Honoring Sacrifice

Brendan 1941.JPG

Since the earliest ceremonies in small American towns following the Civil War, we have gathered on Memorial Day to honor and remember those who made the ultimate sacrifice in service to our nation. As in those early days of laying wreaths and placing flags, our national day of remembrance is often felt most deeply among the families and communities who have personally lost friends and loved ones.

Uncle Hubert 1943Since World War I, more than 645,000 men and women have given their lives in defense of our freedom here at home and around the world. 

This national holiday may also be the unofficial start of the summer season, but all Americans must take a moment to remember the sacrifice of our valiant military service members, first responders and their families. Memorial Day is a day of both celebration and grief, accounting for the honor of our heroes and reflecting on their tragic loss.

This Memorial Day, join us in remembering those who bravely sacrificed their lives for our country, including the many first responders of COVID. 

At NAMCOA we pay tribute to Honor, Duty and Sacrifice.  

Client Note April 2020

Equity markets moved up strongly in April.  The S&P500 moved up 12%, and currently off 3% from the April 29th intraday high.  Gold jumped early in the month, then flat for a gain of 7% in April.  Long treasury bonds moved up in price by 1% but have been on the wane since April 21st.   Most asset classes have been rangebound (+/-3%) since early to mid-April, reflecting a decrease in market momentum.  The average moderate portfolio gained approximately 9% vs the SP500 gains of 12% in April.  Year to date, through April 30, SP500 is off 9.9% while most portfolios are very close to 0% year to date. 

Economic data continues to come in at extremely negative levels.  Auto sales fell by 45% April 2020 vs April 2019.  China, in February saw a 90% drop.  Current market sentiment is bearish and consumer confidence declined from 101 in February to 71 in April.  This is similar to the decline from February 2007 to June 2008 (the month Fannie and Freddie’s first attempted bailout, after losing 50% of their value that month), which saw a decline of 35%.  This could be another reflection on how this recession is being ‘front-loaded’.   We have seen already how GDP and employment has fallen as much as the entire 2008 Great Financial Crisis, but now expect robust rebound by year end.

In light of all this, equity markets have remained buoyant, after the March decline.  This may further indicate the front-loaded- ‘ness’ of this economic period.  And at the root of it all is the expectation that the economy will rebound strongly in the second half and especially in the 4th quarter of 2020.  While GDP estimates for Q2, which will come out at the end of July, range from -10% to -30% (annualized basis), some estimates for Q4 are as high as +20%.    I believe that we are again priced for perfection.  The past few years saw valuations (price to earnings, price to sales, etc.) elevated with expectations of an acceleration in earnings and wages to justify the then-current prices.  Today a significant economic rebound is priced into the market.   If the economy in late May and June isn’t picking up quickly enough it could put pressure on equity prices.  It depends on re-opening the economy and that depends on subduing the pandemic.

We have seen momentum decline recently and thus increases the potential for volatility in equity markets.  If the S&P500 cannot breakout above 3000 in the near term, we’re likely to remain rangebound vacillating +/- 6%.  Bonds and gold are at a point where they are testing support and have the potential to move several percent as well.  If we are to remain rangebound, my preference would be to reduce risk until there is more confidence in further upside.

On a side note, I have significantly reduced the amount of cable and national news I watch on TV.  It’s the same sad and fearful story we’ve heard the past 6 weeks.  I have noticed I feel better doing this.  A client went back north recently and was surprised/disheartened at the difference in the local news in Naples vs the local news in the tri-state area.  Avoiding the bad news TV and enjoying the good news of spending time with family/projects/hobbies/exercise can be an important factor in getting through this time and being ready to embrace the other side of this crisis.

Stay safe and thank you,

Adam Waszkowski, CFA

Observations and Outlook April 2020

Current State of the Markets

After the most precipitous fall in market history and now a 50% bounce-back, investors are trying to figure which way the wind blows.   The NFIB (Natl Federation of Independent Businesses) estimates that half of all small businesses cannot survive the shutdown through June.  Small businesses make up half of all employment.   We are already seeing massively negative numbers in unemployment claims and PMI surveys.  This is expected given our current situation.   IF unemployment is going to 25%, has the market priced this in already, albeit briefly?  Will the several trillion dollars in stimulus and liquidity overpower economic gravity and keep asset prices elevated?  Valuations for stocks had been in the top 2% most expensive of all time, for a couple of years.  If prices stay or climb higher without commensurate wage/economic activity, valuations could surpass recent levels—inflation in assets, deflation in wages.  In the past, these two generally have not gone together, except in the post 2008 era.

In addition, past recessions have seen job losses increase over several periods.  This time, a lot of the economic impact is happening in a short period of time.  Much of the impact is being front-loaded AND is expected to be short-lived.  Estimates are that GDP has contracted as much as all the previous recession.  As we contract further, the risk that we have not done enough stimulus becomes greater, extending the timeframe for recovery which in turn will lower sentiment and expectations for asset prices.

Which is it? Bull or Bear Market?

The terms bull and bear have a long history, dating back to the 18th century during the South Seas Bubble.   Some attribute the attacking postures each animal takes, the bull goring and lifting upward; the bear, swiping its claws downward.  The definitions we use today though are very new, dating only to the 1970’s.  The arbitrary 20% measurement to label a market as a bull market or bear market can be misleading.   We say today that the recent fall was greater than 20%, thus a ‘bear’ market; and now we have seen prices rise more than 20% from the bottom, a ‘bull’ market.  Do these labels help us in determining whether to be invested in stock markets? Do these labels provide any clarity to the nature or outlook for the markets? No, on both questions.   For a far longer time the terms bearish and bullish have been used to describe the nature of the market.  Bear-ish and bull-ish can better describe the character of the market one is in.  A trend can be described with these terms, also the behavior can be better characterized with these terms.  In bearish markets, large daily movements can be seen in the context of a downtrend.  Bearish markets move fast.  Bullish markets are a slower daily grind in an uptrend with a rare day showing more than 1% or 2% move.   Its certainly a subjective interpretation, but the change from a bearish market to a bullish market, in addition to a visible trend change, should also see smaller intraday percentage moves.   While the daily trend has turned up, the daily percentage moves remain elevated.

A Visual of Fed Interventions

Recently, some famous names from the 2008 crash reflected on that period and concluded they should have acted faster and with larger amounts of stimulus.   The Fed certainly has taken that to heart this time around and indeed has acted with vigor.  The first chart below tracks the Fed’s actions overlaid with the S&P500.  Even after the bottom, the Fed continued with QE 1, 2, Operation Twist, and QE 3.

fed actions vs sp500 2008

All the Fed actions, in real time, did nothing to stem the decline in prices.  The S&P 500 Price to Earnings ratio in early 2009 exceeded 100 (trailing 12 months earnings).  In late 2008, we saw 50+, prior to banks recognition of their losses.  Here is another chart, with recent Fed actions overlaid against the S&P 500.

fed actions vs sp500 2020 resized

Looking at these, an honest question is whether the Fed has any influence over equity markets in the short term.

Covid-19 or Global Dollar Funding Issues?

Few remember way back in September 2019 when the US overnight interbank lending rate increased by a factor of 5, rising from the targeted 2.2% to almost 10% (annual rate, intraday) on September 16th.  This caused the Fed to intervene, putting $53billion into interbank lending on an overnight basis.  The overnight lending quickly morphed into multi-day and multi-week repurchases agreements totaling more than $300B in a few weeks.  Previously banks had been lending to each other, overnight, secured with collateral (red line).  The Fed went from no participation in the $1 trillion+ overnight market to more than $350 billion, and then moved from repurchase agreement to outright permanent purchases and began the massive balance sheet expansion we are seeing today.  The Fed balance sheet rose from $3.76T in mid-September 2019, to $4.3 by March 11, and now is $6.4 trillion. Another $1 trillion and the recent expansion will be larger than QE 1, 2 and 3 combined.

The red line secured overnight lending began spring 2018, right after the February 2018 market correction, AND foreign dollar-funding costs (TED spread- orange line) jumped to the highest level since 2009.  The volume of funding increased for several months until banks ran short on capital to use as security, as dictated by liquidity rules in the Volcker Rule.   While demand (red line) had been growing for liquid cash dollars, the amount of collateral used to secure this lending was not enough, and when demand outpaces supply, the price (overnight funding rate—green line) goes up.  But that price was too high, and the Fed intervened, and the total volume of dollar funding continued to increase (red and blue lines together) at an increasing rate.

repos global dollar

We can see how due to the demand for US dollars began to increase in early 2018 (orange line), funding for dollars increased to a point where major banks could not meet demand for dollar liquidity, and the Fed stepped in and took over funding.  There was balance in the supply and demand from November 2019 to the end of February 2020.  From February 26 to March 4, the TED spread (a measure of stress in markets) began to grow rapidly.  The economic contraction stemming from Covid-19 exacerbated the serious issue of dollar funding (less activity means less trade/less dollar flow).  Today the Fed is fighting the dollar crisis AND the loss of over $2trillion in US output/GDP.

Monetary Base and the case for S&P 500 to 4000

For most of the post WW2 era, the growth of the monetary base (all currency and bank reserves) tracked the growth in GDP.  Historically, growth in GDP lined up very well to growth in the S&P 500 over a full business cycle.  During the Great Financial Crisis (GFC) with hundreds of billions of mortgage loans going bad, there was a risk that if all the loans were marked to their true worth that the monetary base would contract, resulting in a deflationary debt spiral.  In our current system all money is created by new credit.  If too many loans go bad, the monetary base declines as money that was lent/created disappears as collateral prices decline, and loans are not paid back.

The solution was for the Fed, for the first time in its history to accept as collateral (and purchase outright) mortgage-backed securities.  As the Fed accepted these securities, it provided cash to banks. Without the burden of non- or poor- performing loan, banks were freed up to lend again.  As this new cash was put into the system it also flowed into risk assets like the stock market.

The chart below clearly shows the relationship between QE and the S&P 500.  New cash found its way into stocks and pushed prices up.  The period after QE3 and the brief ‘balance sheet normalization’ saw the most significant corrections post GFC.  A minor 15% correction after the base stopped expanding in early 2016 followed by a 19% decline late 2018 and now the 30% decline most recently.  Other banks, namely China did keep expanding their monetary base in late 2015 and into 2016.  Then as China’s credit impulse wore off and as mentioned earlier, demand for US dollars kept increasing while the Fed lowered supply, we had the late 2018 market sell off.  The Fed backed off its plan to raise interest rates and cut rates summer 2019.  These actions aided liquidity and stock moved up after both actions.

With each QE period we saw the monetary base and the S&P 500 market capitalization increase.

Change in S&P 500             Change Monetary Base

QE 1              +37%                   +33%                                                                                   QE 2              +12%                  +33%                                                                           QE3/Twist    +53%                  +52%                                                                               2019 Cuts    +34%                 -20%  needed rate cuts were due to MB decline  2020             -15%                       +43%

monetary base

Currently the Fed is trying to increase the monetary base to keep asset prices and liquidity up.  We do not know yet to what degree the current recession will lead to loan losses and other credit destruction.  In addition to loans going south there is the general decline in output as we are locked down.

Through April 8th, the Fed has increased the monetary base by $1.2T, or 35% over late 2019 levels.  $1.2T may be the approximate output lost during the lockdown.  The Fed has expanded its collateral and purchases from treasuries and mortgage backed securities to now include junk bonds, corporate bonds, and other collateralized loans.   Over the past week and going forward the Fed will likely continue to monetize these securities, further expanding the monetary base.  If we see another $2T to the monetary base (Fed balance sheet expansion) that would approximate a 100% change in the MB and potentially impact the S&P500 similarly, going from 2100 in late March to 4000 by end of the year.   In this scenario, one would have to accept a reality of 12% unemployment concurrent with S&P500 at 3500+, and a $2 trillion annual deficit.  The wealth disparity would be substantially more extreme than in recent past.

We are entering a period in US history like no other.  The reaction to the Covid19 virus has put the economy into a self-induced coma.   Current expectations are that monetary and fiscal stimulus will pave over/fill in lost income and liquidity setting the stage for a return to economic growth.  The problem with this thesis is that we do not know how long the shutdown will last and after many small businesses run out of cash and close, how many people will get hired back.   There is substantial risk of extremely poor economic data to persist for several months.   The knock-on effects of a prolonged shutdown are difficult to estimate.  The more unknowns, the longer the shutdown, the worse the global dollar shortage, the more extreme market movements we are likely to see.

 

Adam Waszkowski, CFA

 

 

Client Note December 2019

December was another strong month for US (+2.8%) and global equity markets (1.8%). Junk bonds gained 1.1% in price while treasury bonds were off, giving the Aggregate Bond Index a slight decline.   Federal Reserve intervention, beginning early September, as a result of the overnight inter-bank lending drying up, has totaled some $400billion.   The rate of additions to the Fed balance sheet, is faster than in QE 2 (Nov 2010-June 2011) which took 8 months to add a similar amount.  QE 3 was larger, adding $1.7 trillion, over 2 years.   Central bank liquidity is the primary driver of 4th quarter equity market gains.  Economic data and earnings growth remain slow and near zero.

Portfolios gained across the board in December averaging approximately 2%; owing largely to our individual stock holdings and exposure to gold and miners.  Bonds were muted and were a drag.  Bonds look best posed to gain in the near term. Gold can extend further, and stocks have hit a speed bump with the turmoil in Iraq/Iran and may be slightly choppy in the immediate term.

Gold and gold miners gained 3.6% and 8%, respectively, in December.  Both bottomed November 26th and earned most gains in the last week of December, prior to the assassination of the Iranian general.  International stock markets have outpaced US stock markets since 10/15 (as forecast in October’s Note).  Commodities, ex-US equities and gold have gained significantly since the US Dollar peaked October 1, and its most recent lower high, on 11/27.    The dollar has broken down and may find support another 1% lower, matching its level in late June, which would be 3% decline off its high on October 1.  A small change in the value and direction of the US $ can have large impacts on metals and other natural resources.

The decline in the US Dollar corresponds well to the Feds telegraphing its intentions to refrain from raising rates in 2020.  The dollar can fall/rise relative to other currencies for a variety of reasons.   The current decline is not getting much attention.  Most finance headlines are full of talk about “reflation”.  Given the SP500 is off its all time high by a mere .75%, its not a reference to stock prices.

Reflation, is the topic du jour.  This term refers to economic data.  Federal reserve interventions impact the markets first with a much longer lag to the general economy.  China’s recent modest liquidity injections are: 1) much smaller than in 2017 and 2014 and take about 6-9 months to impact the US/global economy. Positive economic data from central bank actions will take at least one quarter to begin to show up.  Easing amongst central banks is as significant today as during QE 2.  CBs have completely discarded the concept of ‘normalization’ over the next year.

The biggest risk I see in the immediate term is the start to earnings season.  Earnings estimates for the 4th quarter, as usual, have declined substantially over the past year.  IF stocks can ‘beat by a penny’ reduced earnings estimates, we should get through with only minor stock market fluctuations.  Conversely, if companies’ lower guidance and/or miss low estimates, we could see a more general ‘correction’.  Bonds appear to have completed a 4-month consolidation and any more gain will give it some momentum, while stocks consolidate 4th quarter gains.

Slow economic growth, questionable earnings growth and the ever present geo-political risk are risks to the stock market.  With bonds and gold looking up for a variety of reasons, diversifying across asset classes (into areas not correlated with the stock market) is always a prudent approach.

Adam Waszkowski, CFA

Observations and Outlook October 2019

October 8, 2019

Perspective

 Over the past 3, 12 and 18 months there has been a wide dispersion in the returns of various asset classes.  US equites remain range-bound while ex-US, stocks continue to ebb.  Risk-off assets like bonds and gold have done very well over the past year, while stocks vacillate.  Interest rates continue to fall, and inflation expectations are subdued.  Earnings growth for the third quarter are expected to be negative year over year, and likely zero growth for full year 2019. US economic data continues to be weak while Eurozone and Asia may be entering a recession.  Below are the approximate returns over the 3-month, 12-month and 18-month time frames.

 

3 mos.            12 mos.                 18 mos.

S&P500                                          1.7%                 4.25%                      13.5%

Russell 2000 (US small cap)      -2.4%                  -8.9%                         .5%

Euro Stoxx 600                                .8%                    -.5%                      -2.4%

Emerging stocks                            -4.2%                  -2%                       -14%

Gold                                                    4%                 23.1%                     10.4%

Long-bond price (TLT)                 8.1%                 25.2%                     21.8%

Aggregate Bond Index                 2.3%                   7.5%                        9.6%

 

Economic data in the US continues to roll over.  The chart below shows the top three inputs into the LEI (Leading Economic Indicator) as published by the Conference Board.  Data continued to slow and is now in contraction in some areas like manufacturing.  Payroll growth has declined significantly during 2019.  These data points must reverse very soon otherwise we will undercut the 2015 slowdown and increase chances of a recession in the coming months.

econ rolling over 10 2019

 

We’ve been seeing risk-off assets outperform substantially in recent quarters under the pressure of slowing global economic data and lack of growth in earnings.   More recently there are been reports of large-scale rotation from growth stocks (like Consumer Discretionary sector; XLY) to more value-oriented stocks (like Consumer Staples; XLP).  Value has begun to outperform growth.   While not completely uncommon, it is uncommon to see this while Consumer Confidence is very high.  Recently I came across the chart below from Sentimenttrader.com which shows how rare this is.

discretionary vs stpales vs consumer confidence

Discretionary items are what people buy with ‘extra’ money, while Staples are what people need for everyday life.  Defensive areas usually outperform only when consumers and investors are less confidence about the future.  Only just after the market peak in 1969 (far left side) and the 2000 peak (center) confidence was high (survey results) while defensives were beginning to outperform cyclical stocks.  If this rotation continues it may portend tough times for the general stock market.

Why might consumers be confident while investors are buying more defensive stocks over more cyclical stocks is a difficult question.  Sentiment is often a lagging indicator.  People feel good and optimistic after good things happen.  The long string of employment growth and a long bull market has buoyed sentiment, perhaps so much that any contrary information is being discounted.  A poor job report or two may change this outlook.  But again, we are faced with an imminent need for very good economic data points to counteract current downtrends.

Credit Expansion (aka QE/liquidity/debt)

china credit impulse pmi

 

us pmi 10 2019

 

These two charts show how China’s credit impulse (QE/liquidity/Reserve Rate reductions etc.) have a lagged impact on US manufacturing.   Coming out of the 2009 recession, China had the spigot wide open and we can see US PMI hit a high mark in early 2011. The Impulse was removed during 2010 which resulted in a decline in US PMI.  The renewed impulses in mid-2012 and late 2015 helped create the rise in US PMI in 2013 and 2016.  There is about a 6-9 month lag between an expansion in credit and its impact on the real economy.

Today we are seeing the impact of a lack of significant credit expansion which should continue   Global economies appear to be completely reliant upon increasingly larger credit impulses to maintain growth.   China has eased during calendar year 2019, but not as much in the past.  Hopefully we will soon see better US PMI numbers to avoid outright recession in the very near term.

Update on the Yield Curve

fed funds vs 2 year inversion 10 2018

We’re not hearing much on the Yield Curve lately.  It remains inverted with the 10-year Treasury yield being lower than the 90-day T-bill rate.  The 90-day bill and Fed Funds rate (set by the Federal Reserve) follow each other hand in glove.  We can see market rates, the 10-year Treasury yield began to decline in earnest about a year ago.  We can also see how the 90-day rate moved lower prior to the Fed lowering rates.  It is clear that the Fed follows the market.

Current market expectations are that the Fed will lower its rate again in October by another 25 bps (.25%).  I have showed in previous writings how the last two recessions began (the official dating) as the yield curve regained normalcy with the 10-year yield rising above the 90-day/Fed Funds rate by .33%.

If the Fed Funds rate decreases by .25%, from 1.75% to 1.5%, and the 10-year yield remains constant at 1.56%, the yield curve will un-invert and become positive.  Further decreases will cause the spread to go above .33%.   In 2007 the Fed lowered its rate enough (following the 90-day T-Bill) to get below the 10-year yield, resteepening/normalizing the curve again.  This occurred August-October 2007, and the official dating (which was given to us November 28, 2008(!) that it started December 2007.   Waiting for economic data regarding a recession, before reallocating one’s investments will always result in very poor returns

 

Adam Waszkowski, CFA

awaszkowski@namcoa.com

239.410.6555

This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision.  Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note August 28 2019

August has been a volatile month.  Since August 2, the SP500 has seen 5 moves of 3-4% in both directions for a net, -3%, through today.

Gold, gold miners and long treasuries (TLT) continue to do well putting portfolios into the green for August.  For August, gold +9%; miners +15%, TLT +11%.  Prior to this almost 12 month run in these areas, it was commonly known that ‘gold is languishing”; and “rates will go up”.  Now, its “gold hits 5-year highs”, and “rates seen to continue to fall”.  Often by the time the media reports it widely, the trend is nearing completion.

As we approach Labor Day and the seasonally worst time of the year (Sept/Oct) I am watching for the SP500 to at least stay over 2850, and if we can get over 2940 it opens the door to climb further-but until then markets are under pressure.   Small cap, international stocks are still well below their highs.

Recently it appears the when the US Dollar weakens, US stocks fall while ex-US are more stable.   If the Fed continues to acknowledge further Fed funds rate cuts are likely, this can weigh on the Dollar—unless Europe et al jump ahead and push rates lower via more bond purchases.   So, we may see relative outperformance from ex-US stocks.

Of the individual names purchased recently, one has bee sold out.  IPHI was falling as the sector and general market was climbing, falling below a recent low in July.  The loss was less than 5%.  Cannabis remains under pressure.  Curaleaf reported 200%+ gain in year over year revenue and today saw a drop of 9% at the open, followed by a 23% climb!  This may mark a turn for the sector, but a reversal of these gains will see us abandon this sector in the near term.

The yield curve inversion has been big news.  The 10-yr treasury yield crossed below the 2-yr yield on 8/13 and again on 8/27.  While many other curve inversions have been occurring, this pair, coinciding with a 700 point down day on the Dow has gotten much attention.  The past 3 recessions have occurred as this curve normalizes, that is un-inverts and re-steepens.  I first pointed this out in my quarterly Observation piece January 2019.

 

Adam Waszkowski, CFA

Fed Does a 180

Prior to December 1, the Fed had widely broadcast that it intended to raise it benchmark rate 3 more times in 2019.   At the December meeting, they lowered that to 2 times in 2019.  In January after the horrid December stock market fall, the Fed changed once again, removing expectations of further rate increases.

The Fed has claimed to be data-dependent and the major economic data points have been indicating slowing growth for most of 2018, and more so since Q2 2018.   The Fed may have realized it overtightened, having raised the Wu-Xia Federal Funds Shadow Rate (Atlanta FRB) by more than 5%.  This was the fastest rate of increase in almost 40 years.

Now the Fed’s balance sheet normalization plan is being questioned and pundits are calling for an early cessation.   In November 2017 the median targeted estimate for the Fed’s balance sheet was just under $3 trillion.   The balance sheet peaked at $4.5 trillion and is currently a tick under $4T.  At the beginning of 2008 it was $800 billion.

So, from a target Fed Funds rate of 3% and Fed balance sheet of $2.75T, to a ‘normalized’ rate of 2.25% and a Fed balance sheet of $4 trillion.    The last few recessions we have seen the Fed raise rates right into economic weakness, only to cease then ease as the recession begins.   With that kind of track record its no wonder people believe the Fed to either be behind the ball, or the outright cause of recessions.

The irony is that the US may have crossed the Rubicon regarding diminishing returns from cheap credit (low rates) aka velocity of money.   While over the past 40 years we have lowered the cost of credit to induce consumption, each recession we must lower the rate below the previous recession lows.  And while we ramp up credit expansion to boost the economy (borrowing more and spending more today) each time, we are getting less and less growth for each dollar borrowed/spent (velocity continues to decrease).  And when there is low velocity, in order to create growth, exponentially larger amounts of money (credit) are required.

I have seen a few reports discussing the idea that low rates decrease future potential growth.  Essentially low rates fail to attract capital, reducing investment, reducing future productivity gains which reduces overall growth.

We have seen the Fed essentially stop tightening (balance sheet runoff should continue to at least this summer) the next step will be for the Fed to ease again, indicating a recession has begun.

Blame the Fed! (for following through on previously telegraphed guidance)

The Federal Reserve today reiterated it plans to continue what it has been doing and said it would continue to do, much to the chagrin of market participants.

While the last Fed minutes showed more dovishness, actual actions that are indeed ‘dovish’ have yet to occur.  Reducing expected rate increases from 3 to 2 in 2019 was widely interpreted as, ‘the Fed might stop raising rates’, for some reason.  History shows us that the Fed telegraphs well in advance what it intends to do.  Thanks to Alan Greenspan, this has been the case for more than 20 years now.

What has the Fed said it will do in 2019?  Raise rates two more times and continue to drain liquidity from the system via its bond roll-off program.  It is also expected that other nations’ central banks will also cease adding liquidity this year. China may not have gotten the memo though, as they just lower their Reserve Requirement Ratio by 1%, freeing up approximately $100 billion in bank liquidity.  This was announced on Friday, January 4, but was not even mentioned in the Saturday Wall Street Journal!

Here is a picture of global liquidity for 2019.  From adding more than any given year in 2017, to net withdrawal in 2019.   Adjust your expectations accordingly.

qt central bank 10 2018

 

The 1031 Roadmap

Advantages of a 1031 exchange include many things aside from the tax benefits. Investors can consolidate, diversify, move markets, or increase income potential on their current investment property. dst 2 black-01

Some people choose to do a 1031 exchange to acquire more income. For example, they can exchange vacant land for commercial or residential real estate. The investor is able to increase income potential by exchanging a property that is not generating any revenue, such as land, into real estate that has greater income potential like commercial and residential real estate.

Another advantage of doing a 1031 exchange is consolidation. Depending on the investor’s situation, they may not want to manage multiple properties. They can exchange their properties into one larger investment property that is easier to manage. Others are tired of managing properties and of being a landlord altogether. These investors can exchange from a residential or commercial property into a more manageable and less time consuming piece of land.

Some investors are looking to diversify. With a 1031 exchange they can exchange one property for multiple property types. For example, an investor can exchange their residential investment property into a commercial, residential, and vacant piece of land. This is one of the most attractive of the advantages of a 1031 exchange!

A 1031 exchange is great for investors who have multiple properties in other states or for investors who are moving markets. Instead of traveling from state to state to manage multiple properties, investors can exchange the out of state real estate into property that’s in one state. If the investor is moving markets, for example from one state to another, they can exchange their investment property in the current states for an investment property in another state.

Every situation is unique when considering the advantages of a 1031 exchange, and it is always advised that the taxpayer consult with his or her tax advisors before making any decisions!

For more information, visit www.DST.investments.

Winter Solstice

They say its always darkest before the dawn, which seems appropriate as we meet the Winter Solstice today, at the lows of 2018.

There is a lot of commentary out there right now about hos investors are ‘worried’ about certain things like Brexit, slowing economies in China and Europe and if that slowing will seep into the U.S.  All these areas of concern have been with us for most of the year.  I have pointed out the Chinese credit impulse (slowing) more than a few times.  Housing and auto sales have been slowing for months.  The only difference is now there is a market decline and all these issues are being discussed.   If the market had not been declining these issues would still be with us, only accompanied by the tag line: “Investors shrug at concerns in Europe”.

In past posts I have described the coming year over year comparisons, 2018 v 2019, regarding earnings and GDP growth.  Every time I have mentioned that 2019 will look much worse than the stellar numbers put up in 2018, thanks largely in part to the one time cut in taxes.   That gave markets a boost and it was hoped that business investment, and wages would go up as a result.  Well it’s the end of 2018 and were still waiting.

The Federal Reserve gave a modest tip of the hat towards global economic concerns by reducing its estimate of rate increases in 2019 from 3 to 2.   There were even rumors that the Fed would skip raising its rate on December 19th and guide to 0 rate increases in 2019.   The Fed NEVER overtly bows to market or political pressures outside of an official recession or panic.   The Fed is in the process (as usual) of raising rates into the beginning of a recession.   Besides the yield curve, there are several other indicators that make recession in 2019 likely.  These indicators have been leaning this way for several months, and finally have tipped far enough that the markets are now concerned and discounting this likelihood.

As this is likely the beginning of a bear market (average -33% post WW2 era), we should expect large rapid moves, both down AND up in the markets.  During the bull market, a 2-4% pullback was common and quickly bought.  Today we see 2-4% intraday moves that continue to fall to hold support.  I expect several more percentage points south before a significant rally in stocks in the first few months of the year.   This will be an opportune time to reassess one’s risk tolerance and goals over the next 1-3 years, as well as make sure that one’s portfolio is properly diversified across asset classes. When stocks go down there are often other asset classes that are performing better, the core idea behind diversification.