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