April 2018

Stock Market Observations 

The S&P 500 closed down for the quarter, 1.2% and -2.69 % for March. Sentiment and prices peaked at 2872.87 on January 26th. U.S. 10-year note yields made their highs on Feb. 21 at 2.94% and closed the first quarter at 2.74%.

Euphoria over tax cuts and rising earnings in January have faded. Concern over trade wars with China, NAFTA and a slower global economy have taken over the news. Negative reports on tariffs and response to tariffs has sunk sentiment along with investor confidence. After passage of the Omnibus budget, deficits are sure to increase, Treasury bond sales will expand and the Fed will not be there to pick up slack as they run off their balance sheet.

U.S. stocks are undergoing a period of correction and global markets have gone along for the ride. European stocks trail the U.S. market.

Emerging markets plus Asia are somewhat better due to faster growth and lower P/E multiples. China appears ready for the tariff battle should it escalate. We await Q1 earnings reports and subsequent conference calls to flesh out future business prospects. A risk off atmosphere is manifesting itself with the rise of gold prices and a rise in long term government bond prices that began on Feb 22. AGG-iShares Core Aggregated Bond ETF started the year at 109.32 and now traders at 106.9. The yield there is 2.73% with nearly 6 years duration on that portfolio. Today a 2-year Treasury note yields 2.27%, with the 10 year at 2.76%, the spread between the two has narrowed to 49 basis points. A flattening yield curve is concerning for bank profits. Banks prefer a rising rate environment, along with a steepening yield curve.  Today's 30-year UST's yield is 3.0%.

S&P 500 earnings estimates for 2018 remain in the area of $154.00. This translates to a 5.9% earnings yield and a P/E ratio of 16.9x on a 2600 base for the index. On an historical basis P/E s are on the high end of their range. Compared with the "risk free" yield of 2.76% on 10-year governments, stock prices are not excessive. If we devolve into a global trade war all bets are off. We will experience a peak in earnings and global GDP. If market leaders give more ground, market averages will follow suit. Hopefully, negative rhetoric cools down and negotiations on trade make progress and stock will rise after a normal, though painful, 10% setback. Mid-term election years are known for below average returns, 2018 may be no exception. Trade negotiations are ongoing and a 60-day period has begun to strike a deal with China. NAFTA is on a tighter timeline.

Financials are the second biggest sector in the SPX only exceeded by Technology which is suffering from a new set of problems including regulation fears, market dominance and trust issues. 

In 2000, when Technology last reached these levels, profits were only 13% of the SPX, now they are 23%.  Nevertheless, profits and market capitalization are heavily weighted in growth stocks versus the broader market.

The top 3 stocks in the S&P 500 are worth $2.2 trillion while the entire Russell 2000 Index is valued at $2.5 trillion. Top 10 stocks in the SPX are worth $5.1 trillion. The top 50 stocks are 50% of the total index value.

Volatility, which had gone away in 2017, has returned. VIX spent most of 2017 around 10 and is now 21, having burst over 50 on Feb 6 of this year, in a flash crash of stocks and reverse VIX, ETF's. 

Communication is for informational purposes only & doesn't constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current, or complete, and such information is always subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written about the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed.

March 2018

February was a tough month after a strong start in 2018.

The SPX lost -3.9% in February, its biggest monthly loss since February, 2016 and the first monthly decline in 11 months. However, the month close was still +7% above February's intraday low and +5% above the lowest close. A close under 2673 at the end of March would mark the first negative quarterly performance in 11 quarters. March has been a decent month in recent years, however, with 8 of the past 12 posting gains and the biggest loss being just -1.7% (the other three declines were all less than -o.65%). Better yet, April has been higher 11 of the past 12 years, although the last 4 gains were all under +1.0%.

Bull markets don't go straight up and they don't end solely on lofty valuations.
Volatility is back, people are nervous but not panicking with the more frequent declines mixed with rallies. As Yogi Berra once said, "it ain't over till it's over." 
If they rang a bell we haven't yet heard it; we are always listening and watching for signs of a top.
With earnings estimated to reach $158 up 19% and ten year note at 2.85% we believe there is more left to this rally but it may be a rocky climb.

∙Concerns over tariffs on steel and aluminum bring on fear of trade wars.

∙The new Fed Chairman Mr. Powell is untested.

∙Global conflicts abound.

∙President Trump is still subject to a Special Counsel inquiry.

∙Volatility is back.

∙The markets are still climbing a wall of worry.

Communication is for informational purposes only & doesn't constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current, or complete, and such information is always subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written about the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed.

February 2018

January got off to a roaring start with the S&P 500 making record highs closing up 5.6% on the month.  Suddenly on Friday February 2, we saw the DJIA plunge 666.75 points in a session. The biggest one-day plunge since the June 2016 Brexit vote when the U.K. decided to leave the European Union. As Mark Twain famously said," history doesn't repeat itself but it often rhymes."

From the bottom of 666.69 on the SPX in March 2009. the stock market has rallied over 9 years to the January 2018 highs of 2872.87. Quite an amazing run from the panic lows of the Great Recession. On Feb 2, the U.S. ten year note yield reached 2.84% up from the 2.4% year end of 2017 and up 39 basis points over the past one year. The one-year T Bill yield is 1.87%, two years note 2.14% and thirty-year bond yield 3.09%. Notice that the 2 year ten-year spread has widened to 60 basis points which some view as a healthy sign for the economy. Spreads in high yield junk bonds hover about 350 basis points over same maturity U.S. Treasuries which is nowhere near attractive or "normalized."

So why did investors pour $100 billion into equity funds in January, the biggest monthly flow ever, according to fund tracker EPFR Global?

Friday's better than forecast jobs report saw wage growth accelerate to 2.9% year over year. Unemployment is now 4.1 %, Q 4 GDP was estimated at 2.6%.

Given last week's drop in the SPX, stocks are still up 3% after a rise of about 20% in 2017. We have not seen a 5% correction in over a year.

Earnings season is in full swing has 75% plus companies exceeding estimates and forecasting more growth ahead given the new 21% corporate tax rate.

Big Questions in Investors' Minds:

Will rates continue to rise?

Will stocks fall harder from these levels?

Are my investments safe?

Do I own the right mix of stocks, bonds, alternatives and cash

to weather any storm?

People poured money into stocks this year. They became very positive as measured by record levels of optimism recorded by Investors Intelligence, 66% Bulls and only 12.6% Bears. These levels have not been seen in 32 years.

Rates continue to rise with Fed Funds now expected to climb by 25 basis points perhaps four times this year for a total rise of 1.00%. Many experts forecast 3.00% to 3.5% for the ten-year U.S. note by year end. Bill Gross says we have entered a Bear market in bonds. Jeff Gundlach forecasts a 6% ten-year treasury yield a few years down the road.

Rates in Europe are rising as most economies in the EU improve while Quantitative Easing dwindles in Europe and ends in the U.S. Japan's QE policy continues unabated.

Stocks fear a spike in long term rates but gradually rising rates signal a growing economy. With that comes higher earnings.

Markets have gone for a record number of months with no 5-10% pullbacks, which cannot continue. A 5% correction which in past times we saw on average three times per year would bring the SPX to 2729. A 10% drop calculates to 2586. Again, the index peaked recently at 2873. 

Given record low level of volatility in 2017 which led to investor complacency, I would anticipate more 5 % plus drops in this new year.

A modest correction would reset the pervasive bullishness and give pause to the "melt up" crowd's predictions. It is time to take the market's temperature.

Trees do not grow to the sky, but there are positive earnings ahead with a rising economy and lower tax rates. S&P 500 estimates will go from $132 in 2017, to perhaps $153 in 2018 with rising margins. Preliminary estimates for 2019 are up to $165.

Fact Set has an 18x forward P/E on the market, well above the 15x five-year average. Earnings and revenues have come in above average for Q4-17.  Fact Set expects earnings growth of 13.4 % year over year. Double digit earnings growth should continue in 2018 at rates of 14.2 %-19.8% in each quarter of this year.

Risks for markets include an exogenous shock from abroad, a policy error by the FED which has a new Chairman and five new voting members. Finally, concern over a political crisis at home could upset this apple cart.

We believe it is time to review your long and short-term investment objectives to ensure your portfolio is in balance with your current needs and goals.

Communication is for informational purposes only & doesn't constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current, or complete, and such information is always subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written about the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed.

January 2018

In 2017, stock prices across the globe added more than

$9 trillion of market value. The S&P 500 finished 2017 at 2673, up 19.4%.

The S&P Global Broad Market Index gained 22%. U.S. 10 year Treasuries finished at 2.41% while

they began the year at 2.44%. Stocks rallied on earning increases, low interest

rates and an historic tax bill lowering rates for individuals and corporations.

Corporate tax rates go down from as much as 35%, one of the highest in the world, to 21%,

more in line with global competitors. Top rates for individuals go down from 39.6% to 37% and as low as 10% for low income earners. According to FactSet, the S&P 500 index calendar year

earnings growth was 9.6%, the highest annual growth since 2011. All eleven sectors are projected to report year-over-year growth in earnings; led by the Energy, Materials, and Information Technology.

Even as the Fed announced an unwinding of their expansive QE policy, stocks continued to rally.

With new leadership in place for 2018, Jay Powell, the recently appointed Fed Chairman is expected to raise the funds rate by 0.25% at least three times this year. The 5 year U.S. Treasury note at 2.44% increased in yield by 0.70% in 2017 which outpaced the 10-year note

yield now 2.44% by a considerable margin. The so-called flattening of the 2-10 yield curve,

currently +51 basis points, is closely monitored by market participants as an early indicator of future recession. Five of the last six times the 2-year treasury yield now at 1.93%, exceeded the 10 year yield the economy subsequently entered a recession. Foreign stock markets outperformed U.S. stocks as their earnings recovered and the dollar lost 14% versus the Euro, its worse year since 2003.

Emerging market stocks outpaced their developed country brethren in 2017. Despite negative headlines from North Korea, natural disasters at home and Russian collusion inquiries stocks rarely dipped more than 2%. Gold was up 13.6%.

Where do we go in 2018?

We remain in bull markets here and abroad.

Inflation, interest rates and future earnings are the keys to

further market appreciation. Fed policy is expected to hold steady.

Investors typically value stocks at 18.1x earnings when the

Consumer Price Index (CPI) stays between 0 and 2%.

Valuations normally drop as consumer prices rise beyond this level.

Central bank's in Europe, Japan and the U.S.  target 2% inflation

which they have struggled to achieve since the Great Recession in 2008.

With a +2-4% average CPI we have historically seen the 17.7 P/E multiple,

moving down to 14.7 P/E with a +4-6% CPI range.

The salient point is that unless we have much higher inflation the market

P/E multiple should hold in the current range barring a recession.

Bond investments appear to be more vulnerable than stocks in a rising inflation and rising GDP scenario. Earnings will continue to climb as GDP pushes above 3% and inflation gradually exceeds the 2%. We remain in a synchronistic global recovery despite concerns about trade wars.

The U.S. has taken a more aggressive foreign policy stance toward Israel, Iran and North Korea. ISIS has been defeated in Iraq. Saudi Arabia has a new leader challenging the old order. The EU will soon taper their QE monetary expansion following the U.S. Japan continues her QE policy at full tilt

as Adenomas is working in the land of the rising sun.

U.S. GDP and wage growth will be spurred by lower taxes, less regulation and increased capital spending, which increases productivity.

Lower unemployment levels have yet to push up wage inflation but as we dip below 4% this may change. After the tax reform bill was signed, many corporations  announced employee bonuses and wage hikes. Repatriation of $2-4$ trillion in overseas cash will lead to more capital spending, buybacks and higher dividends. 

Due to an accounting system that only Washington D.C. could create this repatriated cash counts as an addition to our deficit, as measured by the Congressional Budget Office. In fact, the cash coming back to our shores is a net boost to tax revenues as well as banks, consumers and investors.

Lower tax rates on U.S. corporations also brings jobs and profits home helping our trade deficits.

 Given the stronger economy our Fed will have a timely opportunity to pare down their $4 trillion balance sheet. Some forecasters believe earnings for the S&P 500 index will rise

into the $152.00-$157.00 zone in 2018 and over $161.00 in 2019.

Calendar 2018 estimates are now $146.59 according to FactSet before tax reform additions.

At 2730 on the index, we derive a 17.95 forward P/E multiple and a 5.55% earnings yield on a $152.00 estimate. While the multiple is at the high end of the historic range, prices are not excessive. Bonds appear less attractive than stocks and are likely to underperform again this year. We do not foresee a recession or an inflation spike in 2018. We do see better global GDP growth, rising wages, higher earnings plus, stronger employment. In sum, the table is set for climbing stock prices not withstanding higher interest rates. Money on the margin is more likely to flow into equities, out of cash and bonds.

We wish you all a happy, healthy and prosperous 2018!

Communication is for informational purposes only & doesn't constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current, or complete, and such information is always subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written about the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed.