Thursday, February 6, 2020

I Ignore the Headlines - Just Show Me the Money!

From the Desk of Joe Rollins


As I sit in my office every day and watch the results of the earnings of the major corporations of America report for the fourth quarter of 2019, I am actually blown away as to the absolute dollars in profits they are showing. I watched the other day as Apple reported earnings of $22 billion. Not gross revenue, but net income. Other earnings that have been reported are nothing short of outstanding. Yet, I also sit here every day watching the market go down over totally meaningless non-economic events.

We see the nonsense of the geo-political impeachment hearings, which everyone knew the outcome before it even began. We tried to make the Coronavirus in China important, yet anyone who has any level of reasonableness knows it is not. What I do see, though, is an incredible earning machine in America that is coupled with historically low interest rates and a fabulous economy moving stocks higher.


 Ava drinking from CiCi’s water – Age 3

I want to report things that I find of interest this month, but I want to reassure the readers that economically things are just fine. It may be true that the market goes up and down based upon non-economic events, but anyone investing should realize that in the long-term these things mean nothing. As the short-term traders push the market down, they short the stock indexes and buy treasury bonds. For a day or two, both the stock market equities and the bonds are distorted due to the traders’ actions. However, a few days later the traders reverse that action and nothing has actually really happened. It went down one day and up a few days later. Why anyone would think that they need to do trade around this event overemphasizes how quickly they could move to accomplish that goal. They cannot!

I will attempt to discuss these items and the effect of the economy due to the Coronavirus. Mainly, I want to emphasize how profitable U.S. corporations are and how lucky we are to live in a country where the economy is nothing short of spectacular. While I want to cover all of those important subjects, I need to give you the scorecard for the month of January.


37-year clients Randy and Kathy Wittman, their son, 
Ryan, and their first grandbaby, Robert James Wittman

For the month of January 2020, the Standard & Poor’s Index of 500 Stocks was actually exactly zero. No gain or loss at all during the month of January. Obviously for 2020, it was also zero. It is important to note over the last three months, the S&P of 500 Index is up 6.7%. During the month of January, the Dow Jones Industrials were negative 0.9%. Also, for the year to date, the return is exactly the same. Over the last three months of the year 2019, this index was up 5.1%. The NASDAQ Composite was the big winner for the month of January, up 2.1%. Over the last 90 days this index has jumped higher by 10.7%. These are extraordinary numbers.

The Bloomberg Barclays Aggregate Bond Index was up a very satisfying 2.1% during January and for the year 2020 so far. Averaged over the last three months, this index is up 1.8%. I think it is truly informative to look at the long-term return on these indexes and your portfolio. The S&P 500 Index over the last ten years is up 14% annually. The NASDAQ Composite is up 16.9% and the Dow Jones Industrial Average is up 13.7% annually. If you compare all of these indexes to the bond index, the Bloomberg Barclays Aggregate Bond Index is up 3.7% over the last decade. As you clearly can see, each of those indexes were up mid double-digits, while the bond index was basically 25% of the equity indexes.

One day, I was flipping through the channels and I came across a left-leaning 24-hour news program. If they were reporting news, then clearly they had not checked the facts. This particular day, the two commentators were making fun of the U.S. economy as it currently existed. Their comment was that the GDP in the United States at 2.1% for 2019 was a joke. In fact, they said that it was not even as good as the economy during the President Jimmy Carter years. I almost burst out in laughter at the ridiculous and incorrect comparisons to the U.S. economy today, which is extraordinarily good compared to the Jimmy Carter years, which were extraordinarily bad.


Ava and a Rockette at the Christmas Spectacular – Age 4

So, in order to properly evaluate the two economies, I went back to look at the economy during that time. We all seem to forget that when Jimmy Carter took over the Presidency after the Watergate Scandal, we had very high unemployment and very meager growth. In fact, in 1980, which was the last year of the Jimmy Carter presidency, the unemployment rate was 7.2%, the GDP was a -0.3% and inflation was 12.5%. If you recall the famous “Misery Index” promoted by Jimmy Carter, he would add unemployment to inflation to determine how bad the economy was. Therefore, as he left office, the Misery Index was a very high 19.7%, even though it had only been 12.7% when he took office. You may recall President Ronald Reagan using the “Misery Index” against Jimmy Carter when he ran against him in 1980. When Ronald Reagan left office in 1988 the “Misery Index” was 9.7%.

To compare the economies today to the President Jimmy Carter years is almost laughable, if it weren’t just outright wrong. I am not exactly sure why the commentators bothered to quote economic factors that, clearly, they do not understand. Today, the “Misery Index” is 5.8%, one of the lowest ever registered under this hypothetical theory. When President Trump took office the “Misery Index” was 6.8%, and it has improved over the last 3 years.


MiaRose Musciano-Howard’s son, Mitch (15), 
Staff Sergeant with the nationally recognized 
Fayette County High School Drill Team

We are enjoying a time of truly economic good times. We have an unemployment rate that is at a 60-year low at 3.5%, inflation under control at 2.3%, and an economy that is growing just right at 2.1%. I will further clarify those terms later in this posting.

We have the trifecta of good news at the current time. You may recall the high price of oil during the President Jimmy Carter years, which saw oil at $20/barrel in 1973, but in late 1979 it jumped up to $107/barrel. Primarily this was due to the conflict with the United States and the Middle East, which temporarily cut off the supply of oil to the United States. Most of the people reading this posting do not even realize that during the 70’s we imported 40% of our oil from the Middle East. Today, in the United States, we import less than 10% of our oil and that number is declining annually.

In fact, for the first time ever, the United States is exporting oil and energy around the world. This transformation of energy is due to the technology that has allowed the oil industry to produce oil at a lesser cost. Even after 40 years of inflation impacting the price of oil, it is lower today than it was in the 1970’s. Which is a major economic boost to Americans by saving on gas cost.

It is hard to even fathom that in 1980, as President Jimmy Carter was leaving office, the rate of inflation was 12.5%. The rate of inflation affects every asset that we own, touch, and feel. The price of housing was going up in double-digit rates and not until 1986 did the inflation rate drop to just 1.1%. Therefore, to assume that the current economic environment could be compared in any way to the economic state during the Jimmy Carter presidency is “fake news” at its very best. Compare 19.7% “Misery Index” to 5.8% now.

I cannot comment on the stock market and its performance without going through in greater detail the economic effect of the Coronavirus and the effect it might have on the whole economy. What is interesting about this particular news item is the dramatic effect that China has used to combat the virus. It is hardly possible to believe that China built a full 25,000-foot hospital with over 1,000 beds to isolate the virus in just eight working days. Is their intention to use this facility until the virus is under control and later destroy the hospital in its entirety? If we had tried to build that hospital in the city of Atlanta, it would have taken a minimum of six months just to get a permit from the city. In China’s case, they completed it, start to finish, in eight working days.

Hysteria has taken over the news in a way not likely seen in decades in the United States. I fear that having three full-time 24/7 news channels has raised the hysteria level to a point of facts no longer being comprehended. It has been reported that Google has been flooded with inquiries about the virus being linked to Corona beer.  I cannot even make up these stories since it was reported in USA TODAY. It is hard to believe that anyone would consider Corona beer and the virus to be related, yet clearly that has become a problem for Google in their search for information.

The effect of the virus clearly has no potential of ever dramatically affecting either China’s economy or our own to a great degree. However, the sell-off in Asian stocks and the subsequent retreat by the U.S. markets make investors think there might, in fact, be some sort of worldwide economic negative impact.

Ava enjoying the snow – Age 8

In trying to illustrate this point, I will quote an illustration from this week’s Barron’s magazine; “In order to have any major effect on the U.S. economy, you would have to understand the magnitude of the downturn that would have to occur”. The U.S. economy this year is expected to generate $22 trillion in GDP. In order to have a 0.1% effect on the U.S. economy it would have to decrease the GDP by $22 billion. Understand that we are talking about one-tenth of 1% effect on the huge U.S. economy. It is believed that if Starbucks closes all of their stores in China that it would affect their revenue by $25 million per week while they are closed. If you do the simple math, it would take 880 weeks to even reach this 0.1% threshold. Basically, it would take almost 17 years before the closure of the Starbucks stores in China could reach the 0.1% threshold. To draw a conclusion of this particular virus having that effect borders on the absurd.

Unquestionably, there will be disruptions with manufacturing, and the effect that laying off employees due to the crisis will have. However, one of the major benefits has been that virtually all manufacturing in China has been closed for the last two weeks due to the Lunar New Year. As these factories get back to manufacturing, the effect will be more widely felt. However, to this point, the current economic effect is virtually zero.

The difference this time versus prior outbreaks of infectious diseases is the swift and positive effect the Chinese government has pushed through their economy. The incubation period for this virus is believed to be only two weeks. As two weeks pass, fewer and fewer cases will be reported. To this point, as I write this commentary, there have been only 400 deaths around the world reported from this newly discovered virus. As a comparison, in the 2017-2018 years in the United States over 80,000 Americans died from the common flu.

Once again, you can draw a parallel to understand the hysteria as reported in the media. Another interesting fact regarding this virus, that few people seem to understand, is that at the current time only 2.2% of the people that contract this virus actually die. Back when we had the problem with the SARS outbreak, 9.5% of those people that contracted the virus died. Even the more deadly MERS death rate was 34.5%. All I am trying to emphasize here is that, while not to be minimized, the effect of the virus on worldwide economies is miniscule compared to the $14 trillion Chinese economy or the $22 trillion U.S. GDP.

 Long term client from Nashville, Dr. King, in Kenya

As my headline reads, I have been truly astounded at the level of earnings that have been reported for the fourth quarter of 2019. As you may recall, the so-called “learned experts” were calling for an earnings decline in 2019, as compared to the prior years. In fact, great hysteria was created in the summer of 2019 when the bond yield inverted, forcing all the so-called authorities to predict recession and an earnings decline. Once again, the so-called experts are not so expert in predicting the future.

Earnings have been nothing short of spectacular for the fourth quarter of 2019. When you read about the earnings reports of Apple, Microsoft, Amazon, Google, etc., you just have to shake your head in amazement. These companies are putting up earnings that have never been seen in American finance. There are clearly companies struggling to keep up, such as all of the oil companies, and, of course, Boeing with its current problems. If you average in these lower returning oil companies with the high-flying tech companies, it looks like the fourth quarter of 2019, contrary to perception, will actually show a net positive increase in earnings.

When I look back on earnings and hear the commentary regarding the markets being overvalued, I almost have to chuckle to myself. At the lows of the financial crisis in 2008, the S&P 500 earnings were $49.51. Each year since 2008, these earnings have gradually grown, and in 2019, it is expected that the S&P 500 earnings will be $162.35. In order for stocks to continue to grow, earnings must continue to grow. It is now anticipated that the earnings for the S&P 500 will grow at 9% in 2020. Even more remarkable, it is expected that earnings for the first quarter of 2020 will grow at a sterling 4% from the 2019 levels. There are a lot of reasons for this anticipated growth. Primarily, though, it is due to the strong U.S. economy and an economy around the world that is starting to strengthen. I anticipate earnings for 2020 to be at $180, even higher than the forecast by most experts. A 360% growth from 2008.

Therefore, to assume that earnings have peaked, you would have to evaluate the other external events leading to a strong economy. Most interestingly, bond yields have collapsed to where the 10-year treasury is at 1.5% today. If you have not refinanced your house recently, you should seriously consider it. Interest rates are now at historic lows at the point where refinancing will create billions of dollars in cash flow to homeowners. In addition, oil prices are dramatically lower, freeing up even more billions to consumers. The economy at 2.1% GDP is just great. “Not too hot, not too cold.” This rate should smooth out the economy so that the Federal Reserve does not have to get involved. Therefore, we look forward to a period of flat and constant interest rates throughout all of 2020.

Did you realize that for the first time in two decades manufacturing employment in the United States is actually on the upswing? Did you realize that illegal immigration from our southern border has virtually stopped in recent months due to changes the United States government has made in combination with the Mexican government? President Trump promised lower taxes, a higher economy, immigration control and bringing jobs back to America, and in only three years, he has succeeded in accomplishing all of these things. All things financially and domestically are very good at this time.

When you realize that the dividend rate on the S&P 500 is greater than the rate currently earned on the 10-year treasury, you realize the potential growth that stocks could have over the next decade. It is hard to fathom that investors would actually buy a 10-year treasury bond knowing that the rate of inflation currently exceeds the dividend rate. Therefore, if you buy a 10-year treasury at a rate lower than the rate of inflation, you are guaranteed a loss in purchasing power over that decade. Yet, every day, people make that conscious decision to lock in losses.

 Gorgeous sunset from my deck in Florida

Even though the deficits in the United States are extremely high, there is an interesting phenomenon going on in government finance. The Treasury is now starting to issue 20-year bonds and refinancing the government debt to much lower rates. While we have not addressed the issue of ballooning deficits in the economy, by locking in lower rates, they have reduced the negative effect of higher rates impacting the economy going forward. The government is doing a great job handling the debt of the economy for the betterment of its citizens. If we can reduce the overall cost of financing the deficit in the long-term, everyone benefits.

Yes, it is terrible that the U.S. government cannot finance its operations. It looks like we are going to have one trillion-dollar deficits for years to come. However, I do not fear the deficits as long as the GDP continues to grow. As long as the GDP will exceed the amount of national debt, we should be on solid financial ground, notwithstanding the deficits. Currently, the GDP and the deficit are approximately one to one. If the GDP continues to grow as anticipated, these debts should create no financial risk to the U.S. economy over the next few years since the GDP is growing faster than the debt – much faster.

Notwithstanding the almost-hysteria regarding the Coronavirus, business and the economy in the United States remain excellent. However, the highest growth rates in the world continue to be in Asia. I anticipate that as soon as the hysteria passes in China, they will meet their projected economic growth of 6% in 2020. Economies in Vietnam, Indonesia and Malaysia are exploding with industrial activity as many companies move out of China to other Asian cities. India is just now starting its growth. It is believed that GDP will exceed 5% growth in 2020 in the aggregate for all of Asia. When you compare that with 2.1% in the United States, you can see the fastest growth in the world is in those Asian coutries. Despite the negative downturn in the markets due to the economic impact of the fear of the Coronavirus, my opinion is that those markets will turn around quickly and will start to move higher as this hysteria passes.

As I look forward in 2020, with the known qualities that we know today, I cannot see how the market could not move higher. If we continue with a perceived growth rate of the GDP at 2% or greater for all of 2020, the earnings growth of the S&P 500 of 9%, and with a treasury yield below 2%, all of that adds up as truly positive momentum for the U.S. markets. As we move into spring and summer, it would not shock me to see that the GDP would actually improve and earnings could accelerate. Almost assuredly, these three strong economic predictors will force the stock market to a higher level in 2020.

On that note, come 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, January 6, 2020

Celebrating Our 40th Year Serving Clients And Thankful For One Of The Best Stock Markets Of All Time

From the Desk of Joe Rollins

In this posting I will reflect back on my first 40 years serving clients, and what I anticipate should be another upcoming good investment year. In 2019, we had one of the better stock markets of all time. The S&P 500 Index was up 31.5% and over the last ten years has averaged 13.6%; quite an outstanding performance. Over the last decade the S&P 500 Index is up 189.7%, and the Dow Jones Industrial Average is up 175.1%. If you look at the tech-heavy NASDAQ Composite, it was up almost twice those amounts at 366.9%. The gain in the Dow of 175% is the fourth-best decade in the last 100 years. By any definition, this last decade has been an unbelievably good run for investors. When I hear people talk about flipping houses and buying real estate in IRA’s and other exotic investment schemes, I almost laugh at how ludicrous that really is. Absolutely no asset class has outperformed stocks over the last decade. 

Partner Eddie Wilcox and his family in Tampa, FL

In this posting I would like to reflect back on our first 40 years and the great financial markets we had in 2019. As I always do in the first posting of a new year, I will give you my projection for the current year. Last year, I projected an S&P at 3,000, but the market was so strong in the fall I increased that threshold to 3,100. The market actually closed at 3,230.8, which was a few percentage points greater than my projection. If you compare those projections with so many other financial experts on the stock market, you will see that almost no one except me projected a stock market as strong as it ended up being.

I will cover all of those more interesting subjects later in this posting, but as I always do, let me give you the excellent results from 2019. The Standard & Poor’s Index of 500 stocks was up 31.5% for the year 2019. For the five year period it averaged 11.7% and was up 9.1% in the final quarter of the year. The Dow Jones Industrial Average ended the year up 25.3% and has averaged 12.6% over the last five years. In the final quarter of the year, it went up 6.7%. The NASDAQ Composite was the winner of all the indexes; up 36.7% for the year 2019 and averaged 14.9% for the five year period then ended. For the final quarter of 2019, it was up a sterling 12.4%. Outstanding performance for all three indexes.

As a comparison, the Barclay’s Aggregate Bond Index was up an excellent return in 2019 for a bond index at 8.5%. However, if you compare the numbers above, this index averaged only 3% per year over the last five years. In fact, in the last three months of 2019, that index barely broke even at 0.1%. I often comment on the lack of performance of bonds, and this was an excellent example of how stocks vastly outperformed bonds, even in the fabulous year of 2019. I anticipate bonds for 2020 to either be marginally profitable or negative for reasons I will explain later in this posting.

Eddie, Jennifer, Harper and Lucy Wilcox 
exploring Boone, NC

There are a lot of interesting subjects that we need to discuss in this posting, but I want to focus on the bad news that you received all year from the so-called expert forecasters. The economists told us that tariffs would create inflation and recession. Boy, were they wrong on that subject. The so-called experts that told us the inverted bond yield would almost surely create recession. Have you noticed that the inversion has moved in the opposite direction and, in fact, has steepened significantly in recent months? The so-called inverted bond yield was supposed to bring recession and send shock waves to the financial markets. As I commented here, this is only a temporary adjustment in interest rates and hardly means anything for the economy by itself. You have to consider all of the components of recession before you can draw a conclusion by only one indicator. The financial commentators on Wall Street did not bother to look at the other indicators.

As I reflect on the first 40 years of this Firm, it has been an interesting ride. I began in 1980 in the front room of my small house in Fairburn, Georgia. I only had one client at that time, and obviously, there was not a lot I could do for that one client in a given day. I often would call the telephone operator to make sure the phone was working since it clearly was not ringing with clients. I began teaching at Georgia State in the Master’s program of Taxation to occupy my time. I would always try to keep myself busy during the day, but inevitably at 4:00 pm I would end up watching MASH on TV. I think I have seen every episode of MASH multiple times, and every time, it tended to amuse me.

During those days, there was no financial news. It was very rare indeed that you even got a stock market update, much less any significant business news. I received The Wall Street Journal by mail, which often got to me two days after the fact. I would read The Wall Street Journal from cover to cover since I really had nothing else to do and I enjoyed learning about finance and business. Those were reflective years, but I did not even contemplate my future, given that I was a CPA and doing tax work. I never really thought about being in the investment world, but yet after 40 years I am still here.

The Schultz family enjoying Christmas break

The turn in my thinking came in 1987 with the horrendous stock market crash in October of that year. As you may recall, on Black Monday the market fell 22% in one day, dropping it all the way down to 1,720. Many asserted at that point that would be the last of the investing world since investors would flee the market and never return. Ironically, as we sit here today, the market is at 28,538, so those people that forecasted the gloom and doom in 1987 were clearly incorrect.

At that time, I would send my potential investment clients to various stockbrokers around town. What I found was that the industry was full of conflicts of interest, and they were doing a major disservice to my clients. Not only were they not interested in making my clients money, often times because of the high commissions and conflicts of interest with their investment groups, the clients lost money and quickly learned to despise the individuals behind the recommendations. Stockbrokers rarely made money in those days except for themselves and rarely clients.

At that time, I made the decision that it was time that I would invest clients’ money since I could hardly do no worse than what the brokers were doing, I had no conflicts of interest and only had the best interest of my clients’ futures. As I began to organize in late 1989 to open for business in 1990, I sent out a notice to my clients that if anyone would be interested in investing money that I had set up a company and would help them. To my amazement, checks started flowing in for clients’ investments. I had no staff at that time, no computer background or computer program to account for the money; just a desire to be helpful. That is where it all began in 1990, and who would have thought I would be here 40 years later?

Over the holidays, I had an opportunity to actually spend some time doing one of my favorite pastimes of reading books about business and the stock market. While I have read literally hundreds of books on investing and stock market performance, I was interested in going back and reading some of the books that told the stories of the disasters and what people did wrong. One of the books I read was When Genius Failed: The Rise and Fall of Long-Term Capital Management. This was a most interesting book on the rise and fall of Long-Term Capital Management. This was a group of PhD’s and scholars who thought they knew how interest rates would move and invested their clients’ money accordingly. In 1998, when Russia defaulted on their debts and the emerging markets imploded, their entire fund went to zero. The partners who had net worth in excess of $5 billion lost every dollar of it in five weeks.

Caroline and Reid playing with their balloons

Another book I read that was very interesting, was The Smartest Guys in The Room. This is a story of Enron and the accounting disaster that took a wonderful company basically to zero over a relatively short period of time. At the end of the day, the Enron story was one of fraud rather than business, but it was very interesting to see and hear the story play out of very rich people doing very wrong things to the detriment of investors. Very smart people did some very dumb things.

Another book that was quite interesting was Too Big To Fail, which was the story of the 2008 debacle that occurred on Wall Street and the housing crisis. It included every major Wall Street firm and almost imploded the financial markets and the American economy. What was truly interesting about this book was how the bankers had manipulated the markets to the detriment of investors and, along the way, destroyed housing throughout America. When bankers abuse clients, bad things happen. It was really bad in 2008

All three of these books were interesting, but were driven by one human frailty. All of the people involved in these incidents were seeking out personal enrichment to the detriment of investors. Greed is the underlying concept that ran through each of these interesting books. In many cases, it was outright fraud, but the larger picture was that they were trying to manipulate the markets in such a fashion to the detriment of investors to gain a little more wealth for themselves. Each of the principals involved were outrageously wealthy anyway, but their desire to gain more wealth destroyed the companies for which they worked.

I look back on those books and think about the interesting coincidence that happened. For the Long-Term Capital Management, they imploded in 1998 due to the wild fluctuation in the bond market. At that time, the market sold off and the world appeared to be heading in unison to recession and disaster. However, in the following year in 1999, the markets roared back with a dot.com phenomenon that forced the markets to unprecedented levels that they had never reached before. Long-Term Management was just a small blip in the world of investing that only took 12 months to recover. If you reflect back on the 2008 financial disaster on Wall Street, you have to reflect on the recovery that we have all enjoyed. On March 9, 2009, the S&P 500 Index closed at 666. Today, that same index is 3,230, up almost 400%.

Ava, Dakota, and 35-year clients 
Gerry and Allen Davidson in Florida

What I have learned from reading these books and watching financial markets is that you do not have to be a genius to understand equity pricing. What you really need to understand are the three basics that make stocks go higher. The most important component of any stock market valuation is interest rates. Today, we enjoy unprecedented low interest rates. In 1998, when Long-Term Capital imploded, they were shocked to find that the 30-year treasury had dropped to the unprecedented low level of 5.5%, the lowest it had ever been since the government started issuing 30-year bonds. Today, that 30-year treasury rate is 2.3% (60% lower). By any definition or any standard in valuating interest rates, we are enjoying the lowest rates ever in the history of American finance. That is great for stocks – bad for bonds.

The second component to stock valuation is the economy. The one absolutely undeniable factor that will make stocks go down is recession. If the economy is continuing to grow and people are employed, corporate America will do better and stock prices will rise. Today, we have an economy that is in a “goldilocks” environment. Not too hot, not too cold. The economy is growing nicely at above 2%, not overheating, and seems to be well under control by the Federal Reserve that is clearly watching and making the right moves for the economy. In addition, today we have more Americans working than ever in the history of American finance. The more people work, the more businesses are supported to better the economy. The secret of a good economy is keeping people working, and the fact that employers cannot find qualified employees is the best indicator you could ever have of a very strong economy.

The third component is corporate profits. Corporate profits continue to grow, and with the favorable income tax rate cuts of 2017, corporate earnings are now at record levels. Even today, they are forecasted to be higher in the year 2020 than they are in 2019. If you look at the estimated earnings for the coming years, you will see a gradual, but positive increase over the next three years.

Ava sitting with a giant light up reindeer
 at Tropicana Field 

I reflect back on the ‘90’s when the stock market was hot and cold and up and down, and interest rates were all over the board. I have often criticized then Federal Reserve Chairman Alan Greenspan and his control of the economy during that era. If you look back at the wild moves he made in interest rates that affected the markets, you also have to evaluate his desire that stock market derivatives be unregulated. Due to his desire to have more derivatives in the economy, we saw wild swings in the market that led to undisclosed liabilities by Wall Street banks of literally trillions of dollars. While the Federal Reserve could have stepped in and regulated the derivatives, since Alan Greenspan was an advocate of no regulation, he prevented any regulation from going forward. That proved to be a serious error of judgement in 2008.

Now, we have the economy in good shape, interest rates at low levels and corporate earnings going higher. Those that fear recession are not being realistic in their valuation. While there are many on Wall Street that say recession is a natural byproduct of the American economy, they clearly are mistaken. Did you realize that the decade that ended in 2019 was the only decade ever in the history of American finance that there was no recession? There is no reason to believe that recession is an inevitable outcome of any economy. Many factors lead to recession, none of which are currently present where we sit today. Those that are forecasting recession are assuming some huge geopolitical or military event. You cannot invest based on a presumption that something negative is going to happen because if you do, you will miss huge gains.

I often quote Peter Lynch, the famous fund manager of the Fidelity Magellan Fund. He has given us many words of wisdom about investing that we should all take advantage of. The one that rings true to me is his statement that the average investor does everything wrong. When they have a good stock that goes way up, they sell that stock to buy a stock that is going down. In fact, you should do the exact opposite. You should ride the good stock and sell the bad stock. Most people refuse to sell bad stocks because that would be an admission that they made a mistake. Since no one has access to your portfolio but you, why would anyone care how you feel? Ride the winner – dump the loser.

Markets are much the same. When the market is going up, it tends to go up until something prevents it from going up. The old saying on Wall Street is, “a trend is a trend until the trend is broken.” There is no presumption that markets will go down just because they have gone up a great deal. What makes markets go down are when the three factors above are violated. When you see interest rates progressively going higher because the economy is too hot, then the markets tend to fail. When you see the economy turn to recession, then almost assuredly the markets will go down. When you see corporate earnings start to fall throughout all segments of the largest companies, almost assuredly lower stock prices will follow.

We are fortunate today where none of those events are even remotely in the horizon. The economy is great, interest rates are low, corporate earnings are high and getting higher, and the Federal Reserve has a firm hold on the economy and is controlling it professionally. I see nothing but positives as I write this posting, which almost assuredly will lead to higher stock prices in the coming months.

Dakota, Ava, Santa, and Joe having a Merry Christmas

One of the best things that we have going for us in the year 2020 is that the Federal Reserve has indicated they intend to hold interest rates steady throughout all of 2020. As further encouragement, they indicated they would even cut interest rates, if necessary, to keep the economy accelerating. When it comes to stock market performance, such a commitment by the Federal Reserve is the most powerful statement of all.

Every year I project what the upcoming year should hold. I do not use this forum to come up with some wild prediction based on the changing of the moon or the length of women’s dresses. I actually think about this a great deal and attempt to make an estimate that is based on some sort of reasonable calculation. Hopefully I will be as close this year as I was last year.

The basic calculation of fair value of the market would be some sort of multiple of expected earnings as compared to interest rates. The 25-year average P/E ratio is 19.34. That means the market on average sells at 19 times projected earnings. Using this simple formula, you can actually calculate what you think the value of the market would be at the end of 2020. Currently, estimated earnings for 2020 are expected to be $180 per share. If you round up somewhat due to low interest rates to a multiple of 20, at the end of 2020 the S&P 500 should be at 3,600. Since the closing balance is at 3,230, that would be an increase of 370 points over the course of the year, or an 11% gain. If you add that to the dividend yield of approximately 2%, my formula would indicate that the market should go up 13% in 2020.

Those of you that are skeptical that a market could gain 13% in a year where it just finished up 30% are not much for studying history. Since 1950 when the S&P was up 20% or more in any one year, the following year has an 83% chance of a gain and that average gain is 11.2%. As you recall this year, the S&P was up over 30%. Even more interesting, if you have a year when the NASDAQ is up 30% or more, the following year is positive 78% of the time with an average gain of 14.2%. Most any reasonable investor would readily accept those odds of potential gains in 2020.

As mentioned previously, I am concerned about the valuation of bonds going into 2020. First off, the yield on bonds is certainly not very appealing. The current yield on the 10-Year Treasury, as of Friday, January 3, 2020, was 1.793%. Currently you can almost get the same interest rate on high-yield money market accounts as a ten-year bond. Therefore, if the bond stays steady throughout 2020, the gain you will make barely exceeds the no-risk cash balance. If, however, the bond would move up only marginally to 2.25% during the year, your gain would be totally wiped out, and you would be in a negative position. If you think that the bond cannot move to 2.25% this year, remember that in September 2018 (15 months ago), the 10-Year Treasury was yielding 3.25%. Therefore, it seems to me that the odds of making money in bonds in 2020 are extraordinarily small and a risk I would not be willing to take.

What I think will change in 2020, unlike the last five or six years, is that the international markets will likely outperform the U.S. market. Not that their economy is better or that things are more robust in Europe or Asia, but rather that they have lagged so far behind the U.S. for so long that surely their day in the sun is coming.

There it is; my simple projection for 2020. I project the S&P will end the year at 3,600, that bonds will make little or no money in 2020, and that there is a high likelihood that international markets will outperform U.S. markets. Simple and sweet, but the same basic concept. Equities will continue to be the best performing asset class of them all in the coming decade.

On that note, come 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