The US economy continues to grow in a Global slow growth environment. The stock market pullback in January and February was an excellent opportunity for investors to buy stocks at a discount. Both U.S. presidential candidates express a need to invest in US infrastructure such as ports, roads and bridges. Government spending on infrastructure should provide economic stimulus over the next few years. The Federal Reserve is likely to increase interest rates and this will cause a volatile move in the financial markets. The Fed is starting from a very low level. It will be quite some time before interest rates rise enough to cause a slow-down in the real economy. Inflation is subdued and the Fed is cautious about raising rates.
Central banks in the USA, Japan and Europe have continued to provide a low interest rate environment. Banks and other financial institutions are typically required to hold a portion of their assets as government bonds. In Europe, the Central bank has been buying European government bonds and the bonds of large companies. This has resulted in banks, insurance companies and pension funds buying bonds with extremely low or negative interest rates. This is meant to stimulate the European economy but is an experiment. The British vote to leave the European Union adds more uncertainty to the financial industry. Theresa May, the new British prime minister, announced that the U.K. will begin the exit process in the first quarter of next year. The British Pound broke a new price level this week and continues its slide downward against the U.S. dollar and the Euro. The graph below shows the plunge of the Pound vs the US Dollar. The graph covers 23 years and the right side shows the Pound dropping over the last six months.
G.B. Pound vs. U.S. Dollar:
It is interesting to look at price trends over the last 20 years. Commodity prices such as oil, gas, wheat, rice and cotton fell dramatically.
Clothing costs declined over that period due to low-cost imports and automation. Medical costs and other consumer service costs went in the opposite direction and doubled over the period.
How have stock investments performed over this period? It is instructive to look at the performance of the advanced economies of the U.S.A. and the Euro zone. America’s S&P 500 stock index was stagnant from the year 2000 to 2012 reflecting the two big recessions in 2000 and 2008. The stock index is now in an up-trend and has hit new price highs.
In contrast, the top 50 European stock index, priced in Euros, is still in a trading range. It is at the same price level as it was in 1998, eighteen years ago. America has a dynamic economy. The rising equity market is a good indicator of America’s strength.
Euro Stoxx 50 index:
The companies we invest in are typically valued at a low price to their earnings and relative to the market and historically these types of companies appreciate well. Many pay high dividends which is great in this low interest environment.
Global equity markets have been selling off. The chart shows the equity price decline, in dollars, of stock markets in U.S., Europe, China and Brazil over the last twelve months. The American market, the S&P 500 index in the chart, has been the most resilient with a -9.9% decline vs. much larger declines in other markets.
What are the concerns?
- Although the Chinese economy is still growing, it is doing so at a slower rate as it attempts to transition from a manufacturing to a consumer and service driven economy. The emphasis on manufacturing and export has lead to an over-investment in factory capacity. The suppliers of raw materials to China, such as Brazil, have been hit hard by this slower growth and transition.
- The European economy is growing and is recovering from its painful adjustments to the debt crisis in Greece, Spain, Italy, Ireland and Portugal. The Euro zone purchasing managers index (PMI) at 52.3 remains above 50 indicating continued growth. They are now grappling with the influx of refugees from Syria and North Africa.
- What about the good old USA? Our PMI is at 48.1, down 3 months in a row from 50.1 in October suggesting a slowing economy. We have had PMI readings below 50 briefly in the last 5 years and the economy continued to grow. The PMI gives an indication of current conditions but is not necessarily predicting the future. We currently have a robust economy with a low, 4.9 % unemployment rate and a low inflation rate of +0.7 %. Although the Federal Reserve Board has begun to raise short term interest rates, the increase has been minimal and they are likely to put off further increases in the face of slow global growth. The U.S. dollar may continue to strengthen as the European Central Bank “prints money” to stimulate their economies with a policy of buying bonds called “quantitative easing”. A higher dollar makes U.S. exports more expensive.
- Oil prices have collapsed and further supply is likely to enter the market with the Iran nuclear deal allowing Iran to export oil above board. Low oil prices are the result of both over-supply and a lack of demand. The low oil price impacts the oil companies in the U.S. and their suppliers and local economies, as well as, oil producing countries worldwide. They will lay off workers and stop buying capital equipment. This is a drag on the economy of the U.S. and other oil producers. The flip-side is that low oil and gasoline prices act as a huge tax cut for consumers and businesses and should stimulate economies. One example of a direct beneficiary of cheap oil is the airline industry. Airlines are booming as low fuel costs have improved their margins and profitability. Plus, consumers have more money to spend and can travel more.
The media are filled with stories about the potential for recession due to the Global slowdown. We make no predictions. The World economy is complex and the future is unknowable… until we get there. However, when markets sag and manufacturing slows, it can be prudent to raise cash levels and become defensive. We raised cash in December and early January.
Lower market prices lead to excellent buying opportunities. A defensive cash position allows investors to profit from lower stock prices when conditions stabilize. Historically, the best investments have been profitable company stocks selling at a reduced price relative to the overall stock market. We believe this will continue to be the best portfolio for long term portfolio growth. This is especially true after a market sell-off and stocks are “on sale” at bargain prices.
U.S. employment is trending in the right direction as shown by the fall in the unemployment rate in the graph on the left. Business conditions continue upward. The graph on the right shows business survey trends are positive in both the manufacturing and non-manufacturing areas. It is a good sign when the ISM indices are above 50.
The price of oil has dropped radically over the last seven months from $105 to $48 per barrel. This is partially a consequence of the huge increase in U.S. drilling rigs coming online over the last few years. The graphs below show the trend in drilling rigs and the U.S. share of global oil markets. The Saudis are allowing the price to drop by not cutting back their own oil production. Some speculate that the Saudis are trying to drive the marginal U.S. oil producers out of the market. Certainly, over time, U.S. and global energy firms will cut back on production and the price will stabilize. In the meantime, the drop in gasoline price is like a huge tax cut for U.S. consumers and should stimulate the economy.
The U.S. dollar has also increased in value relative to other currencies. The Euro has dropped from 1.39 to 1.06 over the last 10 months. America has the strongest economy at the moment. A strong dollar means lower inflation and lower cost imports for U.S. consumers but it will reduce demand for our exports. However, exports make a relatively small part of the U.S. economy. Europe continues to struggle with stagnant economies and the potential for an exit of Greece from the Euro. The Chinese economy is still growing but at a slower rate. They have a huge over-building problem in their property market. The slowing Chinese economy means lower demand for exports from the commodity producing economies of Asia, South America and Africa. The squeeze on Russia due to a lower oil price and sanctions from the West due to Russia’s actions in Ukraine may lead to further instability.
Although the U.S. Federal Reserve is likely to begin raising interest rates to try to normalize credit markets, they will do this slowly in light of the fragile global economy. Inflation is low and the Fed does not feel a need to tighten credit conditions significantly when the economy is not overheating.
The U.S. economy continues to improve.
Typhoon Haiyan crushed the island of Leyte. You can help by sending contributions to relief organizations. One non-profit I know well through my wife is KAHIUSA, a charity formed by the people from southern Leyte living in California. KAHIUSA has organizers on the ground with vehicles to move urgently needed food, medicine and materials to devastated areas. Here is their appeal for help:
It’s a comeback for the Ages.
The International sailing race, the America’s Cup, comes to an amazing finale today starting at 1:10 PM PST. You can watch it live on a free iPhone app or watch from the San Francisco Marina or the America’s Cup Park at Pier 27.
Emirates Team New Zealand was ahead of Oracle Team USA eight races to one. They only need nine races to win. In a miraculous streak (and a few boat and crew changes), Oracle Team USA won the last 7 races to tie the score 8 to 8. Amazing to watch! These catamarans are racing up to 40 knots. Today’s race will determine the winner.
Don’t miss this race!
Springtime is here and Bay Area weather is changing. Financial markets have seasons, too. They can arrive early or late in any given year, but we know they are coming. One is approaching right now, in fact.
You may have heard the saying “Sell in May and go away.” The idea comes from a historical pattern traders observed decades ago. Stocks tend to perform better in the colder half of the year. The six-month period from November through April is typically better than May-October. Many studies show that buying stocks around Halloween and selling at the end of April brings better long-term returns and/or reduced risk.
This pattern is not evident every year, of course. May 1 and October 31 aren’t always the magical days. Like the weather, stock market seasonality is variable. Sometimes we get a warm spell in autumn, or a cold day in spring. As Mark Twain observed, “The coldest winter I ever spent was a summer in San Francisco.”
How does the financial weather look this year? The report is mixed. On the bullish side, the Federal Reserve is continuing its “quantitative easing” efforts. By force-feeding new money into the markets, the Fed keeps interest rates low and subsidizes risk-taking. Banks are lending and the economy is growing, albeit slowly. Wall Street can frolic in the sunshine.
At the same time, a cold front could still move through with little warning. As noted above, a typically weak seasonal period is about to begin. Corporate earnings are generally meeting expectations, but the second quarter could be a different story. Washington is practically paralyzed by partisan bickering. Europe still has no solution for its debt crisis.
A summer rally is always possible. If I were a TV weatherman, I would say the roads are safe but bring a jacket with you. As an investment advisor, I have similar advice: stay invested but exercise caution. Avoid unnecessary risks. The weather could change quickly. Focus on the long-term and manage risk.
If you are like me, you focus… on your personal interests as well as your financial success. I am creating this series of articles, my thoughts, to inform and educate my clients and interested investors. I read voraciously every day. I stay informed of Global events and how they affect our financial future. I study history. More importantly, I read the published academic and professional investment literature to stay abreast of financial insights. There is a lot of good information out there.
I have conducted my own in-depth professional research in the behavior of markets and investing for twelve years. My investment studies cover value, growth, trend following, momentum, business cycles and risk management. It is important to use basic theoretical ideas and judge success with empirical evidence. My research involved creating many hundreds of hypothetical portfolios to test investment hypotheses. The studies have covered various time periods depending upon the availability of reliable data. Some studies go back to 1999, others to 1987. My earliest research goes back to 1915 to understand investment behavior through two World Wars, depression, the market euphoria of the 1920s and 1990s and the challenges of the recent decade.
I will also provide ideas on executive compensation, retirement and other topics from my studies in the Accredited Wealth Management Program.
I will try to give you useful insights. If you find my thoughts interesting, please let me know. Send me an email. If you would like me to discuss a particular topic, I would be glad to, if I have the knowledge.
Quality long-term investing for your financial success. That is my goal.
Thank you for reading.