Lions, Tigers, Bears & Trade Wars – Oh My!

Volatility has returned to the markets. What to make of it and how to respond accordingly.

While it may seem like ages ago, the bull market was at historic highs earlier in the year (January 26th), but since then headwinds have picked up. It’s fair to wonder if things could get even worse from here on growing geopolitical tension.

2018 has been a whole lot different than 2017. Last year, stocks marched higher with only minor pullbacks; the largest peak to trough decline for the S&P 500 was less than 3%. 2017 was a year that lacked turbulence and rewarded investors handsomely.

Since early February, volatility has returned, taking stocks on varying swings of good days and bad. Many of those episodes were based on errant tweets that became de facto policy statements. Investors have had a hard time knowing how to respond to the daily barrage of tweets.

I’m sure I’m like most in that I abhor uncertainty, but every day we seem to be awaking to surprise policy moves that could start to harm the economy. I generally disdain discussing politics, so my thoughts aren’t political statements rather commentary on events that affect investors’ monies in the capital markets.

For long-term investors, we should all look past it, but I know that in the short-run discounting such hyperbole can be tough to do.

I like to look at more persistent measures that better gauge the markets. I consider them 3 legs to a bar stool – the nation’s overall economic situation (+); corporate profitability (+); and investor sentiment or crowd psychology (~).

National Economic Growth
We’re in the 3rd (very soon to be the 2nd) longest economic expansion in U.S. history, an expansion that’s broad-based across a full range of sectors with consumer spending, manufacturing activity and construction all showing robust figures as part of a global trend of stronger-than-expected growth. Looking ahead, U.S. gross domestic product (GDP) growth could well average 2.5% this year and next.

For now, there aren’t any real signs that the economy has fundamentally down-shifted. The expansion that started 9 years ago is still underway, buoyed by near record-level stock market performance, low unemployment, robust job growth and other key economic indicators heading in the right direction.

While job productivity has slackened, it’s made for an environment where unemployment is extremely low, allowing for wage gains to build as talent becomes increasingly scarce, forcing competition amongst businesses to bid for workers. While that’s good for workers finally getting their fair shake, it’s wage inflation that the Fed Reserve likes to tamp down so look for 2-3 more benchmark interest rate hikes over the remainder of the year.

1st Quarter Corporate Earnings Outlook
Corporate earnings, the primary driver of stock prices, still look great according to FactSet. For the first quarter, earnings growth rate for the S&P 500 is expected to increase by 17.1% (reports have started to come in, and we’ll get most throughout the rest of the month). The forward 12-month price-to-earnings (P/E) ratio for the S&P is currently around 16.5, above the 5-year average of 16.1 but down significantly from overstretched P/E valuation in January. While earnings are expanding, valuation multiples are contracting (at least until stock prices start to pick up again).

What’s driving a good amount of earnings-per-share (EPS) guidance is good end-demand growth, both domestically and abroad. Secondarily, this is the first earnings report where we’ll feel the impact of the new tax act in lowering corporate tax rates. While the statutory rate is now lower, many multinational companies’ effective rates are already much lower. The effects of lower individual tax rates on investments made are more indirect and probably won’t be felt in earnest until tax season next year.

Global Growth
Spurred on by higher profits and buoyant stock markets, companies around the world appear to be loosening up their purse strings as capital spending starts to tick up (barring growing worrisome protectionist trade friction). Hopefully as the global economic expansion gathers speed, capital investment will stoke not just demand, but ultimately higher wages and inflation, especially when employers have been reluctant to spend even amid an economic upswing.

Analysts’ S&P 500 Price Target
For the 1st quarter of 2018, the S&P 500 lost -1.2% in value, the first down quarter since the 3rd quarter of 2015. Since then, we’ve had a rocky start to April.

According to FactSet, industry analysts (bottom-up price targets) see roughly a 16% increase for the S&P 500 over the next 12 months. At the sector level, Health Care is expected to growth by 18.8%, Information Technology by 18.2%, and Energy by 18.0%. The Utility sector is expected to see the smallest price increase, +4.8%.

Corporate leaders, in their earnings announcements, will also give us guidance on how they expect their businesses to be impacted by the threat of tariffs. Economists and Wall Street analysts will also be chiming in as to the cost in terms of economic growth, jobs, and earnings.

Investor Sentiment
According to the American Association of Individual Investors (AAII) weekly sentiment survey, for the week ending April 4th, pessimism about the short-term direction of stock prices has spiked to its highest level in more than 7 months.

The reason for the dramatic change in mood? Tariffs, counter-tariffs and an escalating trade war with China, let alone a pending renege on NAFTA which would ensnarl all 3 of our largest trading partners, accounting for about $1.7 trillion of trade annually, according to the U.S. Census Bureau.

If there’s a somewhat positive take-away, it’s that tariffs will take several months to implement, so there’s time to negotiate, find common ground, and curtail escalating the matter.

Détente will surely be at hand. But, ramifications of irreconcilable ideological and economic differences between an aging superpower and a rising superpower will linger on in some form or fashion (similar to the Soviet area).

Technology Stocks
Another concern weighing on investors is within the technology sector. Facebook is embroiled in a controversy over privacy and data sharing, and Amazon, up 50% in the past year, sank after the president renewed his attack on the online retailer.

Because of Facebook’s scandal, techlash has been gaining momentum. Since consumer data is the key competitive edge of social media firms, it means there’s always a heightened level of risk and uncertainty surrounding one’s personal information. I don’t think the Cambridge Analytica scandal even remotely compares to Equifax’s data breach in which Social Security numbers, names, addresses and even some bank information was stolen. And, nearly half of the nation has not taken any action to protect their data since the Equifax breach, according to a recent MagnifyMonyey survey. Wow!

While other tech companies fell in sympathy over Facebook’s problems, I don’t see that much follow-through collateral damage to other tech companies and industries. This whole issue may blow over just as quick as it started.

FAANG Stocks Bursting?
I don’t necessarily think so, but these stocks were/are ripe for profit-taking as investors have been increasingly risk-off and looking to lock in gains. Sure, some of the shiny veneer has come off, but tech stocks, specifically FANG stocks (Facebook, Amazon, Netflix, Google) or FAANG (inclusive of Apple), or Fab 5 (inclusive of Microsoft, minus Netflix) have been some of the biggest bull market gainers, even after their recent price drops. These mega-cap tech stocks have lured investors with momentous gains more than triple the market since 2016.

Will technology, in general, be out of favor? Not likely, but there could be a rotation out of FAANG into more fundamentally sound growth stocks elsewhere in the space. There will still be money earmarked to the technology sector, especially big-cap names that offer ample liquidity.

As this rotation within the all-important tech sector transitions, it’s incumbent upon investors to identify where the next big moves are coming – artificial intelligence (AI), robotics, cybersecurity, financial technology (fintech), mobile computing, cloud computing, autonomous cars to environmental technology. Health care too will be a beneficiary as we witness genetics research break-throughs, which will hasten people living longer – and they’ll need income to support themselves in their golden years.

Should you lower your overall tech exposure? That depends. As a Bloomberg Businessweek article recently stated, “Investors comfortable with risk and who have years of earnings power ahead might be happy with their tech exposure. They can ride out market cycles. It’s more complicated for those approaching or in retirement, who have less time to rebuild savings. It’s important to know whether your retirement fund is heavy in tech and to be comfortable with the increased volatility that may bring. Panic selling rarely turns out well.”

Heightened Volatility Weighing on Investors
Investors seems particularly worried right now that a big change is under way. That’s at least what the financial news headlines would have you believe; these news outlets are media companies vying for your attention as much as Facebook.

There are important concepts to remember however. In every decline, no matter how severe, markets ultimately tend to stabilize, and so far, this correction is run-of-the-mill.

Cognitive Dissonance
Remember the last time stocks fell so hard? You probably don’t, and that’s making it all seem a little harsher than it is.

It’s a fact of life of the mind that things always seem worse in the present. But in fact, they’re not. Behavioral economist & Nobel prize winner, Richard Thaler, explored biases and cognitive shortcuts that affect how people process information.

[Read more here: https://www.bloomberg.com/news/articles/2017-10-27/how-to-profit-from-behavioral-economics].

In this bull market alone, there’s been 5 other corrections like this one, and it’s taken around 7 months on average for equities to climb out of their hole, data compiled by Bloomberg show. Based on that path, investors’ anxieties will linger until August.

At the same time, just because bouts of losses are normal doesn’t mean they’re painless, especially when momentum stocks (FANG) are leading the way lower. But the statistic is a reminder that it’s unrealistic to expect a market recovery to involve a straight line back up.

It seems even worse because of how placid markets have been since the last disruption. While individual stocks seem to be regularly rising and falling 5% these days, consider that in 2016 and 2017 the S&P 500 went through several long stretches without posting a single up or down day of more than 1%. Through April 10th, 1% daily moves in the S&P 500 has occurred 28 times this year. In 2017, we only had 8 such days.

“You had this incredible low-volatility environment, but markets are supposed to go up and down,” stated Michael O’Rourke, Jones Trading’s chief market strategist.

A move back to a normal market environment is usually hard to take. According to LPL Research, the average intra-year pullback (peak to trough) for the S&P 500 since 1980 has been 13.7%; half of all years had a correction of at least 10%; 13 of the 19 years that experienced an official correction (10%+ down) finished higher on the year; and the average total return for the S&P during a year with a correction was 7.2%.

The take-away? Turbulence surfaces more often than we recall and patient investors who don’t react emotionally have historically been rewarded. Don’t let short-term market volatility guide your allocation; your investments should reflect your time horizon.

Moving Forward
Springtime is here – a time of rebirth and regeneration, so while the weather may still be a bit cold or inclement, it offers up to evaluate the year so far, to review one’s long-term goals, and clean one’s minds (and homes) as we get ready for summer fun.

Your money life should never be ignored, but it shouldn’t be all-encompassing that it captures too much time away from what you love and care about. The idea is to find a workable balance between your money life and the rest of your life.

I have a hunch that most people would agree they should invest for the future. My second hunch is that many individuals don’t know how to start and are afraid of making serious mistakes, so initial impetus fades.

The work I do, and that of my fellow advisors, is about creating better outcomes for investors. I hope you find my communications informative and not too heady. Please contact me with any questions you may have, and if you or anyone you know is in need of advice, please send them my way.

Rising Inflation Expectations, Rising 10-Year Treasury Yields (Reason to Worry or Not?)

Last week the S&P 500 rallied 4.3% after a quick downdraft at the end of January and into the first week of February that zapped gains on major indices for the year and sent the S&P and the Dow intocorrective mode (down 10% from recent highs), albeit briefly.

That rally from early February lows made for the biggest S&P weekly gain in more than 5 years and got the stock indices back in the black for the year (+1.0% YTD for the S&P 500 through Feb. 21st). The 3 major indices (S&P, Dow & Nasdaq) have now gained back nearly half of their losses from earlier in the month.

The February 5th drop of 1,175 points for the Dow was the largest single-day point loss ever, but in percentage terms that was a -4.6% decline, one that doesn’t register in the top 100 largest single-day losses.

It seems as if a lot of records are being broken as of late, except at the winter Olympics. It looks like the U.S. haul of 37 medals in 2010 in Vancouver will stand. We’re at 19 in PyeongChang as I write this (Feb. 21st evening). In the end, hopefully we appreciate witnessing exciting competition by great athletes regardless of their nationality as the modern Olympics’ aims are for “better world through sport practiced in a spirit of peace, excellence, friendship and respect.”

I won’t speculate on the rationale for lower overall medals for U.S. Olympians but as for the recent equity market sell-off it’s mostly tied to inflationary expectations which feeds through to interest rates, particularly those on the 10-year Treasury note, the most popular debt instrument in the world.

For borrowers, the 10-year is the benchmark for fixed-rate mortgages and the pricing of other credit assets (such as corporate bond rates which trade at a spread over Treasury yields). Overall, think of the 10-year as a gauge of domestic economic growth.

With a tight labor market showing some wage growth and a recent higher-than-expected consumer price inflation (CPI) report, we’re seeing upward pressure on interest rates. Those types of inflationary signs ultimately work their way through to companies as cost pressures, thus potentially hurting profit margins – that’s when stocks start to get roughed up.

Right now, the 10-year Treasury yield is near 2.94%, up from 2.41% at the beginning of the year (a 22% rise).  Some investors like to look to technical measures as a red line be it 3.0% or 3.5% or 4.0% on the 10-year Treasury as the magical switch to reduce their stock exposure.

As we’re starting to flirt with 3.0% on the 10-year, I don’t see it as the indicator to jump ship from one’s longer term goals (one that probably entails having a fair amount of stock exposure). All in all, rates steadily rising isn’t necessarily a bad thing.

As corporate earnings go up, stocks go up, interest rates go up, and bond yields rise. It’s all OK if it’s in balance. It’s a 3-legged stool – corporate earnings, interest rates (influenced by inflation expectations), and investor sentiment (demand for stocks and the ability/willingness to put money to work). Investors need this trinity to work. Similarly, your own body – physical, mental, and spiritual/emotional well-being – needs to be in-sync to feel at your best.

Fourth quarter 2017 earnings have wrapped up for the most part (with 80% of the companies in the S&P 500 reporting, according to FactSet). FactSet calculated the blended earnings growth rate for the S&P 500 is +15.2%. If 15.2% is the final number for the quarter, it will mark the highest earnings growth since the third quarter of 2011 (+16.8%).

We continue to see positive corporate earnings per share (EPS) growth for 2018. Why? The decrease in the U.S. corporate tax rate due to the new tax law is clearly a significant factor (going from 35% to 21%). Other factors include an improving global economy and a weaker U.S. dollar (which helps U.S. exports). Corporate growth and in turn EPS growth should continue to support share prices. For now, we’re not seeing undue profit margin stress across a large swatch of corporate earnings reports. When we do, it may be time to tactically rebalance one’s investment assets.

So, is the worst over? Is the correction done? Is the market no longer concerned about inflation? Many investors and market watchers may not be so quick to jump back on the bullish bandwagon after such a stunning pullback disrupted one of the most epic market upswings in history; it’s certainly shocking to suddenly see the Dow plunge by more than 1,000 points twice in one week.

My hope is that the market has finally found some balance amid higher inflation, rising rates, and increased volatility. Perhaps this was the long-awaited correction that so many investors said we needed, and now the market can resume its upward trajectory.

What’s the tipping point for investors to step away from equities for higher return that may be available elsewhere? Given recent stock performance as the 10-year has moved closer to 3.0%, I’d speculate that stock bulls will turn worried once rates close in on 3.5% and become outright bearish once rates close in on 4.0%. The catch here is the pace to which we get to these higher yields – a steady move up is fine, but a jump to 4.0% (as an example) by the end of this year on the 10-year would surely be perceived as bearish.

I remain constructive on global stocks given solid growth fundamentals in the U.S. and internationally, but see further gains punctuated by bouts of volatility with higher magnitude than the markets have seen in the past few years. Historically, higher volatility has been able to coexist with upward-trending stocks.

It’s understandable that you may be worried about your investments and seeing the vagary of month-end statement values. If that is distressing to you, let’s talk about your long-term goals, your investment mix, and how I may help you stay on course in volatile times.

“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” ~ Charles MungerVice Chairman of Berkshire Hathaway

Wall Street veterans remind us of the adage, “Trees don’t grow to the sky.” The markets had a well-deserved break, spooked by rising interest rates. Markets go up and down. Over the long run we all know they go up a lot more than they go down. But in these times of market volatility it can be stressful on all of us. The key to managing stress from fluctuations in the market is to ignore the noise.

Me and my firm create investment portfolios based on clients’ long-term goals and to make sure they are well diversified, so as not having to worry about occasional market dips which newspapers and other media tend to sensationalize. Investing is about long-term returns not short-term ratings.

Please let me, or one of my fellow advisors, know if you want to discuss anything at all, from current market news to specifics about portfolio construction to preparation for the upcoming tax season. Happy to help out.

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Up, Up and Away – Why Not to Fear New Market Highs

2018 started off with NYE fireworks that have continued. It took only 3 trading days in the New Year for the Dow to surpass 25,000. It took another 8 trading days to close above 26,000.

Do you take your money off the table or do you say, laissez le bon temps rouler?

I’m not a soothsayer (more of a historian), so let’s step back and remember that a day or a month does not make a year.

Performance-wise, 2018 marks a phenomenal start for the Dow index. As of January 16th, the Dow was up ~ 5% YTD, on the heels of being up ~ 25% in 2017. The Dow jumping from 25k to 26k was the quickest 1,000 point move ever. Wow! The Dow is like the Golden State Warriors (as of recent) – we’re seeing some outstanding moves and records achieved.

It’s best to keep everything in check though. We only have to look back 2 years to the beginning of 2016 – the Dow had its worst 10 day start since 1897. The Dow lost 5.5% in January 2016 and 93% of investors lost money, if not more than the Dow that month, according to CNN_Money.

Back then, global economic worries pushed investors away from risky assets. Now an apparent synchronized global pick-up has investors jumping in and seeking risky assets, such as stocks, fearing they’re missing out on the next leg up. It’s a melt-up, the opposite of a market melt-down.

When people know that I’m a wealth manager, they often ask me what I think about the stock market. Often it’s along the lines of “I have cash that I could/should put to work but have been waiting for a pull back as the market is at an all-time high, so I just sit tight.”

I often proffer that “the best time to invest was yesterday and the second best time is today,” in addition to, “it’s about time in the market, not timing the market.”

We’ve been constantly hitting new highs since taking out the old high on the Dow back in October 2007 (Dow 14,093) in early 2013, a span of ~ 5 ½ years to be back in black. Now we’re close to another 5 years since then, and close to 9 years in on a really impressive bull market run.

For those old enough to remember the Nifty 50’s, the Dow climbed 240% during the decade of the 1950s. For me, I remember the Roaring 90’s and the spectacular run we had during that decade. In 1999 alone, the Nasdaq composite rose 86%, the biggest annual gain for a major market index in U.S. history, while the Dow gained 25%, a record 5th year in a row that the index posted a double-digit percentage gain. That’s what a market topping process looks like.

Historically, the stock market has had its share of peaks and troughs, from bull to bear back to bull again, taking out previous highs and setting new ones. How long does that take? It depends on many circumstances but I would say that while the past is no fortune teller, it does offer clues.

Wharton School Professor Jeremy Siegel studied the ‘Nifty 50’ stocks of the early 1970’s. These were much sought-after stocks that got to ‘nose bleed’ valuation levels and then had a melt-down. However, they ultimately turned around and by 1996, they had offered up annualized double digit returns. (you can read the full study here: https://www.aaii.com/journal/article/valuing-growth-stocks-revisiting-the-nifty-fifty)

So even if you believe you are purchasing stocks at high valuation metrics, over a long period of time those securities will reward investors (caveats of diversification, etc. are always warranted).

There will be bubbles – Dutch tulip bulbs, dot-com stocks, and now we’re in the throws of a cryptocurrency craze. And yes, many U.S. stocks are currently stretched, valuation-wise, and probably will be for a while longer as there’s momentum from investors adding to stocks and away from bonds.

As economist John Maynard Keynes stated back in the 1930s, “The market can stay irrational longer than you can stay solvent.” At this juncture, that means a tricky part of putting money into a bearish bet is the timing. You can be right that a market or sector is overvalued but wrong on the timing.

My best answer to investing near or at market highs is to stay steadfast – continue to invest or get started in doing so. Dollar-cost averaging helps as well. Investors with a long runway before they need to draw on their assets should hold a good amount in stocks in their overall asset allocation.

One should take a diversified investment approach and forgo timing entry points. One’s time and energy is better served on focusing on a factor that has been shown to have a greater impact on returns – one’s asset allocation. That should be based on one’s long-range financial goals and needs as well as knowing one’s limitations. A wealth manager who has an informed view of a client’s total financial picture can then position the client to best hew to his or her overall financial plan.

In financial literature we often speak of a “rational investor” but we all know that humans are emotional beings (we’re not Vulcans!). It’s really difficult for human beings to envision what might happen in the future. That’s why we have a very tough time taking money we earn today and saving or investing it for some far-off point. But doing exactly that is what’s required if you want to reach big financial goals.

If you want to get or stay on track to reach your long term goals, feel free to reach out to me (or a fellow Naples Asset Management advisor in your local area) about any adjustments your plan may need.

A creative man is motivated by the desire to achieve, not by the desire to beat others.” ~ Ayn Rand

Student Loan Debt Triples in Past 15 Years, Loan Rates Resetting Way Higher

Student loan debt has tripled as a percentage of total debt owed by U.S. households in less than 15 years, Shahien Nasiripour of Bloomberg News recently reported — https://www.bloomberg.com/news/articles/2017-05-18/student-debt-is-eating-your-household-budget

In 2003, student loans accounted for 3.3% of total household debt, or $240.7 billion, according to estimates by the Federal Reserve Bank of New York. Now that figure stands at ~ $1.3 trillion, or 10.6% of all household debt. The Federal Reserve Bank of Washington pegs that figure even higher at over $1.4 trillion. (https://www.newyorkfed.org/microeconomics/topics/student-debt)

The larger amount of debt reflects higher tuition and campus-related costs as well as declines in state appropriations to public colleges and federal student grants relative to rising college costs. 1 in 6 American adults, 44 million, has student loan debt outstanding.

And student loan debt is only set to rise further as interest rates on federal student loans for the 2017-18 academic year reset on July 1st.

Undergraduate students will pay 4.45% in interest on new Stafford loans, up from current 3.76% rate. For graduate students, the interest rate on new Direct loans will climb from 5.31% to 6.0%. Parents who take on federal debt to help their children pursue a degree can expect to pay 7.0% on a PLUS loan, up from 6.31%. This is comes at a time when interest rates, in general, are quite low – U.S. 10-year Treasury notes currently yield ~ 2.20%.

Because many students and their families have to borrow money each year, continued annual increases could take a significant toll.

The new rates track closely with projections from the Congressional Budget Office, which anticipated rates to top 6 % on undergraduate loans, 7.5% on graduate loans and 8.5% on PLUS loans by 2018.

The government resets interest rates on student loans every year based on the spring rate of the 10-year Treasury note (this year, May 10th the 10-year Treasury was 2.4%), plus a fixed margin (2.05%, 3.6%, and 4.6%, respectively, for Stafford, Direct and Plus loans). Next July’s rates could be higher as interest rates look set to rise, but there are protections for families.

To keep rates on education loans from skyrocketing, Congress has set a ceiling. Interest rates on undergraduate loans are capped at 8.25%, graduate loans are capped at 9.5%, while the limit on PLUS loans is 10.5%. Lawmakers decided several years ago to tie federal student loan rates to the market, rather than setting them.

Even given the higher federal student loan rates, they are still a better bet than private loan rates. And since these interest rates are fixed, they won’t go up later and come with protections such as an income-driven repayment plan that’s tied to a percentage of one’s wages so one can manage their loan repayments.

There are ways to help students and families manage the cost of college, particularly if they don’t qualify for aid, such as federal education tax credits and tax-advantaged savings plans – 529 college savings plans.

If you need guidance on college funding, ask me or one of my fellow advisors in your area how to maximize the bang for your academic buck. Summer is a great time to review contribution strategies, such as 529 college savings plans, for your children or grandchildren to meet these ever-rising educational costs.

“Education is the most powerful weapon which you can use to change the world.” – Nelson Mandela

Lead story, “Student Debt is Eating Your Household Budget,” by Shahien Nasiripour of Bloomberg News, May 18, 2017. Link – https://www.bloomberg.com/news/articles/2017-05-18/student-debt-is-eating-your-household-budget

Disclaimer: The opinions expressed herein are those of the author or the sources cited. The article is for general education and information about investing and economic matters. Nothing should be construed as advice, nor any of it considered an offer or solicitation of any kind to buy or sell any investment products. I/we are not responsible for the accuracy or content on third party websites or sources cited; any and all links are offered only for use at your own discretion; and our privacy policies do not apply to linked websites. Eric Linser is an investment advisory representative of Green Valley Wealth, a dba of Naples Asset Management Company, LLC, a federally registered investment advisor.

 

International Investing – Looking Abroad for Better Returns

With the upcoming Memorial Day kicking off the start of summertime, and 1st quarter earnings season wrapping up, it appears all is well and good, at least outside of the political kabuki theater in Washington. There’s a chorus of animal spirits driving optimism by corporate leaders and consumers alike, which is in turn driving business investment and household consumption and savings.

And it’s not only happening in the U.S. as we’ve seen strong earnings growth and positive surprises across industries and geography – evidence that we are experiencing a bout of synchronized global expansion.

To me, a more broad-based recovery is welcomed as it eases worries of a maturing U.S. business cycle that may not be able to do as much heavy lifting for the global economy as it has recently. And, given such a constructive global backdrop, stock markets around the world may have further to run.

For a U.S. investor, there are 47 individual country-specific exchange traded products (ETFs and ETNs — https://seekingalpha.com/etfs-and-funds/etf-tables/countries) that one could purchase to garner exposure to a basket of stocks in each of these countries.

Post the global recession of 2008 to early 2009, you could have easily ignored 46 of those specific countries and focused on one – the U.S.

You could use the S&P 500 as a gauge or a broader stock market benchmark that includes broader exposure to mid- and small-capitalization companies like the Vanguard Total Stock Market ETF (ticker symbol “VTI”), providing a more complete view of the U.S market than the S&P 500.

It is remarkable how the U.S. stock market has outperformed the rest of the world over the past decade. Among these 47 individual country stock markets at the close of 2016, VTI ranked # 1 over 10 years, # 2 over 5 years (behind Ireland) and # 1 over 3 years. Until last year, investing outside the United States had been a fool’s errand for an entire decade!

But 2017 may mark a turning point. So far this year, the U.S. stock market sits at a lowly 39 out of 47 with a gain of ~ 7.0% year to date (through May 23rd) for the Vanguard Total Stock Market ETF. Of the other investable markets, 29 of the 47 country-specific funds are up double-digit percentages nearly 5 months into the year.

Home Country Bias

If you are a U.S. investor sticking with the U.S. stock market over the past decade has been easy to do; it also has been a winning bet. But the real reason it has been easy is that most investors suffer from a home country bias – the preference to invest in one’s own country’s stocks.

So what? Today, the U.S. stock market currently accounts for 36% of the world’s stock market capitalization; that’s down from 45% in 2003. So, if you truly want a balanced stock portfolio, you should have 64% (nearly 2/3) of your stock investments outside of the U.S. markets.

Does the idea of investing most of your hard-earned wealth in global stocks make you feel queasy? Of course it does. However, you should invest abroad for the same reason John Dillinger gave when the police asked him why he robs banks: “Because that’s where the money is.”

Global Investing Back in Fashion?

Timing the market is more for the lucky than the smart, but still reversion to the mean is the one rule of investing that, given time, always rings true.

Here’s really simple reasons why I think global stock markets have started just such a reversion.

#1 – U.S. investors despise global stock markets. Chances are you have no interest in investing outside the U.S. in either developed or emerging market stocks. After all, international stock markets have gone essentially nowhere in the past decade. If negative sentiment is a necessary contrarian indicator, you could hardly ask for a better setup.

#2 – International stock markets are very cheap. It is no secret that the U.S. stock market is expensive, valuation-wise, compared to the rest of the world. According to Star Capital Research, the U.S stock market is the 3rd most expensive in the world. Only Denmark and Ireland have richer valuations based on future earnings expectations.

As I mentioned earlier, reversion to the mean. Few things are predictable in investing, but given enough time, cheap stocks will get more expensive and expensive stocks will get cheaper.

#3 – International stock markets have turned up and you probably didn’t notice. Chances are you’ve been focused on U.S. stocks more than ever or the political scene in Washington. After all, the Trump Bump gave many U.S. investors a renewed appetite for risk taking, one that harkens back to the 1990s.

However, solid returns in the U.S. stock market year-to-date tell you nothing about how much money you could have made investing outside our country’s borders.

Is 2017 the year that international stocks begin to make their long-awaited comeback? The signs are as good as they have been for a long time. And, who knows, after a few years of leaving the U.S. stock market in the dust, international investing could cease to be a pariah for U.S. investors.

I suspect more U.S. investors will turn to looking outside the U.S. for superior market returns be it in emerging markets or in developed markets like European bourses where a combination of diminished political risks, cheap valuations, years of underperformance, and a European Central Bank (ECB) that is in no rush to hike rates make the region attractive.

The graphic below from Jonathan Krinsky of MKM Partners LLC and Bloomberg points out that a simple comparison of the Vanguard FTSE All-World ex-U.S. ETF (ticker symbol, “VEU”) versus the S&P 500 ETF (ticker symbol “SPY”) showing massive turnaround potential for the rest of the world to catch up.

After several years of underperformance, economic growth in the euro zone has matched that of the U.S. for the past year or so, and appear to be neck-in-neck (as shown in the graphic below).

U.S. vs. Euro Zone, Change in Gross Domestic Product (GDP), Year-over-Year

More than halfway into Europe’s earning season, 69% of companies had beaten earnings per share estimates vs. 75% of S&P 500 companies in the U.S. Overall, this is a fantastic showing.  According to Morgan Stanley, that’s the best showing in over a decade in Europe.

This marked improvement in economic growth is starting to feed through into corporate earnings and revenue. With 1st quarter results in from more than 250 companies, or about a 1/3 of European stocks by market value, the net number beating earnings expectations is on course to be the highest in more than a decade, according to Morgan Stanley. Those companies beating analysts’ estimates for revenue are set for the best performance in at least 14 years, Morgan Stanley added.

Total Returns, including Reinvested Dividends (in euros) of U.S. vs. European Stocks over Past 1 Year

The graphic above shows that over the past year, a recent run by European stocks (as measured by the Euro Stoxx 600 index) has caught up with the S&P 500 over the past month or so.

Total Returns, including Reinvested Dividends (in euros) of U.S. vs. European Stocks over Past 2 Years

On a longer-term basis of 2 years, however, there’s still quite a way to go before European stocks’ previous underperformance relative to their U.S. counterparts is erased.

The Case for Going Global

The combination of an improved outlook for euro zone growth, a benign inflationary environment and a central bank that’s unlikely to echo the Federal Reserve in raising interest rates anytime soon gives European stocks the opportunity to outpace U.S. returns.

Also supporting the case for European equities is the sheer scale of prior underperformance vs. U.S. stocks. However, the same factors also prevail in other major equity regions, especially emerging markets and, to some degree, Japan. However, political risk also remains a negative reality for Europe on a medium- to long-term horizon, even if the most immediate worries seem to have passed.

In many of my multi-asset portfolios, I have followed a geographically diversified approach to my equity positions this year, elevating exposure outside of the U.S. I view my position within the context of diversifying equity exposure across major regions, reflecting a broadening out of economic growth – a synchronization of global growth, if you will – rather than an outsized bet on European outperformance.

While there is a good chance that European earnings growth will come in as the strongest of any region this year, emerging market equities could well give Europe a run for its money in this regard. Japan, too, should see solid earnings growth this year, particularly if the yen remains weak, as I expect it will.

Valuations look significantly cheap for emerging markets as they do for Europe, particularly in comparison to the U.S. stock valuations. Given valuation metrics, the region that looks more challenged than the rest is the U.S. It is clearly the most expensive of any major equity market, and the upside to earnings growth looks somewhat limited unless we can get fiscal stimulus such as tax cuts, infrastructure spending, and regulatory relief passed by Congress.

But for now confidence remains historically high for businesses and households alike, which probably has more to do with expectations for no new anti-business regulations and taxes than actual legislation getting passed that would make it wildly better. With that said, here at home corporate growth (as measured by the S&P 500) is set to accelerate throughout 2017 to a solid 12.3% and 10.8% in 2018, according to Bloomberg Intelligence data. If that comes to fruition, that would be the biggest 2-year advance since 2012 and would help justify rich U.S. market valuations.

In an environment of strong and broadening global economic and earnings growth, I have assigned greater importance this year to being overweight equities relative to bonds, and I am looking to international markets for attractive returns. And while U.S. equities don’t look as compelling as other regions, I’m maintaining exposure a bit of home bias as there are offensive and defensive qualities as well as comfort that U.S. exposure brings to investors’ portfolios.

I wish you and yours an enjoyable summertime ahead and a reflective Memorial Day for those men and women that served and sacrificed to win or preserve our freedom.

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Disclaimer: The opinions expressed herein are those of the author and/or the sources cited. The article is for general education and information about investing and economic matters. Nothing should be construed as advice, nor any of it considered an offer or solicitation of any kind to buy or sell any investment products. We are not responsible for the accuracy or content on third party websites or sources cited; any and all links are offered only for use at your own discretion; and our privacy policies do not apply to linked websites. Eric Linser, CFA is an investment advisory representative of Green Valley Wealth, a dba of Naples Asset Management Company, LLC, a federally registered investment advisor.

Vote at the Polls, Not with Your Investment Portfolio

As I was watching game 7 of the World Series the other night, I knew there could only be one winner of the game and the overall series, and I was OK with either team being crowned champion, as both the Cubs and the Indians were long overdue to lift the curse overhanging each team. I offer a hearty congratulation to the Cubs and their legions of dedicated fans.

Winning in baseball seems way more civilized than what we’ve seen in the Presidential race. We knew it would be ugly, but it’s worse than that and now both sides are pulling out scorched earth negative ads in the waning days of the election, Tuesday, November 8th.

A week or two ago, literally most pundits and voters alike were all concluding that Hillary Clinton was heading for not just an election win but a landslide victory. Now with polls basically a toss-up, uncertainty over the outcome is upsetting investors and they’re selling their investment funds.

One of the key reasons why angst is mounting is because investors believe that the combination of the continued investigation around Clinton’s emails and Trump’s potential unwillingness to concede could create a rather messy post-election situation. And, there’s no shortage of attention on what Trump or Clinton would do as President.

Living in California, I feel there are way more pressing matters – 17 state propositions and 24 propositions in San Francisco (collectively, nearly 550 pages of voter guides for me to peruse). Regardless of the Presidential race (let alone a few tight Senate races across the country), voters are ready to make some big changes locally and at the state level.

As for investors, uncertainty and nervousness is reaching a crescendo in the final pre-election days. Unfortunately, the election noise is blocking out some positives in the economy and corporate results.

3rd quarter earnings season is basically over, and it was a pretty good one. According to FactSet, 85% of the companies in the S&P 500 have reported earnings. The blended earnings growth rate for the S&P 500 is 2.7%. If that reported growth in earnings holds for the quarter, it will mark the first time the index has seen year-over-year growth in earnings since the 1st quarter of 2015, ending a 5 quarter negative trend.

Additionally, the latest batch of U.S. economic data doesn’t appear to foreshadow an imminent recession, which would typically lead to a bear market (20% correction) — consumer confidence (while shaken by political theatrics) has remained strong; housing looks good; the labor market is resilient; and wages are finally starting to rise (+2.8% year-over-year). Additionally, we’ve seen both revolving consumer credit and bank loans increase, indicating consumers are becoming more comfortable in taking on debt. None of this portends that anything bad, economically, looms on the horizon.

sp-tumbles-below-technical-levelHowever, given all of the anxiety around the upcoming election this Tuesday, investors’ fears have weighed on U.S. and global markets. U.S. stocks (as measured by the S&P 500) have fallen to their lowest levels since July, breaking below chart levels that have held for four months (as shown in the accompanying graphic). Concerns over Presidential and Congressional elections as well as an impending Federal Reserve rate hike in December have stoked investors’ desire to move to the sidelines and sit idly in cash.

Somewhat offsetting this negative trend was data on the labor market (out this past Friday morning, Nov. 4th) that showed solid progress at this stage of the business cycle. And stocks have dropped to a potentially oversold territory where the forward 12-month P/E ratio for the S&P 500 is 15.9 (based on the S&P 500’s closing price of 2,089 on Thursday, November 3rd, according to FactSet).

Uncertain times typically provoke investor concern and an urge to fiddle with portfolios and the 2016 Presidential election season seems to be heightening that trend. According to new research from BlackRock (one of the world’s largest asset managers and owner of iShares ETFs), in the run-up to the presidential election nearly 2/3 (63%) of Americans have made portfolio decisions in direct response to election uncertainty. Some of those decisions, however, might be ill-suited to long-term realities.

Research by BlackRock makes clear that many investors pondering the election’s potential impact could benefit, over the long term as well as now, from reviewing some portfolio essentials.

BlackRock recently surveyed more than 1,600 Americans, ages 25-74, on topics ranging from their financial future and investment concerns to portfolio changes, with special emphasis on the 2016 election. You can find the full extent of the survey here — BlackRock Investor Pulse Survey: Americans View Presidential Election As Pivotal For Investing, But Staying Focused On The Long-Term.

There’s no question that the election is much on the minds of American investors. About 1/3 feel it poses a threat to their financial future; 3/4 believe it will have a greater impact on their personal finances than the 2008 election (the last time there was no incumbent president running).

Furthermore in their study, nearly 6 in 10 also say the potential impact on their savings and investments will be an important factor in their vote. Many aren’t waiting until the election to see how that impact plays out. Among Americans saying they’ve already made an election-driven portfolio change, the most likely move has been classic risk off behavior: A net 12% of Americans said they’ve added to cash or savings accounts.

An appropriate cash allocation is part of many good investment strategies, but the fact remains that such positions earn investors very little to nothing in the current market environment. Compounding the potential problem is that, for many, cash allocations are already quite high — about 67% percent of personal portfolios overall. Even millennials, seemingly best positioned to shoulder long-term investment risk,  are over-allocated to low-yielding cash; it represents 69% of their portfolios (according to BlackRock).

For many Americans, then, an affinity for cash seems not only a short-term reaction to election uncertainty, but also a longer-term portfolio commitment, with potentially troublesome implications for achieving long-term goals of wealth accumulation.

While this Presidential race is having an outsized impact on investor behavior; historically, most people let their political fervor drive them to the polls but not out of the market.

If theirs is a positive spin on all of this, it’s that many Americans have bigger fish to fry. Again, according to the study, they have not lost focus on long-term issues that arguably have even greater impact on their finances — higher than the election on the list of perceived threats to their financial future are the high cost of living (52%), health-care costs (46%), Social Security changes (40%) and the state of the American economy (36%).

When it comes to politics, investors need to vote at the ballot box, not with their portfolios. Investors pulling out of the market in response to their fears of a Clinton or a Trump presidency isn’t a good idea, even though both candidates elicit intense reactions.

Our investments should be driven primarily by our own personal circumstances, not our political convictions. Short-term thinking rarely helps us meet our long-term financial goals.

Unfortunately, political campaigns engage our emotions. When it comes to investing, though, emotions aren’t usually very helpful. This extraordinary election gives us an extraordinary opportunity to keep calm and invest rationally.

With election day upon us, it remains an anxious time for investors. But that offers up an opportunity for advisors in providing guidance as the divisiveness we’ve witnessed won’t dissipate post-election. In fact, about ½ (52%) of all Americans—and 72% of advised Americans—say that market volatility this year has made them more interested in professional financial advice.

You Will Never Earn a Decent Yield on Retail Money Market Funds Ever Again

This past Friday, October 14th, commenced federally mandated rules on money market funds – what we typically think of as cash in our investment accounts – and marked the end of the era of prime money market funds.

Money market funds first came about in 1971 at a time when banks were prohibited from paying an interest rate on demand deposit accounts, and for those old enough to remember, you got a toaster or a clock radio as incentive to put money in checking accounts. Money market funds created an interest-bearing alternative to bank accounts; now, neither earns anything worthwhile.

The recent sweeping SEC reforms on money market funds has bifurcated the money market space by distinguishing between institutional and retail money market funds.

The rules create new definitions for retail money market funds which in essence become U.S. Government or Treasury money market funds. For institutional prime(general purpose funds that invest in corporate debt securities in addition to government securities) and municipal (tax-exempt) money market funds, these funds now have more onerous structural changes and are required to price and transact at a floating net asset value (NAV).

The rules were enacted in response to the impacts on the front-end of the yield curve during the financial crisis of 2008 (front-end being debt securities that mature within a year or less). 8 years in, the SEC is finally implementing changes to money market funds in order to make them more liquid, more transparent, and less risky.

Retail funds now have lower weighted average maturity requirements with fund assets being invested in only the shortest of duration government securities. (As I’ll touch upon later, there are perverse ramifications to the front-end that these rules are causing, affecting the global banking system and $7 trillion of debt, but first back to money market funds).

For those with individual brokerage accounts and retirement plans such as 401(k) plans at well known custodians (Fidelity, Schwab, etc.), they have most likely transitioned you to an appropriate fund so there’s no action for you to take. Without knowing your particular circumstances, your core money market fund is probably now Government and/or U.S. Treasury based. Given those investment instruments (short-term U.S. Government securities), you won’t earn any real interest on the account, but you won’t lose any money on it either (you will lose purchasing power in real versus nominal terms though).

For institutional money market funds and retail municipal (tax-free) money market funds, there will be liquidity fees and redemption gates that will penalize investors attempting to sell shares of a money market fund during periods of extraordinary market stress, and possibly make it so that investors are unable to redeem shares at all.

Thinking back before the financial crisis, money market funds weren’t just a place to park cash, they would also produce a low but dependable yield, and in some cases higher. In the good old days, money market funds offered decent yields by taking on some credit risk and investors got a free lunch by not having to take on that credit risk because they got a stable NAV – investors always got their principal back, never breaking a buck.

I remember back in the ’90s analyzing money market rates and purchasing prime money market funds for clients based on yield and other characteristics such as taxable vs. tax-free. Certain funds might be offering yields of 4.0%, others nearing 6.0% or more. Money market funds were an asset class (cash equivalents) that earned you something acceptable; how times have changed.

Money market yields are the equivalent of risk-free rates of return – a very important component to finance academics in Capital Asset Pricing Model (CAPM) and Modern Portfolio Theory (MPT) models. When the risk-free rate of return is close to zero or negative, CAPM and MPT results go out the window. At a yield of 0.1%, on a money market balance of $100,000 you’d earn $100 annually. Using the Rule of 72, you’d approximately double your investment in 720 years!

The SEC reforms had good intentions and are aimed at buttressing a $2.7 trillion market for money market instruments that exacerbated the financial crisis given credit-sensitive investments in subprime, collateralized debt obligations (CDOs) and mortgage-backed securities (MBS) as funds reached for yield. However, the new regulations are causing turmoil in money markets as big banks adjust to the new reality of a shrinking pool of available funding as prime money market funds were an important source of short-term funding for banks.

A key benchmark for the short end of the yield curve is called Libor – Libor being the benchmark rate that big banks charge each other for short-term loans (wholesale funds on an unsecured basis) and is used to calculating interest rates on trillion of various loans such as variable-rate mortgages, student loans, and corporate borrowings in addition to financial contracts such as swaps and futures. Easily, over $7 trillion of debt is pegged to the Libor benchmark.

3 Month LIBOR chart from Bloomberg. Oct. 13, 2016
3 Month U.S. LIBOR chart from Bloomberg. Oct. 13, 2016

Not since the financial crisis of 2008 has Libor experienced such a surge in rates. The three-month U.S. dollar Libor rate has jumped from 0.61% at the beginning of the year to 0.88% currently (a 44% rise) ahead of the money market reform due date (as shown in the Bloomberg graphic above, dated October 13th).

Over the past few months in response to the reform deadline, approximately $1 trillion worth of assets have shifted out of prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt, according to Bloomberg estimates. The exodus has driven up Libor rates as banks, in particular, and other corporate entities compete to find new sources of funding as prime money markets were the largest buyers of bank commercial paper (CP) and certificates of deposit (CDs). Some banks will re-price their CDs at higher rates to attract new investors.

In the past, a rise in Libor typically coincided with a waning perception of bank creditworthiness. Now; however, the current move is a re-pricing of risk during a handoff in the front-end wholesale funding markets from prime funds to a potential new investor base.

The changing landscape at the front end of the yield curve does offer potential opportunities for short-term oriented investors/savers who don’t mind a fluctuating NAV and some credit risk in search for higher yielding opportunities. My caveat here is that without knowing your circumstances, I’d seek the guidance of an investment professional as to what’s best for you.

Retail investors will continue to earn de minimis yield on their new protectedgovernment funds, but for those yearning for more yield, they may want to consider taking advantage of this shift higher in Libor by investing in assets tied to Libor rates, such as floating rate notes, term CP and CDs. Short-term and ultra-short bond funds look attractive, especially with three-month Libor now yielding more than two-year U.S. Treasuries (0.88% versus 0.83%, as of October 14, 2016). Many of these short-term funds are out-yielding longer-duration bond funds, creating a unique opportunity for some.

If you are looking for ways of generating income in a low interest rate world and, now, a more regulated one, please let me know as I’d be happy to discuss options that are available to you.

Prime money market fund as we knew them are gone after a 45 year run. And with interest rates finally starting to tick up after nearly 10 years, federal regulation has found a way to ensure that retail money market participants won’t get better returns all in the name of safety, ensuring no risk, no return.