Published April 8, 2019

The last quarter of 2018 was a big disappointment to investors. Beginning in the autumn of the year, the market dropped 18.9%, reaching a bottom on Dec. 24. While not panicking, investors were certainly shaken.

The world economy, including the U.S., appeared to be slowing. To make matters worse, the Federal Reserve, sticking to its script, raised interest rates by a quarter point, extending worries about the economy. The market drop was sharp.

But, as often happens, the market surprises. The first quarter of 2019 was the best since 1998. The S&P index was up 13.1%, the Dow up 11.2% and the Nasdaq up 16.5%. Well, how do you explain such machinations?

In the fall of 2018 it became clear that the global economy was slowing. At the same time, the Federal Reserve believed it was time to raise interest rates. A bit of a back story: after a long time of historically low interest rates, some believed it was time to raise rates; the Fed subscribed to this idea. We have often written here of policy accidents. We have been worried about policy accidents. The Fed, looking at its tea leaves (and its point chart), decided that we needed to go on a rate-raising program. And raise it they did — nine times since December 2016, including three times in 2017 and four times in 2018.

But with the economy slowing, was December really a good time for another increase? President Trump, who considers himself an excellent forecaster, told the Fed not to raise rates. The Fed, which considers itself independent of political pressure, felt cornered, and to show its independence, resolved to raise rates.

They had […]

Published March 11, 2019

Brazilian private equity firm 3G Capital burst into the United States when it bought well-established food companies Burger King in 2010 and H.J. Heinz in 2013. Its method of operation included cutting costs and executing mass layoffs. 3G attracted the attention of other hedge funds and Warren Buffett’s Berkshire Hathaway. Together, 3G and Buffett bought U.S. ketchup maker Heinz.

In 2015, with Buffett’s help, Heinz acquired and merged with Kraft Foods to create the world’s fifth-largest food company. It was a classic Buffett buy: an easy-to-understand company with iconic American brands, not unlike other long-term Buffett holdings, such as Coca-Cola and Dairy Queen. 3G and Kraft Heinz next attempted to buy Unilever for $143 billion, but that deal collapsed amid concerns about a cultural clash of the two entities.

On Feb. 22, Kraft Heinz disclosed that the U.S. Securities and Exchange Commission was investigating the company’s “accounting policies, procedures and internal controls in procurement.” Kraft Heinz’s share price plunged 27 percent that day; the firm wrote down $15 billion in the value of its Kraft food lines, including Kraft macaroni and cheese, Oscar Mayer hot dogs and other waning brands. The firm also slashed its dividend. The write-down called into question 3G’s management style.

3G had underinvested in its brands to maximize current earnings at the expense of growth. Consumers have demonstrated a declining interest in its legacy food brands such as Velveeta cheese, Kool-Aid and Jell-O and a growing interest in natural and organic ingredients and products. Furthermore, consumers’ buying habits have changed, with private labels such as Costco’s trusted Kirkland Signature putting additional pressure on national brands to maintain position on grocery shelves.

3G’s slash-and-burn […]

Published February 11, 2019

The U.S. has just completed the longest government shutdown in its history. The shutdown came to an end when President Trump backed down from his demand that the government fund his oft promised wall on the southern border of the U.S.

Trump’s “big, beautiful wall” was to be paid for by Mexico. When that didn’t happen, he demanded that the U.S. government pay for the wall. The price tag is estimated at $5.7 billion. When the House of Representatives refused the funding, the president allowed “non-essential” government services not to be funded – an act that he said he was “proud to own.”

After the economy teetered on the brink, the shutdown ended. Government services resumed. Employees, who had not been paid for a month, are in the process of catching up on the work not done during the stoppage. Among the many consequences, the Federal Reserve had to make interest rate decisions at its January meeting without full details of the economy. The Fed wisely decided not to change rates.

Now negotiations are going on within the government as to whether or not the government will pay for the wall. Three weeks were allocated to make that decision. President Trump, who advertised himself as a champion dealmaker, has so far found a deal elusive. He now says that he does not believe current negotiations will yield a solution that he can accept. Since he is apparently playing no role in the negotiations, it is likely that he will not approve any proposal. The question then arises: What will happen next? The president’s State of the Union speech provided no answers.

The fallout from this recent shutdown […]

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 […]