From the Desk of Joe Rollins
Before I explain the title of this blog, I wanted to cover a few economic events that may be of interest to you. The Atlanta Federal Reserve recently announced that their projected GDP for the fourth quarter of 2017 was an almost unbelievable 4.5%. If by chance the economy improves by that percentage, it would be the best economic year for the United States in a very long time. However, the evidence of a strong economy continues to be everywhere in sight. Employment is at full capacity and construction is everywhere you turn, yet some forecasters are projecting a short-term recession, defying any type of logic or economic training whatsoever. If the economy continues to strengthen, there is absolutely no question that stock prices will continue to go higher.
The employment report for the month of October was announced and once again the strong economic reality is overwhelming. The unemployment rate fell in October to 4.1%. Incidentally, that is the lowest level of unemployment since December 2000, almost a full 17 years ago. As I have posted on so many occasions, any time the unemployment is less than 5%, economists view employment as full, so we can easily check the box next to that one. And the good news continues to roll in…October was the 85th straight month to net new jobs in the economy. Think about that for a second; that is over 7 years where every single month showed a net positive increase in employment. One of the major components of improved GDP is having everyone work. Therefore, the above 4.5% forecasted GDP for the fourth quarter of 2017 is not so far out of the realm of imagination given that employment in the United States is full. When more people are working, more people have the financial capability to contribute to the GDP.
Ava at ice-skating
Ava ready for trick-or-treating
Danielle with Caroline & Reid
Before I cover these extraordinarily interesting topics and explain the title of this blog, I need to cover the economic markets for the month of October. Despite October’s reputation for being the scariest month of the year for the stock market, it was once again a flourishing market which added to an already impressive fiscal year. The Standard and Poor’s Index of 500 stocks was up 2.3% for the month of October. For the 10 months ended October 31st, the S&P is up 16.9% and for the one-year period ended in October, it is up 23.6%. The Dow Jones Industrial Average was up a sterling 4.4% in October and is up 20.6% for 2017. For the one-year period ended in October, it is up an almost unbelievable 32.1%. The NASDAQ Composite was up 3.6% in October, 26.1% for 2017 and up 31.1% for the one-year period ended October 31, 2017. Just for basis of comparison, the Barclays Aggregate Bond index was exactly zero for October, up 2.9% for the year and up 0.6% for the one-year period ended in October. Once again, investing in bonds was a losing effort as the broad market equity indexes continue to excel.
With the higher GDP forecasted for the fourth quarter, I am sure everyone is excited about the possibility of a higher business level and increased commerce for our businesses. However, I would like to argue that there is a high likelihood that the reported and official GDP is grossly underestimating the actual GDP. The process under which the GDP is calculated is decades old and could not possibly capture current activity in the business community.
I am sure you are very curious about the title of this blog. Basically, these amounts are each the total net income of four U.S. companies. See if you can guess which amount is the total net quarterly income for General Motors, Exxon, General Electric and AT&T and which is the quarterly income for the new economy players - Facebook, Alphabet (formerly Google), Apple and Microsoft.
The smaller of the two numbers above is actually that of the old-line companies (General Motors, etc.) and the higher amount is that of the new technology companies (Facebook, etc.). As you can see, net income for the four old economy companies is less than one fourth of the net income for the new economy players. While it is very easy to calculate GDP growth with General Motors, Exxon, General Electric and AT&T, it is almost impossible to calculate the GDP growth of Facebook, Alphabet, Apple and Microsoft. For some time, my argument has been, “How do you actually calculate the GDP acceleration for companies in the new economy?” When you click on the mouse, does that really affect gross domestic product? For example, Facebook can send a message to its 1.5 billion users around the world. How is that information calculated and interpreted when calculating gross domestic product. I do not believe it is.
Would you be surprised to learn that all of the old-line companies that have been in business for generations have accumulated cash on their balance sheet of $207 billion? As of June 30, 2017, the new-line companies (the oldest being 27 years old) have a cool $537 billion on their balance sheet. Therefore, the new companies have more than double the cash than the old companies. This is not a 1999 phase of internet companies being created that do nothing; these are very serious and profitable companies that have accumulated vast sums of money that, in my opinion, are not measured by the current GDP calculations that we see today.
Let’s just assume for a second that I may be correct. What if GDP in today’s economy is understated by the current calculation of GDP, which does not take into consideration the gains in the economy created by technology. Couple that with a worldwide boom in economic activity. Business sentiment in Japan and Europe is at a 10-year high. Last month, manufacturing activity in the U.S. hit its highest level in 13 years. The Japanese stock market is absolutely on fire, and for the first time in decades, the Japanese economy is registering a positive GDP growth.
There is also a huge increase in the business activity within the emerging markets. China is the world’s largest consumer of raw materials such as oil, steel and copper. When they cannot produce enough in their own economy, they are increasingly buying these raw materials from emerging economies. The two-sided effect of this movement is that the emerging markets’ producers are stabilizing and China is receiving these items at a reduced price – both of which are good for the world’s economy.
This week, the Committee on Ways and Means gave us the first rough draft of the new tax bill. Believe it or not, I have actually read the bill. While there are things that I disagree with, there is absolutely no question in my mind that if passed, this will dramatically improve the economy in the U.S. by heavily cutting the corporate tax rate from 35% to 20% and by allowing repatriation of funds back to the United States at a preferred rate of 12%. This tax act could dramatically increase business activity and corporate profits in the U.S. I hope you encourage your elected officials to support this bill - and to those who think that this is just a giveaway to the rich and powerful corporations, feel free to call me to discuss further.
Therefore, we are seeing a double-headed stimulus going into 2018, with higher business activity and lower tax rates. Quite frankly, it does not get any better than that. So if corporate earnings were to go up by virtue of a better economy and by virtue of lower taxes, the price earnings ratio of the current stock market would fall rather than go higher as the market goes higher. Until I see some sort of evidence that the U.S. economy is falling into or is forecasted to be in recession, it is highly unlikely that I will change that opinion.
Every day I am confronted by clients who say the stock market needs to go down. When I ask them why they believe that they indicate, “That’s what it always does.” The last year that the S&P 500 was actually down for the year was in 2008. We are coming up on almost a decade of positive stock market performance. Markets do not go down just because they have been up for too long. This has already been the longest economic expansion in the history of the U.S. economy. Almost a full decade of economic expansion...There is no law, axiom or even conversation that will bring the stock markets down, only recession.
In fact, I am getting tired of explaining old Wall Street axioms that are no longer valid. Do you remember the famous quote, “Sell in May and go away”? This falls under the theory that nothing positive happens during the summertime and investors should sell all of their assets in May and not reinvest until the fall. As an example, if you had sold in May of this year and not reinvested until November 1st, you would have lost in excess of a seven-percentage point increase in the S&P 500. Still think it’s worth adhering to?
Often times I wonder why people say they will just wait until the market cracks to invest. Let me give you an example that should put that opinion to rest. Let’s assume that you made the absolute worst investment decision that you could ever possibly make and invested all of your earthly possessions in the Dow Jones industrial average in October of 1987. For point of reference, let’s say you did it the Friday preceding the stock market crash on Black Monday when the markets caved 22% in one day. If you had invested on that Friday, you would have been investing in the stock market when it was at a cool 2200. On Monday, the market went down 22%, creating economic chaos in the financial world. That same index today is 23,539. Assuming you heeded the advice of your financial advisor and stayed invested the entire time your investment would have gone up 10 times the original amount that you invested, notwithstanding the worst possible timing that you can imagine. If you wait for a downturn to invest excess cash, there is that likelihood that you will not get that opportunity for years to come.
In summary, it has been a remarkable year for the stock market through October 31, 2017. I fully anticipate that the markets will move higher, but it will likely be more volatile and less dramatic in the coming months. However, with an excellent U.S. economy and the world’s growth expanding, I fully anticipate higher markets for at least 18 months to come. What absolutely and completely baffles me is why so many investors are sitting in cash and earning zero when they could have earned high double-digit returns for this year. It is never too late to invest and you should do so now.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best Regards,
Joe Rollins
