Finance, Insights

Historical Notes

PaulNolte-2When dealt a bad poker hand, fold or bluff. Some would like to fold and redeal from a new deck of candidates ahead of the elections in November. Can anyone tell who is bluffing or who has the best hand? The electorate is likely the patsy at this table. We also heard from various Fed governors last week who are pressing their bet on higher interest rates this year, even after being dealt poor economic numbers last week. The unemployment report came in below expectations, compounded by little improvement in wage growth. Corroborating evidence of weak employment and wages come from the payroll tax collections report. Collections are roughly 3% higher than a year ago, well below the most recent peak of 9%. Non-farm payrolls, while good, are 20% below the yearly average a year ago. It has been hard to make a decent hand from either earnings or economic data. The current betting is only one more hike at year end, and those are becoming long-shot odds. The consumer has picked up their chips and calling a night well before the party gets going!

The SP500 has once again come within hailing distance of all-time highs set last year and failed. After last fall’s decline, the market raced back only to be a percentage point short. Again the markets declined hard to start the year before a furious rally put the SP500 a hair below both last November’s and May’s highs. The failure to set new highs is seen by some to be a sign that a big market decline is dead ahead. A possibility to be sure, but at this point it is a small one. The number of advancing to declining stocks is in favor of a more positive view. Volume has been strong during this most recent advance, indicating investor interest in “getting on board”. Both of these were decidedly negative during the last half of ’15. So the markets may not fall out of bed, but they may also struggle to have significant gains too. Valuations seems to have kept a lid on the markets, as each time the markets hit roughly 20 times trailing earnings, the averages turn lower. That would be roughly 2115 on the SP500, about three percentage points above Friday’s close. It is this push and pull between investors trying to find returns outside of the paltry yields in the fixed income markets and relatively high valuations in the equity markets that has provided a flat return for over nearly 18 months.

The “safe” part of the market returned to form as bonds have performed as well as stocks for the past ten weeks. Looking
over a longer horizon, even with the big stock declines and rallies, bonds have been showing persistently better
performance than stocks since mid ’15. How can this be with interest rates so low and a Fed that is bent upon raising
them? Essentially the bond market is calling the Fed’s bluff. Interest rates on treasury securities are lower today than they
were at the start of the year. Corporate bonds, especially outside of the energy sector, have also made it back to the start
of the year levels. Will the Fed continue to bluff the markets into believing the economy is strong enough to withstand
another rate increase or fold and acknowledge there are some issues that cheap money just can not fix?

So what is an investor to do in this type of markets with poor yields on bonds, a stock market that is going dramatically
sideways, global concerns about growth and a US election that will soon dominate the news cycle? Play close to the vest.
Taking big risks in hopes to score a big win opens up the potential for big losses too. The odds are not in the favor of the
bettor here and best to take small risks to maintain the chip pile for better opportunities in the future. Bonds, for all the
bashing they take for low yields and lack of excitement have done extremely well over the past two years, especially when
compared to “risk” assets like stocks. For just over two years, a 100% bond portfolio would have performed just as well as
a SP500 portfolio, without all the drama. There is some value in the equity markets, but it resides in the emerging
markets, which have performed rather poorly over the past five plus years. At some point they will begin winning the
performance race, but for now safe is much better than sorry.

The economic data remains below expectations for a growing economy and the earnings season has been less than
stellar. As a result, we continue to err on the side of caution rather than to bounce in and out of the markets trying to catch
the short (but dramatic!) moves in the markets. We are investing for years into the future and while the short-term can be
exciting, it can also be the source of much pain and anguish.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information
that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or
future financial market conditions.