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Category: Economy

Waiting for Godot?

The chorus of investment pundits calling for an end to the current US stock rally has grown larger and louder and yet, the market continues higher. Let’s examine why a correction will happen, why predicting it is hard (and potentially hazardous to your portfolio) and how we think about it.

Corrections have a strong track record of showing up (unlike Godot), as part of a normal market. A correction is commonly defined as a -10% decline. The average intra-year decline is historically -14%. Even in positive years, it is unusual not to experience a mid-to-high single digit decline. (See chart).

We have been waiting for a correction (like Godot), but not for very long. The last S&P 500 correction began in the summer 2015 and hit its low for the year in October. The drop happened to be a decline of about -12%. From November 2015 until February 2016 the market again took a double-digit dive. Since then the market has climbed +33% with fresh highs being set on July 12, experiencing one measly -6% drop along the way.

Based on history we expect a correction to occur before the end of the year. However, timing and duration are elusive and we are not trying to predict it. A correction may be triggered by almost any event – Fed Reserve action, oil prices, a poor jobs report, or a geopolitical incident. Rather than trying to guess the timing, the key is to understand the drivers of any correction in order to assess new investment opportunities.

Post-election Views or Much Ado About…

Well, we can’t say nothing. We aren’t going to rehash the election surprise. What we will do is share our views on the post-election market behavior, outline a possible scenario and actions we are considering and what we will be watching for over the coming months and years.

What happened? Virtually no one in the financial world predicted a rally immediately following a Trump victory, which also very few people predicted. For the record, the S&P 500 opened the day after the election, November 8, at 2130 and closed at 2182 on November 16. This equates to a +2.4% rally that leaves us just below the all-time market highs hit this past August. Now the underlying story is a bit different. During this same 8-day period financial stocks, particularly banks, rallied over +10% and some individual stocks by close to +20%, but many tech companies like Amazon fell by -3% or more. Healthcare and bio tech have also experienced a nice bump up. Bond prices have been knocked down driving yields on the 10-year Treasury bond from 1.88% to 2.35%; right at the 1-year high.

It’s important to note that other than bank stocks making a very decisive move up, none of these numbers are, in and of themselves, eye-catching from an absolute perspective. We have seen most of them in the past 12 months.

What do we see driving this behavior?  Right now we surmise the biggest driver is speculation on the third derivative of policy expectations. It is clearly not investing based on observed facts. Many market participants have made big rotations based on policies President-elect Trump hasn’t made clear, haven’t been implemented and whose effects are just hypotheses, i.e., speculation on the third derivative. Here is a summary of the big themes:

  1. Bank regulations get relaxed or go away so banks are more profitable
  2. Obamacare gets changed or eliminated and capping drug prices is not on the agenda, helping health care and biotech companies
  3. Fiscal stimulus, primarily through infrastructure spending goes up, international trade gets choked off, taxes are lower, all driving inflation and interest rates which helps banks and generally hurts bonds.

Now we don’t argue that these sound directionally right. However, the market movement was quick and in some areas sharp. Quick and sharp are not words often associated with governmental change and therefore we believe the market has over-reacted.

What do we hypothesize will happen over the next 12 months?  Here is a working, third derivative hypothesis, roughly in order of our conviction. It is not precise as we are using the third derivative —  think compass orientation not laser targeting.

  1. We get fiscal stimulus and lower taxes
  2. Rates and inflation rise, but not dramatically
  3. Bank regulations get tweaked not thrown out
  4. The economy improves a bit.
  5. Obamacare gets changed. What’s the effect? See the third derivative, i.e., who knows?

So what are we doing?  We have not been making major investment decisions. As investors, not speculators, we don’t react to quick market moves driven by assumptions from third derivative hypotheses. We are spending a lot of time looking at how we implement our existing overweight positions to technology, healthcare and biotech. We are also looking at financials as a possible overweight. We have been selectively adding to real asset positions due to higher expected inflation and what we believe has been undo pressure on REITs and our infrastructure positions. We have been selectively selling out of some fixed income positions.

What will we be watching? We will be watching measures of economic activity that might indicate a coming recession because we haven’t had one in over 7 years. We will be looking for dislocations in the market to add/rebalance to core positions. We will be listening and looking for real policy statements and activity that give us a better idea as to how those policies will eventually be implemented. We are particularly intrigued to see what happens to US Treasury rates as they will be a good indicator of how the world judges the relative safety of our markets versus all others.

In dealing with the next few years, it will be best to embrace Confucius’ blessing (curse?): “May you live in interesting times,” and to maintain a diversified and carefully monitored portfolio. 

Wisdom From Clients: Is The Economy Like A Good Stew?

When I was thinking about moving over to the wealth management side, a friend said it would fit me because he felt at heart, I am a teacher. I guess there is some truth to that. But like every good teacher I learn a lot from my students, who are my clients.

Low and slow. It’s a food movement people have embraced. It creates dishes that fall into the comfort category: brisket, stew, ribs. It’s also a phrase that describes the economy, but we don’t take comfort when it’s applied here. In a recent client meeting I used this often heard phrase and noted that many feel frustrated with this pace of growth. My client, a physician, asked, “Isn’t low and slow more sustainable?” I didn’t have an answer but it is an interesting question from someone who isn’t eyeball deep in economics and investments every day.

When I think about low and slow beyond the economy it occurs to me that in most of life, low and slow is something we are encouraged to strive for. When life and work start to fray our patience and sap our energy we are told to slow down or we will burn ourselves out. When we are trying to learn a new skill we are told to take our time. As a fly fisherman, one of the big killers to my cast is rushing. Same is true with a golf swing.

Mindfulness. Being present. Meditation. You can’t go more than a few days without reading or hearing about the benefits of these actions for our personal lives and our business lives. They are supposed to help us be more at peace with ourselves and more productive. For the most part they require us to slow down.

Yet the economy is reviled for its low and slow pace. I’m not arguing that wage stagnation, the growing income gap, or unemployment for people left behind by technological change are positives. But what if this is it? What if my client, who happens to be a Buddhist, is on to something? What if this low and slow recovery is actually more sustainable than our boom and bust past? And what if it causes us individually and collectively to reduce our focus on consuming more and instead turn our attention to our health, our families, our communities, maybe our environment? Sure there are a lot of other elements to healing our country but, what if a low and slow economy became accepted and we started to pay attention to other parts of our lives? Given all that ails our world and our country this might be a good thing.

Low and slow is a recipe for great food. Usually simpler but, satisfying food. It’s the kind of food that brings us together with friends and family and helps us appreciate what we have. Maybe low and slow is the recipe for an economy that is important but, not so dominant that everything else that makes a satisfying life is overshadowed by it. We assume low and slow is a bad thing, but is it? Just like that stew that needs to simmer all day, maybe it’s too soon to tell how satisfying it will actually be.

David is a Principal at Nauset Wealth Management helping clients achieve their financial goals through comprehensive financial planning and investment management, and frankly, just carrying the worry for them. He has a particular expertise in working with professionals from the investment management industry.

Author: David Bauer
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Tags: Economy

How to Get Something Good Out of this Market…

Let’s face it. From an investment perspective this year bites. Traders are kicking the market around like drunks playing hacky sack. Suddenly cheap oil is a bad thing. New home purchases are good but new unemployment claims are marginally bad. Consumer confidence good! Manufacturing bad! The Fed probably feels drunk pondering what’s more important: the wealth effect or getting some ammo in the recession gun?

The market is trying to figure out what it will pay for a low growth economy when there aren’t many investment options. We don’t see a ton of upside in U.S. stocks  this year, and we do see the potential for more downside in the near term.

What were we doing this week? Some repositioning and grabbing a real return out of this market by tax loss harvesting. And in a world where there are multiple ways to express most of the positions you own you don’t have to lose the exposure if you don’t want to. 

So while the tape is looking mostly red, bank some green.

Author: David Bauer
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Tags: Economy