In the early summer months of 2011, a sovereign debt crisis was ripping through the Eurozone and putting pressure on asset prices across the globe. Fear of repeating the 2008 financial crisis was growing and concerns for the future of the Eurozone had investors begging for answers. In November of 2011, the European Central Bank (ECB) announced a change in policy that started a slide in European interest rates. A few months later, Mario Draghi delivered a speech to the world that included this now famous quote that the ECB would do “Whatever It Takes” to preserve the Euro.
With most of the S&P 500 having reported first-quarter earnings, we can conclude that this earnings season has been nothing short of bizarre. For the first time in a while, companies that beat earnings were not particularly rewarded, while those that missed earnings expectations were downright punished.
“The Chinese use two brush strokes to write the word ‘crisis’. One brush stroke stands for danger; the other for opportunity.” This quote came from President John F. Kennedy during a speech delivered on April 12, 1959. While this quote has been used to describe many situations over the years, it describes the current situation in market yields quite well.
Having put the talks of a trade war in the rearview mirror for the time being, the market will now turn its attention to corporate earnings. According to FactSet Earnings Insight, the expected earnings growth rate for Q1 2018 is 17.1%. If in fact that number comes to fruition, it will mark the highest earnings growth since Q1 2011. In addition, the expected revenue growth rate for Q1 2018 is 7.4%. It is important to distinguish between the two measures based on what exactly they are telling us and how they are created.
For the first time since the 3rd Quarter of 2015, the S&P 500 posted a negative quarterly return as volatility increased across most major asset classes. Concerns over tightening monetary policy and inflationary pressures have moved to the forefront of investor’s minds. In addition, over the past week we have seen increased pressure on big name tech stocks that had been leaders over the past year, Facebook being the most notable. Add in increased worry about a possible trade war with China and you have all the ingredients for a very nervous market.
On November 25, 2008, the Federal Reserve announced it would purchase up to $600 Billion in agency mortgage-backed securities (MBS) and agency debt. This would be the official start of what would be known as Quantitative Easing or QE. Since then, the Fed has amassed $4.4 trillion of assets on its balance sheet. The ultimate goal of the program was to drive asset prices higher and keep longer term interest rates low. While its hard to argue that the Fed’s QE programs have not been positive for the markets over the past 10 years, the other part of their job may wind up driving interest rates higher.
Over the past month, investors may have begun to notice a strange relationship happening in their portfolios. For the first time in quite a while, both fixed income and equities were losing money at the same time. For those who subscribe to the notion of diversification, this shouldn’t happen.
In 2010, then Federal Reserve Chairman Ben Bernanke penned an op-ed piece in the Washington Post. It came at a time when many were still skeptical of the massive monetary policy experiment known as Quantitative Easing or “QE” and how it would ultimately affect the economy and markets.
The market has continued to demonstrate volatility this week, with two declines in the Dow Jones Industrial Average of more than 4% (more than 1000 points). While not particularly remarkable on a percentage basis, seeing those big numbers in the headlines certainly grabs your attention.
After an unusually strong and smooth 2017, it was inevitable that we would see a volatile correction work off the excess. This is something we have discussed a great deal. The fancy term is “mean regression” and it is what markets do. No surprises there.
The only questions were, when would the correction happen, how deep would it go, and should investors take any protective action.
In the 1980’s film “Wall Street”, Gordon Gecko (Michael Douglas) advises his young protégé Bud Fox (Charlie Sheen) that he should “never get emotional about stocks, it clouds your judgement.” Later in the film, Fox returns the same line to Gecko as he is getting payback for being misled on a deal. The normally cool, calm and calculating Gecko is losing money hand over fist and begins to allow his human hardwiring to take over. He orders his trader to “dump it” as the screen fades to black. He panics!
And, as a reminder – IT IS NEVER TIME TO PANIC!
From Dec 24th to Jan 6th, the city of Cincinnati and most of the US was frozen solid. Record cold temperatures swept across the nation, cars turned a familiar salt-grey and everyone openly wondered, “what is going on?!”. Meteorologists began to describe the event with terms such as “extreme”, “abnormal” and “historic”. These descriptions were also appropriate for the equity markets in 2017. The equity markets in most investable regions of the world experienced double digit gains last year.
When thinking about retirement income security, HCM believes it is necessary to consider the level and trend in interest rates, as they impact the amount of current income a portfolio can generate as well as the appreciation potential of the overall stock and bond markets. To that end, if you had asked people over the past five years where interest rates would be today, most would have said that yields should be higher than they are now. Few believed that interest rates could stay so low for so long.
Over the past 6 days, high yield bond prices have fallen and are trading right around 7 month lows. While this price movement may quickly rebound, there are reasons to pay attention. High Yield bonds offer a different set of risks than most core fixed income positions. The biggest risk for high yield companies is related to credit. The performance of these bonds is often tied to companies that have less than stellar balance sheets and offer a higher probability of defaulting at some point. Because of this excess risk, the investor is compensated with extra return over the prevailing Treasury bond rate.
I am sure you have heard about Bitcoin over the past year. If you haven’t, you most likely will in the foreseeable future. What once started as an off-the-wall investment idea has now made its way into the mainstream. Currently, 1 Bitcoin could be exchanged for $7,249, assuming no transaction fees. So while it is easy to talk about the price of Bitcoin, it is a little more difficult to explain exactly what Bitcoin “is”. While a few paragraphs may not tell the complete story, it is enough to better explain what Bitcoin is and is not.
Following multiple unsuccessful attempts to reform health care, Washington has turned its focus to reforming the Tax system. Tomorrow, Republican leaders in Washington are scheduled to release details of their “Unified Framework for Fixing Our Broken Tax Code”. The document will provide further details about what the Republicans would like to see. To date, the slim policy outlines that have been released leave many questions unanswered.
In his work Republic, the philosopher Plato wrote what came to be known as the “Allegory of the Cave”. The story describes a cave in which prisoners, who have been chained to the wall since birth, see shadows projected on the wall from puppets dancing in front of a fire. Being sheltered in the silence of the cave with no ability to see the puppets, their only reality is the larger than life projection of the images held in front of the fire. They form all their beliefs based on these simple shadows. Over the past 9 years, investors have lived in the silent shelter of a protective cave created by the world’s central banks.
Reigniting reflationary hopes lit a fire under global small cap stocks recently. More specifically, US small caps enjoyed a performance boost post-election on hopes of a corporate tax cut and pro-growth policies. The thinking behind this move is that small cap stocks would benefit the most since they operate at the highest tax rate environment, around 33% in 2016. This compares to 29% for large cap companies. And while small cap returns have now outpaced their large cap counterparts on a year-to-date basis, HCM believes there are still hurdles to clear before this can be seen as a sustainable trend.
Week of September 8, 2017: HCM Market Insights Debt Ceiling "Can" Kicked Down the Road:
It was Hurricane Harvey that spurred politicians into action last week. The debt ceiling and funding plan was packaged with provisions that provide hurricane relief to those suffering from the storm’s devastation. This came just as Florida was bracing for the impact of Hurricane Irma. A government shutdown, the likely outcome of failure to pass a 2018 budget, would have been a serious problem at a time when states are looking to the federal government for much-needed support. And, while Washington averted an imminent fiscal crisis...
Week of August 25, 2017: HCM Market Insights Short Term Danger, Long Term Opportunity:
HCM believes that any number of events over the next few weeks could throw the market for a loop. First, Congress needs to agree on a budget for fiscal year 2018. This exercise could produce a display of legislative brinkmanship as the debt impasse coincides with the deadline to pass a new government spending bill. Second, the Federal Reserve is about to embark on an unprecedented winding down of its crisis-era balance sheet. This takes place as the European Central Bank is preparing to scale back its economic stimulus. One could add to this list any number of issues ranging from U.S.-North Korea tensions to political infighting regarding tax reform.
While political and policy uncertainty may stoke market volatility...
Week of August 11, 2017: HCM Market Insights HCM Second Half Outlook: Stocks have recently welcomed good earnings announcements with indifference while investor sentiment seems to be showing signs of fatigue. That said, in spite of excessive valuations in the U.S. and parts of Europe, the global economy has settled into a steady growth phase where HCM sees reasonably strong global fundamentals leading to positive equity returns in the second half of 2017. As a result...
Week of July 21, 2017: HCM Market Insights Building on A Foreign Foundation: Earlier this year HCM increased our exposure to non-U.S. equities based on...
Week of July 7, 2017: HCM Market Insights Rethinking Risks and Returns: The world economy is making steady progress...
Week of June 19, 2017: HCM Market Insights Why Won't Interest Rates Go Up? The Federal Reserve raised interest rates as expected last week but
long-term yields fell, mostly in response to weak U.S. inflation. In spite of this disconnect...
Week of June 5, 2017: HCM Market Insights Better Returns with a Different Kind of Diversification. For decades, investors have described portfolio diversification in terms of sectors such as financial stocks, industrial stocks, technology stocks, etc. While that is still a valid way to think ...
Week of May 22, 2017: HCM Market Insights The Trump Bust? Last week's big news was Wednesday’s 372 point decline in the Dow. Traders worried that this latest political controversy would mean the Trump administration would not be able to follow through on their proposed pro-growth policies such as tax reform, repatriation and infrastructure spending. In reality, an expensive stock market was looking for a reason to let off a little steam and the political scuffle of the day served the purpose.
Week of May 8, 2017: HCM Market Insights Sell In .... May? Although HCM remains fully invested at our neutral risk targets, it is no secret that we view the markets as expensive. And while softer data continues to show strong readings, the economy’s actual progress has slowed in recent weeks. We need to see a continuation of progress in hard economic data, like Friday’s surprisingly strong jobs report, to justify the elevated levels of consumer sentiment, business optimism and stock prices. We are encouraged by many positive developments, but remain very risk-aware given elevated valuations, low yields and the many policy and geo-political uncertainties that remain.
Week of April 24, 2017: HCM Market Insights What Could Trip the Bull? There appears to be a very low risk of recession at this time even though we are well beyond the average length of U.S. economic expansions (the current expansion started in 2009 while the average expansion since 1854 has lasted about 39 months). With most measures of economic confidence and employment doing well, one might assume that the economy is firing on all cylinders. Unfortunately, the hard facts don’t yet confirm the softer data.
Week of April 10, 2017: HCM Market Insights Are Markets Too Optimistic? While the market has stalled out over the last few weeks, economic data around most of the world has been getting stronger. Consumer confidence is strong and we are moving beyond the point where central banks dominate the markets to where fiscal policy, tax reform, nationalism, and deregulation have more impact.
Week of March 27, 2017: HCM Market Insights Are We In A Correction Now? Recently, global equities have struggled for direction, with most markets and sectors refusing to confirm the latest highs set in major indices. The Administration’s failure on Friday to move forward with health care reform may be revealing internal divides that could make meaningful tax and regulation reform more difficult. If the markets see this as a risk it could be a trigger for correction.
Week of March 13, 2017: HCM Market Insights Where Has All the Fear Gone? The bull market celebrated its eighth birthday last Wednesday. The market bottomed on March 9th, 2009 closing 57% below its previous high. Investors were scared to death then.
Week of February 27, 2017: HCM Market Insights How Long Will the Rally Last? Improving growth prospects and a reflationary trend are reinforcing HCM’s intermediate-term view. And while our intermediate view is optimistic, our risk antennae are twitching.
Week of February 13, 2017: HCM Market Insights Last week we began to unwind a bit of our overweight allocation to smaller-cap stocks. This follows a year where small stocks were one of our top performing asset classes. However, we have some doubts about the ability of smaller companies to maintain their recent trend of outperformance.
Week of February 6, 2017: HCM Market Insights The Dow broke 20,000 last week – for the second time. The backing and filling we have seen in the markets recently is a normal digestion process to be expected after the rapid jump in prices that occurred in the weeks following the election
Week of January 30, 2017: HCM Market Insights The biggest event at HCM last week was our 2017 Outlook Event where we hosted Jeffrey Kleintop, Schwab’s Chief Global Strategist, to hear his market forecast for 2017. We also shared HCM’s views about how and why our portfolios are positioned as they are.