Pitfalls of the Unemployment Rate

Coming into 2014 the stock market was overdue for a pullback.  Concerns over a potential crisis in many emerging market economies ignited the January drop in the markets.  After a rocky start to the year, the S&P 500 has rallied over 5% since February 3rd to get back to break-even.  Economic data and earnings reports in February have not been especially good but stocks have bounced back as emerging markets have stabilized for the time being.

Dig a little deeper and a more interesting story is taking place in the bond market.  Last year bond prices fell, sending interest rates higher as investors became more confident in the economic recovery and on speculation the Federal Reserve would begin to taper its bond-buying program.  The yield on the 10-Year US Treasury rose from 1.83% on Jan 1, 2013 to 3.02% on Dec 31, 2013.

Now to 2014… as the stock market fell in January, investors ran to the safety of bonds sending the 10-Year yield down as low as 2.61%.  What is fascinating is that while stocks have recovered from the January losses we have not seen bond yields return to the 3% level.  In fact the 10-Year Treasury is currently yielding 2.64%.  In the past when there has been a significant variance between the stock and bond market it has been wise to follow what the bond market is telling us.  It is too early to make investment declarations based on the current variance between stocks and bonds but if bond yields continue going lower it will certainly be noteworthy.

Shifting gears, I came across an article this week in the Wall Street Journal that does a solid job in picking apart the over-reliance on the Unemployment Rate and explaining why this over-reliance is problematic.  While the jobs report from the Bureau of Labor Statistics may be the most important economic data released each month, it is the supporting data found in the report that is much more critical than the headline number itself.
Check out the article from the WSJ:

The unemployment rate, in short, is one of the most consequential numbers shaping our body politic. Unfortunately, it is also one of the most misleading.  The real problem is that the number, originally designed for limited purposes, has come to assume totemic status. Focusing so single-mindedly on this one employment figure has made it impossible to have a cogent discussion of labor in the U.S. and to design meaningful responses to our varied economic problems.”
For full article click here:  http://on.wsj.com/1fIe0qG

Tapering Begins

Perhaps no question entering 2014 is more important to the stock market than what impact will the Federal Reserve’s decision to begin tapering the $85 billion/per month have on the market?  We address this and more in our latest video update.

Profit Margins Take Center Stage

The stock market had a fantastic 2013 and we are often asked our opinion on what comes next for the market. If our crystal ball was not so hazy we could give a definitive answer… That said, later this week we will be sending out commentary on what we believe is the biggest factor for the stock market this year.  Be on the lookout.

For today we wanted to touch on an important topic facing the markets.  Over the past five years one of the biggest drivers of the stock market has been the increase in corporate profit margins. A company’s profit margin tells us how much of every $1 in sales that a company earns as a profit after all expenses are paid. It is no secret that revenue growth has been fairly tepid since the 2008-2009 recession but profit margins have skyrocketed, in large part due to corporate cost-cutting.

margins2

As you can see from the chart, margins have tended to fluctuate between 5% and 7% going back to the 1950’s. Among economists there is an ongoing argument: whether profit margins will revert to the mean, potentially causing pain to the stock market, or if higher profit margins have become the new norm. A key point… no one is arguing profit margins can march higher, which means sales growth will be a very important factor to future stock market performance. 

Cullen Roche, one of our favorite financial bloggers, says mean reversion will happen, but no one knows when.  He also points out that in the past profit margins have tended to contract during recessions, something that thankfully is not a current threat in the U.S. 

Stock Market is Not the Economy

October is in the books, but not before my wife and I learned a lesson last night.  While we were out trick-or-treating with our boys (6 and 8) we realized that next year we will need to spend time training for Halloween night if we want to keep up with the boys.  The days of us holding their hands and making 15-20 stops have been replaced by running house to house through the entire neighborhood.

Speaking of October, it was another strong month for the stock market as the S&P 500 was up over 4%.  This was in spite of the much ballyhooed government shutdown.  This was not a surprise to us as we wrote in early October:

“It is important to understand that 17 times there have been government shutdowns since 1970, none of which did lasting damage to the stock market.  This does not mean that this time can’t be different if our “leaders” fail to reach an agreement, but it is to say that we have been here many times. The media and our politicians love to put out dire warnings and whip the public into a frenzy.  The bottom line is that government shutdowns have occurred in the past and our political parties negotiated, came to an agreement and markets moved on.”
http://bit.ly/16T0Y2o

Self-preservation is what the politicians in Washington are all about, the status quo must be maintained above all else.  We have seen this time and time again over the past several years and it will continue in the future.  Until proven otherwise, when the media and our politicians work the retail investor into a panic to achieve ratings and positioning respectively, any market pullback should be viewed as a buying opportunity.

Recently I have been asked a few times how the stock market can be hitting new highs with such a sluggish U.S. economy?  The answer is that the stock market and the economy are not one and the same, there are many other factors that influence stock performance outside of the strength of the U.S. economy.  Certainly there are times when the economy drives market performance, such as a recession or a period of explosive economic growth, but these times are not the norm.  Josh Brown, from thereformedbroker.com, has a piece up that addresses the link between the stock market and the economy:

“Stocks trade based on three things: sentiment, valuation and trend. Yes, economic data feeds into these things, but it is up to the trader or investor to determine their combined favorability, an economist does not do that sort of work. The Greek stock market was the most hated in the world (sentiment), one of the very cheapest on valuation (four times earnings at the bottom!) and the trend had only one direction to go (the Greek stock market, called the ASE, had hit a 22-year low in June of 2012 and was down 90% from the 2007 high). Investors should read voraciously about the economy and be up to speed on the data and prevailing opinions at all times. But the acquisition of this knowledge should be in service of a greater contextual understanding of the world around us – and not as a trigger to do something in our portfolios.”
For more from Josh click here:  http://bit.ly/1dYOCxh 

In the long run economic growth is important for stock market performance, but the beginning valuation of the market, as well as sentiment and trend, are very critical components to performance in the interim.

Government Shutdown

Typically in early October the focus of the markets is on the start of earnings season.  This year is different for a very obvious reason, all of the focus is on the government shutdown. Here are some thoughts:

1)  It is important to understand that 17 times there have been government shutdowns since 1970, none of which did lasting damage to the stock market.  This does not mean that this time can’t be different if our “leaders” fail to reach an agreement, but it is to say that we have been here many times. The media and our politicians love to put out dire warnings and whip the public into a frenzy.  The media does this for ratings, the politicians for positioning.  In any case, here is a breakdown of the S&P 500 performance before, during and after government shutdowns:

If all of these numbers give you a headache here is my summary – One month after a government shutdown the market is generally slightly higher. In other words, past shutdowns have had a minimal impact on the economy.

2)  One of the best articles I have seen that addresses the impasse comes from Ron Fournier at the National Journal: 

“I am on record advocating two seemingly incongruous positions. First, President Obama can’t capitulate to GOP demands to unwind the Affordable Care Act. Second, his position against negotiating with Republicans is politically unsustainable.
Let me unpack both conclusions.”

To read the full article click here:  
http://bit.ly/17fVdeX

3)  From an investment perspective we are closely watching as events unfold.  The stock market pullback that occurred last December on concerns of the Fiscal Cliff deadline presented some great opportunities. Short-term market volatility should continue this time until an agreement is reached to reopen the government and extend the debt ceiling. However, there is one last key point that has limited the market fallout thus far.  Janet Yellen, who should have clear sailing to replace Ben Bernanke as the Head of the Federal Reserve, made it clear in September that the Fed is in no hurry to taper their $85 billion/month bond-buying program, a reversal of Ben Bernanke’s comments in June.  The Fed’s stimulus programs have been a major boost to the markets over the past four and a half years and the government shutdown will only embolden Ms. Yellen’s dovish stance.

The bottom line is that government shutdowns have occurred in the past and our political parties negotiated, came to an agreement and markets moved on.
Despite the current political rhetoric, an agreement is still the most likely outcome this time around, but we are prepared if this shutdown breaks with history.

Rain and a Market Meltdown

I hope your July 4th weekend was enjoyable.  With it raining most days here in Seattle, I mean Atlanta, my wife and I had to get creative over the holiday weekend to keep our boys (and us as well) sane.  Twice we ended up putting on old clothes/rain gear and went on hikes as well as blackberry picking.  It was something different and we had a great time.

Ever since Fed Chairman Ben Bernanke began warning in mid-May that the Fed was working on a plan to taper their bond-buying program volatility has ramped up in the market and significant losses have occurred in a majority of asset classes.

If you look at the graphic below it is clear that recently there have not been many places to hide.  In fact, it is hard to remember a time when US Treasuries, Gold, US Stocks and Commodities have all sold off at the same time.The good news is that the sell off provided opportunities is several asset classes as the baby was once again thrown out with the bathwater. Higher volatility in the summertime  is nothing new and using that volatility to identify attractive investments is always the objective.

Description Symbol 1 Week 4 Weeks 13 Weeks 26 Weeks
US Stocks VTI -4.45% -4.9% 1.12% 11.08%
International Developed Stks EFA -5.98% 7.19% -2.71% 1.19%
Treasury Bills SHV -0.01% 0.0% 0.01% 0.01%
US High Yield Bonds JNK -4.02% -5.71% -4.19% -1.91%
Mortgage Back Bonds MBB -2.17% -2.72% -3.28% -3.16%
International REITs RWX -7.01% 11.25% -9.97% -6.55%
US Equity REITs VNQ -6.68% -11.99% -5.58% 0.88%
Total US Bonds BND -2.45% -3.36% -3.32% -3.55%
Commodities DBC -3.95% -2.99% -6.84% -7.69%
US Credit Bonds CFT -3.42% -5.21% -4.69% -5.01%
Intermediate Treasuries IEF -3.15% -4.23% -4.48% -4.59%
International Treasury Bonds BWX -4.98% -2.49% -3.72% -7.54%
Municipal Bonds MUB -5.29% -8.23% -7.16% -7.38%
Emerging Market Stks VWO -8.91% -14.79% -13.59% -15.65%
Emerging Mkt Bonds PCY -9.1% -12.91% -12.06% -15.7%
Gold GLD -7.36% -7.35% -20.17% -22.84%
Frontier Market Stks FRN -7.15% -12.86% -19.47% -22.7%

Source: Myplaniq.com     As of 6-24-2013

U.S. stocks have been the standout this year as Gold, Silver, Commodities, China, Brazil, Emerging Market Stocks & Bonds, Treasury Inflation-Protected Bonds, Long-Term Treasuries and Investment Grade Corporate Bonds have all suffered losses ranging from 2% – 37%.

Throughout this year we have continued to closely monitor the outlook for U.S. stocks. One of the indicators that we pay close attention to is the Cumulative Advance/Decline Line for the S&P 500.  When this line is trending higher it tells us that the stock market is being driven higher by a larger number of stocks, and thus is more sustainable. Typically as a longer-term rally nears its end the Advance/Decline line begins to break down as fewer and fewer stocks have the strength to move higher.

In the chart below the S&P 500 is rebounding from the recent 6.5% pullback while the Advance/Decline Line is hitting a new high.  This is a positive sign for stocks and is one of the important indicators we will keep an eye on.

breadth

On a personal note, I hope your July 4th weekend was enjoyable.  With it raining most days here in Seattle, I mean Atlanta, my wife and I had to get creative over the holiday weekend to keep our boys (and us as well) sane.  Twice we ended up putting on old clothes/rain gear and went on hikes as well as blackberry picking.  It was something different and we had a great time.

2nd Quarter down…

The 2nd quarter is now in the books and businessinsider.com has a nice chart summarizing the 2nd quarter returns for key asset classes.  After a first quarter with little volatility the 2nd quarter saw a significant increase due primarily to concerns over the Federal Reserve tapering it $85 billion/month stimulus plan.  Of note, 10-Year US Treasurys  were down 8% and Gold was down a monster 23%.

For more click here:
http://read.bi/19POWNq

Sentiment Change??

An ugly day in the market today after mediocre economic reports and significant market declines overseas last evening. Over the past year mediocre/poor economic reports have sent markets higher as investors believed the Fed would not tighten without better economic news. That doesn’t seem the case today, will this sentiment change continue?

http://on.wsj.com/19Jhupc

Investing according to your goals

We came across an excellent article that emphasizes the importance of individuals investing according to THEIR goals. This is a point we like to consistently make with clients, as well as company employees we speak to through our non-profit workshops. Unfortunately, too many people do not invest according to their goals and put their long-term plans in serious jeopardy.

If you are not investing according to your goals you tend to “chase the market”. That is, when the stock market is doing well and hitting highs you decide you want to be more aggressive and make more money. When the stock market is hitting lows you decide you do not want to take more losses and you become very conservative. Investing according to your goals keeps you grounded and minimizes emotional financial decision making, which is something that rarely ends well.

We encourage you to click on the article, it is a quick read and well worth your time. Below is an excerpt, as well as the link:

When we make investment decisions, they should be tied to our goals. We get into big trouble when we either:

a) Fail to get clear about our goals
b) Invest based on someone else’s goals

For more click here:

http://bucks.blogs.nytimes.com/2012/12/24/dont-mistake-investing-folklore-for-personalized-advice/

Headlines that Drove the Market Higher

As ugly as last week’s stock market fall was, this week saw a complete reversal with the market surging.  Let’s take a look at the headlines that drove the market higher:

1) The Federal Reserve led a group of six central banks from around the world in reducing the costs for European banks borrowing dollars in emergencies.  This action is designed to improve liquidity for European banks if a panic occurs but does not address the key issues that have caused the European debt crisis. The market moved higher on this news due to the fact that central banks are being proactive and engaging the issue.

2)  China reduced the reserve requirements for Chinese banks, a move that typically encourages more lending.  Some analysis of this move questions whether China is doing this because growth in the country is slowing quicker than expected: More

3) The ADP private jobs report here in the U.S. came in stronger than expected.  This report was followed up today by the BLS November jobs report which showed the unemployment rate fell from 9.0% to 8.6%.  While this is good news enthusiasm needs to be tempered:

“Peter Boockvar of Miller Tabak points out that the drop in unemployment to 8.6% came because a 278,000 gain in the household survey came alongside a “large” drop of 315,000 in the labor force, which is the most we’ve had since January. “Thus, the drop in the unemployment rate is for mixed reasons,” he writes. “The drop in the unemployment rate reads well but under the hood, the stats are more mixed as less people are in the labor force.” Source

Some humor for you this weekend: