Category: Finding Benjamin

Rotten Apples and Realities

Regular readers know that we are neither bullish nor bearish on the general stock market.  We leave that to the forecasters who must have a lot of time on their hands.   We do call out risks and opportunities as we see them however, focusing more on sectors, specific investments, behavioral economics, and systemic risks.   If you hadn’t gathered, the theme for our commentary since April has been about selectivity – where you should invest your hard-earned capital and what to avoid.   The market is a bucket of apples right now to be sure.  You can find the good mixed in with a few of the rotten types.  In this context, we should all be conscious of the rotten apple mantra, when the bad apples can ruin the whole batch.  We’re hopeful that the rot stays contained.  Today will be a clip fest of interesting charts and data I discovered in my weekly reading finishing with a couple of important reality checks that every investor should understand with total clarity.

Rotten Apples

There are lots of things to like about this market.   We’ve talked about real value now leading the markets – FINALLY!!!  We’ve talked about the all-time new highs in the broad market and the new leadership coming from the cyclical side of the market rather than the defensive sectors – Good.  We’re also seeing the stock markets of the world participate with Europe and parts of Asia actually leading the US higher – Yay!  But as we sift through the apple bucket, we are also finding some serious rot just beneath the surface.  Here are a few rotten apples.

Clearly the stock market has become the dumping ground for unprofitable companies coming to the public markets as a means of offering their founders a very healthy exit plan.   Look at the last three years!  The new buzz phrase our there is “show me your path to profitability” that’s funny.  I’ll just buy the profits thanks. We should all let venture capital and private equity worry about the path to profits.  The annual burn rates (amount of net income LOSSES) in the new companies going public are absurd and, in the Billions, (with a B).

There is also something rotten in Corporate Debt.   Right now, the rot is in the CCC grade corporate bonds which is where all corporate debt rot begins in the early stages of a recession.  Apparently, the default rate in CCC has very suddenly shot up to 11{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} from 3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.   High yield corporate bonds are the proverbial canaries in the coal mines.  When they die, it’s time to be careful/ leave/ run.

High yield spreads are not confirming this all-time new high in the markets.  Again, without stating a forecast, we need to watch this rotten apple closely.  If it doesn’t get up and go soon, we’ll be heading for the exit.  This cart provided by Bespoke Institutional Research

Another canary is the level of Margin Debt being used in the system.  Margin debt is highly reactive to market risk, like High Yield corporate bonds.  As you can imagine, losing money in stocks is no fun, but losing money with borrowed money bearing interest is just an angry experience.   Buying stocks on margin is a thing, a big thing, and used by institutional money managers as WMDs.  As Jim Stack of InvesTech illustrates, tops in Margin debt are often the Hallmark of tops in stocks.   Not bullish, not bearish, just pointing to this rotten apple.

More Rot to be aware of.   In this case, be careful about taking a big bite out of Technology.  I will tell you will complete confidence, that technology is the number one sector in every investor’s portfolio.  How do I know?  Because technology is the largest weighting in the S&P 500 and investors seem very comfortable owning S&P 500 indices in bulk in their portfolios.   Technology is now in its 99.6^th percentile in terms of trailing P/E ratio.  In layman’s terms, that means that Technology is literally red lining and has only been this expensive in 0.4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of all periods in the past. Technology can continue higher, but I’ll say that the risk-reward of owning technology now, or by way of your oversized S&P 500 index, falls into the bad planning category.  Looking at this chart, we should all focus on the right-side sectors where value lives.

I’ll leave you with two reality checks.  Spend some quality time with these (and your family) this week.  The first is a return chart of the S&P 500 covering 15-year periods – thanks to Steve Blumenthal of CMG capital for highlighting this material from Advisor Perspectives in his weekly “On My Radar”.  In our shop, we answer the question of Why Manage Risk? with this simple answer; Because Your Investing Life is Short.  As a matter of fact, investing lives are historically about 16 years long.  That means you are seriously saving and investing for about 16 years of your working life.  Of course, it should be much longer but for as much as our industry encourages saving early, very few really do until they feel they have a lot of discretionary income to invest.  And when does that happen?  You guessed it, later in life, like around age 45, even 50 years old.  I’m hopeful for the next-gen who seem to be actually saving early but we’ll see.  Anyway, look at the return chart below and you’ll see that there is a definite pattern to the 15-year return stream coming from stocks.  We’re about halfway through the range now, so there is real potential for higher prices in the years to come.  But, looking at the big picture, you must know and understand that there are long periods of time when markets are just unproductive and risk management becomes critical to your welfare.

Last one

Inflation is real and really with us in many aspects of our lives.  Not shown on this chart is the 1{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} consumer price index which is supposed to reflect all of these expenses.  This is the biggest lie of our time – that inflation is non-existent.  Total BS unless they are only measuring the real costs of apparel? I’m about to embark on my first round of college tuition for my 18-year-old son. Saving diligently for 18 years, investing aggressively in a solid stock market and I’m barely able to cover the cost of college which is growing at 8{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annually.  Healthcare costs, housing, food, you name it.  Inflation is very real and very embedded in our daily spending habits.  Real returns on investments over the long term and real inflation are the big levers in your life.  Plan accordingly for these realities and you’ll be fine.  Avoid or ignore them and you will find yourself living a life you didn’t expect.

That’s it for now.   Avoid the rot and keep it real with respect to your market expectations and spending habits.  I hope everyone has an incredible visit with friends and family this Thanksgiving.  It’s everyone’s favorite for good reason.  We all have a lot to be grateful for.  Cheers.

Sam Jones

I get the appeal of owning shares of a specific company.  Some part of our ego gets a little endorphin shot when we say, “I own that company”.  However, in all but a few cases, given the rise of highly focused, sector-oriented exchange-traded funds, there is really very little reason to own individual names anymore.  I’ll package this discussion inside the context of our New Power ESG strategy for our client’s benefit as well as any interested parties.

New Power ESG

ESG?  What’s with the new acronym?  Our New Power investment strategy has been anchored in socially responsible investing themes and standards since inception in 2003.  On our site, we describe the strategy as a “Bright Green choice for discriminating investors”.  ESG stands for Environmental, Social, and Governance, which is exactly no different than any of the original socially responsible standards of investing.  This standard mandates investment only in progressive companies that do good things for the planet, employees, or have strong governance practices.  The principle is that companies who choose to promote unhealthy products like JUUL (vaping) or hurt the environment, like any in the fossil fuel industry, will ultimately face economic hardship as society punishes bad actors over time.  Thankfully, we’re seeing a lot of that happen now.   Steering clear of bad guys is generally just a good idea, right?  Not a lot of mystery here.  But today, ESG is becoming a moniker of goodness so we’ve simply chosen to brand New Power with the label for easy identification.   Nothing to see here, it’s the same investment strategy we’ve run for 16 years.  In fact, we go further to suggest that New Power is an Impact investment as we help investors drive their capital toward companies that are challenging incumbents for the better and driving positive change.  Even more, every year, we donate up to 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of net income derived from the New Power strategy to non-profits that support climate action and environmental education.  It’s all that!

For those in the know, New Power ESG has three concentrations for investment:

• Advanced Energy/Natural Resource Efficiency
• Sector Innovators/Game Changers
• ESG Core ETFs – stock and bond ETFs that have passed the ESG screens

Let’s circle back to the topic of why we don’t need to own individual company shares given the nature of the new breed of exchange-traded funds.

Sectors are made of stocks

You can do the fundamental work to try to find that stock that will make big returns.  Sometimes fundamental knowledge of a company actually yields positive benefits as Jim Cramer on CNBC likes to say.  “Do your homework” (and you will get rich!).   Or, as many seasoned investors know too well, you might do the good homework, decide that a company is doing great things for shareholders, only to watch the stock price fall spectacularly for years on end.  These are called value traps and they are everywhere.   I have found fundamental stock research to be a good tool for context and comparisons but a terrible tool for timing individual trades unless you have the patience to wait maybe 5-10 years for the stock price action to finally validate the fundamental data.  What we do know, with hard factual data, is that individual stocks track their home sector very closely, especially when it comes to large-cap names that tend to dominate the make up of the home sector.  I’ll give you an example in the Banking Sector.  Take a look at this chart of KBE (S&P SPDR Bank ETF) in Red next to C (Citigroup) in green.  Citigroup is one of the largest holdings inside the Banking Sector ETF so of course, the two securities track very closely.

But you’ll also find that individual names can add a ton of volatility to your portfolio especially when the markets are in trouble.  Here’s the same comparison looking back to the financial crisis of 2008/2009.   Citigroup was smashed, losing 97{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and will not recover to new highs for probably another decade, or two.  KBE on the other hand, finally recovered in 2017 is trading out to new highs because it owns a lot of other banks outside of Citigroup that didn’t get hammered as badly in the downturn.  Why not just own the Banking ETF and avoid single stock risk?

Inside the New Power ESG strategy, we largely own ETFs now.  There are so many wonderfully focused ETFs that we can really accomplish our goals without playing the individual stock game for a majority of our invested capital.  For instance, in our Sector Innovators concentration, we own the following ETFs;

LIT – Global Lithium and Battery Technology ETF

*the second-largest holding inside LIT is Tesla (TSLA).  Why assume all the drama and risk associated with Tesla the company when you can own the whole battery, lithium sector in a more diversified way.  Tesla will not rise without LIT because LIT owns a lot of Tesla (among other things).  Sectors are made of stocks!

FIVG – Defiance Next Gen Connectivity ETF

-Do you think 5G is big and happening right now?  We do.   We want to own the whole sector, avoid picking the wrong stock, and potentially missing this generational adoption of new connectivity standards.

IPAY – ETFMG Prime Mobile Payment Systems ETF

-Did you notice that cash registers are gone?  We all use square, Paypal, Venmo in our daily lives now.  But IPAY also adds the stability of owning Visa and MasterCard which are probably the greatest investment return generators of all time.

HACK – ETFMG Cyber Security

-This landscape is full of individual stock land mines as we’re really talking about technology and software.  Some are making it, others are not.  But HACK owns the whole cybersecurity sector which is growing steadily and consistently as we all need to spend money creating walls against cyber bad guys.

ROBO – Global Robotics and Automation ETF

-Sadly, for American labor, the robots are indeed taking over any job that is routine and repeatable.   Political ranting will not change this macro trend even slightly as the long-term costs of automation are far less than maintaining employees.  ROBO owns all the primary players in this space and allows us the opportunity to play another important macro trend without stock picking.

BLOK – Amplify Transformation Data Sharing ETF

-You know we like blockchain as a technology.  Adoption is happening all across the globe but there are very few players in this space in the individual stock world.  Here, the ETF sector fund gives us a chance at basic exposure in a relatively thin new sector.

We have several other sector fund ETFs in the New Power ESG strategy, but I’ll leave it there for now.

New Power ESG is now a Blended Asset Strategy!

The BIG, BIG news about New Power ESG is that the strategy is now formally a Blended Asset strategy.   In recent months, several new Green bond ETFs have surfaced, giving investors an opportunity to diversify their ESG portfolio into bonds that represent clean energy projects and other green income opportunities.  The amount of money flowing into these green bonds is astounding and we feel confident moving into this space for a portion of the New Power strategy.  In the end, owning bonds in this strategy should smooth the return stream a bit making it more tolerable for our clients as a more consistent return generator.  We will be re-categorizing New Power ESG as a Blended Asset strategy in all digital material over the remainder of 2019 so please look for that change.

That’s it for now

Sam Jones

It’s been a while since we provided an update on our long-standing “Big 3”.  I hope our regular readers are nodding their heads in that all-knowing way; yes, of course, the Big 3.

Update

There are three long-term opportunities for wise investors who are looking to place their hard-earned capital into segments of the financial markets that are likely to have a long and prosperous period of out-performance. These opportunities stem from a basic concept of mean reversion when a significant piece of the financial markets moves strongly away from its averages in terms of price, valuation, or position relative to historical comps.  Two of them appear to be in motion now, the third is still sitting idle.  Here are the Big 3.

Value over Growth

Since 2006, thirteen years ago, we have watched the growth side of the market gather and consume investor money at the expense of the value side.  By value, we are talking about companies that offer investors real value based on fundamental properties.  Value comes in all shapes, sizes, and different sectors of the economy.  They are not fast growers in terms of their business models but neither do they carry high debt, or make promises they can’t keep (ahem, Grubhub, Pinterest, and Co.).  Instead, value companies offer investors higher dividend payments, high free cash flow, solid management, long track records of excellent performance, and very consistent earnings.  Growth companies can be fundamentally strong as well but after 13 years of price appreciation, it just becomes harder and harder for earnings to keep up with the price. Eventually, they reach a tipping point when price becomes unjustified.

We might be there

This quarter, we have seen a giant number of earnings shocks and investors have hammered those that even whisper (or guide) of lower earnings in the future.  While more than 70{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of companies have beat very low earning ESTIMATES, we have also seen some very high profile price devastation. Arista Networks (ANET) was Friday’s nightmare closing down 24{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} on the day and making a new 52 week low. Arista Networks beat earnings estimates and is still doing great things but the stock price just got ahead of itself (way ahead). Arista Networks is a growth company and not an isolated example.

Meanwhile, on the value side of the market, where prices have fallen for years while earnings and cash flow have been accumulating and rising steadily, we have seen just the opposite.  Prices are popping higher, gapping higher on even the slightest bit of good news.  Our clients invest in our High Dividend strategy, own 16 companies that fall into the value camp representing 60{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of total assets.  You’ve seen some very large moves in recent weeks.  While we wouldn’t call these High Dividend-paying stocks, they are still distributing more than 3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annually.  I’m pleased to report that our High Dividend strategy has been outperforming the S&P 500 weekly since early July, consistent with the move toward value.

The point is that there are some very expensive things out there getting hammered and a ton of very inexpensive things being rewarded.  Even the all might Amazon has under-performed the S&P 500 by 17{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} since last September.  The last time I saw a stock picker’s market like this was nearly 20 years ago in the year 2000.  The Value over Growth opportunity is one that began lightly in September of last year but has accelerated dramatically since August of 2019.  Take a look at this factor chart from Goldman Sachs.

It seems pretty obvious that we should consider accumulating some high volatility, small-cap value stocks (or ETFs) as well as take a few profits in the large-cap growth stock space.  I know…. Unspeakable.

Internationals Outperforming Domestic

The same story holds true here.  Internationals have been wildly under-performing the domestic equity market for about as long as value, almost 13 years.  Granted, Europe and emerging market countries like those in South America, Eastern Europe or South East Asia, have struggled for a number of reasons.  China has given up some relative ground recently but has been outperforming the US stock market for years – and will for years to come (personal opinion).  But it appears the tide is turning now.  If you believe in reversion to the mean, then you will embrace international investments as they are now much cheaper on average than North America.  Like our Big opportunity #1, the shift to Value, we believe investors have enough reason to rebuild, even overweight, their international exposure now.  Today, statistically, investors have very little international exposure, and yet, since August, this is where we are finding clear leadership over the US stock market.

On Friday, we were all pleased to see the US stock market finally break out above recent highs after nearly 21 months of flat, choppy, and volatile action.  But where was the confetti when Europe, Taiwan, Emerging market, Japan and most of the Pacific Rim countries did so nearly 30 days ago.  Here’s a chart of the Taiwan Index ETF which we own in our WORLDWIDE sector’s strategy next to eight other country-specific funds.  Nice!

In a somewhat rare Kumbaya moment, we also have new weakness in the US dollar.   A weak US dollar provides a tailwind for international investing themes.

Commodities Rising From the Ashes

This is the last of the Big 3 investor opportunities and has yet to really take hold.  We’re thinking that this asset class may need more time before it really runs as the environment of strong global demand for hard assets is just not there at the moment.  Gold and Silver which are part of the commodities complex, have started new bull markets and can be part of a portfolio now, but these are really fear trades and not representative of resource scarcity or an environment that would support a more broad-based move in commodities.   On the other hand, tariff wars and other inflationary measures don’t seem to be going away so maybe we’re closer than we think.   Perhaps Gold and Silver are telling us that inflation is coming or understated?  Keep an eye on this one but tread lightly.

Stock/ Bond Ratio Still Favoring Bonds Barely – Side Note

Years ago, we gave up on forecasting.  It’s a sensational exercise that takes a lot of time and yields very little value.  We are not bullish or bearish in terms of the markets looking forward.  We are simply trend followers and asset allocators choosing to keep our clients’ money invested in the sectors, countries, and asset classes showing the best relative strength and risk adjust return properties.  We avoid sitting on large cash positions (unless cash is the best performing asset class!).  Remember, our selections won’t always produce the highest returns, but they will be the best returns available for a given amount of downside risk and volatility.  This quarter has been exemplary for those who don’t understand the unbreakable bond between inherent risks and returns.

One component of our modeling does include something called Net Exposure which helps guide our total exposure to the stock market as well as our internal decisions of how aggressive we want to be from week to week.  But our main focus remains on our Selection screens that point us in the right place to invest our client’s money.  Much of this commentary has been focused on selection obviously.  This is what we do.  You’ve also heard us talk about why investors should have larger bond positions over the course of the last 20 months.  Remember,   stocks (the US stock market) have been very flat since January of 2018, losing nearly 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} at the end of 2018 and just recently recovering those losses.  Bonds meanwhile have gone straight up and generated some very healthy returns on a total return basis over that same time period.   Our Income models have made all-time new highs nearly every week for the last two years.  Now the tide may be shifting back toward stocks a bit.  But the stock-bond ratio provided by Bespoke shows that bonds are still outperforming stocks!   As I’ve said before, this is really the only chart that matters for the majority of investors.

It is still too early to make that call but it’s an important thing to keep your eye on and we all know where to invest in stocks right? (reread above).  Those of us who identify as Dynamic Asset Allocators will be ready to shift our assets towards a heavier stock allocation as the evidence unfolds.  Every day I am grateful that we don’t have to pick a position and pretend to know the future of the market or the economy.  So sensational, such a waste of time!  Following trends are so much easier than forecasting.

That’s it for now, happy November

Sam Jones

We’re very excited to rollout out our Next Generation services as we move into the 2020s.   Today, while avoiding a complete spoiler, we’ll give you a little preview of what we’re planning.  For this update, we’ll offer a compelling and timely suggestion to those young investors who are just getting started with their first investment accounts and want to participate in the global wave of Next Generation companies.  Next-Gen investments for the Next-Gen of investors!  Feel free to pass this on to anyone (kids, friends, etc.) who is a younger investor.  They will thank you!

Stockpile.com, Robinhood.com, and Betterment

Clearly, these newer investment portals have done a great job catering to the younger investor who is looking for a low-cost platform to get started.  Robinhood was the original platform for zero-commission trades.  They pride themselves as being the home of the frequent trader, the guy who uses margin, options, or even wants to own bitcoin.  They are mobile-ready and have a highly functioning app to get it all done right from your phone.  Stockpile.com also pioneered a compelling offer to younger investors with smaller account balances who couldn’t afford to buy ONE share of Amazon, for instance, trading at $1762/ share.  Wait what?  Yes, there are now many stocks that have triple-digit share prices, and few like Amazon with four digits.  My son who is 18, worked all summer and made $3500.  Is he going to put it all into 2 shares of Amazon?  Of course not. Stockpile.com offers investors a way to own fractional shares of any company for a mere .99 cents per trade.  Good idea.  Finally, Betterment is the original robo advisor charging only .25%/ year for a passive asset allocation portfolio to a blend of diversified ETFs.   Interesting, but you can actually get this type of thing completely free from any number of on-line sources and don’t need to pay .25%.  None of these portals come with a relationship of any sort beyond a 1-800 number to call when you’re in trouble, need guidance, panicking about your investments, or have an actual tough decision to make.  So, for what they do and what they offer, these newer portals certainly (did) offer something unique… until Charles Schwab beat them at their own game last week.

Schwab, and all the other discount brokers like TD Ameritrade, Fidelity, and now Merrill (this am) now offer zero commissions to trade equities and ETFs.  Goodbye Robin Hood.  Schwab now also offers fractional share ownership options also for free.   Goodbye Stockpile.com.  And now you can find a passive asset allocation model built for your age and a few preferences in many on-line portals, again for free.  Goodbye Betterment (and Wealthfront).  The big boys have now completed the race to zero.  It’s all free as long as you don’t need help with anything, don’t need to talk to anyone, don’t ever want to, or need to change your investment allocations, don’t need help with taxes or tax strategy, don’t need a will, and are comfortable staying invested in all market conditions including bear markets of -40-50%.

wink

Honestly, there isn’t really a compelling advantage to any of these new investor portals anymore.   The larger discount brokerage shops like Schwab, TD, and Fidelity all offer the same thing.

So, let’s start with the standard that our NextGen investor is going to open an account on a platform that offers a lot of free stuff.  Great idea.   Our clients are at Fidelity and they have it all!

Now, let’s move on to our NextGen Investment portfolio

Next-Gen Investment Portfolio

Please note that this suggestion, not even a recommendation, is not based on any one’s individual risk tolerance, capacity for risk, income, or stated objectives.  It’s really a suggestion based on current market risks and opportunities.  Logically, there is no portfolio of securities that offers a magic mix of stocks, bonds, commodities, or anything specialized that is built for all market conditions.  Factually, there are long periods of time, like 20-30 years when one asset class will either underperform or outperform expected returns of today.   So, our suggestion today is based only on market conditions today but designed for a younger investor under the age of 40, who is just starting out, making their first investments, and has a longer time horizon.  At a very high level, we expect the total return on bonds to be small, we expect the total return on stocks to be below average for domestic and above average for internationals.  And finally, we expect commodities to start providing some diversification benefit to a portfolio but it’s very hard to quantify.  That’s as much information as anyone can offer and these are derived solely on probabilities based on current valuations relative to historic norms.

But here are a few great ideas for a Next Gen investor.

1.  Adopt a core/ satellite approach to your portfolio.

The core is a standard diversified portfolio spread across multiple asset classes.   We would suggest this “core” piece represent about 70% of your total account value.  It will include domestic and international stock funds, bond funds, and few commodity positions.

The “satellite” piece represents the remaining 30% and is going to be more volatile in terms of price changes, effectively revolving around your core holdings.  These are going to be stock positions that capitalize on the Next Generation of leading companies across several sectors and industries.  Next-Gen investors want to own a piece of what they view as the innovative, game changers, and disruptors.  Our current Next-Gen investment satellite positions include ETFs that focus on social media, clean energy, cybersecurity, robotics, new payment systems, energy storage, blockchain technologies, artificial intelligence, etc.

1. There is no need to own individual stocks until you have significant money to invest.

Jim Cramer from CNBC says that $100,000 is the minimum investment balance for an investor to become eligible to invest in individual names.  I would agree.

1. There is no need to own fractional shares of anything

When I hear about fractional shares, it reminds of those old car dealer commercials.  “If you can’t afford it, then finance it!”.  When the world of high-profile stocks is commanding $1700/ share, you’re swimming in the deep end.  Furthermore, it takes a long time and many years of appreciation for any stock to rise to that price level.  Inherently, we know that high price stocks are priced high along with their valuations.   If we can’t afford them, we shouldn’t try to finance them by reaching for fractional shares.  Our focused group of free to trade ETFs is very affordable in the $/ share category and they own many of the same high-priced stocks under the hood, even in concentrated positions.

1.  Tax-loss harvesting and rebalancing are really BS sales tactics

As we mentioned above, there is no fixed asset allocation mix that stands the test of time.  Companies like Betterment and others, offering passive fixed asset allocation mixes, work hard to convince you that tax-loss harvesting and rebalancing does a lot to improve your results, and adapt to changing market conditions.  However, if you read the fine print, you’ll see that they admit that the effort yields only fractions of a percent in improvement in your returns over practically any time period. It’s really just a sales pitch.  Changing your investment mix by weighting and unweighting asset classes based on valuations, expected returns, and current leadership is much more meaningful to your portfolio results.  We do this for our clients in a tried and test method called Dynamic Asset Allocation.  Our Next-Gen Investment strategy will follow the same process and discipline.

1.  Get started early

I can’t emphasize this enough.  If you choose to wait to make your first investment, start a retirement account, save for education for kids or a down payment on your house, the fewer choices you will have in the future.  Get started right now!  Save when it hurts! Put money away when you’re young and you can think of one thousand things you’d rather do with your earnings.

1.  Do it with Tax-Deferred/Tax-Free money

Putting on my financial planner hat now.  Here are great tips and tricks to earn money, invest it, and pay no taxes when you’re just starting out.

• You do not have to file a tax return or pay taxes if you make less than $12,000/ yr.   For most young adults (teens).   You’re not going to make more than $12,000/ year.
• You can legally contribute up to $6000 of your earned income to a Roth IRA annually.  If you are under 18, your parents can open a custodial Roth IRA for you, after 18, you can do it yourself in most states.

https://www.investopedia.com/can-teenagers-invest-in-roth-iras-4770663

• Roth IRA money grows tax-free.  No catches, no restrictions.  Gains that are accrued over many many years can be withdrawn after age 59.5, tax-free. This is the last free lunch, go get some.

In the new year, we’ll be formally rolling out our complete Next-Gen package of services and investment options.  Primarily they are aimed at the children of our existing clients but will have a lot of attractive options for new younger family investors as well.  We look forward to working with the Next Generation of serious investors and will have comprehensive solutions for you including tax strategy, tax strategy, will development, planning, and investments as a package offering.  This is just a teaser.  Please contact us if you would like a more detailed list of the Next Gen Investment portfolio securities.

Cheers

Sam Jones

President, All Season Financial Advisors

We talk a lot about “right place, right time” when it comes to making an actual investment decision.   The environment for investing in energy storage, specifically large-scale battery manufacturers and associated companies, is approaching that right place, right time moment.  Here’s what makes this investment option compelling and potentially actionable in the very near future.  After reading this update, please reach out to us directly with your name and email to request a list of our top picks in this space – some we own already and others we expect to own soon.

Right Place, Right Time

Ok, so here’s the situation

Battery and energy storage costs have dropped by over 70{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in the last 4-5 years making them an affordable and attractive alternative.  Alternative to what?  Glad you asked.  We’re not talking about double AA Energizers here.  We’re talking about the likes of Tesla’s Powerwall for home gamers angling toward self-sufficiency with their residential electric energy production, storage, and use.  We’re talking about the larger batteries going into the many models of plug-in electric vehicles coming out of nearly every auto manufacturer in the next 2-3 years.   We are talking about major utilities seeking to replace aging and very expensive natural gas “peaker plants” turbines with Solar “plus” battery solutions.

This just happened…   NY approved a giant battery plant to replace a 50-year-old gas peak plant

https://www.greentechmedia.com/articles/read/new-york-approves-316-mw-battery-plant-for-peak-power

If you live in a PG & E service area of California, you might resonate with the recent power outage choice made by your utility to avoid another massive wave of wildfires like last year.  I’m just guessing that more than a few people are thinking about going off-grid with solar plus battery storage systems in their homes after two years of this madness.   Indeed, the time is right as battery installations and demand are just now beginning a long-term parabolic ascent toward mass adoption.

Finally, here’s the best part for investors.  Battery companies, like solar and others that have experienced massive drops in the price of their products, are now trading way below their price highs of January 2018 and in many cases, their highs set in 2010.  The entire Lithium-Ion sector is trading down 40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}! and appears to be developing a basing pattern at these levels.  Sentiment toward the battered sector and those who dwell in it like Tesla is about as negative as I’ve ever seen.  Of course, people hate Musk for a lot of other reasons.   Naturally, as contrarians, we start to get excited when everyone hates something.  Tesla reports earnings this week and may run into more trouble so we’ll wait on that one but there are other pure plays in battery and energy storage we find very attractive now.  Today, we bought (back) Enphase Energy (ENPH) which we believe has just completed a very deep and healthy consolidation of -26{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} from recent highs.  Let us know if you’d like our watch list for other names that we hope to include in our www.Newpowerfund.com investment strategy.

Cheers

Sam Jones

I’m reading a lot of articles regarding the impact of the Federal Reserve lowering interest rates.   The articles and posts all seem to have the same theme and they are all missing one very important point.

The Good Stuff

When the Federal Reserve lowers the Federal Funds interest rate, they are doing so to stimulate the economy as well as keep the US dollar in check against our trading partner currencies.  During late economic cycles like the one we’re in now when weakness begins to show up, as it is now, the Fed has had some success with their easing of monetary policy.  Twice, as a matter of fact, they were credited with staving off a recession by aggressively lowering rates.  I’m not sure I would give that solitary act all the credit, but the outcomes were favorable in those two cases.  In literally all other cases in the last 100 years, the Fed’s series of rate cuts was simply coincident with the US economy moving formally into recession.  They prevented nothing.  In the past, the Fed was also lowering rates from a much higher starting point.  In the last cycle, they started cutting rates in August of 2007 from 5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and dropped them aggressively down to 0.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} just as the S&P 500 rang the bell at its lowest point in the bear market of -48{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  Lowering rates from 5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to zero did nothing.  Today, the Fed has lowered rates twice starting again in August of this year from a high point of only 3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  After two rate cuts, the S&P 500 is down 0.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} – not really a robust or favorable reaction after a few months.  But dropping rates has been very favorable for select sectors of the economy.  Home-builders are up 14{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in just two months.  Real estate, in general, remains solidly on the top of the leader board YTD, QTD, and month to date.  Treasury bonds, utilities, and high yield corporate bonds have all seen some accelerating price gains since the Fed started dropping rates again.  That’s all good as home-building and real estate are one of the great pillars of our economy.  Not so much for utilities and corporate bonds.

Also creeping toward the top of the leader board for the first time in a while is Europe, Japan, and parts of Asia.  It would seem that the Fed’s new easing policy is slowing down the rise of the US dollar and providing a bit of a boost to international investment themes.  Again, all good as we like to have that type of diversity in our portfolios.

The Maybe Stuff

Given the sequential decline in economic reports over the course of the last few months as well as a new level of chaos in politics (I didn’t think there could be more), it will be critically important for 3^rd quarter earnings to come in almost shockingly strong.  We are now starting into earning season so each day will bring big news and big action in stocks, up and down.  We feel like the burden of proof is now on the bulls to convince us, all investors, that the game is not yet over.  The bulls need some very strong earnings starting right now if stocks are going to move higher into year-end or avoid erasing the recovery in prices since January.  All things considered, if the Fed lowered rates to zero tomorrow as Trump seems to want, it would seem unlikely that stock prices would just get up and run higher.   The entire financial system, including stocks, has already adjusted, benefited from, historically low rates for most of the last decade.  Real estate prices are not going up anymore, but buyers are still stepping up based on new-found affordability in their mortgage payments.  That does not make the house a good investment mind you, it’s just a relatively affordable living option really. So, the big maybe is whether or not lower rates will have the desired stimulative impact on stocks, the economy, jobs, etc. The Fed will lower rates again so I guess we’ll know soon enough.

The Bad Stuff

Here’s the point that no one is talking about.   When the Fed lowers rates, they also lower the rates on savings accounts and other cash alternatives like CDs.   If we include all deposits, cash, money markets, and CDs with maturities less than 2 years, we know that the aggregate money supply (M3) is nearly $15 Trillion in the US.  When the Fed raises rates, they are effectively stimulating the interest on that massive pile of cash.  When they lower rates, the opposite effect occurs.  Fed Funds interest rates and the interest paid on money markets and CDs are very tightly correlated.  They both rise and fall together.  Here’s what that looks like in the current decade.  These charts have not been updated to reflect the last two rate cuts, but you can see the 6 mos, 1- year, and 5-year CD rates already starting to roll over.  We’re at the top of the cycle and these lines will all work their way to the bottom again.

Now here’s another picture of the same thing looking back at the 2000’s decade. You can see what happened to CD and money market rates as the Fed cut the effective Fed funds rate to zero almost twice.  From here on out, those who are carrying cash or plan to roll their CDs into another maturity, you have what is known as reinvestment risk.   You are going to be paid less and less as each month passes as your different savings vehicles mature.

Just a little tip, while we watch stock, do nothing.

Cheers

Sam Jones

Welcome to the 4^th quarter of 2019!  If you think the last 22 months have been exciting, just wait for the next 12 months.   One year from now, we’ll be so sick of Federal election junk, we’ll all want to go back to tribal rule with lords and fiefdoms.  Already there?  October is one of those turning months.  We have seen a larger than average number of significant bottoms in markets as well as the beginning of crashes and devastating bear markets begin in the month of October.  This is the edgy time when smart investors will focus keenly on the scales of bullish or bearish readings to plan their next course of action.  Let’s take a peek under the hood of the markets to help us find the edge.

Still No (Good) Leadership

As we’ve mentioned many times over the last 14 months, we are still seeing the recession sectors lead the market.  Lead means, losing less on the down moves and making more on the up moves.  Specifically, these investment themes revolve around consumer staples, utilities, and real estate.  Healthcare is suspiciously lagging behind its own recession team and I suspect Elizabeth Warren’s rising prospects, has something to do with it.   Personal opinion – the chance of free healthcare for all in the US is zero, ever.  Healthcare and the many subsectors, are simply too much of a profit center for “it” to ever give in to a socialist type agenda.  Capitalism in the US would have to end first and then healthcare would be the least of our problems.  But I digress.  Today the US stock market is still range-bound as you can see below.

We’re approaching the bottom of the current range which I marked with a red line because that may be a fine place to look for a solid buying opportunity.    But there is also a larger trading range in play marked by the lows in December of 2018- white line.   If the approaching lows are going to hold and serve as the springboard for our next move higher, we’ll need to see the growth/ cyclical sectors take over leadership very soon.  Those are financials, industrials, technology, energy, and consumer discretionary.  So far nothing.  If the short-term bottom does not hold, the odds increase substantially that prices will work toward the deeper discount (-20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).  The blue line in the middle is one that I inserted as a reference to mark the high of January 2018, 22 months ago.  As we close today, the S&P 500 has gained a total of 0.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} since then.     I know, this all makes your eyes and your head hurt.

Bonds Still Outperforming Stocks

This is really the only chart anyone needs to follow.

Honestly, what’s the big mystery?  Own bonds, lots of them, when they are outperforming stocks.  If and when the relationship changes, we can shift back to owning stocks in bulk.  But really, we have no reason to do so yet.  In fact, with the nasty close in stocks today, municipal and mortgage-backed bonds, just went back on a buy signal for us.  We bought more of both today.  We continue to own core positions in intermediate and short-term treasuries.

Recession Risk Still on the Rise

Why are bonds outperforming stocks?  Because recession risk is on the rise and investors want to own safe income-producing things like bonds before and during recessions.   However, there is a timing issue that is critically important to know.  When RECESSION is finally labeled in the US, it is often the time to sell bonds and begin looking to buy stocks.  Remember that the financial markets are just a basket of prices moving around with expectations about the future.  You’ve already heard about recent ISM surveys coming in very weak.   You’ve heard the stories about high-end real estate markets already falling in price by double digits year over year.  You’ve heard about the export numbers making new lows while manufacturing has all but stopped.  GM workers on strike, etc, etc,   And now, our nervous employment numbers are starting to show more signs of weakness last week.  The yield curve went negative in May as you also know.  There is a lot of empirical evidence pointing to recessions being recognized 10-12 months after a yield curve inversion.   So, if our trajectory doesn’t change and we do the math against a calendar, we should expect formal recession headlines in June 2020 and a final top in stocks in the early spring of 2020.  Trump will do everything in his power to keep the wheels on until elections including forcing the Fed to drop rates aggressively and that could be the short-term catalyst for temporary higher highs in the months to come (year-end rally?).   But we have already seen that more rate cuts from where we are now, are not going to keep prices rising sustainably all by themselves

If we put everything on the table, we begin to recognize that the stock market is reflecting what we see on the fundamental and economic cards.  Stock prices have gone nowhere in over 22 months reflecting an economy that has been gradually getting weaker for as long, very gradually.  Conditions can and will change frequently, but for now, our investment portfolios should simply follow the leadership (pre-recessionary stuff).

In our world of dynamic asset allocation, we don’t need to make a big bold bet on the future.  We simply follow trends in asset classes, sectors, internationals, and so forth.   We do not need to defend a position on the markets or the economy because we do not stake ourselves to any specific outcome.  Forecasting is for those who need a lot of attention.  Now that owning index ETFs and trading them is free (Thank you Schwab!), dynamically adjusting your index holdings toward leading stuff makes sense, right?   That’s what we do and have done for the last twenty-five years.

Just a quick check-up on conditions as they stand today as we move into the edgy zone of the year.

Have a great week

Sam Jones

Notable Change in the Market Character

Things are starting to change.  The light, colors, temperature, and the financial markets.   There are seasons to everything.   Yesterday, we witnessed a notable change in the character of the markets that has us rotating in and out of different asset classes, sectors, and holding.  This will be a quick update with the intention of showing you how our system responds to changes in risk, opportunity, and leadership as dictated by market trends.

The Most Interesting Thing I Read This Week

Forbes – Why American Companies Choose China Over Everyone Else – 9/3/2019

https://apple.news/AIUeWy_CuT8KROqfGsFx0zw

This is not an opinion piece.  It is just a clear overview of why so many US-based companies have chosen to work with China over all other developing countries.  What they don’t say explicitly, but imply, is that they are also choosing China over the US as a place to manufacture their goods.  The key driver of overseas manufacturing is the price (cost) of course and it’s going to take a lot more than Trump “ordering all US companies” to bring their manufacturing operations home.   Crazy talk.  Anyway, just a little quiet truth during this political and physical hurricane season.

Change in Market Character

Bond/ Stock ratio at an Extreme

Practically every measure of the relationship between bonds and stocks points to the same level of extremes.  For instance, bond yields are now below the dividend yield of the S&P 500.  That’s happened a few times in history but not many.  Each time, we have seen stocks rise dramatically and bond prices fall sometimes dramatically.  Yesterday, we saw stocks finally break up and out from a period of congestion and high volatility right around the long-term price average.  Meanwhile, bonds of all sorts saw real selling pressure from a place and time that can only be described as extremely overbought.   Yesterday, we reduced our bond exposure and added to our stock exposure.  This looks like a good foundation from which stocks could start a new uptrend.  I couldn’t tell you why or justify the move from a fundamental or economic perspective.  Optically, all things seem to be pointing to a recession in 2020.  But herein lies the greatest challenge for investors over time.  We all need to feel like price action follows a story that we have accepted.  We want to see things happen in an orderly way.   When we all begin to accept the story that recession is coming, then we expect price action to follow accordingly (stocks fall, and bonds rise).  Well, the markets have a crafty way of moving directly against consensus opinion, often just as you have finally decided to embrace the common logic.  This may be one of those times.

Sector Rotation Out of Defensives

Consistent with the stock/bond rotation, we also saw a significant change in leadership yesterday.  Financials, industrials, technology, and growth jumped higher as investors rotated out of defensive sectors like utilities, healthcare, and consumer staples.  In the last week, we have followed the new leadership moving back into banks, financials, adding to semiconductors and industrial stocks.  It is too early to say with confidence that this rotation is sustainable so we’re moving slowly and acting only as price patterns and evidence persists.  We expect to see defensives underperforming from here. It always feels safer to buy something that has recently pushed out to new highs.   But investors should be looking “down” for opportunities.  Find things that have pulled back in price to a rising long term moving average.  Find things that still have attractive valuations and are seeing healthy buying enthusiasm now from a price low.  Be careful about reaching for high dividend payers here or areas of the market that feel safe.  Safe can bite you when the market is rotating back toward the growth side of the market.

Internationals versus the US dollar

The US dollar has been moving steadily higher over the last month as fear and headlines have driven money into bonds and other safety investment (US dollar, gold, etc).  Consistent with the change of character in other areas, the US dollar looks like it just made an intermediate-term peak.  A falling US dollar should be good for internationals, especially emerging markets.  Investors looking to add back to equity exposure might choose a balance between US and international holdings here as we now have the tailwind of a falling (or consolidating) US dollar.

Seasonality is Still Unfavorable

I’ll finish with a quick word of caution.   Seasonally, this is not the best time to be stepping up to buy stocks.  September and October have seen some of the worst market wipeouts in history.  I don’t know why but clearly, we are still in the time zone of buyer beware.  Historically, investors have been better served to wait until Halloween or beyond before stepping up aggressively.  Based on what I’m seeing, it would seem that investors could use the next 30-60 days to PATIENTLY wait for select buying opportunities and let the market action prove itself to be sustainable.  I do have some PTSD from October of 2008 when we saw a similar, brief, rotation back toward cyclical and non-defensive sectors inequities.  Obviously, that was not a time to buy stocks.  Prices fell 40% until March of 2009!  Those who fail to heed the lessons of the past are doomed to repeat them!

Stay tuned and have a great weekend

Sam Jones

Market Jambalaya

Jambalaya (defn.)  Jambalaya is a popular Louisiana-origin dish of Spanish, West African and French influence, consisting mainly of meat and vegetables mixed with rice.  I have a disconnected blend of topics to cover today and this title feels appropriate.  Financial markets, economic status, monetary policy, politics, real estate and corporate trends served up today… mixed with rice.

There Ain’t Enough Room In This Town for the Both of Us

Trump and the Federal Reserve have begun a feud that is leaving Investors and the American economy potentially caught in the crossfire.

The Federal Reserve is very much wanting to flex their independence muscles and show the world that Trump cannot tell them what to do.  Based on Bespoke’s Fedspeak Monitor (dark blue) versus the Bond market’s perception of where rates should be (light blue), there is an enormous gap in future expectations.  Either the bond market is going to get slaughtered and rates will go higher to sync up with current Fed policy (Trump loses) or the Fed is going to cut rates more aggressively than they are saying currently (Fed loses) to meet the demands of the White House and bond market expectations.  One of them is going to be lying in the dust – R.I.P.  I couldn’t say how markets will react either way, but they will react with all the increased volatility that we have seen in the last 18 months.

Corporate Share Buy-backs are Slowing

We have talked at length about the positive impact of share buybacks on the financial markets.  In fact, since the corporate tax cut in January of 2018, buybacks have been largely responsible for keeping the US stock market alive while the rest of the world’s markets have been under very heavy selling pressure.  The US economy has been getting weaker statistically for almost 5 quarters but share buybacks have spiked over the very same 5 quarters, keeping stocks within 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of the old highs…. Until now.

We couldn’t know what’s happening in corporate board rooms.  Are corporations not feeling that confident about their own future earnings?   Trade wars and wage inflation cutting into profits?  Global slowdown hitting US soil?  Political Chaos?  Probably all of the above.

Big City Housing is Unaffordable with Price Appreciation Slowing

Housing is on everyone’s mind.  Should I buy or rent?  Are prices going up, flat (or even down in certain markets).  Interest rates have been so low for so long that changes aren’t really impacting prices as much as you might think.  It’s really hard to get a read on where we are or what to do with real estate.  We do know that prices are very high not just in major US cities but in other cities across the world.  Even with lending rates approaching zero or even negative (In Denmark, the bank will PAY you monthly interest on YOUR mortgage!), affordability is still very low.

And now this from Case Shiller…

To be clear, this is NOT a price chart.  This is the change in aggregate US home prices year over year as a percentage.   Note the fact that we didn’t see prices actually turn up until June of 2011.  Real estate lags the financial markets and the economy!  Also note that the price lag occurs at the top.  Prices are still going up, while stocks and the US economy may have peaked.  We don’t expect real estate prices to fall in aggregate but rather we expect prices to finally behave as they have done for the last century, track inflation rates (2-3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).   Don’t shoot the messenger but here’s a secret.  The last 20 years of price activity in real estate are a historic anomaly.  We saw big gains in the early 2000’s evaporate into price declines.  Now we have recovered from those losses but just barely.  Looking forward, any appreciation greater than the rate of inflation, is simply not sustainable.  If you’re buying, building or spending a chunk of money on an upgrade, keep that in mind.  Expect 2-3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} price gains on your real estate assets for a very, very long time.

Hard to Win a Trade War with the World’s Largest Trade Deficit

This data is two years old but hasn’t changed much since 2017

Our trade deficit with the world, mostly China, is nearly four times larger than the next highest country.  That means we import nearly everything.  As a nation of consumers, that’s what we do; consume stuff made by others.  We don’t make much domestically and we don’t export much, relatively.  I would love to hear a coherent explanation for why adding taxes (tariffs) to imported goods makes sense for the US?  I only have a degree in economics and finance.   Anyone?  Really anyone?  Is this about jobs?  If so, consider this.  A Chinese employee in manufacturing works a 12-hour day and a 6 day work week at a wage that is 1/3 or less than that of a US worker.  I have images of that well groomed guy in the brightly lit GM factory wearing nice clear safety goggles, smiling as he thinks about his employment benefits.  In China, there are no safety glasses, and not a lot of smiling.  We have lost jobs and generated a massive trade deficit because American workers are very expensive in the global labor pool.  We have also lost jobs to automation.  We are also addicted to cheap consumer goods.   Walmart/ Target/ Dollar Store are basically boxes of Chinese stuff.   Tariffs and trade wars will solve none of these harsh realities.  Tariffs are inflationary and bad for everyone and I do challenge anyone to justify why Trump is waging a global trade war given all of the above.  Why are we doing this?

Lots of Cheap Stocks to Buy!

I’ll finish on a positive note.  We maintain lists of companies that meet our “Value” Screens.  We are looking for companies that are trading at significant discounts, have very low valuation metrics, high free cash flow and preferably healthy dividend streams.   Well, folks, our list is getting very long and very diverse across many different sectors.  We’re going shopping and beginning to take new positions again for the first time since last Spring.  In the short term, we’re getting a few buy signals from this oversold condition and the value side of the market is waking up.  This could be very good for returns in our equity strategies which have struggled with the rest of the stock market for the better part of a year.  We bought a few positions yesterday and will buy more today.  More on this later.

Thanks to everyone who made our full house Solution Series workshop on legacy planning provided by our legal partner Merry Balson and her new associate, John Valentine.  We will be carving up the presentation into digestible video clips and sending those out shortly.

Have a great week!

Sam Jones

While most have been out enjoying time with their families in the meat of the vacation month, myself included, we have seen very little change in the character of the markets.   Now pushing up to a full year, we see the same asset classes, sectors and countries leading and the same list of laggards.  All things are still pointing toward recession in the months ahead.

Note from Blaine Rollins of 361 Capital

We have referenced commentary from Blaine many times in the past as he has a way of laying out current conditions well.  I’ll do it again now and here’ the link to his full commentary as of yesterday.

https://361capital.com/weekly-briefing/cracks-forming/?utm_source=wrb&utm_medium=e&utm_campaign=08122019&utm_content=c

Cracks Forming…

by Blaine Rollins, CFA

361 Capital Market Commentary | August 12th, 2019

The September 1st tariffs on the rest of China’s imports are looming large and causing the U.S. Economy to slow down further. The big move in the U.S. Treasury market is confirming this fact. If the tariffs are implemented, the ball will then fall into the Fed’s court to try to save the U.S. from entering a recession. Keep in mind that a new recession, and its accompanying stock market decline will factor into who will likely reside in the White House in 2020. So, will Fed Chair Powell and his board cut rates by 25 basis points or 50 in September? Somewhat ironic as to who might have the upper hand in Washington D.C. now.

To complicate the Fed’s decision, some new cracks have formed on the other side of the equator. The global financial center known as Hong Kong has widened into a full crisis with all business and transportation now being affected as the locals fight for their independence. The financial world needs a stable Hong Kong. And in Latin America, the free markets golden president of Argentina has just suffered a political defeat back toward socialism causing their asset values to collapse overnight and ripple through the rest of the continent. In the northern half of the globe, South Korea and Japan have restricted trading with each other and North Korea continues to light up its missile-of-the-week.

For equity investors, the markets have become very defensive with Utilities, REITs, Insurance companies and Defense contractors leading the market. The Gold commodity and its Mining stocks have even joined the leaders which are very reflective of how cautious stock buyers have become. While the valuations of the average stock have moved lower, so has its earnings growth outlook. This is not a time to be a hero unless you have an actual working crystal ball. Meanwhile, it is becoming much easier for investors to create lists of companies that are going to have a difficult time making it through this next downturn. Just dig for those companies with negative operating leverage, too much debt, and high valuations.

Now, we’ll add some additional color.

Investors have had three distinct windows of opportunity to get aligned with what are now very persistent trends.  The first started at the stock market cycle peak way back in October of 2018.   This was really the obvious kickoff to the new environment we’re in today.  This was an opportunity to cut back on stock exposure (which we did) and add back to our Treasury bond positions (which we did). The second zone to make changes was in May of this year when gold and miners took over leadership for the first time in almost a decade.  We bought gold, silver, and miners in May.   The third event just occurred in August when stocks fell, bonds and gold exploded, following the Fed’s decision to cut rates and the Don’s latest round of market manipulation via Twitter.  Oops did I say that out loud?  

Obviously, when Trump sees enough weakness in stocks, he rolls out another Tweet suggesting that Tariffs are delayed or going away, like today.  Earlier in August, with stocks trading at the top of the price range, he tweets that we’re moving forward with more tariffs.   The stock market is his puppet and he can make it dance!  How fun!   Except he’s using our country’s financial engine as a bargaining chip and I wish he would stop.

Persistent Trends

If we look back to October 1st of 2018 through yesterday, we see some very persistent trends.  Stocks are flat to down (S&P 500 down 1.41{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).  Leadership has moved to the recessionary sectors like healthcare, utilities, and consumer staples at the expense of technology, financials, energy, and most other cyclical groups.  China is really falling apart and seems to be accelerating.  Some might enjoy that fact politically, but I’ll tell you that if China goes down, we all go down.  Be careful what you wish for.  Europe, Japan and developing markets like Latin America are convulsing with changes in leadership, not a good way, but their markets are sort of hanging in there as they are still relatively attractive on a valuation basis.

Bonds of all types are still ripping higher with almost no volatility.  I find it amazing that money continues to flow out of Treasury bonds and into High Yield bonds.  We have traded High Yield corporate bonds off and on, mostly off, for the last couple years with very low expectations.  As of last week, our high yield signal went to a sell again.  We used the proceeds to buy more Treasury bonds.  Treasuries are now core holdings and we are simply moving between intermediate-term and short-term durations.  One note of caution for any die-hard high yield investors out there.  Spreads on High yield energy bonds just moved past their 2016 highs.  

There is a lot of high yield debt wrapped up in energy companies that are in deep trouble.  When “spreads” move higher like this, it indicates that these bonds are pricing in a higher default rate.  That’s not good for High yield in general and not good for the credit markets.  Outside of high yield bonds, the persistent uptrend in all things income-oriented is all good.

Gold, silver and the miners have also established new bull markets as of the last several weeks.  Admittedly, precious metals are hard to own and generally have not been productive to anyone’s portfolio for many years.  But when precious metals get going, they can defy gravity for a long long time.   We have anchor positions in precious metals in Worldwide sectors as well as all Blended Asset strategies since May and have added to those initial positions consistently through the summer.  We’ve got plenty of gold and silver now.  Here’s a quick 12-month chart of Gold bullion in Red versus the S&P 500 in Green.  

Precious metals are really a currency play banking on competitive currency devaluations.  China devalued the Yuan last week.  Thank you!  The Euro is giving up ground as well.  Unfortunately for Trump and the Fed, the US dollar is left hovering at an uncomfortably high level.  We expect another long cycle of currency devaluations as countries work their magic to drive favorable trade.  Who wins?   No one except owners of precious metals.   The trend in precious metals is persistently higher.  I wish I could say the same for base metals like copper which tends to track the state of the US economy.  Copper is trading at a two-year low and can’t seem to get a bid.  What is copper telling us about the US Economy?  Nothing that stocks and bonds aren’t also telling us right?

Heading Toward Recession

Nothing we see today tells us that we are on a different path than the one we have been on since last October.  That path leads to recession.  Until conditions change and the persistent trends of today change course, your portfolio should be aligned with a pending recession.  We’d be happy to help evaluate your holdings anytime if you are not already a client of ASFA.  We have an evaluation tool called Hidden Levers that will evaluate your current holding for exposure to all kinds of macro, micro and market risks complete with estimates of downside and upside potential.

If the markets are right and the US economy heads into recession, we should all consider our decisions today as it relates to personal finance.  I’ll give you a few ideas.

• This is not a time to reach for that big expensive purchase that might threaten your monthly cashflow.  Recessions proved a great opportunity to buy cheap stuff (later).
• Feel free to pay down any debt with an excess cash reserve.  Debt rates on anything are higher than the return on stocks or cash.   Bonds are still productive and generating healthy returns.  Paying down debt with stock money might prove to be a great “investment”.  I suggested as much in January of 2018 https://allseasonfunds.com/red-sky-report/melt-up-and-the-best-investment-for-2018
• Seek or stabilize current and future income streams.  Job hopping now is ill-advised. The last one in is usually the first one out.

Stay tuned.  There is a lot at stake in the next couple of months.   

I hope everyone is enjoying the summer!

Cheers

Sam Jones

Given all the cross currents in the market, especially in light of the US economy, political forces, Fed policy and global trends, we thought this would be an especially important year to offer our take on what’s happening.  On Monday, next week, we will be recording our first ever Red Sky Report LIVE as a video broadcast of our Mid Year Investment Themes.  This update will set the stage.  We hope you enjoy both the written and upcoming live versions.

Balancing Act

Since late January of 2018, that’s 18 months ago, the markets have been caught in a tough environment balancing between an aging bull market and a pre-recessionary economy.  While marginal new highs have made the news in the last couple weeks, we mush all acknowledge a few realities.

1.)  Stocks have been unproductive as an asset class.   Here are the total returns for various benchmark stock indices from January 25^th, 2018 to present

S&P 500                                                                +5.88{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Dow Jones Industrial Average                     +2.63{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Russell 200 Small Caps                                   -2.73{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

All Country World Index                                +0.60{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

All in, we’re talking about annualized returns of 1-3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, a far cry from investors’ built in expectations of 7{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} returns on their stock money.  We would describe the last 18 months as very flat in terms of cumulative returns which included a very nasty 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} decline late last year.

1.) Bonds have been outperforming stocks over the same time period (January 25^th to present)

A few examples of total returns here

20-year Treasury bonds (TLT)                      +9.09{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

7-10-year Treasury Bonds (IEF)                   +8.35{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Interm Muni Bonds (MUB)                           +6.78{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

High Yield Corporate Bonds (HYG)            +7.15{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Emerging Market Bonds (EMB)                  +5.40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

To be clear, for the last 18 months, bonds have outperformed stocks by almost three times.

1.)  We also know that the Federal Reserve is likely to cut interest rates at the end of this month, confirming all of the market action described above.  Essentially, they see enough evidence and feel enough pressure from weakness in global economies, including the US, to justify lower rates.  We can try to guess how much influence our president may be exerting on the Fed, bit it’s not really worth much of your brain power.   We can’t know.  But it would be foolish to assume, given all the evidence in the market and weakening indicators in the economy, that the Fed is dropping rates purely on the basis of political pressure.  The reality is that the Fed is still following the data and the data says we are in a pre-recessionary environment.  Bespoke Institutional tracks an entire Matrix of economic indicators monthly on the basis of year over year changes.  They look at everything from manufacturing to employment, inflation, housing and consumption and develops a net aggregate index of all indicators.  As things get weaker in aggregate on a net basis, the index falls.  Here’s the important takeaway.

Even though stocks have rebounded back to the highs of the last 18 months (give or take), the matrix of economic indicators as now at its LOWEST level since January of 2018.    

Which bring us to our next reality check…

1.) The stock market has rebounded in 2019, purely on the expansion of multiples and buybacks

Okay, let me explain in basic terms.  Strangely, in 2018, stocks lost money even while earnings continued to run pretty healthy.   There was a lot of fear regarding trade wars and the Fed overshooting on interest rate hikes, etc.  From an actual earnings perspective, the losses were unjustified, and the market quickly rebounded on that reality.  Now, the situation is almost opposite.  Gains thus far in 2019 have happened almost entirely on the back of share buybacks from corporations and technical price action rather than coming from the support of earnings.  We call this “Multiple Expansion”.  Take a look at this recent data from JP Morgan.

Obviously, you can see the reversal of conditions between 2019 and 2018.  The positive big grey bars in 2019 tell us that prices are moving higher without earnings leading us to the recognition that stocks have possibly become wildly overvalued again.  There are only two variables that will improve this situation.   The first is that interest rates drop dramatically making stocks comparatively cheaper.  The second possibility is that we see actual earnings turn up.  On Monday, earnings season begins.  At the end of the month, we’ll find out if the Fed is going to cut interest rates.

This is an important moment of truth for the markets.  Expect higher volatility from this point forward.

1.) Technical Conditions Are Still Healthy for Stocks in the Short Term

Despite all of the above, we cannot complete a Mid-Year Assessment without pointing to a few positive technical developments since the lows in May.   Price trends are up and we cannot argue with that reality.  Stocks, bonds and commodities are all trending higher giving us a clear opportunity to remain fully invested in almost all strategies.  Many of the canaries in the coal mine are healthy and alive including strength in oil prices, high yield corporate bonds.  In recent days, we have even seen a return in relative strength to technology, cyclicals, transportation, basic materials, etc.  The market is orienting slowly toward an environment that is not recessionary.  It is telling us quietly that IF the Fed cuts rates now, and earnings coming in healthy, that we might avoid a recession.   The market might be right, but that feels a little too optimistic given the bigger picture.    Technically our Net Exposure model went back on a buy in June after the May Massacre.   We have been almost fully invested since mid-June and our various strategies are tracking higher with the stock and bond markets nicely.  But, the recent highs and recent strength in the more cyclical side of the market needs to persist for a few more weeks for us to believe either are sustainable.

Tune in to the Red Sky Report Live which we hope to deliver by the end of next week.   Sean Powers and I will talk more in depth about the details presented here as well as digest some new opportunities in gold, deep value and a few special situations.

We hope you enjoy the show.

Cheers

Sam Jones

Strangely enough, after seeing the fallout from the news of Greece’s failure to come to an agreement with its creditors, I’m left with a sense of relief.  The setup for a very good-looking buying opportunity is now developing.  In the meantime, we’ll continue to hold our positions in uptrends while cutting positions that break stops following our risk control mandates.  This has quickly become one of those high anxiety moments that needs a cool mind.

 

On Greece

Greece is going to go through a rough time as it has through several periods in the past – not their first default.  Acute economic pain is happening now (in Greece) and will not go away soon.  In fact, they will not recover economically for years to come.  I don’t know if Greece will remain in the Eurozone or not, but I’m not sure it matters ultimately.  We must remember that Greece represents only 2% of Europe’s GDP.   To what degree the pain really spreads and infects the rest of the Europe and the global financial markets remains to be seen. I am skeptical that by itself, Greece will ultimately cause more than headline risk to the global financial markets.  There is the possibility that Greece is just a catalyst for a deeper global stock market correction that wants (needs) to happen anyway.  The end is approaching in this very lengthy saga with pain recognized and managed.  To that end, I am relieved.

 

On A Very Damaging Day For Global Stocks

As I have said many times in the last six months, 2015 will be a Transition Year and potentially a negative year for investment portfolios.  I use the phrase Transition Year because the markets and the economy have approached a cyclical moment where both are adjusting to life without the massive support of central bank easy money.  Stocks must also justify staying at their high valuations by seeing commensurate growth in earnings.  Both of these issues will become front and center to investors starting on July 8^th, with the kick off of the 2^ndquarter earning’s season, continuing on into September with concerns about the Fed’s first rate hike.  On the potential for a negative year in stocks statistically, the odds are simply not in our favor for a 7^th consecutive year of gains.  Why?  Because it has never happened.

Monday’s loss erased all of 2015’s gains in a matter of a few hours.  The breakdown in certain market sectors didn’t happen Monday, it began in April when we saw distinct peaks in utilities, bonds and the transportation sector, all of which made new lows last Friday.  High yield bonds, which tend to act as canaries for the market, also peaked in April and May.  Technically, we have seen divergences and deterioration in market breadth and participation since late April and May as well but until Monday, the market was really hanging tough trading at or very near all time highs. Now, we see all of this evidence coming home starting with Monday’s very notable move lower.

 

On How We’re Playing This

Last week, we began cutting out several of our higher risk positions and did more follow through selling on Monday.  Tactical Equity and Blended Asset models now carry 20-25% cash positions with the remainder tentatively holding positions that are still above their stops.  Last week, our income models moved decisively to almost 80% cash as the remainder of our corporate bonds, floating rate and municipal bond funds broke stops.  Technically, Monday did a lot of damage to the markets (and our strategies) but at the same time, the “event” pushed many indicators into deep oversold territory, close to levels where we often see healthy bounces.

 

Presently, we are moving from a fully invested allocation to a more defensive position, selling as individual positions break trailing stops or sell signals only.  Our Net Exposure, Selection and Position size criteria for portfolio holdings are all dictating our actions.  Like the market, we’ll give up some gains on the way with the goal of avoiding the more significant losses that create bigger issues and longer recovery times.  What we have seen so far is a lot of technical damage to the markets but the primary trend is still up (marginally).  In fact, prices have now moved very swiftly back to the long term uptrending averages which tend to act as support for stocks. Clearly, any buys now would be guesswork with little evidence that a bottom is in, so we’ll wait.

 

What They Don’t Want You To Know – Part 2

The vast majority of investment portfolios are built on the premise of “Modern Portfolio Theory” (MPT) where we have different asset classes, sectors, styles and size categories that offer us the perceived safety of a diversified portfolio.  Most models rely on a set of assumptions called “reversion to the mean”, or the tendency for every security to move from high or low extremes back to an average over time.   These are quantifiable risks as they can be measured with standard deviations or pricing models.  Thus we can easily build portfolios that almost eliminate the risks of having all eggs in one basket with the right blend of securities.  The problem with all of the models surrounding MPT is that they only eliminate what is called systematic risk or quantifiable risks.  Now look back at a day like Monday, 6/29/15, when near every sector, asset class and security lost 2-3%.  What good did diversification do on a day like that?  It did zip in controlling your losses.  Bear markets are governed by weeks and multi month periods where non-systematic risk is present created by investor’s need to cut losses in an environment when liquidity is shrinking or non-existent.  Non-systematic risk can’t be modeled or priced or diversified away because during these periods all ships fall with the tide.  Statistically, again from the good work of Greg Morris, periods of non-systematic risk govern the markets between 60 and 70% of the time.

In other words, Modern Portfolio Theory and all of its various pricing models are only valid and useful 30-40% of the time.   So what can we take away from this?

Investors should not take comfort in simple diversification as the only means to control capital losses.  This is the battle cry of the passive investing crowd and only those with the very deepest of pockets (like Bogle himself) can really tolerate the realities of a market in the grips of non-systematic risk.  Ironically, diversification and thereby MPT only work when markets are rising in a normal uptrend – when you don’t really need it!  When non-systematic risk takes hold of market trends, you need a system of stops that pulls capital off to the sidelines.  In truth, net exposure to the markets (our primary investment screen) is what really matters the most in both rising and falling markets.  Selection (diversification) is relevant but secondary.  Let Monday’s market action serve as a reminder that non-systematic risk is always there and every investor needs to have some method to deal with it.

 

That’s it for this messy, headline driven quarter and I’m glad it’s over frankly. There will be no Red Sky Report next week as we will be writing the Quarterly Change of Seasons Report.

Thank you

Sam Jones

Summer is here!

The sun is shining. Impending vacations are upon us. Overall, everyone’s mood seems to be on the rise.

Speaking of “on the rise”, I wanted to give you a quick update on our Freeway Income model, and more specifically, the municipal bond part of those portfolios.  We continue to believe that now is a great time to deploy any excess cash into the Freeway Income Strategy, given that the market is already talking about the Federal Reserve cutting rates over the next 12-18 months. Forward returns on cash are likely going down.

The Freeway Income Model is built for taxable money. As such, we want to exploit the tax-advantaged nature of the municipal bond market. If you attended our Solution Series in May, you know that we increased the allocation to municipal bonds earlier this year in order to generate higher after-tax yields for clients.

First, let’s look at the after-tax yields for muni bonds compared to corporate bonds.

The graphic from Nuveen below does a good job of making this comparison (https://www.nuveen.com/opportunities-in-municipal-bonds):

The difference is especially large for high income folks. Factoring in a 37{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} marginal federal tax rate plus a 3.8{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} Medicare tax on investment income, one can see that high earners achieve a higher yield with municipal bonds across the maturity and quality spectrum. (Some income may be subject to state and local taxes, as well as the federal AMT).

Using muni bonds is one of the best ways to help save money on your tax bill.

Positive Supply and Demand Dynamics

Municipal bonds have been on a tear this year. Both supply and demand factors– as well as the overall interest rate environment— have offered a great tailwind for muni bond holders.

Here are a few drivers behind the good performance from muni bonds in no particular order:

1. Repricing of short-term interest rate expectations. The Fed reversed its tightening bias early this year which overall helped any bonds with duration associated with them. Interest rate policy went from a headwind to a tailwind almost overnight.

1. Steeper muni yield curve. Published inflation numbers continue to remain subdued. While longer term interest rates on Treasuries have fallen quite a bit this year, the muni curve has stayed relatively steep so that muni investors have been rewarded for going out on the curve.

1. Fewer tax deductions. The new tax laws reduced the number of deductions available—especially the cap on SALT (State And Local Tax) deductions—increasing the demand for municipal bonds.

1. Elimination of advanced refunding options. The Tax Cuts and Jobs Act eliminated the ability for advance refunding for muni bonds issued after 2017 by making the interest on advanced refunding bonds taxable. This will remove a good chunk of supply from the market each year. Some estimates have issuance down 25{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in 2018. Bullish, all else equal.

1. Good credit quality. Appetite for good credit quality bonds has continued unabated. Below is a snapshot of the credit quality in the muni universe from Nuveen. Most of it is investment grade:

1. Upgrades vs downgrades. The upgrade cycle continues to be strong. According to Lord Abbett upgrades have outpaced downgrades for the last several years:

Where The Rubber Meets The Road

So, we’ve laid out the bullish case for muni bonds.  Now the big question—how have they performed?

In a word—well!

Below are the returns for a few S&P Municipal Bond Indexes:

INDEX	YTD Return (through 5/31/19)
1 Year High Grade	1.16{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
Investment Grade Short Duration	1.65{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
Investment Grade Intermediate Duration	4.37{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
20 Year+ Duration	6.31{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
High Yield	5.93{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

As you can see, there have been solid returns for both investment grade and high yield munis this year.

Summary

We are very pleased with the muni bond performance in our Freeway Income model. Given the supply and demand factors we laid out above, we expect that to continue. Rather than using individual bonds, we use a combination of exchange traded funds to capture these returns in a very liquid way. In other words, if you need cash, or your money back for any reason, you can get it back in two or three days with little to no cost. That wouldn’t be possible if we used individual bonds.

Happy Summer!

Sean Powers,

Chief Investment Officer

As a spin on the summertime car game of three truths and a lie, we’re going to work through a few realities regarding recent history of Federal Reserve monetary policy, the timing of rate cuts and the impact on the financial markets.  This will be more fun and educational than it sounds.  Game on!

Three Lies and a Truth

We’ll format this game by posing a statement and then reveal the answer as True or False, with an explanation.  Most of the questions are those you have heard recently in light of all the chatter about the Federal Reserve and when (or if) they will cut interest rates.

Statement – By cutting interest rates, the Federal Reserve will help to avoid an economic recession and any potential stock market correction (or bear market).

Answer – FALSE

Let’s look at the last 30 years of rate cuts after a series of rate hikes to see what happened.   First let’s look at the US economy.    Once the Federal Reserve starts cutting rates, we have seen the US enter a recession in all but two cases (1995 and 1998).  Rate cuts are by nature a sign of capitulation by the Federal Reserve that conditions are weak enough to justify monetary stimulus.  Today the market seems to think there is enough evidence of weakness in the economy to support a rate cut at the next meeting in July (80{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} probability).  The market is a pretty good predictive tool but doesn’t always get it right.  The stock market has had some split results following the first round of rate cuts.  Since the year, 2000, we have seen two generational bear markets unfold that started coincidentally with the first-rate cuts.  Before year 2000, the results were mixed but the markets generally navigated mild economic recessions without too much damage.  This chart from Bespoke is a little tough to read and doesn’t paint the whole picture.  But there are some critical things to highlight from this information.

First, note the “Start Rate {1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}” in the 4^th column of each of the last cycles when the Federal Reserve started cutting rates.  In all cases including the last cycle starting in 2007, the Fed began cutting rates from much higher levels (5.25-9.75{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).  Think of rates as ammunition to fight recessions.  Today, the Fed Funds rate is 2.5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  We don’t have a lot of ammo to fight the next recession obviously.

Next, note the market losses following the last two rate cut cycles beginning in 2001 and 2007.  One year later, stocks are down double digits.   What the chart doesn’t show is that stocks ultimately fell 48-50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} both times over a period of 24 months.   Needless to say, rate cuts in the last two cycles were highly reactive to the market meltdowns.  Did those rate cuts all the way to ZERO help?  Not really.  The US economy still fell into deep recession lasting years and the markets were obliterated both times.  Maybe this time will be different but with rates starting at only 2.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, even if they took rates to zero in one step, how simulative could it be to either the markets or the economy?

Statement – The US stock market can go higher while the Fed is on hold (as they are now)

Answer – TRUE!

Here’s a quick chart of the Federal Funds interest rates next to the S&P 500 covering the last cycle of rate hikes (2003 – 2006), rate cuts (2007 – 2008) and the recent cycle of rate hikes (2015 – 2018).

Focus your attention between the vertical white bars.  This was the last transition period for Federal Reserve policy when they went from a policy of tightening (raising interest rates) to loosening (dropping rates).   Effectively this was a “hold” period that lasted a little more than a year.  I think we are in a similar hold period now which is the point of this discussion.  The Fed said as much in their meeting yesterday.  They are now on hold with pending rate cuts in the future as needed.   We would also agree with the Fed’s statement that rate cuts are not really necessary today given the weight of economic evidence, state of the labor market and mixed economic data (not great but not terrible either).  We think they may indeed “hold” on any changes to rates for the better part of 2019 as they indicated.  They would love to actually raise rates but there is no chance of that while Trump is in office (more on this in a minute).  Between the white lines on the chart, the S&P 500 gained almost 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} before making its final peak and rolling over into a rather terrible bear market.  20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} is 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} percent, even if it’s the last 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  So that’s all good.  The bad news is that the US stock market has already gained 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} off the lows in December, precisely on the back of the change in Fed Policy from tightening to “hold”.   Is it all priced in?  Maybe.  Like I said, the market is a pretty good predictive tool.  The rally off the lows in December is still intact, despite some very choppy action in May.  Smart investors will keep their eye on the big picture and recognize two things; The first is that the last year of every long-term bull market in stocks is often one of the strongest.  The second is that it is the last positive year of the bull market.  Play it as such.

Statement – The Federal Reserve acts independently of the interests of the White House

Answer – FALSE

It is painfully obvious that Trump controls the Federal Reserve now.  The Fed hasn’t been independent since the days of Greenspan but historically, we have never had a bully of this magnitude in the White House.   Powell and Co. are puppets of Trump and his Twitter frenzy.  Trump wants lower rates, Trump will get lower rates, whether they are needed or not. Trump wants a second term and the stock market is the only polling source he cares about.

Statement – The Federal Reserve seeks price stability as part of their mandate

Answer – FALSE

The Federal Reserve, by way of the White House, would love nothing more than to see the value of the US dollar fall versus other currencies.  A falling dollar is good for stocks, helps with exports and is generally supportive of economic conditions.  The markets are now poised to break out to a new all time high this week and they are doing so because the Federal Reserve is talking down the US dollar.   In doing so, they may not need to lower rates as they have accomplished their objective by just talking about rate cuts.  Trump is smiling.  You know who else is smiling?  Gold investors!  We are now back in Gold (bullion and miners) as the conditions for investing in Gold look about as good as we’ve seen since 2001.  The US dollar will be under a lot of pressure (down) considering all the political pressure as well as the fact that the Federal Reserve will have no choice but to fire up the printing press once they drop rates back to zero.  Much of the world is already operating with negative rates and Gold loves a good negative interest rate party.  The Federal Reserve would love to see inflation, but they can get it as we continue to import deflation and cut costs with technology/ software, etc.  The Fed has already proven that they will do QE over and over again, paid for with freshly printed US dollars.  Price stability could not be a mandate when they willingly devalue our base currency right?

So, there you have it, three Lies and a Truth about the Federal Reserve.  History may not repeat exactly but so far; it’s been a good teacher.

Stay tuned

Sam Jones

We all make mistakes.  It’s not realistic to say that we can be error-free or avoid being wrong. The trick is to recognize when we are making a mistake and correct it quickly to limit any damage in the future. Seasoned investors understand this well and it takes the form of cutting your losses short (and letting your winners ride). This update will offer some insight into how your investment portfolio should be allocated now across the various asset classes. But there are other mistakes I see happening now outside of your investment portfolio.

Mistake #1 – Holding and Hoping with Too Much Stock in Your Portfolio

We can’t know the future and we don’t have any control over the direction of the markets looking forward.  We can only control how we respond to current evidence as it unfolds and adjust our investment allocations incrementally and thoughtfully.  Regular readers know that we have been incrementally and thoughtfully reducing our maximum allocation to stocks since December of 2017.  We went from a maximum allocation of 70{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} stocks in January of 2018, to 50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in October of 2018, and then again reduced to 40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in May of 2019.    At the same time, we have incrementally and thoughtfully, added to our alternative and income (bond) allocations, now sitting at 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and 50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} respectively.  Income for us is a blend of corporate credit, emerging market debt, preferred securities, floating rate funds and short-term Treasury bonds.  The evidence supporting these changes in our allocations away from stocks has been overwhelming both on the economic and market fronts. I’ve been over many of the indicators we watch suggesting we are now closer than ever to a formal recession in the US and perhaps even globally.    We made note in February of 2018 that there were two variables still holding strong that have not buckled yet.

The first was the OECD Leading Indicators index which was persistently strong and rising.  This is a global index mind you, but the US is still the big driver of change here.   No recession has ever unfolded with this index trending higher.  Well, now we can add a falling Leading Indicators index to the pile of evidence.   The shaded areas of this chart provided by Bespoke Institutional are formal recessions.  Since the early 60’s this index has fallen dramatically (+15 months) as it is now, 8 times.  7 of them lead to global recession within months.  The odds player won’t argue with this one.

 

The second are the employment numbers.  And this one is really the last and most important variable.  The US employment picture is as strong as I’ve ever seen it and we’ll admit, it is very hard for recession to unfold without a rise in unemployment or a dramatic increase in jobless claims. That event has NOT happened yet.  The Fed is also watching this closely which is why they will not drop rates in June.   But the recent preliminary non-farm payroll numbers came in dreadfully short (75k) of expectations (190k).  I wouldn’t say the employment picture is weak, but I would describe the last four months as nervous looking data.  We will not be surprised to see a jump in unemployment by the end of summer if things continue as they are, and that will be the last variable to fall.

So, the mistake I see today is that many investor portfolios coming to us for consideration are still sitting with the same allocations to stocks, usually 60, 70 even 80{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  That’s just too much.  Bond allocations are generally too small, and we aren’t seeing any holdings that are non-correlated to the movements in the broad US stock market (alternatives).  It is very possible for an investor to remain fully invested across a bunch of different asset classes, like stocks, bonds, real estate, hybrid income, even gold now.   But in our view, for young or old, there is no reason to have more than about 40-50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of your total portfolio in stocks; probably less.  Treasury bonds have been outperforming US stocks since February of 2018 by almost 3:1 and there is no reason to change an overweight position to bonds yet.

 Mistake #2 – Reaching for Returns with Illiquid Investments

Its hard to find a Real Estate newsletter these days that isn’t talking about relative performance of real estate and stock prices.  No doubt, real estate prices have gone up a lot in the last 3-4 years.  In aggregate price trends for housing are healthy and stable.  In select high priced markets like Manhattan and San Fran, prices are down 15-20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} year over year.  In other markets, they might be up as much.  The average looks stable but here again, I would describe this data as nervous and inconsistent.  Real estate people want you to buy real estate.  Stock people want you to buy stocks.  So, it’s really hard to find unconflicted advice out there right now.   You’ve really got to do your own homework and make your own judgments. I wouldn’t buy either anywhere in here unless you can find some special situation.  However, after having experienced several global recessions including generational wipe outs in real estate and stocks, I will argue that it is critically important to maintain liquidity when there are higher levels of uncertainty.  Liquidity means you can get in or out of something with a push of a button.  Real estate is not liquid.  It takes a great deal of pain, time, money and a very high transaction cost (6{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}) to buy or sell hard real estate. Moving money out of the financial markets in order to chase gains in real estate without any evidence to suggest that one will perform better than the other looking forward is really just an exercise in removing liquidity from your net worth.  I wouldn’t do it.  I’d rather make 4-5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in tax free municipal bonds with very little downside risk than tie up my money in real estate with 4-8{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} carry costs (mortgage, taxes, insurance, upkeep, etc).  The same argument can be made against investing in private equity or anything that demands a lock up period at this stage of the cycle.

Mistake #3 – Sitting on Piles of Cash

We are empathetic to the sense of worry out there and understand why you might want to just carry a big bank balance.  After all, if uncertainty is on the rise and we don’t feel confident in making investments now, why not just wait in cash.   Well, there are several reasons.

First, there are incredible investment options now for your cash that don’t have much downside risk and are still generating very healthy returns.  These are income investments and we have been pounding the table on this for months.   Since late November of last year, our own Freeway High Income strategy which owns a huge diversified mix of income bearing securities and heavy in tax free municipal bonds, is trading at all-time highs week after week after week generating total returns of 7{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annualized net of any fees.  I don’t have any idea how long this will last, but it would seem the Fed has our back with pending rate cuts and we’ll probably be hitting solid numbers into the second year of any recession.  If somehow, we avoid a recession and global economies pick up steam, our income model returns will taper back to their 2-3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} numbers.  I’m happy with either scenario for cash considering the best you can get in the bank is still pretty poor, like 0.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

Second, inflation is grossly understated in the US.   I’ve harped on this point for a long time. Gas prices, food prices, healthcare costs, costs to build and maintain a home, rents, labor costs, and now trade wars are making things much more expensive for everyday households. You know it, I know it.  They say there is no inflation. Laughable. There is a ton of inflation everywhere. Cash sitting in the bank is not keeping up with your real cost of living.  You will need to make about 5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to break even with rising living costs.  Do what you can do, right?

Mistake #4 – Not Saving Enough – Spending Too Much

This is sort of a timeless mistake but it seems to become a bigger problem at the end of every business cycle.  I see a lot of reckless spending now and I do mean reckless.  When times are tough and employment or income feels tenuous, we naturally don’t reach for that discretionary thing.  We save our money.  But after years of gainful employment, healthy incomes and a rising stock market, we have a tendency to spend like it will never end and save very little. We are watching the savings rate in the US approach zero again and the use of credit rise strongly, especially in things like car loans and credit cards.  I am also seeing a lot of our clients accelerate their withdrawal rates well beyond our prescribed 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}/ year.  I’m going to waggle my finger now.  This is the time and place to cut back on spending (Goodbye Chai!) and add to our savings for that rainy day.  This is not the time to spend big and hit your investment accounts to pay for it.    Life will not get less expensive during a recession, but you may not have the stock market returns or income to pay for it during a contraction in business activity.   Review your current savings rate or spending rates now.  Keep it real.

Mistake #5 – Avoid Job Hopping and Be A Valuable Employee

Jobs seem plentiful and they are.  Many industries are really struggling to find quality employees.  There are lots of folks who are looking for work or better paying work but really lack the qualifications or skills to land those high paying jobs, but that’s a different topic.  As a new employee anywhere, you have to know that many companies operate on a last in, first out basis.  And many companies are just trying to keep someone, anyone, in the office to maintain existing business.  But there isn’t much job security out there really for anyone.  Software is replacing actual employees at an alarming rate.   Employees in practically every industry, are being forced to redefine their value proposition to their company or risk losing their job.  The new guy (or girl) has to prove that they are not only valuable but worth the added expense. The employment situation in the US is tenuous.  Companies are looking for ways to maintain their profits and the number one way to do that is to reduce their labor costs.  It would be a mistake to try to jump to a different company hoping that the situation will change.  The best thing you can do is ask how you can be a valuable, productive and an irreplaceable asset to your current company.  Keep those benefits, keep that income, stay employed, and redefine your job if you must.

Those are the big 5 mistakes for where we are now in the business cycle.   Remember, it’s not wrong to make mistakes, but it is a mistake to stay wrong. We’re here to help with any and all decision points.

Sincerely,

Your financial partner in all conditions!

Sam Jones

President, All Season Financial Advisors

Anyone familiar with the ad campaigns from Motel 6?

Does Tom Bodett ring a bell?

As the story goes, the iconic phrase that runs through the Motel 6 ad campaigns started as an ad-lib from Tom back in the mid-80’s.

The phrase– “We’ll leave the light on for you” — was a fantastic, down-home way to let customers know that Motel 6 cared about them. Thoughtful. Reassuring. This phrase was designed to evoke comfort after a long day of travel.

In a similar way—and perhaps, only slightly less iconic—our “Lighthouse Project” is designed to provide similar assurances to our clients / prospects.

The Lighthouse Project was designed to provide some guidance on active 401k and other self-directed investment accounts not under our management. It never hurts to know the risk and return potential of what you own, especially if you are looking to retire in the next couple of years.

More specifically, we can review your risk exposure using our risk management platform. We can give you a consolidated view of your investments especially if you have multiple accounts in multiple places.

The main action items are to check your net exposure to stocks (US and non-US), find some investment options that are not correlated to the US stock market (commodities, select REIT’s, etc.), and look for ways to safely invest in short term bonds.

If you would like us to review your investments—especially if you are nearing retirement– please feel free to reach out to us. We will send you a secure folder to upload your statements. There is no obligation on your part, and everything will remain confidential.

As always, we are standing by to help.

The Light Is On.

Since mid-April, we have been talking at length about the sharp rise in market risk from a technical perspective.  May has proved why it is important to have strategies that manage market risk.  The technical damage has been severe enough to turn most intermediate term indicators down for the first time since last November.  In the short term, there is an above average chance that this level will market a Good Buy.  But there is certainly growing evidence that we’re saying Goodbye to the bull market of the last 10 years.  Our clients should not be concerned.  We have been moving aggressively out of stocks since April for our Tactical Equity models while our Blended Asset and Income models have been almost entirely in bonds.  Household portfolios in aggregate are in heavy capital preservation mode as they should be considering the bear tracks all around us.

I took this picture of my porch yesterday.  Yes, these are bear tracks as we live with several bears in our neck of the woods here in Steamboat Springs.  Did the bears just arrive?  Nope, they have been all around our property for months.  But it took an overnight spring snowstorm to prove that they have been up close and present all along.  Similarly, we are of the belief that global stock markets have been in the presence of bear market status to various degrees since last fall.  The spring snow that revealed its true nature was our president who is ramping up trade wars with the rest of the world.  This is Trump’s bear; make no mistake and he’ll get all the credit.  Since his unbridled tweeting on May 1st, bonds have gone vertical, stocks have gone straight down.  This does not include the extra 1.5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} losses in stocks today derived from our brand-new trade war with Mexico.

But bear markets do not just materialize without warning.  Economic conditions that precede bear markets and recessions take years to accumulate, probably before Trump ever came on the scene.  We have been tracking the bear for a long time.  These are just the big topics and events we have covered since January of 2018.

• Inverting of the Treasury bond yield curve – yes it matters.  It always matters!
• Triple top in the stock market extending beyond a year – check
• A peak in the growth of corporate earnings – check
• All the benefits of the corporate tax cut are priced in – check
• The bond market continues to make a new high every week – check
• Commodities are in a death spiral – check
• Margin debt has peaked – check
• Investor Sentiment hit another extreme high (bullish) in mid-April – check
• Leadership from FANG stocks is gone – check
• Canaries for stock market trouble (small caps, oil, high yield bonds) are dead – check

I have more, but I’ll stop there

When I hear comments in the media like “There are no signs of recession” or “The risk of a bear market is low”, I am just incredulous.  Next, they will say, no one saw this coming.  Laughable.

To be clear, we are not in a bear market yet (-20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} or more), but the signs and the evidence that we’re headed that way quickly is overwhelming.

Following our discipline, we have been moving out of stocks for our clients since the end of April.  Categorically, this is our current asset allocation breakdown.

Tactical Equity (all stock investment strategies)

45{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} stock ETFs still showing favorable relative strength to the market

55{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash

Blended Asset (strategies that dynamically shift between stocks, bonds, commodities, and alternatives)

14{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} stock funds

15{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} Alternatives

50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} bonds

21{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash

Income Strategies (Bond and income bearing investment strategies)

95{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} bonds

5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash

It’s obvious that we’re in capital preservation mode.  This is what your portfolio will look like if you are engaged with strategies that manage market risk.

Treasury bonds are currently overbought as they have been appreciating dramatically since March.  We are probably looking to take some profits here.  However, given that we are now closer than ever to an economic recession, bonds should continue to outperform most asset classes, so we’ll remain anchored here until stocks put in a meaningful bottom.  In fact, the market is now pricing in a 37{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} chance that the Fed lowers interest rates by 75-100 basis points (100 basis points is 1{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}) by the end of the year.  We said the Fed’s next move will be to lower rates but that is probably too much in our opinion.

Expecting an Oversold Bounce from Here

As always, the markets never move in one direction in a linear fashion.  Today, stock market conditions are oversold, and bond market conditions are overbought to the extreme.  This is probably not a time to sell stocks, nor is it a time to buy bonds.  Those days were 6 weeks ago.

After today and depending on the close, there is a high probability that stocks will rebound.

Younger investors with long time horizons, solid incomes and a long-range view could consider adding back some stock exposure here or even adding some sideline cash to current investments.  This opportunity is fragile, however, as bear market risk is significant and prices may go significantly lower before this is all over.  If prices hold at the current level, right at the 200-day moving average, this could be a Good Buy.  If not, the next stop is the December lows (-16{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).  Good buy or Goodbye?  We’ll know soon enough.

For those who are in the distribution phase of there lives, specifically anyone who is not working, retired, or living from their investment accounts for any reason, you don’t have much choice here but to stick with capital preservation.  There is just no significant edge here, certainly not enough for you to consider buying stock aggressively.

Decisions you might consider today are therefore highly dependent on where you are financially and your stage of life.  I guess I could say that any given day, right?

That’s it for now, stay tuned.

Sam Jones

Hello everyone, my name is Sam and I have a problem.  I like to drink Chai tea in the afternoon.  For years, I hit Starbucks around 3:30 when my energy hits a low spot and order a “tall” Chai Latte.  Tall is really a misnomer at Starbucks because a Tall is about 6 oz worth of anything.  While I like to think of myself as somewhat economically insensitive to small purchases, I must announce that I have had my last Chai Tea from Starbucks after paying $5.03 yesterday for a tiny, tiny cup.  I took a picture to commemorate the moment (below).  Actually, I’m done with Starbucks altogether effective immediately.  For those who don’t care about my whining and habits, there are some important things we can learn about the current state of globalization, consumer trends, trade wars and ramping inflation… all from a little cup of Chai Tea.’

Picture is almost actual size 😊

Starbucks, Lululemon and Other Overpriced Stuff

Starbucks is not alone in the world of overpriced consumer goods.  I’m talking about their products and their stock prices.  $5.03 for a tiny cup of Starbucks Chai Tea is nuts, especially considering that Starbucks uses a cheap Americanized Chai powder substitute rather than actual Chai tea like you might find sourced from India.

Read all about it – https://qz.com/india/346582/no-starbucks-chai-tea-latte-is-not-real-chai/

Now, let’s bring some globalization into the classroom.  For those like me who are Chai tea drinkers, you know that actual Indian Chai Tea imported into the US, became much more expensive about 12 months ago.  Little shops that served authentic Chai Tea from India posted apologetic notes regarding their “need” to raise prices on their Chai Tea due to their higher costs for the imported stuff.  Did they really “need” to raise prices?  Well only if they wanted to maintain their profit margins.  Passing on higher costs of imported stuff is just part of the American business model.  Only under extreme circumstances, would a company, any company, accept lower profits in order to keep prices the same for their end consumer. More on this point in a minute.

Starbucks took advantage of the situation and began raising their prices as well despite serving the knock off version.  But that’s not the whole story.  You might remember in January of 2018, when Starbucks proudly announced that they were raising wages for all employees from the windfall of Trump’s giant tax cut for corporations.  Well, it turns out that they raised wages and benefits a little above minimum because their employees were screaming already, and the total additional expense was just a fraction of what they saved in corporate income taxes.

Here’s how the pay raise to $9.60/ hr. and increase in benefits was received by employees (from Reddit in January of 2018)

Starbucks pay raise only 2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}?

They acted like the pay bump was such an impressive and awesome thing for their employees when they announced it in January, but my pay went up by a whopping 19 cents… interesting the tax legislation that passed in December cut the federal corporate tax rate by 40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} or so. They could have afforded to pay their employees way more even before the tax cut since everything at Starbucks is overpriced and they bring in a ton of money. Personally, I am not impressed by the other benefits either: 1 hour of sick leave for every 30 hours worked, and a $500 stock grant IF you stay for another year. Yet they continuously understaff, all the while adding new complicated drinks constantly, mobile ordering keeps increasing traffic, and they are adding additional routines I believe too. Thoughts?

Once again, Starbucks seems to be passing on their higher costs of goods and now labor to the end user.  After everything rolls up, we end up with 6 oz. of powdered stuff that costs $5.03.  #DonewithStarbucks.

Starbucks stock is now trading again at nosebleed levels after netting huge financial gains from the corporate tax cut in 2018.  Most of that benefit is now behind them.  Their stock trades at a Price to Earnings ratio of nearly 31, 60{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} more than the broad market multiple of 18 which is high as is.  Good for Starbucks shareholders looking backwards, but I wouldn’t touch it at this level.

As I said Starbucks is not alone.  In fact, there are many public companies out there “serving” their customers overpriced stuff and they are cashing in with a higher priced stock, like Lululemon, the yoga wear clothing fav of all teens and active women (and some men).  Lululemon sources 67{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of it’s manufacturing from Southeast Asia, 23{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} from China and only 3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} is made here in the US.  Lululemon yoga wear is very expensive stuff, but only because the brand has a cult following.  They are virtually the same tights and yoga pants offered by Nike, Under Armor and Athleta’s versions which cost much less. But don’t get between a teenage girl and her Lulu – She will rip your arms off.

Now, let’s bring Trade Wars into the discussion.  Thus far, I can’t say if the high price of Lulu wear is a function of their manufacturing in Asia, but I would not be surprised to see it happen under Trump’s new and enhanced tariffs.  Perhaps, Lulu will shift all manufacturing out of China… to other places in South East Asia like so many other companies are planning.  What they are NOT planning to do is bring manufacturing back to the US and see their earnings get cut in half with much higher American labor costs.  So, Lulu, might be in a tough spot like many others who source overseas, as a result of Trump’s accelerating trade war(s).  They can try to pass on their higher costs to consumers, but they might be at a breaking point already when consumers opt for a lower cost substitute.  Or they can move manufacturing to higher labor cost areas and just make less profit – again, not the American way, especially for a public company that cares a ton about their share prices.  Lululemon is trading at a nosebleed level of 40 (P/E).  I wouldn’t touch it here like many companies in their same predicament.

Consumer Trends and Potential for Ramping Inflation

At the moment, we see consumers like me, making choices related to higher prices.  There are a lot of substitutes out there, so we’ll keep buying, but we are definitely becoming more selective about where we shop and the products we buy.  We don’t have systemic inflation in the system (yet) where consumers just shut down their spending altogether but rather an environment where we slide down the price scale and choose lower cost stuff.  This condition is consistent with many others that are pre-recessionary indicators.  We have to know that the consumer in the US is solid but not so solid that they will pay anything. Quite the opposite.  Consumers are becoming more sensitive to prices and our economy simply cannot handle much inflation without expecting consumption to begin dropping from here.  This is how recessions unfold.  They start from a time when everything is good but strained and it doesn’t take much for people like me to say, “ENOUGH, I’m done with Starbucks!”  Wage pressure is on the rise.  Trade wars are inflationary by nature and we will all pay for Trump’s power play with China.  Nationalism and building walls is inflationary.  Taxes are insanely high still even after the supposed tax cut which was not a cut for many at all.   In fact, those crunching the numbers are indicating that taxes on imported consumer goods from China will now exceed any income tax savings for most households (from the 2018 tax cut) as we move forward.  We have seen healthcare costs for everyone go up nearly 15-20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annually for at least 6 years now.  The potential for real inflation is here, perhaps already here and understated.

I don’t disagree that our trading terms with China could be improved.  But I will say with strong conviction, that the US consumer cannot handle much in the way of higher prices at this stage of the game.  Many companies like Starbucks or Lulu may have trouble looking forward as they struggle to pass on additional costs in the form of higher prices on top of already very high prices.  Earnings may be the thing that gives way.  Investor’s beware.

I wonder what Chai Tea from Conoco tastes like?

Hmmmm…..

Sam Jones

This marks the third time since January of 2018 that we are moving incrementally toward a more defensive position with our asset allocations, specifically within our Blended Asset Strategies (All Season, Foundations and Gain Keeper).  Last week’s bloodletting in stocks was another tip from Mr. Market that the risk/ reward ratio for global stocks is just not there.

Reducing Allocations to World Stock Indices to 40%

As a reminder, our Blended Asset strategies like All Season, Foundations and Gain Keeper annuity operate with maximum allocations to various asset classes.  Practically, that means we can invest up to a certain amount, by percentage, into the big asset classes like World Stock Indices, Alternatives/ Commodities and Income.  These maximum allocations are caps but not mandates.  We can own less of any asset class but not more.  In effect the maximum allocation numbers reflect the evidence surrounding inherent forward-looking risks and rewards.

Since January and October of 2018 (not 2019), Global stock markets are still down slightly but over the last 15 months we have also seen corrections of -12% and -20%, not including the madness of last week.  While we all want to consider ourselves to be that steady-under-pressure investor, we need to face reality.  Staying overweight in stocks while they are just trashing our portfolios with higher volatility, isn’t really a productive use of our capital.

These are the signs of an aging bull market that we have spoken of at length for over a year.  Forward returns for stocks, especially in the developed world are maybe 1-2% above inflation.  That works out to a return of 3-4% annualized on a total return basis (including dividends) until we see prices move back to attractive levels.   Last fall, we sent out several notices to all including many blog posts asking this basic question;

If you are planning or hoping to avoid potential significant losses in your investment portfolio when the real bear market in global stocks materializes, when will you develop a system of risk management and how will you implement it?  We asked the same question then as we will ask now.

If not now, then when?

We certainly don’t want to become uber conservative and risk averse after stocks have lost dramatically.  No, the time to reduce your allocations to world stock indices is in fact now, when prices are still very close to the highs of the last 15 months and the highs of the last decade!

In January of 2018, we reduced our Max exposure to World Stocks by 10% from 70% to 60%.  In October of 2018, we reduce that maximum exposure again down by 10% to 50%.  Last week, we just shaved another 10%, lowering the total to 40%.

Increasing Allocations to Income Bearing Securities to 45%

As we decrease our maximum stock exposure, we need to find a home for the rest of the assets, right?  Well despite consensus opinion, bonds now offer some attractive relative and absolute returns for investors after nearly four years of no gains.   Today, we are 40% invested in bonds in our Blended Asset strategies and I’m pleased to say that our giant overweight position here made money last week, while stocks got hammered.  The benefits of diversification across asset classes is back!  Most of the bonds we own on this side of the portfolio are higher quality meaning Treasury bonds inside 10-year maturities.  We also own investment grade bonds, floating rate funds and preferred securities in smaller amounts. We are realistic about the total potential returns coming from our income allocations.  Interest rates are still hovering near 30-year lows after all and we can only squeeze so much blood from a stone.  But, here’s the important point.  Our 2.40% rates on a 10-year Treasury bond look incredibly attractive compared to zero % or negative rates found throughout the rest of the world among foreign bonds.  The world, including China, will not bail on the only bonds in their enormous sovereign wealth funds because we are the best thing they’ve got going in the income space.  It’s all about relativity with investing.  At this point, most Treasury bond owners are looking at the interest as a bonus while the price of Treasuries is still rising at an annualized rate of return of 16.75% since early November 2018.

Fun facts even after an enormous run in stocks since last Christmas:

Returns from November 7^th of 2018 through yesterday

                                         Total return                       Annualized rate of return

S&P 500                                           -0.07%                                          -0.14%

7-10 yr Treasury Bond ETF (IEF)   +8.05%                                        +16.75%

Side note – for all those who have been drinking the Kool Aid (or listening to the White House talk about our raging economy and stock market), you must wonder why the Treasury bond market is telling another story by pushing toward an all-time high while stocks have gone nowhere for over 15 months.  The Fed has also changed course 180 degrees from their tightening policy.  Their next move will be a rate cut but we have to work through the quiet period of no change before that happens in early 2020 (just guessing).  Why would the Fed change course so quickly?  Hmmmm..

Reducing Allocations to Alternatives and Commodities to 15%

Our maximum exposure here was 25% until the middle of April when we got stopped out of our commodities position again.  We are going to sit with a 15% allocation here for a while because we’re still finding some attractive opportunities in special situation type securities, like Berkshire Hathaway, currencies and a few specialty funds.  This sleeve of investments is intended to generate non-correlated returns to the broad US stock market.

All in, we now have the following asset allocation maximum exposure levels in our Blended Asset Strategies:

World Stock Indices                                     40%

Alternatives and Commodities                    15%

Income                                                          45%

Total                                                             100%

We offer this information now as we know that many investors, including our clients, are wondering what changes are happening in response to market and economic conditions.  Our shop is committed to dynamic asset allocation as witnessed above. We believe there are definite times to make adjustments to your overall exposures, while still maintaining a system that governs buys and sells at the individual security level.  Changes to your asset allocations are really strategic in nature, while the decisions of what to own and how much from week to week, are the tactical ones.

In the next update, I’ll provide insights into our other investment categories – Tactical Equity and Income and the changes happening there.  But that’s enough for one day.  I look forward to seeing a full house at our Solution Series event this evening in the Denver office as we reveal our two brand new investment strategies and discuss the evolution of others.

You can view all strategies here:

https://allseasonfunds.com/our-services/investment-categories

Cheers

Sam Jones