“October. This is one of the peculiarly dangerous months to speculate in stocks.”

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA


October 22, 2018 – DJIA = 25,444 – S&P 500 = 2,767 – Nasdaq = 7,449


“October.  This is one of the peculiarly dangerous months to speculate in stocks.”

This was written by Mark Twain in his novel “Pudd’nhead Wilson”.  Twain underlines how dangerous the financial markets can be in October. As a reminder, the month has witnessed two stock market crashes with the anniversary of the 1987 version being last Friday (October 19th).  In addition to stocks, there have been debt crises, foreign currency melt downs, and general capital market turmoil in past Octobers.

Mark Twain’s recommended restraint regarding speculation in October extends to some other months.  Within the novel, the above quote continues “The others are July, January, September, April, November, May, March, June, December, August, and February”.

Concerning the markets, the wisdom of Samuel Clemens (Mark Twain’s real name) is extraordinarily underestimated and goes beyond the general admonishment of speculation.  His warnings about October have proved to be incredibly accurate, but the most amazing thing about this was that Twain penned this in 1894!!  Obviously this is well before the Panic of 1907 and the Stock Market Crash of 1929 both of which took place in October.  Thankfully, Samuel Clemens lived in the 19th century and was allowed to focus on writing.  Otherwise, someone with this level of insight in the 21st century would have a hedge fund in Greenwich, Connecticut, robbing us of his real talents.

Returning to October 2018, it is attempting to make its own historical mark.  It’s on pace to be the worst October since 2008.  The S&P 500 and Nasdaq are enduring their worst start to any month since 2011.  This is an important statement as there have been several nasty months in that time such as August 2015, January 2016 and February 2018.

Stocks have widely retreated this month.  Below are the major averages’ returns for October and year to date at last Friday’s close.  As you can see, much of 2018’s gains have been given up in the first few weeks of October.

October 2018
Dow Jones Industrial Average -3.83% 2.93%
S&P 500 -5.02% 3.52%
Nasdaq Composite -7.42% 7.90%
Russell 2000 -9.11% 0.43%

So what is haunting the markets?  There is a long and wide ranging list of possibilities.  Issues such as the Italian fiscal debacle and its battle with the European Union.  Tariffs and trade wars is another worry.  Widespread social division does not help matters.  The markets could be concerned that the U.S.’s mid-term elections could thwart Trump’s economic initiatives.  And, of course, add in hot spots like Russia, Saudi Arabia, and Turkey.

While these factors are most likely contributing to investors’ anxiety, there are other important developments that are changing the financial background.  To borrow from The Food Network’s “Diners, Drive-Ins, and Dives”, let’s call these the ‘Triple D’s’ – the dollar has strengthened, the debt markets are facing higher interest rates, and there appears to be a decline in corporate earnings.

First, the U.S. dollar has risen since the spring as compared to other currencies.  The dollar is an important component of global trade as most transactions are done in U.S. dollars.  When the greenback appreciates, it takes more of the local currency to do a transaction.  This results in higher costs.

Another headwind caused by stronger dollar is higher interest costs for foreign borrowers.  Non-U.S. corporations and governments have sold debt in the U.S. during the past several years.  As the local currency loses ground to the U.S. dollar, it costs more money to make the interest payments.

A strong dollar also hurts U.S. companies that sell in foreign markets.  In dollar terms, the price of the product or service provided by a U.S. company increased in terms of the local currency.  In other words, if the dollar rises against the euro, the price of Microsoft’s software is higher for a European customer.

As a further illustration of this, PPG issued a warning of their quarterly results in early October – their third quarter financial results will be lower than forecast.  One of the reasons given was that foreign sales were less than expected due to the stronger dollar.  PPG is a typical industrial company which means that many other international organizations may share this challenge.  The damage from a strong dollar could become a repeated theme throughout this earnings season.

The debt markets are another complication facing investors. Interest rates have been churning higher all year as a function of the Federal Reserve, a stronger economy, fiscal deficits, and inflation.  Higher interest rates increase borrowing costs and pressure corporate bottom lines which might be what the markets are focused on.

Another important part of this development is that it denotes a change in the landscape.  Interest rates have been declining since the early 1980’s.  A shift in this trend could have far reaching impacts.  On top of tighter money and higher interest expenses, the cost of capital will be greater which bring enlarged scrutiny on business decisions.   Perhaps the biggest adjustment will be that many investors and corporate CFO’s have never experienced this type of market environment.  This could become a very big part of the capital markets over the next several years.

The final “D” in our Triple D analogy is declining earnings.  To be sure, corporate earnings have been very strong and that should not change with 3rd quarter reports.  However, future guidance may not be able to sustain the growth of recent quarters.  Returning to the PPG warning, the company also blamed higher logistic and raw material costs.  Again, these are not unique to PPG and are likely widespread across corporate income statements.

Another example of pressure on corporate earnings is in computer chips and semi-conductors.  During the past two months, Morgan Stanley, Raymond James, and Goldman Sachs lowered their forecasts for the chip industry and their suppliers.  The Wall Street firms each referred to higher inventories and lower demand.  As a reminder, chips have become an essential part of our everyday lives.  They are in everything from automobiles to washers and dryers.  If there is a slowdown in chip sales, it could signal a peak in the economy which is not what stocks are expecting.

The remarkable effect of October on the financial markets returns in 2018 as the first three weeks have been among the worst in memory.  It seems that this is part of a changing financial landscape.  While the headlines have focused on trade wars, politics, and international problems, the real issues might be interest rates and foreign exchange.    Past Octobers have offered opportunities despite this painful process.  It’s like a giant financial game of trick or treat.

2018 2nd. Qtr. Kildare Asset Mgt.-Kerr Financial Group client review letter

The following is a copy of the 2nd quarter letter sent to clients. It reviews the markets and the client account’s activity and performance for the 2nd quarter and year to date 2018.

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA


The capital markets rarely travel in a straight line.  While bull markets can last for years, they normally have multiple pullbacks within them.  And these corrections can be material with magnitudes of more than 10% and can last several months.  Determining changes in direction of these various time frames is critical for managing risk.

2018 provides clear examples of significant short term moves not disrupting the longer trend. The stock market started the year by continuing 2017’s rally which was an abnormally smooth steady climb that set records for its lack of volatility.  The major indexes climbed into late January setting daily record highs along the way. Then stocks reversed direction and quickly lost 10% in two weeks.

The stock market stabilized in late February and recovered during the second quarter.  However the quarter included a couple of quick drops – one in April and another in June.  Yet, despite this volatility, the multi-year bull market marches on.

The advance that ended in late January was accompanied by extreme bullishness.  As a reminder, sentiment indicators are normally viewed as contrarian or suggestive of a move in the opposite direction of the signal.  In this case, a high level of optimism could be a sign of a top and then a decline.  This is because investors who are bullish have already done their buying and may not have much dry powder left.  This is especially so at extreme levels and it worked in January

Given the rebound from February’s lows, investors are scouring through the countless statistics for a clue on the strength and potential longevity of the second quarter’s rebound.  While such things as GDP and employment data point to a strong economy and higher corporate earnings, there is a couple of breadth indicators that might cause some worry.

Stock market leadership by the FANG stocks (Facebook, Amazon, Apple, Netflix, and Google) has been one constant throughout 2018.  These stocks have driven the Nasdaq Composite and Nasdaq 100 indexes which have outperformed.  In the first six months, Netflix has more than doubled and Amazon is up around 50%.  The 5 largest components of the Nasdaq 100 accounted for over 60% of the first 6 months gains.

This is very narrow leadership which could be troublesome.  The higher number of stocks participating in an advance usually translates into stronger and more sustainable rallies.  There is nothing preventing a broadening to take place but it typically happens after a bottom such as the one in February.

TPW Investment Management conduct concentration studies and they posted some findings in late June.  Since 2000, when the top 5 stocks’ performance represent less than 25% of the yearly attribution (widespread participation), the S&P 500 average annual return was 19.6%.  When the top 5 represent over 25% (more narrow leadership), the average annual return for the S&P 500 was only 1.96%.  In late June, the attribution of the top 5 S&P 500 names accounted for 52% of the year-to-date returns.[i]

Obviously this indicator suggests challenges ahead.  On the other hand, data from 2000 may not be a large enough sample to be useful especially given that in contained an outlier (the housing meltdown and the financial crisis).

Nevertheless, it does highlight a concern that needs to be watched.  As The Wall Street Journal included in its review of the 2nd quarter, “The one-directional nature of the stock rally has left investors increasingly worried that a market whose gains have been heavily dependent on technology stocks could reverse sharply in the second half of the year.”[ii]

The FANG’s out performance in the second quarter is clearly shown by the Nasdaq Composite’s doubling of the S&P 500’s return – 6.33% vs. 2.93%.  The Dow Jones Industrial Average was up less than 1% and showed a year-to-date loss on June 30th.  Here are the details of the major averages for the 2nd quarter and the first 6 months of 2018.

2nd Qtr. 2018
Dow Jones Industrial Average +0.69% -1.81%
S&P 500 +2.93% +1.67%
Nasdaq Composite +6.33% +8.79%
Russell 2000 +7.43% +7.0%

Using a size weighted average, here is how the average Kildare Asset Management-Kerr Financial Group client’s account performed. This is calculated after all fees and expenses.

2nd Qtr               2018

Kerr Financial Group – Kildare Asset Management




It was a jittery three months for the capital markets.  Tariff threats and potential trade wars that would pressure global growth were a constant investor fear.  The Federal Reserve raised interest rates in June and forecast more hikes. International turmoil continued with concerns over Turkey, Italy, and Russia.  The dollar strengthened in foreign exchange trading which resulted in intense stress in the emerging markets.  To be sure, all markets have things to worry about but these represent an imposing collection.

As a result of these economic and international obstacles, I focused attention to managing risk in your accounts.  Primarily, this was done through mutual funds that move in the opposite direction of the S&P 500.  While this position helps reduce overall market risks to your account, it does not eliminate them.

This mutual fund was a slight drag on account performance in 2nd quarter and this has continued in the 3rd quarter as the stocks moved higher.  However, I believe including this in the strategy is an important piece of controlling risk during this chaotic timeframe.

There are other positions that underperformed in the quarter.  Athene Holding Ltd and FGL Holdings are similar companies as their main business is annuity underwriting.  Athene declined 8.3% and FGL declined 9.3% in the 2nd quarter.  Both stocks were pressured by a flattening yield curve.

One key to successful underwriting is the spread between the yield offered in the annuity and the yield earned by investing the premiums.  During the second quarter the 10-year Treasury yield (a benchmark used to estimate insurance investment earnings) declined from a May peak over 3.1% to under 2.9% at the end of June.  Investors chose to sell first without waiting to see if the declining yields actually hurt earnings.

Athene had two other strikes against it.  One part of the business didn’t produce as much growth as expected.  Secondly, company management told analysts on the first quarter earnings conference call that they were not planning to use cash to buy back stock. Instead they see the better use of capital in growing the business and see many opportunities to do this.  Disappointing growth and not buying back undervalued stock are two things that puts you in the Wall Street dog house.  So entered Athene Holdings.

FGL Holdings has different blemishes.  FGL did an IPO to raise capital to buy the FGL business.  It was an underperforming annuity business.  The two main parties behind the takeover (William Foley – CEO of Fidelity National Financial which has been a long time successful client holding and owner of the Las Vegas Golden Knights hockey team that made the Stanley Cup finals combined with The Blackstone Group to turnaround FGL) have proven track record in developing these kinds of operations.

This new management team is focused on getting an A.M Best rating upgrade to “A” (the highest rating).  This is the result of a strengthening of the balance sheet through more capital and better investment positioning.  This decision is expected later this year.  Brokers and insurance agents are reluctant to sell less than “A” rated products so this could greatly expand their sales channel.

Both companies are trading at low price-to-earnings multiples and have strong balance sheets. Both have unique initiatives that could transform them into bigger and more profitable organizations.  I think patience will be rewarded.

SMHI, which was performed well in the 1st quarter, helped in the 2nd quarter as well. They provide global marine and support transportation services to offshore oil and gas exploration and production wells.  The stock was up over 21% from April through June.

Graham Corporation is a position that was added at the beginning of the 2ndquarter. The company engineers and builds the interworking chemical plants and refineries.  This is a small company at about $275 million of market capitalization and $100 million of revenues.  Graham has a very strong balance sheet with over $7.50 per share in cash and no long term debt.  This is a cyclical business that is tied to industrial capital expenditures.  The company suffered with the collapse of crude oil prices but are rebuilding sales and its backlog.  In addition to rebounding sales, Graham wants to grow through acquisitions.  The stock was up 20% during the quarter.

Understanding and recognizing risk is important to successful investing.  2018’s second quarter provided a good example as the capital markets had to sift through many complex developments that could turn into significant headwinds.  While large cap technology stocks outperformed, the rest of the stock market traded more defensively.  This could remain the theme of the second half of the year.  It will be important to balance risk management while spotting the opportunities as they arise.

Once again, thank you for your continued trust.  Please contact me with any questions.


Jeffrey J. Kerr, CFA

Kerr Financial Group

Kildare Asset Mgt.

45 Lewis Street – Lackawanna RR Station

Binghamton, NY 13901

[i] www.tpwim.com, June 27, 2018

[ii] The Wall Street Journal, June 30, 2018