Download CFA Outlook, Q315 August Update

Investment Outlook
Third Quarter Update 2015
August 18, 2015
By
John E. Montgomery
Managing Director & Chief Investment Officer
Capital Fiduciary Advisors, LLC
4720 Montgomery Lane, Suite 400
Bethesda, MD 20814
301-652-6951 (phone)
301-652-6954 (fax)
[email protected]
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Just When We Thought We‘ve Seen (and heard) It All. . .
along comes Donald Trump, not only running for President but leading all (what is it 97?) other
Republican candidates. In the recent debate, “the Donald” promised to support the Republican
candidate for President as long as it was him. While the winner of the first Republican debate
was…er, debatable, the loser was clearly political debates. Gone forever is the concept that
debates are anything other than television programming. There were even “breaks in the action”
for commercials, many of which were more substantive and informative than the debate itself.
Why should anyone have been surprised? Trump is the ultimate reality television “star” and the
debate was the ultimate reality television show. After all, Donald Trump is the Kim Kardashian
of politics. (I wonder who that last sentence is more offensive to?)
The Donald refusing to support the eventual Republican presidential candidate sets up the
possibility of him running a third-party campaign. Could you imagine another third-party
candidate handing another Clinton the presidency? And the Dems are worried. Already Bernie
Sanders, who has switched banners from Socialist to Democrat, is giving Hillary a run for her, or
should that be our, money. A recent Washington Post headline ran “Activists on left see in
Bernie Sanders what they thought they saw in Obama” which made me think “what a crazy old
white guy?” There is even a movement afoot to get (Uncle) Joe Biden to run and rumors that Al
Gore might get into the race have surfaced. Nope! You can’t make this stuff up.
But for pure political hutzpah nothing can top the recent 80-page Council of Economic
Advisor’s report condemning state government’s occupational licensing schemes as anticompetitive and an impediment to economic growth. This from the same administration that
gave us the Affordable Care Act and Dodd-Frank. Is this merely the White House calling the
kettle black or a warning to the states that the Federal Government needs no help in stifling
economic growth.
And, political irony is not just a U.S. phenomenon. When China’s stock market started to
“correct” after a sharp and, until recently, sustained up-move, the (still Commie) Chinese
government intervened to control the damage. The always oh-so-helpful IMF cheered and
supported this incursion into free markets. A bit later when the (still Commie) Chinese
government decided the Yuan/Renminbi had appreciated too much and intervened, that ever
vigilant protector of free markets, the IMF, also cheered and supported this incursion so long as
it moved the Chinese currency closer to free market exchange rates. It now looks increasingly
like the Yuan/Renminbi will be included in the IMF’s SDR (“special drawing rights”) – the
IMF’s de-facto currency – if it doesn’t start a currency war first.
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ECONOMIC OUTLOOK
It is amazing that there is a consensus that the U.S. economy is improving and, in fact, getting
stronger. Along with the July 30th data on second quarter GDP came revisions to the more recent
data. It showed a downward revision in GDP growth from 2011 to 2014 to an even more anemic
2.0% annual growth rate leading Econoday to remark that “that makes the latest quarter’s 2.3%
growth rate look even more respectable” (emphasis added). Interestingly, net trade added 0.1%
(of the 2.3%) GDP growth. Later when more data became available, a 7% increase in the trade
deficit was reported which might contribute to a downward revision in 2Q GDP growth. The
Wall Street Journal headline read “Trade Gap Grows as Economy Revs Up.” It was hard to find
any evidence in the article to indicate that the U.S. economy was, in fact, revving up. Later,
when the retail sales data for May and June was revised up, indicating that consumers were
spending some of their savings from declining energy prices, which might lead to an upward
revision to 2Q GDP growth.
A recent Financial Times article pointed out that the rise in the dollar that we’ve already
seen based on the mere threat of higher interest rates could shave $100 billion off of U.S.
multinational company revenues over the next year. Additionally, the latest World Trade
Monitor shows a persistent slowing in global trade to a mere 1.5% over the past twelve months
versus its longer-term average of 7%. Trade has been one of the cornerstones of economic
growth during the post WWII period. Exports have played a big role in what little growth the
U.S. economy has experienced since the Great Recession but maybe not for much longer.
But, wait, there’s more (bad news)! The Employment Cost Index rose only 0.2% during
the second quarter for the lowest result in the 33 years history of the ECI. Additionally, virtually
every indicator of income and wage growth hovers around a 2% annual growth rate.
Nevertheless, the consumer is supposed to fuel the economic acceleration!?
Meanwhile, levels of debt continue to expand, contrary to popular belief. Keynesians,
who still control most of the political, fiscal and monetary economic policy levers, believe that
the economy is suffering from insufficient demand. Maybe so, but debt-fueled economic
expansion at historic growth rates is not sustainable without even more debt. Most economists
and central bank forecasters have consistently been overly optimistic about this expansion only
to have to regularly revise forecasts down to reflect economic reality. This is likely to continue.
CFA has long been skeptical of “the economy is rebounding” school of thought. We are
also long-time believers in buying when the last optimist sells. So we noted with some
amusement that the White House recently downgraded its economic forecasts. CFA remains in
the 2% growth, 2% inflation camp and even this may be overly optimistic.
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INVESTMENT IMPLICATIONS
The recently published book Invest with the Fed by Robert Johnson, Gerald Jensen and Luis
Garcia-Feijoo says that investors underestimate the impact of the Fed on financial markets. Now
THAT’s hard to believe. I am so sick of the unrelenting fixation on everything the Fed says −
emphasis on says – since the Fed has done so little recently. We’ve long contended that the Fed
would not raise interest rates but instead wait for the (bond) market to raise rates for it, then
follow the markets up. The Fed controls short interest rates so that’s what we focus on. Over the
past twelve months (through Friday, August 14th) three-month Treasury yields have risen from
0.03% to 0.08%, 1-year yields from 0.11% to 0.14% and 2-year from 0.42% to 0.72%; even
though 10-year UST yields have declined from 2.40% to 2.20% and the 30-year from 3.19% to
2.84%. This might be enough to get the Fed to follow short-term rates higher – that and the fact
that it is about time that the Fed put (rates) up or shut up. Like Mario Draghi and the ECB
finally had to “do whatever it takes” and were finally forced to actually do something, we think
it’s time for the Fed to do something.
Now along comes Chinese currency intervention giving the Fed yet another excuse to do
nothing. To U.S. investors it also gives an excuse to repatriate their investments back into the
U.S. After all, the U.S. markets are again doing better than foreign markets and you gotta chase
that performance dot!
The Fed, other central banks and many governments’ moves to manipulate financial
markets in an effort to stimulate their economies have been less than rousing successes. For all
the efforts, we are witnessing the slowest economic growth in 50+ years, declining productivity,
sub-par wage growth and below average increases in global living standards. It is high time that
the Fed “normalizes” rates so that they can be prepared for the next crisis − no matter how much
the Fed fears that if it does anything it will cause the next crisis. There will always be a next
crisis.
Regardless, it is time to try something different.
BOND MARKET OUTLOOK
“What happens if you throw a party and no one comes?” Now that CFA is finally agreeing with
the consensus that the Fed is likely to raise short-term rates, if not in September, before year-end,
we are also predicting that little or nothing will happen as a result.
Corporations have raised 100s of billions, if not trillions, of dollars in debt to take
advantage of record low interest rates. Wall Street has created a dizzying array of unconstrained
bond, floating rate debt, and limited duration mutual funds…probably all for naught. U.S. rates
remain well above those of most other developed economies and the dollar is rising. Global
investors will be attracted to higher interest rates denominated in an appreciating currency. Plus,
the good old USofA is probably looking increasingly good to U.S. investors, given the myriad of
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global problems (e.g. China, Greece [still], emerging markets, BRICs) even though most
Americans think the U.S. is on the wrong track. At least it’s our wrong track!
CFA’s outlook for interest rates for the remainder of 2015 is that they will be “UNCH”ed
but with volatility…and not even with that much volatility. While no more likely to be right than
the Fed, or even CFA, the futures market expects less in the way of interest rate increases than
the Fed is preparing us for. The Fed keeps crying “wolf” but, so far, no wolf. There are a myriad
of reasons for the Fed to do nothing which is something that the Fed is good at. While we have
long believed that the Fed would do nothing but something would happen, we now believe that
the Fed will do something but that nothing will happen.
STOCK MARKET OUTLOOK
We couldn’t believe our eyes. Just when we were getting ready to write a blood-curdlingly
bearish “stock market outlook” we opened the WSJ’s 8/10/2015 “Investing in Funds & ETFS”
to the headline “Four Things That Could Go Wrong Now.” (Only four?) This reminded us that
no matter how much faux bullishness is purported to be out there, virtually everybody still hates
this bull market.
Bearish sentiment still dominates the media. Those who have been bullishly correct for
this entire near epic bull market run, continue to take a back seat to the unrelentingly wrong
bears. We get it – NO investments, but especially not equities, are cheap and those that are (e.g.
gold, energy) are only gonna get cheaper. Buy what’s going up and sell what’s going down (to
buy more of what’s going up) is the new investment mantra (well, not that new). The smart guys
at Research Affiliates recently published a piece entitled “Are Stocks Overvalued? A Survey of
Equity Valuation Models.” Their conclusion was… “The U.S. equity market is overvalued” but
seemed to imply “so what?”
Sure we’re way overdue. A 10% correction happens on average every 18 months and
we’re going on 48. The S&P has gone nearly 77 months without a 20% decline (a.k.a. bear
market) making this the third longest bull market since 1927! The fact that the market has been
in such a narrow (complacent) range for the longest amount of time since 1965 is, in and of
itself, considered cause for concern. The volatility of the stock market has declined but the
volatility of individual stocks has increased. Stocks which are doing well are “priced for
perfection” and if they disappoint…watch out below. Yes, we’ll feel stupid when the correction
comes but people normally miss more profits from being out of stocks waiting for a correction to
occur than they lose money from being in stocks during corrections.
Directly underneath the “Four Things That Could Go Wrong” headline was “An
Alternative Investment by Any Other Name Is Still…” saying not that alternative investments
haven’t failed but that alternative investments should be marketed better even if they have failed.
Probably a good sign for alternatives!
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As we get older, we become even more reluctant to believe that anybody has any, let
alone all, of the answers. Everyone is selling energy and gold to chase health care and bio-tech.
Maybe doing just the opposite is the better idea. (Buy low, sell high works, or so we hear.) Many
are selling individual stocks to buy index funds. (Maybe you should be a contrarian. That has
historically worked, too.) The consensus says cheap indexing always beats active investing
which is usually true, until it’s not.
According to Invest with the Fed equity markets perform best during periods of
expansive monetary policy (the recent past), less well during periods of indeterminate monetary
policy (the current), and perform worst during periods of restrictive policy (sooner or later). If
the Fed finally does something, it could be sooner…or later.
August 18, 2015
John E. Montgomery
This information is not meant as a guide to investing, or as a source of specific investment
recommendations, and Capital Fiduciary Advisors, LLC makes no implied or express
recommendations concerning the manner in which any client’s accounts should or would be handled,
as appropriate investment decisions depend upon the client’s investment objectives. The information
is general in nature and is not intended to be, and should not be construed as, legal or tax advice. In
addition, the information is subject to change and, although based upon information that Capital
Fiduciary Advisors, LLC considers reliable, is not guaranteed as to accuracy or completeness.
Capital Fiduciary Advisors, LLC makes no warranties with regard to the information or results
obtained by its use and disclaims any liability arising out of your use of, or reliance on, the
information.
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