The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes
Our insights, reflections and musings on the most timely topics relevant to managing your investments.
We were hoping for Santa Claus and thus far all we have gotten is Scrooge. The market is simply in a foul mood and nothing seems to be shaking it. Yesterday we got what we were all wanting and expecting when the Federal Reserve (Fed) raised rates a quarter of a percentage point and then…
What are we to do? When markets move downward it is important to keep things in perspective. We are prudent investors not traders, so it is the long term that matters. Prudent investment is done from the ground-up: know what you own and why you own it. The companies we own are doing well, and ultimately their stock price will reflect that reality.
You know the saying: There are two kinds of people in this world, glass-half-full people and glass-half-empty people. Of course it is the same glass holding the same amount of liquid, but depending on his point of view one is either happy about it or grumpy about it. At the moment, Mr. Market is in…
My kids just watched the Charlie Brown Halloween special, fall weather has finally arrived in Atlanta, and our front porch is full of various types of pumpkins. It is October. So, why is the market selling off? It is October, what other reason do we need? As we said when this selloff began, this is…
It’s a bird, it’s a plane…no, it’s interest rates! Rising interest rates do not kill bull markets; they actually go hand-in-hand. I know this is counter to what you have learned from every financial media outlet and the short-term traders who often sit at their desks, but it is true. In fact, it is “textbook,” as they say.
Yesterday we got what we were all wanting and expecting when the Federal Reserve (Fed) raised rates a quarter of a percentage point and then lowered the forecast for future raises. Chairman Powell said several times in his remarks that the Fed would ultimately be driven by the data. If the economy actually slows, then they will alter course.
Mr. Market acted like a spoiled child who just got everything he wanted for Christmas but throws a fit anyway. Since this market downturn started in October there has been a litany of reasons given for it. The first was that our economy is growing so fast that interest rates must rise; the 10-year Treasury has gone from 3.2 percent to under 2.8 percent as of this morning. The second reason was the trade tensions with China; there is now a cease-fire, and negotiations are at least happening. The latest reason is global growth slowing; there is no doubt that this is actually occurring. Asia, in particular, is looking weak with Japan already reporting a negative quarter and China’s growth slowing.
The big question is, will this slowing global growth spill over to the U.S.? Of course we can’t really know, but here is something to consider: The U.S. economy remains consumer-driven. Consumer spending represents roughly 70 percent of our total economic activity. More consumers are working today than at any time in almost two generations. Wages are growing above the rate of inflation for the first time since the 1990s. The U.S. looks very capable of once again leading the world economically.
A glimpse into this was seen yesterday in Federal Express earnings. Federal Express’ revenue grew faster than expected overall. They saw good growth domestically, but painted a bleak picture for their European and Asian business. The market punished them. Lost in this knee-jerk reaction was the fact that the U.S. demand was strong enough for Fed Ex to beat on revenue even with its international business being down. I’m old enough to remember when the U.S. often led the world in this way.
The probability of the global economy being better than expected next year is high and growing, partially because the pessimism is exaggerated, and partially because they are not giving the U.S. consumers the respect he and she deserve. That bodes well for the future and may explain why emerging market stocks, which had been the worst place to be all year, have quietly begun to outperform.
It is always painful to see portfolio values drop. However, it is precisely in times like this that we must remind ourselves of our long-term (three- to five-year) goals and the prudent fundamentals that will help us achieve those goals. We invest from the bottom-up. There are many companies that remain strong and whose businesses are doing very well. Their stock has just gone on sale and in some cases represents great bargains. It is far easier to spot a bargain than it is to guess what the market as a whole will do.
We have to be risk-averse. Now is a time for looking for opportunities. To paraphrase Warren Buffett, a prudent investor is greedy when others are fearful and fearful when others are greedy. Our mindset should be one of seeking opportunity, but we also have to respect the market. It is not time to jump in with both feet, as no one really knows how long this selloff will continue.
So we are neither going to panic nor go hog wild. We are going to keep our heads about us while those around us lose theirs. If we do that consistently then the world just might be ours, as Mr. Kipling suggested all those years ago.
The market may be delivering a lump of coal, but Christmas morning will come nonetheless and all will be much cheerier in the real world.
Chuck Osborne, CFA
Groupthink is a term first used in 1972 by social psychologist Irving L. Janis. He was referring to a psychological phenomenon in which people strive for consensus within a group to the point where they set aside their personal beliefs, preferring to keep the peace rather than disrupt uniformity.
Wall Street has increasingly become a giant lesson in groupthink, and simultaneously more and more disconnected from anything resembling reality. This downturn is the perfect case in point. Wall Street seems to have forgotten already that this downward movement in stock prices began in October with Federal Reserve (Fed) Chairman Powell making comments about the need for interest rate hikes because of the rapid growth of the economy.
The groupthink at that moment was that things are so good that the Fed would keep raising rates and this would cause stocks to fall. Then the focus went to what we believe is the real cause of this nervousness, the trade tensions, especially with China. Corporate earnings – the thing that actually matters to corporate owners (aka stock investors) – were very strong for the third quarter, and on every earnings call, CEO’s were asked about tariffs.
Here is a lesson in groupthink for you. In this most recent earnings season, analysts asked just about every CEO that I am aware of about the impact of tariffs on their business. Then analysts started talking to financial media about how every CEO was talking about tariffs…which was largely due to the fact that they were answering the analysts’ questions. The idea that CEOs are universally worried about tariffs became consensus, and this meant an economic slowdown is coming.
So now, this market downturn – which was caused because the U.S. economy is somehow too good – is being prolonged by the idea that an actual economic downturn is coming. On Friday one analyst on a CNBC panel had the nerve to be somewhat optimistic about stocks, and she then had to defend herself. She said something to the effect of, “We all know that the economy will slow next year.”
According to the website www.verywellmind.com, the top two symptoms of groupthink are illusions of invulnerability and unquestioned beliefs, respectively. We all know that the economy is going to slow next year? What happens in the future is by definition unknowable, so while we can make predictions and weigh probabilities, no one knows what is going to happen next week, let alone next year. The idea that we do is a clear sign that we have shut down our individual brains and surrendered to groupthink.
So, what is the probability that we are headed towards a slowdown? Globally we may already be in one. Japan had negative growth last quarter. China’s economy, while still growing rapidly, has seen the rate of growth slow. There have been negative indicators in Germany and some other European countries. On top of all of that, we now have a delay in the Brexit vote in Great Britain.
In the U.S., however, there is no actual data pointing to a slowdown. Unemployment is less than 4 percent and wages are growing faster than inflation for the first time in a generation. The CEO of Target recently stated that this is the best environment that he has ever seen. Are there threats? Of course there are, there are always threats. The largest right now are the tariffs. Regardless of what anyone may tweet, tariff costs, like any tax on a product, are passed onto consumers. We pay the cost of higher prices. Americans once understood that, and as a result threw a great amount of tea into the Boston Harbor.
Might the economy slow next year? Maybe. If it grew at 2.5 percent, which would approximately match that fastest pace in the last decade, then that would equal slowing. The data, however, does not point to this, and neither do the outlooks of corporate CEOs who keep telling us that real business is good. No, Wall Street is alone on this, and that is worrisome as an investor.
While tariffs represent the largest real threat, the stock market itself may become a greater threat. The stock market has the ability to become a self-fulfilling prophecy even when what its prophesizing seems so removed from reality.
What are we to do? When markets move downward it is important to keep things in perspective. We are prudent investors not traders, so it is the long term that matters (long term being three- to five-year periods). Prudent investment is done from the ground-up: know what you own and why you own it. The companies we own are doing well, and ultimately their stock price will reflect that reality.
Prudent investing is also risk averse. While we perhaps have not spoken about it enough, most of our moves this year have reduced the risk in our clients’ portfolios. Most notably, we increased our asset allocation to bonds reducing our weightings toward stocks. As of this moment we have not hit any client risk threshold, but IF this downturn continues, we will take action.
Breaking out of the groupthink can lead to long-term success; not appreciating the damage groupthink can cause can lead to disaster. Balancing those two things is what makes investing more of an art than a science. Caution is in order.
Chuck Osborne, CFA
You know the saying: There are two kinds of people in this world, glass-half-full people and glass-half-empty people. Of course it is the same glass holding the same amount of liquid, but depending on his point of view one is either happy about it or grumpy about it. At the moment, Mr. Market is in a glass-half-empty mood.
The market started this correction supposedly because the economy was so good that interest rates were going to keep rising. Then it was blamed on trade tensions. Now the half-empty crowd is saying that the economy must slow and may even go into a recession in 2019. What is the data backing this up? According to the doom-and-gloomers, it is simply time. This good news can’t go one forever.
Now they are pointing overseas. Japan is the first major economy to post a quarter of negative growth. There is no doubt China is slowing and Europe seems to be losing momentum as well. Does that mean a recession here at home? Not necessarily. Unemployment is at an incredibly low 3.7 percent right now, meaning that 96.3 percent of people looking for work have found it, and perhaps more importantly, wages are growing at 3 percent, which is faster than inflation. We have not seen an employment situation this good sine the 1980’s and 90’s. Forgive me if it is hard to see that leading to a recession.
Corporate earnings were really good this quarter and it has not seemed to matter. Any company that has hinted at weakness, or even just at slowing of growth, has been punished unmercifully…which brings us to what, in our opinion, is really our greatest threat: the mood.
We keep hearing how our economy is “late in the cycle,” which is a more sophisticated-sounding way of saying that I know there is no data to back up my melancholy, but I’m in a bad mood anyway. The truth is that no one knows when the cycle changes until the cycle has already changed, so there is really no way of knowing if we are “late in the cycle.” One thing we do know is that economics can often be self-fulfilling. If enough people start to see the glass as half empty and start acting like we are in a recession, then they could make it happen.
This is what happened is 1992. We talked ourselves into having a recession. It could happen again if we are not careful.
~ I’m thankful that the real economy is doing very well, even if Wall Street refuses to see it.
~ I’m thankful for real wage growth in America.
~ I’m thankful for my children.
~ I’m thankful for my family, immediate and extended.
~ I am thankful for all of my friends.
~ Once again, I’m always thankful for Mama’s pumpkin cheesecake and my loose-fitting pants, which make enjoyment of said cheesecake possible, and are a little looser than last year.
~ Finally, I am thankful for you, our clients and friends. Your trust in Iron Capital is our greatest asset and we value it every day of the year.
Chuck Osborne, CFA
~Glass Half Something
My kids just watched the Charlie Brown Halloween special, fall weather has finally arrived in Atlanta, and our front porch is full of various types of pumpkins. It is October.
So, why is the market selling off? It is October, what other reason do we need? As we said when this selloff began, this is a buying opportunity for long-term investors, and buying is pretty much what we have been doing. Slowly and carefully, but we are still positive because companies are for the most part doing well, and companies are the things in which we invest.
Of course, the talking heads have to have something to say, so they will search for reasons. Tensions with China, rising interest rates, the eventual end of our economic expansion – the news has mentioned all of these things, so let’s address them.
China does have real problems. Are they being caused by Trump’s policies? He will take credit, I am sure, but the truth is that it is impossible to know. What we do know is that their growth rate is slowing. Their stock market is down dramatically and they have currency problems as well. Is this impacting our markets? Perhaps, but thus far it has not actually impacted American companies. Earnings reports remain strong, and guidance for future earnings has remained strong. We invest in companies, not markets, so it appears we are good here.
Interest rates spiked suddenly and everyone began talking about them; this is what is causing the downturn. At least that is what many have said. The problem with this theory is that rising interest rates at this point in the economic cycle indicate better growth. It means people are more optimistic about the future and therefore demand a higher return on their money if they are to loan it to anyone. It also stopped; after the one-week spike, interest rates have leveled off. This does not seem a likely deterrent to company earnings unless a particular company has too much debt. That is easily avoided by us or the mutual fund managers we may use.
We are in year nine of our economic expansion and we have to be coming to the end, right? Wrong. It is true that the average economic cycle going back many years is approximately five years. The cycle means we have a recession (which is defined as at least two quarters in a row of negative economic growth), then we have a recovery. After the recovery, we expand and eventually have another recession. We cycle. Nine years is a long cycle; however, there is no evidence that cycles know what time it is or have a stopwatch. Cycles vary; some are short, some are long, and five years is an average. Cycles have also been getting longer. The other factor to consider is that this positive cycle started and for many years remained much slower than normal. Several years into the expansion, polls still indicated that people thought we were in a recession. I know there is a textbook definition, but perhaps one could argue that if most people think it feels like a recession, then it probably is a recession. If we look at the world that way, then this expansion is much younger than the experts claim. We have to be mindful of the data and willing to accept what it is telling us, but at this point there is no sign of recession ahead.
So, what is the reason? In the immortal words of Mr. Gibbs from “Pirates of the Caribbean,” “reason’s got nothin’ to do with it.” Prudent investors see market behavior like this as an opportunity. It isn’t that scary in October – it’s trick or treat time!
Chuck Osborne, CFA
~Boo! October Can Be Scary
Yesterday we were on our way home from a short family vacation when my wife looked over and informed me that the headline she had just received from the Wall Street Journal was, “Surging Yields Raise Threat of Tipping Point for Stocks.” I laughed.
If you are like my wife and you don’t understand why I thought this headline was funny, let me break it down for you. The first line of that story was, “Yields on long-term U.S. government debt moved abruptly higher last week, calling into question the durability of the more than nine-year-old bull market for stocks.”
First, rising interest rates do not kill bull markets; they actually go hand-in-hand with bull markets. I know this is counter to what you have learned from every financial media outlet and the short-term traders who often sit at their desks, but it is true. In fact, it is “textbook,” as they say.
If you wish to get full credit on the relationship with interest rates and stocks on your Level III Charter Financial Analyst (CFA) exam, you had better understand this fact. Let me make it simple: when confused, always go back to the basics. What is stock? On a daily basis it is easy to fall into the trap that stocks are just digital notations (formerly pieces of paper) that are randomly traded back and forth, but that isn’t true. Stock is ownership in a company. When a company’s business is good, the owners are rewarded. It’s that simple.
So, what are bonds? Bonds are loans. When a government or a corporation needs to borrow money, they issue bonds, which is just like you or me going to the bank to borrow money. The interest rates we pay are going to depend on our credit, and on the demand for loans. If the bank is overrun with customers wanting loans, then they can charge higher rates; if we are the only ones in there, then we can negotiate lower rates. Interest rates go up as the economy grows faster.
When the economy grows faster, people buy more products from more companies, which means companies make more money. When companies make more money, stock prices rise. Interest rates and stock prices go up together. The problem with markets is that they tend to get overheated and go too far; that is when stocks go down, and then interest rates go down. Then they do it all over again.
So, are things overheated? With interest rates this question almost answers itself. We have gone from historically low rates to low rates. We have not even really gotten back to normal, so the idea that we are overheating there really is not even being discussed.
Stocks, on the other hand, are coming up on a nine-year bull market run, right? Wrong. This headline is at best misleading and possibly just a lie. It is true that through the marvels of flawed design and questionable math the S&P 500 index has been positive for that many years, but stocks as a whole have not.
The market has corrected several times in the last nine years. We practically had a bear market (by definition, a market down 20 percent in price) in 2015 for every stock except the so-called FANG (Facebook, Amazon, NetFlix, Google) stocks. The FANG stocks then corrected in the beginning of 2016. We are in a bear market right now for Chinese companies, and international stocks as a whole have been hit hard this year. Small company stocks, which had finally come back to life after suffering for most of this nine-year period, have been hit hard of late. So, for anyone who has looked more closely than the most casual observer, this has not been an uninterrupted nine-year run.
This can’t be the end of the nine-year bull market because it has ended and then started again three or four times already. The economy is good; in fact, it is very good. That means rates will rise and companies should continue to report stellar earnings. Any market fluctuations in the meantime are just an opportunity for the long-term investor.
One final thought: Bubbles never burst when people are fretting about this possibly being a bubble. Bubbles burst when everyone is saying, “This time it is different.” In 1999 I was told by a colleague at Invesco that, “valuations don’t matter anymore.” In 2007 I was told by a hedge fund manager that one could “buy mortgage-backed securities and use as much leverage as you need to achieve any return you wish to earn and it is all risk-free.” When people start to talk that way, then we will be nearing the end of the run. Until then, when you see panicky headlines, do what I do and laugh and get ready to go shopping.
Chuck Osborne, CFA
~Up, UP and Away!