Dow - Twenty or Thirty Thousand ??

Barron's is a highly-respected weekly news-rag.  The cover article on their latest issue proclaims:

NEXT STOP:  DOW 30,000

Inside, the article begins with:

The Dow hitting 20,000 was no fluke.  Today's stock prices are well supported by solid prospects for corporate earnings and economic growth.  In fact, if President Donald Trump can avoid stumbling into a trade war - or a real war - there's no reason the Dow Jones Industrial Average can't exceed 30,000 by the year 2025.

First, it reminded me of Warren Buffett saying . . ."We always live in an uncertain world. What is certain is that the United States will go forward over time."

Then, I focused on the word "IF" -- IF President Donald Trump can avoid stumbling into a trade war or a real war.  That is not a snarky comment about the new president.  That is a concern that rapid change increases the odds of sudden mistakes.  That is also a reminder to investors not to get out of the market too soon.  Undoubtedly, sooner or later, President Trump will make a mistake - every president has - and the stock market will "howl bloody murder."   How should an investor react?

IF you are a long-term Buffett-style investor, you will sell nothing and try to buy more stocks as their sales prices decrease.

IF you are a timid investor, you will sell everything and undoubtedly miss the inevitable rally.

IF you are a normal investor, your level of cash will loosely reflect your level of anxiety.  As you lose more sleep, you should increase cash . . . but there is never a good time to be 100% cash.  

Most of all, avoid the company of timid investors and get ready for Dow 30,000 . . . someday.

Slow and Steady . . . ?

The Commerce Department has just released their first estimate of GDP growth during the fourth quarter, showing a 1.9% annualized rate, which is about what was expected.  Although this is down substantially from the Q3 growth rate of 3.5%, it was expected that 3.5% was an aberration, due to agricultural imports.  For full year 2016, however, GDP growth was about 2.1%, which is also the average for the last seven years.

Two things struck me as interesting in this report.  Our average growth rate of 2.1% is the slowest GDP expansion since World War II.  It is also the longest expansion since then.  Is there a relationship between these two facts?  Does fast GDP growth shorten the business cycle between recessions?  There has been precious little economic research on this, primarily because it is so difficult to control exogenous variables.  But, I still wonder . . .

Also, is 1.9% the most meaningful number to gauge GDP growth in a period of strengthening currency?  As the dollar strengthened during Q4, American-made products became more expensive for foreigners to buy and, therefore, exports fell.  Conversely, a strong dollar makes foreign-made products cheaper for Americans to buy and, therefore, imports to rise.  Without the resulting huge trade deficit, our GDP would have grown a whopping 3.6% -- very close to Trump's promise of a 4% GDP growth rate.  (He is already on-the-record for saying the dollar is too strong, making him the first president to ever say such a thing . . . but he is right!)

Bottom Line:  our economy is stronger than the stated GDP growth rate of 1.9%, but does that therefore shorten the business cycle and hasten the inevitable next recession?  I think not!

New Pejorative?

Like most people, I've been called a few names, including some colorful four- or seven-letter names.  Now, I've been called a "globalist" - someone who supports the notion of globalization.  I didn't know that word was a pejorative, but I will wear it with pride!

.25 or 20,000 - Part Two

For my thoughts on the Dow reaching 20 thousand, please read the blog of December 15, 2016.

It took a few extra weeks to get there, but that is a good thing, not a bad thing.

New Economist In A New Job

Peter Navarro is a brilliant Harvard-educated Democratic economist that has been picked by President Trump to direct the newly-created National Trade Council.  After running for office three times without success, he made the prudent move into appointee politics.  He is also the author of Death By China, which warned of war with the Asian giant, both militarily and economically.

Most economists support the notion of "free trade" and globalization, and so does Navarro, but he sees it as something that works in theory but not in practice, because it is so badly administered.  While nobody will argue there is no room for improvement, the current approach looks like a heavy-handed approach to brain-surgery.

Press reports that Mexico and Canada are open to "updating" NAFTA offer a definite WIN for the President and Navarro, but the devilish details won't be known for a long time.  He also feels multi-lateral deals are less effective than bi-lateral deals.  In other words, it would be better to negotiate new trade deals with each nation individually than to negotiate one deal with a group of nations, such as Europe. Bi-lateral deals allow nations to "arbitrage" trade differences between trading parties.

He is certainly impressive and qualified, but I am concerned he may know more about economics than he does negotiation, and that he may be "obsessed" with China.  Let's give him the benefit of the doubt and wish him well.

Doll Thoughts

One of my favorite thought-leaders is Bob Doll of Nuveen Asset Management.  He maintains a strong hold on the long-term perspective and is not prone to panic.  His latest commentary contained the following:

1.  Corporate earnings are increasing nicely.  Consensus forecasts for this quarter is a 6.4% increase.
2.  Weekly unemployment claims hit a 43-year-low last week.
3.  Because most new presidents stumble when first taking office, eight of the last eleven new presidents have experienced a fall in the stock market during February, averaging a 4% drop.
4.  Increased policy uncertainty is a drag on the market, and the president's ambitious agenda is likely to increase this policy uncertainty, because it is not likely the Administration can move on so many fronts in short order.
5.  He retains "pro-growth, pro-risk" investment approach, and I agree!

Death By Spin

When I was doing graduate work at the University of Dallas during the last century, I met a fellow student that I've always remembered him as the "cheerful intellectual," because he wrestled with both facts and truth so optimistically.  He had been a high school math teacher and debate team coach in his prior life, but debate was his true love. He felt about debate the same way some people feel about art or fine wine.  Thankfully, he also taught me some of the rules of debate, such as:

1.  Know everything about the subject matter.
2.  Never interrupt, as windbags will be assessed a penalty by the judge, not you.
3.  Facts can only be stated twice - once during the argument and once in the closing.
4.  Emotions are permitted only in the conclusion.

I talked with him last week and could not resist asking what he thought about the presidential debates, and, as expected, he responded with "what debates?"  He explained that there hasn't been a real, presidential debate since Bush I and Clinton in 1992.  Since then, he said, debates have been killed by spin.  During a real debate, arguments can be mistaken for spin, but there is a difference.

Political spin is more often talking points tinged with emotion and posing as half-truths and repeated endlessly.  If you cannot defend a statement, don't debate it . . . just keep repeating it.

Today, the "cheerful intellectual" has more interest in fine wine than debate, and that's sad!

Remembering the "War on Inflation"

In June of 1981, I was backpacking the Chisos Mountains along the Mexican border.  In those days, there was no news in the backcountry.  Cell phones were still unknown.  However, when we got down, I learned the then-Fed Chairman Paul Volcker has raised interest rates to a record high of 20%.  I knew that made a recession inevitable, and, sure enough, we experienced the recession of 1981-2, when unemployment rose to 10%.  Volcker was pilloried in the press.  Farmers blocked C Street in Washington with their tractors in protest.

Volcker did this because inflation had reached 14.8%.

Tuesday, the latest CPI inflation numbers from December showed inflation had spiked up from nothing to an annualized 3.6%.  Suddenly, there is concern that Yellen will start raising interest rates recklessly.  Even President-Elect Trump has warned her not to be reckless.  That's ridiculous!  Headline inflation is still only 2%.

It was only a year ago that we were worried about deflation, which is a much more difficult problem to control.  The slight "spike" we just saw reflects the increased fuel costs from gasoline and not much else.  There are those who expect four interest rate increases this year.  It ain't going to happen!


Humorously, I have to note that Tuesday's report speaks at some length about the widening difference between eating at home and eating in restaurants.  Of course, I will bring that up the next time my wife wants to go out for dinner . . .

Bye-Bye Bump

I predicted that the market would continue rallying until the inauguration, which is typically a time of good feelings, before reality spoiled the party.  Instead the party was spoiled at least two weeks early.  Maybe, it was just catch-up time for a party that go ahead of itself.  Maybe, it was the realization that Congress will hug the tar-baby of Obamacare, before fixing the Internal Revenue Code or stimulating the economy with infrastructure spending.  Or, maybe, the typical good feelings surrounding the peaceful transfer of power are already exhausted?

The President-Elect enters the office with the lowest approval rating in memory -- only 40%.  I also never recall a President or President-Elect saying the dollar is too strong.  While I agree with that, I've never heard a US leader actually say it.  It is a clear call to the Fed to stop raising interest rates.  It is also a clear message to the Chinese that we can and will cheapen their our currency, just as the Chinese do.  So much for letting "the market" decide on the currency exchange rates?

The "Trump Bump" is over slightly sooner-than-expected.  Now, it is back to normal . . . darn it!

You Are Cordially Invited . . .

. . . to view our new website at www.baycapitaladvice.com

Okay, okay . . . this blog is not yet linked to the website, but you'll get the idea anyway!

Your thoughts would be appreciated!

Greed in a Bull Market

An ancient Chinese proverb by Tao Te Ching says "change your thoughts -- change your world."  Nowhere is that more true than the area of finance called behavioral finance.  Your attitude and assumptions toward money and investing have a huge impact on it.

The best known example is during bear markets, when investors panic and sell out, which is a mistake!  If your total portfolio was worth a $100 at the peak of the bull market but only costs $50 now at the depths of the bear market, doesn't that just mean you need to invest more?  Is the pain of seeing daily market values so great that you'll pay anything to end it?

But, bull markets cause just as much consternation for some investors as bear markets.  In a bear market, you're afraid of losing more.  In a bull market, you're afraid of not making more.  The investor moves from fear in a bear market to greed in a bull market.

If the Dow went up 8%, why didn't my portfolio go up 8%?  First, 40% of the growth in the Dow after the election was due to Goldman Sachs.  Without that one stock, you would not have come close to 8%.  And, why don't we own that one stock?  Maybe, because we avoid money-center banks, due to their books of derivatives.  That is a risk that should not be taken.  But, who cares about risk, when the sun in shining?  Instead of asking how much profit did I make, try asking how much risk did I take?

More importantly, the Dow is only of many market indicators.  That are only the 30 largest U.S. companies in the Dow.  Why not the broader S&P 500?  Nasdaq usually outperforms both of those.  And, since 52% of corporate profits come from abroad, shouldn't you compete against that index as well?

Maybe, greed creates myopia?  Changing your thoughts fixes it!

2016 - In - Review

My quarterly column for Inside Business has been released, and you can read it here:

http://pilotonline.com/inside-business/news/expert-column-as-election-years-go-a-predictable-one/article_b7fab3e0-cbdb-5790-9cd6-ba5b16990d68.html 

Educated Company

One big loser in November's election was gridlock, and I'm glad.  The other big loser was globalization, and I'm sad . . . very sad!

At least, I have good company.  According to research by The College of William and Mary, my old alma mater, there is an inverse relationship between educational level and disdain for globalization.  In other words, the more education a person has, the more likely they are to support globalization.

56% of high school graduates or less think globalization is a bad thing.  50% of those with some college don't like it.  39% of college graduates have disdain for globalization, and only 36% of those holding postgraduate degrees don't like it.

The more educated a person is, the more likely they are to understand the arithmetic of "comparative advantage" and to have been exposed to educated foreigners.

I'm so afraid we are going to "throw out the baby with the bath water."

Interesting Research

Vanguard has done some interesting work.  They looked at the stock market for every single day from 1990 until 2015.  During that 25-year period, they identified the 20 best days and the 20 worst days.  What they learned is that these 40 different days, both up and down, tended to be clustered around geopolitical events and within a month of each other.  Take a look at this chart:


There is a real lesson in this.  If you over-react to geopolitical events and sell, you are very likely to miss the major up day in the near future, usually within a month!

The only caveat I would add is that I would not sell if Russia invaded another country for example or China shot down one of our planes, but I would sell, notwithstanding this research by Vanguard, if the Bank of England shut down for example or the Shanghai market collapsed.

Fear not geopolitical surprises.  Fear not normal recessions.  Fear only financial collapse!

When Was America Great?

President-Elect Trump' s excellent campaign slogan of "Make America Great Again" begs the question of when was America great before?  A friend sent me an article by Karl Malentes in The New York Times entitled "Vietnam: The War That Killed Trust."  It was sobering a read, for example, that 65% of Americans are too young to remember the war.

While the article doesn't say this, I think the last time that America was great, at least in the Trumpian sense, must have been that time between World War II and the Vietnam War.  Our economy was growing nicely.  The American dream was born.  A comfortable middle-class life was possible with only one salary.  College campuses were peaceful.  The quality of life was good.  Most importantly, Americans trusted America to do the right thing!

Then, Vietnam came along and demonstrated clearly that our leaders and institutions would lie to Americans - repeatedly.  The deficit spending to finance the war brought inflation to Americans.  Two salaries become necessary.  College kids "dropped-out and tuned-out."  America was no longer great!

The only good thing that came from losing 58 thousand America boys in Vietnam was that the  war proved that racial integration can work.  Soldiers who depended on soldiers of other races learned to help each other.  Call it a silver lining.

How will President Trump return us to the sanguine 1950s, when Dwight Eisenhower was President?  I don't know!  I'm still wondering if I want to go back there at all.

Swamp Lawyer

The Securities & Exchange Commission is charged with the responsibility of protecting America's investing public.  Since the Great Recession, they have been aggressively policing stockbrokers and financial advisors . . . very aggressively!  I think it had something to do with shutting the barn door on a timely basis.

The problem with such aggressive policing is that it focuses almost entirely on process, not results.  The purpose of their process is to demonstrate a "culture of compliance."  The more obsequious you are, the more likely you can avoid large fines for trivial matters.  If I was chairman of the SEC, I would advocate for less trivial regulation and more violent punishment for those who cheat investors. Today, Bernie Madoff is sitting in a warm prison with three meals a day, free health care, and TV.  He should have been shot!

President-Elect Trump has announced that the new SEC chairman will be Jay Clayton, a big time securities lawyer on Wall Street and represents Goldman Sachs - so much for "draining the swamp."  But, he will be a sharp departure from the last few chairmen, who have been prosecutors, more interested in shaking down investment firms with heavy fines and light jail terms for the actual wrongdoers.  At least, Clayton is a deal-maker, and that will be a big improvement.

It is time for a change, and I wish him well!

Bragging Rights

Politicians receive too much credit when the economy is good and too much blame when the economy is bad.  President-Elect Trump will take office when we already have full employment.  President Obama "produced" twelve million jobs during his tenure.  There is no way his successor can be so lucky.

For the last twelve months, our economy has produced 180,000 jobs each month.  For the last three months, it has produced 165,000 jobs each month.  Last month,it produced 156,000.  The slowing trend is not Trump's friend.

Economists argue that the slowing trend is a good sign, reflecting the tightening labor force, and they are right.  But, there are two things for the President-Elect to consider, in order to win real bragging rights.  First, wages have started to rise, as employers try to retain and recruit employees.  Average earnings are up 2.9% on a year-over-year basis for the last year.  This is the highest rate of wage increase since the Great Recession of 2008.  If the new president can accelerate that, he deserves legitimate bragging rights.

Second, Republicans tend to focus on the Labor Force Participation Rate, or what percentage of the potential workforce is either working or looking for work.  Before the Great Recession, it was about 80%.  Most everybody worked in those days, except retirees and housewives.  Today, it is only 62.7%.  Democrats point out that Baby Boomers are retiring.  Republicans point out that unemployment insurance and generous welfare encourages people to stay out of the workforce.  However, getting these long-term unemployed back into the workforce will not be easy.  Most of them have been unemployed so long that their job skills are obsolete.

It is alleged that the President-Elect is no stranger to bragging, but he will earn legitimate bragging rights if he ignores the unemployment rate and ignores job creation and instead focuses on (1) increasing average wages and (2) increasing the Labor Force Participation Rate. 

2017 -- Off To A Good Start

For the last six months or so, the economic data has been generally improving.  Yesterday's ISM report is a continuation of that pleasant trend.  It indicates that the manufacturing sector is the strongest it has been in two years!  This comes despite the disturbing 5% rise in the dollar since the election and weakening global growth.  Employment in the manufacturing sector has also reached an 18-month-high.  (This could create another pleasant surprise in the latest "Jobs Report" due out this Friday.)  In addition, corporate earnings began improving in the fourth quarter, ending the so-called "earnings recession."

The cautionary details are that inventory levels are down while delivery times are up, suggesting some capacity limits and creating some inflationary pressures.  Stay tuned . . .

It is not clear to me that this bull market is merely a "Trump Rally" of good feelings.  It is supported by the improving economic data, improving corporate earnings, AND the end of gridlock in Washington.  There are many reasons to be bullish right now.  So, enjoy it for now, because the bears are just resting.

Ushering

As we usher out 2016 and usher in 2017, my thoughts turn to difficult transitions.  Which is more difficult:  ushering a child into the world or ushering a parent out of it?

The processes of ushering in versus ushering out are very different.  The first is largely a happy process, while the latter process is difficult.

With a child, you enjoy watching them develop their faculties. With a parent, it is heart-breaking to watch them lose those faculties.

Most children learn to think and reason better with time, but only until they become aged and the trend reverses.

Most children view the world and try to adapt to it.  Parents are often held hostage by the things they have already learned or experienced.

A child enjoys increasing control over their life.  A parent faces decreasing control.

You and your spouse have roughly the same emotional involvement with a child but not with a parent.  Ushering can be lonely.

While the measurement of difficulty is problematic, there is no doubt in my mind that it is far more difficult to usher out the older generation than usher in the new generation.

Parenting classes are commonplace for those ushering in kids.  What is the appropriate class for those ushering out parents and why are they not commonplace?

Drum Roll,Please

It is always amusing to see which blog posts were most popular during the year.  For 2016, the third most popular was "The Lehman Line" on October 22nd, when I worried about the probability of Deutsche Bank posing a systemic risk to our financial system.

The second most popular was "The Only Game in Town" on May 19th, when I explained why the stock market had been over-reacting so violently to anything and everything the Fed says.

Finally - drum roll, please - the most popular blog post of 2016 was "National Sock Day" on July 3rd, when I asked everyone to pull a dirty sock out of their dirty clothes hamper and carry it in their pocket until somebody bad-mouthed America on Independence Day and then stuff it into their mouth, explaining we already have 364 days to be negative.

Maybe, the lesson is that a little tongue-in-check humor is more needed than more serious discussion. 

You Look Marvelous?

If somebody said to you that you looked really great today, would you feel good or would you immediately panic that someday you will not look great?

With the market hovering near all-time highs, you would think people would feel good.  Instead, "all-time high" must be some code word for immediate crash.

The market has been hovering just below the 20,000 milestone for ten days now.  Wednesday, it actually had a real "down" day.  Even interest rates dropped.  The sky is falling!?!  This means nothing, and I expect Thursday and Friday will be down days as well.

There is a well-discredited theory on asset allocation that says 90% of investment performance is a reflection of your asset allocation between stocks and bonds.  It is still part of the conventional wisdom for pension funds and institutional managers.  If your allocation is the commonplace 60/40, then your portfolio should be 60% stocks and 40% bonds.  If the stock market rallies and your stocks are now 75% of the portfolio, then you must sell stocks (driving down the price of stocks) and buy bonds (driving up the price of bonds, which drives down the yield on bonds).

Even though January is historically the best month of the year, the first week is often weak because investors wait until the new tax year before incurring capital gains taxes.  It will probably be somewhat worse this time, as investors are expecting lower capital gains taxes with the Republicans in power.

So, when the Dow does break 20,000, will you enjoy the moment or start looking for the apocalypse?   

Cost of a Strong Dollar

With the U.S. being the only nation that is actually raising its interest rates, it is not surprising that foreign savers are buying dollars, to move their savings and take advantage of the higher rates here.  However, the dollar has increased almost 5% over the last year, making dollars more expensive for foreigners to buy.  So, expect foreign inflows to decrease.

A strong dollar, that makes American-made products more expensive for foreigners to purchase and import into their countries.  Not only do those higher prices increase their level of inflation, it reduces our exports, which is a bad thing for us.

Since a great deal of foreigners' debt is dollar-denominated, that means foreigners must use an increasing percentage of their income to buy enough dollars to pay those loans.  That is true for governments, businesses, and a surprising amount of home mortgages. 

One warning for U.S. investors is that all this becomes a "witch's brew" of inter-connected problems.  Which nation has the right combination of decreased spendable money with current credit needs and rising inflation?  Somebody is going bust, but who?  

It has been a long time since I have been this bearish on emerging markets, but that just means a buying opportunity is approaching.

Better In Theory

I have been a fan of Ayn Rand for a half century and think I have read everything she ever published.  She is the mother of Libertarians and their philosophy of the rugged, determined individual standing against the forces of conformity in general and government in particular.  That is not surprising considering she was a Russian refugee from Stalin's repressive regime.  Her vision of mankind dovetailed nicely with the existential image of every individual is an island, immeasurably alone.  I was enamored with her and was not alone in that feeling, because only the Bible has sold more copies than Ayn Rand.  She is that important!

Over time, I realized that her philosophy worked better in theory than in practice.  A world of individuals trying to be uncooperative is not a world that functions efficiently.  Her philosophy became one distant end of a continuum.

So, it is with some concern that I see so many of the President-Elect's appointees are Ayn Rand disciples.  Besides Trump himself, other disciples include the incoming Secretary of State Rex Tillerson, the incoming Secretary of Labor Andrew Puzder, and the incoming CIA Director Mike Pompeo.  That ignores the existing and powerful Speaker of House Paul Ryan, who gives Ayn Rand books to everybody in his office.

How might the nation look different under Ayn Rand principles, you ask?  She didn't believe in charity.  Poor people are poor because they are weak and should not expect job-creators to make them strong.  Because we are a strong nation, the world is ours to plunder.  She was also a proud atheist, putting church deductions at risk of losing their tax advantage.  Regulations might be enforced less vigorously.  Nobody knows.

I love Ayn Rand in a philosophy class but not in a political office . . . any political office!

2016 Lesson Learned

The last week of each year is probably the most intellectually satisfying week of the year.  It forces introspection, because it is both retrospective and prospective - a retrospective look at the year-ending and a prospective look at the year-approaching.  It begs the question of what did you learn this year that will help next year?

For 2016, my love of and my distrust of numbers crystallized and clashed.  The increasing difficulty of pollsters is only one example.  They were wrong on the U.S. election.  They were wrong on the BREXIT vote in the UK.  Even the legendary bookmakers in London were wrong on both!  The conventional wisdom is that millennials are under-counted, since they have gone wireless and have no land lines for pollsters to call.  Certainly, that is part of the problem.  Another is the refusal of some to share their opinions, either distrusting the pollsters or protecting the sole privacy zone in today's world, i.e., the space between their ears.

Republicans accuse Democrats of practicing "identity politics" or appealing to particular voter-blocs instead of appealing to all Americans.  Maybe?  Or maybe, there are 325 million individual voting blocs?  Maybe, Americans are just too self-isolated or too atomized to do more than ricochet off other atoms.

Polling is not the only business experiencing problems with numbers.  Public distrust of economic data has never been so high.  Few believe the data showing there is only minimal inflation.  The stage for this distrust was set by political parties, who didn't like whatever the data suggested.  Conspiracy theories are always so easy to believe and so hard to disprove.  But, there is more to this distrust.

The conventional wisdom is that our techniques for economic measurement are based on an industrial economy, not an informational economy.  Maybe so, but the volatility of that data suggests an unstable relationship between the data of an industrial economy and that of an informational economy.  We are rapidly reaching the limits of direct measurement without continuous measurement.

For 2017, I will continue to study the numbers, because I love them.  However, because I also distrust them, I will rely more on ad hoc focus groups to form conclusions.  Now, what will 2017 teach us?

2017 Transitions

The under-appreciated research department in the over-appreciated investment house of Goldman Sachs list four themes or transitions during the next year.  They are  (1) globalization transitioning to populism, (2) monetary policy transitioning to fiscal policy, (3) regulation to deregulation, and (4) stagflation to inflation.  These are not minor transitions and will take longer than any one year.  We have reached a "tipping point."

First, it pains me to see globalization get trashed, just because politicians wanted the immediate benefits of it but wouldn't pay the long-term costs of globalization, which include retraining and relocation.  The baby is definitely going out in the bathwater!

Second, I'm thrilled at the prospect of having a vibrant fiscal policy as an economic tool once again.  We have relied too much for too long on monetary policy alone.  This transition is a good thing.

Third, the debate over regulation is like watching a pendulum swing and forth and is equally as boring.  Republicans invariably complain about any regulation, while Democrats have seen very few regulations that weren't absolutely necessary.  Both are right, and both are boring.  Arguments about regulations must be specific to the particular regulation.  Yawn . . .

Lastly, the expected transition from stagflation to inflation is more interesting.  Consumers see a slow-growth economy with rampant inflation, even though that view of inflation is not justified by the economic data.  Goldman Sachs obviously sees the growth rate improving and reinvigorating inflation.  Along the continuum of deflation-stagflation-inflation, deflation is the most pernicious and inflation is better than stagflation.  So, relatively speaking, this is also a good thing.

All-in-all, I hope they are right!