A Year Full of Surprises

I would like to thank all of my clients for the trust that they have placed in me this year to manage their investments.  Before I review 2016, and make my market predictions for 2017, I wanted to wish you and your family a Happy Holiday. This will be my last post of the year. I promise that next year I will continue to probe for potential market risks, as well as seek out new investments that can help you meet your goals. It would be very satisfying to repeat the 2016 return next year!

2016 will go down as a year full of surprises. Merriam-Webster best encapsulates 2016 with their Word of the Year, ‘Surreal’.  Here are a few of this years biggest surprises:

  • The U.S. stock market had the worst start ever to begin the year, only to finish with one of the biggest rallies.
  • Oil fell to as low as $26 a barrel only to rebound 100% to $52 a barrel.
  • The gold bulls drove up prices 25% in the first part of the year, and then prices collapsed 17% in the second half of the year.
  • The political surprises began on June 23rd when Britain voted to leave the European Union, which was one-upped by American voters, electing an anti-establishment president.
  • On July 8th, the 10-year Treasury fell to an all-time low of 1.38%, and has now nearly doubled to 2.60%.
  • And don’t forget the Cubs won the World Series!

I’ll leave my market predictions for 2017 to the prognosticators who make a living out of predicting the future. Nobody could have predicted all of the “surreal” events that occurred in 2016. Larry Fink, who has been named one of the “World’s Best CEO’s” by Barron’s for nine consecutive years, said on CNBC yesterday that retirees should own more equities and less bonds. About one year ago, he was predicting a further 10% drop in equities after stocks had already fallen 10%. I’m positive that he would not have given that same advice last year! Mohamed El-Erian, who some consider the world’s best economist, is warning investors to raise more cash. His interview on Bloomberg TV the other day was very ominous. The only problem is that he has been giving the same warnings all year that investors should hold more cash. I expect him to double down on his warnings to hold cash. I would bet the house that at some point he will get it very right. Timing the correction is the difficult part. If these two market experts can’t make accurate predictions, then their guesses are as good as mine.

While I avoid making market predictions, I monitor for potential market risks. Here are five warning signs that the market is fully valued heading into 2017:

  1. There are more positive leading indicators flashing green than I can remember. Gallup’s U.S. Economic Confidence Index is at another new high in its nine-year trend. You will find many more buying opportunities when confidence is near lows and not at all-time highs.
  2. TrimTabs, which reports market inflows and outflows, showed that the market inflows since Election Day is equal to 1.5X of all the inflows in 2015. The CEO was quoted as saying, “One has to wonder who’s left to buy.”
  3. Rising stock prices have become unhinged from corporate earnings, which haven’t risen as fast. Those that buy stocks with high P/E ratios are betting that future earnings will eventually catch-up to current prices.
  4. TimTabs has noted that buybacks have tumbled to the lowest level in 5 years and insider buying is at the lowest level since 2011.
  5. The Chinese economy is under pressure from a large debt burden. President elect-Trump’s campaign promise to bring jobs back to the U.S. is very negative for China.  He has proven to be a very effective campaigner and has no problem tarnishing his opponents to gain the advantage. He is a master deal-maker and his cabinet/advisors are also full of successful deal-makers. The early signs are that he is not going to play nice with China.

Optimism around Trump’s agenda is the major reason why the stock market has surged and keeps hitting record high after record high. U.S. business leaders are getting behind him 100% to bring manufacturing jobs back to the U.S.. Profits will rise if Trump can accomplish his aggressive agenda. However, the risks that I noted above are warning signs that markets will remain volatile.

I wish you and your family a healthy and prosperous 2017!

What stage of the Economic Cycle are we in?

On Thursday, the Massachusetts unemployment rate dropped to 2.9%, which is the lowest level since January 2001. The Dow Jones Industrial Average is flirting with going over 20,000, inflation is picking up, interest rates are rising, property prices are near highs, and commodity prices are jumping. We have entered the late upswing stage of the economic cycle. The recovery stage was between 2009-2011, and the early upswing stage occurred between 2012-2015.

The late upswing stage will end when bond yields stop rising, the stock market starts falling, home prices fall, and consumer confidence drops. The different stages of the economic cycle tend to be gradual and go on longer than people expect.

A good example to show how long economic stages can last is the case of the stubborn property seller. The level of housing supply is still tight and there are more people shopping for a home. As interest rates rise, monthly payments will also rise. Higher mortgage rates will result in many new home buyers unable to afford overvalued prices. It’s the affordability or monthly payment that matters the most. As interest rates rise, houses will sit on the market longer until sellers adjust their prices lower. It can take 12-18 months before the seller begins to adjust their prices lower. If we enter the recession stage, when job losses are high, home prices can drop dramatically. As we all know, the housing crash in 2008 was only so damaging because prices became overvalued.

Over the next few years, I expect higher market swings, because our President-elect wants to add more stimulus during the late upswing stage of the economic cycle. Cutting taxes, rolling back regulations, creating jobs, and adding infrastructure normally occurs in the early recovery stage. The result of this mistimed stimulus will be higher inflation, record breaking corporate profits, rising wage growth, and higher interest rates.

My favorite economist is David Rosenberg, and he appeared on CNBC with a warning about the extreme values in stock prices. His market worries include the strong dollar crimping profits, mortgage rates rising, and overblown expectations that Trump can achieve all of his ambitious goals. In his view, markets are pricing in above average earnings growth next year, and market sentiment is too high. In 2017, he expects more acute volatility with wider price fluctuations. In his words, active management should “trump” a more passive approach. I agree with his sentiment that to be profitable in 2017, you should be willing to trade the market a lot more than you have in the past.

Since the election, the trading for all of my clients has picked up, as I have taken advantage of new opportunities. The small trading costs have been worth the higher gains in portfolios over the past few months. My belief is that the late upswing stage will go on longer than people expect, but it will be a bumpy ride. The recession stage could come sooner than expected if President elect-Trump upsets trading partners, or if he fails to meet his own very high expectations.

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

November Review and December Outlook

November 2016 Review

November will go down as a epic story of two markets. Major bond indices lost around 3.5% and the S&P 500 gained 3.68%. If you own a balanced portfolio, you most likely made no money. Even worse, the SPDR Gold Shares dropped -8.36% and the iShares Europe ETF fell -2.49%. This month had one of the largest monthly discrepancies between growth and value stocks. The Vanguard Growth Index was up only 1.22%, while the Vanguard Value Index was up 6%. The best investment area was the iShares Russell 2000 Value ETF, which finished up 13.17%.

The U.S. economy is back to pre-Great Recession levels:

December 2016 Outlook

Brace yourself for a bumpy ride. Like almost all elected officials, President-elect Trump has shown signs of making contradictory statements between what he promised on the campaign trail and how he will govern. This is no surprise to even the most devoted Trump supporters. The epic story of two markets might prove to be premature as investors begin to realize that fiscal policy takes long to implement. The impact of infrastructure spending is years away and the tax cuts are still being debated.

Over the short-term, investors do a terrible job of predicting possible economic recessions, interest rates, and inflation rates. It’s not much different than how the pollsters and major media outlets got the results of the election so wrong. The Trump-led administration is not going to be able to accomplish everything it has promised. Yes, there will be a roll-back of regulations, changes made to trade agreements, lower taxes, changes to Obamacare, and more infrastructure spending. However, all the important details are still missing.

There is much apprehension over Trump’s protectionist agenda. Since the election, technology stocks and multi-national stocks have trailed the market as their supply and distribution chains are global. Many of the largest U.S. companies, which employ millions of U.S. jobs, derive much of their profits overseas. Since Trump cares more than anything about creating U.S. jobs, I believe that much of Trump’s trade threats are a ploy to secure future concessions from foreign governments. Trump’s strength is in the art of negotiation and deal-making.

There will be profound long-term consequences if I’m wrong and whether Trump takes a more protectionism route. Nobody will win if Trump increases tariffs and starts trade wars. Going forward, I expect a war of words rather than actual foreign policy changes, which will make for a volatile market.

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

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.

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

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.

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

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.

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

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.

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

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.

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 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