Wednesday, July 3, 2019

The S&P 500 had its best June performance since 1955... The Dow posted its biggest June percentage gain since 1938 and financial advisers that are giving their clients such faulty advice.

From the Desk of Joe Rollins

It is amazing how quickly the financial markets turn. During the month of May 2019, the financial media tried emphatically to convince you in every way possible that the world as we know it could soon end. Surely, the financial markets would suffer with all of the negative headlines regarding tariffs, inverted bond yields, war in the Middle East and unfavorable relations with other countries. I vividly recall the huge downturn of the markets in May, when the President announced additional tariffs on China. So many financial advisers were spouting the notion that the inverted bond yield would clearly create a recession and stop the U.S. economy flat in its tracks. How did those proclamations work out?

As you can tell by the title of this posting, the financial markets had record results in June. In addition, the many assertions of financial disaster, made by so-called experts, were clearly proven incorrect. I want to go through a few of them and discuss how they were wrong. I also want to cover the extraordinarily bad advice being given by the large financial institutions. It absolutely blows me away that so many people out there are calling themselves financial advisers when, in actuality, they are only salesmen of a model portfolio that has absolutely nothing to do with one’s particular needs. I will cover that in greater detail later.

CiCi in camouflage on the beach

As always, I must cover the financial results for the month of June. It is not often that I get to cover such excellent financial results for a one-month period. In fact, the first half of the year has been extraordinary in its performance and the markets have reached all-time highs. If there is one thing that you as an investor should learn from the sell-off in 2018 and the rally in 2019, it is that you should never believe the people on the television proclaiming “Disaster looms ahead…” What you should believe in are the fundamentals of the market, not the headlines. As I pointed out at the end of the fourth quarter of 2018, and in the first quarter of 2019, the fundamentals were strong, the earnings were great and interest rates were low - all three of those economic factors will lead to higher markets eventually. No question there was volatility and no question that there were many questions raised by investors, but in the end fundamentals won.

The month of June was excellent among the indexes. The Standard and Poor’s Index of 500 stocks was up 7% for the month of June, up 18.5% so far for the year 2019, and up 10.4% for the one-year period. The Dow Jones Industrial Average was up 7.3% for the month of June, up 15.4% for the year 2019 and 12.2% for the one year ended June 30th, 2019. The NASDAQ Composite was up 7.5% for June, up 21.3% for the year 2019 and up 7.8% for the one-year period ended June 30th, 2019. The Barclays Aggregate Bond Index was up 1.2% for June, up 6% for the year and up 7.8% for the one-year period. As you can see, each and every one of the indexes was up very impressively for the month of June and also very impressively for the year to date.

I cannot believe the amount of ink that has been wasted on the inverted bond yield discussion. One thing that always baffles me is the use of graphs by those claiming to know something about stock markets. It is amazing how many people I see expressing their opinion on the direction of the markets by comparing it with a certain date and time in the past. For example, I noticed the other day a so-called graphing expert’s market forecast included the same time period in 1938, 1980 and 2019. Surely, this forecaster is not so naïve to underestimate the economic differences between the time periods quoted. 1938 was the tail end of the recession and the country was barely surviving. In 1980 interest rates topped 20% and the country was in a recession. In 2019, interest rates are extraordinarily low, the economy is strong and unemployment is at a 50-year low. Really, if you compare the three time periods, how can any comparison be valid that tries to chart the market? Each of those time periods would have huge differences in the underlying economy, but yet a comparison was made and an opinion expressed. I have to tell you I lost respect for the show that aired such an analyst, given the absurd nature of the assumptions.

Let me give you a more specific example. During the third quarter of 2018, the economy was great and the markets were soaring. At the point the interest rates became inverted, you heard every so-called expert expressing the opinion that within a 12 month to 2-year cycle, the U.S. economy would absolutely be in recession. I sat back when I heard these exclamations and marveled at the lack of support for these opinions. Yes, it is unusual when the federal funds rate is actually higher than a 10-year treasury rate, as it is today. As a predictor of U.S. recession, it is not so precise. In researching the accuracy of these market calls, I went back to actually review the data. Did you realize that the yield curve was inverted in the years 1995, 1998 and the year 2000? Once again, in each of those years the economy was strong and the markets were soaring. However, only in the year 2001 did a recession occur, which had more to do with the dot-com implosion and the terrorist attacks of 9/11. Therefore, even in current economic times this proclamation of a guaranteed recession is not supported by simple research.

Yes, we were truly honored to once again be named to the 300 Top Registered Investment Advisers in the United States by the Financial Times for 2018 and 2019. What gives me great comfort is that there are likely 300 advisors in the Atlanta area and we were picked as one of the top 300 in the United States. But I should not be so surprised at that recognition given the absolute lack of good advice so many advisers are giving. What I found after 40 years in the business is that advisers are oftentimes controlled by their biases for higher income. I see major financial firms filling our soon-to-be clients’ portfolios with these so-called partnership hedge funds and other alternative investments that pay high fees, but earn low returns. These investments make the tax returns very difficult to prepare and if they make money, I would look the other direction. The sheer thought of putting a client in an investment that would give the salesman a 10% commission yet underperform makes me nauseous. It is amazing that clients continue to buy these worthless alternative investments when normal financial investments provide much greater returns without the high commission.

The current trend in the major investment houses is to use salesmen that are barely trained in financial applications. Basically, they just sell a model portfolio that is developed for their clients. What is interesting is that most clients will never talk to the person investing their money. The actual model portfolio has nothing to do with the client and everything to do with making clients adapt to a fixed formula with absolutely no correlation to their financial history. We invest all of your money in this office.

As I have pointed out on many occasions, the financial textbooks all talk about a balanced portfolio between stocks and bonds. The unfortunate part of that financial example is that it was created at a time when interest rates were substantially higher. If you made an allocation to a treasury bond making 5%, well that certainly makes some sense. However, to allocate to a treasury bond today with a 2% coupon for the next 10 years borders on absurd. Basically, if you commit to that 10-year treasury, when inflation is virtually the same percentage, you will be lucky to get back the same inflation-impact dollars that you originally invested. There is no opportunity for growth and the income component is insignificant. Anyone would make that allocation today is clearly does not understand basic economics.

Ava and CiCi on canvas, painted by our client, artist Kim Daniel

We see a lot of clients who have been encouraged to invest in income investments, thus giving up the opportunity for higher returns in equities. Certainly, everyone needs diversification, but each person is totally different. Why would you ever make the same allocation to a person that has leveraged every asset they own and requires high income to service his debt, as compared to a person with no debt and no current need for the money? Most financial advisers would treat those people exactly equal. Basically, they would decide on the allocation of assets based upon their age, their income and their need for income during retirement. However, those people are entirely different and should never be allocated the same way.

As an investor you can see the benefit of these low interest rates. Even as the so-called experts were forecasting disaster with the inverted bond yield, if you really understood the effect of lower interest rates you saw the positive. Once again, homeowners can now refinance at below 4%. In fact, I have seen 7-year fixed and variable rates down close to 3%. Two things happen when interest rates get down this low. The new housing market will pick up due to the fact that more people can afford the mortgages and the refinancing market will accelerate, freeing up more money for homeowners to use for other consumer goods.

Think about all the opinions of impending financial disaster that were shared regarding the effect of tariffs. You may not even recall that in January of 2018, President Donald Trump announced a tariff of 20% to 25% on washing machines imported into the United States. I have written many articles regarding those opinions when they feared these tariffs would force young households to absorb what was sure to bring damaging higher prices.

It has been roughly 18 months since the imposition of these washing machine tariffs. Have you heard any negative financial information regarding these tariffs? In fact, the economic effect has actually been mainly positive. Over this 18-month period, the price of washing machines has gone up roughly 12%, not the 25% cost of tariffs. The washing machine manufacturers in the United States have also been able to increase their prices, stabilizing U.S. jobs, since they do not have to sell their products at a loss. In addition, the U.S. is believed to have collected over $100 million in tariffs from foreign manufacturers in producing these products. While there is no question that people buying new washing machines have to pay a higher price, the effect of helping employees in the United States that work with these products and raising additional taxes from foreign manufacturers seem to weigh in the positive rather than a negative. Once again, the proclamations of financial disaster in reality were never there.

During the month of June, the President announced that effective immediately the U.S. would levy tariffs on all goods coming out of Mexico into the United States. There was huge outrage and public exclamations by so-called experts that the United States could not survive without Mexican products or the workers who migrated from Mexico that do menial work in the states. In fact, it was such a contentious topic that the financial markets dropped just from the announcement.

Employee Lesley Bartlett's kids - Sasha (10), Vincent (9) and Lily (10)

Once again, by Monday of the following week, the tariffs had been suspended with a new working arrangement between the United States and Mexico regarding immigration. Just the virtual threat of tariffs did more to help the immigration policy of the United States through Mexico in 1 week, than what has been accomplished in 25 years. The exclamations of financial disaster regarding tariffs have to be balanced against the economic reality between the countries. In this particular case, while immigration is not an economic factor in itself, the end result will justify the threat. Last month I expressed the opinion that the media was making a bold attempt to otherwise convince the general public that the economy was in trouble. Oftentimes in bold headlines, opinions are expressed that have nothing whatsoever to do with reality. I expressed the fear that the many people who only read headlines and do not follow the facts could be led to believe negative economic news.

In June, with major headlines in virtually all publications, a survey by indicated that 40% of Americans believe that a recession is already here. When I read that headline, I could hardly believe this was not a joke. 40% of Americans would constitute over 125 million Americans who clearly must live under a rock. How could anyone who sees the prosperity around them truly believe the U.S. is in a recession? As one quote in the survey said, “the unemployment rate is the lowest in 50 years – doesn’t mean that everyone’s got a job, doesn’t mean that everyone’s doing great.” Yes, that is true, there are some people that are not employed. However, I rather suspect that is by their own desire and not for lack of jobs. Every industry I know is hammering for employees and even the fast food industry cannot employ quickly enough.

The next area of improper information for investors is the often-repeated exclamation that the economy is slowing. I get up very early and watch the international news from Europe, Asia and the United States. They bring on so-called experts in the field of investing and the one common expression that they all seem to use is that they are concerned about the stock market because the economy is slowing. Isn’t it interesting that they do not explain why that is a problem or explain exactly what that means? I will give you an opinion here that will convince you that we invest not by tired, old economic theories, but by the reality of the current economy. Yes, it is true that the economy is slowing, but that is a good thing.

Many times, in these postings I have criticized the work of former Federal Reserve Chairman, Dr. Alan Greenspan. I have indicated that for years he ran the economy up and down to the point of boom and bust, which was completely unnecessary. He would allow the economy to accelerate without any type of controls and then he would crash it by increasing interest rates and constricted liquidity. The fact that the current Federal Reserve is attempting to control the economy is much more positive than you might think. The Federal Reserve increased interest rates 3 times recently as the economy strengthened. When the economy slowed, the Federal Reserve announced that the most likely effect would be a lower interest rate in the upcoming quarters. That is exactly what the Federal Reserve should do, move interest rates up in an expanding economy and move them down when it slows. The effect is a leveling out of an economy that should not be “too hot or too cold.” This is completely different than what happened under the Greenspan economy. Let me illustrate that with real numbers.

Everybody remembers the rah-rah years of the late 1990’s. It was a time that the dot-com people were getting rich basically by selling paper on Wall Street. I remember many dot-com companies that had no revenue that were using their IPOS to raise billions in ’98 and ’99. Also, everyone remembers the dot-com skyrocketing in 1999 and crashing in 2000. Very few people understood exactly why this expansion and bust occurred. As we now know, Dr. Alan Greenspan was greatly afraid of what would happen in the Y2K conversion. As is well known, Dr. Greenspan never used computers, nor was he computer literate. Since he did not understand what would take place during Y2K, his primary assertion during the late 1990’s was that the economy must be strong in order to withstand the huge economic bust that would occur when the computers, clocks and everything we know about would not be updated on January 1st, 2000.

To give you an example of his lack of understanding the economy, the GDP in 1997 was 4.4%, inflation was 1.7% and unemployment was 4.7%. In 1998, the GDP was 4.5%, inflation was 1.6% and unemployment was 6%. In 1999, GDP was 4.8%, inflation was 2.7% and unemployment was 6%. Each of those numbers are extraordinarily good, but should illustrate that they are way too hot. The Federal Reserve did nothing to slow and temper the economy during these crazy financial times. In fact, GDP was above 4% for 4 straight years during these times and what do you think the Federal Reserve actually did?! Beginning in 1997, the Federal Funds rate was 5.5%. As compared to today, the Federal Funds rate is roughly 2.25%. During 1998 with the GDP growing at 4.5%, rates actually went down from 5.25 to 4.75%.

The Federal Reserve should have been proactive in an economy that clearly had become too strong. Yet, the Federal Reserve allowed it to do so, leading almost assuredly to a hard landing at some point. Not until June of 1999 did the Federal Reserve increase rates, and they did so very aggressively. On June 30th, 1999, the Federal Funds rate had been raised to 5% and less than one year later the Federal Funds rate was at 6.5%, increasing over 1.5% in less than one year.

Employee Shelley Fietsam's son, Cameron (11)

As you would expect, when the Federal Reserve increased rates so dramatically over such a short period of time, the economy took a severe downturn. The NASDAQ Composite suffered a 75% decline from March of 2000 to the end of 2002. In fact, the GDP in 2001 fell from 4.1% in 2000 to 1% in 2001, which was also attributable to the 9/11 attacks. Recall that I indicated the Federal Funds rate at March 16th, 2000 was 6.5%. At the end of 2001, 18 months later, that same rate was at 1.75%. I could go back and give you all of the reasons why these interest rates jumped around and the effect on the economy. But the one thing that we need to understand is that the Federal Reserve was asleep at the wheel. They should have been increasing interest rates during 1997, 1998 and 1999 to smooth out the economy and reduce the volatility in the economy. Certainly, the recession in 2001 was wholly created by the Federal Reserve and the absolute avalanche of rate cuts in 2001 were to cover their footprints.

I gave you a long economic history to explain why the current fact that the economy is slowing is positive for stocks. It is clear that the Federal Reserve intended to slow the economy in 2018 and they were successful in doing so. It also is clear that the Federal Reserve intends to stimulate the economy later this year to keep the economy strong. All of these are extraordinarily positive signs for future stock prices. Unlike the proclamations by the so-called experts, a level economy is what we all desire. We desire a GDP of roughly 2%, an inflation rate of roughly 2% and unemployment of roughly 4%. The fact that we have been operating at those levels for several years now is extraordinarily positive.

As we sit here today, we certainly expect volatility for the rest of the year. It is crystal clear that the media will attempt to convince you that the economy is weak. We now know that their attempts are based on incorrect, incomplete information. The economy is not weak, but yet strong. If the Federal Reserve does their job over the next 6 months, there should not be a recession over the next 2 years. It also is clear that corporate America is focused on higher earnings and is using the worldwide economy to improve their financial outlooks. I have been saying for a long time that the reason the market continues to go up is that interest rates are low, the economy is strong and earnings are high. As we sit here in July 2019, those particular items are actually better today than they were 6 months ago and therefore I project that the market will zigzag its way higher and round out the year 2019.

There is no question that a sitting President has a great effect on an economy. A President can do many things to stimulate an economy leading into an election. There is also no question that this President desires for the economy to be stronger as he campaigns for lower interest rates from the Federal Reserve. Since it is inevitable that this President would like to be reelected in 2020, there is a high likelihood of the economy continuing to expand over the next 18 months. Those that are espousing a recession in the United States either are expressing an opinion without any type of economic background or clearly have political biases in their exclamations. One of the things we try to do here is give you facts, not headlines. The facts do not support any type of recession, which likely moves the market higher rather than lower without a geopolitical event occurring. You can not invest for geopolitical events; you can only invest for the financial fundamentals.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Monday, July 1, 2019

Happy 4th of July!

In observance of Independence Day, the offices of Rollins Financial and Rollins & Van Lear will be closed on Thursday, July 4th and Friday, July 5th. We will re-open for business on Monday, July 8th at 8:30 a.m.

If you have any pressing matters that require immediate attention on Thursday or Friday, please do not hesitate to contact any of our staff.

Please be safe, and enjoy the holiday! 

Best Regards,
Rollins Financial, Inc.

Thursday, June 27, 2019

Rollins Financial Garners Another National Recognition

From the Desk of Joe Rollins

Since 1990, we have always strived to set ourselves apart from the plethora of financial advisers located here in Atlanta and around the United States. We recognize that every individual is unique, from their financial situation to their future goals, but we believe EVERYONE deserves a financial adviser who puts the needs of their clients first. As a fiduciary, that is exactly what we are required to do, but frankly, we really enjoy helping people and would do so anyway.

When I started my CPA practice out of my living room in Fairburn, Georgia in 1980, I would have never dared to dream of receiving national recognition for my company. Now, 40 years later, we are both excited and honored to announce that we have, once again, been named to the Financial Times 300 Top Registered Investment Advisers* – making the list in both 2018 and 2019. “The list recognizes top independent RIA firms from across the U.S. This is the sixth annual FT 300 list, produced independently by the Financial Times in collaboration with Ignites Research, a subsidiary of the FT that provides business intelligence on the asset management industry.”

The Financial Times 300 Top Registered Investment Advisers is an independent listing produced annually by the Financial Times (June 2019). The FT 300 is based on data gathered from RIA firms, regulatory disclosures, and the FT’s research.

The listing reflected each practice’s performance in six primary areas:
- Assets Under Management (AUM)
- AUM Growth Rate
- Years in Existence
- Advanced Industry Credentials of the Firm’s Advisers
- Online Accessibility
- Compliance Records

The final FT 300 represents an impressive cohort of elite RIA firms, as the “average” practice in this year’s list has been in existence for over 22 years and manages $4.6 billion in assets. The FT 300 Top RIAs hail from 37 states.

We believe that you can overcome an abundance of weaknesses in many areas by simply being committed to hard work. But, in my opinion, the extent of our success would not be attainable through hard work alone – that hard work must be accompanied by the ability to successfully manage clients’ money. My staff works diligently for many hours a week, and even on the weekends during tax season, to try to achieve such results for our clients. All of my partners, Robby Schultz and Eddie Wilcox of Rollins Financial and Danielle Van Lear of Rollins & Van Lear, have been at the firm in excess of 15 years, and provide our clients with the knowledgeable and dedicated service they have come to expect.

From left to right: Danielle Van Lear, Robby Schultz, Joe Rollins and Eddie Wilcox

Over the last several years, we have received the following recognitions:

• Atlanta Magazine FIVE STAR Wealth managers, 2009-2018
• #20 on CNBC’s List of Top 100 Fee-Only Wealth Management Firms in the U.S., 2015
• Accounting Today Top 150 CPA Firms by AUM, 2017
• Financial Times 300 Top Financial Advisers, 2018
• Accounting Today Top 150 CPA Firms by AUM, 2018
• Financial Times 300 Top Financial Advisers, 2019
• Accounting Today Top 150 CPA Firms by AUM, 2019
• AdvisoryHQ’s 11 Best Financial Advisors & Planners in Atlanta, GA, 2019

When we received the award from CNBC based on assets at December 31, 2014, we managed roughly $274 million. Today, our assets under management total nearly $600 million; therefore, in the last four years we have more than doubled the size of our firm. And the fact that we continue to receive national recognition is completely attributable to the hard work of my staff and loyal clients like all of you.

We thank you for your trust and look forward to growing with you for many years to come.

* This award does not evaluate the quality of services provided to clients and is not indicative of the practice’s future performance. Neither the RIA firms nor their employees pay a fee to The Financial Times in exchange for inclusion in the FT 300.

Best Regards,
Joe Rollins

Wednesday, June 5, 2019

Why is the media trying to scare you regarding tariffs? Is it the truth, or fake news? Tariffs will not destroy the economy, neither in the United States nor in China.

From the Desk of Joe Rollins

It seems like every time I turn on the TV the financial news reporters are hyperventilating over tariffs. I, on the other hand, have never quite grasped the urgency of the matter. From a philosophical standpoint, there is absolutely no question that a properly trained economist would not want any type of tariffs on any type of goods being transferred between countries. However, in order for trade to be on a fair and equal basis, it must be in a totally free economy, where governments do not control companies and competition. Unfortunately, that is not the case for China.

There is no question that trading with China has needed reformed for decades. Their capital structure, which owns or controls many industries in China, attempts to compete with U.S. based companies that are not controlled by the government. The end result of that competition is that while the consumer benefits from lower prices, it is detrimental to the U.S. economy in that it transfers goods formerly manufactured in the United States over to China, with the corresponding loss of U.S. jobs. If they were competing on a fair basis, there is no question that the consumer would benefit from the economic windfall; however, for the consumer to win, but the country to lose, is a complete misnomer and not good for the United States.

The media’s overreaction to this tariff matter is almost mindboggling. I often fear that investors get all of their financial information from just reading the headlines or on social media. Too many investors do not bother to do their own research to determine whether the severity of this situation warrants the incredible volatility that the stock market has suffered through this year. But before I go into more significant details regarding the incredibly negative headlines, I just want to give you one fact.

According to Deutsche Bank, there has been roughly $5 trillion in losses within the equity markets due to the perceived issue regarding tariffs. Just as a basis for comparison, Deutsche Bank points out that this $5 trillion loss equals 12 full years of the bilateral merchandise trade deficit with China. Therefore, in a period of less than 6 months, we have suffered losses in our own equity markets greater than the import export deficit over the last 12 years. If you really want to talk about an overshoot or a lack of understanding of economics, there it is in black and white.

Ava feeding geese in Ohio

Ava on her 8th birthday

Before I launch into more interesting topics, I do have to cover the financial markets for the month of May. Clearly it was a down month in every respect, but the year-to-date numbers are still quite impressive.

There is no other explanation for the economic performance during the month of May other than it was pretty crappy. The Standard and Poor’s Index of 500 stocks was down a cool -6.4% for the month, but continues to be up 10.7% for the year 2019. For the one-year period it is up 3.8%, the 3-year period it is up 11.7 % and the 5-year period 9.7% annualized. The Dow Jones Industrial Average was down -6.3% for the month of May, but it is still up 7.5% for 2019. The one-year returns are 4.1%, three-year 14.4% and five-year 10.9% annualized. The NASDAQ Composite was the big loser of the month as it was down -7.8%, but yet it is up 12.8% for the year 2019. The one-year returns are 1.2%, three-year 15.9% and five-year 13.2%.

As you would suspect, when the equities are down the bonds will be up. The Barclays Aggregate Bond Index was up 1.8% for the month of May 2019, 4.8% for the year 2019, 6.7% for the one-year return, with the three-year up 2.5% and the five-year 2.7% annualized. Even though the one-month numbers were pretty ugly, the year-to-date numbers for 2019 are still quite respectable. As I will explain later, I expect better returns as the year 2019 progresses.

Often times, I feel like the hysteria that you see in the media must be political rather than informative. How could respected journalists actually misinterpret the information and inform the public so poorly that it could be anything other than intentional. It has gotten to the point where the facts are completely drowned out by the noise. Let us take the recent proposed increase in tariffs between the United States and Mexico, for example. You would have thought that an economic disaster was imminent given the reaction in the media. But wait a minute, did you even bother to look at the facts or did you actually sell before you understood?

I am reminded of the recent quote by Warrant Buffet’s 95 year old right-hand man, Charlie Munger, who has demonstrated economic prowess for the majority of his life. While Charlie has openly supported Democrats over the years, he recently expressed that “Donald Trump is right on (immigration).” At the shareholders meeting at the Berkshire Hathaway company, he exclaimed “Democrats are committing suicide…they hate him (Donald Trump) so much that they’re against him even when he’s right. We should have way more control over our borders than we do.”

So, the proposed tariff increase in Mexico was basically a call for help in the immigration disaster that is occurring along the southern borders. This weekend it was announced that over 900 immigrants were crammed into a border control center that was designed for 125 people in El Paso, Texas. There is a bona fide disaster occurring along the borders of the southern United States, but you rarely read about it in the press.

I sit at home sometimes and contemplate what exactly Congress is talking about when it comes to immigration. Surely no one in their right mind wants unlimited immigration into this country, or do they? Does anyone understand the economic effects of trying to take care of all these immigrants during the short-term and then supporting them over the long-term? Do we not have laws on immigration?

These immigrants come to this country with virtually nothing. The U.S. government supports them in every form and fashion after their detention. The cost of supporting them is astronomical and we, the taxpayers, pay every dollar of it. And yet, the elected officials in Congress cannot have a reasonable discussion on the subject since it has become so politicized. Surely, they want to protect our borders.

Notwithstanding the political ramifications of such a move, did you even bother to consider the economic aspects of this transaction? Even though the 5% proposed tariff has not occurred, our financial markets sold off with immediate haste. Did you even realize that the peso declined by 2.7% on Friday? So in just one day, the cost of the 5% proposed tariffs was already reduced by half.

It is also true that there is a high likelihood that these tariffs will never be put in place. It would not be a huge commitment for the Mexican government to make an attempt to regulate the borders, which would postpone such tariffs. They do almost nothing now. But assuming the absolute worst situation, the full tariffs imposed in the automobile industry, according to Deutsche Bank, would be $93 billion. If the auto industry was responsible for the full absorption of this cost and passed this along to the consumer, this would increase the cost of a vehicle by $1,300 per unit sold. Ponder the economic reality of those numbers.

First off, most people do not buy a new car every year. In fact, now the average age of a car in the United States is roughly 9 years old. So the effect of the purchase of new cars would only affect relatively few Americans. I believe that if it costs $1,300 per car to attempt to bring the border matter under control, then that seems like a cost that each and every American should be willing and happy to absorb. I am not sure exactly what it costs to house, feed and provide medical care to the flood of immigrants that are coming across the southern United States border, but I would bet that the $93 billion referenced above would be close.

Let us move on to the Chinese tariffs, where the information is so misleading that I rather suspect that most people do not grasp the economic effect of these proposed tariffs. Let us look at the real numbers as compared to those quoted in the financial press. The only numbers you should evaluate when comparing the U.S. against the China’s economy is nominal GDP. For 2019 the U.S. nominal GDP is projected to be $21.3 trillion, with China’s projected to be $14.2 trillion. So in true economic terms, the U.S. nominal GDP is approximately 50% higher than the Chinese nominal GDP as of 2018.

Josh skydiving for his birthday

What are the true numbers regarding imports and exports from China? During 2018 the United States imported from China roughly $539 million. Correspondingly, the U.S. exported to China $120.3 billion in 2018. The financial media argues there would be an enormous financial effect on the U.S. taxpayer if China no longer imported goods from the United States. Article after article has been about the farmers’ financial disaster because of the lack of exports to China if tariffs are imposed. Farm crops exported to China in 2018 were $5.9 billion. You may have read most recently where the President provided a subsidy of $15 billion to U.S. farmers affected by the lack of exports to China – this amount is 3 times the actual dollars exported to China. More fake news.

What real effect do China tariffs have on the U.S. consumer? Do you realize that if we were to exclude 100% of the exports of China, the effect on the U.S. GDP would be less than ½ of 1%? Why are we so paralyzed by the potential of losing such a small amount of goods?

Let us also evaluate the other side of the transaction. What would happen if 100% of the proposed 25% tariffs were also imposed on all of the goods coming from China to the United States? According to Oxford Economics, the full cost of that tariff would be $62 billion per year on the goods already proposed for the 25% increase. Now listen to the economic effect of this carefully. Based on Oxford Economics, the total out of pocket cost for this increase in tariffs of 25% would only be $490 per household. Based on the media, you would think that this number would be crippling to the U.S. economy. While $490 is a lot of money to some people, to most Americans it is insignificant. I think if the public totally understood the financial implications of getting our arrangements straight with China, they would gladly support this cost (which barely equals double their Netflix monthly subscription fee on an annualized basis).

So, here we are evaluating both sides of the tariff arrangement with China. We recognize that our exports to China are relatively immaterial to the U.S. economy, and that the cost of the tariffs on imports from China is totally immaterial to the average U.S. household. But what else are we not evaluating that should be considered?

During the month of May, the stock of Apple went down 20% because of the perceived problems with the Chinese tariff matter. I recognize the fact that journalists might not be the smartest business people in the world, but surely you must realize that the most profitable company in the world has long since contemplated this issue. Do you really think that Apple has not looked for other means of handling their goods coming out of China? Do you not think that they have adjusted their supply lines from China to Vietnam, India and other Southeast Asia countries? Do you think that the most profitable company in the world is not smarter than the financial analysts that write the headlines?

You may rest assured that Apple, along with most all U.S. companies manufacturing in China, have already evaluated moving their production out of China to a part of the world much more efficient. The longer China holds out to making a deal with the U.S., the more manufacturing that will escape that country and move to more U.S. friendly countries. Yes, it is possible that China could prevent all U.S. imports from occurring and they could also punish U.S. companies that function in China, but it would be to their own detriment.

China is in a situation where they need us a lot more than we need them. Certainly, they could punish U.S. companies operating in China, but that means that Chinese citizens would lose their jobs. If manufacturing and supply lines moved out of China, then who would replace those jobs, and at what cost? The Communist party has been able to control the government in China over the last 30 years for one simple reason. As long as the people are working and they are able to move from the fields to the cities in China, they are happy with the nondemocratic government. But China realizes that they cannot risk putting citizens out of work. That risk would be overwhelmingly negative for their non-representative government. It is my opinion that China will do everything to prevent that from occurring and certainly they will not punish U.S. manufacturers in China if it means higher unemployment for the average Chinese citizen.

I was reading an article the other day in USA Today that made me wonder whether the journalist writing the article did any research whatsoever to base the story upon. Basically, his assumption was that China will get really irritated with the U.S. over this trade matter and “invoke its nuclear option”. No, not nuclear in the way of a military bomb but economically, by selling 100% of the U.S. treasury’s bonds held by the Chinese government. While this article may have been written to scare the average investor, it is certainly not based on any type of economic reality.

First off, it is believed that the Chinese government directly holds over $1 trillion in U.S. Treasury bonds. As a point of fact, there are not enough bonds issued by all of the governments in the world that would be a substitution for these Treasury bonds. For example, if the Chinese government attempted to sell all of these bonds immediately, who would be the buyer? Clearly, a wholesale rush to sell these bonds would lead to much higher returns and losses on these bonds leaving the Chinese with absolutely nowhere to invest the money since there are not enough bonds issued by any government in the world to replace the U.S. $1 trillion.

The principal reason why the Chinese government could never sell the bonds is more basic. If they sold the bonds that would mean that they would be selling their U.S. dollars and converting that money back to their local currency. The effect of that transaction would be to absolutely destroy the valuation of their currency in the world market. When you convert from U.S. dollars to local currency, you dramatically decrease the value of the dollar against your local currency. This would be devastating to the exports from their country, therefore lowering the value of their currency in all worldwide transactions. Certainly not a smart move by the Chinese government even if they just want to inflict pain on the U.S. government. I do not think the Chinese are so dumb that they would make any moves that would be detrimental to their own currency.

This week they once again rolled out the assumption that the yield curve inversion between the 3-month Treasury bills and the10-year notes would certainly mean a recession in the United States. The same people who wrote the article in 2018 were writing it again - that it was a 100% indicator that the economy will fall into a recession when short-term yields are higher than long-term. If you want an example of how silly interest rates have become, consider the facts. At the current time the 5-year Treasury is earning less than a money market account in America. What sane person on Earth would take a 5-year risk on a bond when you could make exactly the same rate of return or even higher on a money market account? Secondly, the dividend rate for the S & P 500 is now greater than the interest rate on the 10-year Treasury. Would you prefer to invest in something that has growth potential or would you rather take a 10-year risk that interest rates will not go up over the next decade? Once again, not a reasonable comparison to the informed investor.

Yet, here we are again. The same people who have forecasted a financial disaster in the fall of 2018 are back again making the same prediction. Do you want to know when the last time that the inversion of interest rates created a market sell-off, followed by forecasts that the U.S. economy would soon be in a recession? That was in September 2018. The so-called experts projected recession would clearly follow and the markets would fall. While it was true that the market fell in the last quarter of 2018, the economy today is as strong as then and clearly shows no signs of decline. No recession in sight. Fake news.

The reason why the 10-year Treasury rate is so low has everything to do with competing interest rates around the world. As of the date of this writing, a 10-year Treasury has a current rate of 2.133%. While that rate is extraordinarily low, by worldwide comparisons it is an extraordinarily high rate. The 10-year bond in Germany has a current yield of -0.207%, in Japan their 10-year Treasury has a current rate of -0.102% and no, that is not a mistake. Those rates are actually negative in both Germany and Japan. Basically, if you buy a 10-year Treasury in either Germany or Japan, at the end of the 10-year period they will give you back less money than you actually invested. Now that is a good deal?

Ava fishing in Florida.  After this
picture was taken, I showed her how
to cast and the rod slipped, fell into
the water and sank.  I prefer to buy my
fish at the market anyway.

What reasonable investor would make the decision to buy these bonds when they can buy a similar bond in the United States with better credit, yielding 2.133% or higher. The belief now is that there are roughly $10 trillion in government bonds around the world that are yielding negative rates of return. Germany is fighting a potential recession and they are encouraging people not to save money, but rather invest it in the economy. The same has been true for Japan for roughly 20 years as their economy basically sits at breakeven. Therefore, there is a flood of money from the rest of the world investing in U.S. Treasury rates that, while incredibly low, are still the highest in the world at the current time with the very best credit list.

So, to use the words of my nemesis, Dr. Alan Greenspan, when asked why long-term interest rates would not go up, “it’s a conundrum.” You would think by reading the financial headlines that the U.S. economy is a conundrum and therefore susceptible to huge risks. In fact, nothing could be further from the truth.

Low interest rates are extraordinarily favorable to stocks, which we have at the current time. At the beginning of this year, it was estimated that the U.S. S&P 500 companies would earn $171.10 per share during 2018. Since that time, it is now estimated that the S&P 500 earnings for 2019 will now be $175 per share. More importantly, it is projected that S&P 500 earnings in 2020 will be $187, going up 7.5% year over year. Do you recall reading that there would be a huge reduction in corporate earnings this year due to the tariffs and the potential recession? Completely false – fake news.

It is amazing to me that people write headlines, but that they do not check the facts. Let us assume that we only use $175 estimated earnings for 2019 and put a 17 multiple on those earnings; we would expect that the year-end numbers for the S&P 500 would be 2,975. As I write this posting the current valuation of the S&P 500 is 2,752, which would imply an 8.1% gain in that index before the end of the year.

So back to my original thesis as to what is going on in the equity markets. I think, for reasons that are unclear, the media is trying to scare the average investor from their position so that the professionals can take advantage of the upswing in the market that is surely to come. I have no idea what their motivation is to write such negative articles other than maybe they do not have anything else to write about since things are so good. If you evaluate the U.S. economy based on its full employment, extraordinarily low interest rates, and great earnings that are increasing as the year progresses, a higher stock market is almost surely at hand. Notwithstanding there will be high volatility based on headlines, this too will soon pass. While the economy is slower than it was earlier this year, it is still extraordinarily strong.

You should never invest your money based upon current headlines or an analyst’s interpretation of the facts. You should independently evaluate facts and make a determination as to their validity. As of today, nothing has changed. While the volatility is upsetting and it clearly affects your portfolio, the only thing that would create a permanent long-term reduction of the value of your investments would be an oncoming recession. As of today, clearly there is no evidence of such a downturn coming this year.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Friday, May 24, 2019

If You Want To Thank A Soldier, Be The Kind Of American Worth Fighting For. - Unknown

In observance of Memorial Day, Rollins Financial and Rollins & Van Lear will be closed on Monday, May 27th. Please note that all major U.S. stock exchanges and banks will also be closed in honor of those who died while serving our country.

Our office will reopen on Tuesday, May 28th at 8:30 a.m. If you need immediate assistance on Monday, please do not hesitate to contact our staff via email.

Take time to celebrate, honor, remember, and have a safe and wonderful weekend!

Best Regards,
Rollins Financial

Tuesday, May 7, 2019

Why do we fear prosperity? Understanding the wealth effect.

From the Desk of Joe Rollins

This has been a very unusual and exciting month in the financial markets. We have received unbelievably overwhelming positive economic news, yet for some reason we seem to be ashamed of our own prosperity. There are many things I want to talk about in this posting, but recently I have been scratching my head, trying to understand why the general consensus in the media is that we should be ashamed of this country’s success. The purpose of this post is to examine that concept and try to understand where it generates from. When we went through the fourth quarter of 2018, the same financial experts were predicting a recession in the U.S. in 2019. They also assumed that a political quagmire and overly aggressive Federal Reserve would destroy the U.S. economy in 2019. And surely the bull market that has been ongoing since 2008 would collapse and burn as the final coup de grace. Well, I guess I am here to tell you that those guys were wrong.

All over the news are so called self-styled socialists who believe that income equality should be the true goal of the American economy. Poor people should be compensated like rich people. The rich should share their wealth with the poor. The people who work hard or are better educated should share their wealth with the people that do not work as hard and who are not as well prepared. When you compare those two statements, I am a little bewildered how the logic fits from an economic standpoint. There is no question that everybody would like to stamp out poverty in America, but just exactly how do you do that? Do you do that by giving them money, retraining them for jobs or by just taking money from the rich and giving it to the poor for no good reason. I would like to review those subjects as we progress along.

Partners Robby Schultz and Danielle Van Lear's children, Caroline and Reid

As always, I would first like to cover the most recent month and the performance of the financial markets. The month of April was truly an extraordinarily good month from a financial standpoint. Even though the news was full of political gyrations related to the current President, the financial markets ignored all of that and turned in a sterling performance. The year-to-date performance of all of the major market indexes have been nothing short of breathtaking.

For the month of April, the Standard and Poor’s Index of 500 stocks was up very nicely at 4%. For the year 2019, that index was up 18.2% and over the last ten years that index has averaged an increase of 15.3%. The Dow Jones Industrial Average was up 2.7% in April, 14.8% for the year 2019 and over ten years it has averaged a gain of 15.4%. Once again, the one-year return was double digits for both indexes.

The NASDAQ Composite once again led the major market indexes as it was up 4.8% in April and for 2019 is up 22.4%. Over the past ten years, that index has averaged an annual return of 18.1%. In comparison, the Barclays Aggregate Bond Index was exactly flat in April and is up 2.9% for the year 2019, while only averaging 3.6% over the past ten years. I do not need to spend a lot of time emphasizing the glaring difference between the returns in the indexes and the bond index. All three of the major market indexes have averaged an annual return over the last ten-years of greater than 15%, while the bond index has averaged 3.6%. I continue to read the advice given to seniors just entering into retirement, stating that your portfolio should have a percentage equal to your age in bonds. In my honest and now well-documented professional career, that type of blanket advice borders on negligence. Such advice has led to overly conservative portfolios which almost assuredly will underperform the indexes in the next decade.

A client called me recently, frantic that the national debt would continue to grow at this seemingly accelerated rate and undoubtedly lead to financial chaos in the future. I responded that I was not terribly concerned about the growth in national debt as long as GDP continues to grow, and that the national debt is less than one times GDP in any given year. I pointed out that Japan’s national debt is roughly two times the GDP and has been that way for close to 35 years. There is no question that this level has slowed their economy, creating a subdued GDP in the intervening period, but it has never led to the complete destruction of the Japanese economy. Slowed down? Yes. Led to destruction? No.

I indicated to him that over the last decade GDP has basically doubled, and that as long as GDP was growing I did not share his concern. The President basically said the same recently, when he exclaimed that if we could continue to accelerate the growth in GDP, a lot of positive things would occur in the economy. By the very definition, income tax dollars paid to the Treasury would have to go up. With these extra dollars, the government could complete its long-awaited capital projects such as, roads, bridges and dams. Correspondingly, the money spent by the government on these projects would further increase GDP, coming full circle as these tax dollars go back to employees. He was exactly right on this subject.

Ava at her ballet recital

After we hung up, I went back to actually look at the numbers and make sure that I did not misquote and provide this client with inaccurate information. The GDP in 2009 was $14.418 trillion. In 2008 GDP was $20.495 trillion. GDP for 2019 is expected to come in somewhere in the neighborhood of $23 trillion. Okay, so perhaps I did misquote. From 2009 to 2019, GDP only went up from $14.418 trillion to roughly $23 trillion. So that is only a 60% increase, not 100%. But there is much more positive information in that analysis than meets the eye. In 2009, the unemployment in America was 9.3%. In 2019, unemployment in America is 3.6%. In 2009, even after one of the worst recessions in recent time inflation was at or near the same level it is today.

So basically, the country has increased its GDP by 60%, while its unemployment has dropped dramatically and the inflation rate continues to be at virtually the same level. I guess you would have to say that with that strong backing of economic performance over the last decade you certainly would have to be encouraged about the future, and you certainly should not be concerned that the growing national debt will endanger the economy.

I often mention in these postings that the most important component of a strong economy is the number of people working. It is believed that 70% of the current GDP is controlled by consumer spending. It should be self-evident, even to the uninformed, that if you have more people working, you have more people consuming. For every person that has a job, there is a downflow of money that creates GDP. They buy food at the local market, feed and clothe their children and spend money on consumer goods. The more people that are working, the better it is for the economy.

Last Friday we received the news that the unemployment for the month of April was 3.6%. It is hard to believe, but that is the lowest unemployment for our economy in almost 50 years. Clearly, more people are working now than ever over the last half of a century. How could you not be encouraged by this strong economic information?

So, you might assume that with the economy growing 3.2% in the first quarter and unemployment being 3.6%, that there would be, almost by definition, a shortage of labor to fill jobs. As a general consensus, it is always assumed when there is a shortage of labor employers bid up the cost of labor creating inflation, which would correspondingly mean a higher interest rate by the Federal Reserve, and almost assuredly a slowdown in the future. Once again, the people who wrote the textbook do not understand the economy in 2019.

For the first quarter of 2019, productivity actually increased at a rate of 3.6%; the highest increase in productivity since 2010. If you look at the time period from World War II to 2018, which included both expansions and recessions, productivity rose at an annual rate of 2.1%. Even in the previous economic cycle for 2000-2007, productivity rose at an annual rate of 2.7%. While we are seeing the computerization of many jobs in America, these computers are not replacing people. With computers, manufacturers are now able to increase productivity and therefore get more work out of the same number of employees.

The fact that productivity went up in the first quarter is particularly surprising given that first quarters are historically slow. Weather and other conditions typically slow down productivity, but this was basically a gangbuster quarter. This is a very important trend in the future of U.S. GDP. In order for GDP to grow, you must have productivity gains. The same people must produce more or the GDP will falter. This increase in productivity in the first quarter of 2019 should be very reassuring for those skeptics that believe the economy must fail just because it has had a 10-year positive run.

As we finished 2018, the forecasters were assuming that the economy would clearly be in a recession in 2019 and GDP would falter. I guess those forecasters were also wrong when the Federal Reserve reported an extremely robust 3.2% increase in first quarter GDP, which was up sharply from the 2.2% in the fourth quarter of 2018. How could so-called “expert” economists be so very wrong about the economy? Certainly, if you look at all of the geo-political events, you could see trouble for the economy ahead. However, the one statistic that you really need to evaluate is how many people are actually working, since that is where the GDP benefits the most. With the highest level of employees working during the last 50 years, it is unlikely that the GDP could fall into recession without a major reduction in those working Americans.

For reasons unclear to me, people seem to be ashamed of the prosperity that Americans have enjoyed over the last decade. In 2008, the average GDP per American was $48,302. By the end of 2018, that number had risen to $62,606 - a fairly substantial positive move given the number of people. I always question when the general public is addressed by the media with the misplaced notion that we should be ashamed of this prosperity. I guess I cannot clearly understand their skepticism. If you have worked hard and you do a good job, why should you not be well compensated? That is what is happening in America today. Due to the hard work, better education or just luck of the draw, employees are earning more than ever and are benefitting from their success.

There is this ongoing discussion that the wealthy should subsidize the poor for the betterment of America in general. I do not concur with those assessments. I could not help but be mindful of the quotes yesterday at Berkshire Hathaway’s annual meeting. When Warrant Buffett was asked if he was concerned that socialism would overtake America, he replied, “I don’t think the country will go into Socialism in 2020, or 2040, or 2060.” His vice chairman, Charlie Munger, added “I think we’re all in favor of some kind of government social safety net in a country as prosperous as ours. What a lot of us don’t like is the vast stupidity with which parts of that social safety net are managed by the government.” Truer words have rarely been spoken.

So basically, in an “income equality” society you would take the money from the rich in the form of higher taxes and turn it over to the government to reallocate based on their assessment of who should benefit. However, we have already seen, as mentioned by Munger, the vast stupidity of which the government allocates resources. Why anyone would actually propose or assert that the government will do a better job in the future than they do now is certainly naïve by any definition.

Caroline and Reid enjoying another beach day

A much better way to stimulate the economy is to do so without government intervention. The government has proven repeatedly its inability to administer social programs with any level of efficiency. However, a reallocation of wealth is actually occurring in the U.S. today. I have written on the subject of the wealth effect many times in these pages, but we see it virtually every day. We see clients that have enjoyed a run-up of 328% in the equity markets since the S&P 500 bottom in 2009. Every day, we see clients that are taking money out of their investments and using it to stimulate the economy. Maybe they buy a new car, fix their house, or educate their children…If the markets had not run-up so dramatically, then it is very likely that they would not have taken their money out of the markets and spent it in the economy.

You need to understand exactly what happens when the wealth effect is in operation. First, it is very likely that the investor creates income taxes by virtue of selling investments. These income taxes go into the government and help to fund future operations. The investor spends that money at the local car dealership creating sales for that dealership and correspondingly more employees are paid and those wages typically go up. So once again the wealth effect creates a tremendous positive attribute for the American economy. An investor takes a little profit off the table, creates income taxes and creates jobs. Does anyone really think that we could have realistically gotten the unemployment in the U.S. down to 3.6% if the wealth effect had not positively impacted the economy over the last decade?

And here we are now, being assaulted daily by the assumption that the bull market that started in 2009 must end for no particularly good reason other than “it always has.” As explained here before, bull markets do not just die of old age, there is always a reason. The reason more often than not is that the economy slips into a recession, and the stock market correspondingly goes down in sympathy to the recession. But also, the basis for which those forecasts are made should also be called into question. Forecasters were predicting a recession in 2019, which clearly looks like they were in error.

They also asserted that corporate earnings would be down in the first quarter at least 4%. As the vast majority of the companies making up the 500 indexes have now reported, those earnings appear to be fractionally higher than even last quarter’s robust earnings. I reflect back on the forecasters who said the S&P was very expensive at the end of 2016. The market could not go up in the intervening years because the indexes were overvalued. Just for the record, the S&P 500 index is up 36% since the end of 2016. So once again, do not believe everything that you read, unless it is contained herein.

One of the most respected corporate executives in all of America is Chairman and CEO of JPMorgan Chase, Jamie Dimon. He echoed my sentiments when he stated that just because things are good, doesn’t mean they have to go bad. Just recently while discussing if there has to be a recession , he said, “If you look at the American economy, the consumer is in good shape, the balance sheets are in good shape, people are going back to the workforce, companies have plenty of capital…business confidence and consumer confidence are both high… So it could easily go on for years. There’s no law that says it has to stop.”

I sure wish he would quit quoting me without due reference. He is so accurately correct though. There is absolutely no reason why economic expansion could not occur and there is clearly no reason why it must go down. As I pointed out in my last posting, I went through the volatile years of the Greenspan years at the Federal Reserve. By his own admission he would take the economy from boom to bust and vice versa for no good reason. Since 2006, the Federal Reserve has been controlled by much more educated and well-respected leadership. The best solution for everyone would be an economy that is not too strong and not too low, just right. The so-called “goldilocks” economy that we have today. If the Federal Reserve does its job, and it adheres to this double mandate of controlled inflation and full employment, this economy could continue to expand for many years to come. Today, it is hard to fathom that any type of recession could enter into the United States prior to the election in 2020.

Ava and her nameless bunny

I am often approached by potential investors for my opinion on Washington. Yes, I understand it is troublesome and that the nightly news is full of horror stories of political misdeeds, but you are missing the most important point to be learned from these political shenanigans. When Congress is completely concentrated on the irrelevant, as they are today, they are not passing laws that would be destructive to the economy. Since 2016, the current administration has rolled back regulations that were no longer needed in the economy. This has loosened up business expansion and improved the economy for everyone. If Congress remains as dysfunctional as it is today, they can never pass new laws that would add this form of legislative burden to society. I cheer them on in their incompetence.

Let them debate the irrelevant and totally worthless subjects that they appear to be focused on today until the cows come home. They can have all the hearings, meetings, subpoenas, and cross accusations they want, as long as they do not do what they are paid to do, which is to legislate. Some of the greatest stock markets of all time have been during a time of congressional incompetence. I think what we are seeing today is the government at its worst, but markets at their best.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Wednesday, April 17, 2019

What Do Accountants Suffer From That Ordinary People Don't? Depreciation.

Please note that the offices of Rollins & Van Lear and Rollins Financial will be closed on Friday, April 19th as a show of gratitude to our staff for working their assets off these past few months. And thank YOU for choosing us for your accounting and tax needs again this year; we appreciate your trust, patronage and support!

We will resume normal business hours on Monday, April 22nd at 8:30 a.m. However, if you have any pressing matters that require immediate attention on Friday, please do not hesitate to contact any of our staff.

Thank you again for allowing us the opportunity to serve you and have a wonderful weekend!

Wednesday, April 3, 2019

Best stock market quarter in over a decade, and reflections on our first 40 years investing.

From the Desk of Joe Rollins

As we end the first quarter of 2019 you cannot help but be impressed by the stock market’s performance in the first quarter after the carnage from the fourth quarter of 2018. The stock market made a stunning turnaround to recuperate nearly all of the losses it suffered during the fourth quarter of 2018. Virtually all segments of the market were up, including the beaten down oil sector along with a sterling performance by technology. There is a lot of positive things to say regarding the economy and the markets, although it is often minimized by the negative talk regarding a slowing economy. As I have pointed out in the past, a slowing economy is actually a virtue in that it keeps worldwide interest rates low as earnings continue to prosper, albeit at a slowing pace.

I have much to talk about in this posting regarding the economy as well as some reflections as we approach our 40th year in business. I wanted to reflect on some of the events that led to our current thinking and a successful investment criterion. If you wanted the stock market to perform well, this would be the economic environment for it to do so. We are currently in a “goldilocks economy” with interest rates low, earning high and inflation contained. That is the trifecta of positive investment returns as I will illustrate below.

Eddie, Jennifer, Lucy and Harper
skiing in Utah

I also want to describe the growth of this investment thought pattern over the last 4 decades that led to positive returns. However, before I do so as I must always reflect on the performance of the financial markets for the first quarter and for the month of March 2019.

As we reflect back on the best quarterly performance in a decade, virtually all financial assets were up in this quarter. The Standard & Poor’s Index of 500 stocks increased 1.9% in March and is up a sterling 13.6% for the year 2019. Also, the one-year performance is up 9.5%, which you have to remember includes the disastrous selloff in the fourth quarter of 2018. It is always interesting to note that the 10-year average in this index is up 15.9% per year for the last decade. The NASDAQ Composite was the best index of the quarter, up 2.7% in the month of March and up 16.8% for the year 2019. The one-year performance is also up at 10.6% and the 10-year average is 18.9% per year. The Dow Jones Industrial Average, mainly due to the downturn in Boeing stock, was only up 0.2% during March, up 11.8% for the year 2019 and up 10.1% for the one-year period then ended. The 10-year average on this index is also up double digits at 16.0% per year for the last decade.

Even the downtrodden fixed income index was up during this period. For the month of March, the Barclays Aggregate Bond Index was up 2 % and is up 2.9% for the year. The one-year performance on the bonds are 4.6% and for the 10-year period they average 3.7% per year. Once again, you can see the huge differential in returns between equities and bonds as the above numbers indicate. One of the most important things you have to consider with a fixed income investment is the direction of interest rates. Today, we have one of the lowest 10-year bond yields of all time and if you were a betting person, you would almost bet that index was going higher rather than lower. If, in fact, the interest rates do move up with the good economy, it is almost assured that your fixed income investments will operate at a loss. From a standpoint of potential investment returns, clearly equities favor higher returns than fixed income, which will likely operate at a loss or breakeven over the rest of 2019.

As we go into the second quarter of 2019 there is much to reflect upon. There is no question that the earnings for the first quarter are expected to be somewhat lower. It is currently anticipated that earnings would fall for the first quarter by 3.8%, however that must be taken in context with the fact that earnings are at historic highs and a small move down would not lower the anticipation of another strong earning cycle. Also, earnings expectations have historically been minimized by earnings that have exceeded expectations by an average of over 5% going back to 2010. If that is truly the case, we would anticipate an earnings growth this quarter that is basically even with the prior quarter. During the last quarter of 2018, with all of the financial forecasters believing that recession was inevitable, earnings growth actually increased by 3.5%, which quelled these fears and led to a large turnaround in the first quarter of 2019.

We are also seeing other positive attributes that are leading to market gains. For reasons that are hard to explain, the 10-year treasury rate has fallen dramatically this quarter. Back in October 2008, the 10-year treasury was currently trading at 3.25%, dropping all the way to the 2.4% range we enjoy today. This dramatic decrease in interest rates will most assuredly lead to a rush of refinancing and purchasing of homes, which has slowed due to the higher interest rates over the last 6 months. Lower interest rates have a very positive effect on the economy, creating new jobs in housing construction, suppliers and all the retail outlets that cater to home upgrades and improvements.

It is also clear that the current administration is campaigning for lower rates to keep the economy growing, but honestly the markets have provided the lower rates which should do the work for them. Surprisingly, the economy enjoys a continuous low inflation cycle. Last Friday, the Federal Reserve’s favored inflation gauge, core personal consumption expenditures, rose just 1.8%. This percentage is well below their optimal inflation rate of 2%. But more importantly than that, with inflation well contained, the Federal Reserve should have no reason to increase interest rates at this point, which is positive for the economy.

As you know, the Federal Reserve has basically two mandates to keep employment high while keeping inflation low. At the current time, employment operates at close to full employment and inflation is well contained. Given that double mandate, there is virtually no academic reason for increasing interest rates for the remainder of 2019, which should lead to a strong economy throughout the year and a recession is highly unlikely. While the equity markets will certainly be up and down over time, the positive trend is clearly intact and while swings in the market are almost inevitable, the trend up is clearly in tact and should be even higher at the end of the year, than they are today.

As we approach the start of our 40th year in business in year 2020, I could not help but reflect on what has led to the successful growth in our business and the beneficial events in history that helped us grow economically with our investment philosophy.

Over the last two years, we have enjoyed national recognition that may be unprecedented for a relatively small local investment company. Many of these awards were not campaigned by us, but yet came through national recognition and public filings. We are honored to have enjoyed the following recognition over the last two years.

1. In 2015, we were acknowledged as the 20th best nationwide investment advisors by CNBC. At that time, we managed roughly $274 million in assets and today we have doubled in size to roughly $560 million.

2. In 2018, we were awarded as One of the 300 Best Advisors in the United States by the Financial Times.

3. We were nominated by Accounting Today as one of the 150 largest CPA firms in assets under management.

4. Recently, we were awarded one of the 11th best financial advisors in Atlanta by Advisory HQ.

All of these awards were greatly appreciated, but I think they acknowledge 40 years of hard work spent understanding financial markets and reacting to those markets in a positive economic way. Not to say we have not made any mistakes over the past 40 years, but hopefully we have learned from those mistakes and improved along the way. The history of the firm is centered on the financial aspects that control the investment philosophy of today. When you evaluate financial firms, many of them were formed recently without this economic backdrop. How many investment advisors can boast that they have gone from a firm started with absolutely nothing, to an award-winning one from a small office in Atlanta?

Joe and his first computer

I would like to reflect on the history of the firm from when I started it in 1980. In the prior years leading up to 1980 we suffered through the disastrous inflation-prone years of President Jimmy Carter. One of his principal advisors was Dr. Alan Greenspan, which I will comment on extensively as follows. I vividly remember waiting in long lines to purchase gas due to our support of Israel during the war in the Middle East. Today, we are no longer economically dependent on the Middle East for oil and technology, and open markets have led to a boom in oil production in the United States. As I began the accounting firm in 1980, just as President Ronald Reagan was taking office, interest rates soared and the economy was clearly in recession. It was certainly not the optimal time to begin a small tax practice, but sometimes crisis leads to opportunity.

In those days, I would send my best clients to people that I believed could help them financially. Oftentimes, I would refer clients to the largest investment houses only to suffer disappointment. I soon found that these large brokerage houses had way too many conflicts and they would invest in financial products that met their own financial goals, not my clients. The final straw for me was when a client was led by a well-known broker in town to invest in a real estate partnership which carried huge fees and unrealistic appreciation of the assets. When the project had completely failed a couple years later and my client lost his entire investment, I complained to the broker who had advised my client to purchase into this without my knowledge. His response was that the client was “a big boy” and he could have read the financial document himself. Once I recognized these conflict-laden practices were not in the best interest of my clients, I formulated the plan to invest my clients’ money myself.

This process began in 1987. During the Reagan years, the stock market had performed extraordinarily well as interest rates fell from their highs in 1982. Unfortunately, President Ronald Reagan appointed Dr. Alan Greenspan on June 2nd, 1987 and he immediately announced his intentions to begin increasing interest rates to slow the accelerating economy. These increases in interest rates had a very negative effect on Wall Street, leading to the market crash in October 1987 (when the market fell from a high of roughly 2,100 to roughly 1,700 in one day). This 22% decline was the largest one-day stock market crash of all time. This was certainly not the optimal time to consider an investment company. However, I have to reflect on that market that closed that day in 1987 at roughly 1,700 but today is 25,928.

I wanted to build a new kind of investment company where there would never be any conflicts of interest. It would be a firm where the client’s interest was always held at the highest level of importance and we would not invest money where we would be paid to do so, rather we would only be paid by the client. We would sell no commission products and would take no money from any source other than the clients, period. Since this was such a radical change from the common way big brokers worked, I knew it would be controversial to them. In addition, there would be no surrender charges, a client could leave whenever they wanted to and the only way we could make money would be to grow their account.

We were the very first CPA firm in the area to seek to create an investment company. At that time, the AICPA, which was the governing party of CPA firms, would not allow CPA firms to have investment companies because of the perceived conflict of interest. We received permission, but were required to do so as a separate company. Thus Rollins Financial was founded on January 1, 1990, as we are competing our 29th year in business with the investment company.

As I began my investment company, I went through many boom and bust cycles. I vividly remember when President George Bush refused to cut taxes to stimulate the economy which led to a recession in 1990, leading to the election of President Bill Clinton in 1992. I also remember the 1990s as being extraordinarily good for the stock market, except for the wild fluctuations and interest rates as Greenspan pushed the economy in one direction or another. In his famous speech in December 1996, Dr. Greenspan expressed his concern of “irrational exuberance” that forced the market down dramatically for a year or so. I also remember Dr. Greenspan’s paranoia about Y2K and his fear that all computers would not reset as the century turned, which of course in retrospect was ridiculous. I spent the night in New York City on December 31st, 1999 and awoke the next day to computers working the same as they did the day before.

Harper and Lucy Wilcox in Utah

Dr. Greenspan’s wild expectations of negative financial news in 2000 led to him flooding the economy in 1998 and 1999 with liquidity of unprecedented levels. This in turn led to the huge run-up in the dot-com stocks and a market in 1999 that was too hot. As was typical during the Greenspan era, in early 2000 he reversed course and drained the economy of liquidity and increased interest rates. This led to the final coup de grace in March of 2000, when the dot-com bubble burst. At that time, the NASDAQ Composite reached over 6,000 before falling to close to 1,000 a few years later. Once again, reflecting back, that same index today is valued at 7,729, but it took almost 18 years to exceed that level of March 2000.

While 2000 was a down economic year, nothing could have affected the market more than the 9/11 attacks in 2001. Once again, the market suffered huge declines and Greenspan cut interest rates to compensate for that decline. If he had maintained a normalized interest cycle during this time frame, maybe this selloff and the economic downturn after 9/11 could have been minimized.

During this entire timeframe we learned that interest rate cycles are the most important aspect of equity investing. In anticipation of a bad economy after 9/11, Dr. Alan Greenspan decreased interest rates in 2002 to a then low of 1%. In fact, at the beginning of 2004, Dr. Greenspan advised that it would be better that all home owners adopt variable interest rates due to the extraordinarily low rates. Once again, only a few months later, he began increasing interest rates that over the next two years would move from 1% to 5.25%. He increased rates 17 consecutive months.

There are many that argue that Dr. Greenspan was the architect of the 2008 real estate disaster. He believed that low interest rates would accelerate the economy and would expand housing. However, he was a stanch opponent of federal intervention of derivatives, which led to the high risk mortgages which we all know so well today. In fact, the increase in short term interest rates from 2002-2004 in many ways led to the foreclosure disaster that occurred in 2007. People who could afford interest rates on a variable rate in 2002 could no longer afford them in 2007. As would be the case, bankers borrowing money basically for free from the Federal Reserve could loan it out for higher interest rates and make a large profit. What they did not count on, which was the single most important component of the 2008 disaster, was that the Federal Reserve would continually increase the interest rates to make the homes no longer affordable for the homeowner.

Dr. Greenspan remained Chairman of the Federal Reserve for 16 very volatile years. He often said that most of his economic analysis occurred when he sat in his bathtub with his yellow pad and thought deeply about the economy (it is best to avoid the visual aspects of that thought). What it actually led to was almost two decades of huge swings in the equity markets by an uneven Federal Reserve policy. During this time, we learned a lot about how the market moves based upon interest rates and the economy. I think this learning cycle has served us well in investing at the current time.

Fortunately for us, Dr. Greenspan retired in 2006. Since that time, we have seen a stabilization of interest rates and their movements to the market. Yes, we incurred the huge down move in 2008, but that was clearly at the hands of Dr. Greenspan and his prior administration. It appears to me that Federal Reserve Chairman, Jerome Powell, is of high credibility and knows exactly how to control the economy by gradual moves in interest rates to keep the economy at a high level.

The biggest benefit we have going forward is that the economy is strong and if the Federal Reserve stays out of the way, the economy should grow as we go forward. There is absolutely no reason why we should go from boom to bust as often as we did under Greenspan if the Federal Reserve does their job efficiently. At the current level of basic full employment, the economy should grow in the 2-3% range for years to come. However, any intervention to increase interest rates is likely to disrupt that normalized growth. Hopefully the current members of the Federal Reserve understand this and will leave the economy alone to grow its own foliage.

All of us should feel encouraged by the technology that is changing virtually every aspect of our lives. They did not find a better way to drill oil to turnaround the oil industry in America, they instead discovered that technology could allow them to find oil and allow them to drill it more efficiently than any other developed means of bringing oil to the surface. Technology led to oil wells that never before existed. Due to fracking and shale oil production, the U.S. is now the largest producer of oil in the world. In the 1980s and 1990s we begged the Middle East to sell us oil; we no longer need to do so.

There is also a technology that is changing the natural gas industry. Today we are able to liquefy natural gas and ship it around the world. Huge liquefied gas manufacturing plants are currently under construction near the Gulf Coast, which will take very cheap natural gas from the south, liquefy it and ship it to Europe and China to sell it cheaper than their current supplier.

President Trump was very critical of the fact that Europe acquires most of their natural gas from Russia. He understood the national security concerns that having natural gas being supplied by a potential enemy could have devastating effects on the European economy. But now, the U.S. can ship natural gas into Europe and sell it for cheaper than they are currently buying from Russia. There is a change occurring that is unprecedented in economic cycles.

I remember back only a few years when the so-called forecasters were predicting that robots would put many people out of work and take jobs from Americans and run them with machines. Today, in the automobile industry, robots manufacture the majority of a car, but yet employment remains full. Technology has changed the way that cars are produced and they are better than ever with fewer defects and higher reliability. I remember often times buying a new car and taking it to the dealership the day after purchase with a long list of defects. The car I currently drive has never been to the shop in over 2.5 years.

Now we are enjoying the electrification of cars and the potential it holds. Electric cars are common now, which get long range and do not use fossil fuels to drive. Clearly, they have their limitations, but it is my projection that within the next 10 years, every car manufactured will have electric features that will change gasoline consumption forever. Cars today have electronic features unthought-of only a few years ago. Electric censors in cars keep you from backing into your neighbors’ tree and stop you short from running over people. These features make the cars so much safer nowadays than they were only 5 years ago. It is quite unbelievable.

So, in closing, I reflect back on these 40 years and see all that has changed. Yes, there are problems in the world that will make us adapt our thinking. There is no question that the deficits will have to be addressed, but not immediately. The strength of the economy reduces billions in taxes, but we have to be able to afford the entitlements that we enjoy in America. Very small changes in the Social Security system could make Social Security solvent for 100 years. However, until we have a congress willing to support any changes in that law it is not likely to occur any time soon. But technology is changing everything we do and making our lives simpler and better. The reason I am optimistic for the economy and the stock market is that I see that huge companies generate a substantial portion of their revenue not with people or manufacturing, but through services. These services are extraordinarily profitable and their stock will be rewarded.

CiCi and Ava

The one negative aspect of stock market investing is that the only clear indicator of a down market is if there would be an oncoming recession. A recession will almost always reduce the value of the markets due to the lower earnings of the corporations. Fortunately, with lower interest rates in place, higher earnings and inflation intact, any recession is likely 2 years away and, if the Federal Reserve does its job, maybe even longer than that.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins