Published January 14, 2019

Over the course of the past year, I have written often of the risk of policy accidents. Since September, two significant policy accidents have created havoc in the financial markets.

First and foremost is the tariff war. Although initiated earlier, the tariff war came home to roost in the fourth quarter of 2018, when tariffs began to have their full impact. Once billed “easy to win” by the president, the tariff war is proving anything but easy. As the impact of the trade war on the global economy became visible and economies began to slow, the prices of equities and commodities fell in concert. Money began to flow from these assets, and markets tumbled.

Then the Federal Reserve made good on its promise to raise interest rates. Chairman Powell promised to raise rates until the Fed charts showed that rates were in the “right place.”

And so, beginning in early September, equity markets tumbled into bear market territory, down about 20 percent. The markets went from optimism to pessimism in a matter of weeks. The yield curve suggested a recession was in the offing. Having predicted 13 recessions – and eight happening – the yield curve frightened investors. Retail investors bailed out in fear. Institutional investors, by and large, held their ground. Volatility went to extremes, with the Dow stocks plummeting nearly 800 points one day and jumping 1,000 points another day.

Fundamentals remained strong, but with the cloud of dubious leadership, confidence was shaken. With the “full faith and credit of the United States” in doubt, investors ran for cover.

Added to these factors were Brexit, riots in the streets of France, Italian budget problems and a […]

Published December 10, 2018

I have frequently discussed the danger of policy mistakes in this column. This year has seen a plethora of policy mistakes, and they are now coming home to roost. In spite of a strong economy, with growing GDP, full employment and record consumer confidence, the U.S. equity market suffered big losses in October. Since the market normally looks ahead six to nine months, what did it see?

Not to be outdone, U.S credit markets have suffered their worst year since 2008, as investors shed corporate debt. What brought us to this point? Can the mistakes be rectified?

The first policy mistake was by the Federal Reserve. After record low interest rates for a very long time, the Federal Reserve has been on a rate hike trajectory. Ever cautious, Janet Yellen was on a very slow, deliberate, rate-rising schedule. The market did not question the need to raise rates. However, President Trump decided to replace Yellen, reportedly because she was too short at five feet, two inches.

The president handpicked Jerome Powell as his chairman. Powell had a different idea on rate increases; he wanted more and faster increases. The market absorbed this news at first, but when Powell announced in September that rates were not near normal – i.e., not high enough, the market broke. The S&P dropped 6.8 percent for the month. Trump, who has extremely high disapproval ratings, has been able to count on a strong economy to buoy his presidency. Now, with the economy threatened, the president eviscerated his own appointee.

The Federal Reserve has been considered independent since its inception over 100 years ago. Whether Powell listened to his president or to the […]

Published November 9, 2018

October is a notoriously difficult and volatile month from an investment point of view. This October was no exception, with the market down 6.8 percent on the month – the biggest monthly drop since 2008.

The October effect, according to Investopedia, is a theory that stocks tend to decline during the month of October. It’s considered mainly to be a psychological expectation rather than an actual phenomenon, because most statistics go against the theory.

Some investors may be nervous during October, because that is when some large historical market crashes occurred. They include the Panic of 1907, Black Thursday (1929), Black Monday (1929), Black Tuesday (1929) and Black Monday (1987). The latter crash, which occurred on Oct. 19, 1987 and saw the Dow plummet 22.6 percent in a single day, is arguably the worst single day. (See reference in my book “Who Shot Goldilocks?”) The other black days, of course, were part of the process that led to the Great Depression – an economic disaster that stood unrivaled until the mortgage meltdown nearly took out the whole global economy with it.

The October effect is overrated. Despite the dark titles, this seeming concentration of days is not statistically significant. In fact, September has more historical down months than October. From a historical perspective, October has marked the end of more bear markets than it has the beginning. This puts October in an interesting perspective for contrarian buying. If investors tend to see a month negatively, it will create opportunities to buy during that month. However, the end of the October effect, if it ever was a market force, is already at hand.

What is true is that […]

Published October 5, 2018

This column is being written on an unusual day: the same day that the month and quarter end. So it is an opportunity to reflect on the year to date and the previous quarter.

In spite of persistent worries among investors, the third quarter turned out to be quite good. The Dow Jones was up 9.0 percent, the S&P was up 7.2 percent and the NASDAQ was up 7.1 percent.

So far for the year, the Dow is up 7 percent, the S&P is up 9 percent and the NASDAQ is up 16.6 percent.

The market was spurred on by strong earnings and the effects of the tax bill. Earnings last quarter were up 17.9 percent, which is not likely to be repeated. The tax bill led to increases in earnings because of lower taxes and spurred stock buybacks and mergers – all shareholder-friendly activity.

At the same time, the market braved substantial headwinds: interest rate increases, election uncertainty and tariff threats.

Annualized GDP growth was 4.2 percent for the second quarter, with most segments of the U.S. economy posting solid gains. The economy will likely cool going forward, but that may be positive for the long-term outlook. Consumer spending contributed an exceptionally strong 2.6 percent to GDP growth in the second quarter, up from the comparatively weak first. Consumer confidence remains strong, suggesting that the consumer will be a strong contributor to GDP going forward.

Inflation remains tame. Still, the Federal Reserve increased interest rates by 25 basis points just as the quarter ended and signaled another rate rise is due in December. The yield curve remained under pressure, perhaps indicating a slowdown in the economy … or […]

Published September 7th, 2018

U.S. gross domestic product (GDP) grew at an annualized rate of 4.2 percent in the second quarter of 2018. The GDP came in 0.1 percentage point ahead of the “advance” estimate (released in July) and almost double the 2.2 percent increase witnessed in the first quarter. This growth represents the strongest economic performance in nearly four years and the highest rate since the third quarter of 2014, when the GDP growth was reported to be 4.9 percent. Government spending rose 2.3 percent, compared to the 1.5 percent increase in the first quarter of this year. Exports increased 9.1 percent, while imports fell 0.4 percent. The Fed forecasts GDP to grow by 2.4 percent in 2019 and by 2 percent in 2020.

Federal Reserve Chairman Jerome Powell stated in comments during the Fed meeting in Jackson Hole, Wyoming, that the U.S. economy is strong and does not appear at “elevated” risk of overheating.

“Many of the most significant challenges facing the U.S. economy – such as slow wage growth and rising government debt – remain outside the powers of the Fed to address,” he added.

U.S. shares increased and the dollar index fell after Mr. Powell’s remarks were published – a sign of diminished concern among investors that the pace of rate increases would suddenly accelerate. Nevertheless, it is expected that the Fed will raise interest rates by 0.25 percent in September.

For the second quarter of 2018 (with 99 percent of the companies in the S&P 500 reporting actual results for the quarter), 80 percent of S&P 500 companies have reported a positive EPS surprise and 72 percent have reported a positive sales surprise.

Earnings growth: For the second […]

Published Aug 13th, 2018

As U.S. equity markets powered onward, the Federal Reserve called the economy fundamentally strong and hinted at two more rate hikes this year and perhaps three hikes next year.

Earnings have been strong, with almost all of the S&P 500 results released. So far, reported earnings increased nearly 25 percent year on year. Eighty of the companies have beaten estimates. The proportion with rising earnings is a record 62 percent. No doubt, if we did not have trade conflicts, we would be doing even better.

Trade talks between the Trump administration and China have stalled. The president is threatening further tariffs; China is responding by weakening the yuan. The spread between dollar value and yuan value is widening, so the dollar is rising against other currencies as well. While a strong dollar has benefits for importers, it makes it harder for exporters to sell goods. For those wishing to narrow the trade deficit, it is a self-defeating strategy. Import more, sell less abroad and complain about the widening gap. The logic is hard to understand. Most economists do not agree with the strategy.

Domestic unemployment continues in the low range. According to the latest measurements, 219,000 jobs were created last month. There are now more employment positions available than there are people to fill them.

Some industries, such as construction, are feeling a severe shortage of available workers. Overall, there are jobs for everyone who wants one. Companies are lowering their educational requirements. People with disabilities can get jobs. People with criminal records are getting jobs. Immigration policies are shrinking the workforce.

Wage pressure, and therefore inflation, will surely follow, but for now the Fed is happy with […]

Published July 9th, 2018

U.S. equity markets show uncertainty and less growth. The economy stumbles over trade conflicts and rising interest rates, amid evidence of inflation and a strong dollar.

Year to date, the S&P index is up a meager 2.65 percent, about the annual rate of inflation. June saw only a 0.62 percent increase in the S&P. The Gross Domestic Product annualized growth for the quarter was 2.0 percent versus the forecast 2.2 percent and White House boasts of 4 percent. The Atlanta Fed forecasts a slowing GDP growth rate. Personal consumption fell slightly on the quarter. Why are the market and the GDP pausing now?

A host of negatives provide headwinds for the market.

Interest rates are on the rise. The Fed has already raised them this year, and three to four more increases are being discussed. The White House, through Larry Kudlow, President Trump’s top economic advisor, took the very unusual step of admonishing the Fed about interest rate increases. No White House in memory has told the Fed what to do. Since it was first established, the Fed was to be independent of politics.

Kudlow also took time to assure the markets that the massive deficits incurred by the tax cut were disappearing. No signs that the deficits are disappearing have been noted. The Congressional Budget Office says the deficits are persistently large and show no signs of decrease.

Rising interest rates have the effect of strengthening the dollar. A strong dollar coupled with proposed tariffs make U.S. products more expensive to foreign buyers, which means a slowing economy and fewer jobs in the U.S. Many companies have warned that their production will be curtailed and their employment […]

Published March 9, 2018

President Trump began his term by abandoning the Transpacific Trade Agreement, angering many of our allies. By threatening to impose steel and aluminum tariffs, he has further distanced himself from our allies when he needs them. Now he finds himself isolated in the trade talks with China, when he needs the support of other countries to come to favorable terms with them. Having determined that the U.S. is unreliable at present, our trading partners are making separate deals with China, further isolating the U.S.

Recently, Trump had to back down from his penalties on ZTE, a Chinese company that he had sought out for punishment, until President Xi Jinping retaliated with tariffs on U.S. agricultural products. Trump’s interest in controlling technology transfer to China was left on the cutting room floor in order to salvage U.S. soybean exports.

In Trumpian style, he has sought to double down on his losing position. He wants more tariffs, this time on automobiles and auto parts. He is apparently unaware that auto products can and do cross borders, sometimes several times, in the manufacturing process. His strategy will disrupt global supply chains and damage the global economy. China will lose, but so will the US.

Congressmen and women are proposing legislation to limit Trump’s trade authority, fearful that he has gone too far. Jamie Dimon, CEO of JPMorgan, has warned about potential negative consequences of the trade conflict. The Business Roundtable CEOs are concerned about the Trump administration’s approach to trade, with a recent survey showing 95 percent see a risk that foreign retaliation could hurt U.S. exports, while 91 percent see risks that consumers will be impacted by higher costs of imports.

In […]

Published May 11, 2018

Expectations for the market heading into 2018 were very high – that company earnings would be up 18 percent year on year. The market was stretched to meet these high expectations. Aided by the tax cut bill, actual earnings far exceeded forecasts. By early May, with most companies reporting, actual earnings were up an astounding 27 percent. Normally, one would expect the market to show a similar increase, but it did not. The market has barely moved since the start of 2018, compared with a 7 percent increase as of this time last year.

With earnings strong, the price-earnings ratio of the market dropped from over 18 times earnings to about 16 times earnings – closer to the historical average. Fixed income became a better investment than equities; even cash earned more than equities because equities remained flat since the start of earnings season. Yields on the 10-year Treasury bond rose to 3 percent, making fixed income competitive with equities. In addition, volatility rose dramatically. Was the market getting tired? Was the market tipping over?

The May jobs report came in with the number of jobs created at 164,000, down from the expected 192,000. But the rate of unemployment fell to 3.9 percent – the lowest since December 2000. The rate of unemployment for black workers fell to 6.6 percent – the lowest ever. Wage growth was tepid at 2.6 percent.

Meanwhile, the labor pool is shrinking: 410,000 more people dropped out of the workforce, out of a total of almost 96 million employed. This shrinking labor pool is the largest reason for the drop in the unemployment rate. A shrinking labor pool is not good […]

Published April 6, 2018

On March 9, 2009, the U.S. equity market touched a low, having weathered the Great Recession brought on by a financial crisis. Since that time equities have climbed a wall of worry to reach new records. Frequent corrections occurred, but the market managed to overcome many hurdles and somehow reached new highs every quarter.

A slow but steady growth in the economy carried the market quarter after quarter. It was a much-hated rally, with investors always suspicious of its reliability. Economic growth was uneven, leaving out many people, but the overall economy grew. During this time earnings and gross domestic product increased, but slowly.  The tepid nature of the growth may have been one reason that the rally was so unloved.

Since the election of President Trump, headline news has dominated the airwaves. In this column, we frequently said to disregard the headline news and focus on the economic fundamentals, because the fundamentals were strong. We said our growth could continue so long as we did not have policy mistakes. Policy mistakes are frequently the reason for the end of a bull market.

The Federal Reserve is a potential source of mistakes and is frequently blamed for the demise of a bull market. “Bull markets don’t die of old age, they are murdered by the Fed” is a frequent adage. Lately, the Fed has been inching interest rates up. This is risky business, which can only be done with great care. Our rate of inflation is low, but approaching the Fed’s target rate of 2 percent.  While the rate of increase is not alarming, the Fed wants to stay ahead of it. The newly constituted Fed […]