Tuesday, December 29, 2015

Our Year-End Letter, Part 3: The Wrap Up

We’ll wrap up this year's letter here with my views on the major themes that presumably moved markets in 2015, an assessment of each in today's light, a breakdown of the results of major averages and sectors, and a teaser of what---in terms of future commentary, and discussions with clients---is to come.

The major themes in 2015 were China, the Fed, the dollar, and the amazing decline in the price of a barrel of oil:


The pace of economic growth in China---the world's largest consumer of commodities, the home of 20% of the world's population, the bullseye for U.S. multinationals like Apple---slowed this year. As I expressed throughout, the popular notion that China is about to implode under the weight of ghost cities and private sector debt was, in my view, faulty---or, at a minimum, untimely. Yep, the world's second largest economy has its issues, but, nope, it's not nearly ready to bring on the next great global recession. Not yet---not by a long shot! Here are a few snippets from my earlier commentaries:
I have received a few inquiries with regard to the recent volatility in the Chinese stock market, and whether it’s as big a worry as many in the media suggest. I counsel that, indeed, China’s crazy market of late has created volatility in other markets (U.S.’s included). My view regarding the Chinese economy, however, does not jibe with the consensus.  A China slowdown was to be expected as the powers that be rightly move the economy to more of a consumption/services orientation.

China has issues, not the least of which is mounting private debt. And while, like any economy, it’ll experience fits and starts—exacerbated and aided by a regime that can’t help but try and control it—I don’t see a great Chinese recession occurring anytime soon ($3.8 trillion in reserves carries a lot of fire power) Although I do see continued volatility in the China stock market.

Well, there may or may not be a black swan (an unforeseeable event) lurking somewhere within the Chinese economy, but I can tell you with certainty that last week’s currency move was not an attempt to circumvent some impending cataclysmic event. While, granted, a cheaper currency may indeed help China’s slowing manufacturing sector—which I suspect was one justification for expanding its range—the following statements from the International Monetary Fund (IMF) speak volumes about another key motivation (the IMF is considering a bid to move the RMB closer to becoming a world reserve currency). I also included IMF commentary on China’s economy that reiterates what I’ve been reporting about its move to a more services/consumer-oriented economy and the resulting slower GDP growth—plus, the IMF’s view of where China’s present vulnerabilities lie:

The changes by China will help it gradually transition from a tightly managed system linked to the U.S. dollar to one that is more open and more flexible and more responsive to market conditions. The currency ought to move to free float within two to three years.

The Chinese government should put in place an effectively floating rate for the yuan before fully liberalizing its capital markets.

Moving to a free float is necessary for allowing the market to play a more decisive role in the economy, rebalancing toward consumption, and maintaining an independent monetary policy as the capital account opens.

China is moving into a phase of slower, yet safer and more sustainable growth.

Gross domestic product will expand 6 percent in 2017 before rebounding modestly. Growth should be allowed to slow to 6 percent to 6.5 percent per year to address vulnerabilities in the economy.

China’s reliance on credit-financed investment as the primary engine of growth since the financial crisis has created large vulnerabilities in the fiscal, real estate, financial and corporate sectors.

Thus, a key challenge is to ensure sufficient progress in reducing vulnerabilities while preventing growth from slowing too much.

As it turned out, the Chinese currency is now included in the IMF strategic drawing rights basket (along with the U.S. dollar, the Japanese Yen, the Euro, and the pound sterling), which, as I suggested, was clearly the primary motivation behind allowing the Yuan a greater trading range.

The Fed:

Were I to snippet for you all the seemingly pertinent commentary I offered up this year on the Fed, well, I suspect you’d grow weary and stop reading sometime between now and daybreak tomorrow. Suffice it to say that the market was more than a little focused on when the Fed would at last begin the next tightening cycle (raise the Fed funds rate for the first time in 9 years). So, it happened on December 16th, and, lo and behold, the ball will still drop on Time Square this Thursday midnight. The question is, will the stock market drop as the Fed pushes interest rates higher in the months ahead? Actually, a better question would be, will the Fed indeed push interest rates higher in the months ahead? Well, actually, both are good questions:

Starting with the latter, it depends on the economy. If the consumer continues consuming and if the employment situation continues to tighten, we should see the Fed continue to nudge short-term rates into 2016. If, on the other hand, the economy doesn’t exhibit continued strength---I’m guessing it will---then the Fed stands pat and tries to talk the economy to better health (promises to do whatever it takes with no intent [barring an actual recession] to dump additional liquidity onto the banking sector).

As for how the stock market will respond if the Fed continues to raise rates into the new year; it depends on the economy and how aggressively they move. If the economy’s clicking along---and that translates into higher corporate profits---stock valuations can hang in there as the Fed gets us to an interest rate environment that we can relate to historically, as long as they proceed in, as they’ve promised, gingerly fashion.

The Dollar:

The dollar (using the dollar index as my proxy) appreciated some 9% during the course of 2015---and that’s after rising by 13% in 2014. That’s gotta be driving the doom and gloomers absolutely batty! The thing about a strong dollar is that while it’s nice if you’re an earner and spender of dollars, it’s not if you’re an earner of another currency and want to spend it on U.S. stuff. I.e., if the dollar has grown 22% in two years versus what’s in your wallet, what’s in your wallet had to grow by 22% to buy the U.S. stuff it could’ve bought 2-years earlier. And that’s not great news for the U.S. companies---many of whose stocks occupy your portfolio---that effort to sell their goods and services into foreign markets. Of course those exporters’ inputs---that they buy from abroad (think the Chinese-produced parts in a Ford) ---are cheaper when the dollar’s more expensive. However, if you believe their earnings reports, the weight on the foreign consumer (and the translation of profits earned in other currencies into dollar terms) often more than offsets the gain from cheaper inputs.

And now that the Fed has begun raising rates (we presume it’ll be more than one and done), the consensus seems to be that the dollar will just keep right on rising---as, surely, folks will exchange their foreign currency for U.S. dollars and earn a higher yield in the process. Well, that’s what the text book, and today’s currency analyst, says, but that’s not always what history says. Here’s my chart (the red arrows point to periods when the dollar was falling while the Fed was tightening, the yellows point to periods when the dollar rose while the Fed was loosening).     click to enlarge


I’m thinking that the dollar may not be all that problematic going forward.


You’d think---based on so much of the high profile financial commentary of late---that the U.S. stock market has been perfectly correlated with the price of oil throughout 2015. If you’ve been reading my stuff, you know that that’s not my base case. Take a look (the green line is the S&P 500, the brown is WTI crude):


While there were definitely days here and there when stocks and the price of a barrel of oil moved in the same direction, the above is not what I’d call a picture of positive correlation.

In terms of whether it even makes sense that stocks---or, for that matter, the economy---should rise and fall with the price of oil, allow me to re-share something I wrote almost exactly a year ago.
Boone Pickens (famous oil man/expert) says oil will be back to $100 per barrel in 12 to 18 months. Others say it’s heading to $40. Again, that’s what makes a market.

Me, I don’t know where the price of oil is heading in the near-term. But I do know this, plunging oil prices first result in reduced, if not halted, investment in new capacity. Low prices that remain low will result in cuts to current production. Cuts to current production will alter the supply/demand equation, particularly when we’re talking about a commodity that, in one form or another, every human on the planet consumes. And one that when its price majorly declines becomes a major economic stimulus. And folks living in a majorly-stimulated economy feel good. And folks who feel good like to drive places and fly places and buy stuff with parts made from petroleum products. Yep, you get it, the price ultimately comes bounding back.

I’ve heard a number of pundits downplay the economic stimulus story of plunging oil prices. They cite the boom in states like North Dakota, and how the folks there will suffer if this keeps up: A good number of those jobs will go away and that’ll reverberate throughout the rest of the economy. Well, they’re right, and, well, they’re wrong. Yes, some folks could lose their jobs, but if “reverberate” means that a cut in U.S. oil production will effectively nullify the economic gains of lower oil prices, they’re wrong—on two fronts. One, the U.S. oil boom has been the result of newly adopted (i.e., it’s been around awhile, but it’s just now being used en masse) technology that doesn’t rely on human capital like the old technology did. Meaning, the productivity of today’s oil industry is way higher than yesterday’s. I.e., it takes substantially fewer man hours to fill a barrel of oil than it used to. Plus, the U.S. remains a net importer of oil. Meaning, the boon to the U.S. consumer and industrial user of oil overcompensates for the hit to the oil producing states.

So, I say we enjoy it while it lasts. Because, alas, it won’t last forever. And, yes, we’re still a ways away from the point where the alternatives take over. And the price of oil will traverse many cycles in the meantime.

Obviously, Mr. Pickens didn't know OPEC like he thought he did. The cartel, at the behest of the Saudis, remains hell-bent on regaining market-share (putting some of the competition out of business) by keeping production high and, thus, the price low. But make no mistake, my little lesson of a year ago on the basic economics of oil (or, for that matter, any commodity) will indeed prove to be the story at some point going forward, despite the Saudis. You see, the social programs they ramped up in response to the democratic uprisings that sprung throughout the Arab world in 20011 (the "Arab Spring") were ultimately unsustainable to begin with---pile on the self-inflicted hit their taking in oil revenue and this game ends sooner that it otherwise would have. Of course the question is, given the rest of world's capacity to produce, to what extent these days can OPEC actually move the needle? I suspect some, but I wonder if Mr. Pickens will live long enough to see that $100/barrel again. Of course I'm not predicting anything!

So let's finish up here with a brief synopsis of how the market performed in 2015, dispensing with the long sector-by-sector and regional dissertations (as we’ll be diving into those weeds in each weekly update going forward):

Here’s how major averages fared in 2015* (keep in mind, today’s the 29th [the following are as of the 28th}, so these won’t be right to the decimal point):
The New York Stock Exchange Composite Index:  -5.74%

The Dow Jones Industrial Average:  -1.65%

The S&P Global 1200 Index:  -2.64%

The S&P 500 Index:  -0.12%

The MSCI Europe, Australia and Far East Index:  -0.73%

The MSCI Emerging Markets Index:  -15.74%

Here’s a look, using index exchange traded funds, at the U.S. market by sector**:
IYH (healthcare):  +5.09%

IYT (transportation):  -17.75%

XHB (housing):  +  1.00%

XLB (materials):  -  9.84%

XLE (energy):  -23.64%

XLF (financials):  -2.99%

XLI (industrials):  -5.73%

XLK (technology):  +4.52%

XLP (consumer staples):  +4.76%

XLU (utilities):  -7.77%

XLY (consumer discretionary):  +9.05%

Talk about your mixed bag!

And here’s how bonds faired**:
TLT (long-term treasuries):  -2.96%

HYG (high-yield corporates):  -10.70%

And, lastly, commodities**:
GSG (tracks the S&P GSCI Commodity Index):  -34.80%

GNR (tracks the stocks of commodity producers):  -26.07%

Along with my view on sectors and non-U.S. equities, there’ll be much more to come on bonds and commodities in the coming weeks.

In the meantime, you---if you consider yourself an opportunist---might be wondering if opportunity lies in the above numbers. Well, perhaps: I recently ran the charts on how the S&P 500, the EAFE (non-U.S. developed markets) and GSG (commodities) have fared over the past 40+ years of Fed intervention. The following summary covers the periods---like the one that ended two weeks ago tomorrow---between Fed tightening cycles (when the Fed was either reducing rates or leaving them alone), and the periods when the Fed was raising rates:     click to enlarge...

Between Fed-9 Hikes Mean Results

As you can see, there may be some careful tweaking of allocations in order during the months to come...

On behalf of everyone at our firm, I'd like to take this opportunity to thank you clients out there for the opportunity to take the burden of managing your long-term money from your shoulders. We are truly blessed to work with such a wonderful group of people! Sincerely!! 

For the rest of you subscribers, thank you as always for reading! 

We wish you and yours a Very Happy and Prosperous New Year!




*Source: Broadridge

**Source: CNBC.com

Sunday, December 27, 2015

Our Year-End Letter, Part 2: The Economy

There's a saying a truism a strategy known to those in the attention-getting business: It's used instinctively by little kids, deftly applied by certain political candidates and utterly mastered by some folks connected to the world of money and economics; it's called "Any Publicity is Good Publicity" (we'll say "attention" with regard to kids)---be it good, bad, correct or not.

Over the past few months I've been asked what I think about the apocalyptic prognostications of (to name two)  Ron Paul and  Peter Schiff, and of the two-thirds chance of a 2016 recession prediction by Citigroup. As for Mr. Paul, he's always had a soft spot in my heart, for, like him, I am very sympathetic to the Austrian brand of economics (think Frederic Hayek [Road to Serfdom] and Ludwig Von Mises). As for his predictions, well, they're forever dire and, well, he's been making them forever. And I must say that his recent hookup with Porter Stansberry  disappoints me. As for Mr. Schiff, he too touts the Austrian theory and, yes, he too understands that any publicity is good publicity. Schiff has been promising runaway inflation and $5,000 gold for I don't know how many years (more than a few). I'm certain that far too many unsuspecting investors bought his story and invested accordingly. I wonder if he pays for security when he's out in public these days? I'll come back shortly to Citigroup's legitimate forecast.

I'll just sum up my view on unwavering prognosticators by re-sharing this brief 2012 blog post:

While, in the, following, I'm tough on Bill Gross [a truly gifted bond investor], my main point is to emphasize how the factors impacting the global economy are uncountable, let alone unpredictable, and, therefore, can make otherwise brilliant individuals look foolish when they attempt to foretell the future...
Beware the King(s)

The “King of Bonds”, Pimco’s Bill Gross, has given the world a priceless gift. He’s accomplished something other mortals have aspired to, but forever at the expense of their credibility. Thanks to Mr. Gross we finally know precisely what to count on, financially speaking, for the remainder of life as we know it on planet Earth. The guessing’s over. I suppose I should re-think my career path.

Apparently the past century of stock market gains and wealth accumulation was a “freak” anomaly, one to never be repeated. His incomparable (out of 7 billion) brain, has put all the pieces together. He has solved the great riddle; he has determined what he’s dubbed the “new normal”: That is, sub historical-average economic and asset-value growth, in perpetuity.

In essence; he knows precisely how all the world’s individuals will transact their affairs for eons to come.


He foresees advances in consumer technology,





and living standards in general.

old city

future city

He can predict the outcomes of political
power grabs,

political cartoon

weather patterns,

sunny day


and natural disasters.


And has gauged the precise impact of each on the global economy.

He has indeed solved nature’s great mysteries.


What forever baffles me is the correlation between the capacity for thinking and the lack thereof for reason. The sad thing (seemingly, but surely not in every case) being; the larger the capacity of the brain (or perhaps the academic achievement, or perhaps the professional accomplishment), the larger the ego – the larger the ego, the lesser the humility – the lesser the humility, the greater the God complex – the greater the God complex, the greater the following – the greater the following, the greater the damage when a black swan (a purely random event) falls from the sky.

As for Citigroup's 65% chance of a 2016 recession. Well---unlike Messrs Paul and Schiff---at least they left some margin for error. Citi's "rates strategists" are worried about China and I suspect a whole host of other things, but presumably their chief concern rests in the likelihood that one of history's best recession signals is going to turn red far earlier than most folks expect. It happens to be an indicator that I closely monitor---it's the treasury yield curve.

Recessions tend not to occur until after the yield curve inverts---that is, when long-term bond yields fall below short-term bond yields. When, in essence, investors pile into longer-term bonds (sending prices up and yields down)---because they see economic pain ahead and want to lock in higher yields before they plunge under the weight of the coming slowdown.

The white  line in the chart below represents the 3-month treasury bill yield, the green represents the 10-year bond yield, and the red outlines past recessions. The arrows point to each time since the late 1960s that the 3-month yield surpassed the 10-year (times when the curve inverted). As you can see, 8 of the past 10 inversions were closely followed by recession. What Citi's analysts are essentially saying is that the Fed is entirely wrong in their assessment of the economy and that by raising short-term interest rates they will manufacture a downward sloping curve. And, thus, usher in the next recession:     click to enlarge

Inverted Yield Curves

As you see at the far right, the present picture looks fairly tame. We'll see how good (lucky) Citi's experts are in the coming 12 months.

Oh, if it were only that easy; if all we had to do was watch the yield curve and adjust accordingly the minute it inverts my job would be cake.

While I have no doubt that Citi's team comes highly credentialed, I do, at this juncture, doubt that we'll be congratulating them on their predictive prowess anytime soon.

Here's a bit of the data that (along, ironically, with the yield curve), for the moment, keeps me out of the recession camp:

Weekly Jobless Claims


Auto Sales:

Auto Sales

Housing Starts:

Housing Starts

The Chicago Fed Financial Conditions Index

Chicago Fed Financial Conditions Index

The St. Louis Fed Financial Stress Index

St. Louis Fed Finl Stress Index

The Kansas City Fed Financial Stress Index

Kansas City Fed Financial Stress Index

The Cleveland Fed Financial Stress Index

Cleveland Fed Finl Stress Index

The Index of Leading Economic Indicators

Index of Leading Economic Indicators

Industrial Materials Prices

Industrial Materials Prices

If indeed Citi has it right, we'll have to rethink the business cycle going forward. In that we will have experienced an expansion that did not culminate with the usual bout of inflation, a breakdown in the indicators I just presented, and a period of leadership (in terms of investment gains) from those late-cycle sectors that we'll discuss in Part 3.

Wednesday, December 23, 2015

Our 2015 Year-End Letter, Part One

Wow! Here we are. I can’t believe it’s been a whole year since I penned last year’s year-end letter! Indeed, life is like a roll of toilet paper; i.e., the closer you get to the end the faster it goes.

So, let’s see, today is December 23rd… by the time I finish writing about the U.S. economy, the global economy, maybe a little on a few specific countries, on the Fed, on politics, on inflation, on commodities, on bonds, on stocks, on sectors, on and on and on, it’ll probably be New Years Eveish before I’m ready click the send button and deposit the link to this year’s opus into your email box.

Maybe I should mix it up this time and have it published in hard copy; send it to you as a late Christmas present---maybe you’re the nostalgic type who likes the feel of the pages between your fingertips. Maybe your idea of a good time is curling up by the fire with a treatise on the aforementioned topics---one the size of Gone With the Wind... Hmm… Nah…

Of course I know better. So much so that I’ve decided to really make this year’s compilation palatable---by not compiling it; by delivering it to you in relatively short, concise, hopefully appetizing slices. Beginning here with some basics…


I recently picked on the late Albert Einstein; suggesting that he either thought successful investors were utterly insane, or that he was oblivious to the fact that sticking to one’s discipline---essentially doing the same things over and over again and expecting that results will differ in the short-run---is the essential element to long-term investment success.

I addressed the fact that the past two years have been a virtual standstill for the portfolios of globally diversified investors. I suggested that, if asked to, I’d be happy to produce a few charts illustrating similar periods of the past. Well, nobody asked, which means you are all either very patient, very comfortable with the work we do (talking to our clients of course), didn’t even read the commentary in question, or any combination of the three.

I, alas, really wanted to say that I produced the following charts upon request. Oh well…

We'll begin by taking a look at the New York Stock Exchange Composite Index from 12/31/2013 to the present:

click to enlarge

NYSE FLAT 12-2013 TO 12-2015

Yep, nothing! Well, okay, a lot if you look at all the ups and downs---but nothing in terms of growth over the past two years.

Per my December 20th commentary, too many individual investors left to their own devices would be throwing in the towel right about now, if they hadn’t already. Here’s that short essay in its entirety:
In yesterday’s commentary I touched on Einstein’s insight into an aspect of human nature that can kill one’s odds of achieving long-term investment success:

“Human beings must have action; and they will make it if they cannot find it.”

In last Monday’s Wall Street Journal, Wesley Grey made the point beautifully. Here’s a snippet (HT Jeff Miller):

Imagine the following theoretical investment opportunity: Investors can invest in a fund that will beat the market by 5% a year over the next 10 years. Of course, there is the catch: The path to outperformance will involve a five-year stretch of poor relative performance.  “No problem,” you might think—buy and hold and ignore the short-term noise.

Easier said than done.

Consider Ken Heebner, who ran the CGM Focus Fund, a diversified mutual fund that gained 18% annually, and was Morningstar Inc.’s highest performer of the decade ending in 2009. The CGM Focus fund, in many respects, resembled the theoretical opportunity outlined above. But the story didn’t end there: The average investor in the fund lost 11% annually over the period.

What happened? The massive divergence in the fund’s performance and what the typical fund investor actually earned can be explained by the “behavioral return gap.”

The behavioral return gap works as follows: During periods of strong fund performance, investors pile in, but when fund performance is at its worst, short-sighted investors redeem in droves. Thus, despite a fund’s sound long-term process, the “dollar-weighted” returns, or returns actually achieved by investors in the fund, lag substantially.

In other words, fund managers can deliver a great long-term strategy, but investors can still lose.

Yep, those stretches of poor/flat performance can drive a person insane!

So here’s a look at what waiting out those flat periods of the 80s would’ve delivered to investors who---unlike those who traded the CGM Focus fund during the 00s---had stayed with their discipline:

click to enlarge


Here’s the 90s:


So, now you’re thinking that periodic dead zones are always followed by stretches of great results. Well, look what happened after the flat periods that occurred from 1999 to 2001:

NYSE FLAT 1999 to 2001

Can you imagine? Waiting patiently, maybe having studied the 80s and 90s, and then experiencing the bursting of the 90s tech bubble!

Well, that’s what we did, while convincing clients who were still working to not only continue funding their retirement program’s, but to take full advantage of that bear market by increasing their contributions if they could. And while rebalancing (buying on the way down) the portfolios of retired clients who had enough fixed income exposure to continue their retirement distributions without having to sell stocks during a down market.

Then the ensuing rebound:


Which included a flat stretch, that was followed by a bear market for the ages:

NYSE FLAT 2005 TO 2008

Repeat the above "Can you imagine?" paragraph here; replacing "tech bubble" with "real estate/mortgage bubble".

Then the ensuing rebound (taking us to 2015):


Which included a few flat stretches:

NYSE FLAT 2010 TO 2012

And, again, here we sit today:

NYSE FLAT 12-2013 TO 12-2015

In case you're wondering, the NYSE Composite Index was at 585 when our story began. It sits at 10,258 today.

So, going forward, what should we expect from the market? I wish I knew. I can make a compelling case for either direction (in the near-term) from here.

As I’ll illustrate in another section soon, U.S. stock valuations, in the aggregate, are not presently compelling (which is cause for concern). However, the near-term odds of recession are slim and sentiment kinda stinks (which, believe it [the latter] or not, are two reasons to relax).

I personally find great comfort in the simple fact that the success of our typical client’s long-term portfolio is tied to the fortunes of literally hundreds of the world’s very best companies. The vast majority of which will be profitably selling their wares to a world of desiring consumers for eons to come, while paying dividends to their shareholders (and/or buying back shares and/or buying other companies) regardless of what their stock prices do along the way.

Here’s a snippet from a recent essay where I drove that point home:
Tell me you’re not at least a little nerve-wracked over the stock market these days. I’m not hearing anything because you can’t tell me that. As much as we know that equity investing is a long-term affair—and that volatility is inevitable—let’s face it, when it’s “bad” it stinks!

When the stock market’s “bad” we wish we weren’t in it. When it’s “bad” we’re sad.

When our clients take a look at their monthly statements—or, worse yet, when they daily pull up their accounts online, they, save for a few, don’t see the individual companies they hold. They see the names of funds that  assemble the stocks of the individual companies they hold; names that aren’t what you’d call “household”—names that don’t engender any pride of ownership.

So, while we may be sad when the market’s “bad”, would we indeed be as sad if we knew we owned a company that has a couple hundred billion in cash and utterly dominates the world of wireless devices—even when its share price is in decline? Well, we might, but we shouldn’t. How about if we owned the retailer that is largely responsible for the pain dealt to the market this week by the likes of Macys and Nordstrom? We might, but we shouldn’t. How about if we owned the world’s largest and most profitable banks? The chip maker that dominates cloud technology? The leader in home improvement goods? The place where you connect with hundreds of friends you didn’t know you had? The company run by the world’s most successful investor? Again, we might, but surely we shouldn’t.

If you’re our client, here—in order of their weighting (taken from a representative client account)—are the top 25 companies (out of hundreds) you hold.

Apple Inc
Microsoft Corp
Amazon.com Inc
General Electric Co
Wells Fargo & Co
Chevron Corp
JPMorgan Chase & Co
Exxon Mobil Corporation
Alphabet Inc Class A (Google)
Comcast Corp Class A
Home Depot Inc
Citigroup Inc
Facebook Inc Class A
Monsanto Co
Cisco Systems Inc
Oracle Corporation
Berkshire Hathaway Inc Class B
Alphabet Inc Class C Capital Stock
Bank of America Corporation
Medtronic PLC
Visa Inc Class A
Procter & Gamble Co
Intel Corp
Boeing Co


Being in a position to own 25 companies that the world assigns over $2 trillion of its annual spending to is, you must agree, a pretty enviable position to be in—even during those inevitable stretches when their share prices are trading lower. I.e., those visions of destitution your brain conjures up during market selloffs simply do not jibe with the undeniable fact that the institutions you own ain’t going nowhere!

And to close this chapter: If, assuming you’re still awake, you need more convincing that the end of the world stories that certain blokes love to tell via the media should be digested with your proverbial grain of salt, this short one from last month ought to do the trick:
It Ain’t Easy Predicting Bear Markets

My charge as counselor to the folks who entrust their portfolios to our firm is to teach them how to think like long-term investors, which, in today’s media-rich world, can be quite the task. When pundits who—by nature of their media exposure—have to know what they’re talking about tell us that there’s a “99.7% chance we are in a bear market”, that “the S&P may fall further 10-15%”, that we should go “long bonds and short stocks”, that there’s “danger ahead”, that “equities have another 10% to fall” and that “now is not the time to buy”, it can be tough for little old me to convince our clients to buy and/or hold stocks through the inevitable fluctuations that are part and parcel to the business of long-term investing.

In showing this chart (click to enlarge) exposing the recent miscalculations of today’s media darlings, I in no way want to suggest that these chaps are always wrong. I have no doubt that they’ve made some very impressive calls during their careers that have ascended them to their present perches.


When Carl Icahn (arguably one of the world’s best investors) issued his “danger ahead” warning, he said that experts like himself should’ve helped the little guy by sounding the alarm ahead of the 2008 bear market. Problem is, he didn’t see it coming either, the hedge fund he managed took a 35% hit that year.

It’s gotta be tough being a prognosticator, especially when notoriety comes only when you accurately predict a bear market. The visual below (click to enlarge) tells why predicting higher stock prices doesn’t garner much attention, it’s easy. Stocks tend to rise over the long run. Guessing the red, on the other hand, ain't.

bull & bear market chart

I’ll be back soon with more.

Merry Christmas my friends to you and yours!


Monday, December 21, 2015

A Top Analyst Who Shares (some of) My Views (video)

If you’ve been reading and listening to my stuff this year, the following from Jim Paulsen (Wells Capital’s Chief Market Strategist) should sound familiar.

Not so much his trading advice, or prediction for the U.S. market next year, but his disappointment with the quick bounce back from this year's correction, his comments regarding pricing pressures (inflation), his assessment of where Non-US equities have been as well as their potential going forward, and his opinion with regard to the dollar next year (which is very much out of line with the current consensus):

Friday, December 18, 2015

Weekly Update: Another, Better, Black Friday!

Wow! Two Black Fridays in one season! And while everyone marveled at the deals to be had on that fateful day after Thanksgiving, the second one, yesterday, was really the one to behold!

I had only a single meeting yesterday so I got to sit back and watch sellers slash their prices in a most desperate fashion. The sales were utterly ridiculous! Well, ridiculous compared to what they were charging the day before. Yep, the stock store decided to throw up a surprise sale and blow out its inventory at whatever prices it could fetch.

I mean Apple was going for $106; it was like $115 just the other day---back in April you had to pay $134. Crazy! There was a fire sale on Disney as well; $107 a share! It was $114 day before yesterday! Back in August you couldn't get any for less than $122! Again, crazy!

So a couple of Apple's component suppliers lowered their earnings guidance---fanning those flames of fear that smart phone growth in China may be waning. Add to that the fact that those who chart the share price find it breaking some "resistance level" and you'd think the whole world forgot about how the whole world will be buying (and, not to mention, upgrading) smart phones far into the future. Check it out:     click to enlarge

Smart phone growth emerging mkts

And Disney, geeze! Star Wars is about to demolish every movie-going record known to man. Imagine the franchise to come! And, Friday at least, its shareholders freaked out over one analyst's downgrading of the shares and assigning them a $90 price target. This particular bloke believes ESPN subscribers (a serious source of revenue for Disney) are about to unplug in droves. I don't know, but I'm more than happy to hold the stock and wait and see. I'm thinking the force will be with Disney for years to come.

So what gives? Those smart phone concerns weren't conjured up yesterday, we've heard that argument for months. Same for the ESPN worries. Well, like I said in yesterday's commentary, Friday was messy: I suggested that during the season of low trading volume (the Christmas season) prices can range in a big way, and that that was a reasonable explanation for the depth of Friday's decline. Well, I gotta completely take that one back: In the two hours following yesterday's audio, volume absolutely exploded! I mentioned that, at the time of my recording, Facebook had traded 7 million shares, while its average daily volume of late has been 27 million. Well, by the end of the day it had traded a total of 36 million shares. The commodity stock I mentioned (which happened to be Freeport-McMoRan) ended up trading more than twice its daily volume. 96 million shares of Apple changed hands versus average daily volume of 46 million. And Disney shares traded at 3-times their normal pace. So, no, yesterday wasn't about lack of attention after all.

So what was it? Did the "market" suddenly change its mind about what the Fed rate hike means going forward? Too soon to tell (although I would classify the week's action by sector as being somewhat defensive [as in fear of an economic slowdown]). Was it oil? Well, I heard that a lot yesterday, but no, not in my opinion. Was it because it was a big options/futures expiration day? Maybe a bit. Tax loss selling? Yeah, some of that I suspect. Technical (charts) weakness? Yep, there was definitely some of that.

Jim Cramer had an interesting take that hadn't occurred to me. He's thinking it was hedge funds making good on an avalanche of redemption requests. Here's from CNBC.com:
Jim Cramer could only explain the decline of the averages on Friday as a repercussion of being in the heart of liquidation season.

Liquidation season occurs when clients of poorly performing hedge funds ask for their money back. It tends to occur at the end of a quarter or year. In response, hedge funds must sell stocks in the open market to raise the money that needs to be returned to investors.

That means if a hedge fund performed poorly this year; it is probably flooded with liquidation requests right now. In fact, there have been more failed hedge funds this year than any time since 2008.

Hmm... that is interesting... I do know that anyone who had the "good fortune" to have been able to hire a David Einhorn or Bill Ackman (modern legends in the hedge fund business), to name only two, at the beginning of this year are less wealthy on paper far into the double digits (percent-wise) versus where they started when they joined the elite. So Cramer---himself being a former hedge fund manager---indeed may be on to something.

Oh well, all I know is that today some really lucky folks bought some really good companies on the cheap and, assuming they're really patient, are likely to one day be really happy they did. Really...

On that note---after hitting you with four commentaries in the past three days---I'm going to let you off easy and close up for the weekend. Plus, I'm saving up for the year-end letter(s)...

Hope you're thoroughly enjoying your loved ones this holiday season!

Market Commentary (audio)

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Thursday, December 17, 2015

Market Commentary (audio)

Where I say "500 Dow points" I'm referring to Mon, Tue and Wed in total...

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Tuesday, December 15, 2015

Thought of the day (audio)

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Sunday, December 13, 2015

Just do what comes naturally... Uhh.... maybe not!

In yesterday's commentary I touched on Einstein's insight into an aspect of human nature that can kill one's odds of achieving long-term investment success:
“Human beings must have action; and they will make it if they cannot find it.”

In last Monday's Wall Street Journal, Wesley Grey made the point beautifully. Here's a snippet (HT Jeff Miller):
Imagine the following theoretical investment opportunity: Investors can invest in a fund that will beat the market by 5% a year over the next 10 years. Of course, there is the catch: The path to outperformance will involve a five-year stretch of poor relative performance.  “No problem,” you might think—buy and hold and ignore the short-term noise.

Easier said than done.

Consider Ken Heebner, who ran the CGM Focus Fund, a diversified mutual fund that gained 18% annually, and was Morningstar Inc.’s highest performer of the decade ending in 2009. The CGM Focus fund, in many respects, resembled the theoretical opportunity outlined above. But the story didn’t end there: The average investor in the fund lost 11% annually over the period.

What happened? The massive divergence in the fund’s performance and what the typical fund investor actually earned can be explained by the “behavioral return gap.”

The behavioral return gap works as follows: During periods of strong fund performance, investors pile in, but when fund performance is at its worst, short-sighted investors redeem in droves. Thus, despite a fund’s sound long-term process, the “dollar-weighted” returns, or returns actually achieved by investors in the fund, lag substantially.

In other words, fund managers can deliver a great long-term strategy, but investors can still lose.

Yep, those stretches of poor/flat performance can drive a person insane!

Saturday, December 12, 2015

When Are We Going to Make Some Money? Successful Investors Are Insane! And Your Weekly Update...

The potential subject matter for this week’s update is so deep (voluminous) that doing justice to each relevant topic would require more of your attention than I dare ask you to devote less than two weeks before Christmas.

Therefore, I’m thinking I’ll simply list a few---and offer up a (I promise) brief summation for each. There’ll be much more in our forthcoming year-end letter.

Was last week’s stock market selloff really about:

1: oil,

2: risk in the high yield bond market, or

3: the looming Fed rate increase?

And when are we going to make some money?!?

So, was it oil? That seems to be what some really smart people think. And this chart of last week virtually proves them right:

The white line represents the S&P 500, the yellow is the price of a gallon of West Texas Intermediate Crude... click to enlarge...

SPX and OIL last week

Although, this more concentrated chart of the past 3 days tells a little different story:

SPX and OIL three days

And, as you can see in this year-to-date chart, sometimes oil and stocks tandem up, sometimes they don't.


So why do I continue to buck the consensus when, per chart 1, there’s probably sufficient evidence to make the case that, at the moment, oil and stocks are pretty darn correlated? Well, I’m about to backtrack on that a bit, but first I’ll reiterate what’s behind my resistance: While, yes, the U.S. energy complex has been a real source of capital investment the past few years and, therefore, the lack thereof indeed inflicts economic pain (particularly on the manufacturing sector, and certain regions), the net effect of energy cost savings to consumers (not to mention energy-guzzling industries) in a consumption-driven economy is an unambiguous net positive.

Now for my backtracking: You may be aware that high yield bonds are presently getting hammered. As it is, the biggest issuers of high yield debt (loans made to borrowers whose credit worthiness demands that they pay up for their debt) the past few years have been energy producers. As oil prices fall, so, literally, do the marginal producers. And as the marginal producers fall, so does their wherewithal to pay back their debt. And there’s a lot of that debt sloshing around these days. And if it all goes belly up at once, a market that still suffers some PTSD from 2008 might have a flashback (remember that mortgage debt mess?). And forward-thinking institutional investors might want to short stocks now just in case. Hence, the maybe stronger correlation than usual between stocks and oil these days. (More on high yield in a minute).

Ah, but wait a sec! If you buy into the correlation story, and you want stocks to go up, all this shuttering of capacity (as those producers pack it in) is music to your ears! For, as the chart below illustrates, less production (amid steady demand) ultimately means a higher price per barrel.

The white line is the Baker Hughes U.S. oil rig count, the yellow is the spot price of a barrel of West Texas Intermediate Crude:   click to enlarge


So are stocks suffering due to the rout in high yield bonds? Too soon to tell. But I will tell you that it’s not an across-the-board rout. As I suggested above, the principal drivers of the selloff in high yield bonds are energy/commodities companies and those with close ties; while the lower-quality debt issued by sectors that reflect the health of the consumer and the domestic economy—think financials, tech and media—are trading at perfectly normal levels. That said, the argument I presented above is certainly plausible.

So is the market tanking over the looming Fed increase? In my view, yep! Not that the other possibilities should be excluded. It’s just that they wouldn’t be nearly the issues were it not for the looming Fed rate increase. I.e., higher rates are supposed to mean a higher dollar (although I can debate that) and lower bond prices. And a higher dollar is supposed to mean lower oil prices, and lower oil prices spell disaster for the energy companies that issued high yield debt,  and, alas, monster problems for the buyers of that debt. Here’s from :
Back to why all the hullabaloo (around a tighter monetary policy): Less available money means less money chasing stocks, higher interest rates on fixed income assets (competition for stocks), higher cost of borrowing for companies (lower profits) and the higher cost of home and auto loans for consumers (less economic activity, and lower profits), which makes for nervous equity markets. Hence my lack of sympathy with the consensus view that the market is going to take the beginning of the next Fed tightening cycle in perfect stride—despite the still historically low range we’d be looking at.

Now, I’m not predicting that the market is about to come crashing down in some epic fashion (although anything can happen). I happen to be in the camp that believes the economy is indeed healthy enough to withstand a slow and steady increase in borrowing costs going forward. And if my camp has it right, stocks—with their attendant volatility—are probably okay for the time being. Although the market leadership (in terms of sectors) is surely to change as the Fed slowly exits the lowest interest rate policy since the beginning of mankind. And, again, I’m guessing the transition to the next phase might be somewhat rocky in the beginning.

And, at last, the question of the day: When the *&#! are we going to make some money?

Albert Einstein was a really smart guy. But I wonder if he was much of an investor… Although he did understand at least one of the key basics:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

But had he been a successful long-term investor, I believe he’d have committed to a different definition of insanity. His, as you know, was:
“The definition of insanity is doing the same thing over and over again and expecting different results.”

I’ve been looking for a follow-up quote that might suggest that he understood the ultimate secret to long-term investment success. Something like:
“Successful long-term investors are all insane, in that the secret to investment success is to have a discipline and to stick with it. I.e., to keep doing it over and over again.”

But, alas, nothing! Oh well, back to the issue: After a 2014 of flat to low single-digit results and, barring a monster Santa Claus rally, what looks to be a similar 2015 for global equity portfolios, when are we going see some real gains?

Well, you know that’s a question I can’t answer. Of course I can talk about valuations, interest rates, the economy, earnings prospects, currencies, sentiment, trends, technicals, liquidity, and on and on, and on—much of which I’ll be covering in the year-end letter—but all I can ultimately do is put the pieces together and opine on how they line up going forward. Which, if I did here, I’d be breaking the promise I made in paragraph two. Plus, I'm saving it for the year-end letter.

So, instead, I’ll leverage my experiences from 31 years of working with money and refer you back a few lines to what Einstein might’ve said had he understood equity investing.

As for our discipline: It’s to maintain global diversification, to never try and time the broader market, to rebalance periodically back to each client’s target mix (based on time horizon and temperament), and to periodically rotate, at the margin, among sectors/regions to create slight biases based on our view of the macroeconomic environment.

The past two years of marginal results (assuming nothing major for the balance of 2015) were anything but unusual. And, without knowing what the near-term has in store, I can say with confidence that to abandon a strategy that requires one remain exposed to the world’s best companies for the long-term would be sheer insanity for the otherwise long-term investor. I.e., employing the same strategy over and over again indeed leads to different results as market conditions change.

(As you might imagine, I could offer up charts ad nauseam showing previous two-year (or more) market pauses, or losses, followed by substantial gains [shoot me a message if you’d like me to]). 

Einstein, savvy investor or not, indeed had insight into why your typical individual---when left to his/her own devices---tends (per the studies) not to fare so well when it comes to investing:
“Human beings must have action; and they will make it if they cannot find it.”

In other words, impatience is a portfolio killer!

Friday, December 11, 2015

Mirror Image Fridays... Audio Commentary

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Wednesday, December 9, 2015

Market Commentary (audio)

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Tuesday, December 8, 2015

Market Commentary (audio)

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Saturday, December 5, 2015

Tickle Me Elmo and the Fed AND Your weekly update...

So it's all but guaranteed that, come December 16th, the Fed (short for the Federal Open Market Committee, or FOMC) will raise its target range---from 0.00-0.25% to 0.25-0.50%---for the interest banks pay one another for the short-term borrowing of the reserves they maintain at the Federal Reserve. Hmm... seems pretty benign don't ya think? If so, then why all the hullabaloo?

Well, let's consider what the Fed actually has to do to get that benchmark rate off of zero.

You might be thinking that Janet Yellen and crew control the Fed funds rate by simply telling banks how much to charge each other. Nope, not that simple. You see, money is essentially a commodity and, like other commodities, the law of supply and demand dictates its price. But whereas the supply of most other commodities is influenced by demand in the marketplace, the supply of money (that banks hold on their balance sheets) is influenced by the Fed's desire to influence demand in the marketplace.

The Fed is kinda like the Organization of Petroleum Exporting Countries (OPEC). OPEC has its members who influence the price of oil by controlling its supply. The Fed has its members who influence the cost of money by controlling its supply. When OPEC wants the price of oil to rise, it lowers the available supply. When the Fed wants the price of money to rise, it lowers the available supply. For when a constant, or rising, demand for any item meets with a reduced supply, the item's price naturally rises.

Like when the supply of Tickle Me Elmos ran short during the 1996 Christmas season, the originally-priced- $28.99 spasmodic muppet toy was going for thousands via the internet.

Of course we know why the likes of OPEC, or a toy company, controls the availability of its wares, but what inspires the Fed to control the availability of money? Well, it's that the Fed is held to a mandate that requires that it influence the price of oil and the price of plush children's toys.

Think about it: In the Tickle Me Elmo example, the price rose because the available pool of desiring money was far greater than the available pool of red ticklish muppet toys. Therefore, their price shot through the proverbial roof (they call that inflation). Now expand your thinking to the economy overall. If money is super cheap and easy to get, it'll get got, and it could potentially (after a fashion) get spent at a pace that could send overall inflation off to the races (I call it the More Money Wanting Elmos Than There are Elmos phenomenon). History is replete with characters in control of printing presses who got way out over their skis and caused avalanches of inflation. Again, today's Fed has a mandate that says don't you do that.

So then, if the Fed fears that money is cheap and available to the point where the price of a toy, or toothpaste, might accelerate to the extreme, it'll cut its available supply (resulting in what I call the Less Money Available to Buy Elmos, Which Keeps Elmos in Stock at a Reasonable Price phenomenon)---which, as borrowing banks then clamor for access to a smaller pool of money, pushes up the pool's price. 

The Fed closely monitors the process and gently tickles the supply of money to maintain the price (interest rate) range its after.

Back to why all the hullabaloo: Less available money means less money chasing stocks, higher interest rates on fixed income assets (competition for stocks), higher cost of borrowing for companies (lower profits) and the higher cost of home and auto loans for consumers (less economic activity, and lower profits), which makes for nervous equity markets. Hence my lack of sympathy with the consensus view that the market is going to take the beginning of the next Fed tightening cycle in perfect stride---despite the still historically low range we'd be looking at.

Now, I'm not predicting that the market is about to come crashing down in some epic fashion (although anything can happen). I happen to be in the camp that believes the economy is indeed healthy enough to withstand a slow and steady increase in borrowing costs going forward. And if my camp has it right, stocks---with their attendant volatility---are probably okay for the time being. Although the market leadership (in terms of sectors) is surely to change as the Fed slowly exits the lowest interest rate policy since the beginning of mankind. And, again, I'm guessing the transition to the next phase might be somewhat rocky in the beginning.

My challenge as an investment counselor is to find where the opportunities lie under a monetary regime different than the one we've experienced during the past 6 years+. And, thus, to---at the margin---exploit those opportunities in a manner that improves the performance of our clients' portfolios without taking undue risk.

So, should the Fed indeed take the barely-inclined exit ramp and begin tickling the market with slightly higher rates, and should the economy continue to chug along---with an arguably tight labor market ultimately pushing up on wages, and an arguably loose commodities market tightening up on production---we should begin thinking about what the sector, asset class, and geographic leadership is likely to look like going forward.

And that's what I've been up to lately. In the following I chart what I identify as the 8 Fed tightening cycles over the past 40+ years (where there were merely slight pauses in the pace of Fed rate hikes I combined what others might deem to be two separate cycles). My objective is to identify how different areas of the world and areas of the equity markets tend to respond to a tightening U.S. monetary policy.       

Click to enlarge...

FED HIKES-1 12-31-1971 TO 06-28-1974FED HIKES-2 03-31-1976 TO 03-31-1980FED HIKES-3 06-30-1980 TO 12-26-1980FED HIKES-4 03-31-1983 TO 09-28-1984FED HIKES-5 03-31-1987 TO 03-31-1989FED HIKES-6 12-31-1993 TO 3-31-1995FED HIKES-7 03-31-1999 TO 06-30-2000FED HIKES-8 03-31-2004 TO 06-30-2006

As you gathered from the charts, and as you'll see in the following table, history suggests that a tweaking toward more exposure to non-US markets and commodities (and/or commodity-related stocks) would have delivered very nice dividends to the patient investor's diversified portfolio.

Note: The data back to the early '70s was only available for the U.S. market (S&P 500), developed non-U.S. markets (EAFE), commodities, transportation stocks and utilities. We, therefore, have to be careful drawing conclusions from the performance of, say, technology stocks. The data on the S&P Tech Index was only available for the past three rate hikes, two of which occurred during the expansion of the '90s technology bubble.       Click to enlarge...


So (you clients) there's your primer for our upcoming portfolio review meetings.

Have a Wonderful Weekend!


Friday, December 4, 2015

Market Commentary (audio)

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Thursday, December 3, 2015

Market Commentary (audio)

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Tuesday, December 1, 2015

Market Commentary (audio)

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