“I’m Caught in a Crossfire That I Don’t Understand”

September 18, 2017-DJIA = 22,268-S&P 500 = 2,500 – Nasdaq = 6,448

“I’m Caught in a Crossfire That I Don’t Understand”[ii]

Headlines deteriorate, capital markets appreciate. It is a perplexing mystery that has many confused and incredulous. Issues such as North Korea, Charlottesville, social protests, political discord, terrorism, and natural disasters dominate the headlines. Everyone is aware of them and naturally assume the financial markets should be a tumultuous mess. Yet, markets maintain a calm levitation.

Last week the Dow Jones Industrial Average closed at all-time highs for 4 consecutive days including Friday. The S&P 500 also closed the week at a record high while the Nasdaq reached a record earlier in the week and closed slightly below that level. Even more remarkable is the fact that this is happening in September which is one of the historically weakest months.

Here are the major averages’ performance at the close of last week.


Dow Jones Industrial Average +12.7%
S&P 500 +11.7%
Nasdaq Composite +19.8%
Russell 2000 +5.5%

A partial explanation for the markets’ strength is that numerous negatives provide a wall of worry for prices to advance. In other words, there is so much bad news and it is so widely known that a lot of that risk is priced into current levels. As mentioned, a logical investor, given this news landscape, has probably already distanced him or herself from risk assets.
Another important support for record stock prices is corporate earnings growth. S&P 500 earnings have been quietly and materially expanding. For 2017’s 2nd quarter, profits grew at a double digit rate with the year-over year growth over 12%. Additionally, S&P 500 revenues have grown more than 5%. We’re not sure investors who are focused on the myriad of negative headlines appreciate this development.

Part of the story of earnings growth is foreign exchange related. The U.S. dollar has fallen in comparison to other currencies and is having one of its worst years ever. The chart below shows the value of the dollar in 2017 compared to every year going back to 1995.[iii] It is kind of a messy chart but the red line clearly shows this year’s performance. The irony of the beaten up greenback is that a Trump Presidency was supposed to be accompanied by a stronger U.S. dollar.

The weaker dollar has boosted earnings of large, international companies. The value of foreign sales in euros or yen, for example, translate into higher numbers in U.S. dollars because the euros and yen ‘purchase’ more dollars as they are ‘converted’ for accounting purposes.

Given this financial tailwind, as expected, stocks with significant international sales have greatly outperformed those that have largely domestic customers. Borrowing another chart from Bespoke, this illustrates the difference in the stocks’ gains.[iv] The blue line is S&P 500 companies with greater than 50% of their revenues from international markets and the red line are stocks that have 90% or more of their revenues from the U.S. As you can see, the “domestic’ stocks are up a little more than one-third the gain of their “international” siblings.

This also partially explains the underperformance by the Russell 2000. This index is primarily smaller businesses with domestic customers. On the other hand, larger companies that have global markets, including technology, are included in the S&P 500 and Nasdaq.

Another ‘under the headlines’ reason for the stock market’s record level is the prospect of tax reform. President Trump committed to revamping and reducing the corporate tax burden as part of his campaign. Within dysfunctional Washington, this issue has moved higher on the to-do list and is gaining some momentum.
It is unlikely that anything gets completed in 2017, however, there is a growing chance that something is done in 2018. A new tax law reducing corporate rates will have a major benefit to company bottom lines. The likelihood of something happening on this front is moving stocks higher now.
In addition to growing profits, reducing taxes could easily increase investment back into the business in the form of capital expenditures. This could have an exponential benefit as investing in their company will have a far reaching economic impact. The stock market is discounting this as well.
While the financial markets seem to be oblivious to the bombardment of negative news, it might the case of investors focused in the wrong area. It seems that we are overlooking some important economic positives. Specifically, corporate earnings are healthy and could become a lot stronger if tax reform becomes a reality. Of course, relying on Washington is a risky proposition. However, all parties realize the importance of these market expectations and will ultimately work with the opposition to accomplish something meaningful. And as we wait, we hope that the news flow improves because it’s pretty discouraging right now.

[i] Grant’s Interest Rate Observer, September, 2017
[ii] Bruce Springsteen, 1978
[iii] Bespoke Investment Group, September 8, 2017
[iv] Ibid

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

“The Smiles Are Returning To the Faces”[i]

The level at which any security trades is part fundamental valuation, part supply/demand, and part assumption regarding future events.  These conjectures concerning upcoming developments can be fickle especially as headlines impact investors’ attitude.  In fact, Wall Street’s reaction to the news is often more telling than the news itself.  In other words, when traders are bullish, good news is good and bad news is good.  Of course, in a bearish backdrop, all news is lousy.


The current mentality is that all news is good.  And to be sure, there have been some rays of sunshine that optimists can point to.  Housing has improved, there are no U.S. troops in Syria (yet), and Congress took August off.  The bad news, however, has been visible.  Whether Mr. Market is viewing all bad reports as good because it leads to more quantitative easing or is just overlooking anything negative, we think it is dangerous to believe that all problems can easily be solved by loose monetary policy.

[i]George Harrison

A recent example of Wall Street’s rose colored glasses was the markets’ reaction to the August employment data.  The report’s headline numbers were pretty good with the unemployment rate falling to 7.3% (the lowest in 5 years) and an estimated 169,000 jobs created in the month.  That brought the six month average job growth to 180,330.  Unfortunately, this is below the 200,000 target that some policy makers have set.[i]


Disconcertingly, adjustments to July and June’s data showed softer employment growth.  The estimated number of jobs added in July was reduced from 164,000 to 104,000 while June’s payroll gain was lowered by 16,000.[ii]  Some strategists emphasize the size and direction of the revisions as a sign of the job market’s, and the economy’s, health.  They are dismayed by these adjustments.


Further the decline in the unemployment rate was caused by a bigger drop in the overall labor force rather than job growth.  The number of workers employed fell by 115,000 while the overall labor force declined by 312,000.  This caused the labor participation rate (the number of people either working or looking for work as a share of the working-age population) to drop to 63.2%.  This is the lowest level of participation since 1978 or 35 years ago.[iii]


This soggy job market is clearly a drag on the economy.  Not only do consumers have less income, there are fewer and fewer workers supporting an increasing number receiving government benefits.  Perhaps QE is not all that it’s supposed to be.


Stocks immediately fell after the report but steadily clawed their way back throughout the day and finished little changed.  In the glass is half full view, the bad jobs data supported the Wall Street belief that that the Fed will not “taper” their $85 billion monthly bond purchases which have supported risk assets such as stocks.


After a monthly fall in August, equities have rebounded in September and, at the end of last week, have climbed back to approach 2013’s highs.  Here are the year-to-date performances for the major indexes.



Dow Jones Industrial Average  +17.3%
S&P 500                                    +15.2%         
Nasdaq Composite                    +23.3%

Russell 2000                              +24.1%


Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends


While there are some other noticeable blemishes (last week we had lower than expected consumer sentiment and retail sales reports), it is not affecting investor cheerfulness.  45% of the respondents to the AAII survey were bullish (the long term average is below 40%).[v]  This type of reading is often viewed as a contrary indicator (high bullish readings are bearish).


“It Seems Like Years Since it’s Been Here”[vi]


Another concern is the current high level of margin debt.  Margin is debt that is financed with investment securities used as collateral.  The amount of borrowings being financed has returned to levels that coincided with some not so pleasant times for the capital markets.  As shown in the nearby chart, the previous times that margin debt was at the current levels were March, 2000 and July 2007.[vii]  In case readers need a reminder, both dates were followed by material drops in the stock market.


Another troublesome observation is the return of market leadership by exciting, revolutionary companies.  Upstart organizations that change the playing field are a constant part of a dynamic economy.  The United States has experienced this creative destruction regularly.  The automobile industry in the early part of the 20th century was followed by radio and then TV.  More recent, of course, are computers, internet, and cell phones in the information technology area.  In addition, medicine has experienced incredible bio-tech advancements, robots are becoming more prevalent, and energy sources are being discovered and recovered from heretofore unheard of areas.


As stated above, current investment prices discount future revenues and profits.  And some of the companies offering new products and services seem to have unlimited potential.  The debate over what to pay for this prospective success is being fought in the current stock prices.


We offer some examples.  Tesla Motors, the manufacturer of electric cars, carries a $22 billion valuation in the stock market while their trailing 12 month (TTM) sales barely exceed $400 million.  To be sure, $3.50 per gallon of unleaded allows for alternatively powered vehicles.  However, in our opinion, a price-to-sales multiple of 55 times discounts some significant growth.


Yelp describes their business as “an online urban city guide that helps people find places to eat, shop, drink, relax, and play based on the informed opinions of a community of locals in the know”.[viii]  Investors must have a pretty high outlook for this business because the stock’s worth in the markets exceeds $2.5 billion.  We are not sure exactly how Yelp generates revenues but they are less than $150 million.  Another bothersome detail for Tesla and Yelp is that they are both losing money.


Even the most primitive Luddite knows what Facebook is.  While many will assign “failed IPO” to this social media leader, it has undoubtedly changed the way we communicate.  The stock has returned to favored status recently.  Mark Zuckerberg’s venture carries an $84 billion market capitalization as it generates $5 billion in sales.  One distinction from Tesla and Yelp, is that Facebook has a bottom line.  At a price in the mid-$40’s, the price-to-earnings is 190.


Energy exploration in shale formations is dramatically changing our economy.  Cheaper energy is driving a manufacturing renaissance in the U.S.  New plants are being built throughout the mid-west and south.  Furthermore, the abundant natural gas is being targeted as an eventual American export.  Many areas of the world are currently importing liquefied natural gas as an important energy source (Japan and Europe are two large importers).


Cheniere Energy is in the process of building one of the first exporting facility in the U.S.  If all goes as planned, it will be operational sometime in 2015.  Wall Street can not contain their excitement.  The stock trades at a market capitalization over $7.5 billion despite only $260 million in sales and substantial red ink on the bottom line.


Returning to the overall landscape, the stock market has had many reasons which could spark a decline.  While August was lower, it was shallow in comparison to 2013’s move.  Investors returned from the Labor Day weekend and bid prices higher.  There appears to be little to worry about.  Of course this is much different from autumn 2012 when worries over the election, Europe, and the fiscal cliff caused investor angst and pessimism.


A year ago we advised clients that a lot of bad news was priced into the markets.  It turned out to be somewhat correct despite a nasty selloff after the election.  With the current environment so cheerful, we fear there is little risk associated with the future outlook for the economy.  We hope for continued expansion but fear the markets’ expectations.



[i] Wsj.com, September 6, 2013

[ii] ibid.

[iii] Bloomberg Business Week, September 6, 2013

[iv] The Wall Street Journal, September 14, 2013

[v] aaii.com

[vi] George Harrison

[vii] BOA/Merrill Lynch Global research.

[viii] Yahoo.com






This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

“There Shall be Disaster After Disaster, Rumor After Rumor”

September 5, 2017 – DJIA = 21,987- S&P 500 = 2,476 – Nasdaq = 6,435

“There Shall be Disaster After Disaster, Rumor After Rumor”[i]

Contrary to what you might expect, the above is not a recent CNN headline describing the Trump administration. Rather it was written around 600 B.C. by the profit Ezekiel, who was exiled to Babylon. He was describing his vision of the unthinkable decline and ruin of Jerusalem which ultimately took place. It was an accurate description of what took place 2,000 years ago and, remarkably, today’s current events.

While it seems that we are undergoing a modern fulfillment of Ezekiel’s prophecy, it is amazing that this has had no impact on the capital markets. The stock market is within a few percentage points of all-time highs, bond yields have fallen, and the dollar has been drifting lower.

The stock markets below the surface view, however, is less tranquil. The Dow Jones Transportation Average peaked out in July and as of August 24th had given up all of 2017’s gains (it bounced higher last week).

Smaller cap stocks have also been moving lower. The Russell 2000, S&P Smallcap 600 and S&P Midcap 400 declined in August and all three indexes are lower for the 3rd quarter. The Russell, as measured from the July high to the August low, fell 6.4% in 4 weeks.

Even within the S&P 500 (large cap index), there’s some blemishes as the smallest of these large companies are lagging. When the index is broken into deciles by market cap size, incredibly the 10th decile (the smallest market cap of the 500 stocks) is down 2.11% year-to-date. Contrasting this with the entire S&P 500’s 10% year-to-date gain, the under-performance is shocking.

Of course, the S&P 500 has FANG which has pushed the index. FANG is the anacronym for current stock market darlings Facebook, Apple and Amazon, Netflix, and Google. And as the index is weighted by market cap, the larger companies have a bigger influence. With Facebook, Apple, Amazon, and Google (Alphabet) all in the top 10 market values, they have been especially influential as these stocks are materially higher for the year.

Also, the trend toward passive investing has a self-fulfilling aspect as the S&P 500 is a popular way to gain equity exposure in this approach. And when money goes into the index it buys more Apple, Amazon, Google, etc.

Here are the year-to-date numbers for the major indexes. Note the disparity between the Russell and the Nasdaq. Is this a sign that the broader market is weakening and the bigger stocks will follow? Or is this an opportunity for contrarian investors to enter the small cap market?


Dow Jones Industrial Average +11.3%
S&P 500 +10.6%
Nasdaq Composite +19.5%
Russell 2000 +4.2%

The Nasdaq’s 2017 gains are noteworthy and, as expected, this has pushed the size of the technology sector to 23.5% of the S&P 500. It would be even greater if Amazon was considered a tech stock. It might be natural to assume that technology’s popularity has pushed the sector’s valuation to unreasonable levels. Surprisingly, this is not the case. The current P/E based on trailing earnings is around 23. As the chart below shows, this is slightly above the average of the past 20 years.[ii]

Another important stock market trend for 2017 is the significant lagging of value stocks as compared to growth stocks. Below is another Bespoke chart illustrating this difference.[iii] While this only accounts for stocks within the S&P 500, the spread is not typically this wide. As mentioned with the disparity of large cap vs. small cap, there will be a time when value investing outperforms growth.

The capital markets are facing many economic, political, and societal crosscurrents. And they are doing it at a historically troubling time of the year as September and October can be volatile months for the markets. That the markets have not suffered any significant setbacks given developments such as Charlottesville, North Korea, a possible U.S. federal government shutdown, and Hurricane Harvey is confounding. Maybe it’s a sign of underlying strength or it could be a delayed reaction with forthcoming pain.

Regardless of what the financial markets do, our thoughts and prayers are with those impacted by Harvey and those who will be hurt by Irma.

[i] Ezekiel, chapter 7, verse 26
[ii] The Bespoke Report, September 1, 2017
[iii] Ibid

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905