Friday, December 11, 2015

The market wants to move higher.

From the Desk of Joe Rollins

The month of November 2015 was basically a non-event in the financial markets. However, any month that records a positive return should be celebrated. With the massive sell-off that we saw in the equity markets during August and September, it was certainly great to have the turnaround we enjoyed in October. The month following a large turnaround gain is critical for determining whether there will be additional advances, or whether the previous one-month gain was an aberration.

Fortunately, November was up and it appears the trend in the market is positive rather than negative. There are a lot of very optimistic aspects to this market, although that is hard to ascertain from the very negative financial press. Before I get into that analysis, I need to report the actual numbers for the month of November.

The Standard & Poor’s index of 500 stocks was up 0.3% for the month of November and for the year is up 3.0%. The NASDAQ composite was certainly the winner in the major indexes during November, up 1.2% and has advanced 9% for 2015. The Dow Jones industrial average is up 0.6% for November and up 1.6% for 2015.

As would be expected with higher interest rates being passed down, the Barclays aggregate bond index was down 0.2% for the month and up 0.8% for 2015. It is fairly clear that interest rates are likely moving up, and as you would expect any price movement in the bond index would be opposite that, therefore negative. My anticipation is that bonds will have a negative rate of return for all of 2016, if the Federal Reserve continues to increase interest rates, as I believe they are most likely will do.

The actual chair from JFK's oval office.

There has been quite a bit of discussion in the financial press about the U.S. economy and how it “continues to teeter on slipping into recession.” Once again, I have no idea on what statistics those negative reports are being based. As I told you in my last commentary on the financial markets, I thought the GDP had been incorrectly stated at 1.5 and would be adjusted. In fact, I was correct and during the month they revised the GDP up for the third quarter from 1.5% to 2.1%. It is very difficult for the government to assert the value of inventories once completing its quick report on the GDP. As the months pass from the third quarter, a better read on inventory is gained and adjustments are made. It still appears to me that the return rate on the GDP is in the 2+ range, and while not great, certainly not negative.

The financial press continues to over report that the U.S. is in a manufacturing recession. With the strength of the U.S. dollar putting us at a competitive disadvantage while exporting goods to international clients, it is to be expected that manufacturing would in fact be down. Empirical evidence does indicate that the durable manufacturing index is down 2.86% over the one year period. Additionally, capacity utilization is down 2.27%, and therefore is clearly lower than the prior year. It certainly does not seem to be a trend for either of those indexes to fall off the cliff at current time.

What is most misleading to people about manufacturing is that it is a relatively small part of the U.S. economy. At one time manufacturing made up a major component of U.S. employment. Today, manufacturing only constitutes 15% of the entire US economy, and therefore a slight reduction in that capacity would not have a great impact to the GDP. Conversely, services make up an increasing portion of the total economy and are not reflected by manufacturing data.

For some reason, people believe that the significant reduction in the price of oil will negatively affect the U.S. economy. Certainly if you work in the oil industry, or if you are a supplier to the oil industry, the downtrend is negative. But let us assume, for hypothetical reasons, that 10% of the whole U.S. either manufactures items going into the oil industry or works in that industry - wouldn’t that mean that the remaining 90% of the population of the U.S. would benefit from lower prices?!

The price of oil affects virtually everyone, every day. The price of food on the shelves is impacted by transportation cost and the gasoline in your car and virtually everything you buy, consume or use in your everyday life is impacted by the cost of petroleum. Therefore, for 90% of the population, this reduction is very much a positive.

Having begun work in the 1970s, I vividly remember when the cost of inflation was in double-digit ranges. I also remember economists explaining the dangers of recession. Many of the comments would point out that the German Army during World War II was paid in cash. Because inflation was virtually higher every week, their currency would be depreciated so it was important to get their pay to them as quickly as possible. We all benefited when inflation increased the value of real estate, but we all understood the negative effects of everything else increasing, while incomes were stagnant or decreasing.

Based upon the most recent information, the rate of inflation is increasing at a 0.2% annualized rate. Therefore, there is no inflation, which is very good. The employment cost index is actually going up at 2.25% and the unemployment rate is now at 5%. There are 2 million more Americans working today than were working only one year ago. Therefore, the trend is mostly positive for employment. Constituents working, the cost of inflation near zero, while wages and other benefits are moving higher - you do not need to be a rocket scientist to understand those three attributes will be positive for the GDP going forward.

One of the most confusing aspects of understanding economic data is trying to get your hands around what items are important and what items are not. I often see so-called economists on TV spouting off one component or another of the GDP and expressing their opinion regarding future performance. Try to separate reality from fiction...

The most important component of the GDP in the United States is personal consumption. It is a percentage of the GDP greater than one half. Personal consumption by the government’s own index was up 3.15% year over year. Therefore, if you consider the facts (1) more Americans are working and the value of their salaries is increasing, (2) there is no measurable inflation and (3) everyone is benefiting from a reduction in petroleum prices, it is fairly clear that future GDP should increase. Given the unbelievably low interest rates in our economy, while also considering the potential increase in December, every working American should be better off this time next year than they are today.

I could provide you with more on Economics 101 as well as statistics to support my analysis, however, few warrant discussion in this matter. Recall that I indicated that personal consumption was up 3.15%, but also note personal savings was up dramatically from 4.6% a year ago, to 5.6% this year. Personal income is up 4.69% year on year. If you read the numbers as I do, it is fairly clear that Americans are becoming more conscious regarding savings, while consuming at a higher level. The only way this is conceivably possible is if wages are going up (and they are) and the consumers’ costs are going down in conjunction with lower inflation and low interest rates. All of this in a word is good for the U.S. economy, and as more and more Americans go to work, the spreading of the wealth effect should have dynamic positive impact on future GDP.

As I often write in these postings, higher stock prices are driven by three major components. As we sit here in November and December 2015, while the financial markets are not up dramatically this year, they are still higher. In evaluating our three important indexes, we know that interest rates are extraordinarily, if not outrageously, low at the current time. We also know that corporate earnings, excluding gas and oil, are up dramatically year-over-year, even including the outrageously high dollar index hurting U.S. manufacturing and exports. And as illustrated above, the economy continues to be strong and may even be getting stronger. While volatility is an everyday occurrence, it appears to me that this market wants to go higher and is likely to do so. The talk of an impending recession is just filibuster, not supported by facts.

I am often confronted with clients citing one geopolitical event or another as a reason not to invest more of their money. Needless to say, we can never invest for geopolitical events since nobody knows when they are going to happen, what effect they would have on the financial markets, or whether they are totally meaningless in the long-term effect. All of these so-called pundits were shocked when the financial markets went up after the Paris massacre. How many of you were invested on 9/11, when the markets dropped due to the attack on America? Rarely do people mention how quickly the markets recovered after that downturn.

All of us remember 2008 and the sharp decline we suffered that year. How many of you are aware that the markets are up 200% since then? When you invest, you invest for economic reasons not geopolitical events. The one great service we think we perform is evaluating those economic performances, and hopefully seeing the potential downturn before it occurs.

Thanksgiving 2015

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

Best Regards,
Rollins Financial, Inc.

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