Go, Cubs, Go!!

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

Nasdaq Composite                     +0.8%

Russell 2000                                +2.4%                     
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
It is interesting that the sell-off took place as 3rd quarter corporate earnings generally beat expectations.  According to FactSet Research, 85% of the S&P 500 companies have reported 3rd quarter results and 71% have beaten earnings per share estimates.  EPS growth is tracking 2.7% growth which would be the first time in a year and one-half that corporate earnings have increased!!
Despite these signs of profit growth, money continues to flow out of stock market.  Per the Investment Company Institute, an estimated net $16.3 billion was pulled out of domestic equity mutual funds in the week ending October 19th.  This represents the largest weekly equity fund outflow in over 5 years.  There has been a shift among investors from mutual funds to exchange traded funds (ETFs) so there have been regular withdrawals from mutual funds.  However, as Bespoke Investment Group points out, the total inflows into ETFs do not account for all the lost dollars from the mutual funds.
Another sign of investor pessimism is the American Association of Individual Investors’ (AAII) sentiment survey.  It has registered sub-40% bullish readings for 53 straight weeks which is the longest stretch dating back to 1987.  It would be easy to blame these developments on the election, but this trend dates back before the primaries began.  Certainly, the election has contributed to the recent accelerated outflows but it seems the public has been disliking the stock market for some time.
This week’s elections will dictate the capital markets in the short term.  The markets have traded better when the chances for a Clinton victory increase as it translates into the status quo.  A Trump triumph has many uncertainties that worry the markets.  Wednesday’s trading will likely follow this trend.
Trying to game the markets based on the election is virtually impossible.  Looking beyond this week, corporate profit growth is an encouraging development.  We’ll probably get an increase in the fed funds rate in December, but much of that is already priced in.
2016 might be an iconic year like 1969.  The stock market began with the worst start to any year in history.  The U.S. presidential primaries along with the general election will not soon be forgotten.  But the year will best be remembered as the year that the Cubs won the World Series.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

OKTOBERFEST

According to Wikipedia, Oktoberfest is the world’s largest beer festival and funfair.  It is held annually in Munich, Germany from mid or late September to the first weekend in October.  It’s been held since 1810 with current attendance around 6 million people per year.
This year the normal schedule just won’t do – it needs to be extended.  After all, if there was ever a time that we needed more beer, it’s 2016.  The U.S. presidential election, Brexit, negative interest rates and the disappointing New York Jets are just a few of the maddening events that we are suffering through.
Of course, Germany (and Europe) are facing similar election woes and economic challenges of their own.  Italy has an important referendum upcoming which may result in more momentum for dismantling the EU.  On top of this, the banking system received another bruise when new worries arose over Deutsch Bank’s financial condition.  How do you say “another round, please” in German?
The financial fragility of global banks has been a market and regulator focus since the financial crisis.  So at some level there is an awareness of the risks associated with the world’s financial institutions.  The latest developments surrounding Deutsch Bank involve a U.S. Justice Department fine, which is expected to be negotiated lower, and renewed worries over continued margin deterioration because of the widespread negative interest rates across Europe.
As part of this latest market indigestion, Wall Street vexed over Deutsch Bank’s portfolio of derivative instruments.  Common derivatives include options, futures, forward contracts, and swaps.  The general purpose of these is to hedge risk, but some traders use them for speculation.  Derivatives commonly enable the buyer to establish an investment position linked to another asset or investment for a much smaller dollar amount.  This is the leverage component common to most derivatives.
According to Deutsch Bank’s 2015 annual report, their derivative book totaled €41.94 trillion ($46.994 trillion).  As a point of comparison, 2015 German GDP totaled €3.032 trillion.  This €42 trillion measures the notional value or the amount of the underlying asset (stock, bond, etc.) that the derivative contract represents.  The actual invested capital is a fraction of this amount.  It is likely that a high percentage of Deutsch’s derivatives are used to hedge interest rate risk – a large risk for any lending institution.  Also, the amount of Deutsch’s derivatives has fallen from €59.195 trillion in 2011.
This is not to imply that the markets’ anxiety over these derivatives is misplaced.  In addition to size of this portfolio, some of the positions as well as the underlying assets are illiquid and hard to value.  This could be a problem if markets were to encounter future disruptions.
Another risk is counterparty risk.  Some derivatives are not traded on an exchange but are contracts between two financial institutions.  In these situations, there is risk that one of the parties in the contract is impaired and unable to deliver their part of the agreement.
In the case of Deutsch Bank, the size and breadth of their global operations could result in systemic fallout if they could not honor their derivative positions.  If this happened, it might impair other organizations who then could not fulfill their contracts which could damage their counterparties.  It is hard to predict how far the damage would travel if Deutsch Bank were to fail.
Keep in mind that Deutsch Bank is just one bank with this issue as many other financial institutions have similar sized derivative books.  An important difference, however, is that the other organizations are better capitalized to withstand problems.  The worries with Deutsch Bank is that they can’t raise capital at a reasonable cost and that negative interest rates are squeezing their profit margins.  The recent dialogue has centered on possible bailouts if that is needed.  The German government originally pushed against this but has softened their opposition.
While Deutsch Bank’s problems have weighed on the markets, U.S. stocks have chopped sideways in a narrow range and moving from one end to the other in a single day.  Since the Dow’s 395-point drop on September 9th, we have had 3 daily moves exceeding 200 points and 6 days + or – 100 points.  In the meantime, the Dow has traded between 18,000 and 18,400.
This frustrating back and forth bounce seems to be a function of a lack of investor commitment ahead of the U.S. elections.  No one wants to take positions for more than a few hours let alone a few days.  Seemingly, no one wants to be left holding the bag.
Also, it could be related to the large influence of computer trading.  Algorithms play a big part of the current trading landscape and their approach is largely short-term, trend following.  For the time being, this environment is unlikely to change.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professiona

“Do You Find Me Undesirable?” – Mrs. Robinson[i]

Investors face some undesirable choices.  Undesirable candidates, undesirable interest rates, undesirable policy makers and leaders, undesirable social unrest, undesirable economic growth, and an undesirable stock market.
Unfortunately, there is plenty of time for the presidential campaign to get even more undesirable as there is 6 weeks until election day.  Lots of opportunity for a higher level of lunacy.
Turning to the undesirable economy, since the end of the financial crisis, as most know, it has struggled to achieve a normal growth trajectory.  For the past seven years, GDP has expanded below historical recovery rates.  To be sure, some statistics appear strong.  For example, the unemployment rate has fallen and certain real estate markets have rebounded well beyond last decade’s levels. However, the overall level of economic performance has been disappointing, despite the rhetoric.
Last week we had two much anticipated central bank pow-wows.  The Bank of Japan and the Federal Reserve both conducted meetings that included interest rate decisions.  The Bank of Japan announced more unconventional policies on top of the past 20 years of unconventional monetary policy.  The decision included the goal of keeping the yield on the 10-year Japanese government bond at 0%.  The BOJ would adjust the pace of its current bond purchasing program to achieve this objective.
Earlier this year the Bank of Japan joined the Europeans and introduced negative interest rates. The intent was to fight deflation with the goal of 2% inflation. Many questioned this decision as it was more of the same policies used since the 1990’s.  In other words, if you’ve had an ongoing battle against deflation for over 20 years without progress, maybe it’s time to question the tools that you are using.
This was likely what was on Mr. Market’s mind last week as the reaction was not what the central bankers wanted.  Unexpectedly, the yen strengthened instead of weakened and the yield curve flattened.  A stronger yen will be an economic headwind which could increase deflationary pressures.  Further a flat yield curve hurts banks which restricts loan creation.  Again, not helpful if you want higher inflation.
The big news surrounding the Fed’s decision to leave interest rates unchanged was that there were three dissenting votes (voting for a 25 basis point increase).  This marked the most dissention since December 2014.  In defense of holding rates the same, we’ve had some soft economic numbers recently.  There were weaker than forecast ISM numbers at the beginning of September and last week housing starts and building permits were below expectations.  While Chairwoman Janet Yellen suggested an increase in December, the decision will depend on forthcoming data on such things as inflation, employment, productivity and GDP.
The U.S. markets welcomed the announcement and strongly rallied on Wednesday afternoon and Thursday.  That brought the major indexes back to recent highs with the Nasdaq Composite closing at record levels on Wednesday and Thursday.  So much for a September swoon!
Here is where the major averages’ year-to-date performances stand at the end of last week.
2016YTD
DJIA                        +4.8%
S&P 500                  +5.9%                           
Nasdaq Composite +6.0%
Russell 2000            +10.5%                                
 Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
The fixed income markets also surged after the Fed meeting.  Bond prices jumped (lower yields) as the 10-year Treasury note’s yield traded back to 1.61%.  This retraced a move higher for this yield as it had spiked to 1.75% earlier in the month as markets absorbed Janet Yellen’s Jackson Hole speech and anticipated the BOJ and Fed.  More importantly, as yields moved lower last week, it eased worries that these higher rates would be an obstacle for stocks and the economy.
Despite being close to all-time highs, many think the markets are whistling past the graveyard.  The list of “undesirables” above are a part of the blemishes that skeptics point to. Also, stocks valuations are not cheap and earnings estimates are being reduced.  Many believe that stocks are up due to central bank policy reducing the relative attractiveness of bonds.  If global central banks stop buying bonds (or even reduce the pace), some believe that the equity markets will fall.
On the bullish side of the debate, stocks have had plenty of chances to retreat but haven’t.  On the contrary, the S&P 500 recently broke above a 2-year range which is strong sign.  Our “undesirables” are widely known and could be priced in.  Further, there are some high profile strategists that think we are just in the middle of a major bull market.  Part of their view is that earnings growth will begin soon and support higher stock prices.
In the short term, it will be constructive if the S&P 500 remains above the 2,140 – 2,150 level.  Trading below this level won’t mean that the party is over but may signal a correction.  On the other hand, this support level could lead to a move to new highs and a year-end rally.
Whatever direction the market moves, it will do so with less investor participation.  $150 billion has been pulled out of domestic mutual funds and ETFs so far in 2016.  Since the financial crisis, outflows have exceeded inflows in every year except 2013.  Investor sentiment is equally pessimistic as bullish percentages have been at historically low levels for many weeks.
To be sure, investors need to remain flexible.  There are opportunities across the assets classes.  Certain sectors of the bond market offer a good balance of risk and reward.  Of course, there are pockets of opportunity within the stock market.  Keeping some cash to take advantage of future situations is also advisable.
It’s remarkable that the markets have done so well considering these indicators.  We would offer that investors view stocks as more than “undesirable” and bordering on “deplorable”.  It would seem that investing in the U.S. stock market is currently the ultimate contrarian position.  There is a Wall Street saying that the ‘hard’ trade is the best trade.  Buying U.S. stocks might fit this definition.

“It’s Been a Hard Days Night”[i]

Just as everyone was getting comfortable quoting stock market statistics at their favorite watering hole about the narrow trading range (43 trading days without a 1% move), the Dow hits an air pocket and drops 395 points last Friday.  It’s not clear that stocks have transitioned to a different pattern but the volatility continued this week.  Prices rebounded on Monday (up 239) but gave that up on Tuesday (down 258).
The possibility of higher interest rates and further geo-political tension gave investors reasons to sell. Boston Fed President, Eric Rosengren, offered that gradual interest rate increases will prevent the economy from overheating.  There is a Fed interest rate decision on September 21st so the timing of this statement got investors’ attention.  Also, he is considered a dove among Fed officials so this was out of character.   This happened after North Korea conducted another test of a nuclear bomb and, taken together, Wall Street choose to “sell”.
The calendar may partially explain this volatility.  Had these taken place in July or August, stocks may not have reacted so dramatically.  But as we know, September (and October) have historically been tumultuous months so news can have larger impacts than expected.
Vacation – All I Ever Wanted.  Vacation – All I Ever Needed”[ii]
Amazingly, September is the only month with negative monthly average returns for past 100, 50, and 20 year timeframes.  This suggests a repeating adjustment of investor sentiment.  Anatole Kaletsky of GaveKal Research proposes an explanation for this September trend.  “During the summer holidays, when trading is light, people tend to defer big decisions. The return to work concentrates minds, and the result is often a drastic market re-pricing to reflect events that were not sufficiently recognised or analysed (sic) during the summer months.”[iii]
As we know, there have been plenty of noteworthy developments over the past several months so it’s possible that the markets may not have fully considered their importance.  For example, the ‘Brexit’ vote was in June.  While the global markets initially fell hard, they quickly recovered and may have overlooked the longer term fallout of Great Britain’s withdrawal from the EU.
More than 25% of the OECD government bonds trade with a negative yield and this percentage is rising.  Negative interest rates are not part of a normal economic system.  Maybe the markets are more ‘sufficiently’ becoming aware of this and re-pricing assets accordingly.
The U.S. presidential election is another variable with an unknown outcome.  The campaigns have repeatedly resembled a “Three Stooges” episode and it’s unclear if the markets have properly considered a Clinton or Trump administration.  This is similar to how the markets have become complacent regarding BREXIT.  It’s easy to see these things taking unexpected twists and turns over the upcoming weeks, but are the markets prepared?
As the markets re-think the above issues, the U.S. economy may be slowing.  The August employment report was disappointing and the latest ISM Purchasing Managers Index report came in at 49.4 which was lower than expected and lower than July’s 52.6 mark.  Readings below 50 are often associated with recessions.
Before last Friday’s drop, the S&P 500 had climbed almost 20% since the February lows.  20% moves in a six-month stretch are pretty rare and usually coincide with strong growth.   Unfortunately, as we know, GDP is only expanding at around a 2% rate and corporate profits have been stagnant.  In fact, analysts have been reducing their bottom line estimates.  The result is unattractive stock market valuations and investors are starting to notice.
While everyone is scouring every word from Fed officials trying to determine when the next interest rate increase will take place, the market is not waiting.  The 10-year Treasury note’s yield closed at 1.54% on September 7th.  Two days later (last Friday) yields spiked to 1.67%. and touched 1.75% on Tuesday.  Obviously, higher borrowing costs are an economic headwind, but they also reduce the current value of future earnings and cash flows.  This doesn’t help our ‘challenged’ valuations and provides another reason to question the summer rally.
Market trading has changed in recent years.  Trading has become dominated by computer programs, algorithms and passive strategies.  These are reactive to developments as opposed to the process of discounting future expectations with the goal of finding undervalued opportunities.  These trend following black boxes will likely increase price volatility in both directions.
Last Friday’s decline left the S&P 500 below its 50-day moving average and vulnerable to test the 200-day moving average which resides over 3.5% below current levels.  If the averages can stabilize and then recover the 50-day, it would be a bullish sign.  However, we would expect some further selling as the uncertainties facing the global economy are properly priced in.  In the meantime, that hated asset class, cash, might become more popular than just at happy hour.

 [i] John Lennon, Paul McCartney
[ii] Gary Knight, Connie Francis, Hank Hunter
[iii] GaveKal Research, September 12, 2016
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

Tail Wagging the Dog

The day after Janet Yellen’s Jackson Hole Speech two Fridays ago, The Wall Street Journal’s headline read, “Yellen Sends Strong Signal on Rates”.[i]  According to the article, the Fed chairwoman believes the economy is at a point that the Fed will more strongly consider raising interest rates.  Naturally fed funds futures increased the likelihood of a September increase to 36% and a December hike to 64%.  Other markets reacted as expected – bonds yields moved higher and stocks reversed morning gains and sold off.
This has become a common occurrence.  Every press release, statement, speech, hangnail and sneeze are analyzed for clues of future policy changes.   Only the most isolated or distracted (such as excited Met fans after their team got back into the wildcard race) are not aware of the intense level of focus that the markets have on the Fed.
To be sure, the FOMC’s interest rate decisions are a component of monetary policy which have economic influences which affect capital market prices.  Undoubtedly they are significant.  However, the markets have developed an addictive condition when it comes to the Fed that has grown to a point where it appears to be a case of the tail wagging the dog.  In other words, rather than the Fed watching the economy and adjusting policy accordingly, the economy and the markets are watching the fed and trying to front run their next move.  Corporate earnings and valuations have become afterthoughts.
During the past several decades the relationship between the Fed and the capital markets has changed.  The Fed traditionally used money supply and short term interest rates to implement the desired monetary policy to slow activity when the economy was too strong and to boost things when needed.  Dating back 100 years, the central bank’s original purpose was to smooth out the cycle of booms and busts and keep the economy as steady as possible.
Obviously, this role has transformed into its current character of financial repressor and protector of asset prices.  The Fed claims to be ‘data dependent’ so they are closely watching and striving to get better GDP growth.  But the reality is that setting interest rates at zero and buying bonds has done very little to help the economy.  Indeed, the chief result of the zero interest rate policy (ZIRP) and quantitative easing has been to drive speculation into higher risk assets.
While stocks have probably been the biggest beneficiary of global central bank mechanizations, perhaps the capital markets are starting to wonder if their confidence is misplaced.  Interestingly, on the day of Janet Yellen’s speech, the Journal’s front page headline was “Fed Stumbles Fueled Populism”.[ii]  The article critically points out how the Fed has misjudged the effectiveness of their decisions.  Further it hints that some discontent is growing among the markets.  Jon Hilsenrath, the author, notes, “Three key miscues by the bank since the financial crisis add to public disillusion with institutions”.[iii]
While a confidence crisis could be a problem, the fact remains that stocks trade at record levels.  This is more impressive given we are in the dreaded August – September period.  During the past 5 years, August has averaged a 1.87% drop which makes it the worst month for the period.  September has been the second worst month with an average decline of 1.19%.[iv]  Stocks made it through August 2016 in good shape (minor losses for the month) so maybe this trend is changing.
Here are the year-to-date returns for the major indexes as we begin September.
                                      2016YTD                      
Dow Jones Industrial Average  +6.1%
S&P 500                                    +6.7%
Nasdaq Composite                    +4.8%
Russell 2000                              +10.2%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
After breaking out in July, the equity markets have traded in an incredibly narrow range.  Looking at the past 40 days, the S&P 500 has traded in a range of 1.77% which is the tightest 40-day range ever!![v]  Given the volatility in the first and second quarters, maybe we continue sideways for a little longer.
The markets’ resiliency in the face of all of the obvious headwinds has caught many off guard.  As noted in previous newsletters, there have been many high profile predictions for a nasty market drop starting in the spring.  Yet stocks refuse to fall (so far).  We think investors should remain flexible and open minded.  The stretch from Labor Day to New Year’s Eve could see a return of the dog wagging the tail.

[i] The Wall Street Journal, August 27 – 28, 2016
[ii] Ibid, August 26, 2016
[iii] Ibid, August 26, 2016
[iv] The Bespoke Report, September 2, 2016
[v] Ryan Detrick, CMT, September 7, 2016
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

All Quiet On the Western Front

For those frustrated and tired with politics and the elections, stay away from the stock market.  As hard as it is to believe, the markets are worse than Trump and Clinton.  On one hand, some really smart, successful professionals are pounding the table that trouble is coming and investors should get out before the markets implode.  Yet last week the three major averages (Dow, S&P 500, Nasdaq) reached record closing levels on the same day.  Contrary to the warnings, this trifecta is usually a sign of a strong market.  1999 was the last time it happened.
While it has been a confounding year for the capital markets, the recent action has been a different vexation from the volatility in the first and second quarters.  After Brexit and July’s upside breakout of the 2-year trading range, U.S. stocks have been quietly moving sideways.  This slithery stretch is somewhat misleading.  While the financial media correctly broadcast that the averages are setting new records, those not following closely believe that the markets are having a terrific 2016.  Not that a mid-single digit return is that bad. But for those not faithfully following developments, one could easily believe all of the records translates into a blockbuster move.  As you can see, the year-to-date returns are respectable but not off the charts.
2016YTD
DJIA                       +6.5%
S&P 500                 +6.8%
Nasdaq Composite +4.6%
Russell 2000          +8.9%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
This calm stock market landscape is out of character.  In fact, according to The Wall Street Journal, volatility in the equity markets is the lowest in 20 years.  During the past 30 days there were only 5 trading sessions where the S&P 500 moved more than 0.5%.  That is the fewest in any 30-day period since 1995.[i]
These non-volatile markets have another notable feature.  Low trading volume.  Market volumes are typically lower during the summer as there are thinner trading desks and this year is no exception.  As an example, the trading volume in the SPY (the S&P 500 exchange traded fund and one of the most widely traded stocks) has been below its 50-day moving average for the past 30 days.
This quiet and calm has some worried that it is a prelude to trouble.  And to be sure, there have been cases of stock market problems after periods of tranquility.  Also, the S&P is up over 20% during the past 6 months as measured from the February lows to the recent highs.  It’s natural to expect a hesitation or correction after such a move.
As mentioned above, there have been several high profile investors emphatically telling everyone to get out of the markets.  George Soros, Carl Icahn, Jeff Gundlach, and Stanley Druckenmiller have all warned that they believe there is significant market risk and that investors should get out.  It’s important to note that these warnings began earlier in the year and prior to the recent run up to record levels, so they haven’t been accurate (yet!).
The bears have a lot of ammunition.  The capital markets are being manipulated and controlled by central banks and the markets are starting to lose confidence in these policy makers. Further, trillions of dollars of sovereign debt trade at negative yields as a result of central bank actions.  Fiscal deficits are at record levels, and economic growth, where it can be found, is anemic.
And despite this environment, we find U.S. stock markets at record levels.  This points to an additional concern – U.S. stocks are not a bargain.  There are countless ways to value securities such as price-to-earnings, price-to-sales, dividend yield, book value, etc.  None of them currently result in “undervalued”.
Given these intense cross currents is there any surprise that investors are confused?  Within the glass half-full world, we think that July’s breakout to the upside is important.  The S&P 500 had been in a 2-year trading range which was roughly 1,800 to 2,100.  That the move out of this range was to the upside is a material event.  Moreover, it advanced in the face of the negatives covered above.
Secondly, some think that the U.S. economy is ready to expand beyond the stagnant performance of the past few years.  This could be the unknown helping last month’s move.  If this does take place, global stock markets should continue to move higher.
Returning to the ursine view, there are plenty of reasons for pessimism and in addition to those economic obstacles, there is social acrimony.  The country is polarized and the divide is growing and will continue past the election.  This has a chance to impact issues beyond the economy and politics.  It is a risk that is difficult to quantify.
David Tepper, another high profile hedge fund manager, recently confessed he was unsure of the markets’ direction.  He offered that he wouldn’t be too long or too short and he concluded that having an above average cash balance made sense.  We would concur and add that keeping an open mind towards the markets will be a good approach.

[i] The Wall Street Journal, August 23, 2016
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional

2nd quarter Kildare performance letter

A common investment debate involves buy and hold vs. active management.  The buy and hold approach believes in investing for the long term while active management attempts to adjust positions according to various market conditions.  In a strange set of events, 2016 had something for both sides.  The year began with a gut wrenching drop, then a recovery, and finished the first six months with historic strength.  So rewards came to the properly timed trader as well as the investor who rode out the volatility.  This hindsight makes it sound simple, but neither strategy was easy to execute.
2016 started with the worst stock market decline ever to start a year.  By mid-February the Dow Jones Industrial Average and the S&P 500 had fallen by over 11%.  The Nasdaq and Russell were each down over 16%.  A partial list of investor anxiety included the impact of falling crude oil, weakening emerging markets, and U.S. interest rate increases.
The markets bottomed in February and then recovered the losses by mid-April.  From there markets treaded water until the Brexit vote in late June.  The unexpected vote to ‘Exit” caught the markets off guard and global stock markets fell.  But after only two days, stocks stopped the decline and, amazingly, reversed course.  The bounce quickly gained momentum and turned out be to a historic move.  The S&P 500’s last three days of June were gains of 1.78%, 1.7% and 1.36%.  This better than 4.5% spike was the third strongest end to a first half of the year for the S&P and the strongest since 1962!  This helped return three of the major averages to the plus side for the six months.
At the end of June here are the returns for the major averages:
2016YTD
Dow Jones Industrial Average  +2.9%
S&P 500                                    +2.7%
Nasdaq Composite                    -3.3%
Russell 2000                             +1.4%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
Someone looking only at the six month numbers, like a ‘buy and hold investor’, would conclude not much happened other than a small advance for most averages.  An active investor might be equally satisfied if they were able to navigate 2016’s volatility.  The reality is that it is difficult to time the markets on a short term basis so there are likely some active investors who underperformed a buy and hold approach.  That’s not to anoint the buy and holders as there were several ‘long term’ investors who could not take the pain that the markets were piling on.  They sold positions into February and missed out on the rebound.  Further, it seemed that both sides were selling into the Brexit result.
Client’s accounts followed a mix of some long term core positions as well as some adjustments that helped to stabilize returns and reduce risk.
One of the strategies that contributed to client accounts’ success in 2016 has been positions in closed end funds focusing on high yield corporate bonds, corporate loans, and taxable municipal bonds.  This asset class (high yield corporate debt) was a big loser in 2015 as these bonds were widely used to finance oil and gas exploration and production.  The drop in the price of crude oil increased concerns that the bond issuers might not be able to pay off these bonds.
However, the selling of the energy bonds caused weakness across all of the high yield sector.  While the energy related bonds did have increased risk, the widespread selling resulted in good opportunities in bonds from other industries.  Further investing in this debt through closed end funds presented enhanced value as many of the funds were selling at significant discounts to their net asset value.  This offered a compelling margin of safety.
After the markets bottomed and the economy offered signs of stabilizing, these bonds increased in price.  The closed end funds appreciated along with the underlying bonds.  These higher prices together with the 6 – 8% yields offered solid double digit total returns in the first half of 2016.
When choosing the funds, I focused on ones that did not have exposure to the energy sector.  Some that I used are Blackstone Strategic Credit Fund (BGB), Blackstone Floating Rate Fund (BSL), Blackstone Taxable Municipal Bond Trust, and the Eaton Vance Senior Income Trust (EVF).  We sold the Deutsche High Income Trust (KHI) after the price appreciation moved the fund up to a slightly overvalued level.
Looking towards the second half of 2016, both ‘buy and hold’ and ‘active investors’ are facing high levels of uncertainty.  Geopolitical conflict, terrorism, Brexit, negative interest rates, and a polarizing U.S. presidential election are just a partial list of unknowns facing the markets.
I think the post-Brexit move in the stock market (as hard as it is to explain) is significant.  And U.S. stocks have added to this move in July.   As mentioned above, stocks ended June with the third strongest three-day performance ever.  In the two other examples as well as the fourth best (1999), the S&P 500’s median gain in the second half of the year was 7.03%.  Admittedly, this is a pretty small sample but it is something to keep in mind.  I will continue to look for the opportunities that offer favorable risk and return situations throughout the next six months and beyond.
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

Solar Capital Ltd.

Solar Capital Ltd., despite its name, has nothing to do with the solar industry.  It is a business development company (BDC).  BDC’s are similar to a bank as they invest and lend to small and medium size organizations.  The difference is that many of these companies are young and growing quickly.  Often they lack the collateral that traditional banks look for.  BDC’s step in to meet the demand for capital.
The BDC stocks had a very difficult 2015.  Worries over higher interest rates together with uncertain economic growth provided headwinds.  Also, the drop in crude oil played a role.  Some BDC’s had loans to energy related companies and the drop in oil and gas increased the risk that these loans would be repaid.  2016 has seen a recovery in BDC stocks especially those without energy exposure.
Solar Capital employs a value-oriented, fundamental credit underwriting approach to make investments primarily in senior secured loans and subordinated debt of private, middle market companies.  They were one of the few BDC’s that increased their book value last year.  One of the reasons for this is that they have no energy exposure.  Further, 99% of their portfolio is performing with a weighted average yield of 10.5%.
SLRC’s stock is currently priced below its book value and has a dividend yield of 7.9%.  In their recently released quarterly report, the company grew earnings through expanding the loan portfolio and contributions from loan prepayments.  Looking forward, the company will look to continue to enlarge the investment portfolio which could increase earnings.
Solar Capital invests and lends to small and medium size companies.  Obviously, this is riskier than traditional commercial lending.  However, SLRC’s low valuation and above average dividend yield offsets some of these risks.  I think that Solar Capital is a good risk – reward opportunity for investors with a longer time horizon.
Please contact me if you would like further information.
 Sincerely,
Jeffrey J. Kerr, CFA
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

MVP REIT II income opportunity

The MVP REIT II is an income opportunity investment. It is a publically registered, non-traded real estate investment trust (REIT). Non-traded REITS do not trade on an exchange and can be illiquid.
MVP REIT II is focused on acquiring parking facilities (garages, lets, structures, etc.).  The U.S. parking industry is fragmented and includes more than 40,000 facilities.  Between 2014 and 2019, the parking industry is estimated to grow by 18%.  Some other industry trends include innovative technologies leading to improved control and payment automation.   Further benefits include steady cash flows from lease operators and geographic diversification.
The MVP REIT II currently yields 6% (currently it is 50% cash and 50% additional shares).  The dividend is paid monthly.
This offering closes on October 1, 2016.
MVP has experience in building a parking lot business.  MVP REIT I closed in September 2015 and has 25 properties.  It continues to pay an over 6% dividend yield.
The company intends on listing MVP REIT I for trading in the 4th quarter of 2016.  This might provide liquidity for MVP REIT II in 2017-2018.
If you are interested and would like to discuss in more detail please contact me at 607-231-6330 or [email protected].
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

Even If We’re Just Dancing in the Dark

One step up and three steps back.  That’s the recent stock market as prices, after reaching a high for 2016, have declined for the past three weeks.  The good news, however, is that the total loss during this time was only 2.2%.  This is compared to the average loss of 6.3% in the 72 other three consecutively weekly declines since 2000.[i]
This stock market two-step has also been a daily dance.  For example, last week the Dow Jones Industrial Average climbed 222 points on Tuesday, gave it back on Wednesday (down 217), and fell another 185 to close out the week on Friday.  It seems neither the bulls nor bears have the ammunition to move the market out of the trading range that began in March.
This range has been defined by 2,100 as a ceiling for the S&P 500, which was reached in April.  The lower floor is 2,040 which has been tested three times, most recently last week.  The short-term and intermediate direction of the market could be determined by a break out of this range.
2016YTD
Dow Jones Industrial Average  +0.6%
S&P 500                                    +0.1%
Nasdaq Composite                     -5.8%
Russell 2000                              -2.9%
 Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
While the major indexes have been moving back and forth, some market sectors have been more one directional.  The Dow Jones Transportation Average has plunged 7.4% in the last 3 ½ weeks.  The retail sector ex-Amazon has been one of weakest areas of the market.  Macy’s, Kohl’s, J.C. Penney, and Nordstrom’s all reported weak 1st quarter sales last week.  Furthermore, the forward guidance was lowered across the board.  The department store group fell 16%.
However, this is not a consumer obituary.  April retail sales were released on Friday and they were up 1.3% which was above expectations.  Actually, the April increase was the best gain since March 2015.  So where is money being spent?  Gas, groceries, and restaurants/bars saw healthy sales numbers but the real leader has been online sales.  As a comparison, according to LPL Research, department store sales in April totaled $13.3 billion while ‘non-store’ (online) retail sales totaled $45.2 billion which represented a 10% year-over-year increase.  The $13.3 billion of department store sales in April 2016 is a DROP from the $14.1 billion of January 1992!!  That’s an amazing 24 years with no growth.  Money is getting spent but it’s not going into the cash registers at department stores.[i]
Given the overall choppiness together with some weak parts of the market, precious metals and oil have been steadily moving from lower left to upper right.  The gold rally has been helped by negative interest rates as securities with negative yields are less competitive.  Also, worries over BREXIT and lower confidence in global central banks have increased buying as a safe haven.  Furthermore, George Soros announced his fund took a large position in gold via miner Barrack Gold Corp.  As part of the same filing, Soros increased his short position in the S&P 500.
Predictions of supply-demand becoming more balanced has pushed the price of oil back in the mid $40’s.  Recent developments include fears of supply disruptions because of Nigerian violence and the wildfires in the Canadian Oil Sands region.  Also, Goldman Sachs, who has been pretty bearish on crude oil, increased their 2016 price target to $50 per barrel.
The capital markets’ indecision is partially a result of the uncertainty over corporate earnings growth.  Economic growth has been weak so revenue and earnings growth is a challenge.  With valuations currently near the top of most methods of measurement, a stronger economy and visibility on expanding earnings will be needed for stocks to convincingly breakout of the trading range.
Of course, global central banks and monetary policy impact the economy.  Concerns over U.S. interest rate increases and the end of easing initiatives have contributed to the stock market’s sideways trade.
Recent Federal Reserve banter increases the possibility of the another rate hike as soon as the June meeting.
This alternating action on a daily or weekly basis will end at some point and prices will breakout.  Whether that is a move up or down, markets will probably begin a sustained move as all traders are waiting for this range-bound market to finally decide its future direction.

[i] LPL Research, May 16, 2016

[i] Ryan Dietrich, CMT, May 16, 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

Mr. Kerr is an Investment Advisor Representative of advisory services offered through Kildare Asset Management, a Registered Investment Advisor.
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.