Valuations

The Andresen & Associates 2018 Annual Review

2018 started nicely enough. But then it turned stormy. Almost all of our major indices were down in 2018. Most of the chaos happened in the last few months.

Paradoxically the US economy, and most of the global economy, continued to boom in 2018. U.S.  corporations delivered astonishing growth, with earnings up some 20.5% according to FactSet. This was fueled in part by deregulation and 2017 tax changes. Job growth was similarly nothing short of astonishing. There have been about 3.8 million jobs created in 2017/2018, more than half in only five states: California, Texas, Florida, New York, and Georgia. Apparently 1.1 million of those jobs were added October 2017-October 2018.

Surprisingly, some communities of the US remain mired in a post 2008 recovery, and have experienced little improvement in quality of life for decades . And, of the 43 million Americans receiving social security, 62% rely on those monthly checks for at least 50% of their retirement income. In other words, the distribution of economic growth and income disparity are going to be giant issues going forward.

Nevertheless, in general, the economy in 2018 was stellar. For example, Americans bought 17.3 million new cars, the fourth consecutive record. It was a bumper year economically.

As a result, stock markets of the world, including that of the US, rose substantially early in 2018. Then, in the second quarter, President Trump initiated an angry trade war with the world, largely with China, from which foreign stock markets immediately recoiled.

Perhaps this trade war was inevitable. Led by hardware maker Huawei, state-owned Chinese technology firms have become so blatant in their thefts of American intellectual property, and in their capacity to conduct surveillance on Americans, that some response was necessary. It might be argued that the US government’s response was a sledgehammer to cope with mosquitos. But those mosquitos increasingly have the ability to bleed us dry.

Due to fears of an overheating economy, the United State’s central bank, the Federal Reserve, raised interest rates four times during 2018, to 2.5%. That’s still low by historical standards, but compared to the almost-zero rates of a few years ago, it was a steep enough rise to give bond markets the frights.

While this was happening, the Fed was also quietly allowing $355.5 billion of its government debt to mature without making new purchases. These bonds were the remnants of 2011’s Operation Twist, in which the Federal Reserve drove down longer term interest rates, causing the economy to grow and also causing some of the excessive corporate and private debt load we see today. This Fed action was probably more important than the interest rate hikes, because it reduced money supply, and implicitly reduced bond demand, allowing longer term rates to move up. As a result of these decisions, interest rates began to rise from market behavior as well as government actions. Mid year, our bond mutual funds were showing losses for the year.

Meanwhile nothing aside from great statistics and wage growth of about 3% appeared to suggest that inflation was about to run rampant. Inflation, after all, is one of the greatest destroyers of wealth. However, it stayed below 2% in 2018, in the United States. In comparison, apparently the inflation rate in Venezuela was over 1,300,000% in 2018, because of national collapse. So, yes, inflation CAN get out of control.

Meanwhile, in Europe, the economy continued to contract. One interesting note about the ongoing Brexit process…Great Britain exiting the European Union…is that the European Union isn’t that attractive an organization. Europe faces gigantic demographic, debt, governance, and trade issues. And, in 2018, their economy and often their stock markets struggled. Italy endured a budget crisis due to overspending in 2018, but the EU kicked that can down the road by essentially refinancing. There’s genuine discussion by serious analysts about the ability of several European states to repay their debt at all.

In fact, one of the big themes of 2018 was the surfeit of both private and government debt worldwide. My guess is that eventually we will have a reckoning, but that moment of truth may not happen for decades. Meanwhile the governments of the world are busy covering it up. In the short run this makes a recession more likely although the indicators suggest 2020 rather than 2019. And, of course, a recession may not happen in the immediate future, with slower growth the reality instead.

Interestingly the Chinese became net sellers of U.S. Treasury bonds in 2018, although they still own $1.14 trillion of our debt. My thought is that these sales happened because they’re worried about economic softness at home.

In July, the U.S. population recorded the lowest year-over-year growth rate, 0.62%, since 1937. Half the growth was from the surplus of births versus deaths. Half was from immigrants becoming U.S. citizens. 2017’s data tells us that U.S. women are having an average of 1.76 children, below replacement rates and the lowest since 1978. Holy Japanese demographics! The future looks very different.

The U.S. S & P 500 large cap index reached an all time high of 2931 on September 20th, 2018. It then fell 19% to the end of the year, which may or may not qualify as the 20% necessary to be a full-on bear market. Downturns like this usually take an average of 24 months to regain all-time highs. But that’s just an average. Meanwhile, global equities outside the U.S. plunged the most on a monthly basis since 2012. Outside the United States, most stock markets struggled.

In November, in the midst of much toxic division, Democrats regained the majority of the United States House of Representatives. Despite the alarmist and meandering rhetoric by both extremes, my experience has been that a divided Congress is often a better Congress because more useful compromise legislation is sometimes the result. The alternative – deadlock – is often better than one political faction running away with the government while creating debt and discord.

As stock markets declined sharply in late December, bonds played their traditional safe harbor role. Yields went down as bond prices went up, resulting in positive or at least neutral returns for many of our bond mutual funds for the year. And in the first week of December, the yield curve inverted very slightly, as the yield on the three year Treasury rose infinitesimally above the yield on the five year Treasury. That sometimes…but not always…signals a recession in coming months. To me, it didn’t seem like a very strong signal, and it didn’t last. But of course the media’s talking heads were all over it.

In expectation of a possible recession, which may or may not happen, oil prices declined sharply towards year end and gold rose slightly towards year-end. This meant that our asset allocation funds, which traditionally use energy stocks to offset inflation, did less well than normal in 2018.

The result of this wild ride was a down year for the financial markets in general.

Literally on the lowest day of the stock markets in 2018, December 24th, when the S&P 500 closed at 2351,  I had three clients call to ask to liquidate. When clients call to liquidate, it’s a very positive sign. Fear tends to mark market lows.

To put all this in context, according to BTN Research, since 1950, the S&P 500 has been up 54% of 17,361 trading days, 60% of 828 months, 66% of 276 quarters, and 72% of 69 years. Since 1926, 84% of the rolling 3 year periods of the S&P 500 Index have produced a positive return.

In other words, history seems to be on our side. My plan for now is to stay the course, weed the garden, and buy bargains. Down markets are full of opportunity. I’ll spell out my thoughts for 2019 more deeply in my next newsletter in a few weeks.

I know that it’s hard to endure financial market turbulence with the life’s savings which is essential for your wellbeing. Nevertheless, turmoil is normal, and we’ve been here before! 2018 marked our 30th year, and in those 30 years we’ve experienced many twists and turns on the road to creating long-term financial success. Our patience has genuinely created wealth, hasn’t it? As a result of our ability to cope with, and even take advantage of, tough times, Andresen & Associates has grown to where we are today. We expect success in these uncertain times as well. Thanks for being our clients.

Stock markets at all time highs!

This week we’ve seen US stock markets climb to new records, despite trade wars, political chaos, and overvaluation. The data says we’re at high risk, and the stock markets keep going up! The tactic of selling out and going to cash has been a miserable failure in the past. What has worked best has been the choice to simply keep our portfolios very diversified, allocate conservatively, and be patient.

https://www.marketwatch.com/story/dow-set-for-best-week-since-july-as-stock-futures-imply-deeper-push-into-record-territory-2018-09-21?siteid=bigcharts&dist=bigcharts. 

The Asian stock market downturn is probably not permanent.

Yes,Asian stock markets are being damaged by the nascent trade wars. At some point they are going to be bargains. My thought is that due to Asian growth and American confusion, the 21st Century is possibly going to be the Asian Century. That may happen with lots of volatility and angst. With that in mind, we’re already buying more, in small amounts and diversified. Our expectation in these high risk venues is to outperform the U.S.’s S&P 500 in the long run ten year time frame. https://www.bloomberg.com/news/articles/2018-09-12/asian-stocks-are-caught-in-the-longest-sell-off-in-16-years?cmpid=BBD091218_MKT&utm_medium=email&utm_source=newsletter&utm_term=180912&utm_campaign=markets

Focus on the long term

I was reminded of that today when a client called up and asked what return he could expect on his investments. I said we really can’t predict, but a long term average of 7% has historically been both attractive and doable, with discipline. We really can’t say what the future will bring.

What does “discipline” mean? To some degree it means that we ignore the day to day noise and focus on long term realities.

Reality: Bitcoin is probably a bubble. Thus we should approach cautiously if at all.

Reality: The economy is profoundly leveraged, “in debt up to our eyeballs”. That always has negative consequences.

Reality: The financial markets are probably overvalued. A downturn in the future is probably inevitable. The downturn will probably be followed by an upturn, as day follows night.

Reality: history tells us that we really can’t guess. In the decade or longer time horizon, by buying low and avoiding bubbles, we will probably steer our investments towards attractive gains. In other words, in the long run, most of the above doesn’t matter. Stay the course. Stay diversified.  Patience pays.

Read more.

Thirty years ago

Thirty years ago this week I was beginning what was then a very novel business model: fee-only, no commissions. I was working at Christopher Weil, Inc, after a few years at E.F. Hutton. The consensus among the veterans was that fee-only could never work. Now it’s the industry standard, and I was present at the beginning.

Much to the chagrin of some of my managers, I had moved my clients’ accounts to safer positions because I thought the stock market was overvalued. As the Quotron…a primitive computer…kept posting lower and lower numbers, I looked over at the office manager. His face registered horror. We turned on a speaker from the floor of the New York Stock Exchange, where the trading was done with paper and voice, and we could hear a roar from the crowd. Everyone was trying to sell.

After that, I bought stock mutual funds for my clients and for myself at bargain prices. The market fully recovered within months. Our portfolios benefitted much more than any losses hurt us. Black Monday 1987 was the first time that awareness of overvaluation produced a big win for us.

Since then, calling out overvaluation has been much harder. In the 1990’s we were right but it took YEARS before the 2000 Tech wreck, and many clients became discouraged before it happened. The 2007/2008/2009 Financial Panic was different because recovery took a long, long time. Many clients were discouraged by that as well.

Now the financial markets are overvalued again, but the central banks have changed the game by stimulating. We don’t really know what will happen. Eventually I expect that a correction must occur, but it may or may not replicate the sheer terror of Black Monday 1987. Meanwhile, all we can do is pay attention and stay diversified. As my life illustrates, patience pays.

 

Gone and mostly forgotten.

Ten years ago today, the S&P 500 U.S. stock market index hit its record high before falling about 57% in the Financial Panic of 2008. It recovered in March, 2013.

Before the meltdown, there were already major issues in the financial system which were larger and more dramatic than what we are facing today. So is such a meltdown imminent now? If so, I can’t see it. But valuations and debt levels are again high.

How soon we forget. Read more here. 

60% of a bag full of slow

The stock markets of the world appear to be impervious to every current geopolitical event, including the threat of nuclear terrorism and serial hurricanes, while a growing number of writers are shrieking that the end of the financial world is nigh. (Read the latest apocalyptic broadcast here.) Hmmm. I have my doubts, but there’s a lot of smoke in the air. Conditions being what they are, last week I moved 5% in many clients’ accounts from stocks to short term bonds. That’s very unusual for me. I’ve learned the hard way that even the best-calculated predictive indicators are easily undone by Fed easing. So usually nowadays we simply stay invested. The long-term force is with equities.

However, bonds aren’t deeply attractive right now either, except as a place of relative safety. Some bonds, especially longer-term issues, are overvalued like stocks. And the perception that the Fed Will Make All Things Good is strongly at work in bond-world as well. Here’s an interesting article which details the almost nonexistent difference in three year performance between top-end bond funds. Some of our conservative clients have portfolios which are 60% bonds. Those bonds aren’t producing much. Granted, bonds are traditionally holistically safer than equities, but in terms of gains, they historically don’t do much.

Right now, because of valuations, we temporarily have clients with 60% invested in boring. My hope is to eventually get them into equity bargains, and make some real long term gains. Patience pays.

Are Small Stocks Leaving the Party?

The market for small stocks just turned negative for the year. That’s big news, and you aren’t likely to hear it elsewhere because it disrupts the narrative of a rising stock market.

Why is it happening? This article provides more data to suggest stock market overvaluation. In this case, it’s the small stock markets, exemplified by the Russell 2000 Index. What’s more, this downturn is a divergence: the performance of the Russell 2000 Index is now negative for the year whereas the market for large cap stocks is up. Shades of 2000.

However, this mild decline in the small stock arena, combined with the insecurity created by terrorism in Europe, is likely to trigger a Federal Reserve stall of plans to raise interest rates. So a decline is by no means certain. We simply need to remain aware. Since we are diversified and modestly defensive, if a real downturn DOES occur, we’ll be buyers. When that will actually happen is anyone’s guess.

Everyone expects to be a winner (and all children will be above average)

I’m reposting this here from the Heisenberg Report. According to this study, essentially everyone thinks the stock markets will finish higher in one year.

Such a high level of optimism is some kind of record.

My guess is that we got here because EVERYONE expects the central banks to intervene forever. Having painted themselves into this particular social expectation corner, it’s going to be interesting to see what the central banks do next.

Way back in the days of free markets, we were taught that extremes of market consensus are danger zones, and that “the consensus is often wrong”. But as I wrote on August 1st, traditional diversification has been proven unnecessary for so many years that investors could be forgiven for it’s just gonna stay like this forever.

My plan is to stay diversified and keep searching for bargains.

We’re doing great! Now let’s stay cautious.

I’m reviewing clients’ portfolios this afternoon, and given that most of us are relatively conservative I’d say we’re on track for a nice finish for the 2nd quarter. I’m saying this while crossing all digits and holding my breath.

Our international holdings, especially our emerging market holdings, have done great so far this year, which is quite emotionally rewarding since after we bought them last year they laid down like raccoon road kill for some months, and were mostly a drag on our portfolios. Now, however, they have recovered, and more.

Likewise our decision to double down on health care has been rewarding, and our decision to stay in tech has been profitable as well.

However I remain nervous like a cat in a room full of pit bull dogs. As I wrote last week, this has been a very thin market especially domestically. Political risk remains high. Markets are overvalued.

So let’s stay cautious, please.

Read more scary stock market predictions here, hopefully with a small glass of oak-aged rum. Predictions do NOT all come true. However they ARE evidence that we should be careful.

Meanwhile we’ll stay invested and stay diversified. It’s a marathon, not a sprint.