“There is Nothing More Deceptive than an Obvious Fact”[i]

The Dow and S&P 500 both closed last week at record levels. Obviously, one would conclude, stocks are having another good year.  Even an experienced market observer would naturally feel it’s a redux of 2013’s 30% advance given that seemingly each day’s headlines include “a new stock market record”.  The obvious is that the indexes are at record levels.  The current deception is that the underlying signals are suggesting caution.

 

This most recent rally began in mid-May.  Prior to that the markets spent six weeks trading sideways to lower and was marked by a divergence between the blue chips and the rest of the market.  Specifically the Dow and S&P 500 moved sideways while the Nasdaq and Russell were soggy.  (The Nasdaq was down 3% and the Russell fell over 6% from the start of April to the middle of May.)

 

But just as the “sell in May and go away” crowd was feeling emboldened, equities stopped retreating and buyers returned.  And while the Dow and S&P grabbed headlines, the lagging Nasdaq and Russell has also participated and have recovered their year-to-date losses within a few weeks.  Here are the major averages for 2014.

2014 YTD[ii]                                  

Dow Jones Industrial Average         +2.1%
S&P 500                                                  +5.5%
Nasdaq Composite                              +3.5%                           

Russell 2000                                          +0.1%                           

 

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

 

Naturally record stock market levels often coincide with increased investor enthusiasm.  While emotion is somewhat difficult to accurately measure, there are clear signs of complacency.  Last week Investors Intelligence showed that over 60% of responding advisors were bullish which is the highest level since October 2007.   Importantly, Investors Intelligence defines any number above 40% as “excessive optimism”[iii]  Also, there were only 17% bearish advisors which is lower than in October 2007.

 

There are a couple other attention grabbing nuggets to pass along.  The CNN Fear and Greed Index reached 86 on Friday which is the highest in a year and also in extreme territory.[i]  This survey’s scale ranges from 0 to 100 with higher numbers reflecting greed.  Lastly, the CBOE Equity Put/Call ratio hit a low of .43 last week which was the lowest one-day reading since January 2011.  This index is based on the buying of put options (bearish) vs. call options (bullish).  Readings below .50 and above 1.00 are viewed as abnormal.

 

For those unfamiliar with these statistics, they are used as contrary indicators.  In other words, widespread optimism and few worriers is usually a headwind to higher prices as bullish investors have already put their money to work which could mean a peak in buying power.  In the past it has been prudent to step away from the crowd when sentiment gets this ebullient.

 

Combining the market’s current emotional state with some fundamentals results in even more alarming signs.  John Hussman points out that when sentiment is optimistic (II survey above 60% bullish) at the same time as market records and an S&P 500 P/E above 18 (measured by trailing earnings), it has been a sign of a top.  Dr. Hussman states that only times that these three stars have aligned were October 2007, January and May 1999, August 1987, and January 1973.[ii]  Attention, please.

 

Dr. Hussman points out that these may have not been the top ticks but, importantly, all preceded material market corrections.  While short term timing is difficult, there are some other trends that support near term caution.  During the past 10 years, June has averaged a 1.33% decline making it the worst month by a wide margin (the next worst is August with a .45% average decline).  Also as a point of reference, over the past 50 years September is the weakest month.

 

The above data probably suggests a correction (they can be very unpleasant for those who’ve forgotten) but we wouldn’t expect a bear market.  Aside from investor’s emotional state, the economy is doing ok.  Corporate earnings continue to grow.  According to Factset, 497 of the S&P 500 companies have reported 1st quarter earnings with 74% exceeding the mean estimate.  53% have reported revenues above the mean estimate.  The estimated growth for 2nd quarter earnings is 5.4%[iii]  Further corporate balance sheets remain strong and mergers and acquisitions have been very active.

 

“Abby someone?  Abby who?  Abby Normal.”[iv]

 

Turning to the fixed income market, the U.S. 10-year treasury has had a roller coaster ride recently.  From a 2.70% yield at the end of April, the yield dropped to 2.4% at the end of May.  The yield then rebounded back to 2.65% during the past 1 ½ weeks.  For those not familiar with the bond market, this may not appear

to be that significant, but it is not normal behavior.  It is incredible volatility on both an absolute and relative basis.  There has been a lot of ink spilled over the cause but there has not been a definitive reason identified.  We’ll be keeping an eye at this and will continue to search for causes.

 

Today’s capital market conditions are challenging.  But this is nothing new.  We wonder if the record stock prices is the ‘obvious fact’ or the ‘deception’.  After all, it seems illogical that this is happening in the face of terrible fiscal and monetary policy.  Which leads to the following quote which has been making its way around investment blogs and other social media platforms recently.  We think it accurately describes 2014’s markets but it was actually written 25 years ago by the sagacious Merrill Lynch strategist Bob Farrell.

 

“Money managers are unhappy because 70% of them are lagging the S&P 500 and see the end of another quarter approaching. Economists are unhappy because they do not know what to believe: this month’s forecast of a strong economy or last month’s forecast of a weak economy. Technicians are unhappy because the market refuses to correct and gets more and more extended. Foreigners are unhappy because due to their underinvested status in the U.S., they have missed the biggest double-play (a big currency move plus a big stock market move) in decades. The public is unhappy because they just plain missed out on the party after being scared into cash after the crash. It almost seems ungrateful for so many to be unhappy about a market that has done so well. . . . Unhappy people would prefer the market to correct to allow them to buy and feel happy, which is just the reason for a further rise. Frustrating the majority is the market’s primary goal. . . .” [i]


[i] Robert Farrell, September 5, 1989


[i] www.money.cnn.com/data/fear-and-greed/

[ii] www.hussmanfunds.com, “Weekly Market Comment”, June 9, 2014

[iii] Factset, “Earnings Insight” June 6, 2014

[iv] Young Frankenstein, 1974

 

 

 


[i] Arthur Conan Doyle

[ii] The Wall Street Journal, June 7, 2014

“One dog goes one way, the other dog goes the other way, and this guy’s sayin’ ‘Whadda ya want from me?'”[i]

The S&P 500, since it broke above the 1,750 level last fall, has been like the two dogs in Mrs. DeVito’s painting – unable to decide which way to go.  Twice it has fallen to 1,750 (most recently in February) but both times reversed and moved higher.  Three times the index has tried to push above 1,850 but has been unable to decisively break through.  In fact the S&P 500 has spent the last couple of months moving back and forth between 1,820 and 1,890.  As shown above, last week’s close was 1,864.

 

The dogs join the bulls and bears in struggling whether this sideways slither is a base from which we extend 2013’s rally or a significant top before the long awaited correction.  One worrisome sign is that the rally’s leaders and favorites have cracked.  For example, FireEye (symbol = FEYE), a company offering software products that provide malware protection, approached $100 per share during March’s first week.  By April it was below $50.  The biotech sector gained 60% in 2013 and was up an additional 20% in 2014 in the first two months.  From that peak, the industry index has given up over 20% with many stocks falling much more.  Furthermore, the Russell 2000, a strong leader during 2013, has been among the weakest areas during the January retreat and since the March highs.

 

While the Russell has demonstrated clear signs of distribution, the Dow Jones Industrial Average and S&P 500 have showed relative strength.  In fact both large cap indexes recently reached all-time highs.  And while this is an undeniably positive development, it is at the same time a warning sign.  First, the weakness in the Russell, Nasdaq, and favorite sectors relative to Dow and S&P’s is a troublesome divergence.  These indexes moved together during last year’s rally so this breakdown in the pattern is another sign that things are changing.

 

Also, two weeks ago the Russell finished a few points of its 200 day moving average (DMA).  Remarkably this last happened almost 1 ½ years ago (November 2012) which we interpret as an important trend change.

 

Applying this analysis to the S&P 500, it has been over 350 trading days or 17 months since this index has touched its 200 DMA.  This streak is the 10th longest since 1928, the 4th longest since 1965 (soon to be the 3rd longest) and the longest in 15 years.  As MKM Partners describes this, “To say that the SPX (S&P 500) is ‘due’ for a 200 DMA test would be a bit of an understatement”[ii] The current 200 DMA for the S&P is around 1,761 or about a 7% correction from the recent highs.

 

What does this mean, if it were to happen?  History tells us that one week to one month returns are negative after the test.  Again quoting MKM Partners, “after such a sustained period of a steady rise, once it finally breaks, weakness tends to persist in the near term.  In fact in 8 of the 9 longest streaks, returns were negative a week later by an average of nearly 3%”[iii]

 

Beyond this indicator, further worries are supported by the fact that defensive asset classes (bonds and utilities) are strongly outperforming equities.  Remembering way back to the beginning of the year as we are learning to dislike the polar vortex, everybody’s 2014 forecast included higher interest rates.  This once again proves that when everyone thinks the same way, nobody is thinking – interest rates are lower as the 30-year Treasury bond has provided a 10.52% year-to-date.   Furthermore the Dow Jones Utility Average is up almost 9% in 2014.

 

Taking a look at where the major averages stand, they rebounded strongly last week after some nasty selling two weeks ago.  We start the week, except for the S&P, lower on a year-to-date basis.  We’ve also included the 1st quarter numbers.

                                            

  2014 YTD[iv]        2014 1st Qtr                 

Dow Jones Industrial Average   -1.0%                     -0.7%
S&P 500                                  +0.9%                    +1.3%
Nasdaq Composite                    -1.9%                     +0.5%

Russell 2000                             -2.2%                     +0.8%

 

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

 

Before looking one way (forward), we look the other way (backward).  The S&P 500’s first quarter marked the 5th consecutive positive quarter.   This has happened 5 times in the past 40 years.  In 4 out of those 5 occurrences, the next quarter was negative.  The fifth time it was part of an historic streak of 14 consecutive quarters in the mid-1990’s.  It’s little wonder that the dogs can’t make up their mind.

 

On a shorter term and despite these divergences and warning signs, April has been a good month.  April has been the best month for the S&P 500, the Dow, and the Nasdaq over the past 10 years, averaging 2.33%, 2.33%, and 2.56% gains respectively.  The Dow hasn’t had a negative April since 2005.  Of course, this could be a prelude to a “sell in May and go away” moment.

 

For the investor with a longer time frame, we think the economic back drop continues to be ok and that some exposure to the stock market makes sense.  However, the markets may offer a better entry point in the intermediate term.  Of course, as we have seen in 2014, sectors can present buying opportunities without the averages declining.  For example, “old” technology and energy have performed well this year and we expect similar sector rotation throughout the rest of the year.

 

An important part of the investing process is managing risk and the recent price action has flashed some warning signs that should not be ignored.  This is not to suggest an oncoming bear market but rather some the possibility of some painful turbulence.  For those prepared, it presents an opportunity.  This is especially true for those with a time frame beyond the next quarter.  This brings back to our belief that 2014 will be a choppy year with an agonizing pullback or two.  Or as part-time art critic Tommy DeVito describes it, “Ping! Pow! Boom! Bing!”[v]

 

 

 


[i] “Goodfellas”, 1990

[ii] MKM Partners, Technical Strategy, April 13, 2014

[iii] Ibid

[iv] The Wall Street Journal, April 12, 2014

[v] “Goodfellas”, 1990

 

 

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

 

“I Got High Hopes”

Since the beginning of 2013 many investors have been hoping for a correction or some sort of meaningful decline.  The stock market started last year with a bang and steadily and constantly climbed for the rest of the year.  This move extended the advance that hasn’t contained a normal 10% or greater pullback and naturally, added to the frustration of the crowd on the sidelines waiting for a “better” entry point.

 

Upon the arrival of 2014 prices finally broke.  While the pullback was somewhat minor as historical corrections are measured, it was nevertheless greeted not with a welcome embrace but with angst and fear.  The bigger worry is not that a 3% – 5% retracement happened but instead that it caused such pandemonium.  It would seem logical that following the 30% advance in the prior 12 months a correction would be expected.  Further is should be viewed as helpful as it would strengthen the long term health of the move.

 

Of course part of the problem is not that the pullback “did” happen as much as “when” it happened.  January is commonly thought of as an indicator of the rest of the year.  Many talk about the direction of the first week of the New Year as predicting the rest of the month and, in turn, January’s performance foretells the rest of the year.

 

According to WSJ Market Data Group, the Dow Jones Industrial Average’s January performance has predicted the full-year direction 87 times in the last 116 years (75%).  On the years of a January down Dow, the blue chip index was lower 26 of those 42 years (62%).  Interestingly, sometimes instead of being predictive, January is an inflection point.  Following a lower January, the Dow is down in the remaining 11 months only 48% of the time.[i]

 

There is another indicator with higher accuracy and is more foreboding for 2014 – the “December Low Indicator”.  This watches the Dow’s December low point and forecasts a down year when that level is violated anytime during the first quarter of the New Year.  There have been 31 occurrences since 1950 and in all but 2 years (1996 and 2006) the Dow was lower for the year by an average of 10.9%.[ii]  To add to the worry, there have been only 4 instances (out of 31) of wrong signals when these two indicators are “combined”.

 

For those not keeping score at home, let’s review what has happened this year.  First, the major indexes were lower in January.  The Dow lost 5.3% during the month while the S&P 500 and the Russell declined 3.6% and 2.8% respectively.  The Nasdaq composite led the way by only falling 1.7%.  On the December Low Indicator, the Dow easily fell below the December 13, 2013 low of 15,739.43.  The Dow’s closing low for 2014 is 15,372.80 on February 3, 2014.

 

This is not to suggest that we should give up on 2014 as we need to remember that no forecast is foolproof.  Further we have the Fed and other policy makers keeping at least one eye on the financial markets and are ready to act if conditions deteriorate.  This has likely played a roll in the strong rally that stocks have had off last month’s lows.  Also, maybe January was a deviation and the markets have returned to the steady climb that started in late 2012.  However, there are some further signs that imply that 2014 won’t be a rare non-conforming year after January’s signals.

 

“It’s Midnight in Manhattan, This is No Time to Get Cute”[iii]

 

Starting in January many market internals have weakened. Such things as market breadth, new highs vs. new lows, and divergences among the indexes are indicating that overall market strength has declined.  The stock market’s breadth (a measure of the number of advancing stocks vs. declining stocks) has narrowed during the recent rally indicating the latest rally has had fewer participants.  Further the number of issues making 52-week highs and 52-week lows has weakened.  Lastly, while the S&P 500, the Dow Jones Transportation Average, and Russell 2000 reached record highs earlier this month, the Dow Jones Industrial Average has yet to exceed the record level reached at the end of 2013.  Here are the year-to-date numbers for the major indexes.

 

2014[iv]

Dow Jones Industrial Average    (-3.1%)
S&P 500                                      (-0.04%)
Nasdaq Composite                       +1.6%

Russell 2000                                 +1.5%

 

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

 

Investor sentiment can have a big influence on asset prices and, currently, we worry that we don’t have enough worry.  Unlike the emotional landscape at the start of 2013, the present mindset is at a minimum complacent and, within sectors, ecstatic.  Readers might find the diagram[i] below helpful in determining where the 2014 capital markets reside.  While we haven’t gotten to the point where all sports bars have channels set to Bloomberg or CNBC, lets see what happens after March Madness.  We are not suggesting the polar vortex is about to target its wrath on stocks and bonds, however, in the short to intermediate term, a correction would clear out investor smugness.

Despite the short term emotional state being too bullish, there is still much skepticism on a longer term time frame.  The financial crisis of 2008-2009 has turned many investors into Mark Twain’s cat.  Namely they view equities the same way that the feline who sat on a hot stove looks at an oven.  In other words, every stove is to be avoided no matter its temperature.  Similarly the scars of the Great Recession are seared into our memories and some think that all stocks are to be shunned.  The good news is that this disdain may provide further fuel for the rally to continue for years to come.

 

In the meantime, in addition to the tape sending some subtle signals that bear watching, some other developments have our attention.  Under the heading “that the more things change the more they stay the same” we can’t help but think that we have seen this movie before and would prefer to avoid the final scenes.

 

Specifically some 2014 valuations would make the internet startups of the late 1990’s blush.  Darlings such as Tesla Motors (losing money and selling at 14 times sales), Facebook (P/E = 108 and 17 times sales), Chipotle Mexican Grill (P/E = 58 for Mexican food?), and SolarCity Corp (losing money and 48 times revenue) rival anything from the tech bubble.  Insane valuations can even be found among more mature companies such as Amazon.com.  The company that is dramatically shifting the retail environment changes hands at 609 times earnings.  These valuations assume a lot of future success.

 

Another Wall Street trick was also recently spotted.  Reminiscent of the late 90’s research on high flying stocks, last month Morgan Stanley doubled its price target on Tesla.  The timing was a little odd being that it happened the day before the company sold a convertible bond.  Yet strangely, as part of the report, the analyst did not change either the sales or earnings estimates.  Nevertheless, the stock jumped 20%.  It’s peculiar that regulators didn’t question the timing of the change or the fact that Morgan Stanley was lead underwriter on the bond deal.

 

Rising prices result in higher monthly statement balances which in turn help us feel better (and smarter).  But sometimes these feelings cause us to become over confident, take short cuts, and ignore risks.  We don’t know anyone who would do such things, but we are told by reliable sources that it does happen.  Attention to changing developments and disciplined decisions will to be valuable habits for the rest of the 2014.


 

 

Jeffrey J. Kerr is a registered representative of LaSalle St. Securities, LLC, a registered broker/dealer. Kerr Financial Group is not affiliated withLaSalle St. Securities, LLC. Securities are offered Only through LaSalle St. Securities, LLC940 N Industrial Drive, Elmhurst, IL   60126-1131 Member FINRA/SIPC

 

 

 

[1] The Wall Street Journal, January 31, 2014

[1] Finance.Yahoo.com, February 3, 2014

[1] Bruce Springsteen, 1973

[1] The Wall Street Journal, March 15 2014

[1] minyanvill.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

“I Took Off For a Weekend Last Month Just To Try To Recall The Whole Year.”[i]

[i] J. Buffett, 1977

During the New Year’s celebrations, likely there were more than a few toasts to Ben Bernanke.  Of course, alcohol is a normal part of holiday gatherings, so it’s understandable that common sense and logic may have impaired partiers to the point that our Fed Chairman was credited for the stock market’s success.  While central bank policy has a big influence (perhaps too big) on the capital markets, we’re not sure how much of the equity sector’s move should be attributed to it.  That issue aside, 2013 was undoubtedly a very good year for stocks.  While the question of whether last year’s historic performance was a coincidence or a direct result of monetary policy needs to be examined closer, let’s take a look back at last year.  .

 

One of many notable market developments during 2013 was the fact that stock indexes were never down on the year.  From the January 2nd spike, at no time was the S&P 500 negative year-to-date.  Secondly, there were only two down months – June and August.  For those inquiring minds, there have been two years with 11 out of 12 advancing months – 2006 and 1958.

 

2013 was the best year for the Dow Jones Industrial Average since 1995.  During the year the blue chip index closed at record highs 52 times.  It was the 5th consecutive yearly gain and the index ended 2013 on a 4-month winning streak.  Among companies within the index, Boeing was the best performer (up 81%) while IBM was the only loser (down 2%).

 

The S&P 500 had its best year since 1997.  The two best performers were Netflix (up almost 300%) and Best Buy (up 237%) while Newmont Mining was the worst stock in the index (down a little more than 50%).  2013 was the 10th best year ever for the S&P 500 while the Nasdaq’s 38.3% rise ranked as the 7th best.  Here are last year’s returns for the major averages.

                                                    2013[i]

 

Dow Jones Industrial Average    +26.5%
S&P 500                                      +29.6%
Nasdaq Composite                      +38.3%

Russell 2000                                +37.0%

 

I

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

 

 

Assisted by 20/20 hindsight, 2013 was pretty easy.  Stocks were stronger from the beginning of the year and, except for a couple of brief declines, steadily climbed throughout the year.  By December, everything seemed straightforward and simple. Living it in real time, however, was a much different story.

 

“All of The Faces and All of The Places,
Wonderin’ Where They All Disappeared.”[ii]

 

Naturally, 2013’s story starts as “Auld Lang Syne” was being sung to ring out 2012. In sharp contrast to current sentiment, at that time there was widespread pessimism overhanging the markets.  Everyone was convinced that stocks were too risky and that bonds (which were finishing a very good year) offered the best combination of safety and return.  Throughout 2012, investors had been bombarded with a series of developments that would surely shake the stock market at any minute – Greece, Obama’s reelection, an elevated unemployment rate, sub-normal economic growth, record deficits, and as if to put an exclamation mark on the year, the fiscal cliff.

 

As 2013 began and the widespread anxiety over the “fiscal cliff” subsided, everyone started to realize that the world wasn’t going to end.  But stocks had already spiked so it was logical to wait for the correction which had to be just around the corner. Unfortunately for those not invested, it never arrived. But next was the sequestration that would surely knock the legs out from underneath the economy and the market.  Once again the talking heads proved to be wrong.

 

After this was Chairman Bernanke’s comment that the Fed might begin to “taper” its monthly bond buying which caused second thoughts about rising stock prices (this did cause a bloodbath in the bond market).  And while we survived these challenges and even managed to name the new royal baby, the government shut down was sure to be end of the world.  As we all know, this too came and passed.  Perhaps one of the lessons learned from 2013 is that following conventional wisdom can be risky.

 

While some have been emotionally converted just by higher prices, others ponder the mystery of how record levels coexist with bad headlines.  To this latter group the current landscape is a bubble that will ultimately burst.  And while the “bubble” debate is ongoing, the explanation behind the stock market’s incredible rally involves dynamic features.

 

To be sure the bears and bubble supporters have ammunition.  News flows seems to be constantly negative, the public is ready to tar and feather everyone in Washington, job growth is anemic, and we face numerous geopolitical problems.  However, there are many reasons for optimism.  These include the drive toward energy independence in the U.S., “onshoring” or the return of manufacturing to the U.S. (assisted by lower energy costs and robotics), the increasing global “digitization” led by U.S. companies, medical and biotech breakthroughs, and continued growth of emerging market’s middle class.

 

Undoubtedly, low interest rates have helped provide capital to these developments.  However, let’s hope that these projects are economically viable beyond suppressed interest rates.  Otherwise those calling this a bubble will be right.

 

“If it Suddenly Ended Tomorrow, I Could Somehow Adjust to The Fall”[iii]

 

This returns us to the New Year’s partiers’ raising a glass to Ben Bernanke which leads to a question – have the Fed policies worked and, if so, how much of the economy and stock market’s performance should be attributed to monetary stimulus?  Undoubtedly, they have done a very good job of printing money and buying bonds.  Additionally they have successfully kept the short end of the yield curve low.  Of course, some think the Fed policy has been successful just because banks aren’t failing and the stock market is setting records.  By those standards alone, they have done a good job.

 

To others, ZIRP, QE, Operation Twist and the other various programs are viewed with more skepticism.  Andrew Huszar, who had spent seven years at the Fed before working on Wall Street, returned to the Fed to manage one of the QE operations.  Specifically, he managed the Fed’s $1.25 trillion mortgage buy back program during 2009-2010.  In a The Wall Street Journal Op-ed, he criticizes the policy by saying, “The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.”[iv]

 

 

Beyond the debate of its effectiveness, the Fed’s stimulus policy has added another layer of risk to the capital markets.  The various programs, our central bank has admitted, have never been tried before and, consequently, their outcomes are uncertain.  The Fed has also stated on multiple occasions that they are ‘data dependent’ or that they rely on economic information to judge whether more or less stimulus is needed.  Yet, many economic reports are far from accurate when released.  For example, the monthly employment report, one of the most widely followed reports, is subject to huge revisions.  Further these revisions continue many months after the initial release.  For a data dependent analyst, we would think that this decision process is, at best, cloudy.

 

Whatever the driver, the stock markets’ 2013 performance was welcome.  Due to many factors, however, we’d caution against expecting a repeat.  Valuations are no longer as cheap as they were a year ago, economic growth is not certain, and sentiment seems a little excessive.  On this last point, the bull/bear ratio has been extremely bullish for weeks (this is a contrary indicator).  Furthermore, The New York Times columnist James Stewart recently wrote, “In the many years I’ve been surveying experts for their predictions for the coming year, I cannot recall another time when optimism about the stock market, the economy and corporate profits was so widespread.  As is pessimism about the bond market.”[v]

 

While we are reluctant to make specific predictions, we are confident there will be some curve balls thrown at the markets some time during 2014.  As usual, these situations will provide opportunities.  The hard part will be to separate the short term noise from any meaningful change in the economy or market’s composition.  We look forward to the journey and hope to raise a toast to 2015.


 

 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 

 

 

 

 


 

 

 

 

[1] J. Buffett, 1977

[1] The Wall Street Journal, January 2, 2014

[1] J Buffett, 1977

[1] Ibid

[1] The Wall Street Journal, November, 11,2013

[1] The New York Times, January 3, 2014

 

 

 

 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 


 

 

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

John Adams – “In my many years I have come to a conclusion that one useless man is a shame, two is a law firm, and three or more is a congress.”[i]

Now that the government shutdown is over (at least until the beginning of 2014), the news media’s talking heads will stay busy by telling us who the winners and losers are.  To some, the analysis of this episode’s heroes and goats, complete with self-righteous criticisms, is the critical next step.  Those responsible for this ridiculous and childish behavior, in their view, need to be more responsible and conform better to Washington’s status quo.  We think this indignation is misplaced.

 

While the Republicans are widely criticized and blamed for the recent shutdown, even from within their own party, their “offense” is not punishable by hanging (figuratively or otherwise).  Fiscal responsibility is the duty of everyone in public service.  That one prioritizes this responsibility higher than another does not make them the cause of all evil.  Granted it is disheartening that the situation deteriorates into a shutdown.  However, it is equally disappointing how our elected leaders have become so distant from their voters that they have taken on characteristics of an elite ruling class.

 

U.S. government deficits began around the same time as independence was declared.  While George Washington and his men fought, John Adams and Ben Franklin were in Europe with their hands out.  It’s unclear whether it was Adams’ ability to pitch high yield bond deals or the Dutch and French hatred of the British that secured funding but bonds were sold and debt accrued.

 

While fiscal deficits have been common during our country’s existence, there are also many stretches where Washington lived within its means.  Government funding crisis resulting in shutdowns, though not as old as Treasury bonds, are not only a millennium event.  It might surprise many, including President Obama, that government shutdowns and funding shortfalls began about three-quarters of the way through the 20th century.  The first shutdown took place as cassettes were replacing 8-tracks and disco inexplicably started to gain popularity – 1976.  For 10 days starting on September 30, 1976, the first partial government shutdown took place.  These closures became a monthly event the next year.  At the end of September, October, and November of 1977, we experienced a 12-day shutdown followed by two 8-day closings.[i]

 

Afterward, they became an almost annual event from the late 1970’s through the late 1980’s.  In fact prior to the latest incident, there have been 16 separate federal government operational interruptions with the longest being a 21-day shutdown during the Clinton administration from December 15, 1995 to January 6, 1996.[ii]

 

Of course, having a smooth fiscal operation is preferable to a series of disruptions. However, a natural part of a representative democracy is differences of opinion and, sometimes, messy arguments.  We can’t help but think that if those so appalled by this shutdown were in charge 200 years ago, we’d still be part of the British Empire.

 

One of the commonly believed risks associated with this shutdown was that it would slow the economy further and possibly resulting in a recession.  So when Congress announced an agreement had been reached, stocks jumped.  The Dow Jones Industrial Average rose over 300 points and the S&P 500 climbed over 2% on the day following the news.

 

Realization that the Fed would not begin to slow their monthly bond buying added another tailwind to the markets.  Since our government got back to work, stocks have rallied over 6%.  Bond yields have stabilized with the U.S 10-year Treasury note around 2.6%.  Here are the numbers for the major averages through the end of last week.

                                                          2013[i]

Dow Jones Industrial Average    +19.2%
S&P 500                                         +23.5%
Nasdaq Composite                         +29.9%

Russell 2000                                  +29.0%

 

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

 

These impressive gains have left many investors behind, which is easy to understand given 2013’s headlines.  The year started off with fears surrounding the fiscal cliff which was followed by sequestration, which was followed by anxiety over “tapering”.  Add in dismal job growth and an historically bad labor participation rate and a rational being would guess that stocks would be lower.

 

On the surface it appears that the worse news is, the better it is for stocks.  Part of this is that bad news is good in that it better ensures continued monetary stimulus.  However there are some overlooked positive developments.  Corporate profits, as measured by the S&P 500 operating earnings, are at record levels.

 

Furthermore, energy related sectors focused on the North American drilling products and services are experiencing growth.  Another talked about development is the American industrial renaissance.  Cheap energy combined with increased cost of labor in developing countries has spurred the return of manufacturing to the United States.  Of course, exciting new industries involved in the digitization of society and new technologies related to cloud computing, automation, and robotics are contributing to economic growth.

 

We think this reinforces our thought that the business community figures out the landscape and its rules and then works for success.  In other words, while the media is telling us how damaging a government shutdown is, companies throughout the economy continue to strive to get better.

 

Nevertheless, some obstacles just won’t go away and it’s hard to believe that our political leaders will resolve the issues that caused last month’s shutdown.  The result is that we will likely face another shutdown at the start of 2014.  We don’t get a sense that the opposing sides of the debate have softened their views.

 

Unfortunately, this might be difficult to change.  Currently, about 50% of the population pays no taxes but are recipients of many benefits.  Another 30% pay taxes approximately equivalent to the benefits received.  The remaining 20% do the heavy lifting.  The 50% clearly like their situation and their representatives will do everything possible to keep it that way.  The others might be more forcefully looking to change things.

 

Ben Franklin once said, “Democracy is two wolves and a lamb voting on what to have for lunch.  Liberty is a well-armed lamb contesting the vote”[i]   It’s possible that the 20%, feeling threatened, are digging in to force a more balanced equation.

 

If successful, this could ultimately result in a stronger economy and a more efficient government.  We aren’t holding our breath but will be closely watching the upcoming debate over fiscal policy.

 

Returning to the stock market, prices seem a little extended.  With year end in the near future and underperformance being grounds for termination (lagging the markets can mean loss of assets or even a pink slip), there are many anxious investors with significant ground to make up.  We think it is hazardous to predict the next two months, but will be on watch for opportunities that the markets present.

 


 

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.

 

[1] US Diplomat & Politician (1735 – 1826)

[1] The Washington Post, September 25, 2013

[1] Ibid

[1] The Wall Street Journal, November 2-3, 2013

[1] GaveKal, Daily Comment, 10/1/13

 

Past performance does not guarantee future results

 

 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 


[i] The Wall Street Journal, November 2-3, 2013


[i] The Washington Post, September 25, 2013

[ii] Ibid

 

 

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

“She Moves In Mysterious Ways”[i]

The markets can have unexpected reactions to news headlines.  Sometimes good news inexplicably gets sold and at other times prices rally after bad news.  While this can be maddening to the professional, it is especially confounding to the retail investor.  It doesn’t help when the financial media talking heads and internet headlines assign some superficial and often misleading sound bite to it.

Often, it’s this reaction to the news that is more important than the news itself.  When a market doesn’t react as expected it could be a sign that something else is going on.  For example, a market that doesn’t go down on bad news can be a sign of underlying strength.  Similarly, a drop after some positive news report can be a forecast of continued selling pressure.

Part of our job, in managing risk, is to understand both sides of a trade.  In other words if we are bullish, we have to have a sense of what the bears are looking at.  This also applies to when we are less optimistic – we need to know what the bulls are thinking.  The headlines don’t always provide the information needed and sometimes the mystery runs deep.  When the markets act especially illogical and we can’t find a reason, it’s a sign to keep digging.


 

The markets have had to digest some big headlines recently.  Just within the past few weeks we’ve had Larry Summers remove his name for consideration as the next chairman of the Federal Reserve, the current chairman decided not to “taper”, and the federal government is shutdown.  While these are whipsawing the capital markets, we think there are some other less obvious influences that need to be considered.

 

We mentioned in our last newsletter, the employment situation, as measured by the labor participation rate, is troublesome.  Also corporate earnings growth might be decelerating. According to FactSet, Q3 earnings growth was expected to be 6.5% (6/30/13 estimate).  That growth estimate shrank to 3.2% by the end of September.[i]  Analysts are typically optimistic especially as the forecast period increases, but the size of this decline is worrisome.

 

Furthermore, of the S&P 500 companies that have issued Q3 guidance, 82% lowered earnings forecast which is well above the 5-year average of 62%.[ii]  The summer’s interest rate spike has slowed housing sales.  Consumer confidence has fallen slightly.  And the emerging markets have taken a big hit during the summer.  Whether this is a function of rising U.S. interest rates (which increases the cost of debt in the EM’s), falling commodity prices (less revenues), or a temporary correction is unknown, there has been significant slowing in emerging market economies.

 

“Don’t Be a Debbie Downer”[iii]

 

 

Of course, with stocks at record levels, the news can’t be completely bad.  Over 4 years of quantitative easing has helped risk assets like equities.  While reasonable people might debate that the economic benefits of spending $85 billion per month (or over $1 trillion per year) do not outweigh the costs, the Fed’s policy of monetizing the government’s debt has helped the capital markets.

 

In early September, Verizon Communications sold $49 billion of bonds which is the largest debt deal ever.  It is almost 3 times Apple’s much talked about bond sale earlier this year.  Undoubtedly, these offerings probably wouldn’t have gotten done or, at least, not at the size that they did without QE.  This milestone by Verizon helped push September’s investment grade corporate debt sales to $145.7 billion.

 

QE has helped the economy as well.  The U.S. private sector growth has averaged 3.4% since Q4 2009.  The overall GDP numbers have been lower because of reduced government spending which ultimately is an economic positive.  Moreover, corporate profit margins are at record levels.  This once again proves that U.S. businessmen and women figured out the changing landscape and have been successful despite questionable fiscal and monetary policy.

 

Looking forward, there are more positives.  An index of OECD leading indicators is rising.  The GaveKal Q Indicator (a monthly series of leading indicators and market prices that indicate global growth) is positive. And the Citi G10 economic surprise index is at a 2-year high.[iv]

 

The U.S. stock market has rebounded from some turbulence in August as the Dow, S&P 500, and Russell all reached record highs in mid September.  2013’s first nine months have provided good returns.  Here are the numbers for the major averages through the end of last week.

 

                                                  2013[v]

Dow Jones Industrial Average  +16.4%
S&P 500                                    +18.6%
Nasdaq Composite                    +25.2%

Russell 2000                              +26.5%

 

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

 

Mark Twain said “October. This is one of the peculiarly dangerous months to speculate in stocks.”  (He followed that by saying, “The others are July, January, September, April, November, May, March, June, December, August, and February.”)[vi]

 

Entering the 4th quarter, the markets are facing some strong cross currents.  Such things as possible monetary tightening, dysfunctional political leadership, some not so cheap valuations, and really bad football being played by the MetLife Stadium teams are countered by an American manufacturing revival, a drive toward lower costing energy independence, and dynamic growth in our society’s growing digitization.

 

Whether the bullish view wins out over their ursine opponents, our ongoing prediction is that the markets will offer opportunities.  Future headlines might not easily reveal these situations, but when bad news gets bought, it’s probably time to take notice.

 


 

[1] Clayton, Evans, Hewson, Mullen, Kidjo

[1] FactSet.com/insight, 9/27/13

[1] ibid.

[1] SNLTranscripts.org

[1] GaveKal, Quarterly Stragegy Chart Book, September 2013.

[1] The Wall Street Journal, September 28-29, 2013

[1] “Pudd’nhead Wilson”, Mark Twain, 1894

 

 

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

 

 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 

 

 

 

 

 

 

 

 


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

“Parting is such sweet sorrow”[i]

Saying goodbye can be stressful.  Whether the separation is only temporary or longer term, there is a touch of sadness.    And this time of the year can have various farewells.  Some say goodbye to the beach house or mountain cabin, while others send kids off to college.

 

In this season of hellos and goodbyes, a surprise separation was announced last week.  Steve Ballmer said he would be leaving Microsoft in a year.  Never wanting to be called sentimental, the stock market’s cruel reaction was to bid Microsoft’s stock up 7%.


[i] Romeo and Juliet, Act2, Scenec2

 

This reaction by Wall Street incorrectly blames Mr. Ballmer for the software maker’s below average stock performance for the past decade of his tenure as CEO.  The short sighted forget that he was one of Bill Gates first hires and helped build one of the most successful corporations in history.  He became CEO of a large company that was past its fast growth phase as PC sales peaked.  But in a “what have you done for me lately” world, Steve Ballmer is the scapegoat.

 

Of course, there is another goodbye that has Wall Street’s attention.  Fed Chairman Ben Bernanke will soon resign as Chairman of the Federal Reserve.  In addition to a new chairman, there will be more departures on the FOMC as two other board members will be retiring within a year and another is moving to a position at the Treasury.  This is a lot of turnover and adds to the questions concerning Bernanke’s leaving.  The two big questions center on who will be Bernanke’s replacement and how will this affect the decision whether to cut back on QE.

 

The two candidates for the chairmanship are Janet Yellen and Larry Summers.  Wall Street is largely in favor of Janet Yellen, a current FOMC member, while President Obama is close to Mr. Summers.  In Dr. Yellen, investors believe that there will be a smooth transition and a continuation of the current monetary policy.  Concerns surrounding Larry Summers center on uncertainty of possible policy changes and questions about his experience.

 

Another possible goodbye involves the stock market.  The rally that began at the beginning of the year looks to be finally approaching a level where a correction or consolidation may develop.  As measured by Jeffrey Saut at Raymond James, 2013’s buying is one for the record books.  He measured the stretch at 156 trading days.  He refers to this as a ‘buying stampede’ and defines it as a move without a four day consecutive reversal.  Mr. Saut calculated this move at 156 sessions – his previous high count was 53 trading days which happened 26 years ago.[i]  Here are the year-to-date returns for the major averages as of August 23.

 

The major indexes reached 52-week highs at the start of the month but have declined from that point.  Market strategists are not expecting an end to this bull move, but rather some choppiness that might translate into a meaningful pullback before a resumption of the rally.

 

                                                                        2013[ii]

Dow Jones Industrial Average                        +14.5%
S&P 500                                                          +16.6%
Nasdaq Composite                                          +21.1%

Russell 2000                                                    +22.2%

 

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

 

There are several possible reasons – worries over the Fed starting to “taper”, softer housing statistics, weaker than expected retail sales releases, the Middle East, the higher move in bond yields, and the U.S. debt ceiling debate.  In summation all these have an affect, but also the equity markets have gotten all of the buyers in, for the time being, and a pause is needed.

 

Of course, there are some on Wall Street who are more worried and predicting a decline of upwards to 20%.  Their thought process includes the above issues as well as the belief that investors have become too complacent.  The possibility of something such as further deterioration of the European crisis is not reflected in current market valuations.  Others believe that record stock prices are little more than central bank stimulus and that once (perhaps one could say “if”) they even slow down their money printing, stocks will fall.

 

On the other side of the debate, corporate earnings are good.  Through the middle of August, 62.9% of the companies reporting quarterly results beat their earnings estimates and 56.6% beat revenue expectations.[iii]  If this momentum can carry on, any correction should be an opportunity to increase exposure to the stock market.

 

We say our goodbyes to the various summertime routines, send the kids back to school, and say hello to our ‘regular’ schedules.  How stocks begin September may be an indication of the short term trend.  Clearly, geopolitical tensions are high and they could have a larger negative impact on the economy and the markets.  But any correction might be an opportunity for the 4th quarter and beyond.

 


[i] Raymond James, “Morning Teac”, August 22, 2013

[ii] The Wall Street Journal, August 24, 2013

[iii] Raymond James, “Investment Strategy”, August 12, 2013

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.

 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 

 

 


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

“‘Bout Working All Summer, Just to Earn a Dollar”[1]

As measured by years, it wasn’t that long ago that the markets abhorred central bank intervention.  As measured by perception, the days that were without meddling and manipulation seem like they should be preceded by “BC”.  So dramatically has the market landscape changed that an investment banker or hedge fund manager waking from a Rip Van Winkle snooze would react to ZIRP, QE and Twist by clicking the sell button (of course, he or she would have first tried to call their floor broker only to learn they were replaced by an algorithmic trading computer).

 

Monetary policy makers have become so ingrained that imagining smoothly functioning markets without them is the same as imagining the Jets winning the Super Bowl.  Federal Reserve activism began to increase in the 1990’s.  Global central banks intervened as a response to 1997’s Asian Crisis by cutting interest rates and expanding the supply of money.  This easing then contributed to the Dot-Com bubble which eventually burst and was fought with more money printing and lowering of interest rates.  In turn this contributed to the housing and credit crisis which led to the current state of quasi-free markets.

 

Coming out of the Great Recession, the markets initially disliked this stepped-up intervention but changed their mind as they accepted it as necessary to save the system (a debatable issue).  Since then investors have become so comfortable with the Fed’s finagling that they look forward to any “Fedspeak”.  Now, every speech by a Federal Reserve board member is scrutinized for a sign of policy adjustment.  Every press conference and testimony is broadcast on the financial networks.  Indeed things have changed.

 

Yet this change in perception goes almost unnoticed.  Perhaps it’s analogous to a frog being placed in the pot before the burner is turned on – the change is imperceptible but becomes drastic over time.  Perhaps it’s a function of the wave of younger traders and managers who accept this new environment as natural and can’t imagine the economy working without the Fed’s current role.  Whatever the cause, there is widespread belief that the Fed’s intervention is needed and is a benefit.

 

Financial details like earnings growth, margins, and cash flows remain important.  However, in the modern investing world they are trumped by central bank policy.  To be sure, monetary stimulus or tightening will impact virtually every company’s performance. However, the degree and speed with which the market judges a verb or adjective’s impact on our almost $16 trillion economy is lunacy.

 

During Chairman Bernanke’s May 22nd congressional testimony, he stated that daily bond purchases might be “tapered” beginning in September.  The words barely hit the tape and stocks plunged.  The Dow Jones Industrial Average, which had reached a new high before his appearance, reversed course and fell 235 points.  The 10-year treasury note’s yield spiked to above 2.04% from the morning’s 1.88%.

 

“Taper” was suddenly the word on everyone’s lips and the debate over whether we had finally reached the end of quantitative easing began.  The stock market reversal ushered in a 2013 rarity – a three day losing streak.  Stock chopped around for the next two weeks trading lower 7 out of the next 10 days.

 

While stocks fell over 6% during the month, the real pain was in the fixed income market.  Interest rates started rising at the beginning of May moving from 1.63% on the 10-year note to the 2% level after Bernanke’s testimony.  The yield eventually topped out above 2.7% in early July.  20% losses were common in the bond mutual fund sector and it was a shocking wake up for those who thought fixed income investing provided stability.

 

U.S. stocks have recovered aided by what else but soothing words by Ben Bernanke.  In June, the fed chairman reassured the markets that “The overall message is accommodation.”[1]  Equities rebounded in late June and resumed this year’s pattern of slowly and steadily climbing with the Dow, S&P 500, and Russell 2000 making new all-time highs last week.  Here are the major indexes’ year-to-date returns through last week.

 

 

                                                                                    2013[2]

Dow Jones Industrial Average                                    +18.6%
S&P 500                                                                      +18.6%
Nasdaq Composite                                                      +18.8%

Russell 2000                                                                +23.7%

 

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

 

While U.S. stocks are having a very good year, there are other areas with negative returns.  The underperformance of the emerging markets is a development that has gone somewhat unnoticed.  At the end of last week Brazil had fallen 22.8% this year while the Chinese Shanghai Composite is down 12.2% and Russia has declined 9.6%.[3]

 

Fighting the fed is a perilous occupation.  Equally hazardous is blindly following central bank rhetoric.  The degree to which the Bank of Bernanke influences the direction of the markets is remarkable.  That this is a recent phenomenon matters little except to add another influence and perhaps increase risk.  The risk primarily surrounds the fact that so many are trading the same way.  When everyone trades the same way, it inevitably leads to an excess which results in a painful adjustment.

 

There are many smart strategists who believe quantitative easing is far from being over (see Pimco’s Mohamed El-Erian June 14, 2013 Financial Times article).  While this market tailwind will continue to a positive for risk assets, it is not solving all problems.  The ongoing Europe saga remains without a solution with unemployment in the southern European countries at alarming levels.  The Middle East is in turmoil and global growth is slowing (the OECD industrial production is contracting year-over-year).

 

Perhaps most troublesome is the recent spike in interest rates.  Possibly rates retrace this jump higher but, if not, it could be an economic growth obstacle.  The rise in nominal rates (the stated rate) has caused real rates (nominal rate minus the inflation rate) to dramatically increase.  This type of move in real rates often can slow economic activity.  Maybe this is what’s disturbing the emerging stock markets.

 

There are some market pros who are pointing to 2013’s move as a beginning of a huge multi-year bull market.  While this is possible (and the Fed certainly is rooting for it), stocks rarely move in one direction forever.  A normal cycle has corrections and pauses.  This year has been an exception.  Other than the June pullback, the averages have steadily climbed.

 

However, there are a few signs that we are getting closer to a dip.  Sentiment is at a minimum complacent, but can be considered overly bullish.  Rising prices have pushed valuations beyond what can be considered cheap.  At recent record levels, the indexes are encountering significant resistance.

 

If a correction occurs, it might be an opportunity.  Presuming a normal pullback that has little economic impact, lower prices should encourage buying which could setup a good end to the year.  In the meantime, traders’ summer reading includes Federal Reserve meeting minutes.

 

 


[1] The Wall Street Journal, July 11, 2013, sec 1, pg2.

[2] Ibid, July 20, 2013

[3] Ibid, July 20, 2013

 

 

 

 

 

 

 

 


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

 


 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

News from Kerr Financial Group

When he is talking about investing, listening to Warren Buffett is probably wise. Similarly, although his stature may not be as great, listening to Jim Grant can be wise.  And when Jim Grant quotes Warren Buffett, it is probably noteworthy.  Such an event happened in the July 26th issue of “Grant’s Interest Rate Observer”.  Actually, Jim Grant quoted Warren Buffett who quoted John Burr Williams author of The Theory of Investment Value.  The quote was “The value of any stock, bond, or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset”.[i]

While the Oracle of Omaha has had wittier quotes and scribes, it does not detract from the importance of this statement.  Further it is a simple, direct proclamation that could be lifted from a Financial Analysis 101 textbook.  Nevertheless it has three important assumptions that go to the heart of investment analysis – cash inflows, cash outflows, and the discount rate (interest rate).

Jim Grant followed the Buffett quote by focusing on the interest rate component.  He asks, “It would be nice to know where they’re going” and “It would even be nice to know what they mean”.[ii]

The direction of interest rates in the U.S. is a white hot topic and debate over their future has intensified. As for the meaning of the current state of interest rates, it is clearly distorted by central bank intervention and manipulation.

In May Fed Chairman Bernanke mentioned that the central bank may “taper” the monthly $85 billion buying of Treasury bonds and mortgage securities.  This put a scare into the fixed income markets.  Interest rates, which had been rising since the beginning of the month, accelerated their climb.  The 10-year Treasury note moved through 2% and has kept moving higher throughout June and July reaching 2.73% at the start of August.

It’s easy to dismiss a 2.7% level as unimportant or inconsequential.  And for those who can remember life before the financial crisis and quantitative easing, these interest rates are still low.  To better understand the pain in the fixed income markets during the past few months, one needs to consider a 100 basis point move relative to a 1.65% starting point.  In other words, we’ve had a 60% move higher in the 10-year’s yield.  While many were predicting higher interest rate, not many investors were prepared for such a dramatic move in a short time.

What the future holds for interest rates is a critical question.  Some believe that the Fed will begin to slow their bond buying program which will apply further upward pressure on rates.  Others forecast higher rates due to increased inflation and economic growth.

There are others predicting a reversal of this recent spike.  Their view revolves around the belief that the Fed won’t end QE and that the economy is not that strong.  July’s employment report makes a case for this view.  While there was an increase of 162,000 jobs in the month and the overall unemployment was the lowest since December 2008 (7.4%), some underlying details were weak.  A low participation rate (63.4%), a drop in weekly earnings, and a high number of workers considered long-term unemployed (4.2 million Americans) give defense to those who argue against any near term end to Fed bond buying.

For those supporting the glass is half full view, second quarter earnings have not been bad.  According to Merrill Lynch, sales and earnings expectations are higher now than they were when the quarterly earnings reports began in early July. Sales predictions for the quarter are now 1% higher than they were on July 1.  Furthermore, Merrill Lynch is now forecasting that second quarter earnings will be 2.7% higher than a year ago.[iii]

This just scratches the surface of the discussion over which direction interest rates will move.  And while both sides of the debate make strong cases, returning to Jim Grant’s first question, knowing the eventual direction of forthcoming interest rates will be important to the markets. We think investors should be flexible enough to adjust to either result.

As for the meaning of interest rates, it’s not what it used to be.  The zero interest rate policy (ZIRP) being implemented by virtually all central banks has clearly distorted the role that rates used to play.  Once upon a time, interest rates helped put a price on the cost of capital.  Further they were the reward for postponing consumption and saving money.  With the nominal level around 0% and the real level (the level after subtracting inflation) negative, they don’t have the same function.

In recent years, the most important meaning interest rates have is as one of the tools used to stimulate the economy.  In this regard, there has been an uneven reaction.  While the job market hasn’t responded as hoped, housing has been a clear beneficiary.  Looking across the rest of the economy, the impact has been lumpy.

The stock market has been another clear benefactor of ZIRP and QE.  After Chairman Bernanke’s “taper” remarks, equities weakened into late June.  From there they rebounded and made fresh record highs on August 2.  Stocks retreated a little last week as the Dow Jones Industrial Average lost 1.5%, ending a stretch of six weekly gains for the blue chips.  Here is the major averages year-to-date performance.

                                                                        2013[iv]

Dow Jones Industrial Average                           +17.76%
S&P 500                                                             +18.6%
Nasdaq Composite                                            +21.2%

Russell 2000                                                       +23.4%

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

If the current meaning of interest rates is unknown, the stock market is at least an equal mystery.  Are stocks that dependent on the Fed that as soon as the end of easing is just mentioned prices move lower?  Are corporate earnings sustainable without low interest rates?  To these questions add variables such as the European crisis, geopolitical issues, and fiscal deficits that are not being addressed.  We offer that neither Warren Buffett nor Jim Grant have definitive answers.

Despite these issues, it’s hardly the time to raise a white flag.  While we don’t

 think it’s time to be “all in”, there are opportunities whether tapering starts or is postponed.  The markets have had a good July and sentiment has gotten pretty complacent.  This can lead to a consolidation or pullback.  Another short-term headwind will be expectation of a Fed announcement at the Jackson Hole conference or at the next FOMC meeting in September.

As we plod through the markets’ gyrations, we’ll be on the lookout to buy situations with increasing cash inflows or decreasing cash outflows or, preferably, both.  Buying these situations at the right price, as Warren Buffett would attest, is the goal.


[i] “Grant’s Interest Rate Observer”, July 26, 2013, pg 9.

[ii] Ibid

[iii] The Wall Street Journal, August 5, 2013.

[iv] Ibid, August 10, 2013

 

 

 


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

 


 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

“I’ve Got Good News, I’ve Got Bad News”

The recent developments surrounding the financial markets cause, at a minimum, mixed emotions. First, the good news – stocks are at record levels. Further, belief is quickly spreading that even higher prices lie ahead. Worries over the election, the fiscal cliff, and sequestration seem to be antiquated emotions of the good old days. More recent developments such as China, North Korea, and Cyprus are quickly dismissed as unimportant or, at worst, easily fixable.

 

The bad news is that stocks are at record levels – at the same time as interest rates are manipulated, debt is monetized, and currencies depreciated. Some argue that these artificial factors are the only reason for the market’s ascent. While they are not insignificant market influences, stimulus and easy monetary policies are not the lone reasons for the rally. Valuations are reasonable, profit margins are strong, earnings are growing and non-financial balance sheets are well positioned.

 

Whatever the reason behind it, stocks have had an incredible 2013 with the occasional selloffs being little more than one-day wonders. This steady levitation has resulted in the major averages, except the Nasdaq Composite, reaching new all time highs in the first quarter. This page from the tortoise’s playbook may have played a part in what seemed to be a generally subdued reaction to this market milestone.

 

While economic growth and corporate fundamentals have been important components driving equities, central bank policy has also played a key role. Our Federal Reserve with it many versions of QE (a fancy name for debt monetization) has been an active market manipulator for many years. Of course, among the gangs that can’t shoot straight, the European Central Bank (ECB) appears to be especially incompetent. Regulators and policy makers propose their final and ultimate bailout solutions on a monthly basis. Not to be left behind, the Bank of Japan has recently committed to fighting deflation by printing as much Yen as it takes. Given that the Land of the Rising Sun has been fighting deflation for over 20 years and conceding that creating currency with the press of a button is effortless, we wonder if “deflation” is still favored to win.

 

This renewed Japanese commitment is commonly referred to as “Abeonomics” as it is a key part of Prime Minister Shinzo Abe’s economic plan. It includes goals of helping domestic manufacturing through currency devaluation as well as motivating its citizens to move further out on the risk spectrum. In addition to buying the Nikkei, this can be done through selling the Yen and buying stocks with the newly purchased currency. Of course the U.S. dollar can be the recipient of this capital flow which then presumably finds its way into the stock market.

 

There is little doubt that the capital markets have welcomed this stepped up liquidity. Whether this ultimately increases GDP remains a question among some. However, central bankers and regulators strongly believe intervention and price manipulation are necessary steps to support the current system. As far as any associated risks, Chairman Bernanke repeatedly tells listeners that they are “manageable”.

 

“Once upon a time there lived a vain Emperor whose only worry in life was to dress in elegant clothes.”

 

That manipulation and intervention qualify as sound procedures troubles us. We are further disturbed by the widespread confidence that is seemingly placed in a group whose track record is far from spotless. This is largely the same cadre who were supposed to save us from the crisis that befell us. Everyone assumes, like Hans Christian Anderson’s emperor, the Fed , ECB, and BOJ are fully clothed. But the realization that they are naked is not part of today’s bids and offers. Perhaps there never comes a time when the markets see through this folly, but it won’t be pleasant if they do.

 

The incredulous need not look very far or hard to find catalysts. Some of the obvious include fiscal deficits without a semblance of a cure, a slowing China, and Europe without a fix. Cyprus bank depositors being included in the “bail in” is a new and alarming component to addressing a bank crisis. Furthermore, Italy can’t form a government. And how does one price the risk associated with North Korea?

 

Our worries are not a prediction for a stock market collapse. However, a painful correction would not surprise us. In addition to being a historic stretch without a pullback, we think there is too much complacency surrounding the economic landscape and global developments. If the markets continue their climb without an adjustment, there are always opportunities.

 

 


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

 


 

Jeffrey J. Kerr is a registered representative of

LaSalle St. Securities, LLC, a registered broker/dealer.

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC