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Normal Service for a while.

The Days Ahead: CPI, Europe economic indicators, which will show how much trade tariffs hurt.

 One-Minute Summary: Nearly all sectors were up except the new Communication Services, but see our explanation below. We had felt that the October sell-off was overdone. It was pricing a recession, which is not going to happen for some time. Buyers came back to the market and the election removes a very big overhang. No surprises from the Fed but short-term rates came within a whisper of 3%. There’s now only a gap of 46bps between two-year and 30-year bonds. We don’t see that changing.

Oil is now officially in a bear market having fallen from $76 to $59 in a month. China remains a big concern on the trade issues and on how much the economy is slowing (see here for a very interesting read of how the middle class is economizing).

 1.     Did markets care about the mid-terms? Not really. Markets read polls and the outcome was pretty much as expected. Generally, markets are fine with split government. Nothing much gets done. Nice and predictable. But there were some early polls suggesting the Republicans would keep the House and the bond market, even in after-hours trading, took a sharp turn for the worse. The concern? That fiscal policy would ramp up and the already deteriorating debt position would head into even wider deficits.

We’ve talked about the deficit. It's a story that’s going to be with us for a while. Start with the deficit in the fiscal year just ended. It was $780bn, up $113bn, and would have been $823bn if spending in 2017 had not been brought forward (i.e. it ended up in last year’s deficit when it really should have been in 2018). Personal and payroll taxes rose $105bn in 2018 but corporation taxes and revenues from fines matched that almost dollar for dollar, falling $99bn. Meanwhile government spending rose $173bn.

So we saw the 2-Year Treasury climb to 2.98% on Tuesday night. It settled to 2.92% but it may not be too long until we see a 3% handle on the two year. Meanwhile, the Fed all but confirmed they will raise rates in December and the expected slowdown in the economy is already happening. It was 4.2% in Q2, 3.5% in Q3 and will probably come in at 2.7% for Q4. The concern on Tuesday was simply that with the economy slowing, a full-on Republican administration would add further fiscal stimulus.

2.     The Fed met and… didn’t really say much other than confirm the economy is growing nicely. They did point out that “Business Fixed Investment” or capital expenditure, slowed. They didn’t indicate whether this was i) noise ii) concerns about trade iii) the money was better spent on buybacks or iv) lower demand. We’d go for i) and ii). To be fair, the Fed would never really talk about buybacks so that was unfair.

 The interesting story at the Fed is away from rates. It's this:

It’s the Fed’s balance sheet and it started the year at around $4.2 trillion (the blue bars). It’s now $3.9tr. You can see how much it's down and the annualized rate of decline is in the green line. It's around 18%. This is the Fed selling the securities it bought in five years of QE. Except they don’t sell them. They let the bonds mature and do not repurchase. But unlike a regular Treasury, they don’t get their money back from the U.S. Treasury. The money just disappears in the same way it was created when they bought the Treasuries.

But the U.S. Treasury still needs the money (because we’re running the deficits up there in section 1) so now they have to borrow more than they would if the Fed just held onto their bonds. Think of it as when the Fed buys bonds, they disappear. When they sell them, or don’t reinvest, they come back to the market.

Here’s a very good description.

 Bottom line? Fed monetary policy is much tighter than it appears from watching interest rates. Hence, we like the U.S. Treasury Floating Rate Note (FRNs) for the short end of the curve. 

 3.     How ETFs distort markets. We’re big fans of ETFs but there are a few rules to follow if you want to get the best out of them. One key thing to remember about ETFs is that they are not passive. Every ETF tracks an index and that index is comprised of stocks selected by the index provider. It used to be that investment management worked like this:

  1. A fund manager made a list of stocks that they thought would go up

  2. They bought them

 Now it’s

  1. Fund manager makes up a list of stocks they think will go up

  2. They pile them into an index

  3. Set up an ETF to track the index

  4. The ETF buys the stocks

 Even the grand old S&P 500 index is not just the 500 largest companies listed on the stock market as S&P excludes companies they feel don’t meet their standards of probity, governance or profitability.  But index providers are big and powerful these days so when they make a change to an index it can leave ETFs scrambling to keep up.

And that just happened. Back in the summer the folk at S&P decided to update the various industry sectors (Called GICS or Global Industry Classification Standards). Fair enough. There used to be a steel sector, mining and railroads sector…you gotta keep up with the times. They decided to:

  1. Eliminate the Telecom sector, which had only three companies left in it and AT&T and Verizon were 90% of that sub-index

  2. Reduce the number of companies in the tech sector and move them to Consumer Discretionary

  3. Add a new sector called Communication Services

  4. Move more companies from tech to the new sector

Now, a rough guess tells us that index funds make up around 20% of the S&P 500 and another 25% of active managers use it to benchmark their performance. So, cue lots of money moving around. This is what the market sectors looked like on the day the changes went live:

The tech sector fell from about $6.8 trillion and 28% of the index down to 20%, while the newly named Telecom sector rose from $500bn to $2.3 trillion or 2% of the index to nearly 10%. There are, of course, sector ETFs that track all these and it seems that investors did not sell down their tech ETF and rebalance. That meant there were a lot of forced sellers of tech shares like Google (was tech, now Communicating Services) and Netflix (was Consumer Discretionary and also now Communication Services) but there weren’t enough buyers on the other end…indeed there were no Communication Services ETFs to take up the slack (h/t John Authers).

 Anyway, we think this along with the share buyback blackout, accounts for some of the recent weakness in tech. It will rebalance in time but meanwhile we must live with the distortions created by passive funds.

 Bottom Line: As we’ve noted before the stock market has become considerably cheaper this year. Companies have reported around a 25% increase in earnings, with another 8% at least next year, but stocks are mostly flat and the market trades at around 15x times next year’s earning. That means valuations have fallen around 20%. We would not quite count on a rerating back up to 18x but we think the rest of the year will trend up. The two big risks: China trade (who tweets first) and the pace of the economic slowdown.

 Please check out our 119 Years of the Dow chart  

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Changing the way we remember

 --Christian Thwaites, Brouwer & Janachowski, LLC 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Once upon a time…

Why we’re not fans of Floating Rate Note funds.

Floating Rate Notes are back in the news. Here's our take. 

1.     What are they? Floating Rate Note (FRN) funds come out to play whenever there’s a whiff of interest rate hikes in the air. They are bonds that reset their coupon as rates move. So, if the initial coupon is 4%, they may move to 5% if rates rise or 3% if rates fall. The price of the FRN (or floaters) will, therefore, be less volatile than a normal bond because the reset reflects current conditions. Nice. The price should stay around par value. What could possibly go wrong?

2.     Who issues them? Typically governments, financial companies and industrial companies. For governments, it's  a cheaper way to borrow for short periods and for financials, the liability of the coupon payment (i.e. it goes up and down) is very similar to the income of their assets (i.e. bank deposits). That’s not always the case for a manufacturing company.

 3.     How often do rates reset? First, understand that the reset period and the coupon period are independent. Coupon payments may be quarterly, semi-annual or annual. Reset periods are mostly quarterly but can be daily or annually and pretty much everything in between.

4.     What determines the reset? For U.S. Treasury FRNs it's relatively easy. The rate calculates as a spread from recent T-Bill rate auctions. Recent spreads have been in the range of 4bps to 7bps. As of writing a U.S. FRN maturing in October 2018 yields around 1.36% and a three-month T-Bill yields 1.25%.

For corporate bonds it’s more complicated and many FRNs are tied to a LIBOR (London Interbank Offered Rate and see below) spread and is often called “the index.”

5.     What are some examples of FRN? Let’s look at three examples. Some are quite straightforward. So first up, the Goldman Sachs FRN November 2018, which is a large component of the Bloomberg Barclays FRN  <5 Years Index. It has a BBB rating and pays a coupon of three months LIBOR plus 1.1% and has a yield to maturity of 2.19%. It’s a senior note and non-callable. For the last twelve months, the price has been between $100 and $101.

6.     Got it! And another? But to provide investors with a higher yield, things become more complicated. So for number two, let’s look at a major FRN fund’s largest holding, which is First Data Corporate New Dollar Term Loan, 3.00%, 7/08/22. There are several things to note here:

  • It's a term loan, which means it’s a loan originated by a bank and then sold to investors.

  • It's not tied to LIBOR but to ABR (Alternative Base Rate), which is a mix of LIBOR, Fed Funds and the prime inter-bank rate.

  • It’s not rated. This doesn't mean it's a bad credit just that given the amount of the loan, at $725m, a credit rating was probably too expensive.

  • It comes with covenants, which lower the payment to investors if the company’s EBITDA falls below a certain ratio.

  • It's thinly traded and is a Level 3 asset. This means there is no observable price (like a trade) so values can only be calculated using estimates or risk-adjusted value ranges

7.     Are there mortgage or asset backed FRNs? Indeed there are, which brings us to our third example. One high quality FRN fund that holds Federal Home Loan Mortgage Corporate FRN of 25 Feb 2046 looks like this:

  • It’s backed by individual Adjustable Rate Mortgages or ARMs and by FNMA

  • It has a floor rate of 0% and is based off LIBOR 1-month. They can change the index any time

  • It's subject to the normal pre-payment risk and the experience of the underlying mortgages.

8.     LIBOR is going away, so what happens to FRNs? The end is coming for LIBOR after banks manipulated the rate. It used to be that banks would report the demand for inter-bank funds, in any currency, take a daily average and publish the LIBOR rate. But with LIBOR going away in 2021, it looks like each country will take its own approach. Meanwhile, there is confusion all round. In the U.S., the Fed thinks there is no trading in about half of the standard LIBOR notes. This is why funds have to use Level 3 pricing. The Fed has yet to come up with a solution.

Bondholders could be at risk because if there is no LIBOR rate, issuers will use a “fall back rate” which will be the last, and increasingly stale, LIBOR rate. So if rates increase, investors could be left with low paying bonds and prices will adjust down.

9.     What has been the experience of FRN funds? Funds holding high quality rated floaters pay a little more than money market funds and should have a stable NAV. The trouble begins when funds chase yield and buy lower quality assets. Here’s a chart:

FRNs_BFRIX-USA.jpg

One of the promoted benefits of FRNs is low correlation to other fixed income assets and low volatility of principal. As you can see in 2008, rates fell and the recession began to bite. The problem with the FRNs was that credit fears took over, default fear rose and the price of the two FRN funds shown fell some 20%.

The next problem was in early 2016 when rates began to rise but the FRNs rate reset was slow to follow. So fund investors were left holding a lower rate bond at a time when rates were increasing. This time the price decrease was around 5% to 10% depending on the fund. Meanwhile benchmark long bond (the blue line) increased in price.

10.     And performance? Here’s a quick recap through November 16th 2017:

frns table.jpg

So what can we conclude?

  • FRNs should have a stable price but many don't especially if the credit cycle is deteriorating or rates are rising fast

  • Stretching for yield often means credit quality declines.

  • Many of the securities are illiquid or use Level 3 pricing.

  • The higher the quality of the FRN fund, the more it's likely to concentrate on financial stocks. The Bloomberg Barclays FRN <5 Year index has 65% invested in financials.

  • FRN funds seem not to have performed better than high quality bond funds in both rising and declining rate environments despite taking i) more concentration and ii) credit risk and iii) less interest rate risk.

Give us a call if you’d like more information.

Other information:

Fannie Mae on floaters

Quick definitions

How it's taught at business school

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Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Whiff of Contagion

The Days Ahead: Jackson Hole Symposium, which is often a good source of Central Bank think. Very thin economic reports and corporate earnings season is all but done.

One-Minute Summary: Consumer confidence fell. That surprised some but we think it’s not tied to claims and employment, which are running well. But to wages. I know we bang on about this a lot and there are plenty of others following the same story. Here are the latest wage increases:

Wage increases are barely positive and we believe even those numbers are inflated by supervisory pay. In other words, non-supervisory employees are seeing negative growth in real wages. There are many more workers than bosses so we think the average number is misleading. And it’s been happening all year. There are plenty of plausible and conflicting reasons why this is happening but none are important to markets right here right now. We'll just leave it that consumer spending cannot sustain a 4% growth rate. Wages aren't strong enough.

Gold was down (it usually drops if the dollar strengthens). The S&P 500 finished mostly higher with defensive sectors (telecomm and staples) ahead. The 10-Year Treasury was up. Economic news was mixed. Slow housing starts. Strong retail sales. Productivity growth stayed around its recent, not-so-great trend. Tesla dropped and Elon Musk apologised.

1.     How’s Turkey doing? Not well. If you're an Emerging Market with an inflation and budget deficit problem, you're meant to:

  1. Increase your domestic interest rates…it helps to defend the currency
  2. Tighten fiscal and credit markets…anything, like raise the pension age, curb bank borrowing, but, you know, something
  3. Get some external funding, which usually means calling the IMF

It’s a pretty well-trodden road and see, passim, Argentina, Thailand, Mexico and even Turkey in 2002. What you're not meant to do is:

  1. Pick a fight with your allies
  2. Openly seek assistance from countries with sanctions against them
  3. Not increase bank rates and keep your son-in-law as head of Finance.

So Emerging Market bears continued to sell Turkish stocks, bonds and currency. The bonds alone widened out by 200bps in the last few weeks, which means they had a capital loss of around 22%. Here’s the chart:

One might reasonably ask why Turkey, with its 1% weighting in the Emerging Markets stock index brings everything else down? It’s mostly because of contagion fear.

First there are European banks with outstanding loans to Turkey. Those loans will be impaired. Banco Bilbao, in Spain, is down 13% in the last few weeks and down 25% over the year.

Second, investors start to look at countries that share the same problems as Turkey, and number one on that list is South Africa.

Third, there’s a problem with covariance in Emerging Markets. If a developed market runs into a recession, stocks fall and interest rates fall. So, there is some portfolio diversification benefit. But in Emerging Markets, currencies need protection so interest rates rise and stocks fall. There is no diversification benefit.

Emerging Markets are also caught up in the Sino-U.S. trade war. News of renewed trade talks later in August helped markets recover on Friday but China is still slowing…the trade talks may help but signs in the currency (it’s down) and commodities (way down) suggest the Asian correction isn't over. Again, we’re using protection for what might be a troubled few months.

2.     Fidelity launched a 0% ETF. Isn't that great? Perhaps. So, yes, Fidelity launched a zero cost ETF and even stuck “zero” in the name, so they would be taken seriously.  What could possibly go wrong? Well, not much, perhaps, but there are other things to think about when we get to near zero fees. For every $10,000 you have in the Fidelity account, you would pay $4 in a similar Vanguard fund and $3 in a Blackrock iShares fund. Fidelity is a fine company. But we’d also look at:

1.     Securities Lending: Many ETFs lend out their securities to custodian banks. We could not find how much of the securities lending proceeds Fidelity will credit to the fund and how much to the investment company. The split should be around 80/20. Our guess is that the investment company will take a larger share.

2.     Index: Fidelity came up with its own index to track the U.S. market. Again, nothing wrong with that but others like Blackrock, Schwab and Vanguard use external, independent indices. Which, we sort of prefer.

3.     Returns: not all indexes are created equal. We've written about the performance of the small cap S&P 600 (up 213% in 10 years) over the better-known Russell 2000 index (up 162%). While not quite as big a difference, here are the 10-year returns of five big, U.S. multi-cap stock funds and ETFs:

They’re all bunched together but squint at the end lines and the extra returns for a $100,000 portfolio over 10 years for an investment in the top and bottom funds turn out to be $17,530. The best fund was not the cheapest. Nor was the worst (we’re talking relative here) the most expensive. It all came down to which index the fund tracked. Some indexes are better than others.

So, pick your index, then the cost. Cheapest does not mean the best (h/t Dan Wiener).

 Bottom Line: Treasuries will remain bid, mainly because of the expensing of pension contributions we discussed last week. We'll be testing Emerging Markets contagion again.

Please check out our 119 Years of the Dow chart  

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Pastafarianism is not a thing

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

Closing note: Aretha and Chains

Not happy about it but…

The Days Ahead: More corporate earnings. Initial estimate of Q2 GDP.

One-Minute Summary: There should have been plenty to upset markets this week. The President questioned the level of the dollar and Fed policy, trade tariffs rose again, the EU made a strong trade deal with Japan, housing starts were down, retail sales weak and one of the regional Fed surveys showed that companies are seeing higher prices which they do not expect to be able to pass on (which means a margin squeeze). The yield curve continued to flatten. Netflix had a bad quarter. Yet things kept moving along well enough. Why?

Let’s deal with the first one. The President can criticize the Fed for raising rates but we think Chairman Powell will disregard any and all such comments. He’s going nowhere and the Administration can do nothing about Fed policy. They're stuck with him.

On the others, the market is growing sanguine. The trade pressures are built into the market’s wall of worry for now. Sure, things could get worse but the underlying economy is moving slowly forward and, as we've said before, companies are reporting great earnings. Thank the tax cuts. The path of rate increases is steady and Chairman Powell reassured markets and politicians not to expect policy surprises.

We did see some increase in short-term rates with 3-month Treasury Bills trading above 2% for the first time since September 2009. This was expected. So far this year, the Treasury market has had to absorb $720bn of net new public debt. That’s what happens if you cut taxes in a late-cycle economy. In the same period last year it was -$74bn. Last week, there was $22bn of T-Bill (i.e. 3 month bills) net new issuance and there’s $130bn coming in the next two months. So why aren't rates higher? Because the economy is expected to slow, real wages are flat and because the Fed has clearly signaled where it expects equilibrium rates to settle: not much above where we are.

One item that got our attention was this:

This shows the yield on the S&P 500  (blue) inching below the rate now available on 3-month bills. That hasn’t happened for a decade. You would think equities should yield more. They're more risky. But dividends grow and bond yields do not and for much of the previous 50 years, from 1959 to 2009, equities consistently yielded more than bonds. Equity investors did a lot better, in real terms, than bond investors. It’s too early to say if this is a major signal but at its simplest, it shows that cash is now a viable asset.

1.     How’s Berkshire Hathaway doing? Quite well. Berkshire has never been a modish company. They only authorized share buybacks in 2011. Dividend? No. If investors want cash, they should sell the shares on the basis that dividends are i) taxed at higher rates than capital gains and ii) taxed twice, first by the corporation and again by the shareholder. They did pay a dividend once, in 1967, and Mr. Buffett said he must have been in the bathroom when it was authorized.

As for share buybacks, the Buffett philosophy was i) why would the company buy shares that are overvalued because it’s a waste of shareholder money and ii) even if they're undervalued, shareholders would be selling at a discount and why make shareholders mad at you by making them sell at a bad price? (This is horribly simplified and you can read his original thoughts here and here) So, you make money with Berkshire if the underlying investments and operating companies do well. And they've succeeded.

If only more companies followed those rules things would be simpler and executives would not waste shareholder money on over-priced buybacks.

But Berkshire also has a secret weapon. Its book value is one thing (the cost of assets less depreciation and liabilities) but its intrinsic value is much higher. It’s a subjective number but is basically the value of i) its stock portfolio ii) the cash generated by its operating companies and iii) the discounted cash flows of retained future earnings. The good thing about Berkshire is that for much of its life it has traded well above book value and well below intrinsic value.

It slipped to around 88% of book value (so a discount) in 2009 and in 2011 to 109%. Mr. Buffett then said, fine, we’ll make sure that doesn't happen again and in 2010, approved the buying back of shares if the stock traded at less that 110% of book value. He then bumped that to 120% in 2013. The black line in the middle chart above shows the threshold and you can see that the stock has consistently traded above 120%. Since 2011, the company has bought back less than $1.8bn in shares. Compared to its market cap of $490bn and the average buyback in the S&P 500 of 2% a year, that’s next to nothing. What Mr. Buffet was saying was he didn't need to use money buying back shares when he can earn a much higher return for shareholders. Shareholders were happy. The top chart shows Berkshire (blue bar) handily beating the S&P 500 (green) over most rolling 5 and 10-year periods.

Last week, the company announced it could repurchase shares at “any time”. That’s great news. The company has $100bn of cash so could use some to close any valuation gap. Berkshire is no high flyer. It’s a slow growing but predicable company with great franchises. It’s also “cheap” compared to the value of its business. We like it.

And if you're keeping score, you would have made more money in Berkshire than Apple since Apple went public. One -hundred dollars invested back in 1981 in Apple is worth $50,000 today. For Berkshire, it's  $61,700.

2.     Are those Fangs big? Well, yes, they are thank you for noticing. The story of the FAANGS dominance (so that’s Facebook, Apple, Amazon, Netflix and Google) has been around a while now. The race is on for the first company to break $1 trillion in market cap (which was actually done a few years ago by PetroChina back in 2007 but it fell 80%.)  While fun, the landmark is irrelevant.

 Performance of those six has been up between 25% and 90% in the last year. They're now giants and worth more than the bottom 300 companies of the S&P 500. They don't make nearly as much money. The sum of their earnings is around $184bn compared to $461bn for the bottom 300 (h/t John Authers via Michael Batnick).

Should we care? Well, they’re growing, of course, and are near monopolists in their respective businesses. They generate huge cash flows and are generally asset light. So that's all nice. But their dominance is high, they're expensive and the top 5 or 10 companies in the S&P 500 tend to change quite a bit over time. So, you know, probably won't stay that way. 

 Bottom Line: Stocks continue to move higher and become cheaper. It's all because earnings are coming through. Watch the dollar, if that begins to correct as the Administration wants, overseas markets will recover quickly.

Please check out our 119 Years of the Dow chart  

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The last time a President pushed around a Fed Chair

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

Sophie Hunger

Vacation Week Trading

The Days Ahead: Corporate earnings kick off. It’s going to be another strong quarter.  

One-Minute Summary: U.S. Treasuries had a good week with the 10-Year Treasury at 2.82% and the 30-Year Treasury well under 3.0%. The gap between the two is now 11bps, the lowest in 11 years. Stocks had a good week and we’re now in positive territory for the S&P 500 year to date with small company and tech stocks way ahead…up over 11% in both cases. International markets recovered but Emerging Markets again struggled.

On the one hand, yes, the trade issues continued but markets have had plenty of time to adjust to the threats so nothing really new. On the other, international markets stand to lose more from trade so will take longer to adjust. Things got a little better when a story went round that Trump’s Ambassador to Germany offered zero tariffs on all auto trades. Could happen. And on the other (see what we did there), the dollar weakened and bonds rallied on an employment report that showed no increase in wages and more people looking for work. That would seem to shut the door on the whole wage inflation, labor shortage argument.

We'd remind readers that summer trading can be very thin and misleading. The short holiday week and a heat wave on the East Coast meant volumes were light. Markets can and will overreact to news. And as we say, “prices move faster than fundamentals… don't confuse the two” (h/t David Ader)

1.     "Trade wars are easy to win". You might say to yourself, if you measure the country’s trade deficit since the phony trade war started in January and moved into a more serious phase a few months ago. And if you were into charts, you would point at this and say, let’s Make American Exports Great Again.

Because of the way the BEA calculates GDP, the improvement from January to May would account for about a 0.7% improvement in GDP. Pretty good work. What shall we solve next?

But this month’s trade figures give us the excuse to bring out one of our favorite charts: U.S. soybean exports. And here they are:

The U.S. is a big exporter of food. Around $150bn a year out of $1,400bn in total goods exports. The U.S. sells a lot of soybeans, corn and meat products and imports wine, fish and fruits and vegetables. They tend to balance each other out. But one big export earner is soybeans. And they all go to China. The green line shows the trend. They rocketed from $2bn to over $4bn. That’s a very big change on an annualized basis, which is how GDP will measure it.

They have spiked before, notably in 2016 when there was a poor harvest in Brazil. But this increase is even bigger and there’s no mystery why. Chinese importers were buying ahead of the tariffs imposed today, which were in retaliation to the $34bn of Chinese goods targeted by the Administration. We certainly don't expect these numbers to improve in coming months.

So, the headline looks good for now and will help the Q2 GDP numbers for sure. But by the middle of Q3 the deficit will start to worsen.

Look, we know U.S. trade is a mess right now. Companies don't know whether to change suppliers, move overseas, expand or prepare for price increases. The ISM data on manufacturers’ prices paid has risen for 28 straight months and is by far the highest indicator in the dozen metrics tracked by the ISM. Trade talk is going to continue to dominate capital markets for the rest of the summer. We think that eventually businesses, politicians and consumers are going to protest at higher prices and the overall disruption. But it’s only the last constituent that counts for this Administration. And they have yet to feel the pressure.

2.     Are bonds good value? We'll preface this timeless question with the normal “it depends.” But by one measure, yes. We looked at the yield on the S&P 500 and compared it to the 10-Year Treasury. Here’s the chart:

The black line is the 10-Year Treasury yield at 2.84%. The blue line is the yield on the S&P 500 at 2.04%. When equities yield more than bonds (which is not often), they tend to be very good times to buy stocks. When bonds yield 200bps more than equities, it tends to be a good time to buy bonds. We're not there yet. It’s only around 80bps. But here’s the point. Stocks these days don't offer a great dividend payout. Some 100 of the S&P 500 don't even pay a dividend. Many would rather use buybacks to boost share prices because they're more tax efficient and tied to executive pay (color me skeptical, I know).

So, bonds at around 3%, which they were a few months ago, seem very fair value against stocks. We've seen a lot of the bond bears reverse position in recent months. Some of that is shorts caught out but some is down to bonds, especially Treasuries, just representing good value right now. As clients know, we've been investing in the mid-part of the Treasury yield curve for some months now and we’re inclined to remain there.

 Bottom Line: Good earnings numbers coming up but export traders (BA, CAT etc) will remain under a cloud. Large cap will probably remain in the 2600 to 2800 trading range. It closed 2750 on Friday.  Emerging Markets remain the weak point.

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Drone over Tesla, Fremont

 --Christian Thwaites, Brouwer & Janachowski, LLC

 Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.
Friday on my Mind
 

Hog Wash

The Days Ahead: Employment report and probably some trade talk. Shorter week.

One-Minute Summary: Markets lost their patience with the trade issues. Ye gods, on Friday the rumor was that the U.S. will withdraw from the WTO. That actually require an act of Congress so no immediate threat. The market recovered from its lows but there was a general risk-off theme.

The 30-Year Treasury had a good week, with yields falling from 3.08% to 2.96%. Why? Well, we’re in the middle of a great quarter for growth. We know this because 1) first quarter GDP was revised down to 2% 2) since the crisis, there are some very weird seasonals not captured in Q1 that flow through to Q2 and 3) with things like a lower trade deficit, the GDP now model is flashing around 4% growth.  There have been some quarters of 4% growth since 2009 but they have very quickly rolled over to the lower average growth of 2.0% to 2.5%. We think that’s going to happen again. The decline in the 30-Year Treasury yield tells us the market is not convinced growth will last.

A rough week for Emerging Markets, which are dominated by the dollar, interest rate and trade issues. We're watching to see how China reacts. They may impose more tariffs. But they could just 1) weaken the Renminbi 2) sell U.S. Treasuries or 3) go after U.S. companies doing business in China from China. Apple has 18% of its sale in China and another 18% in Asia Pacific. Any iPhones sold there are made there. If China was to start making life difficult for firms selling in China, then goodbye Queensberry and hello cage fighting.   

1.     Markets are jumpy – maybe because there are fewer defensive stocks around. Stocks feel like they're volatile but the standard deviation and VIX numbers are pretty much in line with levels from two years ago. It’s only against the unusually low 2017 levels that it feels more risky.

 But in some ways the market as a whole is a more risky animal than in past years.

 We looked at the classic defensive sectors of the S&P 500. So, that’s utilities (e.g. DUK, SO) telecommunications (T, VZ) and consumer staples (PG, WMT, KO, MO). We took their combined market capitalization as a percent of the S&P 500 market capitalization. Here it is:

Defensive stocks have indeed fallen to a near all-time low of 12% of the market from 21% in the pre-crisis era. Some of that is because these companies face more competition and they’re just not great businesses. But some is because big companies keep getting bigger because, well, they are good businesses and there has been little to no anti-trust enforcement.

So, Amazon is 25% of the Consumer Discretionary sector and accounts for 35% of the gain in the S&P 500 this year. The top 10 growth companies account for 100% of the gain. And the top four tech companies (AAPL, GOOG, FB, MSFT) are 42% of the tech sector.

It’s going to get worse too. In the fall, S&P will create a new sector called “Communication Services” by taking some stocks away from tech and consumer sectors. When that's done, the top five stocks of each of those three sectors will account for 50% to 70% of those sectors.

So, yes, the market has become less defensive which means the market is more vulnerable to any correction in non-dividend paying, momentum stocks (h/t David Ader).

2.     Bought a washing machine lately?  So how much will the tariffs cost us in the end? We're more concerned about the on/off mixed messages of the tariffs. If we take a more or less worst case scenario and all imports from China are taxed at 25%, we would see a about a $125bn cost to the U.S. economy. Sometime in the second quarter of this year, the U.S. economy passed $20 trillion. So that’s a 0.6% hit to GDP. The economy will grow around 3% this year. A drop from 3% to 2.4% does not remotely qualify as a recession. Of course, we can play with even bigger numbers. How about 25% on all auto imports? That’s 0.2% of GDP. Or the EU throws a 20% tariff on all U.S. exports? That’s 0.3%.

But of course, it’s much more than keeping score on who can raise the most or who blinks. The real problem is in the complex global supply chains of modern companies and flow of intellectual property. So, if Harley Davidson, which was in Twitter’s sights last week, faces a 20% increase in its prices in the EU and higher steel prices in the U.S., it must divert production to its existing overseas plants. To do otherwise would surely be a breach of its responsibilities. The stock (HOG) is down 25%.

We don't really know yet what the impact of the trade disputes will be. We do know that tariffs are a tax. Someone has to pay the tax. If companies pay the tax, margins are squeezed. If consumers pay the tax, prices go up. Back in January, the administration imposed a 50% tariff on washing machines and 25% on solar panels. Consumers ended up paying for this one. This is how washing machine prices have changed:

That top green line shows prices accelerating by 83% in the last few months. That's after many years of price declines. This tariff was targeted at LG Electronics and Samsung. Both companies’ share prices fell 13% to 25% this year and showed up in South Korea’s exports to the U.S. (in the blue bars).  

So, all together, tariffs hurt consumers. The question now is how will consumers, businesses and politicians respond to the trade talks? If there’s enough of a blow-back, we might get less bluster and more thought. But it will take at least six months to show up in the data. (h/t Ian Shepherdson at Pantheon Economics)

Bottom Line: Large cap will probably remain in a trading range. The S&P 500 should remain above its 2700 support level but expect some rapid moves.  Emerging Markets remain the weak point.

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NIMBYism San Francisco style

Rodents in ATM

 --Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Dreams

Hike but no spike

The Days Ahead: Fed meets Wednesday. Yes, they will raise rates. Bonds won't move much. New dot plots will be important

One-Minute Summary.  After flirting with crossing below its 50 and 200-day moving average (better known by its Wagnerian title, The Death Cross), the S&P 500 had a solid week and is up 4% for the year. The Small Cap world of the S&P 600 and Russell 2000 reached all-time highs and are up around 10% this year. Bonds hung in the 2.90% to 2.95% range. Pretty much unchanged for the last month.

Europe is still worried about the Italian politics, debt and bond world. Italian banks were down over 6% and even the news of a merger of Unicredit with SocGen was not enough to stop a 2.5% drop in the share price. The trade news was not good. One would expect the markets to freak out at the retaliations, a very grumpy G-7 meeting and rate pressure. But the trade war has not changed the generally good narrative. Why? Well 1) the devil is in the details on trade and until we know what they are, it’s tough to put a number on growth and 2) perhaps markets are in the “take it serously, but not literally” world.

Something very definite came in last week from Commerce Department on Chinese steel flanges. You know, the things that look like this. If it goes ahead, U.S. customs will charge importers around $50m. But imports would quickly take up the slack so the final cost to consumers will be negligible in a $20 trillion economy.

Meanwhile, the U.S. ISM numbers were good. Job openings were up. The trade deficit narrowed. The FANG basket of tech stocks has outperformed the S&P 500 every month this year except April and have done it again in June. This won't continue but there’s a trend in place.

1.     Markets are jumpy (Part 3): This week was the turn of the Brazilian stock market.

The basic story was that the government imposed fuel price controls following the trucking strike, which has been going on for weeks. The central bank stepped in with some aggressive currency swaps to try to prop up the Real. But inflation is on the rise (hence the price controls) and there’s an election in October. Throw in trade problems, the Emerging Markets (EM) debt problems, and one wonders why it took so long for the market to wake up.

We think the EM story is solid but the recent weakness is because:

  1. Core yields have risen in developed markets and EM’s track the increases. We think these will moderate.
  2. The dollar has strengthened which hurts EM’s debt management. We expect the US dollar to soften over time.
  3. Crude has been on the rise which hurts more EM economies than it helps. We think that’s about to end.
  4. Trade tensions are high. They will remain so but we don't expect them to affect intra-EM and EU trade.

So, it’s been a test of resilience for sure but Emerging Markets remain an excellent asset class for solid growth.

2.     There’s an awful lot of debt. Yes, but not in the usual places. If we’re looking for the next bear market, one place you can pretty well know is that’s it’s not going to be in the same place as the last time. So, as we said last week, don't go looking at the MBS world. In fact, don't even go looking at consumers. The new snappily-titled Z.1 report came out this week. It was called the Flow of Funds report, which describes exactly what it is. But, hey, I’m not a branding expert and someone came up with Z.1. And who can blame them? It’s a ton of information that gives us plenty of blog subjects if the markets aren't really doing anything or we need a break from tweets and headlines like this.

Here’s what caught our eye:

The blue line is household debt. That’s all the mortgages, credit card, auto loans, and home equity lines thrown in together. You can see the peak of 120% of GDP a few years ago. Since then, households have taken the message of running down debt very much to heart. It even fell more last quarter. So it seems consumers are a) not following through on the confidence they say they have and b) not using the tax cuts to borrow more.

The other line is non-financial corporate debt (we need to exclude banks who need debt for capital and loan growth). It’s at an all-time high. Now we know one of the themes of the last few years was for companies to borrow at low rates to offset cash held offshore and pay for share buy-backs. And we know that we should probably adjust the number for cash and cash equivalents held by companies (remember Apple’s $100bn cash pile).

But still, that’s a fair amount of borrowing and we think it’s one of the main reasons why stocks have been tepid in recent weeks. Yes, the tax cuts have helped a lot. Estimates for S&P 500 earnings in 2018 made in early December were $146, up 11%. By January, they were $158, up 19%. The difference was entirely due to the lower tax rate. So in a high-leveraged world, companies with lots of pricing power (think software, personal products, pharma) do well. Companies with less pricing power and leverage (think energy, transportation, autos) will not. And there are a lot more companies in that second group than the first.

So what? We're keeping a close watch on the leveraged companies. We’re out of some of them (like REITs) and expect more sideways market action until the story is clearer.

Bottom Line: Yield curve is flattening again. This time in the 5s and 30s. Europe will struggle with the trade news. Volatile but sideways stocks.  

Light blogging only next week. Heavy travel. Back in two.

Call 415 435-8330 or email at cthwaites@bandjadvisors.com if you need anything. 

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Why farm-raised salmon are deaf

G6 plus one, more than G7

--Christian Thwaites, Brouwer & Janachowski, LLC

 Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

Weekend Music: Band Apart

A lot of action but not much change.

Available on Apple Podcasts • Soundcloud • Google Play


The Days Ahead: Quieter week for big economic numbers. Watch for trade and updates on the Eurozone.

One-Minute Summary.  When markets crack, we know two things. One, the problems don't come from the last crisis (so no need to look in the MBS world). Two, they come from things you barely notice. Last week it was Argentina and Turkey. This week, it was Italy (see below). U.S. bonds promptly rallied 4.5% and the 10-Year Treasury yields, which many predicted would soar to 3% and beyond, fell to an intra-day low of 2.79%. Bonds got medieval on Tuesday and one Bond King had a very bad day.

Domestic and international stocks and U.S. bonds finished more or less unchanged on the week. But there was plenty of action along the way. Small caps had another good week (they tend to not get riled by trade stuff) and are now some 500bps ahead of the large caps so far this year.

The trade talk is not good. The U.S. went ahead with tariffs on steel from Canada, Mexico and the EU. We don't think they're going to take this one lying down. In past years, the parties would have taken the issues to the WTO and talked about it for a couple of years. This time Cecilia Malmstrom, the very accomplished EU Trade commissioner fired right back with, “When they say American (sic) first, we say Europe united.” So far markets have tended to view the trade talks as bluff followed by climb down. That’s worked. So far. Still, expect a lot more disconcerting headlines.

1.     Markets are jumpy (Part 2): Here’s something you don't see very often. A G7 sovereign bond crashing in a single morning’s trade. As everyone knows by now, Italy is trying to form a government on a coalition of two parties. The Northern League (secession, pro-Russia, anti-GMO, lower taxes, Eurosceptic) and the 5-Star Movement (guaranteed minimum income, Green, unsure about immigration and mostly Eurosceptic) tried, failed and tried again to form a government. In Italy, winning parties must present their cabinet and government candidates to the President. He has veto power. And he used it. The fear then was another election in the fall with both parties running on an explicit “out-of-Euro” platform because…that’s the only thing these guys really agree on.

Now we've seen Italian governments come and go and, with 42 Prime Ministers since 1945, a change of government in Italy passes as a Cabinet reshuffle elsewhere. And we don't really think this time is different. A government will form, it will make a few changes and it will argue with the EU about debt, growth and bond restructuring.

So why did this happen?

That spike on the right is the spread between Italian (BTP) and German bonds (Bunds). Both Euro sovereigns. Both have never defaulted in 70 years. Both with rapidly improving current account surpluses. But the spreads “blew out” (technical term) from 120bp to 270bp which meant the price of an Italian bond dropped from €102 to €89. Stocks took a smaller hit and investors dumped Italian banks, who, of course, must hold BTPs for capital. Some of the big-name stocks were down some 25% from their late-April peak.

By week’s end, things had settled down. The 5-Star and League parties will get their people in. The problems from the Berlusconi years (see famous Economist cover) will remain. Italy’s GDP per capita hasn't risen in 20 years. It seems unlikely a rancorous split from the EU will achieve much. And markets probably don't expect Italy to take it that far.

We don't own foreign bonds and this week was a good reason why. You can lose much more of your principal on a spread-widening event than you can on rising rates. To us, fixed income allocations should reduce the risk of a portfolio, not increase it. But expect this to play for a while.

2.     Jobs, jobs, jobs: Yes, the numbers were good. So good the President leaked them an hour before they were released. Which, I dunno, suggests why he may give Martha Stewart a pass. Here they are:

The headline unemployment number is now at a 20-year low. Last time it was this low, the 10-Year Treasury was 6.5%. So why is it only 2.8% now? And didn't even move on the day? Sure, some is because of the Fed’s QE and low inflation. But we think the market is not wholly convinced about this labor market. We've touched on some of these in the past but here goes:

  1. The uninsured part of the labor force is the lowest it’s ever been. If you're not insured to receive benefits, you don't register for them.
  2. Wage inflation is barely moving in nominal terms and flat in real terms.
  3. Quit rates have not reached their pre-crisis level. You tend to quit a job if you're sure you can get another, so it's a confidence thing.
  4. The U-6 (underemployed) rate is nowhere near a 20-year low.
  5. Participation in key age cohorts is way down.

To which, critics respond, well the labor market has changed, if you want a job you can get one and look this week’s Beige Book says St Louis is even hiring convicted felons. So, it's  a tight labor market.

Fair enough, but nearly six months into the stimulus we’ve yet to see big consumer spending numbers, even though people are paying a little less tax (in aggregate, not in California). As one of the best analysts put it, “the longer the stimulative benefits of those particular policy changes [tax cuts] take to show up, the less likely it is that they will.”

Bottom Line: The Spain and Italy markets support our belief that U.S. Treasuries will remain well-bid and the 2-Year Treasury looks attractive above 2.5%. U.S. economic numbers last week were good but seemed more to be catching up with a run of less-than-great reports.

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Other:

Musk: public safety too important too important to abide by the government’s rules.

Robo advisors web sites don't work

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

Something for the weekend

A small dose of nerves

The Days Ahead: Jobs number on Friday. Short trading week.

One-Minute Summary.  Bonds were up, large and small cap stocks up a small amount and international stocks off around 1.5%...much of that was because of autos (see below), which are around 20% of the German and Japanese stock markets. Emerging Markets had a troubled week mainly because of the bad news coming out of Argentina and Turkey (we talk about it in our podcast here).

There are really two tracks going on in Emerging Markets. One, those countries with high U.S. dollar borrowing, budget deficits and importing oil. Two, those that don't. In the first category are Turkey, Argentina and the Philippines and in the second, China, Taiwan and South Korea. We're oversimplifying, we know.

Right now, there’s a great deal of concern about the former and they're overshadowing the better story from the others. It’s also a problem that a lot of Emerging Market investing is done en bloc, meaning investors buy a single ticker and they're either all in or all out. We think some of this will settle down but in the meantime are looking to protect our Emerging Markets exposure.

1.     Markets are jumpy. Combine coming up to a long weekend, month-end positioning, little company news and some unpredictable headlines, and markets can move very quickly. Here are two examples from last week. First, the 2-Year Treasury when the Fed minutes were released at 2.00pm on Wednesday:

It’s highly unusual for the 2-Year Treasury note to move that much. The reason was that the Fed said:

 “It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective. “

Which is Fed-speak for inflation may run a little hot for a while rather than hiking rates as soon as we see a CPI print of over 2%. So it was “dovish” and the 10-Year Treasury promptly dived back under the 3% level, which people got so worked up about a few weeks ago.

The second was this:

The catalyst was the Commerce Department announcing an investigation into automobile imports under the same Section 232 of the Trade Expansion Act of 1962 used in the case of steel a few months ago. Immediately, foreign car manufacturers fell and wiped off around $20bn in market cap from the five companies shown.

Now, the world auto market is a little tricky to get your arms around. Global production is around 97m units a year. But companies have multi-country supply chains. Germany, for example, exported around 450,000 cars into the U.S. but made 804,000 in the US, some for the U.S. market and some for export. European tariffs on U.S. autos and U.S. tariffs on European autos are about the same if you adjust for America’s high tariff on trucks (SUVs are “trucks” in the U.S. and cars everywhere else).

Similarly, Ford makes a lot of cars in Mexico and Canada and imports them to the U.S. In fact, the only car producer that makes 100% of its cars in the U.S. is Tesla and they account for 1.2% of U.S. total production.

It will be fiendishly difficult to target companies and levy the right amount of tariffs. Expect a lot of carve-outs or indeed nothing at all. This all may blow over. Meanwhile, it shows us the hyper-reactive phase the market’s going through.

2.     Volume Smile. We're big fans of ETFs. Sure, there are some dopey ones  and the clue is normally in the ticker. But they're generally great vehicles and do their job efficiently.

We talk a lot around here about whether they distort markets. I mean, look, they’re multi-billion dollar behemoths and to some extent transform liquidity, which means making something inherently illiquid, liquid. Here’s a good write-up of how the folk at Blackrock manage  their $55bn Aggregate Bond Fund (AGG), which tracks 10,000 bonds but “only” buys 7,000 of them.

What we look for is, a) are they distorting markets in b) a way that can harm investors? The answer to a) is emphatically “Yes.”  So, far the answer to b) “Not sure, don't think so.” In recent years we’ve seen the emergence of the “trading smile.” Here it is:

This shows the volume for SPY, which is the mother of all ETFs and tracks the S&P 500. It's $264bn, has 2,000% turnover and accounts for around 6% of NYSE volume (even more on a dollar basis). It's a good proxy for the market. The chart shows the volume for Thursday of last week and, there it is: a large volume at the beginning (9:30am but shown here 6:30am PST) and end of the day (4:00pm or 1:00pm PST)) and a very large drop off from around 7.00 am to 12.30am. And that’s a badly drawn smile on top (hey, no one hired us for Microsoft Paint skills).

What’s going on? Well, you would expect a drop-off around lunch but this looks like traders do their thing in the opening and closing half hour of the trading day. The answer is that passive products and complex algorithmic investors realign their portfolio at these times so active managers stay away from the market. Bob Mincus of Fidelity (here but behind FT pay wall and also here) sees an opportunity here and he should know, he manages billions in equities:

“We view the close as an opportunity. As more volumes migrate towards the close, we will follow it.”

This clearly creates some problems because a big buyer coming in mid-day will almost inevitably run into a liquidity shortage, which means more volatility. So, we have a weird situation where an efficient market vehicle (an ETF) creates an inefficient market. Some people are calling for a shorter trading day. In Japan, the stock market opens from 9:30 to 3:00 and closes for an hour at lunch. All very civilized. Their market is a lot less volatile.

Anyway, we don't much like this trade funneling and try to stay away from ETFs that we think might not do well under “smile” conditions (and SPY is one of them).

Bottom Line: The market lacks a theme. Emerging Markets will move on any bad news even though the likes of Turkey and Argentina are hardly mainstream investment destinations. But otherwise, we think markets will drift for a while. They may also become inured to some of the sillier headlines and tweets. 

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Shrieking lynx

Ship caught in trade talks  does two gigantic U-turns

No, Uber is hopelessly unprofitable

 --Christian Thwaites, Brouwer & Janachowski, LLC

 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

A look at some bubbles

The Days Ahead: More earnings and jobs numbers.  

One Minute Summary: A lot more economic news to feed off this week but not a lot of action. GDP numbers were soft with consumer expenditures and almost every category weaker than the last quarter of 2017. The high point was a build-up in inventories, which makes sense because consumers went on a mini spending binge last year and companies then had to build inventories back up. Anyway, the market yawned as they did with disappointing factory orders and lower home sales.

The S&P 500 was flat. Some oversold sectors like staples and telecomm did well. Europe was mostly flat but we think they're likely to outperform this year. Emerging Markets were flat but off 2% in dollar terms as the dollar rallied, particularly against the Euro. The 10-Year Treasury hitting 3% was not unexpected and soon retraced.

What we’re seeing with earnings is a pattern of selling on the news. Some of the biggest moves this week were companies that reported perfectly fine numbers but gave weak outlooks. Caterpillar (CAT) was a good example…down 9% on multiyear margins and net income. 3M (MMM), Teradyne (TER) and Freeport McMoRan (FCX) were the same. What’s going on? A lack of the next big thing. Earnings are good, economy okay, inflation ticking up gradually. These are all fine but there’s no big catalyst in the wings so stocks are taking a breather. No reason for any portfolio changes

1.     Bubbles: The problem with bubbles is that they're difficult to spot when you're in them (post hoc is a piece of cake). Having gone through two out of the three worst market corrections in the last 80 years, let's just say we’re on the lookout for any signs of exuberance, rational or not.

Two areas that have given us some concern are commercial real estate and (some) tech and we’ve written about both at length. The two came together spectacularly in a bond offering from WeWork, a company that creates a world where people work to make a life, not just a living. It’s basically shared office space for the tech firms, the gig economy with a lifestyle twist (like free beer and foozball) and has raised plenty of equity money to value it at $20 billion, which would make it the 150th most valuable company in the S&P 500, if it were listed. But to get into the S&P 500 you kinda have to make money, which WeWork does not. The 342 offices are all over the world and in some pretty nice locations too.

They came to market with a 7.85% seven-year $500m bond, with a rating B+, which is pure junk or as S&P put it, has:

“Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.”

No kidding. You’d think with all those offices, it would be an asset intensive business. But WeWork doesn't own the properties, it leases them. So it’s more of an operating real estate company and should be asset light.

Why, then, does it need the money? Because it's tearing through cash. In 2017, it had revenues of $822m and lost $883m. At that rate, it will eat up its cash assets in two years. It has no equity cushion, unless SoftBank chips in another $4bn. Its EBITDA is so awful that the company has to adjust it like crazy:

Source: WeWork Prospectus via FT Alphaville

GAAP says you must produce a real, accountant certified earnings number. That’s around $771m in the above. But GAAP also says you can restate EBITDA if there are one-off expenses (like stock options you grant once), or you expect some earnings to come through for a full year (instead of a partial year). You don't have to disclose exactly how you got there but, from the above, all that gets WeWork to a $193m loss.

They then put in a “Community Adjusted EBITDA” to get it to a $233m profit (the bit in yellow). How did they get there? By adding back in all the sales and marketing expenses saying, in effect, they won't happen again. No investor has ever heard the phrase “Community Adjusted EBTDA” before or quite so aggressive an income restatement. Neat trick: turning a $933m loss into a $233m profit. 

Enough on accounting. But suffice to say it’s a very dodgy way to report your expenses but because it’s a private company, you have to go with it. So how did steely-eyed irascible bond investors take it? They over-subscribed and the company looks set to raise $702m.

So why are we concerned? Mainly because it's:

  1. A hunt for yield
  2. A basic business model (it's a landlord) masquerading as something new age
  3. A ton of debt sitting on a ton of debt because the properties they lease don't belong to them but leveraged real estate companies.
  4. An eye watering valuation

So, leverage on leverage, novel accounting and demand at-any-price is not a great combination. Add in that seven of the world largest tech companies are tech and that never before has one sector dominated the large cap universe, that tech is now 27% of the index (it was 33% at its peak) and, you know, the general euphoria around tech, and well, color us skeptical.

It's another reason why we focus on quality, dividends and companies with management discipline.

2.     ETF Screens: We attended a meeting with a major index provider and asset manager the other day, somewhat under Chatham House rules. The topic was social investing and index managers. Blackrock has made a big splash about corporate responsibility asking that companies account for their societal impact or risk the ire of the world’s largest asset manager. But Blackrock is the largest shareholder in multiple firearm manufacturers and doesn't have much of a choice except to invest in them as long as they are listed companies.

On the firearms side, we ran the performance of the four listed manufacturers (there are others but they're mostly private or foreign) against the Russell 2000 small cap index. They're terrible investments but that’s not really the point.

Most of them are small market capitalizations and together they're only 3 basis points (so, $15 for every $50,000) of the index. The lower line shows the performance of the four companies and, clearly, they have not performed well at all.

What we wanted to explore was whether we could use an ETF that excluded either i) firearm manufacturers ii) retailers of firearms or iii) some broader definition of societal good and responsibility. We'd like your thoughts and please let us know either here and jump to the comments section or here.

Bottom Line: We're in a range bound market for bonds and equities. We expect it to stay that way. We'll be looking for wage and hourly earnings increases in the job numbers. We don't expect to find any.

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Stuffed anteater disqualified

--Christian Thwaites, Brouwer & Janachowski, LLC

 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.
 

Excuse me, have you seen the Budget Deficit?

The Days Ahead: Earnings season starts up. Financials and Energy stocks should be good.

One Minute Summary: The Fed published the minutes from its March meeting. They think growth will accelerate later on this year and made the usual cautionary noises about inflation. The bond market ignored it. Bonds were also unfazed by the inflation report (see below). Markets were also not terribly surprised by the CBO report, which calculated that the 10-year cumulative deficit will rise 32%. Most economists had worked that one out.

The market was mesmerized by tweet storms. Some historians went back to the Cuban missile crisis to see what happened there (a 7% drop then recovery) or with the NATO bombings in Yugoslavia in 1999 (the market rose 12%). The placatory remarks from President Xi Jinping helped. Stocks rose 3.2% through close on Thursday. It was a good week for most sectors except utilities and REITs, which tend to be rate-sensitive.

U.S. small cap, Emerging Markets and International are all ahead of the S&P 500 year to date. Russia had a bad week, down 14%...which happens if you get hit with sanctions. Russian stocks are only 3% and 2% of the Emerging Markets equity and bond indices (we don't use Emerging Markets bonds).

There has been no direction to the market for over a month. Some of this is because of a news cycle that's more noise than signal. Earnings season starts soon and it will be good. Expect big numbers across the board and especially energy. No changes to our portfolios.

1.     How’s the CBO doing? Pity the staff at the Congressional Budget Office. They have a hard-earned reputation for non-partisan work but had to rush through an analysis of the tax cuts in December 2017, days before the bill was passed. Their best estimate at the time was that the bill would add some $1.4 trillion to the deficit over 10 years.

But it's actually quite a bit worse. This time last year, the CBO report said that the 10-year projected deficits would be $9,422bn (here, page 89). Fast-forward to December and it was, well, if you go and cut taxes, it will add $1,454bn to that number.

Last week, they had a chance to run the numbers again and it's $3,000bn more than this time last year. So, now instead of the 10-year deficit being $9.4 trillion, it’s going to be $12.4 trillion, Oh, and debt held by the public (which is all the federal debt except that owned by trust funds like Social Security, Medicare and Retirement funds) will grow from 75% of GDP to 95%.

Anyway, here’s the chart of budget deficits as a percent of GDP to 2028, heading up to 5% of GDP from a 50-year average of 3%. In fact, the deficit has only been over 5% of GDP five times since 1946 and four of those were in the depths of the 2007-2009 recession.

Why are deficits growing? Well, it comes down to lower revenue from corporate taxes of course which are permanent, and lower income taxes up to 2026, after which they jump because they expire in 2025. And it’s also because of mundane things like higher interest rates on the higher deficit.

Does it matter? You tend to get three answers:

1.     No. We owe it to ourselves. See Japan etc.

2.     Heck, yes. No family budget can go on spending like that.

3.     It's complicated.

 There were an awful lot of people who were on the side of #2 but they've gone to ground/retired recently. Answer #1 can be true if you have a nation of savers and don't rely on outsiders to finance your debt. As for #3, the CBO puts it best:

 “Such high and rising debt would have significant negative consequences, both for the economy and for the federal budget”

We've had deficit panics in the past. But then we had higher growth and higher inflation (which reduces the real cost and value of debt). Today we have neither of those. Put it all together and we would say this is another reason to expect low growth for many years.

2.     Do we have an inflation problem? Not yet. We had two major inflation reports, Producer (PPI) and Consumer (CPI) prices. The headline numbers were 3.0 % and 2.4%. On the CPI side, we’d note that there’s a “base effect” especially in three areas. First, in energy. This time last year, prices for gasoline and energy were flat or down. But oil is now 26% higher than a year ago (lucky California drivers are paying 30% more than 18 months ago), so energy prices are up 7% but from a low base. Second, cell phone prices dropped sharply last year (we wrote about it) but now they've stopped dropping. Third, medical care expenses rose from a year ago when the ACA had negotiated lower hospital costs. Those too have started to rise. Together these three are around 15% of the index.

Here’s the chart with the cell phone expenses at the bottom now rising.

Take some of these base effects out and we’re looking at core CPI at 2.1%, which is unchanged. Over on the wages side there is no real movement either. Any increase is in more purchasing power not increased wages. Remember the BLS puts you down for a wage increase if your wages don't change but prices fall.

So we remain in the camp that inflation won't really take much hold although the Fed will talk about it.

Bottom Line: We don't think business and consumer confidence is running very high. Stocks are going to react and overreact to very bit of news. Look for what CEOs say in earnings calls. We feel we’re well positioned for a rough few weeks.

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Takahata Isao and Grave of the Fireflies

And Gillian Ayres died

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.
All charts from Factset unless otherwise noted.

 

Political headlines dominate but little market impact

The Days Ahead: Fed meets. Look for any change to their economic projections.

One Minute Summary: Trade issues hung over stocks. The administration lined up China, which runs a $35bn monthly trade surplus with the U.S. It's quite a lot less if services are included but many businesses are annoyed at China’s freewheeling IP (Intellectual Property) transfers. The President asked for a $1bn a year reduction in the trade deficit but given that the deficit is more like $380bn and some 40% of the U.S. total, he probably meant $100bn. As for the new Chief Economic Advisor, Larry Kudlow, I’m hard pressed to remember anyone in that position who had much influence. But he seems like a decent enough fellow.

Small company bank stocks rallied. The Senate passed the snappily titled Economic Growth, Regulatory Relief, and Consumer Protection Act, which raises the threshold for enhanced supervision by the Fed from a $50bn threshold to $250bn. So, that’s nice if you're a Key Corporate, Fifth Third or State Street. You now no longer have to provide a liquidation plan. In fact, only 12 of the 43 banks with over $50bn in assets will come under enhanced supervisory rules. All others get a pass. And yes, they all took TARP.

Bonds rallied. Stocks were lower but small companies had their best two weeks of the year. They're now just ahead of large caps year-to-date. Europe recovered. It seems to be out of the trade crosshairs right now. Japan and Emerging Markets rallied some 2%. The dollar barely moved.


1. How’s the economy doing?

Not as well as the administration thinks. The most important assumption of the tax package, and the one that presumes there won't be a trillion dollar deficit in the next few years, is that the economy will grow at 3%, or 50% faster than the post crisis level. If it doesn't, the whole Laffer curve, animal spirits, trickle down economics falls to the ground.

Now some funny stuff has gone on with first quarter GDP growth for the last few years. It’s nearly always lower than the rest of the year. Why? Well, the economists are busy writing PhDs about it but it probably boils down to faulty seasonal adjustments. If retailers, for example, start holiday discounting earlier, then sales will be brought forward and there’ll be more of a New Year slump. Statisticians try to adjust but it’s a fiendishly difficult task.

But this quarter’s revisions look particularly severe. The Atlanta Fed puts out a nifty report that tracks GDP in real time. Here’s our version of it:

The February projections were for 5.5% growth. Since then, it has steadily fallen as manufacturing, trade, inflation and retail sales numbers have all come in below expectations. The latest number is for 1.9% and the two lines show the street and administration expectations. The street is revising its numbers now and we expect them to come in lower.

Does it matter? Well, it’s the direction not the magnitude. So, yes, if growth is less than expected and consumers are not buying into the tax-cuts and higher take-home pay story, then the interest outlook changes. Treasuries rallied this week, as we would expect with lower growth. The peak on the 10-Year Treasury on February 21 at 2.94% now seems quite a way off and we feel very comfortable with our position in 7-10 year part of the curve.


2. ETFs, easy, right?

We like to talk around here about how not all ETFs are created equal. Some are great, the VOOs and SPYs of the world. Some are patently dopey, some dangerous. And some you really need to understand. One of those is the S&P 500 equivalent of the bond market, the Bloomberg Barclays Aggregate Bond Index (AGG).  

The S&P 500 is, mostly, the largest quoted companies in America sorted by size. The biggest component is Apple at $900bn and the smallest is Frontier Communications at $0.5bn (it’ll get bounced out at the next semi-annual rebalancing). Own the S&P 500 through something like Vanguard’s VOO and you’ll experience 3% turnover.

But a bond index gets tricky. You start with all the bonds that meet your criteria of quality, maturity and size. Then you need to constrain it somehow or else a big corporate borrower like Ford will dominate your index. You then have to take bonds out that repay, or mature, or are downgraded, or if a new issue comes along. Then you ignore some bonds altogether like Treasury Inflation Bonds (TIPS), floating rate note bonds, or step-up bonds. This all gets busy and so the index rebalances every month. Own the AGG through something like iShares AGG and you’ll experience 250% turnover.

So what? Well something interesting is about to happen. The AGG excludes Treasuries and MBS that are held by the Fed under the QE program. Fair enough. They're out of circulation so no need to count them. But the Fed is selling them and they're going back into the index. At the moment, the AGG has 37% of its assets in Treasuries. By most estimates, it's headed to 45%.

We also know that Bond Index ETFs are growing. They have at least $1.0 trillion today and are expected to grow to $1.5 trillion in a few years. That's a lot of demand. Numbers are hard to come by but we think ETFs, as forced buyers, will buy some 30% of Treasury issues in the next few years. It’s one reason why we think there will be a smooth run up in rates. (H/T David Ader).

Bottom Line: We'll see the new Fed at work. They'll be looking at this, which is the spread of 10-Year Treasuries to 2-Year Treasuries. The lower it gets, the more likely an economic slow down.

It took another dip last week. No major changes to portfolios. Growth should come from International and Emerging Markets. We're lightening up on real estate and other rate sensitive stocks. We continue to like investments providing downside protection on the S&P 500.

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Vanguard says no to genocide free investing

Time up for the Blood Unicorn

--Christian Thwaites, Brouwer & Janachowski, LLC

 Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

2018 Outlook.

A year to remember.

We sent this to clients recently, so if you're a client, you can skip this. 

It was a most extraordinary year. It started fearful and ended exhausted but exuberant. In January, stocks were in a “show me” mode. The brief post-election rally fizzled, bonds tracked sideways and only the dollar was showing any sign of weakness. But markets then took a calmer look. The givens were that the Fed was going to move slowly and announce clearly. No surprises and no drama. It was the opposite in Washington but markets seemed to distinguish bluster from threat. And anyway, one consistent motif was that government was going to go light on business regulation, cut taxes and spend on infrastructure. In the end they delivered on two out of three, although we’d be the first to agree, it was a messy process.

Overall, we’d point to three main themes:

1.     Supportive Monetary Policy: From March on, we had only minimal and short-lived corrections. For the year, the S&P 500 was up 22%, international markets +25%, long and short-term Treasuries +7% and 1% respectively and Emerging Markets +38%. From mid-year on markets never looked back. It was also a year when there was a noted absence of volatility. We were not surprised. Volatility in the past was often the result of the Fed playing its cards close and keeping markets in suspense. This time, the major central banks led by the Fed but closely followed by the European Central Bank and Bank of Japan, flagged their intentions loud and clear. Meanwhile, we saw steady and synchronized growth across the world.

2.     Corporate Profits recovery: But perhaps the most important feature of 2017 was that companies delivered on growth. For some years, we’ve seen U.S. companies produce decent earnings growth through a combination of share buy backs and financial and tax management. This was fine as far as it went but the fashion for big buy backs was on the wane going into 2017. Investors wanted real growth and they got it in 2017. We saw corporate earnings for the S&P 500 grow around 10%. All sectors participated including energy and commodity stocks, both of which had a tough couple of years. Only one industry sector had a negative return: telecomm, which found itself in the middle of a price war.

3.     Global Growth: Europe finally started to perform as the monetary easing fed through to the real economy. Two major elections in Germany and France returned centrist, pro-growth governments. Japanese stocks had a very strong year, up 19% (but up 23% to a U.S. investor). Why? A successful reelection by a popular Prime Minister, pro-inflation policies and a pick up in world trade.

So what’s ahead for 2018? As we write this in the first week of trading in the New Year, we’ve seen all major markets run ahead. Some of that is a reaction to the tax changes rushed through in the last days of 2017. Although the plan runs to 400 pages, its central tenet is lower corporate taxes. For many companies, especially if they are more domestic than multinational, the 15% tax decrease falls straight to the bottom line. Companies will start to talk more about the effects of a lower tax in the upcoming earnings season. But for most, there will be very little downside to the changes.

Elsewhere, this is what we see running in 2018.

1.     World Economy upswing. Global growth is moving along at 4% or so, up from 3.5% in 2017. The sheer size of the U.S. economy, some 25% of the world economy, looks like it will break through the 2% growth pattern we've seen for years and could grow at 2.5%. In the last three quarters of 2017, growth exceeded 3% but that may be unsustainable given recent trade numbers.

Emerging Market economies should have a strong year. China will grow at around 6% but more important, Russia and Brazil will recover from years of low energy prices and consumption. Japan will remain a huge beneficiary of global growth and we expect higher inflation and wage growth to support the domestic side of the economy. The EU is still early in its growth cycle. Many European multi-nationals will benefit from U.S. tax reform and corporate margins and profitability remain well below their 2007 peak. Plenty of room for upside.

2.     Interest Rates. The Fed will raise rates. The unemployment rate will remain around 4% and most of the Fed believes that a tight labor market means higher wages and prices. Of course, neither of the last two has happened and we don't expect them to. But the FOMC is more hawkish in 2018 than 2017 and several seats remain unfilled. So expect two to three rate increases this year. But, two important points:

1.     When interest rates rise, equity declines are rare. In other words, higher rates mean a better economy, which is good for stocks.

2.     If rates increase gradually, which is what we think will happen, bond markets and prices adjust. And total returns will remain positive.

We also believe rates will remain low globally. Other major central banks are three years behind the Fed in tightening. We expect German and Japanese long bonds to remain well under 1%.

3.     Equities will outperform bonds.  This may not sound like a high hurdle but equities here and overseas remain attractive compared to bonds. International markets are cheaper than the U.S. (even after adjusting for different industry weightings) and companies are still generating strong cash flow and paying and increasing dividends. We would look for an 8% improvement in U.S. stocks and stronger numbers overseas.

Some portfolio changes. We reduced our allocation to Treasury Inflation Protected Securities or TIPS and reinvested into longer-term U.S. Treasuries. We also will continue to take some profits on U.S. REITs, and allocate money to Asia-Pacific markets and international small cap.

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119 Terrible Years of the Dow

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.