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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

                                                          2013[i]

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

Russell 2000                                  +29.0%

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 


 

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

 

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

[1] The Washington Post, September 25, 2013

[1] Ibid

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

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

 

Past performance does not guarantee future results

 

 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 


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


[i] The Washington Post, September 25, 2013

[ii] Ibid

 

 

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

“She Moves In Mysterious Ways”[i]

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

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

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


 

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

 

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

 

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

 

“Don’t Be a Debbie Downer”[iii]

 

 

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

 

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

 

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

 

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

 

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

 

                                                  2013[v]

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

Russell 2000                              +26.5%

 

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

 

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

 

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

 

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

 


 

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

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

[1] ibid.

[1] SNLTranscripts.org

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

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

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

 

 

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 

 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 

 

 

 

 

 

 

 

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

“Parting is such sweet sorrow”[i]

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

 

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


[i] Romeo and Juliet, Act2, Scenec2

 

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

 

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

 

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

 

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

 

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

 

                                                                        2013[ii]

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

Russell 2000                                                    +22.2%

 

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

 

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

 

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

 

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

 

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

 


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

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

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

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

 

 

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

                                                                                    2013[2]

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

Russell 2000                                                                +23.7%

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 


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

[2] Ibid, July 20, 2013

[3] Ibid, July 20, 2013

 

 

 

 

 

 

 

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 


 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

News from Kerr Financial Group

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

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

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

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

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

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

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

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

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

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

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

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

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

                                                                        2013[iv]

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

Russell 2000                                                       +23.4%

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

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

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

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

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


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

[ii] Ibid

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

[iv] Ibid, August 10, 2013

 

 

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 


 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 


 

Jeffrey J. Kerr is a registered representative of

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

Kerr Financial Group is not affiliated with

LaSalle St. Securities, LLC. Securities are offered

Only through LaSalle St. Securities, LLC

940 N Industrial Drive, Elmhurst, IL   60126-1131

Member FINRA/SIPC