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

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA


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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Life is a clue in a crossword

Kerr Financial Group

Kildare Asset Mgt.

Jeffrey J. Kerr, CFA


August 13, 2018 – DJIA = 25,313 – S&P 500 = 2,833 – Nasdaq = 7,839


“Life is a clue in a crossword”[i]

Current economic and capital market analysis is like doing a crossword puzzle.  Some developments have multiple intersections with other events and are intensely linked.  At the same time, some news, while important, is a little economically distanced with only peripheral connections.

For example, a six letter word for a tax or duty to be paid on a particular class of imports or exports is “tariff”.  The “r” could intersect with either “r” in “trade war”.  And the other ‘r’ in “trade war” could intersect with the “r” in “dollar”.

Or a 14 letters (2 words) for the calculation of dividing the number of unemployed individuals by all individuals in the work force.  This is obviously the “unemployment rate” and it is connected to “interest rates”.  Bonus points would be awarded for getting the clues for BREXIT, cultural division, inverted yield curve, and $1 trillion market cap.

The obvious point is that the capital markets are at a high degree of interlinkage and it’s hard to stay on top of all of the relationships.  The not so obvious point is that these relationships are dynamic with wide reaching influences.

For example the stock market doesn’t like lower profits – that’s easy.  And tariffs can cause higher expenses and potentially shrinking net income.  But what if the exporting country’s currency drops in value relative to the U.S. dollar.  Does this foreign exchange development reduce the price for the foreign seller to a point where they maintain their sales in the U.S.?  This appears to be the case with the Chinese yuan as recent the fall in its value is offsetting the impact of higher tariffs.

Another important piece of our financial crossword puzzle is “earnings season”.  With the reporting of second quarter results coming to an end, earnings have been good.  Of all of the companies releasing 2nd quarter numbers, 65.6% of these reports have beaten consensus earnings expectations.  Further, 67.5% of companies exceeded the consensus revenue forecasts.  While both of these are good, they are below the previous two earning seasons.

The stock price’s reaction to these reports can be just as important as the numbers themselves.  As expected, good news was rewarded and bad news was punished.  For the second quarter numbers, the average 1-day % change for the stock price of a company after their earnings release was +0.45%.  Dividing this into the number of companies that beat earnings estimates and those that missed earnings estimates, stocks of companies that exceeded earnings estimates averaged a 1-day 1.8% increase in their stock price.  On the other hand, stocks averaged a 3.6% one-day drop for those that missed earnings estimates.[ii]

Within this group of misbehaving companies who experienced a stock market ‘time out’, there are some unexpected name.  This year’s biggest winners ran into some speed bumps in the second quarter.  Not that their earnings and sales numbers weren’t exceptional – they were.  But apparently they weren’t good enough as the market gave them a clear thumbs down.

For example, Netflix (symbol = NFLX) which describes itself as “the world’s leading internet entertainment service with over 130 million memberships” reported a 40% surge in year over year revenues  together with an amazing 482% jump in net income.  Total subscribers grew almost 30% from 2017’s second quarter.  Hard to criticize these numbers and a natural assumption would be for a higher stock price.  Surprisingly it fell over 10% or $50 per share.  Management lowered the forecast of future subscriber growth and current subscribers viewing hours and that’s not something the market was looking for.

Some other FANG (Facebook, Amazon, Apple, Netflix, and Google) stocks suffered similar unexpected reactions to their second quarter earnings.  Facebook tumbled on its release as users spent less time on the website.  Also management reported that expenses would increase as the company enhanced infrastructure and security to deal with their issues concerning privacy.

Amazon’s 2nd quarter revenues increased 39% year-over-year yet its stock price declined.  Apple saved the day with an earnings estimate beat.  Its stock price rose and Apple became the first company to exceed $1 trillion market capitalization (total value in the stock market).

Despite Apple’s accomplishment, it hasn’t been a good stretch for these stock market leaders.  Prior to this earnings season, the FANG stocks have been responsible for a large portion of the stock markets’ year-to-date returns.  Naturally, Wall Street, never missing an opportunity to sell a new product, developed a FANG index.

The FANG + index is “an index that provides exposure to a select group of highly-traded growth stocks of next generation technology and tech-enabled companies”.[iii]   The FANG + index’s components are Facebook, Apple, Amazon, Netflix, Google, Alibaba, Baidu, NVIDIA, Tesla, and Twitter.  These have been investors’ favorites in 2018 and seemingly could do nothing wrong.

However, the weakness in these stocks after their earnings reports could be a sign that too much good news had been priced in.  At the end of last week the index has declined 6.78% since making a 52-week high in late June.  And much of this drop has occurred since Facebook’s earnings release.  With these market darlings selling off, it’s kind of like the popular kids got sent to detention.

Here are the year-to-date performance numbers as of last Friday for the more conventional indexes.


Dow Jones Industrial Average                                                                           +2.4%

S&P 500                                                                                                                 +6.0%

Nasdaq Composite                                                                                               +13.6%

Russell 2000                                                                                                         +9.9%

Another part of the FANG + index, Tesla (symbol = TSLA), is a crossword puzzle on its own.  Or, better yet, a reality show.  The electric car maker has a controversial history with many critics believing that the company has over promised and vastly under delivered.  Tesla has never been profitable and has an annual cash burn rate measured in the billions.

The company’s C.E.O., Elon Musk, has been at the center of the storm that has surrounded this company. Supporters view him as a visionary genius while his detractors claim he is a fraud.  He has fueled the fire with an ongoing soap opera on Twitter. To be sure, there a lot of Twitter soap operas, but the Tesla dialogue has to be near the top.

For example, on April 1, he posted a picture on Twitter of himself passed out against a Tesla car with the post “Tesla goes bankrupt”.  As a reminder, this year’s April Fool’s Day fell on a Sunday which happened to be Easter Sunday.  The peculiar timing increased questions of Mr. Musk’s stability and focus.

Another controversial moment occurred during the company’s first quarter conference call when Mr. Musk rudely dismissed an analyst’s question.  Again this unprofessional conduct brought criticism and questions regarding the conduct of a C.E.O of a $50 billion company.  Mr. Musk apologized during the recent second quarter (three months later).

In July, Mr. Musk referred to one of the British drivers rescuing the trapped soccer team in Thailand as a “pedo” – a shortened term for pedophile.  Vern Unsworth, the driver, had previously described Elon Musk’s offer of a mini submarine as a “PR stunt”.  Mr. Musk deleted the tweet a short time after posting but, by that time, there were many re-tweets and word quickly and widely spread.  Mr. Musk apologized a few days later in an indirect manner as he responded to another post on Twitter.

Last week, in what might be the pinnacle (or nadir depending on your view), Elon Musk posted the “Tweet of the Year” (so far).  Last Tuesday, Musk tweeted “Am considering taking Tesla private at $420.  Funding secured.”  No further details, no press release, no 8-K filing (an S.E.C. filing of material events and news releases), nothing but a tweet.  At $420 per share the deal would exceed $80 billion.

Trading in Tesla’s stock was halted after the tweet.  When trading resumed a couple hours later, the stock jumped to $380 per share.  Then the fireworks really started. Given Elon Musk’s unusual behavior, was this another prank?  Or was this his way of making a factual announcement?  Did the $420 price have drug significance (the number 420 being associated with marijuana)?

As soon as the tweet was posted there was widespread doubt on the claim that financing was secured.  Yes, the bond market has been a 35 year bull market (despite several predictions of its end) and money has been plentiful in the corporate debt markets.  But given Tesla’s challenged operating performance, this was far from a slam dunk.  Secondly, a deal of this size and complexity was not getting thrown together over a weekend.  The required due diligence would take considerable time.  Lastly, a deal of this magnitude, potentially the largest corporate takeover in history, would have generated a constant stream of rumors and leaks.

In addition to these issues, there was outrage over Musk’s tweet given that he is the largest shareholder of Tesla.  Wall Street has a history of stock promotion and things like the internet and financial news networks can be a means to that end.  Many questioned if this was Musk’s way of attacking the large short interest in the stock at same time enriching his net worth.  It is hard to believe that someone would so blatantly and obviously manipulate the stock price.  But given Mr. Musk’s history, nothing is out of the question.  While law suits began over the past weekend, there’s been no enforcement by the S.E.C. (so far).

If listening to earnings conference calls while scanning Twitter wasn’t enough, Wall Street had another meltdown to cope with last week.  The Turkish lira plunged to its lowest level ever over worries about the country’s economic stability.  While no one confuses Turkey with an economic powerhouse, in a financially intertwined global system, everyone matters.

The lira’s decline seriously weaken international confidence and will make it harder for the country to refinance debt.  Also, Turkey’s issues cast a shadow across all emerging markets as well as fragile developed countries such as Italy and Spain.  Also, European banks have exposure to the Turkish economy.

Uncertainty over international stability caused the U.S. stock markets to fall on Friday.  It snapped a string of 5 consecutive weeks of gains for the Dow Jones Industrial Average and the S&P 500.  The S&P 500 had recently broken out of a trading range and had been trending toward a new all-time record level.  It got to within 1% of a new high before Friday’s retreat.

A backdrop of an expanding economy and growing earnings is supportive of higher stock prices.  The employment picture is the strongest since disco was popular and business confidence is at record levels.  Corporate balance sheets are generally strong and business investment is slowly moving forward.

The bearish side of the trade has many intersecting clues.  First global central banks led by the Federal Reserve are talking about or are in a tightening cycle.  This means higher interest rates and less systemic liquidity.  These could turn into significant economic headwinds.

Also, the narrow market leadership is a concern.  As mentioned the FANG + have accounted for such a large portion of the 2018’s stock market gains.  Sustainable market trends typically have a broader participation.

Next sentiment might be overly optimistic.  Some investor surveys are indicating excessive bullishness including an above average level of hedge fund longs in the e-mini S&P 500 futures.  Remember that these indicators are normally viewed as contrarian because investors who are bullish have already done their buying and may not have much dry powder left.

Other risks, of course, include trade wars, geopolitical tensions, and, as mentioned above, emerging market turmoil.  To be sure, these have been potential market obstacles throughout the year but have not had any lasting impact.

Navigating the markets is tricky.  The news flow can have wide reaching effects with unclear connections to other developments.  Something that appears to be pretty straightforward can turn into a tangled mess.  On balance the markets are absorbing the bad news and trading well.  And in an attempt to fill in the blanks and complete the puzzle, perhaps the best mindset for investors is a 19 letter 3 word answer – “optimistic but cautious”.




[i] Ian Anderson, 1979

[ii] The Bespoke Report, August 3, 2018

[iii] www.theice.com




Who’s Afraid of the Big Bad Wolf?

The stock market has been on a historic run since the election. A steady series of record highs in spite of a landscape of protests, name calling, and divisiveness. Given the elevated level of widespread acrimony, one would logically expect stocks to be broadly lower instead of at all-time highs. Nevertheless, there hasn’t been a meaningful correction since the before the election. Two weeks ago, the major averages had their largest weekly loss of 2017 and it was first time the S&P 500 had a down week in a month and one-half. It also ended a seven-week winning streak for the Nasdaq and four consecutive advancing weeks for the Dow.

The averages got back on the winning side last week thanks to a spike higher on Wednesday afternoon after the Federal Reserve’s increased the federal funds rate 25 basis points. Since a rate hike was widely expected, this decision was discounted. Instead, the rally was driven by dovish comments by Janet Yellen concerning future rate increases. The market had begun to fear four increases in 2017 which could push against economic growth. But, after Wednesday’s press conference, the markets are now expecting only two more in 2017 (three total for the year).

Of course, higher interest rates result in increased borrowing costs and lower profits. Not the typical recipe for a good stock market. Furthermore, higher interest rates result in lower present values of future cash flows i.e. lower asset prices. However, past Fed tightening cycles have not always translated into troubled markets. The table below shows the returns for stocks, bonds, and cash during past periods that the Fed was increasing interest rates.[i] Surprisingly, these asset classes do quite well during rising interest rates. As can be seen, stocks averaged a gain of +21.61% during the 15 cycles since 1958. Even fixed income and cash have historically done well, +5.77% for bonds and +10.26% for cash. Maybe the markets’ current worries are focused on the wrong area – it wouldn’t be the first time.

The danger of rising interest rates might increase after the last rate hike. Below is another table showing the average returns for stocks, bonds, and cash after the last rate increase of a cycle.[i] As can be seen, the average returns one year after the cycle ends are much lower for stocks and cash (+8.79% and +6.71% respectively) but better for bonds (10.08%). The average annual returns for the five years after the end of the cycle is 10.79% for stocks, 9% for bonds and 5.77% for cash.

A couple of notable and worrisome numbers are the returns after the last two tightening cycles. Stocks did poorly after both examples down 14.83% in 2000 and down 13.12% in 2007. Of course, these were the bursting of the tech bubble and the beginning of the financial crisis, but it causes one to wonder if another bout of higher interest rates will lead to another crisis.

We reached another stock market milestone two weeks ago – the 8-year anniversary since stocks bottomed in March 2009. Much has changed in 8 years. First, investor psychology is very different. It hasn’t traveled the typical journey from deep bearishness to widespread optimism. Instead there remains a general mistrust of the capital markets combined with the begrudging acceptance that some level of exposure to the stock market is required.

This mistrust is an extension of a lack of confidence in our financial leaders and regulators. One of the reasons the Federal Reserve was created was to prevent these types of meltdowns. Yet we suffer through a stock market bubble followed by a systemic crisis and the central bank’s response is more of the same approach that led us into these messes. The public recognized that money printing in the form of programs such as TARP and QE together with lowering interest rates was the same old stuff and they didn’t trust it. The markets eventually stabilized but it’s debatable whether the reason was central bank policy or the internal, self-clearing market mechanisms.

Another notable difference between March 2017 and March 2009 is the composition of leaders. There are several currently popular stocks that weren’t around 8 years ago. Facebook came public in May 2012. Tesla’s IPO was June 2010. Other significant IPO’s during this time period were Twitter (November 2013) and Alibaba (September 2014). At a minimum, this shows that the markets continue to evolve and move forward.

Returning to 2017, as mentioned, it has been a good year so far and there are some signs that it will continue. We recently passed the 50th trading day for the year and, at that time, S&P 500 was up 6.03%. Since World War II when the S&P 500 is up at least 5% at the 50th trading day of the year, stocks have a remarkable history of continuing higher. Of the 22 prior occurrences, the S&P 500 added to those gains 21 of those years. The average gain was 12.16% in the remainder of the year. Sticking with this indicator, gains can be stronger in the first year of a presidential cycle with 5 prior examples – 1961 +12.89% the rest of the year, 1985 +18.57%, 1989 +19.74%, 1997 +6.67%, and 2013 +9.61%.[i]

Events over the past year give pause to confident predictions and using history as a guide to the future. Maybe this will be one of those rare years where the first 50-day rally fizzles. Furthermore, the current landscape in Washington looks to be changeable. Given that much of the Trump rally has been driven by anticipated changes in tax code and business regulations, the markets could be susceptible to disappointment if there are delays or cancellations of this agenda.

Add to these crosscurrents and confusion the fact that the Federal Reserve will be raising interest rates again later in the year. Then mix in the valuation backdrop of a pricey stock market at all-time highs and we have markets that could use a correction. In the short term, we have end of the 1st quarter approaching which is normally supportive of equities. Perhaps we get a pullback next month. If that happens it could recharge the bulls for another leg higher. Of course, this assumes the economy strengthens and Washington pushes through the expected changes. This promises to be an interesting year.

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13901

[i] Bloomberg, March 10, 2017
[ii] ibid
[iii] The Bespoke Report, March 17, 2017