Halftime 2018

As the first half of 2018 comes to a close I’d like to recap performance (or lack thereof) and give a few thoughts for the second half.

Markets has been interesting thus far.  The S&P500 began the year by rallying 7% to start the year then promptly falling 11% over the next 2 weeks.  Since then it’s been a maddening back and forth with 5% rallies and 5% drops.  At the moment, The S&P500 is up on the year, but only slightly (+1.7% as of 6/28). 

Bond prices have struggled with interest rate hikes.  The average bond holder is down slightly on the year (-1.5%)*, as are international stocks (-4.5%)**, Emerging Market Stocks (-8.5%)***, and gold (-3.4%)****.

What does the second half of the year hold for investors?  I’m afraid it looks like more of the same maddening swings.  We maintain the belief that we are in the late innings of the bull market which may continue longer than it logically should.  In full disclosure, I felt like we were in the late innings in 2016 as well, but tax reform provided a nice lift that we didn’t expect.  Nevertheless, we are likely much closer to the end of the bull market than the beginning.  

The case for the bull market (gains) to continue:

Earnings must continue to surprise on the up-side and investors have to maintain confidence that a recession is years in the future.  2016 and 2017 saw investors bid prices higher in hopes of increased earnings from the tax-reform.  We are now starting to see the earnings come through – and thus far they haven’t disappointed, but investors are now in search of the next catalyst.

Case for a bear market (losses) to takeover:

Trade war concerns still loom large and could escalate.  Increased tariffs are likely to weigh on stocks.  Futhermore, interest-rate hikes are increasing yields on ‘safe money’ investments like CDs and saving accounts, which is likely to remove some incentive for investors to chase returns in the stock market.  In the end, higher rates will likely remove some of the desire for investors to continue to pay premium prices on stocks.

On a different note, most of the performance in the overall market over the last 2 years has been driven by the technology sector.  Valuations look very rich for many names and should come back to earth at some point which could drive markets lower.

Of course, the wild card risks such as terrorism, political upheaval, and Twitter rants remain, but generally don’t cause long-term disruption to markets.  From a technical standpoint it’s concerning that the market bounces lower each time it gets back near the January highpoint, which leads us to believe that the January high may stick as the high point for the year.  Time will tell.  At any rate, we continue to scale back on risk and exercise caution.

*Bloomberg Barclays US Aggregate Bond TR USD


***MSCI Emerging Markets

****SPDR® Gold Shares


Student Loan Concerns

As a kid, the last day of school was always exciting!  It meant the beginning of summer, which afforded the ability to swim, sleep late, and stay up even later.  My friends and I would rotate spending the night at each other’s house.  Video game tournaments would last until the wee hours of the mornings before someone would eventually get mad and throw the controller.

As an adult, the end of the school year brings slightly different feelings.  On the surface, it means having to find activities to entertain kids for 8 weeks.  More importantly, it means being one year closer to car purchases and college expenses!

The sobering truth is that college costs have risen three times faster than inflation over the last twenty years.  Unfortunately, the use of student loans is now the most common way to pay for college.  Last year, seventy percent of college grads carried a student loan balance at graduation.  The average was $37,000.  About 6% of college grads owed more than $100,000.  That’s a difficult starting point on your first day in the working world. 

On the economic front, student loans have risen at such a dramatic pace that many economists are concerned about the long-term impact on the economy.  Student loan debt totals more than $1.4 trillion, the second highest category of debt in the country behind home loans. 

Who owns all those loans?  The largest loan holder is the federal government.  Federally-owned student loan debt totals nearly 6% of the total economy, up from 0.8% a decade earlier.  The 90-day delinquency rate on those loans is over 11% according to the New York Fed.

For comparison, the delinquency rate on mortgage loans at the peak of the 2008/2009 financial crisis was 11.5% according to the Federal Reserve.   Currently, the mortgage delinquency rate is about 3.5%.

With that said, the student loan issue is relatively unlikely to lead to a crisis like we saw in the mortgage market a decade ago.  The most likely outcome is that high student loan debt becomes a drag on spending and hampers economic growth as interest rates move higher. 

More importantly, as parents or grandparents or other family members, we can begin planning now for the future education of our loved ones.  There are various tools available to plan and save for future college costs and other expenses, such as cars.  Pre-paid college tuition plans are available in most states, as well as 529 College Savings Plans.  Even Roth IRAs offer educational flexibility.  Custodial accounts (UTMA / UGMA) also provide an avenue for family members to save money for more flexible expenditures that aren’t necessarily college related.

If you are interested in learning more about strategies to save money for the next generation please contact us to discuss your specific concerns. 


Source: CNBC, Wall Street Journal

Can Interest Rates Predict Stock Market Performance?

Much talk has been made recently about rising interest rates.  One of the most followed gauges of interest rates is the rate paid when the US government borrows money.  This information is regularly available and acts as a proxy for interest rates in the economy.  The government routinely borrows money at differing time intervals, e.g., 2 years, 5 years, 10 years, 30 years, etc.

Depending on the marketplace, each time interval likely has a different interest rate.  Interesting, these interest rates have historically been a signal to stock investors as well as bond investors.  Allow me to clarify:

As of 4/26/18, the 2-year Treasury Bond interest rate was 2.48%

As of 4/26/18, the 10-year Treasury Bond interest rate was 2.95%.

Therefore, the government is paying an extra 0.47% to borrow money for 10 years rather than for 2 years.

Three years ago, the difference between those two yields was 1.50%.

So what?

Well… the difference in bond yields may act as a pretty solid indicator of future returns in the stock market.  If there is only a small difference between the two (less than 1%) it generally implies we are in the later stage of the economic cycle, and future stock market returns may be muted.  Take a look at the following numbers for the S&P 500 since June, 1976, (the earliest data set I could readily find). 

yield spread analysis.png.jpg

Ideally, investors like to see steeply sloping yield curves with a big difference between short term and longer term rates.  The implications of interest rates today suggest once again that the upward trend in the stock market over the last 10 years may be running out of steam.  Returns may be muted over the coming year, and the odds of a negative outcome may increase.  Investors may be wise to look for returns in more defensive areas of the investment world and scale back on their stock exposure.


The last month has been filled with headlines of new tariffs being imposed from one country to another.  It began with the US imposing a new tariff to protect the American steel industry and soon shifted to tariffs on China.  Threats of retaliation came quickly from other countries, the consequences of which are unknowable, but the end result is extremely likely: inefficiencies will arise and consumers around the world will pay a higher price for a variety of products.  We’ve seen this before.  Let’s examine.

Smoot - Hawley Tariffs

US farmers were struggling to make money in the late 1920s.  Rather than focusing on oversupply, imports were blamed for the falling prices.  Senator Reed Smoot and Representative Willis Hawley had a plan to help.  They proposed an additional tax on imported crops and produce from overseas to help protect the US farming industry, known as the Smoot-Hawley Act.  This tariff would push prices higher and protect the American farming industry.

In order to win support for the bill, Smoot and Hawley compromised with the requests of more and more congressmen as each lobbied to protect industries in their hometowns. 

“Why just protect farmers, when we can protect other industries?” the congressmen argued.  By the time the bill made its way through Congress, the total number of proposed tariffs had grown to 890, impacting more than 20,000 imported goods.     

Canada responded to the new tariffs by imposing a collection of harsh tariffs on American imports.  Europe followed suit as well, and soon the Smooth Hawley tariffs escalated into a full-blown trade war.  Global trade of goods and services fell nearly 66% in the five years following the enactment of the tariff in late 1929, coinciding with the depths of the Great Depression.

Tariffs didn’t disappear completely after the failure of the Smoot-Hawley, but the push for protectionism slowed tremendously as tariffs decreased around the world following the passage of the Reciprocal Trade Agreement in 1934 by President Roosevelt, which was aimed at reducing tariffs and barriers to trade.

Playing Chicken

One of the more fascinating tariffs that remained was the tax imposed by European countries on imported chicken from the United States.   Shortly after World War II, advancements in the chicken farming industry in the US increased supply tremendously, transforming the food from a delicacy to a low-cost dining option.  European chicken farmers had a hard time competing at the lower prices as the cost of poultry plummeted. 

France was the first European country to impose a tariff on imported chicken in 1961, but other European countries soon followed suit to protect their own chicken producers.  The US responded with tariffs on imported European goods like brandy, and ‘light’ trucks. The brandy tax was a direct shot at France, while the ‘light’ truck tax was aimed directly at Germany.  Volkswagen’s truck sales plummeted in the United States, and the additional hike in prices for French brandy caused Americans to look elsewhere for their nightly toddy.

To this day, the chicken tax on American imported chicken remains in effect.  While most of the tariffs imposed in response to the chicken tax have disappeared, the tariff on ‘light’ trucks and delivery vans also remains.  Ironically, this has also created complicated production issues for many of the US automakers. 

As globalization took hold in the 1990s, it became advantageous for US automobile companies to take advantage of cheap labor abroad.  Ford, for example, found a booming business for pickup trucks in Thailand, where they opened a factory in the mid-1990s.  The factory in Thailand specializes in smaller vehicles, such as lightweight pickup trucks and delivery vans.  Ford, however, can’t import delivery vans into the US from their Thai factory without incurring the 25% tariff still in effect from the 1960s.  In order to circumvent it, Ford reportedly imports passenger vans equipped with seats and seatbelts, then converts them into delivery vans by removing the seats and seatbelts and opening up the cargo hull. 

The end result is that American consumers still pay a premium for delivery vans because of a tariff on chicken imports to Europe imposed in the 1960s. 

Needless to say, tariffs have historically created inefficiencies that distort free markets and raise prices for consumers.  Unfortunately, these tariffs will likely do the same.



Fred McMahon.  History is clear—high tariffs and trade wars devastate countries.  October 3, 2016. Fraser Forum Fraser Institute.

If You Aren't Worried About A Trade War, You Don't Know About The Chicken Tax.  Mar 3, 2018.  Bryce Hoffman. Forbes Magazine.

To Outfox the Chicken Tax, Ford Strips Its Own Vans. By Matthew Dolan. Updated Sept. 23, 2009 12:01 a.m. ET

Risk Management Plan

The S&P 500 fell more than 10% from January 26 to February 9.  It was one of the sharper selloffs in recent memory.  For many, the abrupt selloff raised questions such as… Do I stay in?  Do I get out?  When do I sell?  What’s the plan? 

We have no way of knowing whether or not the selloff in early February will be remembered as the beginning of a bear market or simply a sharp and sudden correction.  Throughout the last 10 years we have seen several such instances for one reason or another (Greece, China, etc.) that amounted to little more than a temporary setback.  However, we also feel that the market is expensive and in the later stages of a bull market; i.e. we don’t discount the possibility that it could be beginning of a bear market. 

What should investors do?  What are the different ways to handle the increased volatility?  Here are some options.

Option 1: Do nothing. 

For buy and hold investors with a long-term time horizon, the best path is often the simplest.  If you like the investments that you own and you don’t anticipate needing to sell anytime soon, then simply staying put is often the best plan.  Litmus test: were you investing in 2008?  Did you panic then and sell?  If you were able to stomach 2008 / 2009 without panic then you should likely do the same the next time around.  Ignore the fluctuations, watch less news, and don’t be concerned about markets.

Option 2: Change your allocation now.

If the fluctuations in your portfolio in late January and early February made you uncomfortable, then you need to be proactive and change your allocations now.  Don’t wait until later.  The stock market is still within 5% of an all time high.  Consider adding some fixed income and precious metals to diversify risk and reduce volatility. 

Asset allocation is a function of time horizon, risk tolerance and the prevailing investment landscape.  If any of those inputs change then the asset allocation likely needs to change as well.  Be honest with yourself about how much volatility you can stomach.

Option 3: Have a plan in place to reduce risk.

This is the approach we take for the discretionary accounts that we manage.  We can’t time the market, but we can have certain “trigger” points to attempt to reduce risk in a portfolio.  For example, rules for risk management may look like this:

“If the six-month return for the S&P500 becomes negative, reduce equity holdings by 25%”

“If the 50-day moving average falls below the 200-day moving average, reduce equity holdings another 25%”

Also, we can use “stop loss” orders to reduce volatility on individual holdings. 

“If Wal-Mart falls 8%, then let’s sell it.”

Having rules in place to help manage risk can be a powerful and helpful tool in investment management.  Regardless of what camp you fall into (hold, re-allocate now, or rules-based) knowing yourself and knowing the plan is pivotal to long term investment success. 

Please feel free to reach out to discuss the specifics of your risk management plan.

Newton's Law of Inertia

Why does the stock market continue to rise? 

It seems like the market has been rallying on news of tax reform since Trump’s election win in November, 2016. Sure, tax reform is one reason for the rally, but we’ve known about that for months.  Corporate earnings have been strong, but not abnormally so.  Economic growth has been good, but not dramatically above average.  Lately it seems that the stock market simply goes up for no reason at all. 

Isaac Newton’s first law of motion may give us the answer.  Newton’s law of inertia states (paraphrased) that “an object put into motion will remain in motion unless acted upon by an outside force.”  Simply put, the stock market is going up because it has no reason not to.  It will remain in the uptrend until acted upon by an outside force.  The law of inertia was always my personal favorite of Newton’s!

What may cause it to end?

What ‘outside forces’ could halt the motion?  The obvious suspects like war and terrorism are always possible.  Bad corporate earnings could cause a reversal, but that’s unlikely in light of the new tax reform.  International concerns like we saw from Greece in 2012 or China in 2016 could spook investors.  Higher interest rates could become problematic.  Either way, at some point, an outside force will stop the trajectory of the market.  Until that time, however, let’s continue on the assumption that the market will remain in motion. 

When might it end?

The economy generally follows a pattern of expansion (early cycle), peak (mid cycle), contraction (late cycle), and trough (recession).  Equity performance tends to be best from the trough to the peak.  With that said, it does appear that we may be transitioning from the peak (mid cycle) to the late stages of the business cycle.  The business cycle is generally more predictable than the stock market, but that’s not super helpful because it tends to be a lagging indicator.  In other words, the stock market tends to head south before the actual economy does.  I believe we are seeing the early stages of a rotation into “late-cycle” dynamics. 

Generally, in the later innings of the business cycle we begin to see sectors like Utilities and Real Estate underperform the general stock market as interest rates increase.  On the other hand, we see the outperformance of sectors like Energy and Materials.  The Energy sector is often a classic late-cycle indicator.  Fidelity’s paper The Business Cycle Approach to Equity Sector Investing researched performance of each sector throughout various business cycles and stated, “Looking across all three analytical measures, the Energy sector has seen the most convincing patterns of outperformance in the late cycle, with high average and median relative performance.”  As the economy matures, the Energy and Materials sectors often see the biggest gains from the heightened demand and benefit from increased inflationary pressures.

According to Fidelity’s research, once the market enters the later phase of the business cycle, which generally lasts a year and half, stock market performance slows.  However, the performance is still positive, averaging roughly 5% on an annualized basis.

In the last thirteen weeks the best performing sector in the market is…. Drumroll…. Energy (+16.32%) as of 1/23/18, measured by Morningstar research.  The worst performing sector over the same time is…. You guessed it….Utilities (-7.54% courtesy of Morningstar), followed by Real Estate (-2.78%).  It appears that a changing of the guard is taking place, and it’s pretty easy to make the argument that we are entering the later stages of the business cycle.

The Problem with Predictions...

A Bullish Call

Wall Street's Seers Forecast More Gains for Stocks Next Year.

Indeed, the dozen seers we've surveyed all have penciled in higher stock prices (for next year), although their estimated gains vary widely, from 3% to 18%. On average, the group sees the Standard & Poor's 500 … about 10% higher

-Barron’s Magazine

 December 17, 2007


Wall Street analysts missed it in 2008.  By about 47%.

It’s that time of year again.  The time when investment gurus from big investment firms such as Goldman Sachs, JP Morgan, Merrill Lynch, Bank of America, etc., make predictions about the coming year.  Allow me to save you some time.  They’re optimistic.  They’re always optimistic.

Every. Single. Year. Since 2000, the consensus of Wall Street analysts has been bullish.  The average return for stocks predicted by Wall Street firms was 9.5% each year according to research done by Bespoke Investment Group as reported by the New York Times.   Not once has the consensus predicted a down-market, even though there have been five such instances over that time frame for the S&P500.  

Salil Mehta is an independent statistician who was formerly the director of research and analytics for the United States Treasury’s Troubled Asset Relief Program and for the federal Pension Benefit Guaranty Corporation.  Mehta studied the public forecasts of Wall Street firms going back to 2000, 186 in total.  92% of the forecasts called for positive year in the market.  Only 8% called for a negative year. 

The worst three years in terms of market performance over the past 18 years were 2001, 2002, and 2008, with returns of -12%, -22%, -37% respectively.  Collectively, there were 23 forecasts released from the Wall Street firms during those three years.  Not one of the 23 forecasts called a negative year.  The forecasters were 0 for 23 on the direction of the market, let alone the actual performance!

So, in summary, be careful what you read about market forecasts for 2018.  No one knows what 2018 holds; just like no one forecast the bursting of the dot-com bubble in 2000 or the mortgage crisis in 2008.  In light of that, we maintain that the best investment strategy for 2018 is to remain diversified, focus on yield rather than growth, and react to changing conditions as the market dictates. 

We remain cautiously optimistic, but fear that much of the good news about the economy is already baked into the recent runup in prices.  At some point, news of the tax reform will subside and investors will look for the next market catalyst.  Perhaps they will find one, perhaps not.  Either way, my personal forecast for 2018 will likely be no better than the large Wall Street firms.  And I’d rather not be wrong in writing.

That Eerie Silence

My home is humming with life most of the time.  My wife Christen and I have two sons (14 and 11), three dogs (Bailey, a maltipoo;  Maggie, a snoodle;  Lieutenant Dan, a three-legged mutt), and a cat (Mr. Hemingway).  Among the eight of us, there is almost always a buzz of activity and noise.   It’s only when things get quiet that I become concerned…

To say that things have been quiet in the market lately would be an understatement.  It’s eerily quiet.   With November’s close, the S&P 500 has now gone higher every month for 13 consecutive months.  The longest stretch for consecutive “up” months is 15 months in a row during 1958-1959. The truly strangest part of the rally has been the calmness of the upward ride. 

From 2010 to 2016 the S&P 500 had 417 trading days in which the index went up or down by at least 1% or more.  That’s an average of roughly 60 days per year of at least a 1% swing.  So far, in 2017, we’ve had exactly 10 such days, the lowest reading since 1965.  Politically, this year has been anything but calm, but markets have continued to ignore the headlines and have moved higher month after month.

The calmness isn’t confined to the US.  The Wall Street Journal provides daily data on forty stock markets around the world. Thirty-nine of the forty are “up” on the year.  The only exception is Israel, which is down 2.4% as of 11/28.  And it’s not just stocks.  Fifty-five of the fifty-seven bond indices reported by the Wall Street Journal are positive this year (bond indices in Germany and the Netherlands are down less than 1%).  Everywhere you look, it’s as if risk has disappeared.  It’s… eerie. 

Employment numbers in the US increased for 83 consecutive months before being derailed by the hurricanes in September.  Still, the number of months set the record for the longest consecutive streak of job growth in US history.  Retail sales for Black Friday also set records, and Adobe Analytics forecasts that online retail sales will surpass the $100 billion threshold for the first time ever. 

We will all likely look back on this time as a uniquely nice, but strange, anomaly.  We are currently living in the “good ole days” of the market.  It’s enjoyable.  It’s kind of boring.  It’s eerie.  And it may even last a bit longer… but it’s also somewhat concerning.

Source: MFS “By the Numbers” November 27, 2017