Wednesday, May 4, 2016

“For 240 years, it has been a terrible mistake to bet against America, and now is no time to start.” - Billionaire investor, Warren Buffett, in his letter to shareholders.

From the Desk of Joe Rollins

If you had been like Rip Van Winkle and gone to sleep on January 1, 2016 and not awakened until May 1, 2016, you would have thought that the stock market had done nothing since you fell asleep. After hearing that the Standard and Poor’s index of 500 stocks was only up 1.7% during that time frame, you would have no idea what a great roller-coaster ride you had missed during those four months.

The 2016 year opened with the Dow Jones Industrial Average losing roughly 1,100 points or 6.2% at the end of the first week. Then out came the forecasters of “gloom and doom” projecting that the market was going to go down 75%-80% and the only hope of salvation financially was to buy gold or silver. Even RBS, a major global bank, told clients to “Sell everything now.” Albert Edwards, a global strategist at Societe Generale, predicted that there would be an “ice age” for financial markets and he warned that the stock market could fall 75%. There were numerous warnings of a repeat of the financial crisis in 2008 and 2009. A great way to start the year!

By the middle of February 2016, the S&P was off nearly 13% for the year. The prediction for the U.S. to go into a recession, and of course the world to follow, was the lead article in every financial news report. The bank stocks were tanking, the U.S. dollar was climbing, oil was falling and, of course, a world recession was only around the corner. Everywhere you looked, there was financial chaos. And then, to no surprise, on February 11, 2016 the market bottomed.

As there was no reason for the down draft, there really was no reason for the up draft. Then, everything seemed to change. Oil had bottomed at $26 per barrel, which was a 13-year low; not since 2008 had oil traded this low. With the realization that no recession was likely, the market roared back. Rather than climbing, the U.S. dollar fell. Oil basically doubled, moving to $46 per barrel. By May 1st, we found ourselves 2% from the highest average the markets have ever enjoyed. As you can see, it was far from a very boring four months. After all was said and done, the S&P ended up 1.7% for the year as of April 30, 2016, which is about where it should be.

In reality, contrary to the wide fluctuations in the market, nothing really happened – just as I predicted. The United States was never in fear of a recession. It was ridiculous to assume China (the 2nd largest economy in the world) would melt down and it was equally as ridiculous to assume that the price of oil would continue to fall below the cost to produce it. However, the market gets itself in such a wild state of fear that it assumes every rumor to be true and every possibility becomes an absolute. As I have illustrated in my reports over the years, you have to ignore the headlines and look at the financial reality of where we are today. Bear with me, as I would like to revisit basic economics and general trends that reflect the reality that we find ourselves in today as compared to the scary headlines you read in the financial press.

But before getting into my breakdown of the economy, I wanted to share some photos with you that have recently made me stop and think about the events of my lifetime. It is hard to believe that Josh just turned 21 years old, is taller than me and will be a senior at Auburn University in the fall. Below are pictures of him at three years old and at 20 (accompanied by his best friend, Carter Roberts). It is amazing how fast time sneaks up on you.

Josh (age 3)

Josh (age 20)

Ava also has a birthday coming up; she will be five years old at the end of May. The pictures below at two years old and almost five illustrate how fast she is growing up. It is hard to believe how these five years passed so quickly, and she is no longer a baby, yet a young girl. Kind of scary for an old guy like me!

Ava (age 2)

Ava (age 4 1/2)

Father/Daughter Dance 2016

I have also been reminded that I started my accounting practice 36 years ago. It is hard to believe that I have now had my own practice longer than the 30 years prior in my lifetime. Additionally, we started the investment business 26 years ago with basically an idea that would be a satellite to the CPA practice. Both have grown significantly over the years and we are very proud that we continue to be successful and independent after all these years. And in case you missed it, we were rated #1 in Georgia and #20 in the U.S. last summer on CNBC’s list of Fee-Only Wealth Management Firms.

One of the questions I am asked almost daily is, “When do you plan to retire?” I always answer, “When Ava is 18, I will be 80 years old. Maybe at that point, Warren Buffett and I will consider retirement.” You may rest assured though that I will not retire until the day I quit breathing. I feel confident that they will carry me out of my office on the way to retirement.

On that note, let us get back to basics. On the days when the market is fluctuating at high levels for no particularly good reason, you start to question whether you have lost the ability to properly assess the financial roadmaps that we follow for guidance and investing in equities. I think a great deal of the negative press, nowadays, is reflective of the presidential election. It is totally amazing to me that all of the candidates think the economy is terrible and “surprisingly” only they can fix it.

I am often confronted with the question, “Which candidate would be better for the financial markets?” Financially, I am not really sure it makes a great deal of difference. There is no question that the president makes a great deal of difference in the trajectory of the United States and its ability to affect world policy. However, even the best (and worst) presidents are only there for eight years, at most, and that is just too short of time financially to make a big difference.

I often quote the headline above made by famous investor, Warren Buffett. His point is that regardless of what these politicians say, the U.S. economy continues to be outstanding and there is almost no chance of a major recession in the next few years. I love it when Warren Buffett says, “As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do. That view is dead wrong: the babies being born in America today are the luckiest crop in history.”

But the most striking example of the improvement in the American way of life is Warren Buffett’s comment, “American GDP per capita is now about $56,000. As I mentioned last year that – in real terms – is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently, and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well.”

One of the most common explanations the naysayers of the stock markets give is the failure of the S&P earnings to continue to grow. This is somewhat bewildering, given that obviously they have not even attempted to apply any common sense to this forecast. First off, if you take out all of the negative earnings associated with the oil companies, it is fairly clear earnings are not that bad. But as you compare the earnings for 2016 to 2015, there are many attributes that are positive now that were negative in 2015. This is great news for 2016.

In 2015, the price of oil was falling virtually every week and was negatively impacting the earnings of the companies in the oil industry and the suppliers of that industry. In addition, the U.S. dollar was rising dramatically against foreign currencies, which led to a drag in U.S. companies exporting to foreign companies and those large multinational companies that had international operations. If I am going to evaluate earnings and the effect that external economic events had on those earnings, I would certainly want to review the status of those negative attributes in 2016.

I guess the “gloom and doom” people have not noticed that the price of oil has almost doubled in 2016. Also, they did not notice that the dollar has fallen a full 10% in value against other countries’ currencies since the beginning of 2016. Both of these financial implications are extraordinarily important for valuating earnings this year.

Already, earnings are forecasted to increase a full 10% from the first quarter of 2016 to the end of 2016 by the Standard & Poor’s. It is difficult for me to understand why, if you are assuming that the financial markets are going to disintegrate, you would consider the positive attributes of two items that greatly affect corporate earnings.

It would also be very unusual if the country were to fall into a recession when employment is virtually at capacity. Just check the most recent employment numbers and you will see that over the last year, more than 3 million Americans are employed that were unemployed a year ago. It is presumed that every employed person in American supports at least five other individuals, whether directly or indirectly. If you consider that someone employed buys groceries, eats out at restaurants and has basic commodities within their home, you can see how one job creates multiple opportunities.

If that is the case, this constitutes 15 million people that are better off today than they were a year ago. That is roughly 5% of all the people in the entire United States. It is highly unlikely that an economy would fall into a recession starting at full employment. As a personal example, we recently ran an ad for a new professional staff member and did not even get one single resume for that position.

Review the spending on construction and you will see that we are very close to a booming time. Construction spending at the end of February was up 10% year over year. New housing was up 14% and nonresidential spending is up 10.5%. Across every cycle, construction is higher than it was a year ago - certainly not indicative of an upcoming recession.

There are simple things that you can check to determine whether there is any validity in my claims such as the index of leading indicators up 1.65% year over year and the index of lagging indicators up 4.04% year to date. Certainly nothing there would give you an indication that the economy is in anything close to a recession.

Therefore, once again let us summarize the positive within the U.S. economy and the upcoming positive attributes. Interest rates are at an all-time low, and if they move higher it will only be marginally so. Non-energy earnings are flat at the current time, but projected by Zacks Investments Management Services to be 10% higher by the end of the year. U.S. employment is very strong and moving stronger. As history has told us, U.S. businessmen are normally very reluctant to hire any new employees, yet they are continuing to do so. This, to me, is a clear reflection that business is better and corporate America is expecting there to be work for these new employees. This is clearly not a sign of an upcoming decline.

Therefore, in summary, my three main components to higher stock prices remain intact. 1. Interest rates are low and are not likely to get much higher. 2. Earnings are flat and are likely to get higher before the end of the year. 3. The economy, while not robust, is fine and there is a high likelihood that it will be higher at the end of 2016 than it is now. Therefore, the three most important components aggressively argue that stock prices will be higher at the end of 2016 than they are today.

You really cannot rely on the financial advice that you receive from the financial community. How many times over the last three weeks have you seen how bad Apple’s earnings are? In fact, for the quarter, they had $50 billion in sales and a $10 billion profit. By the way, those are higher than any other corporation in the world. Their earnings constitute 5% of all the earnings in the S&P 500 – combined. Secondly, they command a cash portfolio of close to $230 billion, which they could use to purchase their own stock or other companies.

While Amazon stock was up dramatically on their corporate earnings, they had only $500 million in earnings compared to Apple’s $10 billion. If you truly believe Apple’s earnings are awful, as reported by the financial press, I have some beachfront property in Kansas I would love to sell you.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

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