Thursday, November 17, 2016

"Every dollar released from taxation that is spent or invested will help create a new job and a new salary."

While doing research for this blog on the 2016 U.S. presidential election, I ran across some interesting quotes. I thought the one above was really interesting, so I did some additional research. Consider this is a quiz – can you guess which individual is responsible for the following quotes? Here is the first one: “Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased – not reduced – flow of revenues to the federal government.

Another interesting quote I found is, “In today’s economy, fiscal prudence and responsibility call for tax reduction even if it temporarily enlarges the federal deficit – why reducing taxing is the best way open to us to increase revenues.

One more: “It is no contradiction – the most important single thing that we can do to stimulate investment in today’s economy is to raise consumption by major reduction of individual income tax rates.

Okay, last one: “The largest single barrier to full employment of our manpower and resources and to a higher rate of economic growth is the unrealistically heavy drag of federal income taxes on private purchasing power, initiative and incentive.

After reading all of the quotes listed above, it became fairly clear to me why the U.S. stock market is rallying on the prospects of President-elect Trump’s proposed changes to the federal income taxing system. By now, I am sure you are thinking that that all of the above quotes must have been made by a very conservative Republican, designed to benefit the wealthy and not the poor. However, it could not be further from the truth. Each and every quote above was made by President John F. Kennedy during his short presidential time from 1961-1963. Even in those years, JFK, a Democrat, saw the economic benefits of lower tax rates. Unlike the last eight years where we have constantly faced higher taxes and larger government spending, Kennedy, saw the benefit of lower taxes, an increased economy, higher GDP and more jobs.

I can vividly remember the night that Ronald Reagan was elected President of the United States in 1980. Much like President-elect Donald Trump promises, Ronald Reagan, the former actor, believed that cutting taxes would clearly stimulate the economy and tightening of financial interest rates would slow inflation. The combination of the two would lead to unprecedented growth in the U.S. economy, and in subsequent years would benefit all of us with a better way of life.

If you go back and reflect on the record, you will see that is exactly what happened. During the 1980s, with lower taxes, the economy expanded and through the George H. W. Bush years and Bill Clinton years, the economy expanded with lower taxes, employment was full and the federal budget was balanced. In fact, for the 20 years from 1980-2000, the S&P 500 index averaged 17.88% per year for the 20 years – wow! To me, it does not look like you would need any more proof that lower income tax rates stimulate the economy and the evidence is readily available from the example mentioned above.

I will be one of the first to admit that I incorrectly called the outcome of the election, along with 99% of the polls on the subject. Believe me, it was quite a roller coaster ride the night of the election. As I sat in front of my TV watching the results come in, I kept my iPad open watching the futures on the stock market react. At one point, around the time of the Pennsylvania returns, the futures were down well over 800 points for the evening. Around midnight, some of the circuit breakers kicked in and reduced the losses. And when I got up the next morning after only a few hours of sleep, the futures were down 375. As we approached the opening of the market, I felt a little better but it was still down 250 points. Interestingly, the very first tick on the Dow Jones Industrial Average was actually up and not down. In fact, the markets over the course of the evening moved from roughly 17,500 to 18,700, up over 1,200 points. Over the course of 7-8 hours, we watched the stock market perform a 1,200-point swing.

It would be impossible for me to evaluate the social and economic actions of the President-elect as clearly none of us have any idea of what he will actually do once in office. People must keep in mind that it will be 90 days before he takes office and likely years before any significant legislation is passed. However, I find his economic proposals certainly encouraging for a higher economy and correspondingly a higher stock market, just as John Kennedy recognized in 1960 and Ronald Reagan in 1980. He is basically proposing that if we have lower tax rates and provide less regulation, we will subsequently have a higher GDP, a better economy and full employment. You may think that is wishful thinking, however, that is exactly what happened in both President Kennedy and President Reagan’s cases. As demonstrated in the last eight years, we now know that higher taxes and more regulation do not lead to higher GDP nor reduced deficits.

I find many of the proposals so obvious that it amazes me that they were not done years ago. Currently, all major U.S. corporations that have international operations do not pay taxes on those operations until they bring the money back to the United States. With the United States having the highest corporate tax rate in the world, it is no wonder that few of these corporations will bring their money back to the U.S. at the current 35% tax rate. One of the proposals under the Trump administration would be to tax this money coming back at a one-time 10% rate. It is believed by many experts that roughly $1 trillion would reenter the United States creating a windfall tax of $100 billion in only one year. In addition, this money would be used to improve U.S. facilities, pay dividends and compensation - all of which would create additional income tax to help the economy. This situation has been going on for years, but the government did not react to it, costing the United States plenty of lost revenues. This law will surely pass.

Balcony of the Speaker of the House - 1995

Ava and Josh - 2016

When you go back and reflect on the fact that the lower tax rates under the Reagan administration led to a balanced budget in the 1990s for the Clinton administration, you see the blueprint of the proposal that Trump is promoting. In reducing the federal tax rate for both individuals and corporations, there will be more money for taxpayers to spend to improve the economy and expand GDP. As President John Kennedy points out above, even though the rates are lower, the absolute dollars to the treasury would be greater.

Once the stock market realized that President-elect Donald Trump might actually win, they realized that a higher GDP would be better for corporate profits, and therefore a positive for the stock market. Almost simultaneously, there was a significant increase in interest rates and a rotation from bonds into stocks has already begun. With interest rates moving up above 2.2% on the 10-year Treasury, it is the highest rate so far in 2016. A higher GDP growth is most assuredly going to lead to higher inflation in the coming years and correspondingly higher interest rates. These higher interest rates should be great for the savers in CDs and money market accounts, but not for those investors holding bonds. Do we know this will actually happen? Of course not!

So, the most important part to watch during this new administration will be what exactly they are able to get through Congress and make effective over the short term. One of the benefits that Trump will have that has not been available since 2008 is a Congress comprised of only his own party. Now that the Republicans control the House, Senate and the White House, while still difficult, there is a high likelihood that many of the proposals that he made during the campaign will become law. Almost unquestionably, there will be a reduction in income tax rates for both individuals and corporations.

Using history as our guide, lower income tax rates will lead to higher GDP and profits, which will benefit equities. In addition, the President-elect has indicated he would be tougher on interest rates so we will likely see interest rates go up in the coming years. As interest rates increase, bonds move lower and the money escaping from bonds most likely will find its way to equities, giving them an added boost. We should also expect to see higher inflation in the coming years, which will benefit people holding real assets. Real assets include real estate, gold and other things you can drop on the floor that could hurt your feet. Higher inflation necessitates higher interest rates and again all of these are detrimental to bond investors.

The President-elect has also proposed massive infrastructure projects. These include building roads, highways, airports, etc. But just as President Obama found out in 2009, this is a lot simpler to propose than to implement. As we now know, these shovel-ready projects took years to implement and had little or no effect on the economy. As Gary Shilling said, “They haven’t even made the shovels yet, and they no doubt would be made in China!” It will take years.

The effect of all of these acts will almost assuredly increase Federal deficits, which will be a drag on future generations, but lower tax rates will be enough to offset the lack of revenue to the government with more people paying tax even at a lower rate. So, there is much to be seen as it affects the U.S. economy. Already, the effects overseas have been noted. The emerging market funds have lost roughly 6% only in the three trading days since Donald Trump was elected. Mexico, particularly, has been hit hard with the peso down 9% and the indexes representing Mexican companies now down 12% since the election. Of course, Asia, which was a perceived enemy of the President-elect, is also down dramatically, but the economics of the Asian economy will probably be more influential than the actions of any president. Currently, the Asian markets are 15% lower than their traditional averages and their earnings are higher. The emerging market companies are the cheapest index in the world, but are currently being pounded by the rhetoric of a president who has not even taken office.

I am not surprised that the equity markets have gone up since the election that was predicted by almost no one. If you believe that a new president can get his proposed legislation through, then it would be the natural assumption that equities must move higher along with GDP and correspondingly inflation. All of these are factors that lead to higher stock prices. Given the totally unexpected victory of President-elect Donald Trump, you would expect to see traders try to exploit areas of the market that they think would benefit from future legislation.

As always, traders tend to trade first and think second. Whatever happens in the legislation will be a slow process, even with the majority of Congress being controlled by the same party. Any income tax decreases are likely not to be effective until later years, certainly unlikely in 2017. As we know, shovel-ready projects tend to drag out for months if not years. Therefore, all of the changes that are being proposed are likely to not be as dramatic or as rapid as we might believe, and your temptation to trade on these possibilities will likely be time-challenged.

It is, therefore, my opinion that the best approach to investing, even with our new President-elect, is to be diversified along a broad range of investments that give you exposure to various asset classes. I fully expect that the international markets will recover shortly since they are too important to us to continue to drift down. Frankly I would be shocked if the President-elect is successful in proposing tariffs to foreign countries to import into the United States. While he has promised to improve the job possibilities in the United States by bringing manufacturing back from overseas, it will be a slow process and certainly not something that will happen over the short-term. Further, while it benefits all citizens to create more jobs in the United States by transferring manufacturing back here, it is a detriment to consumers who currently buy products built overseas but sold in the U.S. at a lower price.

Therefore, there is financial hope that we will enjoy a higher GDP going forward, but at this point, it is just a hope. A higher GDP will create a lot more jobs than tariffs that interfere with worldwide commerce. I think we will see a dramatic difference between the candidate Trump and the President Trump. Once he is in office and finds the obstacles of implementing legislation that is being proposed, a good deal of the current assumptions will be tempered by negotiation and time. Given the unknowns and the time necessary to implement proposed actions, I do not recommend any significant changes in any portfolios based upon these facts at this time.

We invest in companies and mutual funds that we believe have great long-term prospects. Nothing that happens over the next 30, 60 or even 120 days will have a dramatic long-term effect on these companies. Clearly, short-term traders try to benefit from these changes in economic circumstances and political change, but remember they are traders, not investors. As investors, the best course of action is to be consistent, diversified and conscientious of what is happening around you. Nothing I know today or have read in the hundreds of articles on the subject indicate anything other than to stay the course with your investment philosophy, but yet be aware of what is actually happening and hope that we all benefit from whatever actions are taken.

If our own history is a guide, the era of the 1980s-1990s is a good example. While deficits soared under Reagan’s reduced income tax rates, they led to much higher GDP, higher growth and in the end, higher revenues to the government. President Clinton was the benefactor of that increase in revenues to the government. By actions taken by him in Congress, we actually had surplus revenues during the 1990s. As compared to the last eight years of increasing taxes, I am optimistic that trying something different might be the answer to the deficit issue. Higher taxes have not even come close to reducing the deficit – so far.

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

Best Regards,
Joe Rollins

Tuesday, October 11, 2016

"What gets us into trouble is not what we don't know. It's what we know for sure that just ain't so." -Mark Twain

Every time I see the above quote by Mark Twain, I shake my head in astonishment because he was absolutely correct. Although this quote was penned in the late 1800’s, it is still very true today. Almost daily, I see some “expert” telling the world that certain events will happen and they are absolutely sure because it happened in the past. I find myself thinking, now there is a prime example of someone who knows something for sure and it just ain’t so.

Everyone who forecasted that the economy would turn into a death cycle this year and that the stock market would fall (for any number of reasons) has, thus far, been incorrect. Given the negative sentiment by the investing world and numerous world events that continue to keep the market in an uproar, the stock market has actually survived extraordinarily well. And despite it being difficult to find people to actually express it, this has been quite a satisfactory year financially.

I would like to cover several issues in this post, so bear with me. And because there is not a whole lot going on economically, I will be sharing a story that a client suggested I include in my blog: how I personally contributed to the fame of one of collegiate basketball’s best players of all time. I will also be addressing the end of the bull market, current economic news and other world events that I find most interesting.

Two of the most dangerous months of the year in the investing world are thought to be September and October. There are a lot of reasons for these particular months to perform below par, but principally it has to do with the lack of participation during the summer. As more and more people go on vacation, it takes less volatility to move the market in one direction or another. So if a certain group of investors tries to move the market, it does not take a lot of volume to make that happen, which in turn makes individual investors uneasy after summer’s end.

We are fortunate to have just ended the third quarter of 2016, and in all accounts, it was an excellent quarter. We survived the volatility of August and September and actually had a nice return for the third quarter. The year-to-date numbers for all the financial indexes have been very good, and contrary to the commentators’ words of doom, it appears we are in for a solid financial year in 2016. However, this is not the thinking of the average investor as there continues to be a record number of investors holding uninvested or underinvested cash. It is also true that interest rates are finally starting to move up, and the bond market that has performed so well over the last few years is now posting negative returns. All of this is interesting, but the reasons behind it are often hard to explain. I will try to cover some of these important points below.

Before analyzing the numbers for the third quarter, I thought I would share some pictures of Eddie Wilcox, partner at Rollins Financial, Inc., with his beautiful family.

Harper, Jennifer, Lucy & Eddie

Lucy (Age 5) & Harper (Age 7)

For the third quarter ended 2016, the major market indexes have performed admirably. The Standard and Poor’s index of 500 stocks is up 7.8% for the year 2016. The third quarter finished with a return of 3.8% and the one-year return for the S&P 500 is now 15.4%. These numbers are nothing short of excellent. The Dow Jones industrial average while negative for September is up 7.1% for 2016, up 2.8% for the three-month period ended September 30, 2016 and up 3.5% for the one year then ended. The NASDAQ Composite was up a cool 10% for the third quarter of 2016, up 16.5% for the one-year period and by far was the best performing index in the group. In contrast, the Barclays aggregate bond index was down 0.1% for the month of September, only up 0.5% for the three months ended September 30, 2016 and up 5% for the one-year period.

It is always interesting to look at the long-term returns for these indexes to get a better feel for the long-term returns. For instance, if you look at the 10-year returns, which include the negative year 2008, this shows you how strong the indexes performed despite the huge selloff in 2008. For a 10-year period, the returns are as follows: S&P 500 7.2%.; Dow Jones industrial average 7.4%; NASDAQ 10.1%, and Barclays aggregate bond index 4.4%. I think it is fairly clear and obvious from looking at the records, stock market investing should produce a return roughly double that of the bond index. Unquestionably, that comes with higher volatility and greater stress, but in investing, volatility brings long-term performance which is the most important goal of investing.

You would be surprised how many clients say to me, “The market has to go down because there have just been too many good years in a row.” I am not really sure where that philosophy was developed, but certainly the markets have no recollection of past events. The markets are controlled by earnings, interest rates and the economy. All three are excellent at the current time, and therefore there is no reason to assume that market would go down dramatically. Keep in mind that over the last 14 years, the S&P 500 has produced a positive rate of return in 13 of these years. There is no economic law that says there must be a down year since there have been so many good years.

One of the great investors of all time, Sir John Templeton, characterized the life cycle of market advances as follows: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” I think that is a good roadmap to explain where the markets are today. If you characterize his statement, it is absolutely clear that these markets are not driven by optimism or euphoria. In fact, the absolute opposite is true. You cannot read a single financial update without some noted forecaster, investor or speculator forecasting a major market down cycle based on reasons that even they cannot define. Therefore, in my reading of John Templeton’s statement, I would say that we are in the skepticism stage. While the market continues to move up on a regular basis, the skepticism could not be higher. The general investing public is skeptical of the market’s ability to move higher, even though they do not need the money for years, if not decades, in the future. I am confronted everyday by investors who say “I will invest in the market when there is a major move down; I want to buy at the bottom.” Some of those investors have been waiting since 2008 and the market is up close to 300%.

The other argument that the skeptic investors like to point out is that the market is expensive. Expensive is a relative term in my way of thinking. If interest rates were higher and you could get a 5% rate of return on a CD, there is no question that billions of money would flow out of the stock market and into those CDs. But the fact is, it just ain’t so. When a five-year CD is paying a little over 1% and the rate of inflation is closer to 2, that money invested in the CD loses buying power in the economy year after year. Therefore, if you evaluate the stock market at a period when interest rates are 5% as compared to a period of time where interest rates are approaching zero, certainly the fundamentals of the market would be changed if interest rates increased.

It is absolutely true that the price earnings ratio of the S&P 500 has risen over the last couple years. In fact, the price earnings ratio has moved up from 18 to approximately 21 times earnings. The question you would have to evaluate is whether or not 21 times earnings with a zero interest rate is high. I would argue that it is, in fact, quite reasonable priced.

If you look back over time, Zacks Investment Research has forecasted the price earnings ratio in the last 6 bull markets, they top at 30. As mentioned above, the current is roughly 21. If the S&P 500 was trading at a 30 multiple rather than a 21 multiple as it is today, then the S&P index would be 2,935, or 36% higher than it is today. Based upon prior history, this would tell us that even if overvalued, in order to reach levels where other bull markets have ended, the market would still need to move up significantly higher. There is no question that if interest rates moved up dramatically, this higher level would have to be significantly reduced lower. That is why we evaluate the market on an ongoing and continuous basis so that we understand exactly where the economy stands in order to evaluate stock market performance.

The most important component that we see today is interest rates. With interest rates being at all-time lows, other types of investing compare more favorably than do investments with stated interest rates. It is interesting how technology is changing the environment of interest rates. Due to technology, everything has gotten quicker, faster and, more importantly, cheaper than it was in the past. I would be shocked to see inflation move up dramatically in the coming years. In fact, it is very interesting that technology companies produce more and more and their costs continue to decrease. You can purchase a computer today significantly cheaper than you could have purchased one three or four years ago. There is no inflation in technology and that is reducing the cost of everything we buy. And while new cars today do things that were unheard of in those produced only five years ago, they are cheaper today than they were then.

The entire world is adopting technology for the betterment of us all and our personal budgets. Given the advancements in technology and the computerization of the economy, I would not expect to see inflation in the U.S. economy within the next decade. And if I am correct, we would not see a major increase in interest rates over the same time period, and therefore equity investing would appear to be more favorable than debt and bond investing.

Recently, I was telling clients about when I played basketball at the University of Tennessee. Not a whole lot was memorable during that time frame, but one particular incident stood out. At the time I played, freshmen did not play with the varsity. We, as the freshmen, played a game preceding each varsity game, which was usually attended by few. In most cases, when we started the freshmen game, the janitorial staff would still be cleaning up from prior events. As an 18-year-old kid out of Tennessee playing in 20,000 seat arenas was exciting but generally we played before few fans.

However, one team was completely different. The famous “Pistol Pete” Maravich was at the same grade level in college as I was, despite him being a year older. For those of you that are not familiar with Pistol Pete, he may be one of the most famous college basketball players of all time. Even though college basketball did not have the 3-point shot or the 30 second shot clock back then, he has the highest average of any collegiate basketball player of all time. He averaged 44.2 points per game over his three-year college career. One season, he averaged 44.5 points for every game in the season. Pete played three years at LSU prior to having a very successful but less memorable pro career.

Being 18 and not knowing a lot about the rest of the world at that time, I was unfamiliar with Pistol Pete’s reputation when we played the freshmen game at LSU in the old field house on campus. Contrary to our normal playing crowd, when we showed up to the arena to play our freshmen game, every seat in the house was full to watch Pistol Pete. In fact, after the freshmen game, most of the crowd left and did not even watch the varsity game. That night, we played a box and one, which meant four of our players played a zone and guarded the interior of the lane in front of the basket. One player was picked to guard Pete Maravich and it was me. Essentially, I was designated to chase Pete around on the court and do the best I could while the rest of the team just attempted to keep the game in control.

Even though I worked very hard that night to keep Pete down, he was an incredible player and scored a whopping 66 points against our team. He scored 66, yet the entire team only scored 88 and we won the game. As a freshman game, it meant nothing in the long-term scheme of things, but it meant a lot to my basketball career. It proved once and for all that I did not have the skill set necessary to play at a level of the Pete Maravichs of the world. Fortunately, I realized that early enough that I was able to resign from the team a year later and move on to other higher aspirations.

I got to know Pete a little when he was playing for the Hawks in Atlanta. At that time, he was not married and was pretty much a wild man enjoying the sights and sounds of Hot Atlanta. Subsequently, he was traded and later became very religious. He dedicated the remainder of his life to religion and would go around the country giving religious basketball clinics. At age 40, Pete had a massive heart attack and died. Even though he had been a spectacular athlete for most of his life, he was born with a heart defect that no one discovered and he subsequently died on the basketball court during a scrimmage. It is very sad that someone that physically fit and devoted to physical activity would die at such a young age to a heart condition.

Therefore, in the annuals of the legend of “Pistol Pete” Maravich, I could exclaim that I was helpful in making him the ultimate star that he was. They always made fun of his droopy socks as pictured above. The only time I saw those socks when playing basketball against Pete was after he had already passed me and was doing a layup.

As we look forward to the end of the investing year, you should be somewhat optimistic. The best time for investing is said to be during the span from November through May. That is not a statistical outlier, but is based on true economic facts. The principal reason why this is likely true is that corporations fund their retirement accounts generally late in the year and as that money is put to work the market goes higher. We have already enjoyed a very successful year so far, and I would anticipate that it will go up even farther before the end of the year. But there is a major change I am noting which we are now investing to capture.

After many years of lagging the U.S. market, it now seems the emerging markets are starting to catch up. It looks like China will have a GDP in excess of 6% this year, and India may be even higher. The economies of Brazil and Russia have been in recession but appear now to be breaking into the positive. Throughout the entire world, the economy is bottoming and starting to move up. Not in a big dramatic way, but more positive than in the past. Over the last five or six years, the U.S. markets have led all world markets in performance. Therefore, the emerging markets have a long way to go to catch up. You will note that we have been moving into emerging markets, emerging Asia and other worldwide funds to capture this catch up phenomenon. With interest rates low, earnings improving and the economy stable, I would be shocked if the international markets did not outperform the U.S. market over the next couple years.

With the holiday season coming up, it would be a great time to visit with us and learn more about what we do so that we can learn more about how you want to invest. Most importantly, if you have not made IRA contributions for this year, you should do so now. Every week, someone says “I do not want to do an IRA contribution because it is not tax deductible.” In summary, everyone should do an IRA yearly, regardless of its deductibility- whenever you have the opportunity to make money on a tax deferred basis, you should do so.

Ava is getting ready to see the Rockettes in New York City!

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

Best Regards,
Joe Rollins

Tuesday, September 13, 2016

Really, why are you so worried?

It never ceases to amaze me the level of concern that investors get over the slightest bit of short-term economic news. In the 40 years that I have been doing this, I have never really understood why investors get so concerned over an event that will affect the market over weeks or months, when in fact they do not need the money for years and years. Just exactly what difference does it make if the market goes down next week if you do not need the money until a decade from now?

When I first began in the investment business, the market fell 22% on one day in 1987. On that day, the Dow Jones went from 2202 to roughly 1700, and today it is close to 18,000. If you were to look at a chart from 1980 through 2016, you would note that the 1987 downdraft does not even appear in the graphic. It is just one continuous straight line up. For that 36-year period, the average gain is roughly 9% per year.

Yet, every day I talk with investors who seem to have a great deal of inner conflict about investing for one reason or another. I do my best to try to explain the basics of economics but quite frankly, in most cases, investors who have a preconceived notion cannot be convinced otherwise under any circumstances. Often times, their anxieties are based upon information from tabloid headlines. “The world is coming to an end”, “life as we know it will change”, “social security is bankrupt”, “the U.S. dollar is worthless”, and many more of which I will not bore you. I only wish I could invoke common sense when it comes to analyzing these outrageous tabloids designed to sell an agenda of one sort or another. Hopefully, I can help you to better understand these issues, and therefore invest better going forward.

Before I jump into the fun stuff, I thought I would share a few pictures of Robby and Danielle, two of the partners here at Rollins Group, with their family.

Reid, Robby, Danielle and Caroline

Reid - Age 1

Caroline - Age 2 1/2

The month of August was basically a “nothing” month from an investment standpoint. For the month of August, the Standard & Poor’s index of 500 stocks was up a miniscule 0.1%. However, year to date, it nobly stands at 7.8% and one-year total return at 12.5%. The NASDAQ composite was up a satisfying 1.1% for the month of August and up 5% for the year. It too has a double-digit one-year return at 10.5%. The Dow Jones industrial average was also up 0.1% for the month of August, up 7.5% for the year and up 14.2% for the one-year period. In comparison, the Barclays aggregate bond index was down 0.2% for August, up 5.7% for the year 2016 and also up 5.8% for the one year period ended August 31, 2016. While certainly not outstanding returns, given the historic bad performances of the month of August, I would have to consider the fact we did not lose any ground as a positive.

As many of you know, the ideal time for investing in the stock market is the period of November through May of the following year. So far in 2016, we have had a very satisfactory year from an investment standpoint, and yet we still have the best time of the year to look forward to. Therefore, I thought I would just cover a few subjects that seem to perplex every one when it comes to investing.

There is no question that the economy slowed down during the month of August, and therefore it is creating some level of concern among investors. If you were to exercise even the slightest bit of common sense, you could easily explain this phenomenon. Given that virtually all schools are back in session prior to the end of August, would it not seem reasonable that there were a lot of people not working during the month of August for vacation and family reasons. Look at Europe, hardly anyone works in August. The fact that business slowed during the popular vacation month of August should come to absolutely no one’s surprise; however, it seems to always do so.

You may remember that during the month of February, the market sold off ten percent under the presumption that the slow economy meant a recession was surely around the corner. As I explained at that time, the economy is always slows in the winter, for reasons that are so obvious that I do not even need to repeat them. Contrary to the belief of the many investors who sold off, the economists did not know what they were talking about. And, of course, the market bounced back quickly and the dire reports of a slow economy were once again an error in judgment as they did not even bother to consider the time frame at which it actually went down.

I guess you also remember that the market dropped another 10% when Brexit was announced. Do you remember how you read those headlines about how surely Europe would be transformed and the world as we know it would change going forward? As I explained at that time, Brexit would not even come into play for another several years. Here we are now, some five months after the Brexit vote, and absolutely nothing of any kind has taken place. As I have pointed out before, the British may be one of the most methodical and slow-moving democracies of all time. Do not expect anything to happen in this regard for many years to come. Even with those absolute crystal clear facts, investors still became concerned and sold. Once again, the market quickly recovered and went up even further. Wrong again!

I often quote the famous investor Peter Lynch of the Fidelity Magellan Fund. “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has ever been lost in corrections themselves.” How good of an example of that fact do we have today? Yes, it is true the market crashed in 2008. However, in the last 14 years, the S&P has been up 13 years and yet everyone is trying to gain an advantage and trade for the ultimate market crash. A 93% win rate seems pretty good to me, yet some investors still do not seem satisfied.

I wish many investors would just use facts. Sometimes, “intuitive” knowledge leads to incorrect decisions. For example, every single day over $1 billion in new money is invested in stock market investments through 401(k) plans. This money comes in consistently, regardless of market conditions. Yes, it is true there is money also going out. If nothing else, this new money buying investments alone supports the market and puts the floor on the downside. Yes, it is true that traders would like to scare you out of your positions, but believe me, they are much more scared of this flood of new money coming in than they are concerned about market volatility, since it affects their livelihood.

While we hear negative publicity every day about an economy that is stalled, did you realize that for the month of July, the savings rate in the United States was up a sterling 21.28% year-over-year. Let me emphasize that again: we are talking about a savings rate in a country, which historically has not saved enough. It would seem to be relatively obvious that savings rates would not be going up if employment was not secure and people did not have excess money to spend.

The empirical evidence on the subject is everywhere. Automobile car sales are up gigantically over the last few years. Building contracts continue to soar, new housing starts are dramatically higher and residential spending continues to set new records. Given the now famous S&P Case– Schiller index of home prices is up 4.28% over the last year. If you have a calculator, just calculate the value of every home in the United States, multiplied by 104% year-over-year. As wealth is built through the stock market, homeownership and job security, Americans are able spend more money on cars, homes, vacations and everything else in between.

Now let us look at the numbers regarding employment. 2.5 million Americans are working today that were not working one year ago. Yes, it is true that the participation rate is low at 60%, but I suspect a lot of those not working are doing so because they do not have a need to work due to other financial reasons. However, every working American creates a group of people (spouses, children, relatives) who are supported by their work. If you do not believe that 2.5 million new Americans working over the last year who were not previously working does not increase the economy and GDP, then you really do not understand basic arithmetic. Consumer spending is at an all-time high – have you heard that lately?

Okay, let us assume that you are the cynic and that unemployment at 4.9% is not correct, but rather the U-6 unemployment calculation of 9.7%. As you know the U-6 unemployment takes into play part-time people and people that cannot work full-time for one reason or another. Over the last one-year period, that ratio was down a sterling 5.83%, and therefore even that negative unemployment report is improving. People are working which helps the economy.

The fear is that the Federal Reserve will increase interest rates thus throwing the economy into recession, and therefore creating a negative economy going forward. Too often I watch the financial news and shake my head in bewilderment at some of the statements they relay. Let us really take into perspective exactly that particular point and consider the ramifications. First off, interest rates are at a historic low, and have been for years. Any rate increase would still be below the previous historic low, and therefore does not really make any difference to stock prices anyway.

Also, I need to point out again that in Europe, especially in Germany, we already have negative interest rates. Currently, if you loan money to the German government, at the end of 10 years, you actually get back less than you originally loaned. And if you think that is an isolated example, one of the largest economies in the world, Japan, has exactly the same negative rate of return. Maybe you did not realize it, but this week in Europe, major corporations were issuing bonds to investors with negative interest rates. Not governments, but regular corporations. These companies are so incredibly secure financially that they can get people to basically loan them money for free. Does that sound like an environment in which the U.S. could increase interest rates?

What happens if the U.S. increases interest rates in the face of these economic sectors that create negative rates? First and foremost, the dollar would go up and international currencies would go down. That creates an economic boom for the overseas economies in that they have a more competitive dollar to sell goods in the United States. It also creates a negative in the United States in that the dollar strengthens and therefore we could not compete in international economies due to the higher dollar. Really, why would our Federal Reserve ever want to create a situation where they would make U.S. manufacturers less competitive?

It is very important that you understand the double mandate of the Federal Reserve in order to understand interest rates. The Federal Reserve was created basically to avoid inflation. In recent years, they have received a lot of publicity regarding the double mandate of low inflation and full employment. Although the financial news criticizes them for trying to manipulate the economy, you have to evaluate whether they have been successful or not. Currently, the unemployment rate is 4.9% which by all definition is full employment. Have you actually looked at inflation lately? Right now, the producer price index over the last 12 months is down (2.49%). The rate of inflation today is 0.8%, which is less than 1%. Based on that double mandate, the Federal Reserve has its full employment and low inflation. Therefore, there is no reasonable cause for an increase in interest rates, and due to the international constraints of lower rates, you may rest assured any rate increase would be small and not detrimental to the economy.

So once again, I sit here today trying to understand the philosophy of investors. Yes, I want to be tolerant and receptive to investors’ ideas but I also want to be realistic. I want to sit back and evaluate the economy and try to figure out, based upon what I know and see, whether the economy is good or bad. Perhaps you have not seen the acceleration of home prices that is occurring throughout the United States. Try to get a contractor to do work at your house at the current time. Why are the skies full of cranes building commercial real estate? Try to get a reservation at one of the finer restaurants anywhere.

It does not take an economist of special knowledge to notice that supply and demand is pushing the economy forward. Consumers have money to spend and they are spending it on things that increase the economy. The Atlanta Federal Reserve puts out one of the most respected GDP forecasts in the United States. Today, they are forecasting that the third quarter ended September 30, 2016 will have a GDP growth of 3.5%. We know that interest rates should remain low for years to come. Going forward, for the higher GDP and lower interest rates, corporate profits will continue to rise. As I write this September posting, we have a trifecta of good news: higher profits, better economy and low interest rates. I am absolutely sure that I have no idea what is going to happen in the market next week, next month or next quarter, however, with a high degree of confidence, I can assure you that ten years from now, when you need your money, the market will trade dramatically higher than it is trading today.

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

Best Regards,
Joe Rollins

Tuesday, August 9, 2016

Conspiracy Theory?

I have to admit that the first seven months of 2016 have been a real roller-coaster ride. Twice during this period, we have had declines in the financial markets close to 10%. The first was the ugly selloff in February 2016 that was blamed on the experts’ opinion that the U.S. would fall into recession. Needless to say, they were wrong on that subject. The second one was brought on by the Brexit vote in the U.K. Experts came out and immediately contended that surely the world would end, and life as we know it would stop. They, too, were wrong. As we ended the month of July, most of the financial markets now sit at all-time highs. Not at an all-time high for the week, month or year 2016, but an all-time high for the history of the financial markets.

You see the strength of the U.S. economy everywhere around you, except in the government reports. In my opinion, there is an inconsistency that does not warrant the anemic reports that we get from the GDP. I am not sure whether you would call it a conspiracy theory or just a theory, but the visible strength in the U.S. economy compared to the strengthening U.S. economy that is reported seems almost unexplainable.

If you go back to the first of 2016, the so-called “experts” were promoting the fact that the U.S. economy had clearly stalled, and the world was in such dire financial state that you should hide under a rug for the rest of the financial year. They stated that you must buy non-investable assets, such as gold and silver, and sell off all positions to cash. How many times and how many articles have we seen that the Dow Jones Industrial Average would sink to 6,000 and bread lines would be forming in every major U.S. city.

To the contrary, there were those investors, such as myself, that said all of that is hogwash and you need to look around to see what the economy is like. As I have written in prior blogs, make a determination from what you see rather than what you hear. Believe me, I read all of the negative reports along with the positive reports, but the highs still tell me that the economy is fine and no recession is near. If you had followed all of the pundits’ negative assertions for the year 2016, you would have missed a very satisfying market trend.

For the month of July, the financial markets were nothing short of great. When least expected, the financial markets move up and the so called “market timers” are left wanting. Review the numbers for the month of July and you can see how excellent they were. The S&P 500 was up a very satisfying 3.7% for the month of July and up 7.7% for the year. The long-term averages have also improved with the one-year return at 5.6%, three-year at 11.2% and five-year at 13.4%. This is nothing short of spectacular, wherein we have averaged over 13% for the five-year period. The NASDAQ Composite was the real winner in July, up sterling 6.7% and year-to-date stands ahead at 3.8%. The one-year return is 1.9%, three-year is 13.9% and the five-year at an almost spectacular 14.8% per year, annualized. The Dow Jones industrial average, which only represents 30 large stocks, gained 2.9% in July and is up 7.4% for the year-to-date. The one-year return is 7%, three-year return is 8.6% and the five-year return at 11.5%. As you can see, these three major market indexes are all averaging double digits for the last five years.

Every day, we see people that sold their stocks in 2008 and never reinvested. For the last five years, double digit returns have made back all and substantially more than the money that was lost in 2008. In comparison, the bond index has lagged considerably behind over time. The July return was 0.6%, the year-to-date return is 6%, the one-year return at 5.4%, the three-year return at 3.1% and the five-year return at 3.4%. As you can see, the five-year return on the S&P 500 index is almost four times the return of the Barclays aggregate bond index.

Before I get into my specific comments regarding a conspiracy theory, I realize everyone is excited that it is back to school time. Therefore, I thought I would share with you some “first day” pictures of Ava from each year since she began school. Admittedly, they have all been preschool since she is only 5 years old, but I thought you would enjoy seeing these pictures leading up to her first day of kindergarten.

Age 2

Age 3

Age 4

Age 5

I have to say that it is hard to believe that the economy only grew 1.2% for the second quarter of 2016 and less than 1% in the first quarter. On Friday, the employment numbers were announced for July, with a net increase in employment of 255,000 new workers. That coupled with the strong report from June of 287,000 just does not follow with a weak economy as reported in the 1.2% increase in GDP.

You do not have to be a rocket scientist to see all of the cranes and houses being built in Atlanta. If you think business is not good, try to hire a contractor to do anything at your house for virtually any cost. I drive by Lenox Mall every day and note that the parking lot is full of potential buyers. I speak with clients every single day that mention it is hard to buy a house because the inventory is so low. In every aspect, whether at a store, your favorite restaurant or the mall, everywhere you look, business is robust. How is it consistent that the government continues to report very weak GDP numbers? As many of you know from reading my previous blogs, I am a firm believer that everything the government does is inferior to the private sector, except military and police and they do not do that very well. Virtually nothing the government does is as good as what private enterprise could do, if given the opportunity. I think that might be exactly what is going on here. If you need any evidence of our government at its worst, just go to the department of motor vehicles at any time for any reason and you will need no further evidence.

It was self-evident to me before writing this blog that the governmental numbers are not capturing actual reality.
It is my assertion that virtually everything that is happening in cyber space is not captured in the economic numbers as we see them. For example, I am an avid consumer but have not been to a mall in over 15 years. When I can order Ava’s toys from Amazon and in most cases get next day delivery, why would I ever go to the trouble of actually visiting a toy store? I can get what I want, when I want it, exactly as I need it, almost instantaneously. And since that is not a typical brick-and-mortar store, that information is not captured in the government’s numbers.

And while I know absolutely nothing about Facebook, I am completely amazed at the fact that they have over one billion daily visitors to their website. What company could actually talk to one billion visitors a day? However, they can basically offer a portal for one billion people to converse with their friends, simultaneously, all over the world, and not one single individual is involved. Do you really think the government captures that part of the economy?

While I am not assuming that there is any great conspiracy to the numbers of our government, I am fairly sure that the numbers as reported do not truly reflect the actual economy. Therefore, if the government reports 1.2%, exactly how comparable is that to the 4% reported in the 1980s when Ronald Reagan was president. At that time, there was no internet; everyone purchased from the local store and the capturing of information was relatively simple. Now with the electronic age, sales occur instantaneously and are reported to no one but the company itself. Therefore, I think if there is a conspiracy, it is due to the ineptness of our government and its inability to convert economic ratios to current events.

For all of those that argue that the economy is weak and a potential downturn will occur, just let your eyes give you the correct answer. As the saying goes, “Who are you going to believe, me or your lying eyes?”

While certainly the months of August and September have historically been bad months for the markets, it would only be a temporary setback. As the second quarter earnings continue to come in much better than expected, it looks like the third quarter might be a positive one for earnings in 2016. Undoubtedly, the third and fourth quarters will be up, which is a positive trend in earnings.

We are now enjoying negative interest rates in Japan and Germany. And just this week, England cut their interest rates to conform to the rest of the world. While certainly the U.S. may increase their rates modestly between now and the end of 2016, you may rest assured that rate increase will be modest due to distortion in currencies that an increase would cause. The Federal Reserve would not want to strengthen the dollar to the point of making U.S. exports noncompetitive and therefore hurting manufacturers even more.

In summary, maybe I have said this way too many times but it cannot be emphasized enough - Earnings are accelerating, interest rates are low (and will be low for a long time) and the economy is positive (and may even be growing). All of those components argue for higher stock prices going forward. Even though we are at all-time highs on the major market indexes, I certainly would not be surprised to see higher stock prices by the end of 2016 and certainly higher in 2017.

I am always amazed, troubled and completely confused as to why people hold so much money in cash. I know I have offended a lot of my clients over the years with my bewilderment at their decision to do so. When interest rates were normal, that might have made sense, but they are not normal and there are better ways to make the most of your cash.

One of the great parts of my business is meeting new potential investors almost every week. Sometimes I sit down with new investors three or four times a week. The standard questions I ask include, “What is your family budget?” and “What do you spend on a weekly and monthly basis?” In a rough estimate, I would venture to tell you that 90% of those people really have no idea what they spend on a monthly basis. They have no budget, and therefore cannot analyze it. Many young couples spend what they have available. If they have the money, they spend it; that is their budget. I encourage you to not fall under this category and actually prepare a budget. Most people I meet with do not even maximize their 401(k) contributions – they contribute but they do not maximize it. If they have available cash flow from their compensation, they find a place to spend it.

If you would like to sit down and discuss your budget, investments or any other items of interest, we are always available to meet with you. I understand that the flat market over the last year makes for a confusing time from an investment and financial standpoint. I can assure you I do not have all the answers and cannot explain the volatility of the market, but I do know that you cannot time the market, and being invested at all times is the best solution. After 40 years of studying the financial markets, I still learn something new every single day. Anyone who thinks they can understand investing on a part-time basis is really fooling themselves. Yes, they might outperform for a week, month, or even a quarter, but day-in and day-out, your investments are better served by professionals that do it full-time and are compensated for that service.

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

Best Regards,
Joe Rollins

Tuesday, July 12, 2016

"Looking Up - Straight Up."

It seems like we have been avalanched with nothing but bad news since the beginning of 2016. Every day, you pick up the paper and read something negative about the U.S. or the U.S. economy. I am not exactly sure what is bringing about all of this negativity, but there is a presumption that the next person who predicts the stock market crash will become famous. That happened in 1987, but not so much in 2008 when no one predicted it correctly. However, based on the news, it certainly seems to be a very small chance of a major market correction, as far as I can see.

The first six months of the year ended has pretty much been non-eventful. Although the markets have moved around significantly, it can pretty much be said that not a lot is actually occurring. Yes, the market is up but most of the growth mutual funds are actually down for the year. I wanted to report on some of the major market movements during the period, but more importantly, I wanted to reflect on the good news that is coming. Over the last 15 months the market has been substantially flat. I think that is getting ready to change for the better, and hopefully you will be patient enough to still be around when the good times roll again.

Before we dive into stock performance, I thought I would share a picture with you. Here is Ava at the Atlanta Airport, seeming a little jet-lagged. This is what I like to call a 5-year old attitude...

For the first six months of the year, the Standard & Poor’s index of 500 stocks is up 3.8% for the year 2016. For the one-year period, this same index is up 4%; for the three-year period, up 11.7% annualized; for the five-year period, up 12.1% annualized; and for the 10-year period, up 7.4% annualized. As you can see, gains have been significant of the last 10 years, just not so much in the most recent year. For the year ended in June, the Dow Jones industrial average is up 4.3% and up 4.5% for the one-year period, 9% for the three-year period and 10.4% for the five-year period. The NASDAQ composite is still down 2.6 for the year, down 1.7% for the one-year period, up 13.9% for the three-year period, 13.2% for the five-year period and 9.5% for the 10-year period. As you can see, this index is the highest performing index of all the major market indexes, but it is also the most volatile. The Barclays aggregate bond index is up 5.3% for the year, up 6% for the one-year period, 3.9% for the three-year period and 3.6% for the five-year period. Even though the bonds have performed well recently, they are the worst performer of all the major market indexes over the 10-year period.

During the last two weeks of June, the market received a tremendous shock when the countries that make up the UK voted to leave the European Union, which has become known as Brexit. For the two trading days after the vote, the market dropped a dramatic 1,000 points. We received many calls from clients concerned about this major market selloff and the unknown of the future. I never really understood what the confusion or the fear was that was represented by this vote and the stock market reaction. An attempt to try to get a better understanding of exactly what would take place, I read over 100 articles explaining the vote, the economic consequences and the potential fears. What I quickly realized after some of this excruciatingly boring economic commentary, nothing will happen quickly.

It needs to be understood that nothing about this vote will stop trade between Britain and the continent. Both need each other, and therefore that will not change. In fact, it appears to be that the UK will be stronger now that it will not have to support the weak sisters of the EU, such as Greece, Italy, Spain and Portugal. But the main reason the locals in Britain wanted out of the bureaucratic and socialistic rules of the EU was to better control their own immigration. While clearly immigration will go on in the UK, at least they will be in control of it and not the bureaucrats from Brussels. This would appear to me to be a huge economic advantage to the UK after the vote.

The main reason I wanted to learn more about this event is why it would affect the U.S. market. Are the U.S. companies not going to sell the same to the UK? Are the U.S. companies not going to sell the same to the EU? Quite frankly, none of this has any effect on the export sales of either.

I guess an argument could be made that, because of Brexit, the UK could fall into recession, and therefore buy and produce less for their economy. However no one that I read on the subject seems to think that was a given. It was clearly illustrated that nothing is going to happen for two years, and the results of whatever happens will not be known for three or four years, so why exactly did the market selloff 5% overnight? As so clearly illustrated in these pages - traders trade, investors invest, and never the twain shall meet. As the traders thrashed around trying to figure out where to go next, the market returned back to its pre-Brexit levels only a few days after the selloff. So, I guess it could be said that it was a “nonevent”.

I have watched a lot of movies and read many books recently, including The Big Short and Flash Boys, and note the trend of essentially assassinating all investing in the name of bad traders. Further, you cannot be reading any financial press without seeing those same people that have been forecasting “gloom and doom”, repeating those same unwarranted charges of a market meltdown. In fact, there are few investors that have proclaimed the ultimate market demise during my entire investing career. Since I will be closing in on over 40 years of investing, it is absolutely clear that these predictions have fallen upon results that were nothing short of spectacularly good.

When it comes to analyzing asset classes, I am always asked whether we should be investing in stocks, bonds, or some other specialized asset mix. A study recently completed by J.P. Morgan illustrates that point. They indicate that over the last 20 years, the S&P 500 has produced at an annualized return of 9.9%. However, if you were in 60% stocks and 40% bonds, you produced 8.7%. If that is flipped and you have 40% stocks and 60% bonds, it would be 8.1% annualized. Bonds come in during the study at 6.2%, gold 5.9%, oil 5.7% and homes and your principal residence 3.2%. Therefore, clearly as an asset class, stocks have outperformed virtually any of the alternatives. Yet, the pessimism continues to rise and the skepticism in the press is almost deafening; and it is consensus that surely, from a financial standpoint the world is coming to an end.

These pages will try to put a different spin on that presumption. Lately, it seems to me that the market has been firming up nicely and with the backdrop of historically low interest rates, it is hard for me to see the market’s path of least resistance to continue to drift higher. It is remarkable that at the current time, the 10-year Treasury bond has hit an all-time low in rates of return. As I am writing, the 10-year Treasury is yielding an anemic 1.395% 10-year yield. What is interesting about this yield is that the S&P index now has a current yield of about 2.1%, which is well above the 10-year treasury. Everyone keeps asking how the 10-year treasury continues to go down. In the era of fast money, that answer is crystal clear.

The equivalent of the 10-year German bond has a return now of -.1962%, which means that if you invest in a German bond, you get back less money at the end of 10 years that when you actually invested. In addition, the Japanese 10-year government bond has a yield of -0.294%. The exact result of Germany is also reflected in Japan. Around the world, money is flowing into the United States seeking yield. If you are holding a German or Japanese government bond, my suspicion is that you would rather own a U.S. bond paying something rather than those bonds paying nothing (or worse – negative yield). The corresponding result is that every time these investors move from their local currency to the U.S. dollar, it weakens their currency and strengthens the U.S. dollar. I guess no one has really noticed that the Japanese yen is now on par with the U.S. dollar. During the 1970s, when Japanese car builders were considered the best in the world, the yen was 300 to 1; today, it is 100 to 1. All advantages that once were realized by the Japanese in currency have evaporated.

As I mention every time, my three most important major components of investing are earnings growth, the economy, and interest rates. It looks like the current economic results will reflect a GDP growth of roughly 2.5% in the second quarter of 2016. This builds on a roughly 1% growth in GDP in the first quarter and projections now assume a GDP growth of close to 3% in the third and fourth quarter of 2016.

I was somewhat amazed when I picked up an issue of Barron’s the other day which the title read, “Recession is coming!” Since I did not share in that projection, I had a high desire to understand why they were projecting a recession when the economic indicators are so strong in a positive way. You had to read the article to understand, but basically the title was a tease. As the author explained, a recession will certainly be here at some point in the future, just not anytime soon. I concur with that assessment.

With interest rates and the economy in clearly positive ground, you have to be concerned about the third and most important ingredient, which are earnings. It is absolutely true that the S&P 500 earnings have declined over the last year and a half. It is not like companies are not increasing earnings; it is just that, on average, due to the huge hits taken by the oil industries, earnings have declined depreciably. That is all getting ready to change. It is now estimated that earnings will go up in every quarter for the rest of 2016. Based on this consensus, earnings should be up 8.3% in the second quarter, 19.2% in the third quarter, and a whopping 37.4% in the fourth quarter. I am not so naïve to not realize that forecasters work based on assumptions that may or may not be valid. I did not repeat these projections to assume that they are guarantees. I am really not concerned about absolute increase in earnings as I am with the trend. Even if these projections were only 50% correct, the fact that earnings are projected to go up significantly between now and the end of the year should give you encouragement as an investor.

Actual Earnings - black
Projected Earnings - green

Therefore, once again, the three components of higher stock prices are in place at the current time. Interest rates are at an absolute all-time low, the economy is stable and actually moving up, and earnings have reversed the negative trend and are moving up positively. I guess you would have to say, as an investor, it really does not get better than this. In this writing, the S&P is virtually at its all-time high. That is clearly reflected by the better economic and earning results.

I would be the first to admit that the world has a lot of problems. If you watch the news in the morning, by the time it is over, you are almost ready to commit suicide. The drumroll of bad news never leaves the national news. I guess the old axiom “if it bleeds, it leads” should be the real title of any major news program.

It is my job to read and understand the news, but also to reflect the economics behind the news. I have so many clients who express dismay and fear regarding the future based upon the news. I often ask them what this really has to do with stock market performance. Do not tell me what the presidential election will do to you emotionally or mentally, tell me how it affects the economy and I will tell you how the stock prices will go.

Having started in this business with the stock market crash of 1987 and watching the Dow Jones industrial average grow from the low of 1,722 in 1987 to close to 18,000 today, I have to make sure I caution everyone that it would be a severe mistake to ever underestimate the U.S. economy. Today, if you put the 1987 stock market crash and plotted the increase over time, you would note that this correction does not even appear as a bleep in the growth of the U.S. markets.

Going forward we are watching and learning. There is no reason to assume that a huge correction would occur, but that could change at any time. If and when that correction occurs, we will obviously move quickly and decisively to different positions, but for the time being, all is well and we intend to hold the course.

If it is true that the consumer provides the energy for the growth of the GDP, the news is currently outstanding. It is assumed that the consumer sector provides 70% of the growth in any GDP. Recently, it was announced that household debt had been reduced to 10.1% of disposable personal income. Therefore, the U.S. consumer now has less household debt than virtually any time in the history of U.S. finance. In addition, the household net worth is now at its highest level ever. While clearly household net worth took a major hit in 2008, both in assets and in financial investments, all of this has recovered and is higher by roughly 1/3 than it was at the peak in 2007. Therefore, if it is true that the consumer provides the dynamite to blast the GDP higher, clearly, there is enough kindling in this fire to start it roaring again once any type of stability is reached in world problems.

I fully realize that no one cares as much about pets unless they are your own, but I did want to mention that my old Labrador, Daisy, passed away this month. It was time – she was 14 years old, had mothered 20 pups, and had both knees replaced. She was definitely struggling for the past few years. In fact, we added a puppy to the family 2 years ago for Daisy to enjoy a companion for the end of her life. She kept holding on until the very last second.

Daisy was never my favorite dog, but she was always the most loyal – you could not run her off, even if you tried. In fact, she may have been the most educated dog of all time. In the past 14 years, she watched the business news religiously from 5:00 – 7:00 a.m. every day, with absolute religion – as if she had a choice. Name me a companion who would have watched so much financial news – or anyone for that matter!

Daisy’s first litter of puppies was 7 yellow Labrador retrievers, 2 black and 1 chocolate (pictures below). The second litter was 6 blacks, 3 yellow and 1 chocolate. Both litters came from the same parents – father was a black Labrador, while Daisy a yellow. It is a marvel of nature that each of these dogs was absolutely pure in color, and not a spotted one among the group.

This section was not written for sympathy, as Daisy lived a long and fruitful life. Many of you have been to my house and met Daisy at one time or another, so I thought I would let everyone know about her passing.

Daisy - Christmas 2016

Daisy with her first pups

Daisy's First Litter

Daisy's Second Litter

Ava and her pup, CiCi

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

Best Regards,
Joe Rollins

Tuesday, June 7, 2016

"Ali and Me."

Since there is not a whole lot going on in the investment and equity markets at the current time and not a lot of news to report, I thought I would reflect on the passing of the great Muhammad Ali, who unfortunately died over the weekend. While I did not know him personally, I did meet him on a couple of occasions and I thought that I would share those reflections after giving you a run down on the financial news for the month of May.

The month of May was very satisfactory, for the equity markets have now come full cycle from the 10% decline that we saw in January through mid-February 2016. For the month of May, the S&P 500 index was up 1.8%, and for the one-year period has a 1.7% total return. The NASDAQ composite average increased 3.7% in May, yet reflects a -1.2% for the one-year period. The Dow Jones industrial average was only up 0.3% for the month of May and reflects a gain of 1.2% one-year total return. The Barclays aggregate bond index was down 0.1% during the month of May, but leads all major indexes by being up 2.9% for the one-year period.

I would be remiss if I did not point out the more long-term returns on these indexes. Once again, it is an attempt to show that short-term results are not meaningful when you invest in equities. As an example, the S&P 500 index is up annually on the five-year period 11.7% and the 10-year return is 7.4% annually. The NASDAQ composite is up 13.1% and 9.7% annually for the five-year and 10-year periods, respectively. The Dow Jones industrial average is up 9.9% for the five-year return and 7.5% for 10- year period. As you would expect, the Barclays aggregate bond index is the laggard of reporting indexes. For the five-year period, this index is up 3.2% and for the 10-year, 4.6%. As is almost always the case, the equity markets outperform the bond index over longer periods of time. The bond index protects you from short-term volatility, but if you are truly interested in long-term performance, you almost universally have to be in equity indexes.

What is interesting about this year is that for the one-year period, the S&P 500 index is the best performing index as compared to broad-based mutual funds. While the S&P index is up 1.7% for the one-year period (all earned in May), virtually all mutual funds of every description are reporting a loss over the one-year period. While you probably have seen this happen in the past where a passive index outperforms active management, it is usually only a short-term phenomenon that turns around as the equities begin outperforming once again. I fully anticipate that the actively managed mutual funds will well outperform the S&P 500 index over the next 5-year and 10-year cycles.

While it does not seem that long ago, we are surprisingly coming up on the 20th anniversary of the 1996 Olympic Games here in Atlanta. I took advantage of every opportunity that came my way while the Olympics were being held here and had many wonderful experiences. While those who were at Centennial Olympic Park during the explosion may not have as fond of memories, we fortunately had left about a half-hour early. In fact, we did not even know the explosion took place until we saw it on television the next morning.

As you know, Olympic Stadium later became Turner Field. It is hard to believe that only 20 years later, the Braves are abandoning Turner Field, which was brand new in 1997. I had many opportunities to buy tickets to the opening ceremonies at the Olympic Stadium so I traded tickets around in order to improve my seats in order to see the historic opening ceremony. I eventually ended up with seats in the 10th row, right at midfield. It is hard to imagine that even 20 years ago, I paid close to $800 per ticket just to be that close. We did not get home until 3:00 AM due to security getting out of the stadium.

Security that night was overwhelming. The event did not start until 8:00 PM, but you were required to be in the stadium in your seats by 6:00 PM. Since it was a hot and humid night and beer was being sold plentifully throughout the stadium, the crowd became anxious as the opening ceremony began. Amazingly, we were sitting among a great number of celebrities.

To our left, Demi Moore and Bruce Willis were sitting with their daughters, Scout and Rumer. At that time, Scout was five and Rumer was eight. What was particularly memorable was that Demi Moore had her head shaved since she was in the process of filming G.I. Jane, which required no hair. It is hard to believe that recently we saw Scout walking topless down the streets of New York City in a protest of some kind. My how time flies….

Down the same row where we were sitting was Roy Firestone, along with his young son. I am sure many people do not remember Roy Firestone, but at the time, he was the biggest name on ESPN and was by far the most famous sports commentator of the time. Unfortunately I did not get a chance to speak to him, as the only time we were within talking distance was in the men’s room.

Directly in front of us was Greg Louganis, who by far was the most famous U.S. Olympian of the time. As I am sure you are aware, he won the gold medal for diving in the 1984 and 1988 Olympics. At that time, he had not officially come out as being openly gay however, there were rumors to support that cause. Needless to say, we were happily sitting among the celebrities in anticipation of the opening ceremony.

Demi Moore and Bruce Willis

Greg Louganis

I have to admit, it may be the most impressive show I have ever seen in real life. It could have been just a reflection of the excitement and the energy in the stadium, but I was absolutely flabbergasted at how moving and well-coordinated the show actually was. But without question, the highlight of the evening was when the Olympic torch entered the stadium. It was an unusual presentation in which no one knew exactly who would light the Olympic cauldron. I remember seeing numerous people carry the torch around the track, but the most recognizable was Evander Holyfield due to his size.

Directly in front of us, the torch was passed to Janet Evans (an Olympic swimmer) who ran it up the side of the stadium to light the cauldron. Right at the last second, Muhammad Ali stepped from behind the curtains to accept the torch from Janet. It was noticeably visible that he was shaking and the torch appeared to be heavier than his weak arms could handle. At this time, he was already suffering from severe Parkinson’s disease, and it looked like he was not going to be able to raise it to put the fire to the Olympic torch, but thankfully he did. Later, it was learned that he had a special torch that would not go out in case he did in fact drop it. It was one of the most moving and inspirational of events I have ever attended. But that was not my last encounter with Muhammad Ali.

I was fortunate to be good friends with the president of the Super Bowl Host Committee that came to Atlanta in the year 2000. Robert Dale Morgan had been a long-time friend and was privileged to be appointed chief executive. He later moved on to Houston to be their Super Bowl Host Committee president, but unfortunately died prematurely a few years ago. Anyway, Robert Dale Morgan got me tickets that year to a special presentation at the Fox Theater where Elton John performed, as he was a special guest of the Super Bowl in 2000.

As we were filing into the auditorium, I came upon Muhammad Ali and his entourage. Despite visibly quivering, he was cordial and stopped to shake hands. As he came closer to me, I was somewhat flabbergasted to note that he was considerably smaller than I was and had lost much of his muscle tone by that time. That came as a major surprise, given his legendary boxing status.

A few days later, Robert Dale arranged for me to see Muhammad Ali in order to get him to sign the picture that I had obtained from the Atlanta Olympics four years earlier. Although there were 40 or 50 people in the room and it was difficult to understand him as he spoke, he was very amiable. I clutched a hundred dollar bill in my hand with the anticipation that I would pay him for signing my picture. As I offered it, he waved it off as not necessary.

I will never forget getting close to him as he signed the picture reflected below. He literally stood up and braced his right hand with his left arm and entire body to keep his hand as steady as possible. His manager said that he had to sign small since his hand could not move very far as it was braced. It was quite amazing to be in his presence, and it is hard to believe that he is no longer with us.

And now back to the financial markets. Everyone is well aware that the year 2016 began in a very negative fashion. At one time during February, the S&P 500 index was down almost 10%. At that time, all of the critics and “the world is ending” chorus was espousing that the markets would go down 70% or 80%. I actually never quite understood what they were going to use as a catalyst for this major decline. However, interestingly but not surprisingly, at the end of the day they were all selling gold and silver.

In mid-February 2016, the markets turned on a dime and started to rally. There was a noticeable increase over the next several months, leading to the S&P 500 index up 3.6% year-to-date, through the end of May. The three-month total return on this index has been 9.1%, which shows you how far down the markets were prior to rallying.

If the gain of 3.6% for the period through May was annualized this return would be 8.6%, which is well in line with my projection for 2016. However, the people that believe in a 2016 stock market crash will not let up; every day you see the stunning proposals and all the financial press of the major market meltdown that is coming. Interesting to note that as of May 31st, the S&P 500 sits only 1.9% below its all-time high. Pretty impressive considering the market has basically gone nowhere over the past 12 months.

I often sit back and contemplate why people feel so strongly about trying to forecast a market crash. Perhaps due to my age I have seen so many of them along with a quick rebound that it is hard for me to get terribly concerned about a short-term selloff.

My first connection to a stock market crash occurred in 1987. Who could forget the famous crash in 1987 on the day that the Dow Jones industrial average began at 2,247 and closed at 1,739, a 22.61% decline in one day? As many of you know, that decline was devastating to investors at that time and was clearly the largest one-day fall of all time on a percentage basis. While we went through severe market declines in 2000-2001 and 2007-2008, nothing compares to the one day market decline in 1987.

I reflect back on that crash with an interesting perspective. At the end of that terrible day, the Dow Jones industrial average was at 1,739. At the end of May 2016, the Dow Jones industrial average was at 17,787, a 1,000% increase at 8.5% annually. Therefore, the market has gone up 10 times the level of the 1987 decline. In fact, after each so-called market crash, the market has come back stronger than before. And as we sit here today, we are enjoying an almost all-time high.

Therefore, these projections of a major market crash are based upon evidence that is not apparent to me in reading the financial pages. While it is true that the GDP for the first quarter was a tempered 0.8%, that is really not too bad for a January through March quarter. The Atlanta Federal Reserve is now projecting that the second quarter, which we are currently in, would have a nice rebound of 2.9%. That is a constantly moving and updated index, and as history has reflected, it has been fairly accurate. More interestingly, they are projecting that the third and fourth quarter GDPs might even be higher than the second quarter GDP. I would like to remind you again that there have not been any major market declines without a corresponding recessionary period. Therefore, no recession is even remotely in the horizon with the information we have today.

In fact, economic news has recently been pretty good. Existing home sales were up 6% in May and up an astonishing 22% in new home sales. All of my residential real estate friends comment on the fact that there is just a shortage of inventory of houses to sell. It is a seller’s market with buyers wanting to purchase but no homes are available for sale. What more evidence could you need to prove a strong real estate market?

Retail sales have been strong at 1.3% in May, the largest increase in over a year. Durable goods were up 3.4%, the largest increase in six months. While the economy is clearly tempered, the economic news continues to be good.

The most recent job report for the month of May was clearly a negative with an increase of only 38,000 new jobs. However, it is hard to get terribly concerned about that when you review the employment numbers, as I often do. Over the last 12 months, there are close to 3 million new people working in America and the unemployment rate has fallen to an astonishing 4.7%. It makes zero sense to me that all of these new people are working and the unemployment number has dropped below what is considered the full employment rate in America, yet so many people are forecasting a severe recession?

I drove up Roswell Road, in my home city of Atlanta, and without even looking saw three “help wanted” signs at various small businesses. Yes, I recognize that these are low-paying retail jobs, but they are still jobs. Employers are looking for workers that they cannot find. That just does not happen during a recession.

I guess I need to remind you of how bleak it can be in a major market downturn. Yes, the jobs report was weak in 38,000 employees hired, but during 2008, it was not uncommon to see this same government report reflect employment losses of close to 600,000 per month. But one of the positive attributes of a poor employment report is that it likely keeps the Federal Reserve on hold, and therefore no major increase in interest rates for now.

Many people ask me my opinion regarding future interest rates. Interest rates are going up; it is just a matter of when. There is almost zero chance that interest rates will fall dramatically over the next couple of years. Therefore, if you are satisfied with a 10-year treasury rate of 1.8% with no appreciation in value, then bonds represent a good mix. I do have to remind you though that the S&P 500 index has a yield in dividends of close to 2.3%.

Lastly, I cannot help but reflect on the negative sentiment that seems to be reflected in the investment markets. The recent AAII summary of individual investors finally reflected that 17.8% of them were bullish. This is only the third time in the 29-year history of this survey that it has fallen below 20%. It is also the lowest rating in over 16 years. As reflected in the most recent Fidelity Monitor and Insight, when this index gets this low, the market tends to have a 10.6% gain over the next six months. Basically, the reason for this phenomenon is that when people are the most negative, they are the least invested. With so few people invested, it would not take a major buying spree to greatly improve the returns in the financial markets.

When people express the opinion that the market is going down by large sums, I ask them why they feel that way. Almost universally, the answer comes back that they get that feeling because of the negative tone of the media. I assert that whatever the media says is tainted by whatever political feeling they have on any given day. As I so often comment in these postings, you have to evaluate earnings, interest rate and the economy. Even though earnings were somewhat down in the first quarter of 2016, they are projected to be higher for the rest of the year. And while the economy was also low in the first quarter of 2016, it is forecasted to be higher for the rest of the year. And as mentioned above, there is almost no chance that interest rates will increase dramatically during 2016.

Therefore, it is a slam dunk that all the important economic indicators are at least neutral or positive. It is therefore highly unlikely that we will see a major decline in equity balances that will not be followed by major reversal. Since we are investors, not speculators or traders, I see no reason to change our investment philosophy at the current time. The market may be volatile now and may go down for the short-term, but long-term the trend is clearly up.

In closing, I will once again quote Muhammad Ali, “Silence is golden when you cannot think of a good answer.” I cannot think of a good answer why I should write more, and therefore I will be silent.

Various memorabilia from our offices of Muhammad Ali

The Phantom Punch vs. Sonny Liston, II - Signed AKA Cassius Clay

Muhammad Ali and The Beatles (At the time of this picture, he was much more famous!)

Muhammad Ali AKA Cassius Clay - Age 12

World Champ

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

Best Regards,
Joe Rollins