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In celebration of the Thanksgiving holiday, the offices of Rollins Financial and Rollins & Van Lear will be closed on Thursday, November 27th and Friday, November 28th. Our regular office hours will resume on Monday, December 1st at 8:30 a.m.
If you require immediate assistance during this time, please contact Joe Rollins at 404.372.2861 or jrollins@rollinsfinancial.com. And don't forget to check out our new website.
Be safe, have a wonderful thanksgiving and please know we are very thankful for you!
Warm Regards,
The Staff of Rollins Financial
From the Desk of Joe Rollins
October was clearly a volatile month. Although the stock market had been soft during the latter part of September, it really became unpredictable during October. This is not terribly unexpected, but at the same time it does not happen on a regular basis. As corporations start to announce earnings, the traders that make their living in volatility hedge their bets against whatever the companies will eventually announce. At one point during the month, the broad market was down to almost 10%. It got so bad that I even wrote an interim blog Conundrum where I indicated that even though the market was volatile, the underlying fundamentals were intact and there was no reason to abandon the market due to this volatility.
Looking back at that period in the middle of October, it was a scary time for many investors. However, having watched the markets for close to 40 years, these volatile times are not a rarity. Once volatility begins, it is important to understand why, and whether it is something you need to be afraid of or should just ignore.
As the end of the month rolled around, it was clear that my message to investors in “Conundrum” was correct. After all was said and done, the market rallied back to fully recover its 10% decline and actually ended up positive for the month of October. Who would have ever thought in the extraordinary volatility of mid-October that we would actually end the month in a positive light?
For the month of October, the Standard & Poor’s Index of 500 stocks was up 2.4%. The NASDAQ Composite grew 3.1% and the Dow Jones Industrial Average was up 2.2%. Even the beleaguered Russell 2000 was up a stunning 6.6%, which was the best of all the indexes. The S&P 500 is up 11% for the year as of the end of October and up 17.3% for the 12 months ended October 2014. The NASDAQ Composite was up 11.9% for the year 2014 and 19.6% for the year ended in October. The Dow Jones Industrial Average is up 6.9% for 2014 and up 14.5% for the 12 months ended October 31, 2014. In contrast, the Russell 2000, which has been extraordinarily volatile, is only up 1.9% for 2014 and only up 8.1% for the 12 months ended October 31, 2014.
Just so you have a basis for comparison, it is also interesting to see that the Barclays Aggregate Bond Index was up 1% for October and continues to be up 5.1% for 2014, but only up 3.9% for the one year ended October 31, 2014. While many people hide out in bonds in order to avoid volatility, we are almost certainly in a rising interest rate environment.
When interest rates rise, bonds move down. The Federal Reserve has already announced that they will begin increasing interest rates in 2015, and it would not surprise me to see rates move up faster than most people expect. As I will illustrate below, the economy is quite good and it is only a matter of time before the Federal Reserve begins moving interest rates up to offset an economy that might end up being “too hot.”
I recently spoke at a seminar on investing and thought I would go back over the years and illustrate why market timing is an absolute waste of time. When I first became active in investing in 1987, we were all crushed by the market crash on October 21, 1987. In fact, I saw many so-called experts using this time during October 2014 to surmise that the market would go down as much as it did in 1987. On that day in 1987, the Dow Jones Industrial Average went down 22% in one day. For those of you who are not familiar with this time, that was 22% in just one trading day - not a week, month, or year. Please look at the chart below illustrating this dramatic activity.
I have identified on the chart below when the stock market crash of 1987 occurred. On that fateful day, the Dow Jones Industrial Average ended down at a level of 1738. Today, the Dow Jones Industrial Average is 17,380. That means that the market has gone up tenfold since 1987. For those of you interested in statistics that is 1,000% higher than it was in 1987.
I started this blog by quoting Peter Lynch, who was maybe the most famous investor of our lifetime. Peter Lynch managed the Fidelity Magellan fund through some of its most successful years. I have read all of his books and enjoy his writing. The most important thing I like about his writing is his simple way of understanding the futility of trying to time the market. His philosophy is to buy good companies and the market will take care of itself. One of the most famous quotes relates to his position that you cannot predict the economy, interest rates, and the stock market. As Peter Lynch said, " If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes." I also enjoy the following because it is so true - “It’s only three dollars a share, what can I lose?” to which Peter Lynch replies, “Three dollars for every share you buy.”
While it gives me great pleasure in writing the words that my blog of October 15th was correct, I do not find joy in seeing my clients make moves that are not beneficial to their investment future. I wish I would have kept track of how many clients called indicating their concerns that the market was headed for a major correction. Despite very few of them actually making any moves after speaking with us about the markets, it still bothers me that clients are not evaluating true economic data, and choose instead to give weight to some of the ridiculous proclamations of so-called knowledgeable people in the financial press. If you are ever having a hard time evaluating data, please give us a call as we certainly would love to discuss it with you.
While writing this, I am reviewing the financial and economic issues in the US today. Clearly, there is no indication of a weakening economy when you read that the durable manufacturing is up 6.42% over the last one year, and capacity utilization borders on a full capacity 80% with a reading of 79.3% for September of 2015. Manufacturing is extraordinarily strong and that is a positive. Also, exports increased 4.5% over the last one year, even in face of a dollar that is strengthening dramatically due to the strong US economy. We hear so much about employment and the employment participation rate that it obscures the actual facts. While it is clear that there are way too many people living off government subsidies, employment has dramatically improved over last year.
Over the last two-year period, we have added almost 4 million new jobs. This is a significant number since this is 4 million people that can now contribute to the economy by buying goods and services, which improves gross domestic product. Virtually every aspect of employment has improved over the last year, although I don’t believe the unemployment rate is truly 5.8%, as the government reports. While certainly better, who knows exactly how good it is at the current time. But what I do know is that these previously unemployed 4 million Americans will now be contributing to improve the economy.
Earnings for the third quarter of 2014 were up almost 10% over the identical quarter in 2013 and interest rates continue to be zero or lower and as illustrated above, the economy continues to be strong. It is interesting to note the rate of inflation was recently announced at an annualized 1.7%. However, many of the people reading this posting today have funds in money market accounts earning zero and CDs earning less than 1%; having money in cash today means that every single day you are losing money to inflation as the cost of living grows.
I have indicated in multiple postings that the market will reverse when one or more of the indicators of interest rates, earnings, and the economy change. Currently, all three are positive and are increasing. When I wrote the blog “Conundrum” in mid-October, I had absolute confidence whatever was happening would not affect the stock market in a dramatic way. You may rest assured though that I have no pretense about predicting market crashes. No one can, no one will, and it is unlikely that I will even try.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
On Broadway, most musicals and theatrical shows will have "previews" that are performances that allow the director and production team to make changes or for the cast to become settled in their part before the show is attended by theatre critics. Generally, you won't find much difference between a show in previews and when it is technically "opened," but much like Broadway, even The Rollins Financial Blog can at times have technical glitches. Our last blog, "Broadway Junkie," for some reason had issues with the photos not appearing in the email that was sent. We believe that everything has been fixed for this "Take Two" edition - but if not, please click here to be directed to the website to view the post and pictures completely.
From the Desk of Joe Rollins
I realize that I have not written my investment report for the month of October, which was a very volatile month on the stock market, but intend to do so later this week. In the meantime, I thought I would give you an update on my recent trip to New York, which is a lot more entertaining. Suffice it to say that the month of October, even while extraordinarily volatile, ended up being an excellent month for the financial markets. Also, November has started out strong, so we are progressing nicely into the most successful part of the year for the stock market, which is the November through May financial year. As I mentioned, I will cover each of these items at a later time.
About this time last year, I wrote 48 hours in The Big Apple. This year I made another trip to the Big Apple, not only for the Baron Investment Conference but also to attend as many Broadway plays as I could during a three day weekend. To see four Broadway shows and get the most value for my money, I attended a play on Thursday, Friday, and Saturday night, along with a matinee on Saturday afternoon. Flying back to Atlanta early Sunday morning, I knew it would be a busy weekend but well worth it.
While I was there, I also had the opportunity to visit the 9/11 museum. If you have not been and ever get the opportunity to do so, you should certainly make a trip down to Lower Manhattan. They have recently opened the museum and the new 1 World Trade Center is open for business (picture below). While certainly not as impressive as the preceding twin towers, it is still pretty overwhelming if you have never seen it up close and personal.
During the day on Friday, I attended the annual Baron’s conference, which is always a treat. Not only is the financial part of the conference good, but it is held at the Metropolitan Opera House and always features big-name entertainment to break up the monotony of discussing the stock market. For lunch, I was somewhat surprised to see they had the entire New York Symphony Orchestra performing. There were at least 50 musicians and 20 singers to perform the songs from the famous Show Boat musical composed by Jerome Kern. While certainly beautiful and Broadway related, it is just not my cup of tea. After a short while, I left that venue and headed over to see country star Carrie Underwood perform. Given her relatively short time in the limelight, she really is an excellent performer. The concert was all Broadway mixed with Hollywood- laser lights, the entire works... And yes, it is true… she is pregnant, and it shows.
Ron Baron was as excited as the rest of us to announce that the entertainment for the afternoon would be Paul McCartney. And believe it or not, I sat in the very first row, less than 10 feet from one of the greatest musicians of all time. Having grown up in rural Southwest Virginia, to a very humble life, I would have never dreamed I would be afforded this opportunity. Due to their influence on my during my high school years, no one was more famous to me (and many others) than The Beatles. For years we could not believe the success and the honors that The Beatles accumulated in the United States. Who would have ever thought that forty years later I would actually be within 10 feet of Paul McCartney? He performed many of the original songs, including “I Want to Hold Your Hand” and “Hey Jude”. I can report that even today, Paul McCartney at age 72, sings as well as ever. It was certainly a thrill beyond belief to see him perform so up close and personal.
I even love the old playhouses on Broadway, with their uneven floors, seats too close together, and inadequate restrooms. When they built the Marriott Marquis in Times Square, they had to tear down many of the original playhouses. This caused such a public outrage that the city of New York made all of the original playhouses “historic buildings”. Due to this historic designation, apparently playhouses cannot be renovated or updated. And despite everything wrong with these venues, I truly love them and hope they never change.
On Saturday afternoon, I went to my 11th viewing of the Jersey Boys – and am already looking forward to my 12th. This is sheer energy and talent with a bunch of unknown actors, singing songs that were recorded almost 40 years ago. There is nothing more enjoyable than to see the story unfold, surrounded by the fabulous music of The Four Seasons.
There is one scene in the musical where the character playing Frankie Valli does a solo version of “Can’t Take My Eyes Off of You”. At the end of the song, the 2,000 people in attendance all stood at once to applaud; and I have never witnessed a time when the audience’s reaction was not the same after this song. The only time I have seen anything comparable to this reaction on Broadway, was when I saw Michael Crawford and Sarah Brightman perform The Phantom of the Opera in 1990. In the original run of the Phantom, these two best known performers literally brought the audience to their feet when they sang the lead song. I know it is an exaggeration, but I still believe it to be true: the house shook. I have seen Phantom of the Opera at least 10 times and that was by far the best.
Finally, on Saturday night I attended the most recent version of Les Miserables. I have actually seen Les Miserables nine times, in nine different versions - including 3 times in London, once in Atlanta, and now 5 times in New York. This was an updated version and the production was pretty spectacular. Once again, young kids expressing enormous talent and no big-name performers. As the performance progressed, all I could think about was how poorly the movie was in relationship to this. It seems pretty silly that the movie was made with million-dollar actors, none of which could really sing, and here before me were these amazingly talented, young kids performing extraordinary songs while earning virtually nothing.
In summary, this was definitely a whirlwind tour of the Big Apple this trip. Four Broadway plays, Carrie Underwood, Paul McCartney, and most importantly the 9/11 museum. You could not have squeezed in an additional event over the two and a half days I was in New York.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
From the Desk of Joe Rollins
The stock market has sold off for the last three weeks for a lot of different reasons, which I would like to try to explain from my point of view. Anytime there is a large movement in the market, I attempt to analyze the underlying issues to determine if the issues are real issues or issues just perceived by the public. There is absolutely no question that when the market goes down, everyone feels pain. The question for us, as investors, is whether we need to change what we are doing or whether we should maintain our positions and wade through the downturn.
First, this may be hard to absorb, but the market movement has actually not been as bad as the public perceives. The S&P is down only 8.5% from its all-time record high. You have to have a movement of 10% or greater to realize a correction; we have not reached that level yet. I realize that we could reach that level, but as of Thursday morning, the market is holding strong at that percentage.
There is no question in my mind that the major driver of the downturn is the fear of the Ebola virus and it’s potential to spread. While watching the news at 4:30 a.m. yesterday morning, it was announced that the most recent Ebola patient was allowed to fly on a commercial airline with the permission of the CDC. Almost immediately after that announcement was made, the Dow futures dropped over 100 points. The panel of commentators on the financial show all expressed fears that an Ebola epidemic would cause the public to limit their actions insofar as going out or traveling. In other words, they are afraid that people will stop going to movie theaters, stop going shopping (which in turn they forecast as negative news for Christmas sales), and they would certainly stop flying. But when you consider that there are only two people in the United States, of which we are currently aware, to have contracted the virus from a population of over 300 million, that seems to be a fairly extreme position in my opinion.
The other major driver is that the price of crude oil has dropped from over $100 per barrel down to about $80 per barrel. The argument here is that a lack of demand for oil signifies an economy in a downturn. If there is no demand for oil, either the consumers cannot afford it or businesses are suffering so much that there is no demand for fuel for trucks and other industries. While certainly that might be the case in Europe, there is no evidence that is the case in the United States. In addition, the strengthening dollar, as I will discuss below, has an effect on the price of imported oil, making it more expensive. Consequently, oil production in the United States is more attractive, since there is not the high cost of transportation from the Middle East. Frankly, our energy prices are not a negative to me; in fact, it all sounds fairly positive.
We have been talking for years about the very important economic effect of higher production of energy in the United States. It has been somewhat surprising that that this additional production of crude oil did not lead to lower prices for consumers years ago. In fact, we expected to see lower prices much sooner than now.
So is this reduction in crude oil prices due to oversupply and economics of demand/supply, or is it in fact due to the upcoming recession either in this country or in Europe? Certainly there is no evidence of the downturn in the economy in the United States, so you have to think that it is mainly due to supply and reductions in demand.
It appears to me that the fair price for oil is somewhere around $90 per barrel and it must be realized that the price of oil can only go down so much. When the price of oil reaches a level of the cost of production, the wells will just be capped. When you use fracking to extract oil from shale, your cost of production is much greater than under normal extraction techniques. Therefore, it does not seem that the price of oil could fall much lower than it is today.
The positive spin on the low price of oil is that this is a huge benefit for the consumers. If consumers have lower gasoline prices and lower commodity prices, that is good for everyone. Virtually every industry uses energy in some form or another, and lower prices are good for everyone.
The other major concern is the strengthening dollar. Once again, this should not be much of a surprise to anyone. The 10-year treasury bond in Germany is at 0.8%, less than 1%. It should not surprise anyone that people from Europe are investing their dollars in the United States, where the interest rates are much higher, even at the miniscule rate of 2% annually for a 10-year treasury bond.
It is true that when the dollar strengthens, U.S. companies that sell products to international consumers are less competitive while selling outside of the United States. Many of the S&P 500 companies receive a significant portion of their revenue base in a foreign currency. While it is true that these prices will definitely go up and make them less competitive in other countries, it also positively impacts all assets held in the United States based on U.S. dollar terms. It also brings back money from overseas to the United States, which also increases the value of the dollar. Of little notice is that many companies hedge their currencies. Much of the manufacturing takes place outside of the United States, and then products are shipped to other countries outside of the United States. In return, this (in dollar terms) should not greatly affect profits of corporations.
The other major concern that is affecting the market is the deterioration in the European economies. For many years, the European Union has been fighting over whether they should stimulate their economy with government support, or whether they should allow economies to sink or swim based upon their own momentum. The cost of government in Europe is well over 50%, and therefore it is hard to affect pricing when the government controls so much of the economy.
In France, Italy, and the smaller European countries, they are begging the government to stimulate the economy, while Germany refuses to participate. Of all the European countries, Germany has the tightest grip on their economy and is scared to death of inflation. European economies are basically functioning at a breakeven GDP, there is certainly no evidence that those countries will spiral down into a major recession. While European economies are weak in comparison to that of the United States, it is hard to imagine that this would have a long-term effect on the U.S. economy.
I have written many times in these blogs that you can expect a 10% down movement in equity markets, either up or down, at any time. Over the last 50 years, there have been 30 times when the markets have moved at least 10%. With that being said, it is not an unusual circumstance. That does not mean that we do not take this movement seriously. We watch it every day and study the fundamentals to determine whether a change needs to be made in our basic investment philosophy. For the period ended September 30, 2014, the S&P was up 19.7% for the one year period. Therefore, even with a 10% move down, the S&P would still be up almost double digits over the last year.
In analyzing the fundamentals, it is important to make sure that something has not changed that we need to address. I constantly review economic reports and earnings to determine whether some adjustments need to be analyzed. It is just unusual to see a movement this large without some sort of economic reason. Certainly, if you are in the camp that you believe Ebola is going to develop into a pandemic throughout the United States, then of course, there is your economic reason. The effect of lower oil prices, the stronger dollar, and the mild economic weakness in Europe certainly would not have the same negative economic ramifications.
What is interesting is that all the economic fundamentals are clearly intact. I have been watching corporate earnings very closely over the last couple weeks, and all of them appear to not only be strong, but above expectations. Interest rates have fallen to 2% on a 10-year treasury bond, which in return helps all aspects of the economy. Now consumers are realizing lower mortgage payments, and every facet of credit is cheaper due to the lower rates. The economy recently appears to be on track for 3% GDP growth, which by no definition would indicate any type of weakness. Therefore, the three components that we analyze to determine whether stock prices are reasonable are all intact: earnings are great, interest rates are low, and the economy is stable and growing. Therefore, fundamentally, there is no change from our opinion that stock prices should move higher.
An explanation is needed to understand the fundamentals of momentum traders. The so-called “fast money” moves strictly on momentum and not on fundamentals. They move a market in the direction of what the trend is, either up or down. When you see the large volume that occurred in the markets on Wednesday, October 15, 2014, you realize the fast money, or momentum traders, were involved. Due to the huge volume that occurred, it could only be them trading in such enormous share volumes.
This is not to say that these momentum traders would not have an effect on the overall market at the end of the day. On the other hand, it does prove that it does not reflect fundamentals. Therefore, it is probably not relevant for future stock prices.
The conundrum for investors (such as us) is whether we should make a large fundamental change in our positions to accommodate a short-term scare or momentum traders changing the direction of the overall market. The fear, of course, is that being uninvested, the momentum traders could shift gears and the market could go up as much as it is down over the same relevant time period.
When momentum traders sell the market, they usually do so with a technique known as shorting the indexes. Along with any other investors, the traders only have so much capital to work with, and therefore are limited as to how much they can move the market. It is inevitable that at some point they would have to cover the shorts, meaning they would buy the indexes to cover the shorts. This unwinding of the shorting technique creates upward pressure on the market, which is positive. Since the moves by the momentum traders are designed to make short term profits, none of these transactions will happen in the long-term.
In summary, after a review of all the fundamentals and the underlying economy, we have made an election to hold our position and watch it for a few more days. That does not mean we will not change our opinion tomorrow, but today (Thursday, October 16th) it appears that the fundamentals are intact. Interest rates tend to be low and the threat of Ebola is so small that it is virtually meaningless. Of course we would be more than happy to notify you if our thoughts change.
If you are still feeling uncomfortable regarding the movements in the equity market, even after reading this, then please give us a call and we would be happy to discuss it with you and update your portfolio to reflect any conservative path you would prefer to take. In the meantime, as I write this post, the market has rallied back to breakeven, which is a positive compared to the last several weeks.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
From the Desk of Joe Rollins
I know the title of this blog may sound confusing, but I will explain it later in greater detail. However, I wanted to begin by saying how happy I am that we finished the third quarter financially unscathed, and express how much I am looking forward to the fourth quarter.
We just experienced a quarter that had at least six ongoing wars (Syria, Afghanistan, Libya, Iraq, Israel and Palestine), an invasion by superpower Russia into Ukraine, an outbreak of an infectious disease in Africa, a total lack of confidence in the United States government and the executive branch, and we still finished essentially breakeven. I would say that’s not too bad! Oh, and let’s not forget the political unrest in Hong Kong and the ISIS beheadings – need I say more? Historically the third quarter is always the worst quarter of the year financially, principally due to the fact that many stock market traders do not work during the summer months. Due to the low volume and vacuum of traders, even the smallest move can have an enormous effect on stocks.
For that same reason, the fourth quarter of the year is generally considered the best. It is a time when all the traders come back to the floor, and a flood of new money comes into the stock market by way of pension plan investments. While somewhat scarce in the third quarter, the fourth quarter tends to evoke a frenzy of trading. There have been many studies that indicate if you stay in the market from November through May, and leave the market June through September, you will have captured all of the gains in history. Maybe it’s a mere coincidence or maybe it’s just the nature of human beings trading in a competitive market. Whatever the reason, the fact that we got through the third quarter essentially breakeven is pretty good and very exciting for the upcoming quarter.
Before addressing the seemingly inane title above, I wanted to provide you with the finishing results of the third quarter. For the quarter ended September 30, 2014, the Standard & Poor’s Index of 500 stocks actually had a gain of 1.1%. For the year, the S&P 500 is up a very satisfying 8.3%. While September was down and extraordinarily volatile, the fact that the major market index ended up positive for the quarter illustrates the underlying strength of the equity markets.
For the third quarter, the Dow Jones Industrial Average was up 2.0%, and reflects a 4.7% gain for 2014. The NASDAQ Composite was up 2.2% for the third quarter and is up 8.6% for the year. Even the much maligned Barclays Aggregate Bond Index finished marginally higher for the quarter and up 4% for 2014.
As I have pointed out before, the Russell 2000 Small-Cap Index is continuing to get crushed this year. For the third quarter of 2014, it was down 7.4%, incurring a stunning 6.1% loss in the month of September alone. For no reason that I can discern, this index is down 4.4% for the year. Rather than try to be a hero, I have sold virtually all of our small-cap index funds and will look to reinvest again at the beginning of next year. There is certainly no reason for this broad-based sell off of the small-cap index, but you cannot just stand in front of a moving train… you need to get out of the way and let it settle.
While attending public speaking events, I am often asked why we do not invest in gold and precious metals. The principal reason is that there is no way to evaluate what a fair price is for gold. If there was ever a quarter that justified an increase in gold prices, it would have been the third quarter of 2014, inundated with its many crises. However, surprisingly gold was down a stunning 9.0% for the month, and now shows negative returns for 2014. Although many have been taught that you should invest in gold during world crises, it is proven here that any type of quantitative analysis is not followed by fundamental performance. Thus our decision to steer clear of such investments...
September was a particularly bad month for virtually all of the financial markets with equities, bonds, precious metals, natural resources, etc. all ending with losses for the month. Often when I see these types of months, I wonder whether this is a fundamental economic change or if the lack of volume exaggerated the losses and therefore really does not mean much. However, the foundation is set for higher stock prices going forward. As the title of this blog indicates, there certainly must be a pony in there somewhere.
I am often reminded of the joke that President Ronald Reagan always referenced. It certainly was not a joke that was created by him, but overnight the term became an international sensation. Looking back, it is hard to believe that it has been close to 30 years since Ronald Reagan was president and used this joke to illustrate the difference between an optimist and a pessimist. For those of you that do not remember the joke, I will quote it in its entirety to illustrate how clever it really is:
“The joke concerns twin boys of five or six. Worried that the boys had developed extreme personalities -- one was a total pessimist, the other a total optimist -- their parents took them to a psychiatrist.
First the psychiatrist treated the pessimist. Trying to brighten his outlook, the psychiatrist took him to a room piled to the ceiling with brand-new toys. But instead of yelping with delight, the little boy burst into tears. "What's the matter?" the psychiatrist asked, baffled. "Don't you want to play with any of the toys?" "Yes," the little boy bawled, "but if I did I'd only break them."
Next the psychiatrist treated the optimist. Trying to dampen his outlook, the psychiatrist took him to a room piled to the ceiling with horse manure. But instead of wrinkling his nose in disgust, the optimist emitted just the yelp of delight the psychiatrist had been hoping to hear from his brother, the pessimist. Then he clambered to the top of the pile, dropped to his knees, and began gleefully digging out scoop after scoop with his bare hands. "What do you think you're doing?" the psychiatrist asked, just as baffled by the optimist as he had been by the pessimist. "With all this manure," the little boy replied, beaming, "there must be a pony in here somewhere.”
This joke illustrates how I feel today. With so many negative occurrences in the world, it is hard to illustrate the positive that is occurring financially. While watching TV the other morning as the stock market futures were trading at an essentially breakeven level, it was announced that a nurse in Spain had contracted Ebola; almost immediately, the stock market futures sold off 100 points.
With close to 6 billion people on Earth, for the US market to react in this fashion just illustrates that there is little common sense or common logic being exercised in investing. As I have written so many times in so many ways - interest rates, earnings, and the economy hold the key to stock performance. When you have the trifecta of these economic indicators, as we do now, it forebodes a higher stock price in the coming months.
In an attempt to find the pony, you need to look closely in order to find the positive news regarding the stock market. You should actually be happy with all the negative publicity and criticism you see of stock investing in the newspapers and in the media, as the publicity actually might keep stocks from getting too far ahead of themselves. Every paper you pick up talks about over-extended investors and unrealistic valuations. Quite frankly, stock market tops are generally not made with negative stories dominating the media today.
Stock market tops are achieved when economic and market sentiment is overwhelmingly positive. When you see the stock market mentioned in a positive light on the cover of a major news publication, then you need to worry. Today however, the opposite is true. The majority of the headlines are negative and the media is focused on pointing out the negative.
Stock market tops are not reached when the economy is accelerating. Even though we had a negative GDP in the first quarter of 2014, the second quarter GDP rebounded nicely and ended with a sterling increase of 4.6%. It looks like the third quarter GDP might be in the 3.0% to 3.5% range and similar returns are expected in the fourth quarter. In fact, economists are forecasting the GDP to be even higher in 2015 than in 2014. It would be very unusual for the markets to top until the economy starts to turn down. Nothing we see today would reflect that reality.
The other major component of stock market performance is interest rates. The Federal Reserve has already announced that interest rates will not increase until 2015. There is no question that the Federal Reserve would have to move interest rates if inflation were to pick up or the economy were to accelerate out of control. Neither is the case today. The second quarter inflation report is up only 1.7% on a year-to-year basis. That is much lower than the 2.0% that is desirable by the Federal Reserve. In fact, the Federal Reserve would like to have inflation higher not lower, as it is today. I believe there is little chance that interest rates will increase over the next seven to eight months, and therefore, there are plenty of opportunities for stocks to improve during that time frame.
The most important component of stock prices is earnings. Earnings have been nothing short of spectacular and appear to be accelerating. The current forecast for the next four quarters for earnings are increases of 11.7%, 11.8%, 14.7%, and 16.7%. It is hard to even imagine that the extraordinary, record earnings that we are realizing today are projected to go up by double digits over the next four quarters. Stock market tops do not happen when earnings are accelerating. Stock market tops happen when earnings are declining or when a recession is in sight. Neither of those conditions exists today.
Therefore, in summary, it looks like, “Virginia, there might just be a pony in your Christmas!”
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
From the Desk of Joe Rollins
I recently just passed my 65th birthday and I am starting to realize as I get older how quickly time passes. It is actually hard to believe that the firm started in my living room in 1980 has just past its 34th birthday. I never had any intentions of being an employer, I just wanted to prepare tax returns correctly and that was the reason for establishing the firm. I saw so much that I disliked in large accounting practices, but mainly I disliked seeing my clients mistreated. Therefore, the origin of the practice began in a small bedroom in Fairburn, Georgia, and now 34 years have passed so quickly.
Below are two pictures from Ava’s first day of school at age two and age three. Not that it has anything to do with what I am writing, but if I do not put a picture of Ava in the blog, I am heavily criticized. It seems like only yesterday she was born, and now three and a half years old, she is probably at the peak of her intellectual ability.
The main reason why I wanted to make this point is because over the last year we have enjoyed extraordinary success by investing. For the one year period ended August 31, 2014, the Standard & Poor’s index of 500 stocks is up a sterling 25.3%. The NASDAQ Composite is even better at 29.1% and the Dow Jones Industrial is up 18%. Given that the rate of inflation is currently around 2%, there are very few times that you can enjoy a rate of return 10 to 12 times the rate of inflation. It is been an extraordinary year by virtually anybody’s standards.
I am asked almost every day, “When should I expect the large market crash?” During the month of July, when the market was volatile and traded to the downside, there could not have been more market forecasters predicting the ultimate demise of the financial markets. Do not get me wrong, there are plenty of reasons in the geopolitical arena that would lead to this conclusion. It is almost a war everyday throughout the rest of the world, and frankly things do not appear to be getting any better in the Middle East. Yes, a major war with Russia would have a terrible effect in Europe; however, I question whether it would have much effect on the United States.
As I wrote in the July blog, I did not think that the market volatility was much to be concerned about, especially since the fundamentals were still exceedingly strong. Also, I argued that earnings were great, interest rates were low, and the economy appeared to be on the upswing, and therefore, I did not anticipate a major move to the downside in the financial markets in July. I guess I was right!
The month of August was quite an excellent month for investing. The S&P 500 was up 4% in August, and is up 9.9% for the year 2014. The NASDAQ Composite was up 4.9% in August and up 10.5% in 2014. The Dow Jones Industrial Average was up 3.5% in August, and remains up at an excellent 4.7% in 2014. As comparison, the Barclays Aggregate Bond Index was up 1.1% in August, but still up an impressive 4.7% in 2014 for bonds.
Many times a week, I meet with you (clients) and I am always blown away by how impersonal and uninformed the financial advice is that others receive elsewhere. I guess there must be a chart out there somewhere that says if a person is of a certain age, they require a “set” combination of stocks and bonds, notwithstanding any other information. It is amazing to me that someone who has never met a client and knows nothing about their financial life, needs, or what their time horizon is, can recommend any type of investment protocol.
As a matter of fact, we have some clients come in and they have never actually spoken with their financial adviser. They deal with a salesman who sends some money off to some unknown location for investing. I often ask them if they had ever talked to the person who invests their money. Often times, the answer is no – they do not even know who that person would be. The big difference between the way we do things and the way other people invest money is that we attempt to fully understand the client’s needs and invest with knowledge, not off an investors’ chart that probably has not been updated in decades.
A thought popped in my mind the other day, my first recognition (of any type) of interest in the financial markets began in 1980. At that time, we were enjoying a new administration with Ronald Reagan during a time when America felt good about itself. We had gone through serious inflation during the 70’s and interest rates were totally out of control. I vividly remember when the 10-year Treasury rate nudged up against 16% in 1981. It is important that you understand how much interest rates affect financial markets. I am enclosing a chart below that illustrates the 10-year Treasury beginning in 1980 up to today.
In reviewing the report, you will note that interest rates topped out around 16%, and are now currently down approximately to 2.4%. However, if you draw a straight line, you will note that for the last 34 years, the trend in interest rates has always been lower. Therefore, unless you have a financial adviser that is as old as I am, they have never witnessed a negative bond market in their LIFETIME!
Even though interest rates in 2014 have been stubbornly low, this has been good for the financial markets, however bad for savers. Interest rates paid at banks are virtually zero, and if anything will continue to go lower – not higher. However, we know that the party is beginning to end. We know that interest rates will go up in 2015, we just do not know when. When interest rates start to move higher, there will be a large number of investors who are currently invested in bond funds, that will see a negative rate of return on an investment they were told was solid.
Maybe for the first time, a lot of financial advisers will see a negative bond market and really not know how to advise their clients. As we have for the last several years, we have avoided bonds since we anticipate the trend in bonds to be negative; no one knows the exact date or time, we think it is coming. In the meantime, since equities have been performing beautifully, there is no reason to take the risk that I believe bonds are today. This also goes for bond-like investments, such as real estate and some forms of utility stocks. Many of these financial instruments trade much like bonds, and will be adversely affected, as will bonds, when interest rates go up. Therefore, we have been trimming back our exposure in bonds and focusing more on investments in equities.
There is no question that the government’s manipulation of interest rates is helping the financial markets. Even through the U.S. Treasury at 2.4% is extraordinarily low, it is not as low as the 10-year German equivalent treasury. That current rate is 1%. Likewise, how could a country as economically unstable as Spain issue bonds with lower interest rates than the United States if it were not for government market manipulation? All of this is to say that governments can hold down interest rates for a while, but at some point market pressure will require higher rates. When those higher rates come, the principal of bonds will be endangered. Beware… you have been warned!
I saw an interesting article in Barron’s this weekend where they were analyzing market tops. The one that caught my interest was the market top of 2000, as compared to today in 2014. The most interesting aspect of this chart where, for the most part some are provisioned similar ratios existed, the huge differential was in the amount of the 10-Year Treasury. In 2000, the 10-Year Treasury was 6.2%; 4.7% in 2007; and 2.4% in 2014. Arguably, when interest rates are as high as they were in the prior years, an investor would have an incentive to move from equities into interest rate instruments. Today, moving from equities to the 10-Year Treasury would not be beneficial, since the 10-Year Treasury barely exceeds the rate of inflation today; much less over a ten year period.
Therefore, even though the markets rallied significantly during the month of August, I maintain my position that stocks will continue to trend higher as the year progresses. While it certainly may not be as dynamic as August, I do anticipate them to increase. It certainly would not surprise me to see a 3-4% additional gain between now and the end of 2014. Yes, there will be scary days and geopolitical events will shake our confidence, but do not read the front page of the New York Times to get your financial news. If you analyze interest rates, earnings, and the economy, you will know a lot more about the financial news than most people giving advice on TV.
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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