And I could tell the wise men from the fools

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June 26, 2017 – DJIA = 21,394 – S&P 500 = 2,428 – Nasdaq = 6,265
“And I could tell the wise men from the fools”[i]
Going into the Memorial Day weekend, the S&P 500 was up 7.89% YTD.  A nice 5-month stretch.  But for those keeping score at home, there’s more to this story as not all stocks deserved a long weekend.
The 5 largest stocks in the index (Apple, Facebook, Amazon, Microsoft, and Google/Alphabet) were responsible for about 40% of this number.  In other words, without these “Fab Five”, the S&P 500 would have advanced a more modest 4.6%.  As a result of their stock prices’ success, our five horsemen have grown to become 14% of the index’s value which exceeds $20 trillion.
That these are premier companies is indisputable.  That their collective financial results should drive such a disproportionate stock market gain is a bull market.  Regardless of the level of logic involved, the fact is that the FAAMG stocks are leading this bull run.  And we must remember that perception is reality in the stock market – it may not make sense but market’s price is the market’s price.  (As a point of clarification, the more commonly used stock market acronym is FANG which includes Netflix at Microsoft’s expense and the “A” accounting for both Apple and Amazon).
Stock market trends eventually end and it may be happening to this one.  On June 9th, a day like most, these investor favorites were leading the indexes to new record levels.  Then suddenly, out of nowhere, the favorites fell.  Apple, Amazon, Facebook, and Google all fell over 3% that day.  Netflix dropped 4.7% and Nvidia dove 6.5%.
The Nasdaq Composite retreated 1.8% from the previous close and 2.1% from the morning highs.  The Nasdaq 100 (the 100 largest of the Composite) fell 2.44%.  The weakness was primarily in technology as the Russell and Dow Jones Industrial Average (both less technology weighted) advanced that day while the S&P 500 was flat.
Interestingly, there was no definable event or cause for this tech wreck.  Some attributed the reason to a Goldman Sachs report that was released that morning which suggested these stocks had increased “mean-reversion risk”[ii]  In other words, these stocks had gotten extended from the rest of the markets in both performance and valuation.  In addition to this Goldman Sachs news, there were rumors that short sellers were targeting some of the names.
Despite this sell off, technology remains the best performing sector for 2017 by a wide margin.  One of the main reasons is that these companies are showing the most growth in an economy struggling to find a higher gear.  Here are the year-to-date returns for the major averages through last Friday.
                                                                                     2017 YTD
Dow Jones Industrial Average                                       +8.3%
S&P 500                                                                         +8.9%
Nasdaq Composite                                                         +16.4%
Russell 2000                                                                  +4.2%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
It is noteworthy that many of the targets of the June 9th carnage remain below the levels from that day.  For some of these stocks it may have been an “emperor’s new clothes” moment and marked a longer-term inflection point.
Companies like Apple, Amazon and Google are transformative.  They have developed products that changed consumers lives, and as a result, have a high level of customer loyal.  However, all tech stocks are not equal especially when it comes to valuation.
For example, Apple trades at a price-to-earnings ratio of 16.8 and 11.4 times its enterprise value-to-EBITDA.  (The enterprise value to EBITDA ratio compares the value of the company’s stock and net debt to cash flows from operations).  Both numbers are reasonable for a premier organization like Apple.
Google and Microsoft trade at slightly higher valuations.  Google’s P/E is 31 and its EV-EBITDA is 18.  Mr. Softy’s P/E is 22 while its EV-EBITDA is 14.
Turning to the other high-profile market leaders, Amazon’s valuation is rich.  It trades 183 times trailing twelve months earnings and 36 times EV-EBITDA.  In addition to this nosebleed price, the retailing powerhouse is getting into the grocery business by buying Whole Foods.  While grocery industry has a notorious reputation as being a miserable business, Jeff Bezos has proved many doubters wrong as he changed the retail industry.  Maybe he can do it again in this low-margin, cut throat business.  It will be interesting to see what happens.
Netflix’s credit rating is junk (single B) and its stock carries a 197 P/E and a EV-EBITDA multiple of 12.  Apparently, Mr. Market is willing to overlook such details as long as they keep growing revenues at 30% per year and the stock price keeps moving up.
The June 9th reversal in the stock market’s technology leaders should be noted.  It might be nothing more than another dip that gets bought with no lasting impact.  Or it could be an important declaration that these stocks are overpriced and a correction is needed.  Just as it took a child to pronounce the obvious in “The Emperor’s New Clothes”, the Goldman Sachs observation might embolden the bears – what few that are left.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905
[i] The Emperor’s New Clothes, Hans Christian Andersen, 1837
[ii] Barron’s, June 10, 2017

“How Do You Measure Yourself with Other Golfers? By Height.[ii]

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June 16, 2017 – DJIA = 21,080 – S&P 500 = 6,210 – Nasdaq = 5,805
“How Do You Measure Yourself with Other Golfers?     By Height.[ii]
The Federal Reserve raised interest rates on Wednesday for the third time since December.  It was widely expected as the market had placed a nearly 100% probability on the event.  However, hours before the announcement, the economy, trying to fit into the populist movement, coughed up a couple of hairballs at the feet of our bureaucratic bankers.
Specifically, the Labor Department reported that seasonally adjusted consumer prices fell a 0.1% in May.  Also, the Commerce Department reported that retail sales dropped 0.3% in May.  To be sure, these are just two data points but they are suggesting slow growth.   A softer economy, if this becomes a trend, is not what the Fed is expecting and will not mix well with rising interest rates.
In another display of irony, long-term interest rates have been declining as short-term rates have been climbing.  This has resulted in a flattening yield curve.  In fact, the spread between the yields on the 2 year and 10 year Treasury note (a commonly watched indicator) closed yesterday at 81.5 basis points. The spread between the 5 year note and 30 year bond reached 102 basis points or 1.02%.[iii]  In other words, investors are rewarded 1% for buying a bond with a 25 year longer maturity.  Ummm…. we’ll pass.
Inquiring minds want to know – what’s causing this?  Is the economy slowing and with it loan demand?  Or is this a temporary situation and a good time to sell long maturity bonds before interest rates move higher?

Some interesting data related to this debate is that the St. Louis Federal Reserve released business loan numbers recently.  Commercial and industrial loan (C&I) growth has been stagnate over the past 7 months at just under $2.1 trillion.  As a point of reference, C&I loans grew 49% from 2012 to 2016.[iv]  A strong, expanding economy should be generating increasing loan demand.  

That it isn’t happening is something to be noted.
This, of course, places increased importance on upcoming reports such as June’s employment figures, ISM surveys, and orders for durable goods.  It promises to be a busy summer.  Wall Street didn’t need a vacation.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

[i] Hedgeye.com, June 14, 2017

[ii] “Caddyshack”, 1980
[iii] Grantspub.com, Grants Almost Daily, June 15, 2017
[iv] Ibid, June 12, 2017

“I Think I Can, I Think I Can…”

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Stocks reached a new 2016 high in the first half of last week at 2,120 for the S&P 500.  Traders and strategists agreed the next stop would be a short trip to 2,130 and a new record high.  This would break a 13-month drought without a fresh record close.  However, by week’s end the S&P was back below 2,100 and the optimism shifted to gloom as worries grew over U.S. interest rate increases, slowing global economic growth, and BREXIT.
The 2,100 level on the S&P 500 has been a difficult level to overcome.  This was where the markets began the year and before the nasty selloff that marked January and February.  After equities stabilized, the rally brought the S&P back to 2,100 in April from where it fell back again.  This latest assault appeared to be a ‘third time is a charm’ event as we traded 7 consecutive days above 2,100 before retreating.
Eventually the S&P as well as the Dow Jones Industrial Average will rally to make a new high.  But last week’s selloff raises the risk that we test materially lower before celebrating new all-time highs.  Market breadth deteriorated as stocks fell with Friday being especially weak.  This could be a sign of increased selling pressure before finding a bottom.
The worries mentioned above go beyond stock market turmoil.  Bond yields are the lowest in history.  Over $10 trillion of global government debt trades at a negative yield with Germany’s 10-year Bund trading just above 0% (at 0.02%).  The Swiss 10-year bond changes hands with a negative 0.5% yield and the Japanese 10-year bond is negative 0.17%.  Obviously, this would not be the case in a normally functioning economy or even the prospect of one.  The fact that more debt has recently slid into negative yield territory could also be a result of a declining confidence in policy makers and their various forms of quantitative easing.
While negative yields are a head scratcher, there are some bond market sectors that are performing well.   High yield bonds are those with credit rating of BB and lower (BBB and above are considered investment grade).  They normally are issued by medium and smaller companies and usually offer a higher interest rate to compensate for the higher risk of repayment.
High yield bonds, after being hit hard in 2015, have rebounded in 2016.  The declining price of crude oil and natural gas was a big component in last year’s selling.  Many energy producers used bonds to finance operations and investors sold that debt as commodity prices plunged.  Indeed, some in the energy area have filed bankruptcy in 2016.  However, there are many non-energy issues that got thrown out with the bath water and presented a good opportunity.
The high yield market bottomed in December.  Clearly, this area has been helped by crude oil’s rebound as $50 per barrel gives the producer more bottom line than a $30 price.  But, also sentiment got too pessimistic as there were predictions of widespread financial calamity in energy.
Looking at the two high yield bond ETF’s, HYG and JNK, they have performed well during 2016 and especially strong since the February market lows.  HYG is up 3.4% year-to-date and 8.8% since bottoming in February.  These returns are competitive with the stock market but exceed equities when the almost 6% dividend is included.  The JNK has similar YTD returns – 4% YTD and 12% since February.  JNK trades with a dividend of 6.3%.
As a comparison, here are the major averages for 2016.
2016 YTD                            
Dow Jones Industrial Average   +2.5%
S&P 500                                   +2.6%
Nasdaq Composite                    -2.3%
Russell 2000                             +2.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
The stock market often rallies when the headlines are bleak – climbing a wall of worry.  And while it can always get worse, it is hard to imagine anything exceeding the current news flow.  We have slowing economic growth combined with many levels of global uncertainty on top of ongoing terrorist attacks wrapped in a presidential campaign with two polarizing candidates.  That’s a pretty steep wall of worry.  Perhaps this is why some high profile investors (Stanley Druckenmiller, Carl Icahn, George Soros) are recommending getting out or shorting the stock market.
Nevertheless, we’ve been dealing with these obstacles for a while and it could be argued that they are priced in.  As mentioned in the last newsletter, investor sentiment has been pretty negative for some time.  In the short term, it would be constructive for the U.S. markets to hold their 50-day moving averages and the May lows.  That could recharge the stock market for yet another run at the record levels.  If that fails to happen, it might be a tough summer.
Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

Too Much of Everything is Just Enough

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May 30, 2017 – DJIA = 21,080 – S&P 500 = 6,210 – Nasdaq = 5,805
“Too Much of Everything is Just Enough”[i]
From tulips to technology, investors have a long history of becoming fixated on fads.  Sometimes these trends become so popular that they develop into bubbles.  Of course, Wall Street is happy to feed these infatuations by offering products and strategies to meet their clients’ desires.  But don’t misjudge this as enhanced customer service and increased altruism – it generates increased commissions.
Under the heading of there’s nothing new under the sun, in recent years, investors have been flocking to an old approach – indexing or passive investing.  We’re not suggesting that this movement ends the same as past overcrowded manias, but it should have investors’ attention.
Passive investing or indexing is a buy and hold approach where investor’s capital is diversified across asset classes.  Typically, this involves assets invested in large cap, mid cap and small cap equity sectors.  It can be further divided on both value and growth styles.  Also, international and emerging markets can be included.  And most passive strategies include fixed income, real estate, and precious metals.
Some of the advantages are ease and economics.  Instead of conducting the research needed to develop a portfolio, it is much easier to buy the index.  Also, buying the index and holding it for the long term reduces trading expenses.
Although many have recently become more aware of indexing, it is not new.  The mutual fund industry has been offering the strategy for decades and Vanguard built an industry powerhouse based on the indexing philosophy.
Passive investing’s popularity has grown to incredible heights during the past few years.  It is estimated that inflows into U.S. equity ETFs have exceeded $15 billion per month for the past 6 months.  For the twelve months ending February, a record $281 billion was invested in ETFs.  Since March 2009 (the start of the bull market), ETFs have received net flows of $1.67 trillion.  This compares to $179 billion into equity mutual funds during the same time.  The chart below illustrates the growth in the investment capital into ETFs.[ii]
When an index ETF receives inflows, they have to invest these dollars in order to maintain the portfolio’s proportional match to the index.  Holding cash is a no-no even if you think the market is risky.  This results in some interesting market dynamics.
Let’s look at the most popular index, the S&P 500, and some of the ETFs that index to it.  Before getting into the ETFs, it’s important to remember that the S&P 500 is a cap weighted index meaning that the larger the market capitalization, the more influence it has on the index.
iShares and Vanguard are the two ETFs families with the largest year-to-date inflows.  The iShares Core S&P 500 ETF (symbol = IVV) has around $9 billion of assets.  Their top ten holdings have to match the S&P 500’s 10 largest stocks and they do.  They are Apple, Microsoft, Amazon, Facebook, Exxon, Johnson and Johnson, Berkshire Hathaway, JP Morgan, Google, and General Electric.
Sticking within the iShares stable, the iShares Core S&P Total U.S. Stock Market ETF (symbol = ITOT) has $1.653 billion under management.  Its top ten holdings are exactly the same as the IVV.
Turning to Vanguard’s S&P 500 ETFs, the Vanguard S&P 500 ETF (symbol = VOO) has $4.475 billion under management including $310 million of recent inflows.  Its top ten holdings are exactly the same as the iShares IVV and ITOT.  The Vanguard Total Stock Market Index Fund (symbol = VTI) is a $3.148 billion ETF which enjoyed a $550 million addition of investment dollars.  It too owns the exact same top ten holdings.
Of course, there are some adventurous mavericks that still participate in the capital markets.  These guns slingers might be courageous enough to deviate from the stock indexes if only for a small amount to complement their passive assets.  Say our brave investor wished to move part of his or her portfolio into the $25 billion Vanguard High Dividend Yield ETF.  Among the top holdings for this independent thinker’s decision are some familiar names – Microsoft, Exxon, Johnson and Johnson, and JP Morgan.  So much for diversification!
Or maybe someone wants to speculate further and include the Vanguard Mega Cap Growth ETF in their portfolio.  Once again, our decision doesn’t add much to a broadening of the investment reach as this ETF’s top holdings include Apple, Google, Amazon, and Facebook.
Naturally, distortions can happen when there is too much demand for something with a stable supply and the stock market provides another the example.   At the end of last week S&P 500 was up 7.89% year-to-date.  If we remove Apple, Amazon, Facebook, Google, and Microsoft, the S&P 500 is up 42 percent less or 4.6%.  This means that the ‘Fab Five’ in addition to accounting for a little less than half of the year’s gains also represent 14% of the index.
Of course, that these leaders are up so much means that they attract even more interest which bids their prices higher.  Where and when this cycle ends is guesswork.  This touches upon an important point to passive investing – economic fundamentals and stock valuations do not matter.  Index ETFs don’t care about such things as earnings, GDP growth, the Fed’s next meeting, or Brexit.  Index ETF’s buy the components of its index, everything else is noise.
Not only has the number of indexes grown, they have gotten creative.  HACK is the symbol for Purefunds ISE Cyber Security ETF.  The Vaneck Vectors coal ETF’s symbol is KOL while their Agribusiness ETF is MOO.  The SPDR Bloomberg Barclays High Yield Bond ETF is appropriately listed as JNK.  Oh those crazy Wall Streeters.
Here is a graph from the Bloomberg report of the history of the number of stocks as compared to the number of indexes.  The number of publicly traded stocks peaked at 7,487 in 1995.  This downward trend seems to have stabilized during the past few years.  On the other hand, the indexes’ hockey stick shaped growth is remarkable.
The ETF population remains well below the number of mutual funds which have plateaued since around the turn of the century.  Here is a chart which includes the mutual fund industry. [iv]
While the popularity of indexing is not an evil, it has distorted the markets.  The market price-to-earnings ratio is historically high and bond yields are low across all sectors.  Both are influenced by capital inflows into passive investing.  It might be hard to imagine but someday, away in the future, investors may want to reduce market exposure. Perhaps one day the capital markets negatively react to an interest rate increase or a terror attack or some Washington wackiness.  If this happens in a large quantity, ETFs will be selling the same positions at the same time likely causing prices to fall.  This could strain liquidity which would cause the retreat to accelerate.  The melt up we’ve witnessed but in reverse.
Of course, there is the possibility that stock and bond prices have experienced a permanent landscape shift and that valuations and yield spreads are at new and proper levels.  In other words, it is different this time.  Investing history tells us that those words can be a dangerous description.  But for now, investor worries are few.  We just hope that someday we don’t have to sing more lyrics to the song we began this newsletter with – “I Need a Miracle Every Day”.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905
[i] Barlow, Weir, 1978
[ii] Yadeni Research, April 5, 2017
[iii] Bloomberg View, May 16, 2017
[iv] Ibid

We’re on the Road to Nowhere

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The headlines from a year ago, as usual, covered a wide range of events.  For example, Hillary Clinton announced her candidacy for the 2016 Democratic presidential nomination just before the governor of Maryland declared a state of emergency in Baltimore as riots began over the death of Freddie Gray.
Lighter headlines from a year ago included the birth of the Princess of Cambridge, Charlotte Elizabeth Diana who is 4th in line to succeed Queen Elizabeth II.  Also American Pharoah became the 12th winner of horse racing’s Triple Crown and the first since Jimmy Carter was president (1978).
This time last year in the financial markets, the U.S. stock market reached record levels.  This wasn’t noteworthy as stocks had been steadily moving higher for several years.  The Dow Jones Industrial Average closed at 18,312 on May 12, 2015 which turned out to be the last time the Dow has closed at a record.  This 377 day (as measure by calendar days, trading days plus weekends and holidays) streak without making a new high is the 12th longest stretch in history.
The longest time between record Dow closes was the
period from September 1929 to November 1952 which exceeded 9,200 days.  Certainly this is a unique time in history as it contains both an economic depression and world war.  Looking at what might considered a “normal” number of new highs in a year, there were 10 in 2015, 53 in 2014, and 45 in 2013.  The record is 77 in 1995.[i]
This twelve month Dow drought of record highs is part of a wider and multi-year trading range.  The S&P 500 first exceeded the 2,000 level in August 2014.  Since then and for the past 22 months the index has bounced between 1,850 and 2,130.  This is only the 5th time that the S&P has traded in less than 20% range over a 22-month period.  The last two incidents were in 2005 and 2006 which signaled the end of the bull market.  The other two occurrences were in 1984 and the mid-1990’s.  Both of these examples were resolved with the stock market moving materially higher.[i]
We would offer that many are not aware that the markets have been treading water for the past 2 years.  It’s a function of the narrow stock market leadership in 2015 (see FANG stocks) which gave the illusion of healthy landscape.  These handful of large companies drove the major averages while the rest of the market floundered.  Within the MSCI All-Country World Index (a wide scoping global stock index), 66% of the stocks in the index are lower than they were on May 21 last year.  Removing the emerging market portion (which were challenged in 2015) from this index, we still end up with 40% of the market lower than last May.[ii]  This market churn is clearly evident when we look at the year-to-date numbers for the U.S indexes:
2016YTD
Dow Jones Industrial Average           +2.6%
S&P 500                                             +2.7%
Nasdaq Composite                              -2.7%
Russell 2000                                       +1.3%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
The stock markets’ lateral journey has resulted in some very unique measurements in investor sentiment. As reported by the AAII (American Association of Individual Investors), bullish sentiment fell to its lowest level in over a decade at 17.75%.  One would naturally conclude if the percentage of bullish respondents fell, the number of bears must have increased.  Not to be – the bearish number also decreased from 34.1% to 29.4%!
The largest group in this week’s survey was the “neutral” camp which increased from 46.5% to 52.8%.  This is an astonishing event.  Going back to 1987 (or almost 30 years or over 1,500 weeks), there have been only 30 weeks where the bullish sentiment reading was below 20%.  Furthermore, there 28 weeks registering over 50% neutral.[i]
While this outsized neutral view is understandable given:
  • the U.S. economy is stuck in low gear
  • uncertainty surrounding profit growth
  • negative interest rates
  • the possibility of a rate increase in the U.S. in the next couple of months
  • untested monetary policies
  • terrorism
  • a unique and contentious political landscape in the U.S.
Further, this indecision is a sign of apathy towards the markets.  Again, this is reasonable after 2 years of stocks going nowhere combined with a 10% correction last August and the horrid start to 2016.
The debate among strategists and traders centers on how these worries get resolved.  The glass half full view suggests that these issues are already priced into the markets.  This argument holds that stocks could surprise to the upside even with modest economic progress.  Indeed, from a shorter term view, a couple of weeks ago stocks tested the lower level of the range at S&P 500 2,040 for the third time since March.  Sellers pushed the S&P down to 2,025 intraday on May 19th and it looked like the bears may finally gain control and take stocks lower.  Unexpectedly, the selling pressure dried up and stocks recovered before the close.  Equities rallied during the next few days and the S&P 500 quickly moved back to 2,100.
Perhaps the high number of “neutral” investors played a role in the failure of the bears to get the upper hand.  It’s hard to believe that these worried investors hadn’t already sold positions and raised cash.  Maybe there were no sellers left.
While this reversal was noteworthy as it snatched victory from the jaws of defeat, all we have accomplished is a move back into the upper part of the trading range.  Interestingly, when we look at returns after the previous times where bullish sentiment was below 20% and when neutral exceeded 50%, we see reasons for hope.  The S&P 500 has averaged a 6.81% return 3-months after a sub-20% bullish reading.  This improves to 13.26% 6-months after and 19.97% one year later.  Turning to the 50%+ neutral readings, the S&P averaged an 3.59% increase 3-months after hitting this threshold, a 7.67% gain 6-months later, and 19.94% in one year.
Based on sentiment only, we would look for a trading range breakout to the upside.  However, given the possibility of further gaffs from Donald Trump, an indictment of Hillary Clinton, a Bernie Sanders surge, or any other unexpected development, an upside move is far from certain.  2016 has been full of unexpected twists and turns with several very unique developments.  Maybe that is the new landscape and the markets continue to churn throughout the summer.
[i] The Bespoke Report, May 27, 2016
[i] Ibid, May 23, 2016
[ii] GaveKal Research, May 31, 2016
[i] LPL Research, May 24, 2016
Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing
involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

Balancing risk and reward Looking for yield without too much risk

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An important consideration when investing in bonds and fixed income securities is that there are two typical kinds of risk.  Credit risk is the possibility that you won’t get your principle paid back. Interest rate risk is the opportunity cost that interest rates move higher while you are invested in a lower yielding instrument.
When dealing with credit risk, you normally receive a higher interest rate to compensate for the higher probability of not getting your investment back.  Credit risk can be avoided by buying treasury bonds and bills.  Of course the yields of today’s government securities are not very exciting.
Interest rate risk is buying a bond or CD with a set rate and having yields subsequently move higher.  For example, buying a CD paying a 4% interest rate and then having the same maturity move to 4.5% while you are receiving 4%.
Interest rates are expected to move higher over the next several years.  If that happens (its far from certain), investing in safer things like CD’s and bonds will be tricky.  It will re-introduce interest rate risk to the market for the first time in 35 years (Interest rates have been falling since 1982).
As a way to educate investors, we have constructed some options to consider.  Please know that this is not a comprehensive list and there are many more options available.  These are used to illustrate the state of the market.  Further this is not a recommendation as they may or may not be appropriate.
The table includes the yield, the duration, and the 3-year range for the price.  Duration, for those who are not familiar with the term, is the time-weighted average of the security’s cash flows.  The higher the number the greater the sensitivity to changes in interest rates.  In other words, high duration bonds will go down in price more than low duration bonds given the same interest rate move.
The 3-year price range is provided to offer a sense of price volatility.  Bond prices move inversely to the move in interest rates.
This table emphasizes price stability or low interest rate risk.  We try to help readers understand what yields are available for the lowest interest rate risk.  Some of these examples do not have credit risk (CD’s and TIPS) but some others do.
        Yield     Duration     3 year price    Variance from mid-pt.
CD’s                     1%         6 months

Franklin               2.12%    1.4 years    $100.14 –              1.57%

Liberty Short                                        $97.04
Duration US
Govt ETF
Fidelity Adv        1.63%     2.6 years   $11.62 –                 1.18%
Ltd. Term                                             $11.35
Bond Fd
Lord Abbett         2.05%     2 years      $4.56 –                   3.28%
Short Duration                                     $4.27
Income Fund
Putnam                6.03%     1.1 years   $8.05 –                   11.42%
Diversified                                           $6.40
Income Fund
Vangurad Short   -0.25%    2.8 years   $52.12 –                 4.31%
Term TIP ETF                                      $47.81
Nuveen NY        3.89%      7.3 years   $14.89 –                 7.16%
Tax Freed                                             $12.90
DoubleLine        0.62%      0.2 years   $10.02 –                 0.10%
Ultra Short                                           $10.00
Bong Fund
For more information or questions, please contact me.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

Balancing risk and reward Looking for yield without too much risk

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An important consideration when investing in bonds and fixed income securities is that there are two typical kinds of risk. Credit risk is the possibility that you won’t get your principle paid back. Interest rate risk is the opportunity cost that interest rates move higher while you are invested in a lower yielding instrument.

When dealing with credit risk, you normally receive a higher interest rate to compensate for the higher probability of not getting your investment back. Credit risk can be avoided by buying treasury bonds and bills. Of course the yields of today’s government securities are not very exciting.

Interest rate risk is buying a bond or CD with a set rate and having yields subsequently move higher. For example, buying a CD paying a 4% interest rate and then having the same maturity move to 4.5% while you are receiving 4%.

Interest rates are expected to move higher over the next several years. If that happens (its far from certain), investing in safer things like CD’s and bonds will be tricky. It will re-introduce interest rate risk to the market for the first time in 35 years (Interest rates have been falling since 1982).

As a way to educate investors, we have constructed some options to consider. Please know that this is not a comprehensive list and there are many more options available. These are used to illustrate the state of the market. Further this is not a recommendation as they may or may not be appropriate.

The table includes the yield, the duration, and the 3-year range for the price. Duration, for those who are not familiar with the term, is the time-weighted average of the security’s cash flows. The higher the number the greater the sensitivity to changes in interest rates. In other words, high duration bonds will go down in price more than low duration bonds given the same interest rate move.

The 3-year price range is provided to offer a sense of price volatility. Bond prices move inversely to the move in interest rates.

This table emphasizes price stability or low interest rate risk. We try to help readers understand what yields are available for the lowest interest rate risk. Some of these examples do not have credit risk (CD’s and TIPS) but some others do.

Yield Duration 3 year price Variance from mid-pt.

CD’s 1% 6 months

Franklin 2.12% 1.4 years $100.14 – 1.57%
Liberty Short $97.04
Duration US
Govt ETF

Fidelity Adv 1.63% 2.6 years $11.62 – 1.18%
Ltd. Term $11.35
Bond Fd

Lord Abbett 2.05% 2 years $4.56 – 3.28%
Short Duration $4.27
Income Fund

Putnam 6.03% 1.1 years $8.05 – 11.42%
Diversified $6.40
Income Fund

Vangurad Short -0.25% 2.8 years $52.12 – 4.31%
Term TIP ETF $47.81

Nuveen NY 3.89% 7.3 years $14.89 – 7.16%
Tax Freed $12.90

DoubleLine 0.62% 0.2 years $10.02 – 0.10%
Ultra Short $10.00
Bong Fund

For more information or questions, please contact me.

Jeffrey J. Kerr, CFA

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

Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm

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April 17, 2017 – DJIA = 20,453 – S&P 500 = 2,328 – Nasdaq = 5,805
 
“Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm”[i]
The history of Russia spans over 1,100 years.  As expected with anything that has this longevity, it’s not been a smooth journey.  They have been responsible for historic cultural advancements in art, literature, architecture, and science.  Unfortunately, the lows include revolution, conquest, corruption, oppression, world wars, and cold wars.
Surrounding the U.S. presidential election, Russia became the target of the Democrats’ disdain as they were blamed for Hillary Clinton’s defeat.  The election was close in many key states so anything that swayed votes influenced the outcome.  However, without giving a pass to Boris and Natasha, there are many other scapegoats with several being internal.
Of course, more recently, the list of Russian detractors includes Team Trump which was originally criticized for allegedly being aligned with Moscow.  After Nikki Haley’s United Nations tongue lashing and President Trump’s decision to bomb Syria, it’s safe to assume there are not any White House dinner invitations addressed to Vladimir Putin.  Or vis-a-versa.
Global tensions have risen which is causing some unexpected coalitions.  President Trump has back-peddled a bit on the campaign rhetoric concerning China.  Given Chinese influence over North Korea, issues such currency manipulation and trade imbalances were not on the agenda when Chinese President Xi recently met with Mr. Trump.
Unexpectedly, headlines about Syria, Russia, North Korea, ISIS, and other geopolitical problems have not derailed the stock market.  Admittedly, the major averages have pulled back from the records reached at the beginning of March.  But most would have anticipated much lower prices after the news of bombs in the Middle East together with the unstable Kim Jong-un testing nuclear missiles.  Instead, the 2017 version of the U.S markets take this news in stride.  Whether this is whistling past the graveyard is unknown.  Here are where the major indexes are year-to-date.
                                                                                  2017 YTD
Dow Jones Industrial Average                                    +3.5%
S&P 500                                                                      +4.0%
Nasdaq Composite                                                      +7.8%
Russell 2000                                                                -0.9%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
A couple of noteworthy nuggets from the current market landscape.  We draw your attention to the numbers above to highlight that the Russell 2000 finished last week lower for 2017.  As a reminder, the Russell 2000 was the best performing index in 2016 and was especially strong after the election.
On the other hand, the Nasdaq is the strongest of the major indexes through the first 3 ½ months.  Returning to 2016, this was the weakest of the bunch after the election as investors were convinced that Trump’s immigration restrictions would be an obstacle to technology related businesses.
Combining these two reversals, this could represent a rotation from small caps (Russell 2000) to technology (Nasdaq).   It could also be a correction of the solid 2016 gains for the Russell.  Once again, this reminds us that past performance is no assurance of future results.
A common commandment at the start of 2017 was that interest rates would be moving higher.  Indeed, the 10-year Treasury yield, which closed 2016 at 2.43%, rose to 2.61% in March.  Since then, however, bond yields have fallen.  The 10-year finished last week back at 2.23%.
This surprising rally for the bond market (lower yields = higher bond prices) is partially caused by the lowering of 1st quarter GDP estimates, delays in tax reform and regulation cutbacks, and lower inflation. And let’s not forget that the U.S. Treasury market is viewed as a safe haven.  With bombs falling and international tensions high, it makes sense that some global capital flows to U.S. government debt.
Another explanation might be that this move lower in bond yields is a function of how one sided the market had become.  After the election, investors believed that the economic growth would pick-up driven by reduced regulations and increased infrastructure spending.  These additional fiscal programs would be theoretically financed by higher government deficits.  Higher yields would be required to entice buyers of these newly issued bonds.
The result was a crowded investment.  Markets are the summation of investor opinions.  If everyone believes that rates were going higher, prices reflect this. If the market becomes too one-sided, in this case everyone bearish bonds, there are fewer and fewer sellers.  Once the sellers exhaust themselves, the market has to move the other way in order to regain balance.
A final point on the fixed income market.  At the same time that longer term interest rates are falling (10- year and 30-year bonds), the Federal Reserve is raising the short maturity rates (federal funds).  This flattening of the yield curve is often a sign of a sluggish economy.  This is case, however, it might be the necessary rebalancing of the bond market which includes the punishing of the bond bears.
The capital markets have had a lot to digest recently.  And there more on the way – French elections this weekend, British elections in early June, first quarter earnings, and the steady stream of presidential tweets.  Of course, the geopolitical landscape can throw in a knuckleball any time.

It is a bullish sign that the global markets have navigated the recent cross currents without a more prominent pullback.  Nevertheless, this remains a highly-valued market facing a lot of uncertainties.  This skinny margin of safety won’t be problem as long the economy expands, the Fed doesn’t raise interest rates too fast, France stays in the EU, the fleet of U.S. aircraft carriers can cover all international calamities, Congress accomplishes something, Amazon becomes the only retailer left, and the New York Jets don’t do anything too stupid in next week’s NFL draft.  That’s not too much to ask for!

Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905
[i] Lennon-McCartney, 1969

016 4th qtr-year end Kildare Asset Mgt-Kerr Financial Group client review letter

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Vladimir Lenin, founder of the Russian Communist party, said, “There are decades where nothing happens; and there are weeks when decades happen”[i].  There were a lot of weeks in 2016 where decades happened.  The year contained a number of historic events that changed the direction of societies, political systems and economic structures.  While a lot of these events surrounded a rise of populism, their impact flowed to the financial markets.
The year began with the markets in turmoil over worries surrounding China.  The concerns were that a large devaluation of the Chinese currency would lead to a deflationary shock that would cripple the global economy.  This led to the worst start of a year for U.S. stocks.  The major averages lost 10% – 15% in the first six weeks of 2016.
China did not devalue the renminbi and markets stabilized.  Amazingly, U.S. stocks fully recovered their losses and by April they were up for the year.  For the next couple of months, the markets traded in a range as they debated the Federal Reserve’s next interest rate increase and awaited the Brexit vote in June.
As we know, the United Kingdom unexpectedly voted to leave the European Union.  Once again, global markets were chaotic and stocks plunged.  The U.S. stock market dropped over 5% in three trading days.  And once again, prices recovered regaining the losses in the next three days
The exclamation mark for this incredible year was the U.S. presidential election.  Once again there was an astounding change in the markets’ point of view.  In the weeks before the election the U.S. stock market dropped whenever Donald Trump gained in the polls.  And as Hillary Clinton fell behind on election night, U.S. stock futures tumbled with the Dow Jones Industrial Average futures plunging over 800 points.  Then the markets, without obvious reason, reversed course and have not looked back.
Here’s the final tally on the major U.S. stock indexes for 2016.  I’ve also included the returns after the election as they were a significant part of the year’s numbers.
                                                               2016        Election to year end
Dow Jones Industrial Average               +13.4%              +7.8%
S&P 500                                                 +9.5%                +4.6%
Nasdaq Composite                                 +7.5%                +3.6%
Russell 2000                                          +19.5%              +13.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.

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

2016            Election to year end

                                                           +16.42%                +4.97%
There were several holdings that contributed to the 2016 performance.  As was covered in the 2nd and 3rd quarter reviews, positions in closed end mutual funds that focused on high yield corporate bonds and corporate loans.  Throughout the year these funds appreciated in price which was a bonus to the real reason for their purchase – 6% to 8% dividend yields.
Layne Christensen (symbol LAYN) has been a long term holding that moved higher in the second half of the year.  The company is a global water management organization that provides solutions for water, mineral, and energy resources.  The company has had problems involving underperforming divisions as well as pressure from the energy sector when commodity prices fell.  Last year they achieved progress in some of the initiatives to improve efficiencies.
Layne’s stock price in late June was less than $7 per share.  It ended the year over $11 or 50% higher than late second quarter.  If management can continue to make improvements, I think the stock price could see further gains in 2017.
Avianca Holdings (AVH) is another position that contributed to 2016’s gains.  AVH is a leading Latin American airline based in Columbia.  It has one the broadest flight coverages throughout Central and South American together with flights to major U.S. cities.
AVH was undervalued by most financial measures.  While airlines typically trade at discounts to market multiples, Avianca seemed to be mispriced.  Part of the problem was that some of their debt was issued in U.S. dollars.  As the dollar rose in 2015 and 2016, AVH had to pay more in interest as measured in Colombian pesos.  While the company was profitable and fuel expense was declining, the market didn’t like its capital structure.
Outside of the financials, Avianca’s route network appeared to be an asset that would be difficult to reconstruct.  To this point, rumors developed during 2016 that the company could be a takeover candidate.  In December, some U.S. airlines starting having discussions with AVH about acquiring the company or forming a partnership.  The stock rose above $10 per share.  It began the year around $4 but had risen into the $6’s by mid-year.  Avianca is currently in talks with United however the structure (partnership vs. acquisition) is unclear.  Depending on the direction of the discussions, we may move out of the position in 2017.
2016 will long be remembered as its many everts were historic.  Further what happened last year will continue to impact future years on many levels – societal, political, economic, and international relations.  As these pertain to the capital markets, I will remain watchful for opportunities while focusing on managing risk.
Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
168 Water Street
Binghamton, NY 13905

March Madness – April Absurdity. “Curiouser and Curiouser”

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April 3, 2017 – DJIA = 20,663 – S&P 500 = 2,362 – Nasdaq = 5,911
 
March Madness – April Absurdity
The term “March Madness” is typically associated with the men’s college basketball tournament that happens this time of the year.  The exciting games and inevitable upsets attract widespread interest and viewership.  Of course, March Madness can be used to describe other events that happened during the month such as the weather, the markets and the search for Tom Brady’s Super Bowl jersey.
Of course, this year the madness of the NCAA basketball tournament cannot come close to the madness in Washington.  President Trump is discovering that the campaign was a walk in the park compared to being President.  He is criticized for Congress’s failure to repeal Obamacare.  He is scrutinized over wiretapping claims and is questioned on his relationship with Vladimir Putin and the Russians.  Of course, his brash unconventional approach invites detractors.
The wackiness of Washington isn’t exclusive to the executive branch.  Congress’s dysfunctional behavior moves within and across party lines.  And we must not forget the fourth branch of government – the press.  Their job of covering our political leaders has not been exactly objective.  Clearly, we will need more synonyms for ‘madness’ to form alliterations for the other months – April Asininity, May Mindlessness, etc.
This lunacy has had surprisingly little negative impact on the stock market.  Normally such acrimony and uncertainty are headwinds for higher stocks prices, but investors seem to be focused on other factors (or ignoring it).  Stocks just finished their 6th consecutive positive quarter.  There were solid gains for all the major averages.
                                                                          2017 YTD
Dow Jones Industrial                                             +4.6%
S&P 500                                                                 +5.5%
Nasdaq Composite                                                 +9.8%
Russell 2000                                                           +2.1%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
Despite the stocks markets’ recent rally, not all investors are reaping the rewards.  Last week’s American Association of Individual Investors (AAII) survey showed that more respondents were pessimistic than optimistic.  There were 37.4% bears vs. only 30.2% bulls.  This is remarkable on several levels.  First, bulls normally outnumber bears.  Next considering that stocks reached record levels in the beginning of March, we would expect a lot more excitement than the gloominess that those numbers suggest.  Lastly, both figures have deteriorated since the beginning of the year as bullish sentiment stood at 46% in January while the ursine camp was down at 25%.
Away from Wall Street, people are cheerful (this shouldn’t be surprising!).  Last week’s Conference Board’s Consumer Confidence survey jumped to 125.6 from 114.8 in February.  This is the highest reading in 16 years. Naturally, a smiling consumer is good for the economy.
Another part of the survey indicated that consumers have higher expectations for increased income.  Of course, these two are joined.  One of the reasons for a higher confidence level is the belief that you going to see more in your paycheck.
The contrast of a sanguine consumer and gloomy investor is an interesting economic backdrop.  Why the conflict?  Are the consumers’ views a result of being on the frontline of commerce and things are pretty good?  Workers are feeling upbeat about both their current conditions as well as their future and they respond accordingly.
Returning to the grumpy investors.  Are they overly influenced by headlines that are casting the new administration as a modern-day Marx Brothers?  Or does he or she view stocks prices as a little high and getting ahead of the fundamentals?  This latter point does not explain why the pessimism has been increasing while stocks have been rising.  Usually higher prices generate more excitement and enthusiasm rather a river of tears.
The fixed income markets offer another puzzling development.  The Federal Reserve fulfilled their earlier smoke signals by hiking the federal funds rate in March.  And everyone knows that interest rates will be rising.  But for some peculiar reason, interest rates have gone down during the past several weeks.  The 10-year Treasury note’s yield reached 2.6% in mid-March.  This rate closed last week at 2.39%.  The 30-year Treasury bond had a similar drop as it fell from 3.20% to 3.01% at the end of the month.
These moves may seem minor but, for several reasons, they are noteworthy.  First, the bond market is supposed to be less volatile.  Fixed income is regarded as ‘safer’ than equities and is theoretically used to reduce portfolio risk.  We’re not sure a 5% move in two weeks defines stable.  Secondly, interest rates are expected by everyone to be moving up.  That they are doing the opposite calls into question market forecasts and suggests that something else in underfoot.  That there might be unknown market influences logically increases risks.
As we transition from March Madness to April Absurdity, the markets are digesting some large conflicting signals.  While equities have corrected in the last couple of weeks, they remain resilient.  Perhaps this is an example of Wall Street climbing a wall of worry.  The summation of the current market milieu is that it is not an opportune time to increase risk.  Yet, there is no guarantee that the markets provide better entry points for investing capital.   As Alice observed, “Curiouser and curiouser”.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13901