Solar Capital Ltd.

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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

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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

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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.

What a Long Strange Trip It’s Been

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Four months into 2016, it might be difficult for some to recall that the year had the worst start ever for the stock market.  This is partially a function of the historic recovery that started in mid-February which erased all of the earlier losses as well as the markets’ nightmarish memories.  This bounce has included a string of 5 consecutive advancing weeks and 8 out of 10 weekly gains ending in mid-April.  While this returned the major averages to marginally positive year-to-date numbers, they remain below their all-time highs reached last May (the Nasdaq’s high was in July).
Here are the major averages through May 5th:
2016YTD
Dow Jones Industrial Average   +1.4%
S&P 500                                     +0.3%
Nasdaq Composite                     -5.8%
Russell 2000                              +0.3%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
It may surprise many that this back and forth action has been in place well beyond 2016.  For example, the Dow Jones Industrial Average closed above 18,000 for the first time in December 2014.  Then after peaking at an all-time high last May, stocks fell in August on fears surrounding China.  Prices recovered somewhat into year-end but plunged in January.  However, the rally of the past two months has helped the Dow recover this 18,000 level again.  Obviously, the Dow was little changed during this almost 17-month stretch, but remarkably, the index traveled 42,155 points during the trip!!  That’s a lot of mileage to end up where you started.
Stocks have struggled during the past few weeks.  The Nasdaq has been the weakest area as some high profile companies reported some disappointing 1st quarter earnings.  Google, Apple, and Netflix, three of last year’s heroes, all fell after their earnings reports. Of course, Amazon and Facebook are two stocks that reacted positively and have moved higher.
However, there are many high profile stocks trading below the 50-day moving averages.  This might be a sign of a consolidation before another move higher or a signal for a market dip.
Unfortunately, we are entering the historically weaker 6 months of the year as we are in the “sell in May and go away” timeframe.  Since 1929, the S&P 500 has averaged a 5.04% gain during the months November through April.  This is contrasted with an average gain of just 1.87% in May to October period.[i]  While this latter period is positive, there have been some memorable stock market declines during these six months.
Last weekend Warren Buffett hosted Berkshire Hathaway’s annual shareholder meeting.  Naturally, it was the focus of the financial media and Mr. Buffett reminded us that the U.S. is the greatest economy in the world.  But before everyone finished shaking their heads in agreement, Stanley Druckenmiller, speaking at the high profile Sohn Investment Conference, told listeners to sell everything and buy gold.  Mr. Druckenmiller, one of the most successful hedge fund managers in history, criticized the Fed saying that there is no “end game’ for the “radical monetary experiment”.[ii]
Two really smart, successful investors on the opposite ends of a bull-bear debate highlights the uncertainty in the markets.  Both make compelling arguments in defending their view which makes it difficult to determine who the market will side with.  Perhaps the sidewinding price action will be with us for a while longer until a clear winner is declared.
I The Bespoke Report, April 29, 2016
[ii] Yahoo, Finance, May 4, 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.

It’s Darkness Before the Dawn

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After the worst start to a year, the stock market has amazingly recovered.  The nightmare that began 2016 was a tortuous six week drop.  The widespread damage to the global equity markets was relentless.  The panic and fear increased to a point where the Chinese closed their markets for a couple of days to try to combat the selling.
In mid-February, as pessimism was everywhere, something completely unexpected happened – the global markets stabilized and U.S. stocks went on a five week rally that erased all of the losses.   So after the first three months of the year, we’ve had a lot of price movement but little change from where we started.  More importantly, the markets’ emotional state is back to its normal neurotic condition.
Despite ending the quarter with just a small gain, it was a historic three months.  It was the first time in 82 years where the S&P 500 was down over 10% during a quarter and then recovered and closed up at the end of that same quarter.  It last happened in the 4th quarter of 1933.
It was a remarkable shift in investor emotions during 2016’s first three months.  Conventional wisdom during the decline was that the emerging markets were imploding, commodities were dropping, and the world was plunging into recession.  Sentiment switched during the second half of the quarter to a calmer view of the global economy and re-established confidence that the central banks would be able to navigate through the challenges.
The trading action in these three months reflect the decline and then the recovery.  In 2016’s first 48 trading days the S&P 500 moved 1% over half of the time (26 times).  In contrast, March only had 4 days of 1% moves.  That is a lot of motion without much movement (the S&P closed the quarter less than 1% higher than where it began the year).  Of course, inquiring minds want to know if that volatility and recovery signaled a sustainable low.  In other words, did February’s reversal represent a panic point that priced in all of the bad news and none of the good news?
Here are the major averages returns for through April 1st.
2016YTD
Dow Jones Industrial Average        -2.1%
S&P 500                                            +1.4%
Nasdaq Composite                           -1.9%
Russell 2000                                      -1.6%                       
 
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
As referenced above, recession worries and the Fed have been two of the biggest market influences.  This likely remains the background although at any given time Mr. Market will also focus on the potential terrorist threats, BREXIT (Great Britain’s possible exit from the EU), presidential polls, and polar cap ice cover.
While economic reports have improved, progress remains challenged.  For example, the unemployment rate has dropped to 5% but job growth is frustratingly below historic standards and wages are stagnant.  Secondly, automobile sales are at record levels but it’s been assisted by cheap financing.  Finally real GDP, while still positive, is lower on a year-over-year basis.
As the markets digest these reports, their eyes remain on the Fed.  After their December interest rate increase, investors have been on edge over how many more increases will take place in 2016.  Last week Janet Yellen gave a very dovish speech.  While she didn’t provide details on the future monetary policy, she was clearly in no hurry to raise rates again. Some market strategists were looking for up to four fed funds rate hikes in 2016.  Those expectations have been severely reduced post speech to the point where several commentators are forecasting only one more move this year.  Some are predicting no hikes in 2016.
In addition to the economic cycle and monetary policy, stock valuations is another important variable.  As measured by the S&P 500, stocks are trading at a price-to-earnings (P/E) ratio of just under 20 times.  The long-term average for this index is 15.42.  According to Bespoke Investment Group (April 1, 2016, The Bespoke Report), this P/E level is higher than 82% of all daily readings since 1929.  That’s far from an “all clear” sign and unfortunately the recent trend has seen the denominator (earnings) decline.  High valuations are not always the catalyst for falling stock prices but they will not be helpful if markets retreat again.
The S&P 500 has averaged a gain of 2.7% in April during the past 10 years.  Given a recently confirmed supportive Federal Reserve, this trend might continue.  However, there are substantial headwinds to a sustained rally.  Reestablishing corporate earnings growth would be an important development to continuing the stock market’s advance.  First quarter earnings and management’s guidance for the rest of 2016 should be a helpful sign in determining if this is developing.  Otherwise 2016 might turn into a “sell in May and go away” year.
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.

“It Was the Best of Times, It Was the Worst of Times”[i]

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A Tale of Two Cities offers a good description of 2016’s capital markets.  Stocks began January by recording their worst start of any year in history.  By February 11th the Dow and S&P 500 had fallen over 11% while the Nasdaq and Russell were each down over 16%.
From those dark times, stocks have rebounded.  In fact, the major averages have surged around 10% from the February lows and have recorded three consecutive weekly gains. Indeed, in 2016’s nine weeks, Wall Street has experienced both the ‘worst of times’ as well as some care free trading.
Now, investors are facing the debate of whether the February bottom is the end of the selling versus the view that the rally will fade and markets will retreat again.  Bulls point to continued strong employment data (last week’s report estimated that 242,000 jobs were added in February well above the 192,000 forecast).  This helped calm fears over the U.S. economy slipping into a recession which was one of the main worries in January.
The bears contend that the three-week bounce is just a counter-trend move and that prices will ultimately drop to fresh lows.  They maintain that central bank policy (negative interest rates, QE, etc.), China’s economy, and the collapse of commodities (especially crude oil) will have negative economic influences which will eventually result in lower equity prices.
After this year’s selling and then buying, here is where the averages closed last week.
2016YTD                                        
Dow Jones Industrial Average  -2.4%
S&P 500                                    -2.2%
Nasdaq Composite                    -5.8%
Russell 2000                              -4.7%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
“It Was the Age of Wisdom, It Was the Age of Foolishness”[i]
This market environment is making both investors and traders feel frustrated and foolish.  One month Armageddon is at hand while the next month markets believe that central banks will cure all of mankind’s problems.  Indeed, no matter your time frame or investment mentality, it’s hard to find suitable investments ideas.
With the belief that markets trade to extreme levels (both higher and lower), one strategy is to look among oversold and beat up areas of the market.  After the start to 2016, this shopping list is long.  One option worth considering is the high-yield sector of the bond market.  This portion of fixed income was especially hurt in 2015 because of the worries surrounding energy company bonds.  Further, other non-energy issues within high-yield were sold over recession concerns.  Maybe this is a case of the baby being thrown out with the bath water and the selling was overdone.
First, some review is in order.  High-yield bonds are debt securities issued by companies with credit ratings of BB and lower.  In general, these securities offer higher returns in the form of interest payments.  However, the issuing companies’ financial condition is below that of a blue chip organization.
Now let’s turn to some ways of investing in high yield bonds.  Many readers might not be familiar with closed end funds but they offer a structure that would help in gaining exposure to high-yield bonds.  Closed end funds offer some advantages (and disadvantages) over the more familiar conventional mutual funds.
A closed end fund is an investment security that invests in a variety of other things such as stocks and bonds.  In this way, a closed end fund is like a mutual fund – it is a portfolio of stocks, bonds, commodities, currencies, or a mix of the above.  Like the more popular mutual fund (open ended), a closed end fund calculates the NAV or net asset valued.  The difference is that an open ended mutual fund trades at that NAV which is computed after the market close.  A closed end fund trades throughout the day during market hours and often trades at values that greatly differ with the NAV.
A closed end fund sells shares at an IPO and uses that capital to invest. On the other hand, a mutual fund buys and sell shares daily based on investor demand and the share count is continually increasing and decreasing but always at the NAV.
Another important difference is that closed end funds typically use leverage.  This is something that traditional mutual funds don’t do.  The leverage that closed end funds apply is often in the form of preferred shares or repurchase agreements. This additional capital is used to buy more assets in the fund’s strategy.   The intention is to create a positive difference between the fund’s longer term return and the cost of the leverage.  The result is that closed end funds have a higher cost structure but can provide enhanced returns when the strategy is executed properly.
Closed end funds, like mutual funds, can focus on a market sector, industry, geographic region, and various asset classes.  For example, there are closed end funds that cover technology, banking or energy.  Municipal bonds are a popular area for closed end funds and there are several choices from individual states to nation-wide funds.  Staying within fixed income, different approaches include Treasury, corporate (investment grade as well as high-yield), and international sovereign (developed together with emerging market).
Within the equity universe, closed end funds have similar broad ranging options.  From domestic large-cap to international small-cap and everything in between, there is a large assortment of approaches.  There are generic growth and income as well as a variety of value styles.  You can even choose country specific funds such as China, Japan, Germany, India, China, Korea, Taiwan, Turkey, or even Mexico.
Also, it is important to recognize that some well know investment companies offer closed end products.  Nuveen, Blackrock, Eaton Vance, John Hancock, Morgan Stanley, JP Morgan, to name a few of the fund sponsors.
”

It Was the Epoch of Belief, It Was the Epoch of Incredulity”[ii]
Returning to our high-yield theme, we think the closed end funds offer some attractive ways to invest in this part of the bond market.  Before getting into some specifics, let’s review these bonds’ recent performance.
As mentioned above, the high-yield market has been declining since the spring of 2015.  High-yield energy has been the leader in this retreat.  Many exploration and production companies used debt to finance the sizable growth in the drilling industry.  The price declines in crude oil and natural gas are headwinds to these bond issuers’ abilities to service their debt.  Consequently the markets have priced in this additional risk by lowering the bond prices.
In addition, to the energy sector, recession worries also played a role in weakness of high- yield bonds.  As we know, bond prices decline when interest rates move higher.  While this does influence high-yield fixed income, these bonds often trade in the same direction of the stock market.  This is primarily a function of the belief that high-yield bond issuers have an easier time of servicing the debt in a good economy.  Recessions, which are often accompanied by lower stocks prices, make it more challenging for some companies to make interest payments.  Below is a 15-year chart of the Barclay’s U.S. Corporate High- Yield Index and the S&P 500.  While they don’t always move in lockstep there are clear signs of correlation.

This chart clearly shows a divergence since the beginning of 2014.  We would expect this to be resolved – either the S&P 500 declines towards the Barclay’s Index or the high-yield index climbs back to the S&P 500’s level.  Of course, there is the possibility that the correlation has been broken and the divergence widens but 15 years of data would favor convergence.
Below is a table with some specific closed end bond funds.  It gives an overview on four high-yield funds.  Also there is a fifth fund (AllianceBerstein Income Fund) that focuses on Treasuries.  It is included because of some unique recent developments.  Specifically, the closed-end fund (symbol ACG) is being acquired by the AB Income Fund (an AllianceBerstein mutual fund).  This has forced a narrowing of the gap between ACG’s price and its NAV (recently below 2%).  But a 4.9% dividend is available until the deal is closed later this year.
Similarly, The Deutsche High Income Trust recently announced that they are terminating the fund and liquidating the assets.  Upon shareholder approval, it is expected to be completed by November 30, 2016.  This decision was driven by an activist shareholder – Saba Capital Management LP. While the spread between price and net-asset-value has narrowed, it remains approximately 7%.  We would expect this to gradually shrink as the fund begins returning capital to shareholders.  Add this to the 7% dividend yield and you get a pretty compelling total return.
The two Blackstone sponsored funds have a different type of catalyst – since their inception they have a scheduled liquidation.  The Floating Rate Fund (symbol BSL) has to be liquidated and the funds returned to shareholders by 2020.  The Strategic Credit Fund’s has a longer stretch before its liquidation date – 2027.  Notwithstanding other bond market problems, these funds should see their discounts to its net-asset-value contract.
[i] Ibid
[ii] Ibid
[i] “A Tale of Two Cities”, Charles Dickens
“We Were All Going Direct to Heaven, We Were All Going Direct The Other Way”[i]
Charles Dickens’ words seem applicable to our stock market, but provide little help in predicting its future directions.  Investor sentiment has improved from the pessimism of the start of the year.  Some of the worries over systemic issues have been reduced.  Also, U.S. economic growth seems be continuing although at lower levels than previous expansions.
Nevertheless, the challenges facing global economies and markets are not insignificant and its far from clear that the emerging markets contractions and developed countries negative interest rate policies won’t negatively impact our economy.  The bottom line is that there is still a great deal of risk and uncertainty.
In an effort to provide stability and return, closed end funds focusing on the high-yield bond market, might part of the solution.  As explained above, both these bonds and these closed end funds have unique risks that must be considered.  However, recent declines in the price of the bonds as well as the discounts to net-asset-value within the closed end funds offer a margin of safety.  Please contact us with any questions.
[i] “A Tale of Two Cities”, Charles Dickens
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.

If at First You Don’t Succeed, Try, Try Again

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It’s no secret that economic growth has been disappointing.  According to The Bureau of Economic Analysis and the Congressional Budget Office, real per capita GDP growth in the U.S. is averaging 1.3% annually during this recovery (2009-2015).  That is compared to an annual average of 2.7% for recoveries from 1790-2008.  In other words, our current economic recovery is growing at a rate (after adjusting for inflation) that is over 50% below the average rate for the past 200 years.
As we know, considerable efforts have been made to assist economic growth.  The means to that end, from a monetary policy standpoint, has been reducing interest rates and buying bonds.  And everybody is doing it – European Central Bank, Bank of Japan, Peoples Bank of China, Swiss National Bank, and many others.  Amazingly, global central banks have cut interest rates 637 times and have purchased $12.3 trillion worth of assets since March 2008.[i]
Some define insanity as repeating the same thing over and over again and expecting different results.  We’re not sure “insane” describes our central banks’ policy but certainly “unconventional” does.  Collectively they are reading the same playbook and no one is deviating from the script.  This translates into more interest rate cuts.  Furthermore, this is not limited by ZIRP – zero interest rate policy.  The bureaucrats and bankers are so convinced that low interest rates will work that they haven’t stopped at 0%.  Sweden’s Riksbank (the world’s oldest central bank) lowered their main policy rate which was already negative.  The European Central Bank (ECB) and Swiss National Bank have had negative rates for almost a year.  Japan recently joined the gang as the Bank of Japan lowered chief interest to below 0%.  ZIRP has turned in NIRP (negative interest rate policy).
According to Economics 101, lower interest rates are supposed to help the system through providing more money to invest and spend – the stuff that drives the economy.  So if low interest rates are supposed to help, it’s natural to conclude negative interest rates must be even more of a benefit.  As usual, it’s not that easy.
First, negative interest rates are an additional cost to the banking system.  Banks deposit their liquidity at central banks as a matter of convenience as well as safe keeping (central banks don’t go out of business).  In addition to this custodial service, normally the central bank would pay a small interest rate to the depositing bank.  However, under a negative interest rate environment, this is reversed and the service turns into an additional cost – they are charged interest rather than earning it.
Another headwind is that lower interest rates across the yield curve means that banks are receiving less interest from their loans.  Less interest income from loans combined with added costs from increased regulation and having to pay for deposit services equals a squeeze on banks’ margins.  A weaker banking system usually hurts an economy.
Central banks implement a negative interest rate policy to encourage banks to do more loans.  By penalizing banks for keeping too much capital in cash, policymakers hope that lenders will be motivated to do more lending.  However, the ECB has had negative interest rates for almost a year and hasn’t seen much economic improvement.  After six years of cutting interest rates and printing money to buy bonds, the markets seem to be questioning central bank effectiveness.  The emperor may be naked.
Negative rates go beyond bank deposits at their central bank.  More than $8 trillion of high-grade sovereign debt trade at a negative yield.[i]  In other words, investors are more concerned with the safety of the investment than the return on that investment.  They are so worried that they are willing not only give up a return but actually pay someone to take their money.
As for negative rates in the U.S., Fed Chair Janet Yellen was quizzed about it at her recent Congressional testimony.  As expected, her response dismissed that the Fed was considering it.  Recent trader talk, however, has not discharged the possibility.  With some soft economic reports, the Fed is forced, at a minimum, to reconsider the intention of more interest rate increases in 2016.
Turning to the markets, 2016 has been the worst start of any year in history for stocks. In other markets, U.S. Treasury bond yields have declined, gold has moved higher, oil has continued to fall, and the U.S. dollar has been slightly weaker vs. other major currencies.
Despite the stock markets’ ugly start to the year, U.S. markets rebounded last week.  It capped a strong rebound that began on the prior Thursday (the 11th).  After that day, the S&P 500 rose 1% for three consecutive days – October 2011 was the last time this happened.  Another positive was that market breadth was strong.
It was a welcome move after an 11% drop for the S&P to start the year.  The next worst start to the year was 1948’s decline of 9%.  Since 1928 there have been 16 other times where the index started the year down 5% or greater.  The average return for the rest of the year (from that low point) was positive 3.82%.
Volatility has been another noteworthy characteristic of 2016.  The S&P 500 has moved 1% up or down in 21 of the 34 trading days this year (61.8%).  We have to return to the Great Depression to find years with greater moves (1931, 1932, 1933).  Returning to a more stable stock market environment would be a sign of less selling and might be the beginning of a bottoming process.
 
Here are the year-to-date numbers at the end of last week. 
                                           2016YTD
Dow Jones Industrial Average  – 5.9%
S&P 500                                      –  6.2%
Nasdaq Composite                     -10.0%
Russell 2000                                -11.1%                                
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
While the rally in equities was welcome, there were some important blemishes.  The volume on this move was materially less than that of the selloff.  This might indicate a lack of conviction by the bulls.  Furthermore, the best performing stocks during the move were the worst performers going into the bounce.  Also, they were the names with the highest short interest (stocks sold with the expectation of a move lower).
This led many to conclude that last week was an oversold, short covering rally as opposed to a longer term bottom.
Recent economic reports have been mildly ok.  The importance of this is the debate over whether the U.S. is sliding into a recession.  Industrial production, which has a weak point, came in a little better than expected.  And the employment data remains strong.  However, these are backward looking and the recession argument is based on the energy industry’s implosion and several foreign economies that appear to be slowing.
Pessimism and negativity have become pretty widespread across the capital markets.  This could mean that a lot of the worries facing the global economy are already reflected in the current stock, bond, commodity, and currency markets.  However, these obstacles have many uncertainties remaining.  For example, we are only beginning to work through bankruptcies and defaults involving the energy industry.
While it doesn’t look like the fallout will be anywhere near as wide as the sub-prime mortgage problems, it’s unclear who will be the losers and how far the damage travels.
Returning to the central banks, if the markets start to doubt the ECB, BOJ, Fed, et al., it will bring more selling.  This could take the form of acknowledging that the approaches are not working.  Another view is that policymakers are out of ammunition and there is nothing more they can do.  Central bankers have long had critics.  But if global economies don’t start to show signs of significant progress, the number of detractors would grow in size and volume.  This would result in a continued and sizable shift to risk aversion – selling stocks and buying government bonds.
If the markets can hold last week’s moves, it could turn into a base from which further upside could develop.  The drop in stocks and the increase in treasury bonds during 2016 will not likely be reversed in the short-term.  However, stability for the capital markets would be a first step to a widespread recovery.
[i] ibid  [i] The Telegraph, February 15, 2016
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.

“Quoth the Raven ‘Nevermore'”[i]

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January’s capital markets were in upheaval.  It began with the worst first 5 days in history and then fell further.  While the S&P 500 ended the month with a nasty 5% loss, it was down more than twice that amount before a month-end rally provided some relief.  During this stretch, naturally the financial media were franticly trying to determine the causes as well as seek predictions regarding what the future held for the markets.
A common thread from the responders was to quote Ben Graham.  It’s usually a safe move to refer to the late Mr. Graham in any response involving the financial markets.  He is considered the father of value investing and wrote two iconic books on investing – “Security Analysis” and “The Intelligent Investor”.  Further he taught at Columbia University teaching such famous students as Warren Buffett, Irving Kahn, and Walter Schloss.  So, as mentioned, when the markets are especially confounding without logical explanation, quoting Ben Graham is good decision as very few question his wisdom.   That probably explains why he’s not quoted nearly as much when the markets are behaving and trading higher.  After all, a bull market makes everyone look wise!
Here are how the major indexes performed in January.
2016YTD
Dow Jones Industrial Average  -7.0%             
S&P 500                                       -8.0%                               
Nasdaq Composite                      -12.9%
Russell 2000                                 -13.2%                       
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
“Once Upon a Midnight Dreary, While I Pondered, Weak and Weary”[ii]
After the ugly January, there is widespread debate over whether the U.S. stock markets are in a bear market.  Further the discussion centers on what caused January’s drop and what’s the direction from here.
Looking at what is troubling the markets, falling commodities and a slowing China are the common reasons offered.  While they have influenced the markets, these issues were not new to 2016.  Looking for other causes, some are questioning if sovereign wealth funds (SWF) have turned from buyer to seller.  Countries such as Norway, United Arab Emirates, China, and Saudi Arabia built up massive amounts of funds during the past 10 – 15 years.  SWF’s were estimated to be $3 trillion 10 years ago and have more than doubled to over $7 trillion recently[iii].  These countries invested the funds and, as the SWF’s grew, it helped support global markets.  Things have changed.  With plunging commodities and oil together with a slowing China, perhaps these pools of capital have switched from “buyer” to “seller”.
Monetary policy is obviously a large impact on the markets.  The Bank of Japan surprised everyone a week ago as they adopted a negative interest rate policy.  The BOJ lowered their main interest rate from +0.01% to -0.01%.  It was the first time they’ve adjusted this interest rate in 5 years.  They join Europe in implementing negative interest rates in hopes of stimulating their economy.
Global stock markets rallied on the news and, as expected, the Yen fell hard.  Japan will welcome a lower currency to remain competitive on international trade.  Despite the market’s reaction, there is a possibility that traders question if this is a move of desperation.  This then brings in the risk of a loss of confidence in all policy makers.  A confidence crisis of this type would make January’s markets look like a picnic.
In addition to monetary policy, crude oil’s implosion has many worried.  The concerns involve the fallout over the lower prices.  This is counter to the logical view that lower energy prices are an economic boost. Since the financial crisis, drilling for oil and gas has been a large contributor to economic growth.  Not only has it driven job growth and purchased a lot of equipment and machinery, it provided a boost to other business in the drilling geographies.  In other words, if you’re a car dealer in an area of a lot of exploration activity, you’re in the energy business.  Same for restaurants, hotels, and a lot of other services.  These ancillary businesses are slowing as drilling activity contracts due to the fall in crude.
The damage to the exploration industry has also spilled into the bond market.  Drillers and suppliers of energy infrastructure financed the expansion through debt, much of it by selling bonds.  Because the fixed income markets considered many energy companies higher risk, the bonds were sold at higher interest rates (high-yield).  With oil’s collapse, there are growing worries that these companies will not be able to service this debt and defaults will increase.
These concerns go beyond loans to exploration and production companies. Bank exposure through derivatives are a different problem.  The Bank of International Settlements estimates the notional value of the commodities related derivatives market at around $4 trillion.  The risk is that low crude oil causes bankruptcies in commodity producers with large derivative positions.  A bankrupt entity that would not be able to fulfill its commitments in the futures market could result in a wide reaching problem.  This is likely the reason why the stock market and energy markets have recently been moving together.
The worries caused by these issues have been centered on banking stocks.  They have been battered to the point that the banks within the S&P 500 are selling at their cheapest price-to-book valuation since 2009.[iv]
While stocks and crude are holding hands, bond yields have been moving in one direction – down.  Despite the Fed’s December rate increase on the short end of the yield curve and the upheaval in the high yield market, U.S. Treasury rates have dropped since the beginning of the year.  The 10-year note ended 2015 at 2.27%.  This same bond’s yield closed last week at 1.84% which is lower than the levels reached during last August’s stock market sell off.  In fact, this is the lowest level for the 10-year since last April.  Having closed the year above 3%, the 30-year bond yield was down to 2.68% at the end of last week.
Falling yields could be a signal of investors fleeing risk and seeking safety.  In a clear sign of risk aversion, the S&P 500’s dividend yield is at 2.32%, well above the 10-year’s yield.  Also, it could be a sign of a slowing economy with less loan demand.  Another possibility is that the negative interest rate policies in Europe and Japan are impacting U.S. markets.  Global deflation, a possible result of the central bank policies, could be on the horizon.  Under these conditions, the Fed’s inflation goal of 2% seems to be very challenging.
“Deep into That Darkness Peering, Long I Stood There Wondering, Fearing”[v]
Stock have bounced since January 20th.  This is probably a combination of being oversold as well as the start of earnings reports that were not as bad as had been expected.  A February that follows a greater than 5% January loss usually sees further losses.  Median losses are an additional -2% in the previous 9 times when January lost this much.[vi]
Putting all of these cross currents together, markets are focused more on the economic obstacles rather than the positives.  That may continue for the intermediate future until there is better clarity on the fallout of lower commodity prices, what Japan and Europe’s negative interest rate policies mean, and how the U.S. economy performs.  It’s hard to believe that all of the risks are priced in at current levels, however with the passage of time these issues will be resolved.
[i] The Raven, Edgar Allan Poe
[ii] Ibid
[iii] GaveKal Research, January 22, 2016
[iv]  The Bespoke Report, February 5, 2016
[v]  The Raven, Edgar Allan Poe
[vi] The Bespoke Report, January 29, 2016
“Quoth the Raven ‘Nevermore'”[i]
[i] The Raven, Edgar Allan Poe
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.

I’ve Got Some Bad News For You Sunshine

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In case you hadn’t heard, January 2016 is the stock market’s worst yearly start in history.  Every index, large and small (except for the Dow Jones Utility Index’s less than 1% gain), is down over 7% in just two weeks of trading.  Many averages are down over 10%.  And the carnage extends beyond U.S. equities and includes foreign stocks, commodities, bonds, and currencies.
Markets began deteriorating in November.  Stocks then regained losses later that month but retreated again in December.  There was a Santa Claus rally although it was not nearly as strong as expected.  Despite the market’s sloppiness, there was no indication of what was to happen.
As 2016 trading got under way, the markets encountered problems starting in Asia as China’s Shanghai index collapsed 7% on the first trading day.  Weaker than forecast Chinese economic data was one of the reasons, however an unexpected devaluation of China’s currency played a bigger role.  In the past the People’s Bank of China (PBOC) controlled the value of the renminbi (vs. other currencies primarily the U.S. dollar) to a very narrow range.
Last August the PBOC first loosened the renminbi peg and the markets revalued it to around 6.5 renminbi to the dollar from 6.2.  The PBOC provided little guidance with this announcement which, as expected, lead to confusion and questions.  That uncertainty rippled through the global capital markets and contributed to the August/September  selloff.
Apparently the PBOC didn’t learn from that debacle as they repeated the decision during the first week of January.  Once again Chinese officials allowed their currency to decline against the dollar, and once again turmoil ensued.  The questions started – was China encouraging currency depreciation to boost growth?  Others worried that the Chinese officials had lost control of the financial system and that there was a run on the currency.  Of course, rumors were that the economy was imploding.  Whatever the real reason, the capital markets were confused and uncertain. This resulting in selling which spread globally.
China’s markets has remained the focal point during this two week sell off.  This is a function of being the world’s 2nd largest economy as well as it’s where the trouble started.   The attention intensified as the authorities and officials made so many missteps it resembled a Three Stooges episode.  This climaxed when the Chinese stock market opened with another plunge in the first 15 minutes and then closed trading for the rest of the day.
As we know, the damage wasn’t contained to Asia.  The U.S. markets were under pressure from the first trading day as well.  Stocks declined, commodities fell, and bond yields were lower.  As mentioned, it was the stock market’s worst start of a year.
 
Here are the major averages for the first two weeks. 
2016 YTD: 
  Dow Jones Industrial Average  -8.2%                  
  S&P 500                                           -8.0%  
  Nasdaq Composite                      -10.4%
  Russell 2000                                  -11.3%                                 
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
 
While the China’s issues have not helped the markets, U.S. equities appear to be more tied to crude oil prices.  This has been a recent development and appears to be related to the large amounts of debt that the energy sector accumulated over the past 5 – 6 years.  This capital helped finance the U.S. drilling boom.  A significant amount of this debt was raised by smaller companies as high yield bonds.  Crude’s implosion has increased the risk that the debt can’t be serviced.
It’s intuitive to think that lower energy prices are a huge economic benefit.  However Wall Street is worried that widespread default on fixed income could have a much larger negative impact on the financial system.  As a consequence, for the time being, lower crude means lower stock prices.
As pessimism over the stock markets increases, it’s helpful to look back at previous weakness to start the year.  2016 is the worst start in history.  Using a sample of the 15 worst 5 days to begin a year, the declines range from 5.96% (2016) to 1.79% (2000).  Of these past examples, January ended up being higher 36% of the time with an average increase of 1.34% (there were some large recoveries such as 14% in 1934 and 9.5% in 1985).  Looking to the rest of the year, the S&P 500 ended the year up 43% with an average return of 0.85%.
Given the size of the declines in 2016, it’s hard to see a recovery during in the month’s final two weeks.  Another important indicator is flashing a more troubling signal.  The December Low Indicator measures the Dow Jones Industrial Average’s low point in December as a tipping point.  If the Dow trades below the December low in the New Year’s first quarter, it signals a warning.  For the record, the Dow’s low last month was 17,128 on December 18 and we have sliced through that on January 6th.
There have 33 occurrences of the December low being violated.  The Dow has averaged a 10% further decline in those instances.  The index closed higher from that lower “low” in 19 of those 33 examples.  Applying this to 2016, there is risk that we have not seen the bottom for this sell off.
On the positive side, there are several things pointing to somewhat of a bottom.  Two option related statistics are that the equity put/call ratio closed above 1 which has only happened 5 times since 2011 and usually signals at least a short-term bottom. Also the 5-day average of this ratio reached .93 which is the highest since 2009.
The American Association of Individual Investors (AAII) bullish sentiment reading was the lowest in 10 years (this is viewed as a contrary indicator – low bullish numbers can be market bottoms).  Also, the second half of January is seasonally positive.  Last week’s Barron’s cover featured the headline “Bear Scare”.  Clearly there is a good amount of pessimism which is often associated with bottoms.
Whether the problems in the capital markets spill over to the economy is far from certain.  Indicators are still pointing to growth however slower than previous years.  Nevertheless, it would be naïve to think that the headlines and news reports about the global markets won’t have an impact.  Moreover, when these type of avalanches take place, there is usually a sideways period rather than a “V” shaped move as the market adjust and rebalance.
It would be natural for equities, commodities, and bonds to retrace a portion of January’s move.  Assuming this takes place, metrics like market breadth, the number of new 52-week highs vs. 52-week lows, volume (both absolute and up volume vs. down volume) and credit spreads will be important signs of bounce’s health.
It’s a long shot that we repeat the market’s 2008-2009 path.  The banks are not as heavily exposed to energy as they were to the mortgage market.  Further, such things as job growth and corporate earnings remain supportive.  Currently, however, Mr. Market’s focus is on the visible negatives we face.  If that changes together with some further positive signs for the economy, we may find a bottom.

There is Nothing Permanent Except Change

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Three weeks ago the Federal Reserve raised the federal fund rate and Disney Studios released Star Wars – The Force Awakens.  Both have been among 2015’s most anticipated events.  Also, both are notable because they’re the start of many more to come – more Star Wars sequels and more Federal Reserve interest rate increases.  While the Star Wars movies will be a continuation of its storyline, the financial markets are in a process of adjusting to a new landscape.
The Federal Reserve Open Market Committee raised its overnight lending rate to 0.25% – it was the first increase in 9 years.  It’s been so long that many have probably forgotten how markets act when interest rates are moving higher.  Of course, the amount of future increases as well as their timing is a hot financial topic.  There is a growing contingent that believes that the Fed should have waited in December.  On the other hand, it seems that the consensus is for up to 4 rate increases in 2016.
Those in the ‘wait’ camp point to some softening economic statistics.  Industrial production in the U.S. contracted on a year-over-year basis.  It’s the first time that this has happened since the recession.  And while it’s important that production is still positive, a decline in industrial production usually coincides with a recession.
Furthermore, the Institute of Supply Management (ISM) survey remained below the important 50 level for the second month in December.  The index fell to 48.2 which is the lowest level since June 2009.  Unfortunately, most components (employment, new orders, etc.) show little signs of recovery.
Another cautionary sign is that corporate profits as measured by the S&P 500’s 3rd quarter’s earnings declined year-over-year. It was the second consecutive quarter of an earnings decline.
Margins are being pressured by wages and higher interest costs.  Labor expenses are starting to rise.  Employee compensation as a percentage of total corporate expenses has risen recently from a cyclical low of 57% to 58.5% in the 3rd quarter.  The normal long term level is in the low 60%.  A move back toward this level would be a headwind to earnings growth.
Revenues are obviously another important component of the equation.  Unfortunately, there are some challenges in this area as well.  The U.S. dollar has been on a steady rise and has broken above its long term trend line and moving averages.  The higher value of the greenback means that when U.S. companies translate their foreign sales from euro, yen, or rupee back into dollars, it is a lower number (all things being equal).  And as we know, international business has become an important part of the U.S. economy.  Lower sales together with higher labor costs are a troubling combination for profit growth.
Another notable market development has been the turmoil in the corporate bond market especially in the high yield sector.  As we know, the collapse in crude oil and commodities has hurt any company that drills, mines, transports, services, or is involved in any way to these industries.  This hit has increased the risk that some of the entities can’t repay the interest and principle on their borrowings.  Within the fixed income market, these company’s bonds were sold (lower bond prices and higher yields).  While a lower bond price doesn’t immediately hurt the company that issued the bonds, it essentially closes them from selling new bonds to rollover the debt when the older issues mature.  If new debt can be sold to the market, it will be at a substantially higher interest rate (cost to the borrower) at the same time that the borrower is experiencing lower revenues.  A double whammy.  These factors probably had an impact on stocks prices.
Here are the major averages returns for 2015. 
2015 YTD
Dow Jones Industrial Average  -2.2%                     
S&P 500                                    -0.7% 
Nasdaq Composite                   +5.7%
Russell 2000                             -5.7% 
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
Before readers begin reaching for the hemlock, there are positives.  Staying with the fixed income markets, high yield bonds have never had two consecutive down years.  Perhaps 2015’s carnage has priced in all of the bad news surrounding the commodity and energy industries.  If that is the case, 2016 could turn out to be a year of stabilization and recovery.
Another reason for optimism is that there is too much pessimism.  Investor sentiment is typically thought of as a contrary indicator.  In other words, if there is too much bullishness, it is viewed negatively as investors have already acted on this and have done their buying.  The current landscape, as measured by traditional surveys, is far from upbeat.  The AAII (American Association of Individual Investors) weekly report stood at just 25.1% bullish respondents.  This is a low number.  There were only 8 weeks of 40% and above during 2015 which was the lowest number in 25 years!  By far the largest group is neutral or perhaps “confused”.  51.3% of the survey were in this neutral position which is a 12-year high.  Strategists and professionals are similarly situated – a strong statement given that the economy is growing albeit at lower levels.
The capital markets are dealing with some large cross currents.  The Fed will be raising rates while the ECB (Europe Central Bank) is cutting rates.  In fact they are expanding their monetary stimulus as their bond buying program will be to one of the largest ever.  U.S. corporate profits are forecasted to grow but are facing new obstacles such as increasing costs and a slower global economy.  This will likely result in growth but at a lower level than recent years.  Toss in terrorism, geopolitical tensions, and emerging markets problems, it is easy to be confused.
The markets are always facing uncertainty.  It is reflected in such things as earnings multiples and interest rate spreads.  It will be the same in 2016 as the markets digest the news flow and then adjust to new uncertainties.  Unless one of those ‘new uncertainties’ is a recession, investors can expect to find some opportunities amongst the market ebbs and flows.