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 na├»ve 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 Bankrate.com 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







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