Republicans and Russians and Bulls…. Oh My

/0 Comments/in /by
Donald Trump was sworn in as the 45th President of the United States on Friday.  The inauguration was as anticipated including all of the tradition and pomp.  The oath of office, the speeches, parades, balls and celebration, all were done as expected.  Looking forward, it may be a while before we get this degree of predictability out of the Trump administration again.
Everyone knows the general direction the Trump administration wants to move.  There is risk that the implementation of this direction gets complicated.  Issues such as tax policy, cabinet appointees, trade policy, fiscal budgets, foreign relations, and regulations are things that need to be worked out and wrinkles could easily arise.
On election day, the stock market had a sudden change of heart regarding Donald Trump and has signaled its approval ever since.  There is little debate that Washington’s economic influence will shift from hindrance to supportive.  Lower corporate tax rates, reductions in business regulations, and fiscal programs and incentives will boost economic growth.
An important question centers on how much of these positives have already been discounted.  In anticipation of these tailwinds, the Trump rally has carried stocks to record highs.  As U.S. equity valuations are above the historically normal levels, this then leads to another question – are we getting a little ahead of ourselves?
If the new administration’s transition goes smoothly and its policies and programs get implemented without problems or delays, the economic impact could arrive quickly.  This would be stock market friendly for both the current levels as well as higher prices later in the year.  However, if President Trump and his team encounter problems with execution of the plans and programs, the stock market could correct.
History shows that a president’s first year in office can be tough.  Below is a graph showing the presidents that had a recession in his first year.[ii]  This might be caused by uncertainty surrounding a change of direction or battles with Congress or decision making errors. At this point, President Trump might be an exception as there no signs of a recession.  Still there are many variables that still could cause problems such as trade wars or a spike in inflation.
If the January stock market is any indication on the economy or new president, the short-term message is unclear.  After moving higher in the first week, U.S. stocks have traded sideways.  Last week the major averages closed marginally lower.  The Nasdaq, which underperformed after the election, has been the leader in 2017.
2017 YTD
Dow Jones Industrial Average                                              +0.3%
S&P 500                                                                                +1.5%
Nasdaq Composite                                                                +3.2%
Russell 2000                                                                          -0.4%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
In fixed income, bond yields rose last week but are around the same level as they started the year.  The 10-year Treasury note closed the week at 2.466% up from 2.38% the prior week.
One of the most popular predictions for 2017 is that the U.S. dollar will rise against other currencies.  Expectations for higher interest rates together with stronger economic growth make the greenback more desirable.  Last week, however, the dollar index fell and it is down 1.47% in January.  Maybe dollar bulls have gotten tired.
Commodities are higher in 2017 as the CRB commodity index is up 0.78% for 2017.  Crude oil and natural gas are lower but precious and base metals are higher.
Although it is very early in the earnings reporting cycle, the results have not disappointed.  63% of reporting companies have exceeded EPS forecasts which is about average. The story on the revenue part of the income statement is different.  More than half of the reporting companies have missed analysts’ revenue estimates.[iii]  The amount of companies reporting will be much higher in the next few weeks and we’ll keep readers informed how the results are.
Putting everything together, we think there are a few consensus views for 2017’s capital markets.  Many strategists and managers are calling for U.S stocks to be moderately higher for the year.  It seems that the expectations are for high single digit gains for equities.  As mentioned above, conventional wisdom also looks for a rising dollar and higher interest rates.  These experts appear to not overly concerned with potential obstacles and potholes as they believe all of them are manageable.
We would like to share in this optimism but have some concerns.  First, current events rarely play out as smoothly as everyone expects.  Given the proposed and expected changes in Washington, there is a lot that could go awry.  With stocks at record levels and elevated valuations, any deviation from a smooth Trump transition that results in stronger economic growth might cause stocks to dip.  If the stock market develops some doubts over President Trump or the economy, we would expect prices to correct.  We wouldn’t expect a nasty bear market, but a correction that adjusts valuations to more normal levels.  It promises to be an interesting year and we look forward to the opportunities in front of us.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
168 Water Street
Binghamton, NY 13901
[i]  The New Yorker, January 2017
[ii] DoubleLine Funds, January 2017
[iii] The Bespoke Report, January 20, 2017

Brother, can you spare a dime?[i]

/0 Comments/in /by
Actually, can you spare 4 dimes?  Last Friday the Dow Jones Industrial Average came within less than one half of one point ($0.37 to be exact) of 20,000.  Throughout the afternoon there were several attempts to get to that level but the bears defeated each try.  Perhaps they should have passed the hat among the floor brokers on the New York Stock Exchange to get the spare change totaling $0.37 and then start the celebration.  On second thought, it’s likely that no one had anything less than a $20.
While round numbers aren’t supposed to mean anything, there was disappointment in getting so close to this number without pushing through.  Below is an hour by hour chart of the Dow on Friday showing how many times and how close we got to 20,000.[ii]  It was close but no cigar.

 

 

Not reaching 20,000 is a calculation anomaly and there’s no real significance to surpassing it.  But, obviously, there were large sell orders at that point on Friday.  And while there was some dismay over not getting there, the stock market had a good start to 2017 as the Trump rally rolled on.  The three major averages had good weeks and all reached new intraday records on Friday.  Here are the numbers for the first week of 2017.
YTD 2016
Dow Jones Industrial Average                                                      +1.0%
S&P 500                                                                                        +1.7%
Nasdaq Composite                                                                        +2.6%
Russell 2000                                                                                  +0.7%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
Interestingly, last week’s leaders were December’s laggards.  For example, health care, which was the only sector to post a meaningful decline in 2016, was up almost 3%. On a wider measure, if you divide the S&P 500 into 10 deciles, the two worst performing deciles of 2016 led the way last week up 3.52% and 2.24%.  At the other end of the spectrum, last year’s best performing decile was up only 1.08% last week, last place.[iii]   To be sure, it is only one week but there was a clear rotation as we began the new year.
Bond yields ticked up on Friday after December’s employment report showed that job growth was a little under expectations but wages were up.  Since this might be an early sign of inflation which could lead to more Fed interest rate increases, yields moved higher (lower prices).  The yield on the U.S. treasury 2-year note closed at 1.19%.  The 10-year note’s yield finished at 2.41% and the 30-year bond ended the week at 3%.
Fixed income yields spiked higher after the election driven by forecasts of stronger economic growth and fears of larger government borrowings to fund President-elect Trump’s infrastructure programs.  On a short to intermediate term, it appears that yields peaked in mid-December and have trended lower since.  We would expect yields to drift a bit lower before resuming their climb.  For those bond fund holders that got punished in the November and December selloff, this might present an opportunity to lighten up.  Or at least shorten maturities.  We would look for bonds to resume their selloff (higher yields) later in the year unless there is a shock or signs of a recession begin to develop.
As we know, stocks have moved a long way since the election.  The potential for a more business friendly Washington has increased optimism concerning the economy and the stock market.  And while the regulatory landscape will change, the speed and the degree of this transformation is unknown.  This heightens the risk that stock prices have gotten a little ahead of themselves.
To illustrate this point, below is a chart showing the S&P 500 price and the trailing earnings.[iv] The bright blue line represents the S&P 500 price and the dark blue line is the index’s trailing twelve month earnings per share (EPS).  The two lines generally move together but, as shown, the lines have recently diverged. In order for this to return to its historical relationship, one of two outcomes must take place – 1) higher earnings or 2) lower stock prices.
Of course, it’s possible that the lines move farther apart with the S&P 500 climbing higher.  And, there is general agreement that corporate earnings will rise in 2017 due lower tax rates and a reduction in costly regulations.  However, current valuations are elevated as the rally since election day has priced in a lot of these positive developments.
While that graph shows the S&P 500, the chart below focuses on two of Wall Street’s recent favorites.  Goldman Sachs price jumped 30% in the weeks after the election and has played a huge part in getting the Dow to the 20,000 neighborhood.   Caterpillar is another darling that is materially higher since the election.  These two companies are poster children for the upcoming economic improvements.  Goldman Sachs will benefit from reduced banking regulations and Caterpillar will be helped by increased energy exploration and infrastructure activity.
The chart clearly shows how GS and CAT’s stock prices have been moving from lower left to upper right.[v]  Further it shows a dramatic widening between the stock price and earnings.  While analysts will probably raise the earnings estimates for both companies, they must move them a lot higher to get valuations back into a normal range. Otherwise we could see pressure on their stock prices.  And since they are market leaders, this could have a broad impact.
An area that we’ve been encouraging clients to consider is the international markets.  Both the developed and emerging markets are out of favor and could represent opportunities.  They have underperformed the U.S. stock markets since the Great Recession.  Moreover, these markets have been further pressured during the last couple of years as the U.S. dollar has strengthened and commodity prices have imploded.
One of our themes for 2017 is that we’ll see a consolidation for the greenback.  If this happens, it will offer some relief to the emerging markets.  Also, from a valuation perspective, international stocks look appealing.  Here is graph showing the valuation of the U.S. stock market vs. an index of developed markets and an index of emerging markets.[vi]  Both developed and emerging markets trade at much more reasonable valuations as compared to the U.S.
Despite falling short of Dow 20,000, the U.S. stock markets had a good start to 2017.  It’s said that the key to a good prediction is to forecast an event but don’t provide a timeline.  So with that in mind, we predict that the Dow will exceed 20,000 but remain mum on when.  In addition to that valuable nugget, we expect a digestion or even a correction for U.S. markets.  How severe a pullback, if we get one, is unknown.  But it could be a good entry point as we expect U.S. equities trade higher later in the year.  For this reason, we are keeping the “Dow 20,000” hat nearby.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
168 Water Street
Binghamton, NY 13901
[i] Harburg and Gorney, 1930
[ii] Bespoke Investment Group, January 6, 2017
[iii] ibid
[iv] DoubleLine Funds, January 2017
[v] Zerohedge, January 2017
[vi] DoubleLine Funds, January 2017

“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge. “i

/0 Comments/in /by
In this season of traditions, resolutions and predictions for the New Year are especially popular ones.  But for anyone making (or reading) 2017 forecasts, we have a question – don’t you remember 2016?  Brexit?  Trump?  The Cubs?  It was the year that made virtually every professional prognosticator look pathetic.  Having lived through 2016, how can anyone make predictions for 2017 with a straight face unless it’s the result of an uncontrollable character flaw?
Indeed, last year’s surprises covered many parts of our lives – politics, sports, weather, and of course, the markets. Concerning finance, the year started in turmoil with global capital markets falling (U.S. stocks fell over 10% into February marking it as the worst start to a year for the stock markets).  Then, remarkably, the U.S. stock market regained these losses before the end of the 1st quarter.
Of course, this was followed by Brexit in June with its 2-day plunge and then yet another historic recovery.  This bounce in stocks led to an important breakout above a two-year trading range which continued into the U.S. elections.  The market gyrations and volatility on election night as well as Donald Trump’s victory were not expected.  After the election, U.S. equity markets had a much stronger tone and rallied into year end.
Here are the year-to-date returns for the major averages.  Also, we are including the move from the election which shows how much of the year’s performance happened in a six-week period.
YTD 2016            Since election
Dow Jones Industrial Ave.                  +13.4%                  +7.8%
S&P 500                                              +9.5%                    +4.6%
Nasdaq Composite                              +7.5%                    +3.6%
Russell 2000                                        +19.5%                  +13.5
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
 
Below is a graph of the S&P 500’s 2016 journey broken down by month.ii  The graph’s line is green in positive months and red in negative months.  Also, the monthly returns are at the bottom of each month.  The graph illustrates the year’s big moves we mentioned above.  It shows how dramatic the January/February drop was.  Further, the amazing Brexit move stands out at the end of June and, finally, it is easy to spot the trading around the election and the climb into mid-December.
The fixed income markets had some volatility as well. Bonds had a strong first half of 2016, some headwinds in the 3rd quarter, and a bad 4th quarter.  For the buy and hold investor who doesn’t follow the developments day-to-day or even month-to-month, it may have appeared to be another boring year.  The 10-year treasury note started 2016 at 2.25% and ended the year at 2.45%.  Pretty innocent on the surface.  But this masks some volatility during the year.
At the beginning of 2016, the markets were expecting 3 or 4 rate increases by the Fed.  Instead, as the economy lagged, rate hike expectations were pushed further into the future and accommodative monetary policies continued.  This helped bonds as yields fell (higher bond prices) and by the beginning of July the yield had dropped to 1.38%.  The yield moved higher in the 3rd quarter as the job market was strong along with some other positive data.  From the election to mid-December, yields exploded higher (bond prices plunged) as the markets anticipated higher economic growth under a Trump administration as well as larger fiscal deficits.  On a total return basis, the 10-year note lost 3.69% in 2016.
Crude oil spiked 45% in 2016 while natural gas climbed even higher, up 59%.  Both commodities started from depressed levels after imploding in 2015.  Gold had a strong year into September but declined badly in the 4th quarter as the dollar strengthened and interest rates moved higher (both bad for gold).  For the year, it was up 8.4%.
2016 was a good one for the dollar as the index (vs. a basket of currencies) rose 3%.  Against the major currencies, the greenback was up 3.2% against the euro, down 2.7% vs. the Japanese yen, and up 7% against the Chinese yuan.  Some bigger notable moves included a 19% rise against the British pound and a 14% decline vs. the Russian ruble.
Turning to international stock markets, Brazil spiked 39% and Canada climbed 17%.  Within Europe, Germany and France were up mid-single digits.  Japan was flat and China fell 12%.
Below is a diagram of 2016 returns for various global asset classes.iii
Let’s hope that the Trump presidency has a better start to the New Year than Mariah Carey.  While the optimism surrounding the economy and stock market should carry into the new year, expectations are lofty.  Tax reform, regulation reductions, and infrastructure programs are assumed to implemented quickly and easily.  In general, the consensus is that Washington turns into an efficient machine that will support the economy while still effectively addressing society’s problems.  At the risk of making a 2017 prediction, that’s not going to happen.
And how long the Trump honeymoon lasts is a critical question concerning the rally in equities.  Traders have become so smitten with the president-elect that stocks charts are transformed into billboards supporting the new administration as the one below was entitled “Make America Great Again”.iv
Unmet expectations and implementation delays could result in disappointment which could trigger a correction.  Of course, it’s unlikely that the markets would wait for an actual misstep to occur, but rather, some selling might take place before the new administration learns where the bathrooms are.
History offers some thoughts on President-elect Trump’s 2017.  Since 1928, there have been four times that a Republican replaced a Democratic President.  In each of these four examples, the S&P 500 declined at least 6.5% for the new president’s first year.v  Maybe a statistical coincidence or maybe a correlation.  Nevertheless, something to keep in mind as the term begins with so much enthusiasm and optimism.
While it will be tough to compete with 2016, this year could offer its own fireworks and surprises.  There are important elections in Europe (Germany and France) and we know how they changed things last year.  International relationships and trade policies will be altered which will have unintended consequences.  U.S. monetary policy should be tighter than recent years and, who knows, we may even get a budget out of Washington (something that hasn’t happened in years).
At this time last year, no one could have predicted what eventually happened in 2016.  It is equally impossible to accurately foresee 2017.  Whatever happens, there will setbacks as well as opportunities.  Here’s hoping a lot of the latter and few of the former.
Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
168 Water Street
Binghamton, NY 13901
i Lao Tzu, 6th Century BC Chinese Poet
ii Bespoke Invesment Group, The Bespoke Report 2017
iii Deutsche Bank, Bloomberg Finance LP, Mark-it Group
iv Stocktwits, Mike DiBari
v Bespoke Invesment Group, The Bespoke Report 2017

2016 3rd quarter Kildare Asset Mgt-Kerr Financial Group client review letter

/0 Comments/in /by
The 3rd quarter began as the dust from the Brexit vote was still settling and ended with widespread worries over European banks, when the Federal Reserve would raise interest rates, and the U.S. elections. In between, there were concerns over a slowing U.S. economy, debates on the impact of negative interest rates, and rumors that OPEC would cut production to try to boost the price of crude oil.
U.S. stocks began the quarter by breaking above a 2-year trading range as markets bounced from the Brexit selloff.  After this move, markets traded in one of the tightest ranges in history as we went through a 26 day stretch without a 1% move for the S&P 500.    September saw volatility return at the beginning of the month with a one-day 400 point Dow drop and a partial recovery into the end of the quarter.
Despite the lengthy list of worries, the major averages reached record levels during the quarter – the Dow and S&P 500 in August and the Nasdaq and Russell in September. But these new records don’t equate into a block buster 2016.  It’s important to keep in mind that these all-time highs represent mid-single digit year-to-date returns.
However, these levels are over 20% higher from the February lows.  As a reminder, 2016 was the worst start in history for the stock market as global equities plunged for the first six weeks of the year.  It’s been a remarkable recovery especially in the face of the challenges.
While financial headlines focused on the record levels, the markets offered some subtle changes that may signal a transition of leadership.  Stock indexes have recently been driven by a small group of large cap companies.  This was especially evident in 2015 as the FANG stocks dominated the landscape.
A significant shift took place in the 3rd quarter.  What was lagging in the first six months of the year became the leaders in the 3rd quarter.  Also small was better than big as the Russell and the Nasdaq Composite (both have material small cap components) gained the most in the quarter.  Size even mattered within the S&P 500 as the smallest one-third outperformed and the largest companies.  (Please keep in mind the ‘smallest’ companies with the S&P 500 have market values that exceed $4 billion dollars so they are not small caps.).
Overall, notwithstanding the many cross currents, the 3rd quarter was the best so far in 2016.  Here are quarterly and year-to-date performance numbers for the major averages.
3rd Qtr. 2016      2016YTD
Dow Jones Industrial Average                                 +2.1%            +5.1%
S&P 500                                                                   +3.3%           +6.1%                     Nasdaq Composite                                                   +8.8%            +6.1%
Russell 2000                                                             +8.7%           +10.2%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
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.
3rd Qtr. 2016            2016YTD                   +3.04%                   +11.08%
Within the specifics of your account, the closed end funds that I covered in your 2nd quarter letter continued to do well.  To review, we took positions in closed end funds that focused on high yield corporate bonds, corporate loans, and taxable municipal bonds.  Some of the names are Blackstone Strategic Credit Fund (BGB), Blackstone Floating Rate Fund (BSL), Blackstone Taxable Municipal Bond Trust (BBN), and the Eaton Vance Senior Income Trust (EVF).  From the cost basis, the yields we are receiving range from 6% to 8%.
We purchased these when they out of favor and were significantly undervalued.  Since then they have appreciated in price with some up around 15%.  This is a very big move for a bond fund (you normally don’t get 2 -3 years of coupon in price increase).  I am monitoring these holdings closely.  Some of the issues include the current valuation after the price advance, the possibility of higher interest rates, and a possible recession.
These valuations are not extremely overvalued given market and economic conditions.  As you know, bond prices move inverse to interest rates.  If rates increase, it may present a headwind for these funds.  Historically, however, this sector of the fixed income market is more influenced by credit risk rather than interest rate risk.  In other words, the ability for the borrowers to service their interest payments to our bond funds is considered strong in an expanding economy.  Higher interest rates are typically a secondary concern to the likelihood of debt service.
Looking forward to the 4th quarter and beyond, there are some very important sign posts ahead.  The U.S. election and the probability that the Fed will increase interest rates in December are foremost.
From a glass half-full viewpoint, the 4th quarter is normally the strongest one.  The 4th quarter has averaged a 2.7% gain dating back to 1928.  Also since 1928, when the S&P 500 is up YTD through September 30th this quarter averages a 4.3% advance and is up 81% of the time.
2016 has been an historic year on many levels.  As we work through its final three months, I will continue to navigate possible negatives from the elections and the Fed within the context of strong seasonal period.  I will be looking for opportunities while trying to manage risk.
Thank you for you continued business and trust.  Please contact me with any questions.

Extra, Extra, Read All About It!

/0 Comments/in /by
Charles Dow and Edward Jones started publishing the Dow Jones Industrial Average in their newly formed newspaper on May 26, 1896.  It began by adding the closing prices of twelve large companies that Dow believed to represent the stock market and then dividing that number by twelve.  At the time, The Wall Street Journal was published in the afternoon and cost $5 for an annual subscription.
It’s likely that Messrs. Dow and Jones would not have imagined that their stock market index would thrive for over 120 years.  Nor is it probable that they would predict it reaching 20,000.  Yet, at the end of 2016, the Dow is approaching that threshold.
Of course, we’ve gotten here with the help of a 7% rally in the Dow Jones Industrial Average since election day.  And while industrial and energy companies have gotten credit, the real heavy lifting has been done by the financials.  And among the financials, Goldman Sachs has shone the most muscle.
Goldman Sachs closed last week at $241 – up 32% since from November 8th.  Goldman is the highest priced stock in the index and because the Dow is a price weighted index (as opposed to a market capitalization weighting such as the S&P 500) it has the biggest impact.  Of the 1,282 points that the Dow has risen since the election, Goldman Sachs is remarkably responsible for 408 of them.  The next biggest contributors are United Health Care (112 points) and JP Morgan (103).
Of course, inquiring minds want to know – why the move?  Certainly, Goldman Sachs is a premier organization and a leader in finance and investments.  On top of this, the market is expecting lower expenses for the company due to the materially reduced regulations from ‘Trumpnomics’.
Also, we can’t ignore the impact of algorithms and computer trading.  These systems are often trend following so that once something starts to move higher buyers follow.  The “Goldman Sachs” name has been very visible recently as some in top management are moving 200 miles southwest to be part of the new cabinet and administration.  Algorithms and trading software constantly search the news for active keywords and phrases so this could have contributed bids for Goldman Sachs.
Regardless the reason, Goldman Sachs has recently played a big role in helping the Dow approach 20,000.  Naturally this threshold has the financial media’s attention.  And as of last week’s close, the Dow is only 244 points or 1.2% away.  Last week was the 5th consecutive higher week for the Dow and Friday marked the 14th record close since the election.  During that time the Dow has rallied 10.45% which is the best 5 week move since 2011.  Here are the year-to-date numbers for the major averages.
2016 YTD
Dow Jones Industrial Average                           +13.4%
S&P 500                                                             +10.5%
Nasdaq Composite                                             +8.7%
Russell 2000                                                       +22.2%
Indices are unmanaged, do not incur fees or expenses, and
cannot be invested into directly. These returns do not include dividend.
The bond market has been moving in the opposite direction of the stock market.  The 10-year treasury yield finished last week at 2.46% while the 30-year closed at 3.15%.  These two yields were 1.88% and 2.62% on November 8th.  The TLT is an exchange traded fund that tracks the long bond futures contract and it has plunged 9.6% since the election.  This is a big move for any security in a 5-week period, but it is an especially violent drop for a supposedly stable asset class like bonds.  To put it another way, this drop is 3 years’ worth of interest payments.
Unless the world comes to end, the Fed will raise interest rates on Wednesday.  While this has been discounted by the markets, the statement and press release will reveal more on the expected actions in 2017.  The Fed similarly raised the rate last December which resulted in a strong dollar which caused disruptions in the foreign exchange markets.  The Chinese renminbi weaken dramatically and that caused global markets to drop.  The stock markets fell in January as stocks had the worst start to a year in history.
This year has a different landscape.  While the dollar has been strong, the foreign exchange markets are not as fragile as last year.  Also, commodities have rebounded from last year’s levels which provide some support to the emerging markets.  Even Europe will be trying to normalize monetary policy.
Another stabilizing factor is some good economic reports.  Recent data has indicated that the economy is gaining some strength.  And while these reports have been released after the election, they measure activity prior to November.  As an example, the latest ISM (Institute of Supply Management) report was released last week and it showed an increase from 54.8 to 57.2.  Readings above 50 correlate with an expanding economy.
To be sure, some of this good news has been discounted in the markets.  And while we don’t expect a correction, further upside could be a challenge.  Still with year-end quickly approaching combined with many professionals under-performing their benchmarks, prices might get bid even higher.  That would be a nice Christmas present.
Jeffrey J. Kerr, CFA
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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

It’s the Most Wonderful Time of the Year

/0 Comments/in /by
The elves at the North Pole are supposed to busy this time of year as their deadline is quickly approaching.  Wall Street’s elves, on the other hand, usually get a breather around mid-December as the markets often coast from this point through the holidays.  It’s a much different story this year.
Of course, a lot of things are different in 2016.  Concerning the markets, there’s been a full slate of developments to deal with in December.  President-elect Trump is filling out his cabinet and administration and these decisions offer further signs of policy direction.  Given the stock market’s ‘Trump’ rally is largely based on the anticipated economic boost due to the new direction promised by the incoming president, this is important news.
Other nuggets keeping investors on their toes include interest rates moving up to levels not seen in the last 2 years.  Likewise, the dollar has rallied to multi-year levels.  Also, the Federal Reserve held a two-day meeting and raised interest rates.  And, of course, the Dow is on the cusp of reaching the 20,000 level.  This all adds up to a lot of last minute shopping as investors have been too busy.
Although last week’s 25-basis point increase in the fed funds rate was expected by everyone, the FOMC (Federal Open Market Committee) revealed a forecast for 3 rate hikes in 2017.  This was a little more hawkishness than the markets expected and it triggered a broad sell-off for stocks and bonds.
While there was pain across the fixed income market, the brunt of the damage was in the shorter end of the Treasury market.  The 2-year note’s yield closed at 1.239% which is the highest level since 2009.  The 10-year and 30-year yields closed last week at their highest levels since 2014 (2.59% and 3.18% respectively).
Last week’s rate increase is only the second interest rate increase in the past decade!  Further is the only hike of 2016 as conventional wisdom was way off base in predicting 3 or 4 hikes this time last year.  Clearly monetary policy will be tighter in 2017, but how many fed funds rate increases is uncertain.
Below is a chart of the 10-year U.S. treasury and the December 2017 fed funds futures expectations.  As can be seen, the futures market is forecasting a 1.16% fed funds one year from now.  This suggests much, much stronger economic growth.  Importantly, however, this level would only be approximately two 25 basis point increases from here and not the three that the Fed is implying.[i]  The futures have a 73% probability of the first rate hike at the June meeting.
As interest rates rise, the U.S. dollar has strengthened.  The DXY index (a dollar index vs. a basket of currencies) reached levels last seen since 2003.  Some specific levels include an 8-year high against the Chinese renminbi and a 10-month high against the Japanese yen.  Also, the euro has fallen below $1.05 which has been strong support for the past several years.  Dollar – euro parity (1 dollar = 1 euro) is the next big level.
This U.S. dollar rally began in 2014 and there are few reasons to believe that the trend will end, especially in the short term.  However, in the words of Herb Stein, “if something cannot go on forever, it will stop”.  2017 might present some developments that would be a headwind to continued greenback strength.  First, the Trump administration might run into a speed bump or two.  Cabinet appointment delays, potholes in getting legislation passed and implemented, and the president-elect’s Twitter account are a short list of things that could derail a smooth first year.
Also, despite the constant stream of negative headlines out of Europe, some indicators are improving.  The purchasing managers’ surveys released last week for Germany and France pointed to growth with the French index at an 18-month high.  Further the weaker euro will help exports for the EU countries.  Lastly, despite the self-inflected damage, maybe the bureaucrats begin to make a couple helpful decisions which might benefit the economy.
Turning to stocks, it’s a toss-up who is more excited right now – children waiting for Christmas morning or traders waiting for Dow 20,000.  And while the Dow couldn’t get there last week, the S&P 500 reached its own 20,000 level for the first time as the index’s total market cap reached $20 trillion.  During the depths of the financial crisis, the S&P 500’s combined value amazingly plunged to $6.1 trillion.[i]
Once we reach Dow 20,000, what then?   Stocks are extended but these trends usually don’t end in the last half of December.  Here is a chart of the S&P 500 for 2016 plotted against its historical average.[ii]
2016 has remarkably followed the trend but has trailed its average since October.  Rarely is there any large changes of direction in late December.
Further, as shown in this chart, investors are willing to pay higher valuations.  There is confidence that the “E” part of the P/E ratio will increase (lower ratio) in 2017.[i]  Analysts are busy adjusting for increased infrastructure programs and lower corporate tax rates which will increase businesses’ bottom lines.  Nevertheless, it’s not easy to get the magnitude of all these changes correct so there’s some risk of disappointment.
One final chart that compares the current S&P 500 breakout to those in 1980 and 1950.  If the markets follow these trends, it will be a fun trip which could last several years.[i]
As the markets close out 2016, change is coming.  An important one will be a shift from a loose monetary policy with a tight fiscal policy to a tight monetary policy combined with a loose fiscal policy.  The markets have adjusted somewhat to this but there will probably be unanticipated delays and wrinkles which could cause problems.
We don’t expect anything too drastic before year-end, but would be flexible into the New Year.  Reducing risk in the middle to late January might be good timing.  The old Wall Street adage is to “buy the rumor and sell the news” or once the anticipated event happens, it’s time to sell.   The inauguration and first few weeks of the new administration might fit the “news” part of this advice.
We wish everyone a happy holiday season and best wishes in the New Year.
Jeffrey J. Kerr, CFA
[1] GaveKal Capital, December, 2016
[1] The Bespoke Report, December 16, 2017
[1]Topdown Charts, December 16, 2016
[1] Ibid
[1] Ibid

Be Careful What You Wish For, You Might Get It

/0 Comments/in /by
We are at the point in the year where the season for giving thanks transitions into a season of wishes. Normally this enjoyable tradition is a thoughtful, well intentioned part of the holiday season.  This year, however, these lists probably have some additional and unique items.
President-elect Donald Trump’s name is likely on many wish lists this year. The range of the wishes associated with Mr. Trump are spread from loathing and disgust to supporting admiration.  Over time these two factions should come closer together as the critics move to Canada and the devotees become disappointed in the pace of change.
Another common wish is among the media and experts who are supposed to offer insight on events such as elections.  They are desperately trying to get one right.  Being totally wrong on Brexit and the U.S. presidential election has left a mark.  And the streak continued the weekend before last with a French primary election having another upset winner.  It has been a very bad 2016 for this group.
The Federal Reserve has some wishes.  They wish to raise interest rates.  Further they would like to see a pick-up in the inflation rate.  They’ll likely get this first wish before Christmas as the FOMC is expected to increase the fed funds rate by 25 basis points at their meeting later this month.  Looking forward, there are predictions for more fed funds rate increases in 2017 and some high profile Wall Streeters are predicting the 10-year note’s yield to exceed 5% (it’s currently at 2.4%).  It’s hard to imagine the U.S. economy withstanding a doubling in yields.
Wall Street has many wishes with a big one being an improvement in its standing.  As evident during the never ending political television ads during the campaign, it is a distrusted and cynically viewed part of our culture.  The legal profession should be grateful as Wall Street has easily (and by a wide margin) replaced lawyers on the bottom of the reputational totem pole.
Another wish from the stock market bulls is for more of the Trump rally.   Other than a slight pullback last week, U.S. equities have surged after the election.  The leaders have been the small cap stocks as well as financials, energy, and industrials.  The S&P 500, Nasdaq and Russell have all reached record levels since the election.  The Dow, with much fanfare, has made new all-time high, surpassing 19,000 while the Russell was up for 15 days in a row.
To help appreciate this spike since the election, we are including “performance since the election” with our regular year-to-date numbers for the major averages.  A significant portion of 2016’s gains have come within the past few weeks.
Since
2016 YTD         Election
Dow Jones Industrial Ave             +10.0%                   +4.5%
S&P 500                                        +7.2%                     +2.6%
Nasdaq Composite                        +5.0%                     -1.2%
Russell                                          +15.7%                   +10.1%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
A notable number in the above table is the Nasdaq’s losses since the election.  This weakness has been blamed on worries over President-elect Trump’s immigration and trade policies which might increase costs for tech companies.
Valuation is another headwind for tech stocks.  Based on such measures as P/E, EBITDA (earnings before interest taxes depreciation and amortization) ratios, and dividend yields, ‘new’ technology (such as the FANG stocks) is expensive.  Granted these industries have greater growth potential but a good portion of that growth is priced in.
This rotation out of technology goes beyond valuation.  Donald Trump’s presidential victory represents the largest shift in government’s role in decades.  This change should not be underestimated.  As Anatole Kaletsky points out “political events can sometimes have a much greater impact than the monetary and economic “fundamentals” that investors normally consider more important.”[i]
Although the details of Trump’s economic plan are not fully known, generally, a more business friendly landscape is expected. Predictions are for a reduction of regulations (especially in banking and finance) and for increased fiscal stimulus primarily through greater infrastructure spending.
Whether the reason is politics or economics, the capital markets’ aren’t waiting for the inauguration.  They are pricing in stronger growth, higher inflation, higher interest rates, and larger fiscal deficits.  Stocks, interest rates, and the dollar are moving up.
Some are predicting a repeat of the economic cycle that began in Ronald Reagan’s first term.  And while there are some similarities, there are some critical differences.  In 1982, interest rates were at a generational inflection point which turned into 35 years of declining rates.  2016 might be another inflection point but in the opposite direction.  Not only are we without the boost that declining interest rates gave the 1980’s, rising rates will be a headwind.  And likely for many years to come.
In early 1980’s, stocks were despised.  Numerous magazine covers (remember this is before the internet when The Wall Street Journal, Forbes, Fortune, etc. were must have subscriptions) proclaimed the death of equities.  Very few wanted anything to do with Wall Street which translated into insanely low stock valuations and very attractive dividend yields.  It was huge news when the Dow climbed above 1,000!
Looking at the valuations, P/E’s were in the single digits 35 years ago.  In fact, in some cases the EPS (earnings per share) amount was greater than the P/E.  Blue chip dividend yields were also in the upper single digits.  A far different story from today where the S&P 500’s P/E trades at mid to upper teens and the dividend yield is barely over 2%.
Market sentiment changes quickly.  A month ago the market’s feared a Trump win and were declining every time a poll suggested he had a chance.  After the results Wall Street quickly changed its mind.  The biggest moves have been a rally in stocks, a drop in bond prices (higher yields) and a rise in the value of the dollar.
As enjoyable as the rally has been, we must keep in mind that investor sentiment can quickly change again.  While this doesn’t seem likely in December which is historically a bullish month, there is a Fed meeting next week. A 25 basis point hike in the fed funds rate is fully expected so the only surprise would be that the committee holds the rate the same.  Beyond the Fed meeting, the markets have built up some pretty lofty expectations for 2017.  Here’s wishing that the economy can deliver.
Jeffrey J. Kerr, CFA
[i] GaveKal Research, December 2, 2016
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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

Pretzel Logic

/0 Comments/in /by
There are many financial theories that attempt to forecast a securities’ valuation.  Modern Portfolio Theory and the Capital Asset Pricing Model are two of the most noteworthy.  The models try to quantify various factors into a formula that results in a theoretical fair value for stocks, bonds, commodities, currencies, etc.  As part of the calculation, these theories make assumptions on some variables.  One of the important assumptions that investment theories hold is that investors act rationally.  Obviously, this must be called into doubt when considering how the markets traded around the election.
In the weeks leading up to the election, investors were convinced that a Trump administration would be bad for the markets.  Consequently, stocks rallied on any news of an increased likelihood that Hillary Clinton would win and this included the two trading days before the election night.
Election night, as many know, was especially looney.  As Donald Trump gained in the tally, there was an inverse correlation between his electoral college numbers and U.S. stock market futures.  As you can see from the nearby chart (from Barron’s), as Trump’s chances of victory climbed to 90%, the futures on the Dow Jones Industrial Average plunged 800 points!
Further the chart shows the Dow’s recovery in the overnight trading.  From there the markets inexplicably decided a Trump presidency wouldn’t be apocalyptic and a powerful rally lasted the rest of the week.  The Dow jumped 5.4% last week while the S&P 500 rose 3.8% and the Nasdaq advanced 3.8%.  But small caps were the biggest winner for the week as the Russell 2000 was up over 10%.
So, the markets went from Trump being a disruptive market negative that would cause global trade to virtually stop to an economic savior within the matter of hours.  And this happened without any meaningful change of rhetoric.  Remember, we assume investors act logically.
Not every sector participated in last week’s move.  Technology was weak and many leaders were left behind.  Worries over immigration reform and tariffs on imports from Asia pressured the technology sector.  Also, many international stock markets were lower led by Brazil and Mexico.
The bond market was almost as volatile as the equity market.  The 10-year treasury note’s yield was 1.8% on election day but then spiked to close the week above 2.2%.  This may not appear to be a big move but it is huge in the normally stable fixed income market.  Further the velocity of this spike (that it happened in three trading days) was damaging.  Bond traders don’t position themselves for these types of moves so many may have been caught off guard.
Increased inflation expectations worried investors and was behind this move in yields.  The market views a Trump presidency as one with increased spending, lower taxes, and trade restrictions.  Stay tuned on the bond market as it may flip its view as the stock market did.
Last week’s rally materially improved the major averages’ year to date performance. With election behind us and the fact that we are entering a seasonally strong part of the year, prices might continue rising.  However, the Fed will likely raise the fed funds rate in December (although the bond market has priced that in).  Also in December, there is an important Italian referendum vote.  This could be another vote against the EU.
2016 YTD
Dow Jones Industrial Average   +8.2%
S&P 500                                     +5.9%
Nasdaq Composite                     +4.6%
Russell 2000                              +12.9%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
Last week’s markets moved quickly and may have over reacted to the perceived agenda of President-elect Trump.  However, some things look to be high probability changes.  For example, fiscal stimulus, tax reform, and deregulation are priorities that will be acted upon in 2017.  The markets must adjust to whatever the final versions of these initiatives look like.
While these policies will have a bigger impact domestically, they will influence international markets as well.  The foreign exchange markets will be important and last week’s we saw dollar strength.  Part of that was a result of higher bond yields, but also prospects of a stronger U.S. economy attracts international capital.
A strong dollar squeezes emerging markets.  International trade is mostly done in U.S. dollars even if the U.S. is not involved in the transaction.  Consequently, this is obstacle for many foreign economies which could turn into a bigger problem especially if the dollar keeps rising in 2017.
As stocks, bonds, currencies, and commodities adjust to the unexpected landscape of a Trump administration, there is likely to be false moves and corrections across all asset classes.  Of course, it would be a lot easier to maneuver these markets if investor did actually act rationally.  Stay tuned.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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

Go, Cubs, Go!!

/0 Comments/in /by
By the end of last week, one streak got broken while another was continuing.  The Chicago Cubs won a World Series for the first time in 108 years.  In classic Cubs style, they frustratingly fell behind 3 games to 1.  After they recovered from this deficit, they squandered a lead in the decisive game that had fans trembling as they relived the past curses of the billy goat, the black cat and Steve Bartman.  Defying all doubters, the Cubs won in extra innings of the 7th game breaking a century long dry spell without a championship.
The other streak involves the stock market as the S&P 500 closed the week with a 9-day losing streak which hasn’t happened in 36 years (1980).  Surprisingly, it didn’t occur during the 2008-09 financial crisis or the tech bubble burst in 2000.  Also, the decline has been orderly with no large daily drops.  Let’s hope that this market streak doesn’t challenge the Cubbies!
The market turmoil is being blamed on the election.  Specifically, the renewed FBI investigation of Hillary Clinton emails and her decline in the polls.  The markets view a Clinton administration more favorably than a Trump presidency as they think that Trump policies would likely disrupt international trade and the economy.
Beyond the mudslinging of the campaigns, the markets were also concerned over higher interest rates.  The Federal Reserve held a meeting last week and while there was no policy change, it appears more likely that the fed funds rates will be increased in December.  Aside from the central bank, the markets are not waiting.  The 10-year Treasury note’s yield closed last week at 1.78%.  The is up from below 1.6% at the beginning of October.  Perhaps the many (but incorrect) predictions of the end of the bond bull market has finally arrived.
The selloff in stocks began in early October but has accelerated in the past two weeks.  The decline broke through some important supporting trend lines on the charts.  The S&P 500 ended last week testing it’s 200-day moving average.  This line represents approximately the last 10 months of trading so it is a longer trend indicator.  Many investors get very worried if the 200-day line is broken.
The selloff has damaged the major averages’ year-to-date numbers.  This is especially true with the Nasdaq and Russell which were leaders in the 3rd quarter.
2016 YTD                                        
Dow Jones Industrial Average  +2.7%
S&P 500                                      +2.0%

Nasdaq Composite                     +0.8%

Russell 2000                                +2.4%                     
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
It is interesting that the sell-off took place as 3rd quarter corporate earnings generally beat expectations.  According to FactSet Research, 85% of the S&P 500 companies have reported 3rd quarter results and 71% have beaten earnings per share estimates.  EPS growth is tracking 2.7% growth which would be the first time in a year and one-half that corporate earnings have increased!!
Despite these signs of profit growth, money continues to flow out of stock market.  Per the Investment Company Institute, an estimated net $16.3 billion was pulled out of domestic equity mutual funds in the week ending October 19th.  This represents the largest weekly equity fund outflow in over 5 years.  There has been a shift among investors from mutual funds to exchange traded funds (ETFs) so there have been regular withdrawals from mutual funds.  However, as Bespoke Investment Group points out, the total inflows into ETFs do not account for all the lost dollars from the mutual funds.
Another sign of investor pessimism is the American Association of Individual Investors’ (AAII) sentiment survey.  It has registered sub-40% bullish readings for 53 straight weeks which is the longest stretch dating back to 1987.  It would be easy to blame these developments on the election, but this trend dates back before the primaries began.  Certainly, the election has contributed to the recent accelerated outflows but it seems the public has been disliking the stock market for some time.
This week’s elections will dictate the capital markets in the short term.  The markets have traded better when the chances for a Clinton victory increase as it translates into the status quo.  A Trump triumph has many uncertainties that worry the markets.  Wednesday’s trading will likely follow this trend.
Trying to game the markets based on the election is virtually impossible.  Looking beyond this week, corporate profit growth is an encouraging development.  We’ll probably get an increase in the fed funds rate in December, but much of that is already priced in.
2016 might be an iconic year like 1969.  The stock market began with the worst start to any year in history.  The U.S. presidential primaries along with the general election will not soon be forgotten.  But the year will best be remembered as the year that the Cubs won the World Series.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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

OKTOBERFEST

/0 Comments/in /by
According to Wikipedia, Oktoberfest is the world’s largest beer festival and funfair.  It is held annually in Munich, Germany from mid or late September to the first weekend in October.  It’s been held since 1810 with current attendance around 6 million people per year.
This year the normal schedule just won’t do – it needs to be extended.  After all, if there was ever a time that we needed more beer, it’s 2016.  The U.S. presidential election, Brexit, negative interest rates and the disappointing New York Jets are just a few of the maddening events that we are suffering through.
Of course, Germany (and Europe) are facing similar election woes and economic challenges of their own.  Italy has an important referendum upcoming which may result in more momentum for dismantling the EU.  On top of this, the banking system received another bruise when new worries arose over Deutsch Bank’s financial condition.  How do you say “another round, please” in German?
The financial fragility of global banks has been a market and regulator focus since the financial crisis.  So at some level there is an awareness of the risks associated with the world’s financial institutions.  The latest developments surrounding Deutsch Bank involve a U.S. Justice Department fine, which is expected to be negotiated lower, and renewed worries over continued margin deterioration because of the widespread negative interest rates across Europe.
As part of this latest market indigestion, Wall Street vexed over Deutsch Bank’s portfolio of derivative instruments.  Common derivatives include options, futures, forward contracts, and swaps.  The general purpose of these is to hedge risk, but some traders use them for speculation.  Derivatives commonly enable the buyer to establish an investment position linked to another asset or investment for a much smaller dollar amount.  This is the leverage component common to most derivatives.
According to Deutsch Bank’s 2015 annual report, their derivative book totaled €41.94 trillion ($46.994 trillion).  As a point of comparison, 2015 German GDP totaled €3.032 trillion.  This €42 trillion measures the notional value or the amount of the underlying asset (stock, bond, etc.) that the derivative contract represents.  The actual invested capital is a fraction of this amount.  It is likely that a high percentage of Deutsch’s derivatives are used to hedge interest rate risk – a large risk for any lending institution.  Also, the amount of Deutsch’s derivatives has fallen from €59.195 trillion in 2011.
This is not to imply that the markets’ anxiety over these derivatives is misplaced.  In addition to size of this portfolio, some of the positions as well as the underlying assets are illiquid and hard to value.  This could be a problem if markets were to encounter future disruptions.
Another risk is counterparty risk.  Some derivatives are not traded on an exchange but are contracts between two financial institutions.  In these situations, there is risk that one of the parties in the contract is impaired and unable to deliver their part of the agreement.
In the case of Deutsch Bank, the size and breadth of their global operations could result in systemic fallout if they could not honor their derivative positions.  If this happened, it might impair other organizations who then could not fulfill their contracts which could damage their counterparties.  It is hard to predict how far the damage would travel if Deutsch Bank were to fail.
Keep in mind that Deutsch Bank is just one bank with this issue as many other financial institutions have similar sized derivative books.  An important difference, however, is that the other organizations are better capitalized to withstand problems.  The worries with Deutsch Bank is that they can’t raise capital at a reasonable cost and that negative interest rates are squeezing their profit margins.  The recent dialogue has centered on possible bailouts if that is needed.  The German government originally pushed against this but has softened their opposition.
While Deutsch Bank’s problems have weighed on the markets, U.S. stocks have chopped sideways in a narrow range and moving from one end to the other in a single day.  Since the Dow’s 395-point drop on September 9th, we have had 3 daily moves exceeding 200 points and 6 days + or – 100 points.  In the meantime, the Dow has traded between 18,000 and 18,400.
This frustrating back and forth bounce seems to be a function of a lack of investor commitment ahead of the U.S. elections.  No one wants to take positions for more than a few hours let alone a few days.  Seemingly, no one wants to be left holding the bag.
Also, it could be related to the large influence of computer trading.  Algorithms play a big part of the current trading landscape and their approach is largely short-term, trend following.  For the time being, this environment is unlikely to change.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. 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 Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. 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 professiona