companies that the world assigns over $2 trillion of its annual spending to is, you must agree, a pretty enviable position to be in---even during those inevitable stretches when their share prices are trading lower. I.e., those visions of destitution your brain conjures up during market selloffs simply do not jibe with the undeniable fact that the institutions you own ain't going nowhere!


As you noticed, I can type again. But I can't just yet go the distance in a weekly update. So from here on I'm going to dazzle you with my charts.

Here's your third update of my 2015 versus 2011 chart (click to enlarge). You may recall that, prior to this year, the last time the market suffered a 10+% correction was in 2011. As you'll see below, this year continues to follow a similar path. If by happenstance the present pullback were to precisely match the November 2011 pullback---aside from being really freaky---the S&P would touch roughly 1960 before resuming its recent uptrend. In Dow terms we're talking another 370 or so points to the downside.

2011 VS 2015

Even though we now have a firm grasp on what we own and are, therefore, never again going to worry about corrections or bear markets, I'll go ahead and share with you the output from my weekly macro indicator exercise (click the "macro indicators" link below to download).

Each Wednesday I update a group of charts that represent what I believe to be some of the most telling data with regard to the present state of the economy and the financial markets. The color highlights represent my impression of the signal each indicator is sending. Where I highlight a title with more than one color I'm suggesting that the signal could be interpreted as either a positive or a negative.

While there are some yellow and red flags here and there, in the aggregate things look pretty okay at the moment. Which doesn't in any way mean that there won't be lots of volatility as the market digests a somewhat tighter U.S. monetary policy, volatile currencies, the implications of a whale of a commodity bear market, and, sorrowfully, the tragic events that took place in France today. Our hearts, thoughts and prayers are with the people of Paris this evening.


Thursday, November 12, 2015

Market Commentary (audio)

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Wednesday, November 11, 2015

No International Premium?

Here on the blog, and in client meetings (you clients out there), you've heard me extol the virtues of investing outside the U.S.. And, yet, it seems like it's been forever since we've earned a premium by holding the stocks of companies that call home to Europe, Canada, Australia, Japan, China, India, South Korea and so on.

Never mind the fact that, as I continually preach, the U.S. market only comprises 36% of the world's stock market opportunities---and that emerging nations are where, arguably, the greatest economic growth will occur in the years to come---at what point do we throw up our hands and say to heck it! Let's just move it all to the U.S. market and forget about all that global diversification nonsense---it isn't working anyway!

Well, take a look at the two charts below. The top represents U.S. Stocks (SP500) in white, Developed Market Stocks (EAFE) in green, and Emerging Markets (MSCI EM) in red---over the past 5 years. The bottom represents the same indices, but for November 1995 to November 2000 (amazing the similarity!).

1995 to 2000 vs 2010 to 2015

Clearly, had we been investing (which I was) during that '95 to '00 period, we might have expressed that same frustration. And what if we had? And what if we had abandoned our international positions and gone all U.S.?

Well, take a look below. This was the 10-year stretch (November 2000 to November 2010) in between.

2000 to 2010

Yep, we'll stay globally diversified!

(NOTE [added 11/12]: The charts are each normalized to zero to illustrate the % change for each index for the time period featured)

Today's TV Segment (video)

Monday, November 9, 2015

Market Commentary (audio)

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Saturday, November 7, 2015

Thursday, November 5, 2015

Market Commentary (audio)

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