Record Breaking Week

Only a few weeks ago, Hillary Clinton was viewed as the favorable candidate by Wall Street because she represented the status quo. On the other hand, Donald Trump was viewed more warily because of his negative views on free trade and unpredictable behavior.  Since the election, there are now more people hopeful that President-elect Trump can bring positive change. According to a new POLITICO/Morning Consult poll, Trump’s favorability has grown 9 points, 37% to 46%.

Wall Street has rallied because President-elect Trump has shown signs of softening his stances on many of his campaign promises, while keeping his pledge of reducing regulations and lowering taxes. Last Monday, all four major equity indices hit all-time highs for a first time since 1999. The Dow hit a new high of 19,000.

The bond market is not viewing Trump as favorable as the equity markets.  There has been over $1 trillion in global bond losses, as the 10-year Treasury yield has risen to 2.36% from 1.80%.  Global Bonds have not experienced this large a loss in 13 years. The 30-year mortgage rate has risen above 4% for the first time all year. If there was a daily index that tracked home prices, I believe that it might have dropped along with the bond market.

Bond investors are doubtful that President-elect Trump can pay for infrastructure, while at the same time, cutting taxes.  It is still unknown which policies will pass and how much that they will be able to stimulate growth. My biggest concern remains with the growth of the global economy. Global stocks have not participated in the rally and for good reason. The dollar reached a high not seen since 2002 because expectations are that the U.S. will grow faster than the world economy. Higher U.S. interest rates are also attractive to foreign investors as overseas rates hover near zero.

President-elect Trump is emphasizing American production and innovation. The slogan “American First” will be key to the Trump presidency. Many U.S. based companies will be pressured to move manufacturing back to the U.S.  Trump has already taken credit for keeping a Ford automaking plant in Kentucky and lobbying Carrier air conditioning to remain in Indiana. CEO’s of American businesses are on notice not to move production overseas. Republicans will be creating tax incentives so that U.S. companies will regain a competitive advantage to produce in America.

If the U.S. suddenly shifts towards a more isolated economy, there might be unintended consequences. Over the next 4 years, I believe that your investment returns will be highly dependent on whether or not foreign governments respond negatively to changes in U.S. tax and trade policy.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

Deficits in and Spending Restraint out

The markets are still digesting how a Trump economy will function. There are many economic questions that remain unclear. As I stated last week, these wild moves in the market may prove to be premature as actual policy remains uncertain. However, I’m still trying to answer these questions with limited information. Below are a few questions along with my responses, to give you a better idea of how I’m thinking on these topics.

  • How will the government fund $1 trillion in infrastructure spending? Through higher deficits.
  • Will a tax cut for U.S. businesses and repatriation of overseas cash result in job growth or result in more stock buybacks? More buybacks and possibly higher executive pay.
  • Will the personal tax cut benefit the richest 1% or trickle down to everyone? Wealth inequality grows.
  • Can Trump entice companies to move factories back to the U.S? Yes, jobs will be created in the Rust Belt.  America first.
  • Will there be a trade war/currency war with China and Mexico? Hopefully, not. It would be equivalent to economic nuclear war.
  • What will be the impact to the environment and the alternative energy sector if regulations are loosened? We all lose, especially the next generation.
  • Will the repeal of financial regulations cause another banking crisis in the future? Banks need to regulated. (see Wells Fargo scandal just last month. President Bush also learned this hard lesson in 2008. Heads banks win, tails banks win.)

My personal opinion is that the short-term economic picture is brighter, but there is now a greater chance that things get messy over the long-term. Trump is inheriting a strong economy, which is the exact opposite to how President Obama rode into office in 2008. In 2009, Obama said that “buying stocks is a potentially good deal”. He turned about to be a very good stock forecaster. On the other hand, Trump said last month, “stocks are in a big, fat, ugly bubble”. It is yet to be determined if he actually believes that the stock market is in a bubble, or if he was just trying to be “politically correct”.  If these comments do ring true, it will help to have active portfolio management and solid risk management over the next 4 years.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

President Donald Trump: Game changer

My grandmother is 105 years old. In her 90’s, she could name every single U.S. president. I never thought she would be adding Donald Trump to that list. I must have inherited my love of history from her. I’ve read over 30 presidential autobiographies. And yes, I hope to also be able to name all the U.S. presidents in my 90’s.

This week, $1 trillion of value was wiped from bonds, while global stocks gained $1.3 trillion. Investors scrambled to re-balance portfolios from the ‘Clinton’ portfolio to the ‘Trump’ portfolio. For those investors in a U.S. balanced portfolio, this week was almost a wash. The table below shows the weekly change of the potential winners and losers of a Trump presidency.

sectors-trump

These wild moves in the market may prove to be premature as actual policy remains uncertain.  President-Elect Trump doesn’t even know yet what he is going to be able to accomplish.  I believe that a Trump presidency just increased the level of risk in investors portfolios, but also the potential for higher returns.  Donald Trump‘s win on Election Day is no different than Britain’s stunning vote to leave the European Union. This global movement towards more isolationism will continue to spread globally. I expect more global uncertainty as this movement continues to unfold.

In September, Trump said that the Federal Reserve’s ultra-low interest rates created a “false economy” and that “at some point the rates are going to have to change.” He pointed out that the Fed’s policy created a speculative stock market bubble. Trump is going to have to change this rhetoric if he wants to accomplish his agenda. This week, the 10-year Treasury yield jumped the most in 3 years from 1.82% to 2.12%. The hope is that interest rates will remain low as overseas buyers step in to buy our Treasuries because their rates are closer to zero. Bond investors fear that his plan to stimulate the economy could result in a balloon to the budget deficit and an increase in inflation.

In the past, Congress has been reluctant to challenge the bond market’s power. James Carville, who was the lead strategist for President Bill Clinton, coined one of the best quotes that summarizes this point,

“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter,” he said. “But now I would like to come back as the bond market. You can intimidate everybody.”

I believe that the only thing in the world that can intimidate President-Elect Trump, is the bond market. His entire agenda from cutting taxes for corporations, changing the tax code, building walls, removing trade agreements, creating massive infrastructure spending, forcing companies to build factories in the U.S, and adding tariffs will not only need a check written by Congress, but it will also need the bond markets approval.  The early vote from the bond market isn’t looking positive. If interest rates rise sharply, Trump’s vision of a “false economy” better morph into a “real economy”, or the stock market will have disappointing inflation-adjusted returns in the years ahead.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

Election Anxiety

On July 25, 2015, I explained why the iPath® S&P 500 VIX Short-Term Futures ETN (VXX), which is an exchange-traded note, was destined to fail. This poorly constructed ETF is the worst investment that I have ever seen. The last line in my post was, “I’m just informing you that there will be a story one day on 60 Minutes about a few guys that bought an island from shorting this ETF.”

The VXX began trading on January 30, 2009, and it is down over an astounding 99.65%. It has had a 58% annual loss, which works out to an average loss of almost 7% per month. The VXX ETF has even dropped another 50% since the time of my post.

A few weeks ago, I participated on a conference call with the VXX Portfolio Manager, Head of Sales, and VP of the Chicago Board of Options Exchange. I was fascinated to learn that they viewed this product as purely insurance. You pay a premium to own it, and if nothing happens, you will lose money. This product is designed to help protect your portfolio from some losses in the event of a shock to the system.

I don’t think it was a coincidence that the timing of this call coincided with the presidential race. As the polls have tightened, the price of this ETF has risen 25% since Oct 24th. Investors are fearful. Another popular indicator that gauges investor fear is the market’s put-call ratio, and it’s at the highest level since the market crashed 15% at the beginning of the year. As the election nears, all the buyers have disappeared.  The S&P 500 wrapped up the week by posting it’s longest losing streak in 36 years (nine consecutive days of losses).

I expect that the VXX ETF to spike higher if Trump wins the election on Tuesday. The insurance will finally payoff. If Hillary wins, the VXX ETF insurance will once again become worthless. If you are anxious about the looming election, there is one quote that can help give you some peace of mind no matter your political affiliation. It comes from Warren Buffett’s mentor, Benjamin Graham.

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

In the short run, the market is hoping for a Hillary victory but it’s the long run that matters.  If a clear winner emerges on Tuesday night, the VXX ETF is indicating that the build up will result in either panic selling or a sharp increase in prices. A Hillary victory will see the VXX ETF collapse in price and markets will stage a relief rally. In the event of a Trump victory, there will be short-term losses, but it will be the weighing machine that matters over the months and years ahead.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

How do you insulate yourself from inflation?

The global bond selloff continued this week as investors speculated that the Fed will raise interest rates in December because of signs of inflation. However, if you ask the Social Security Administration, they see no inflation on the horizon. The cost of living adjustment (COLA) for 2017 benefits will only rise 0.3% due to the relatively low inflation rate. They obviously did not consider the 8% rise in health care costs, nor the over 40% rise in oil prices. But, I have noticed that the price of eggs is near 10-year lows.

My first suggestion to insulate from inflation is to eat lots of eggs. Overall, most food prices at the grocery store are lower, which is prompting consumers to cook more and sped less money eating out. Now if you don’t want to eat eggs, or rely on a bump in Social Security, or even eat at home, you can always select investments that benefit from a rise in inflation.

The general advice is to select the right mix of stocks and bonds. There has been no better inflation hedge than the stock market. Real estate has also kept pace with inflation over time. My clients that specialize in real estate are already talking about rising rents next year. On the other hand, REITs (Real Estate Investment Trusts) do very poorly when rates rise. The Vanguard REIT Index is down -9.12% over the last month.

The long-term rise of rates can also cause other “safe” investments to become losing propositions. I’ve written often how traditional low-risk investments have become the riskiest part of investors’ portfolios. For instance, the Vanguard Long-Term Government Bond Index is off -5.22% in the past month.

The new expectation is that there will be less central bank help next year and potentially more infrastructure spending from the government. This shift in policy has caused large investment losses in traditional low-volatility sectors. Investing in companies with pricing power is the best bet. These companies are able to raise prices with changing demand for their products. Even though I don’t own them, tobacco, commodity, alcohol, and firearm companies have historically had the most pricing power.

The sector that has performed the best over the past month are the Financials. Higher interest rates will help to increase their net interest margins. They can generally pass any rising funding cost on to consumers. Other less conventional investments include bank loans and high-yield debt. Bank loans will rise in price as LIBOR increases and High-yield bonds have more credit risk than interest rate risk.

Under these tough economic conditions there are no guarantees to hedging inflation. Diversification is the best advice to hedge inflation. So if you don’t want to stomach eating too many eggs, it will be best to spread the hedge risks across a variety of investments, and not put all your eggs in one basket.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment

Is stagflation looming?

On Thursday, the unemployment rate in Massachusetts hit a 15-year-low. The 3.6% MA unemployment rate is at its lowest since June 2001, while the national unemployment rate is hovering above 5%. The 3% real GDP in Massachusetts is much higher than the national real GDP of 1.2%. The US and MA labor markets have many structural differences. A greater percentage of jobs in MA are participating in the high growth engines of the economy areas such as health care, finance, and education.

Massachusetts has benefited from the explosion in the rising cost of health insurance, higher drug prices, technology advances, and rising cost of college tuition payments. In September, the prices for medicine, doctor appointments, and health insurance rose the most since 1984.  Pharma prices have increased on average by 5% in 2016.

On Wednesday, Kyle Bass, a hedge fund manager who predicted the subprime mortgage crisis in 2008, told CNBC that  higher prices and wages, combined with an overall sluggish economy are the ingredients for stagflation. I agree with his assessment that the current economic backdrop is beginning to look a lot like “stagflation”.  It is becoming much more difficult to attract qualified workers and employers are starting to feel the pressure of wage growth. These are all signs that higher inflation is on the horizon.

This economic outcome could become a burden for those in retirement or close to retirement. With interest rates near all-time lows and markets slightly off highs, Bass believes investors will have a hard time generating positive returns over the next few years. Growth may continue to stall if taxes increase, oil prices continue to rise, and the health care system is not fixed.

Other contributing factors to slower growth are changing workplace demographics and a smaller middle class. The workplace demographics is being impacted by the 10,000 baby boomers exiting the workforce each day between now and the end of the next decade. The middle class is shrinking due to rising inequality, where the top 20% of Americans own 85% of the country’s wealth.

CGF Advisor portfolio positioning:

  • Long-term bonds are vulnerable if inflation increases
  • Commodities and real estate have historically been a good hedge
  • Securities with higher dividend yields help to provide downside protection
  • Diversify dividends payouts through multiple types of securities – bonds, stocks, preferreds
  • Floating rate bonds can hedge interest rate risk
  • Increase credit risk with higher yielding bonds

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment

 

Health care and politics

Polls indicate that Hillary Clinton now has a 90% chance of winning the election. The fallout of Donald Trump is already having an impact on the markets. Health Care stocks (Vanguard Health Care ETF) plunged 4% this week as investors began to factor in a Hillary Clinton presidency. A few weeks ago, I wrote that markets prefer a split government. Stock market performance has been higher when one party has controlled the White House but not both chambers of Congress. The new concern is that Democrat’s have an outside chance of regaining control of Congress. The change in government would be disastrous for drug companies. Just the mention of a government official calling out a drug companies’ pricing practice will cause their stock to plummet. Yesterday, Bernie Sanders sent a Tweet on Ariad Pharmaceuticals (ARIA), and the stock price immediately fell over 11%!

No CEO wants to see their company lose 11% of its value because of a tweet. There has been a rampant rise of prescription drug costs to the tune of over $2 billion last year. Health Care inflation is out of control. The Affordable Care Act, has also caused premiums to rise for the middle class. Even Bill Clinton criticized Obamacare, calling it, “the craziest thing in the world.” It is too early now to judge whether or not this sell-off has been an overreaction, making this a great buying opportunity.

The meltdown of Donald Trump and his campaign has made this election cycle different than past elections.  According to a recent poll by ABC News/Washington Post, these two candidates are the two most unpopular presidential choices in more than 30 years of polling. I wrote a few weeks ago that I thought market reaction would be somewhat muted to the new presidency, but I’ve changed my view. An unexpected Donald Trump win, I believe would cause global markets to panic. Now that he is running as an anti-establishment candidate, without much support of the rest of his party, the uncertainty level of his administration is off the charts. You know it’s bad for the Republicans when my mother-in-law who has Fox news normally tuned on for 24 hours a day, can’t stand to watch. 

The negativity surrounding politics and corporate America now threatens to spill over into the broader economy.  Last Friday’s jobs report showed slower job growth in higher-wage industries. Businesses are becoming more cautious as managements are now taking a wait and see approach. Stocks fell this week to their lowest level since July as investors digested bad news coming out of China regarding lower than expected exports. We have entered third quarter earnings season and the estimated sales growth rate for the S&P 500 is 2.6%. It is no surprise that the Health Care sector has one of the highest growth rates of 7%.

I continue to believe that markets will remain very volatile. Many of the major U.S technology companies will be reporting a week before the election. While I do have high expectations for most companies to beat earnings this season, I have much lower expectations that politicians will be able to work together after this nasty election.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment

Is another interest rate hike coming?

In 2008 and 2009, the market was in the midst of a massive stock market meltdown and was on the verge of an economic collapse. Since that time, banks have recapitalized, market values have recovered, and consumer confidence is at a 9 year high. The recovery has largely been driven by strong corporate cash flows and stock buybacks. We have just experience an incredible innovative cycle of technology advances such as cloud computing, genetic engineering, artificial intelligence, the creation of an app economy, and the proliferation of smartphone’s.

There has been an ongoing debate about other reasons why economies around the world have rebounded so strongly.  How much of the economic expansion has to do with the creation of leverage and debt? Central banks around the world have issued a massive amount of debt into the system and companies have also raised money through debt offerings. Bloomberg reported the other day that the world debt level is at an all-time high of $152 Trillion.

Over the past two weeks, markets have begun to realize that central banks are going to be much less accommodating. There is a strong probability that the Fed will raise rates once again at the end of the year.  In my September 2016 outlook, I warned that Utilities, REITs, and Telecom stocks were acting as bond proxies because they pay above average dividends. Investors were starving for dividends which created a “yield bubble”. The air has gotten released from the bubble as the Utilities (symbol XLU) and REIT (symbol VNQ) sectors both have seen values drop more than 10% from their respective highs.

Up until now, the higher market valuations have moved in tandem with the issuance of new debt. Economic growth has been low, but there have been signs of inflation. Medical care costs are out of control and home prices have re-inflated. Also, commodity prices are back on the rise and skilled workers are becoming harder to find. In July, job openings hit a record high. The Fed has good reason to raise rates again. I don’t believe that the Fed will be able to raise interest rates without negatively impacting asset prices.

As the Fed increases rates, I’m less optimistic that investors will be able to harvest the same type of returns that they have experienced over the past 5 years. Without the extra liquidity, earnings growth may slow and markets are starting from higher valuations. If the pattern holds, the Fed raised rates at the end of 2015, and they will raise rates at the end of this year. Next year should play out as it did in 2016. There will much discussion about a third interest rate increase, but the Fed will wait once again until they are certain that another rate hike will not hurt job creation. This belief has many implications and may open up new investment opportunities in the coming months.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Losing Trust

The trust placed in our banking system took another hit when Wells Fargo disclosed that they opened up over 2 million unauthorized customer accounts. Before the news broke, Wells Fargo was recognized as one of the most reputable banks. Even Warren Buffett has placed full trust in Wells Fargo. He owns over 10% of the entire company. The deceitful actions taken by the 5,300 employees exemplifies how the culture of the banking system is mired in conflicts of interest. I’ve always known that the conflicts existed at large financial firms, which is why I chose the path to be an independently owned financial advisor.  I never imagined that a bank such as Wells Fargo would go to this length to illegally open up accounts without the consent of their customers.

The trust in the Federal Reserve bank has also recently been challenged. They have chosen to keep interest rates artificially low, which has punished savers. There is much debate that we are in a “yield bubble” and what the consequences will be if the Fed gradually raises interest rates. We are in uncharted territory with interest rates near historical lows. Nobody knows what will happen if interest rates move higher. The current expectations are that interest rates are going to stay low for a very long time. At the September meeting, the Fed couldn’t raise rates 0.25% because of the fear that they would trigger a massive market sell-off.

I believe that the scandal at Wells Fargo and the Federal Reserve interest rate policy have one thing in common. Both policies have had unintended consequences. At Wells Fargo, top management created an incentive structure that led to employees cheating to increase their compensation. In the case of the Fed, the central bankers have set a course that has forced millions of investors to take additional market risks.

The blame will be squarely on the Fed if they are unable to gradually raise interest rates without negatively impacting asset prices. There are signs that the housing market is becoming frothy due in large part of the low rate environment. Utilities, REITs, and Telecom companies have recently sold off from the highs and rates haven’t even risen yet.

Over the next month, all eyes will be watching what might go down as the nastiest election of our lifetime. As soon as the election ends in November, investors will shift their focus on whether or not the Fed will raise interest rates at the December meeting. The uncertainty of a potential interest rate increase in a fragile economy should help to keep market volatility high through the end of the year.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

August Monthly Update and September Outlook

August 2016 Review

Over the last few months, I’ve written often on the mispricing of safety-oriented investments. In early August, I recommended that Financials were a good alternative to hedge interest rate risk. At the time, it was easy to spot how the quest for dividends in a low-yield world caused many overvalued investments. Last month, Utilities, Telecom, and REITs all experienced sharp price corrections. The S&P 500 was virtually unchanged in August, but under the surface, investors began to brace their portfolios for a rise in interest rates. Money rotated into the Financial and Technology sectors as investors turned their focus to earnings and valuations. These two sectors had underperformed for much of 2016. The chart below shows the dramatic shift out of Utilities and Telecom.

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September 2016 Outlook

I continue to believe that the major risks are political and central bank uncertainty. I’m less worried about the economy and more focused on avoiding investments that will implode once inflation returns. The biggest risk for retirees continues to be low interest rates and the risk of inflation increasing. The lesson learned in August was how low risk, interest sensitive investments can experience significant losses over a short period of time.

I believe that valuations, earnings, cash flows, and asset growth are better metrics that retirees should be basing their investment decisions on.  Owning high-quality companies, that provide stable and growing cash flows, is a better way to invest over the long-term. Unfortunately, these companies are no longer cheap and it is challenging to find attractive entry points to buy. You are now buying high with the hope that these investments will go higher.

I’m no longer bearish on utilities and telecom, but I do believe that these sectors remain vulnerable. After a 8% correction, some of the downside risk has diminished. The U.S. consumer is very strong and this bodes well for future economic growth. Residential house prices are appreciating fast, gas prices are low, 401k’s and retirement accounts are high, and jobs are plentiful. We are in the late stages of the economic cycle when inflation begins to creep into the equation. Price inflation is already present in assets such as stocks, bonds, and real estate. Health Care costs have also risen dramatically and is running at 6-8% per year.

For those living on fixed budgets, rising costs without a hedge to inflation could result in a budget short-fall. For my retired clients, I have slowly adjusted my portfolios into sectors that may benefit from a rise in inflation. For my younger clients, I continue to hold higher quality technology and growth companies.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.