Tuesday, December 18, 2018

I am tired of all the negative news, let's report the positive. Happy Holidays to one and all!

It is somewhat ironic to me that we are in the “joyous” holiday season, yet the airwaves are flooded with negative comments. Many of these comments relate to geopolitical events that have absolutely nothing to do with the economy. Such negative sentiment always runs the risk of becoming a self-fulfilling prophecy. There is much more positive news, which you may not be reading, that overwhelms the negative forecasts so I thought I would devote this blog to pointing those out to you.

There is no question that this has been a disappointing year from a financial standpoint, but it certainly has not been disappointing from an economic perspective. While the stock market has bounced around in all types of starts and stops, the economy has been outstanding. With the economy growing 2.9% in 2018 and unempolyment being reported at the lowest level in the history of employment in the United States, it is hard to fathom that the stock market could underperform. It looks like the traders and speculators on Wall Street are trying to talk you into believing the negative headlines.

Josh & Ava 

Josh, Joe, Ava, Dakota & Carter with Santa

Ava in her Christmas dress!

I will report on all of this very interesting information, but first I must report the activity and performance for the month of November. After an almost devastating selloff in October, the markets rebounded somewhat in November before the volatility struck again the first of December. For the month of November, the Standard & Poor’s Index of 500 stocks was up 2%, up 5.1% for the year-to-date, and for the one-year period ended November 30, 2018 was up 6.3%. The NASDAQ Composite squeaked out a small gain of 0.5% for the month of November, is up 7.2% for 2018 and is up 7.7% for the year then ended. The Dow Jones Industrial Average was up 2.1% during November, up 5.6% for the year-to-date and up 7.6% for the one-year period then ended. Just for comparison, the Barclay’s Aggregate Bond Index was up 0.6% for November, but is down 1.9% for 2018 and down for the one-year period ended November 30, 2018 at -1.4%.

During the month of November, the market vacillated back and forth on 3 basic points. First, there is the ever present concern about the Federal Reserve increasing interest rates to the point of forcing the country into a recession. The second of these was the trade conversation between the entire world and the United States, as promoted by President Trump. The third, which seems to be on everyone’s mind, is whether earnings are rising or falling in the future if the economy sinks into a recession sooner than anticipated. Of course, there are always the extraordinary headlines regarding geopolitical events that really have nothing to do with anything other than polluting the airwaves with needless information. All of these items have affected the market and I want to address them in this posting.

It seems the markets have worked themselves into an absolute frenzy over what is really going on with the economy. Every day, I read extensive articles by so-called “experts” on just how poorly the economy is performing and how they believe 2019 and 2020 will play out. While it is always interesting to hear commentators express their views on what is taking place, what I find much more important is what the experts are actually forecasting. Is it really possible that the economy that is growing at such a pace in the United States could turn on a dime to recession and reflect a negative performance in 2019? In a word, so as not to waste space, NO.

Of course, with the hustle and bustle of the holiday season, you probably haven’t kept up with the reporting of the Atlanta Federal Reserve and its anticipation of gross domestic product going forward. You may recall that the last 2 quarterly GDPs have been excellent and certainly the economy continues to be expanding as we enter into the holiday season. Retail sales are growing nicely, and as I sit here on Sunday morning at 11:30 watching traffic line up to go to Lenox Mall, there is certainly no concern for consumer spending during the holiday season.

On December 7th, the Federal Reserve of Atlanta projected that the GDP would grow in the fourth quarter at a 2.4% pace. While certainly not extraordinary, quite a desirable growth of 2.4% would be a good quarter. However, on December 14, 2018, the Atlanta Federal Reserve increased its anticipated growth rate to 3%. Isn’t it interesting that over that one-week period, the Federal Reserve would increase the projected growth rate while the market makers on Wall Street forced stocks down by billions of dollars? As I have been pointing out in these posts, there is a complete disconnect on Wall Street regarding the reality of the underlying economy, which in reality is excellent.

So, we can all concede that the economy in 2018 has been nothing short of spectacular. The economy has continued to grow throughout the year, employment remains strong, and even hourly earnings are starting to grow. That is the perfect recipe for a strong economy, but what about 2019?

In order to try to determine what exactly we should suspect in 2019, I reviewed all of my available resources to see what the experts have proposed. At the low end, some see a growth next year of roughly 2.3%, while the more optimistic have projected a 3% growth in 2019. The actual growth reported by the Federal Reserve in its most recent update projects the economy at 2.5% in 2019, a slight decline from the previous projection. In any case, even if you take the low growth rate, it would still be quite excellent and certainly above average growth rate for the last several decades. So how on earth could the so-called “learned person” of Wall Street project a recession in 2019 when all of the economists project otherwise? Also, just what economic event would turn around the strongest employment ever in the history of America in 2019 to create an economy where unemployment was rising rather than falling, like it is today? Just about no one can project any kind of negative economic event that would turn the strong battleship of financial performance around in such short time.

So, if the economy is not going to reverse in 2019, there must be something else that is leading to the extraordinary volatility that we are seeing on Wall Street. Maybe the underlying fear is that tariffs will actually convert the economy from growing nicely, to negative. Maybe those projections are not based on current reality. If you have been watching closely, you will note that a trade deal has now been entered into and signed with Mexico, Canada and South Korea. In each of those cases, although not a great deal was changed to any of the existing agreements, the changes that were made were favorable to the United States economy.

So, basically what fear lies in the new tariff war is with China. Is it possible that any deal with China, or failing to make an arrangement with China, could bring down this U.S. economy? As I have pointed out so often in these pages, the U.S. buys roughly $650 billion worth of goods from China, but only sells less than $200 billion worth of goods to China. If it came to a showdown of no trading between the countries, clearly China would be the loser. It has already been well documented that the Chinese economy is slowing, which is only self-evident when you consider their major trading partner is the U.S. Maybe you did not realize, or see the reporting, that China is now back buying agricultural products in the way of soybeans from the United States.

One of the major risks to the Chinese economy due to their inability to make a deal with the United States, is that many of the supply lines will be disrupted and moved from China to other countries. Currently, Vietnam, Indonesia, Malaysia, and India have become major players in supply line suppliers to the U.S. manufacturing. If the Chinese wait too long to make a deal, the supply lines may be too far along to move back to China once resolved.

I have great respect for our President for fighting this war. It is a war that needed to be fought 25 years ago but no other president has been willing to stand up to international pressures to try and level the playing fields. My prediction is that there will be a deal with China during 2019. At the end of the day, it will not change much, but it will at least benefit the United States and create a more level playing field. In the meantime, all of this volatile trading on Wall Street related to a potential deal with China is just a smoke screen to shake your confidence in the actual strength of the U.S. economy. The reason the Chinese will agree to a deal and the reason that President Trump will accept it is quite clear: the Chinese recognize that their economy cannot continue to grow without sales to the United States. They will make a deal not because they want to but because they have to. At the end of the day, they will not risk the effect on their economy just to play hard ball with the current U.S. president.

Of the major concerns that affect the market place and the stock market, the first two are the potential for inflation and the risk of tariffs. As explained in the paragraphs above, I find both of those fears to be misplaced and only a short-term concern. Why would any long-term investor trade around these risks knowing that each or both could be resolved within the next couple of weeks? The one major concern that maybe has some economic effect would be the risk that the Federal Reserve could actually move beyond neutral with interest rates, and therefore put the country into a recession sooner rather than later.

The Rollins family, ready for the holiday season!

The actual selloff of the markets began in October when the newly appointed Chairman of the Federal Reserve expressed with some sort of authority that their intention would be to increase interest rates to a point of being neutral and we were a “long way” from being neutral. At that point, the jittery stock market determined that maybe this newly appointed Federal Reserve was much more hawkish than the previous Federal Reserves, and therefore would increase interest rates to the point that the economy would reverse quickly and would return to a recession sooner rather than later.

Even though the Federal Reserve’s Chairman later corrected that statement when he exclaimed that “interest rates were currently near neutral,” the markets refused to accept his explanation. I think even now the Chairman of the Federal Reserve would agree that the statement on October 1st was truly a rookie mistake. While he certainly wanted to express an opinion that he would be a supporter of the economy, he quickly realized that his exclamation of exactly what their intentions were going to be was misinterpreted by the investing public.

Just to be absolutely clear, no Chairman of the Federal Reserve has any desire to throw the U.S. economy into recession. Anyone who actually believes that really does not understand political appointees. The other thing that was baffling is that no Chairman of the Federal Reserve really wants the stock market to implode. There is very much a “wealth effect” in this country. The “wealth effect” is when the market is high, investors will sell their investments and use those proceeds to buy consumer goods. They buy a new house, a new car, a new toy or go on vacation. When the market sells off, investors are not likely to spend money and are not likely to use that money to prop up the economy.

For that very reason, no Chairman of the Federal Reserve wants to see a major market selloff. Their preference would be for the markets to be stable and not to bounce around wildly based upon comments by politicians. It is clear that this Chairman of the Federal Reserve had neither a desire to create recession, nor a desire to deflate the markets. Given that he had only been in office a couple of months, you have to rack these comments up as a simple mistake.

But the more important consideration is exactly what has taken place since his original October comments. At that time, it was perceived by the markets that there would be an increase in interest rates in December and three or four rate increases in 2019. Given the flat yield curve that we see today, if that forecast had come true, there would have been absolutely zero question that the short term rates at the end of 2019 would have exceeded the long-term rates. As often is the case when exaggeration leads to forecasting, no reasonable economist could have projected that the inverted bond yield scenario as proposed by investors was realistic.

What we now see is that quite almost assuredly there will be a rate increase in December. There is a high likelihood that in 2019 only one or maybe two rate hikes will be in store. If that projection holds true to form, there is absolutely no chance that the increase in the interest rates by the Federal Reserve in 2019 will force the economy into a recession. One more actual fear defeated by the truth.

During the month of November, it was projected that the entire world was falling into recession or clearly a slowdown. The catalyst for this opinion is that during the quarter, Germany and Japan both suffered declines in GDP. Even though there were solid reasons for the negativity in these countries, investors sold before they thought. In Germany their largest industrial production, by far, is automobiles. During the third quarter, there was a severe drop in automobile production in Germany due to the model changes over the years and the adjustment to the new admission standards. As has long been the case for the entire month of August, usually Europeans vacation rather than work. While clearly a decline in GDP for the quarter, it was one that was easily explainable and not likely to occur.

Likewise, in Japan, they had severe weather and earthquakes, which slowed their economic growth. However, this week they are proclaiming that Japan’s 10 year growth cycle has one of the strongest in their financial history. And certainly inflation, while it can always be a factor in future economic growth, the fact that energy has fallen nearly 30% over the last 90 days should dispel any type of fear of future inflation.

Isn’t it interesting that when President Trump pushed the Saudis to produce more oil in order to reduce higher energy costs, the price of crude oil fell over 30% in 90 days? Maybe that tells you something about how highly inflated energy prices are today. It probably has gone without notice, but the U.S. is now the largest oil producing country in the world. The United States produces almost enough oil to be totally self-sufficient in that category. The revolutionary concept of shipping liquified natural gas is just now starting and the U.S. will be the largest ever exporter of it within the next few years. For those that do not believe in the ingenuity of U.S. engineers, just contemplate the ability to take a clear gas and convert it into a liquid that can be shipped around the world and then turned back to a gas in order to heat homes, etc. – it is conceptually mindboggling.

Everywhere I look I see only good news, except when I watch national broadcasts. I guess it is baffling to not only me, but to my readers as to why Congress refuses to do anything proactive. If it is the goal of the minority in Congress and clearly the goal of every news cycle and news channel we see to have the President removed, why is it that they do not focus on not having him at the polls in 2020 rather than trying to attempt to remove him before then? There is no conceptual way that a President can be removed against his will prior to the elections in 2020, and therefore why even try. It would seem to me that if Congress had any inclination or desire to actually help the U.S., they would focus on that rather than these incredible time-wasting and expensive investigations, conversations, and allegations. But then again, the nightly news would have nothing to report on, so…

For those of you who have not been a long time reader of my financial reports, you probably did not realize that I was a firm and longtime critic of former Federal Reserve Chairman, Alan Greenspan. While so many people were praising his genius, I was criticizing his faults. I thought he was so wrong during the 90s in virtually all of his actions and most of his speeches. I thought he made a tragic mistake when he was chairman in 1987 with the big market correction that year and I thought he handled the economy in the 90s and early turn of the decade poorly, as well.

So, I could not have been happier to see him give one of his famous quotes recently. Former Federal Reserve Chairman, Alan Greenspan, explained, “ We are moving into a state of stagflation we haven’t seen in this country in quite a while. It’s slow. It’s progressive.” It really cheered my heart to see him once again express a negative thought about the U.S. economy. There really could not be a stronger contrarian call of the markets than having Alan Greenspan himself express the negativity. He had been so wrong so many times in my economic past that it cheered me to hear his voice once again, and to know how likely it is that he would be wrong again.

In this holiday season, I hope you spend more time with your family, enjoy the season, and worry less of the fears on Wall Street and have conviction in the reality that the economy is great, interest rates are low and earnings are increasing. All three of these will lead to higher markets, and I am not sure whether that is today, tomorrow, this week or next, but I do know with absolute assurance that the markets will be higher years from now than they are today.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Tuesday, November 6, 2018

Everyone loves a great conspiracy theory, I have one...

There is no way to put it mildly – from a financial standpoint the month of October 2018 stunk. I never want to minimize a downturn in the financial markets since people lose money, but this one defies the imagination. During the month of October, the NASDAQ had its worst month since October 2007. I intend to illustrate how completely implausible that correlation is. In addition, I also want to point out the astonishing positive economic evidence that forecasts that the markets will, in fact, recover and soar to new heights shortly. With such overwhelming favorable economic news, how the market can sell off in such a pronounced fashion is mind-boggling. Perhaps I have the answer in the form of a conspiracy theory, backed up by hard economic evidence.

Before I launch into that far-reaching and most interesting explanation, I have to cover the dismal economic performance of the financial markets during the month of October. The Standard and Poor’s Index of 500 stocks sold off to the tune of -6.8% during the month, yet it is still up 3.0% for the year 2018 and up 7.3% for the one-year period then ended. The NASDAQ Composite showed a dismal performance of -9.2% during the month of October but is still up 6.7% for the year 2018 and up 9.8% for the one-year period then ended.

The Dow Jones Industrial Average lost -5.0% during the month of October, yet it remains up 3.4% for the year 2018 and is up 9.9% for the one-year period then ended. If for any reason you thought that you would have been safe in bonds during the month of October, they also lost money, but at a much lesser percentage since they were down -0.7% for the month of October, but they remain down -2.5% for the year 2018. For the one-year period ended October 31 2018, the Barclays Aggregate Bond Index is down -2.1%.

There is just no way to sugarcoat the performance during the month of October, it was just downright terrible. What is fascinating about this performance is that it is not based on economic evidence but rather on the fear that the Federal Reserve is out of control and lacks the common sense to stop the hike in interest rates. I find this perception, that the Federal Reserve does not understand the impact of higher interest rates, both naïve and totally misplaced. I hope to better explain this matter below.

Caroline and Reid Schultz,
with Ava Rollins

Ava Rollins

Ava and Dakota Rollins at the beach

I have written about my father in past postings, but this month brought to mind a very important lesson that he taught me long ago. As I pointed out, my father was brilliant in many aspects. He had a master’s degree in electrical engineering from the University of Tennessee, but had the misfortune of graduating during the Great Depression in the 1930s and was unable to find work. He had drifted into the ministry and remained there the rest of his life. However, I was always amazed by the broad range of subjects that he spoke of and the knowledge he held on virtually all of them.

One of the things I always marveled at was his ability to give his sermons each Sunday almost seemingly without notes. He did, however, maintain a black book that contained sermon notes throughout his entire career in the ministry. When I was in high school, I would sometimes sneak into his office to read the black book. Each sermon was noted by the date and the church where it was given, going back close to 40 years. What was amazing to me was that there were only three or four items actually noted, including a simple phrase or two as a reminder of what to emphasize.

As a preacher, my father was a very dynamic and forceful speaker, but removed from his element, he was not one for small talk. We never had conversations about his profession, except the one day when I caught him in a rare moment of reflection. I asked him how he was able to give a 45-minute sermon based only on the three or four notes in his sermon outline and I will never forget when he replied, “Someday, you too, after 40 years of experience, will know what to say from only a few notes.”

I guess I have to admit that after 40 years of analyzing the financial markets, you find out fairly quickly what is important. You cannot allow yourself to be influenced by all of the talk on the financial news and the predictions of financial chaos that show up in the headlines on a daily basis. You must rely upon what you know about the economy and finance rather than hollow headlines that reflect bias in one direction or another.

This leads me to the great conspiracy theory for October 2018. It is interesting that as indicated in my blog last month , we had just finished the best quarter in the financial markets since 2013. We also reported the lowest unemployment rate in 49 years. How with such sterling financial performance could we suffer the worst market pullback since 2007? Perhaps I have the answer.

It has been long perceived that the month of October is bad for stocks. However, it is not typically the worst month of the year, as September claims that unique negative recognition. However, over the years there have been many noted downturns in the market during the month of October and as we were heading into the month, all of the negative forecasters were pointing this out. Of course, there are a lot of negative headlines surfacing with the midterm elections coming up, along with problems in Italy, Saudi Arabia and other parts of the world. But the principal reason for my opinion focuses on an interview given by the Chairman of the Federal Reserve, Jerome Powell, which coincidently occurred on October 3, 2018. In an interview with PBS, during an offhanded Q&A session, he said the following: “The really extremely accommodative low interest rates that we needed when the economy was quite weak, we don’t need those anymore. They’re not appropriate anymore. Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point, probably.”

With those words, the perception of the investing community was that this Federal Reserve Chairman was totally out of control and would increase interest rates regardless of the economic circumstances at that time. Despite inflation being very well contained and the economy strong, but not overheating, would this new Chairman of the Federal Reserve increase interest rates to the point where the bond yield would become inverted and create a recession in America? This actually happened in 1987 when the newly appointed Chairman, Dr. Alan Greenspan, did exactly that, creating a loss in the stock market of 22% in one day, which coincidently occurred in October 1987.

This point centers on my conspiracy theory! For the last several years, the performance of hedge funds and institutional investors has not kept up with the overall market. The hedge fund industry, which performs well in the down markets, isn’t much of a performer during the up markets. Is it possible that they, as a group, decided that it was appropriate to move the market down, even with such great economic results, in order to improve their performance for 2018?

Joe and CiCi studying the stock market

What seems strange about this sell-off was that it occurred virtually at the beginning of October and ended almost instantaneously during the last couple trading days of the month. There is no question that the momentum traders also participated in this sell-off. As the market continued to fall and support was broken at the 200-day moving average, the momentum traders kicked in their algorithms, which indicated that the market would trend down instead of up, and selling was exaggerated. I have often wondered if many of these momentum traders and hedge fund investors meet up and make a decision to buy or sell as a group. It is like a game of chicken as they short the market as a group and then wait and see who should cover their shorts first. In either case, the market went down without any common logic during the month of October and we all sustained losses because of it.

So, what do you do in the face of these overwhelmingly negative financial markets? The only thing I know to do is to take my father’s advice and use my 40 years of watching financial markets to predict the future. As I have pointed out in so many postings in the past, there are basically only three things that control whether the markets go up or down; the economy, earnings and interest rates. Last Friday the unemployment report came out for the month of October and it showed that there were 250,000 new people added to the payroll during the month, well above any consensus estimate. The unemployment rate remained at 3.7%, the lowest rate since December 1969, the best in 50 years.

But the absolute crushing number was the over 711,000 new people added to the payroll and over 600,000 of those new entries into the employment market found jobs. As I have pointed out many times in the past, the secret of the economy is keeping people working. More people working means more people paying taxes and more people contributing to the economy. Right now, there are more people employed in the United States than ever in our history. Did you realize that over the last one-year period the unemployment rate has fallen close to ten percent? There are close to 3 million more people working in America today than were working only one year ago. These 3 million people support 10 million Americans.

It was recently reported that the GDP went up 3.5% during the quarter ended September 30th. It is currently projected that the GDP for the fourth quarter of 2018 would be in the 2.5%-3.0% range. While not as high, certainly more than acceptable. When you compare that the NASDAQ was down the most since October 2007, you need to review your history. In October 2007 this country was in a major market meltdown. The GDP for that quarter was down -8.2% in 2007 as compared to up 3.5% in 2018. First time unemployment applications in 2007 were in the 800,000-900,000 per month range, as compared to 2018, where employees are actually being added.

You may not recall this, but there was a time in 2007 when the Federal Reserve had to guarantee the money market funds since it was suspect whether those funds would be able to even return the money to investors. The entire country was in a financial meltdown, with foreclosures dominating the news. You compare that horrendous economic performance to 2018 when the economic evidence could not be greater and you just cannot fathom how the markets could report negative numbers. Therefore, my analysis is that the economy is great and strong and certainly there are no recessions in sight during the next couple of years.

The next major component of determining market value is earnings. In order to reassure myself regarding earnings, I went back and looked at the increase in earnings over the last several years. For the year 2017, S&P 500 earnings were up 24%, it is estimated now that earnings in 2018 might be up 22% when finished. Projected earnings for 2019 are certainly slowing, since there will be no tax changes in 2019, yet they are still projected to be up 11%. The increase in earnings therefore has been 57% in the last 3 years. On a compounded basis that is 68%. Wow! What is even more interesting is that as these earnings continued to go up, contrary to the market reaction in October of 2018, the price/earnings ratio has actually gone down. For the last 25 years the Standard & Poor’s Index of 500 stocks has had a price/earnings ratio of 19.2, on average. As we currently stand, the price/earnings ratio is at 18. So, for anyone to tell you that this market is expensive relative to prior years is basically expressing their uninformed opinion.

The earnings for the third quarter of 2018 were nothing short of spectacular. However, I still hear all of the financial commentators and their terribly misinformed views on such. I think it is important to understand the direction of earnings but I also think it is important to understand absolute earnings. When you see stocks you have never heard of go up 20% or 30% in a day based solely on showing a profit you have to evaluate the actual level of those profits before you invest. To express how misinformed financial information can be, let me give you a real-life example of the earnings report from Berkshire Hathaway. For the quarter ended September 30th they reported excellent numbers wherein they earned $6.88 billion in operating earnings (not including financial gains), which was basically double their earnings of $3.44 billion last year. As I watched this commentary, one after another so-called “expert” expressed his and her opinion on the quarter and one, Bill Smead, said “This is absolutely one of the greatest quarterly earnings reports that have ever come out of a United States corporation.”

I reflected on that for a second and compared it with the report the previous day from Apple. As all of you know, that stock sold off close to 7% this past Friday due to so-called negative earnings reports. I saw one commentator after the other criticize the company and its earnings report for close to three hours, citing their financial knowledge on the financial strength of this company. However, after closer inspection I found out that Apple reported an earnings report for the quarter of $14 billion and is by far the most profitable company in the United States - and probably the entire world. Even social media outcast, Facebook, showed a profit of over $5 billon for the quarter and they have no tariff restrictions. Certainly, Berkshire Hathaway profits were excellent, but to refer to them as the best ever demonstrates the bias that financial news brings.

So the first two components, the economy and earnings, both are beyond excellent and frankly are trending higher. Which leads us to the most important component that affected the markets during October – interest rates. Is it possible, that the Federal Reserve could be so inept as to increase interest rates in the face of an economy so strong that it would turn it into a recession essentially overnight? I am amazed that investors and commentators would be so naïve to think any politician would take such action knowing the dire consequences.

I question whether interest rates are even high today, much less too high to destroy the economy. The Federal Reserve has basically two mandates. The first mandate is that it is to keep employment high so that the economy remains strong. The other mandate is that it must control inflation so as the inflation does not get out of control. Based on the information above it is clear that employment is high, in fact, it is at the highest level in 50 years. Clearly, that mandate has been satisfied by the Federal Reserve. The more important component is whether the Federal Reserve is doing its part to tame inflation. I would argue at the current time that interest rates are not high at all. At the current time the inflation index reflects a current reading of 2.17%. If you compare that with the target on the federal funds rate which is set at 2.2%-2.25% you will note that the actual interest rate after subtracting inflation is essentially zero. Rather than expressing alarm, just consider that for a minute.

In order for a saver to actually earn money, they must earn in excess of the current rate of inflation. If you invested money today at a rate less than the inflation rate, then at the end of the term, whatever that may be, you would have actually lost money. If the Federal Reserve would intend to keep the interest rates in line with inflation, then at all times it must be trading above the current rate. If the Federal Reserve was attempting to slow the economy, the current rate would be at least double the current inflation rate. If you saw a federal funds rate that was 2% points higher than the rate of inflation then you would know that it was a concerted effort by the Federal Reserve to slow the economy. Since we do not currently see the Federal Reserve interest rates exceeding the rate of inflation, to argue that the Federal Reserve is attempting to restrict the economy is just uninformed. We may get there in the future, but we are currently not there today.

So, based on my 40 years of experience in this business, during the month of October we did virtually nothing. The three major components of higher stock markets were all firmly in place. The economy was great, earnings were high and accelerating, and interest rates restrained. Therefore, nothing financially led the markets lower. Whether it was a concerted effort on the part of professional traders or just an over exaggeration of the current political environment, I really do not know. The only thing that you can do when in doubt is invest with your experience, and that experience led us to do nothing during October.

We also know that historically the best months of the year are November through May and I would continue to expect the market to move higher after the midterm elections and reach my year end goal of the S&P at the 3,000 level, which is approximately 9.2% higher than it is today.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Tuesday, October 9, 2018

Best quarterly stock market since 2013!... Lowest unemployment rate in 49 years... It just does not get any better than this!... Why are Americans feeling so bad?

As the economy continues to post exceptional numbers and the major market indexes have reached new highs, I am still completely baffled by the absolute negativity exuding from the American population. Rather than out in the streets celebrating an extraordinary economy and the continuation of impressive corporate earnings, all you hear are negative comments that, to me, appear irrelevant to the big picture. So, I thought I would devote this posting to addressing your concerns by providing you with all of the positive economic information out there which should allay your fears.

As always, before I begin, I need to report the results of the month and year on the major market indexes. Although the performance for the month of September was flat, the performance for the quarter was the best in over five years. Many of you have heard of the old Wall Street saying, “sell in May and go away”, well that was not evident this year as the third quarter of 2018 was nothing short of spectacular.

Ava ice skating

Joe and Josh at a Braves playoff game - Braves won!

Ava (age 7)

For the month of September, the S&P Index of 500 stocks was up 0.6%, year-to-date that index has posted a 10.6% return and for the one year ended that performance has been 17.9%. As mentioned, the last quarter was extraordinary and this index posted an increase of 7.7% during the quarter. The Dow Jones industrial average returned a respectable 2% increase in September and is up 8.8% for the year 2018 and has a one-year performance at September 30th of 20.8%. The NASDAQ Composite lost 0.7% during the month of September; however it is up 17.5% for the year 2018 and is up 25.1% for the one-year period then ended. The NASDAQ Composite showed a 7.4% return during the third quarter of 2018, while the Dow Jones industrial average leapt 9.6% during the quarter.

For those of you who insist on investing in bonds come rain or shine, the Barclays Aggregate Bond Index was down 0.6% for September, down 1.7% for the year 2018 and for the one-year then ended was down 1.4%. As you can see, the trend in bond investing is negative and is likely to stay there. For those of you more interested in long-term performance, rather than just recent performance of bonds, the 15-year return on the Barclays Aggregate Bond Index is 1.8%. If you look at the same time period for the S&P 500 index, it was up 9.7% for the last 15 years. There is absolutely no short-term reason to be investing in bonds and, as illustrated, even the long-term performance of bonds is nothing to write home about.


You may recall that in February 2018 the financial markets sold off drastically with the anticipated fear of the tariffs President Trump was going to place on many countries. The so-called financial experts were screaming that tariffs would throw the U.S. economy into recession, create vast unemployment in America and pure chaos in our economy and that of other countries around the world. But not me. As is often the case when economists speak, they were just wrong.

Let us evaluate where we stand on tariffs eight months after the original proclamation. It did not take long before South Korea agreed to the terms of a new deal with the United States for the very basic reason, they had no choice. To the surprise of many, both Mexico and Canada readily agreed to completely redo the NAFTA agreement and have now agreed to terms more favorable to U.S. imports and exports. There were many who said that Canada would back the U.S. into a corner before agreeing to reduce their import duties on milk and other dairy products. I guess they hit a wall, so to speak, as they readily agreed before the October 1st deadline.

It will only be a matter of months, in my opinion, before Japan agrees, as well as the European Union. It is pretty simple to figure out why agreement will be forthcoming. Do they want to sell their products to the United States or just build them solely for their own respective country? The answer is so crystal clear that no explanation is needed. Both Japan and the European Union will be in full agreement before the end of 2018.

So exactly what happens with China? I guess the more accurate question is who really cares. As mentioned so often in these postings, China needs the U.S. a lot more than the U.S. needs China. There is absolutely no question that this would create disruption of the supply chains and many companies that manufacture in the United States, but while disruption will occur, it will not be damaging. Many companies are moving their manufacturing from China into other parts of Asia, such as, Vietnam, Malaysia, Indonesia and India; however, it will hardly affect corporate earnings. The bigger question that remains to be seen is whether China will continue to resist fair tariffs and risk letting their jobs evaporate to elsewhere. I will discuss China in greater detail later in this posting.


As I am sure you are aware, the price of oil has gone up fairly dramatically this summer. There are many reasons given, but frankly those reasons do not survive the “smell test.” The most important reason is that on November 2, 2018 the U.S. will sanction oil that is shipped from Iran. These sanctions will be devastating to the Iranian economy since, unlike before, the U.S. will hold any country that imports Iranian oil accountable. In an act of absolute brilliance, the current President has made these sanctions very simple. If you want to trade with the United States, then you will not import oil from Iran. Take it or leave it. You can either trade with us, or you can trade with them, but you will not trade with both. Never before have sanctions so affected the Iranian export of oil. Already European companies are pulling out of Iran manufacturing and Europe has already canceled long-term contracts to buy oil from Iran. No question that China will fight this policy and buy oil from Iran, but the rest of the world buys oil at their own risk.

What is interesting about this concept is (for reasons totally unclear to me) the price of oil has gone up in the United States by 30%. Do you know how much oil we have bought from Iran over the last 10 years? None! So, the price of oil in the United States has nothing whatsoever to do with the sanctions on Iran. I have been watching the oil markets my entire professional career, which spans over 40 years. What is absolutely clear in the oil market is there is total collusion when it comes to pricing. If one oil company increases the price at midnight on Christmas Eve all the others will simultaneously increase it by the same percentage. There is nothing economically justifying the price of oil at the current time other than the price of oil has been too low for too long and it is now time for catchup. You should read nothing economically into the price of oil at the current time.

However, the positive impact of increasing the price of oil is that shale manufacturing will explode. With the price of oil up, exploration can continue and as this happens the shale fields will become increasingly profitable, putting more people to work at high paying American jobs. It is amazing to me that the financial press cannot understand how the sanctions of Iran have absolutely no negative impact on the United States and that the increased price of oil actually helps the U.S. economy rather than hurts it. So, if this is one of your concerns going forward, that concern is misplaced.

Our awards displayed on our front doors


There has literally been tons of ink spilled on the subject of inverted bond yields over the last 12 months. It is true that an inverted bond yield is an early signal that there might be a recession coming into the economy. It has been an indicator that has proven to be correct numerous times over the last few decades. If short-term interest rates exceed long-term interest rates then businesses will not invest since it benefits them to wait until the future, when these rates are lower. This timetable of waiting to invest slows the economy and for all practical purposes leads the country to recession. As you can see, with higher short-term rates than long-term rates, companies are unwilling at the current time to borrow money to invest in their plant equipment since it would be cheaper to wait until the rates fall.

What is rarely reported regarding an inverted bond yield is that there is a long, inconsistent lead time between the time the bond yield inverts and before the economy actually falls into recession. Over time, that lead time has proven to be in excess of two years. So even if you had an inverted bond yield today, which you do not, it would most likely be over a two-year cycle before you actually saw it affecting the financial markets.

So much has been said about the inverted bond yield but there is very little information given to the real numbers. As I have pointed out for years, one of the reasons why the 10-year Treasury is held back is due to the low 10-year Treasury rate in other countries. As an example, the 10-year Treasury in Germany is at 0.576%. In Japan, the 10-year Treasury is at 0.147%. In the United States, the 10-year Treasury is 3.233% as I write this. Therefore, because the rates are significantly higher for our 10-year Treasury rather than the Treasury of these developed countries, money will move to the U.S. to take advantage of the higher rates. That movement hurts the currencies in both Germany and the European Union, and of course Japan. The most important aspect of this occurrence is that all of the money flowing into the United States Treasury market from around the world keeps the interest rate on the U.S. bond rate lower than it actually should be given normal economic circumstances. This is a good thing since it reduces the cost of capital for home building and the purchase of automobiles in America.

There is no question that higher interest rates will impact the economy since virtually any debt maintained on a variable rate will go up, costing consumers more money to service this debt. But as I write this posting, the 10-year Treasury is at 3.233% and by no definition does that denote any type of inverted bond yield. Therefore, if one of your concerns continues to be fixated on the potential inverted bond yield, we are not even close to that at the current time. Even if we had such a yield, it would be years before it affected the financial markets. Rather than focus on the fact that 10-year Treasury rates are going up and the effect that it might have on the future earnings of consumers, it is much more important to focus on the reason why they are going up. 10-year Treasury rates would not be going up if it was not a result of the realization that the American economy is increasing in value. As a general rule, interest rates fall as the economy declines and goes up when the economy improves. This week, the chairman of the Federal Reserve Jerome Powell said, “There’s really no reason to think that this cycle can’t continue for quite some time, effectively indefinitely.”


I wish I had a nickel for every time I heard this statement from so-called experts on the financial news. They keep quoting that the stock market valuation is too high, and therefore they would not invest new money. The first thing you have to realize is that, by historic standards, today’s stock market is different than prior years. With the advent of 401(k) plans back in the 1970s, that vehicle has become the standard for retirement in America today. The actual pension plan, as we know it, virtually does not exist any longer. Americans, from the very young to the very old, invest money in their 401(k) plans on a weekly or monthly basis directly from their paychecks. It is presumed that roughly $2 billion per day flows into American 401(k) plans. This money is not concerned about market valuations since facts indicate that markets go up over time regardless of good or bad economic projections. Therefore, as an anchor on the market, this money continues to flow regardless of projections by so-called experts.

So, is the market overvalued or are those projections just released to promote whatever product they happen to be selling on any given day. The sure way to find out is to look at the earnings of the S&P 500 index as projected for 2019. As of the date of this posting, they are projecting earnings for the S&P 500 for 2019 as $176.52. If you will look at my year-end projection, I forecasted that the S&P 500 would end this year at the 3,000 level. That is up roughly 3% from where we ended the month of September. If you divide 3,000 by 176.52, you get a price-earnings ratio of 17. Do you want to know an interesting fact? The price-earnings ratio for the last 75 years in the stock market has been 17. Therefore, to argue that the stock market is overvalued at the current time clearly indicates an unawareness of the facts.

Then again, I also hear on a daily basis that we are on a “sugar high”. There is no question that the earnings have increased dramatically because of the reduction of income taxes. But the one thing that people cannot seem to grasp is that taxes are not going back up for years to come. Therefore, it is not expected that these earnings would go down in the second year of income tax reductions. In fact, with an extraordinarily strong U.S. economy and growing optimism by consumers, the more likely the trend for 2019 and 2020 is up rather than down. Therefore, if one of your concerns focuses on the already fully priced stock market, you can discard that concern as being inaccurate.


I keep hearing so many clients say that we will go into recession shortly given the outstanding performance of the economy so far. There is absolutely no historical precedent for an economy going from 4% to recession in a short time period, short of economic disaster or a worldwide economic event such as war, etc. As mentioned in the title, with unemployment at its best in 49 years, more Americans are working today than ever before in the United States. More people working means more people paying taxes and more people contributing to the economy. We had a 4% GDP in the second quarter of 2018 and the Federal Reserve Bank of Atlanta now forecasts the third quarter GDP at an increase of 4%. There is no economic standard or preamble to the future that would indicate that any recession in the U.S. economy is anywhere in sight.

I do, however, agree with the assessment that in all likelihood the U.S. economy should fall into recession in the second half of 2020. This is based on the Federal Reserve’s desire to keep a level economy and prevent it from overheating. However, at their rate of a quarter of 1% increase in interest rates per meeting, it is not likely to occur for at least two years. So, if your argument is that the U.S. economy is going into recession, I would concur. However, that potential recession is over two years from today, so why anyone would make changes in their portfolio to provide for a recession two years out does not warrant discussion.

To invest in bonds at the current time, as interest rates go up, is not likely to be profitable. I often ask clients why their portfolio is currently invested in bonds. Even after I go through a lengthy explanation of why it is almost a certainty that bonds will produce a negative rate of return, they continue to express their desire to be so invested. In my opinion, this is sort of like stepping in front of a train. You know disaster is coming but you don’t know when. The time to invest in bonds is not during an economic boom like today when interest rates are increasing but rather when the Federal Reserve is trying to stimulate the U.S. economy by decreasing interest rates. That date is likely two years from now.


Is your concern that China may in fact economically overwhelm the United States, and therefore you do not want to invest in the U.S. stock market because of this fear? There is no question that the Chinese stock market is the cheapest in the world. By any valuation standard, stocks are dirt cheap in China. Would I invest there today? Absolutely not.

Let me give you a quote that I think about often times when the discussion of China occurs. In many eyes, China has performed miracles by converting their economy from basically a very small middle-class to a middle-class population today that exceeds the population of the United States. They have brought people in from the fields and trained them in manufacturing and made these workers the envy of the world in creating products that can be used in the U.S. and other countries. However, they are playing economic roulette with this middle-class. You cannot create a middle-class that wants higher and higher wages without passing on that cost to the consumer. However, China has not done so. In the last 15 years, average export prices to the United States have been unchanged. Basically, think through that statement. For the last 15 years, prices in the U.S. have been stable in U.S. dollar terms. Except, if you consider that in China, the average wages have gone up over six times. How can a country continue to increase the compensation to their employees but yet their pricing remains stable?

Economics would contend that China is a country headed for economic chaos if their costs continue to go up but their prices continue to go down. One way they have been able to accomplish this is by manipulating their currency and by borrowing an excessive amount of debt to finance their economy. Once again, a risky move from an economic standpoint. Even though their economy continues to grow, it is currently declining. As I write this posting, I note that China has actually taken extraordinary measures to increase their performance. This is a direct action to circumvent the tariff costs of their products shipped to the United States.

It is clear that the Chinese government recognizes the perils of reducing their currency and flooding the economy with more money to offset the negative effects of the tariffs to the United States. A much bigger fear should be that due to this increased cost, their supply lines are being replaced by other countries and this business is lost to the United States forever. Over the weekend, China reduced the amount of cash that the banks are required to reserve for future growth, therefore weakening the banking system. They have dramatically decreased the amount of reserves these banks hold, and therefore are pushing the banks to lend more to the economy. In addition, they are flooding the banking system with new cash to the tune of $109 billion in order for banks to have the excess capacity to loan more.

If you assume in China, as in the United States, that $1 creates $7 in GDP, this is flooding the economy with close to $700 billion of fresh money to create GDP. Those of you who remember the 2008 financial disaster, the TARP at its maximum would have only been $700 billion but in fact less than $300 billion was actually injected into the banking system. It is not often reported, but all of the TARP dollars were repaid with the Federal Reserve actually making a profit on the transaction from TARP. Yes, there were defaults on debts, but the debts earned so much for the Federal Reserve that it did more than offset the losses.

There is no question that you will see the Chinese devalue their currency to offset the price of tariffs in order to remain competitive. It is also crystal clear they are concerned about their economy or they would not be injecting so much money into their banking system. Would I invest in China today? No, I would not; they are looking at hard times for as long as they fight the tariffs in the United States. So, I will say like I have said before – China will agree to the tariffs for one very simple reason, they have no choice.


At the current time, we are moving our emerging market investments, not that I do not expect them to do well over the next year or so, but because their volatility and unknown nature is unnerving to investors. In fact, many of the emerging markets will greatly benefit by the increase in the price of oil. However, at the current time, currencies in these emerging markets are cratering as compared to the U.S. dollar solely for the reason that the U.S. economy is so strong and their economies are so weak. With so many of the emerging markets’ economies dependent upon selling to the United States, as their economies decline and the U.S. dollar goes up, they get a boost in productivity due to the currency exchanges. I fully expect that emerging markets will regain their footing over the next year as earnings go up and their economies stabilize. If I have to invest in one market at the current time, it would be the U.S. We will let the volatility of the international and emerging markets stabilize before moving assets back in that direction.

I have tried above to address all of the issues I think you could raise when deciding whether or not to invest. It is absolutely overwhelming to me how much cash is sitting in investors’ banks accounts earning zero. I get so many reasons why that money is not invested, many of which are itemized above. I am not going to say that I am always right, nor have I been 100% correct over time. However, for the last eight years I have been advising, if not even begging, clients to invest their excess cash as the markets were moving higher. I guess from that perspective, that has been a crystal-clear winning recommendation. But if you continue to resist investing, I would like for you to consider the reasons as itemized above and assume that whatever your argument is for electing not to invest could be answered with a positive response above.

As always, we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Friday, September 7, 2018

Why would anyone invest with any advisor that is not a fiduciary?

I have wanted to write extensively on the title of this posting because I consider it to be of the utmost importance. Everyday I think to myself that there are so many investors losing out on one of the greatest bull markets of all time. With the stock market up over 20% in 2017, and up almost 10% so far in 2018, so many investors have wasted a once in a lifetime return with financial advisors that do not have their best interest at heart. I will continue this discussion in greater detail later in this posting.

Lucy & Harper Wilcox

Lucy (6) and Harper (8)

Eddie Wilcox and wife, Jennifer

Before I discuss that topic, I have to discuss the extraordinarily good month of August 2018 from an investment standpoint and once again emphasize the strength of the U.S. economy and why markets are likely to continue to advance even after they hit all time highs in August. The economy at the current time could not arguably be better. GDP was adjusted higher for the second quarter and unemployment actually ticked down. Corporate earnings are now exceeding the 20% year over year estimates and the consumer has the highest optimism levels in over a decade. What is even more important is interest rates continue to be unbelievably low, despite being higher this year, and inflation is moderate. All things considered it is the perfect Goldilocks economy. Not too hot, not too cold - just right.

For the month of August, all the major market industries posted all time highs. The Standard and Poor’s index of 500 stocks was up 3.3% during August and up 9.9% for the year to date in 2018. The one-year period it reported an excellent 19.7% increase. The Dow Jones industrials average was up a more moderate 2.6% during August and it is up 6.7% for the year 2018. For the one-year period it is up 21%. The real winner during the month of August was the NASDAQ composite, it was up 5.8% in August and is up 18.3% for the year 2018. For the one-year period the NASDAQ composite is up a sterling 27.4%. For those of you that continued along investing in bonds, the Barclays Aggregate Bond Index was up 5% during the month of August but has a negative return for 2018 at -1.2%. For the one year period that index has generated a loss of 1.3%. As you can see any investor that has a significant allocation to bonds is not even coming close to generating a return as high as the underlying rate of inflation.

Due to the new highs being reached in the markets, a great deal has been said in the press lately regarding the potential for a huge decline in the stock market. I am not sure where the naysayers are finding their research on this subject since it is not supported by economic facts. Yes, it is true that the major market industries have hit all-time highs, but the market, by any measurable standard, is not overpriced. Due to the huge increase in earnings that U.S. corporations have realized over the last several years, the P/E ratio is still maintaining historically moderate levels.

If you look at the current earnings for the next 12 months, the P/E ratio for the Standard and Poor’s Index of 500 stocks is only at 17. If you evaluate the last 4 decades of investing you will find that, on average, 17 is the standard valuation represented by this index. So, when your neighbors or friends tell you the market is overvalued, ask them exactly what standards they are using to make this determination. In every decade since the 1920’s the average P/E ratio for the S&P Index has been 17, precisely where we are today!

About 90 days ago, there was much discussion in the press that the inverted bond yield would in fact push the economy into recession sooner rather than later. However, not many people have mentioned lately that the 10-year Treasury has actually declined, hovering around the 2.8% range over the last 90 days. There is actually an economic reason for this lack of movement, although the Federal Reserve continues to push short term rates higher. What we are seeing is a moderating inflation cycle that has not exceeded the 2% threshold as mandated by the Federal Reserve. But more importantly, there is a huge drag on interest rates by the 10-year Treasury rates in competing countries. If the Federal Reserve pushed up rates too high, money would flow out of foreign currencies into the U.S. dollar, hurting their economies and making their currencies less competitive. Trust me; I don’t think the Federal Reserve has any intention of creating that chaos and is likely to only make one more increase in 2018.

It is amazing to me that I have to explain to people how well the economy is doing. You do not have to look far to see all of the construction cranes in Atlanta; and good luck trying to get reservations at your favorite restaurant. Have you noticed that traffic is terrible everywhere you go, at all times of the day? I drive by the full parking lots of Lenox Square and wonder to myself why anyone would be inside a mall on a beautiful Saturday afternoon.

The department of labor has just announced that the unemployment rate continues to be below 4%. The economy added 201,000 jobs during the month of August, which by all historic standards is a very slow month for employment. As I have pointed out in these pages for many years, the more people you have working in America, the better the economy will be. With more jobs you will see the economy pick up in every respect and right now we are above full employment in America. If you want to know how strong the economy is you have to realize that U.S. employers have added to payrolls for 95 straight months. This is the longest extended job expansion in the history of the United States. Also, it was reported that manufacturing activity in August expanded at the strongest pace in more than 14 years and U.S. corporate profits boomed in the second quarter. I am not sure exactly what type of evidence that you would need to accept the reality of the strength of the economy, but those statistics are pretty compelling.

There is no question that there is economic uncertainty in the emerging markets and of course in the world’s smaller economies. Much of this uncertainty and the decline in value is a direct result of the issue with tariffs. However, from a true economic standpoint, the cheapest markets in the world today are Asia and the other emerging markets. They are however, not investable at the current time since the momentum traders continue to create economic chaos by forcing these stock markets down. The traders have neither the capital nor willpower to stay in these trades forever. Even though the emerging markets have incurred 5-6% losses over the last 90 days and are today trading down -7% while the S&P is up 10 %, it will be a quick rebound. Obviously, no one knows exactly what date this rebound will occur, and we are better off not investing in those markets until it does. I’ll bet that you will see the emerging markets rally late in 2018.

The month of August was an excellent month financially, but the more new clients I began to see coming in, the more I questioned why anyone would entrust their hard-earned money to an advisor with no fiduciary responsibility. I see so many cases of new clients who have been taken advantage of by previous advisors, and yet people out there continue to invest with non-fiduciary advisors. Many of these large brokerage houses and banks do not have your best interest at heart; they invest your money in investments that benefit them more than you. It just baffles me that anyone would take that risk, and I intend to cover that matter later in this posting.

Ava at the beach, age 7

Carly Kramschuster at the Braves game

Let me give you a couple examples of what I have seen over the last few years with new potential clients. I had a lady come in recently who was 72 years old. She had absolutely no knowledge of the financial markets and no real understanding of what was going on with her money. However, at 72 years old she was fully retired and expected to live off of her retirement money. She, like many others, was scared to death of investing in the stock market and was therefore drawn in by an advertisement from an insurance company that guaranteed her 6% for the remainder of her lifetime.

She had no idea exactly how this annuity worked and gave me the actual document to read, which ran close to 100 pages. This lady was 72 years old, but the annuity provided that for the very first 10 years of the annuity she was not allowed to touch it. Therefore, her money was tied up from age 72 to age 82, during a time where she desperately needed the cash flow for her monthly needs. This is an example of how insurance agents take advantage of retired people. When you think about it, after the money has sat for 10 years, the commitment to pay 6% over time is hardly a stretch for even the worst investors. The lady decided to cancel the annuity so she could have ready access to the money and transferred it to another form of investing, incurring a penalty of roughly $60,000.

We had an unfortunate situation where a husband died tragically early, but fortunately for his wife and family he had roughly $1.5 million in life insurance. Six months after making this transaction, with annuities from the insurance company, the widow realized she had no opportunity to spend the funds that were to be her livelihood after his death. After a while, she determined that the annuity was impossible to live on based on her cash flow and agreed to take a $150,000 penalty for canceling the policy. Another example of why these types of deals should be illegal... Did the agent really have the widow’s best interests at heart?

We had two clients in recent weeks that had very large government pension plans. If you think about it, a government pension is much like a fixed income portfolio since it pays out for life at a reasonable rate of return with no volatility. It also goes up annually with inflation so it is a wonderful hedge against future expenses. In addition to their wonderful government pension, they had $500,000 or so in fixed rate investments. If you put that on paper, you would quickly see that virtually 100% of their money was in fixed income, with their investments earning next to nothing over the past few years. This is a classic case of an investment advisor who did not understand a client’s entire finances and recommended investments that benefitted him more than the client. Once again, a prime example of why there should be a regulation to keep advisors from taking fees from products they sell to clients.

Recently, I had a very distinguished couple come into my office who lived entirely off of their investments and social security. They had roughly $500,000 invested with their local bank manager. I asked if I could see their investments and found that every dollar was invested in tax-free municipal bonds. Of course, over the last few years as the interest rates have been rising, they have made no money whatsoever on their tax-free bonds. This led me to wonder whether they had a substantial tax problem and thus the need for the bonds. When I looked at their tax return they had zero taxable income and had not paid any income taxes over the last decade. This type of poor advising of the clients is the reason we put so much emphasis on taxation in our investment plans.

Shortly after I started my business in 1980, I would get up every morning, get fully dressed, and sit down at my desk. I only had a few clients and not much to do, so the highlight of my day was when the Wall Street Journal arrived in the mail. By that time it was 2 days old, but it was still news to me. There was no internet and obviously no financial news programs on television. You had to get your financial news the old fashioned way: the newspaper. I would study the Wall Street Journal from cover to cover, reading virtually every article regarding investing and tax matters. It would literally take up the majority of my day, right up until 4 o’clock when M*A*S*H would come on the TV. So, my day would be occupied by reading the financial news and enjoying the Korean War again for basically 10 hours a day. Needless to say, I have seen every M*A*S*H episode that was ever made.

One day, I received a phone call from my “friend” at Merrill Lynch. He indicated they had a unique opportunity that he thought I should invest in. Basically, it was an orange juice manufacturer near Tampa with its own groves that processed orange juice for wholesale. Since my “friend” had recommended it, I elected to buy 1,000 shares at $6.50 per share, which was a world of money to me at that time. Since I was new to investing, I had no knowledge of the conflicts of interest that major brokers legally practiced. With great anticipation, I was sent the confirmation of my purchase and watched it daily in the coming weeks and months.

After about two months, the stock began to fall. I called my broker to find out if there was some negative news I should be aware of, and he indicated no, everything was fine. On the 90-day anniversary, my outstanding stock was now down to $3 per share, losing more than 50% of its value. At that time, I decided it was time for me to find out exactly what was going on. It was not like I had anything else to do, so I booked a flight to Tampa to attend their annual meeting and see exactly what the company was all about. Clearly, I should have done this prior to investing, but again, I was a novice and learning as I went along.

At the annual meeting, the president of the company strolled in; I vividly remember that he was wearing a yellow seersucker suit and was smoking a cigar. To this day, he is still the most obnoxious host I have ever been around in a public setting. He refused to answer questions from the audience, dodging any inquiries into the company’s financial standing. After the meeting, I did an analysis of the financial statements. I found that while the orange groves were on the balance sheet of this public company, they were actually purchased by him personally and he was draining off most of the company’s profits through rent of the actual groves themselves. This was a clear conflict of interest with the business and even I, the proud owner of a mere 1,000 shares, could see it.

I mention this story, not to explain how I lost money since I eventually sold the stock for about $1 per share, but rather to point out the conflicts of interest that play a major part in non-fiduciary brokers’ and bankers’ income stream. I found out later that Merrill Lynch was the underwriter of this particular security, meaning they billed large sums for providing this service. At that point, they turned over the security to their retail brokers and instructed them to call on their best clients and sell out the inventory of the underwriting. By virtue of ten thousand brokers calling their clients across the United States, there was an immediate demand as Merrill Lynch sold off the shares from their inventory. As you would expect, after the entire inventory was sold there was little demand for the stock. The volume collapsed since Merrill Lynch was no longer selling or buying the stock and it ultimately failed, dropping to an almost worthless value.

If you have ever wondered why your broker calls and asks for your permission to buy or sell a particular security, there is a specific reason. Unless they are operating as a fiduciary, as we are, they need your permission to do so. And because they receive commissions on these trades, they clearly need your consent. In addition, they have the authority to lend your shares to short sellers and basically treat your shares as their own while it is held in their accounts. This brings me back full circle as to why you would ever make an investment with any broker or advisor that did not have a fiduciary responsibility to you. My “friend” at Merrill Lynch was never my friend again.

You would think that this concept is so basic in nature that I would not even have to ask that question. It really all comes down to “Do you trust your advisor,” and “Who is truly benefitting from your invested dollars?” If you buy an annuity or life insurance policy with a huge upfront commission, you need to understand that the product you purchased paid a large fee to the person who sold it to you. You should never have to question whether a recommendation from your advisor is better for you or for them. If you are dealing with an advisor that is a fiduciary, you will never have to worry about this matter since no commissions are ever paid to them on investments made.

One of the basic concepts of our practice when I set it up in the late 1980s was that I wanted everyone to know that we would never take a fee of any kind from anyone but our clients. We have no financial relationships with the custodians, the mutual funds, etc. The only payment our firm receives is from our clients - never a third party. A concept as simple as this should be established by any major advisor. Unfortunately, people on a daily basis entrust their hard-earned retirement money with advisors that benefit directly from the investments themselves and not from their clients. The lesson to be learned here is, never invest your money with any advisor that is not a fiduciary.

We encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

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

Best Regards,
Joe Rollins

Wednesday, August 8, 2018

Save the Date - Dow 45,000 in the Next Decade!

I always try to write a controversial title for the start of my blog to try to get you interested in the contents. However, the above title is neither controversial nor outrageous. We will almost surely see the Dow hit 45,000 in the next decade, and I will explain later why that is possible. Every day, I read the financial journals where someone is forecasting economic disaster for the U.S. and its equity markets. However, rarely has there been a time in our lifetime when the economy has been stronger or our dominance in worldwide trade more superior. I will explain all of this later. In addition, I want to share a few subjects that I’ve been thinking about.

Ava and Caroline at Cooking School
Ava in her new Astronaut Suit from the Air and Space Museum

However, before I get to the more interesting stuff I have to reflect upon the markets performance for the month of July. It was quite an excellent month for the financial markets, which have been very successful in 2018, contrary to popular opinion. The Standard and Poors Index of 500 stocks was up 3.7% during July, and up 6.5% for the year 2018, and up 16.2% for the one year period on July 31st 2018. The Dow Jones Industrial Average was up a robust 4.8% during July and is ahead 4.1% for 2018, and the one year period then ended up 18.7%. The Nasdaq Composite was the laggard in July, up a more modest 2.2%, however, it is up 11.8 % for the year 2018 and for the one year period it is up 22.2%. I always like to give you the comparison with the bond market to reemphasize the point I have written so many times , if you are a large holder in bonds you are likely to well underperform the equity markets. The Barclays Aggregate Bond Index was exactly flat for the month of July and is down 1.6% for the year 2018 and down 1% for the one year period that ended. As you can see, investing in bonds has been a losing proposition over the last one year period; exactly as I predicted.

I received a lot of comments over the last article I wrote regarding a few topics about my father. Some of the comments were reflective. Some clients I have serviced over the last 30 years exclaimed that they had no idea that my father was a Methodist Minister. I guess I did not do a very good job of telling this story.

One of the most interesting memorabilia I have in my office is the actual hospital bill from the day I was born. At that time my father was a Minister in Norton, Virginia, which was a small coal mining region in Southwest Virginia. That bill from the hospital, dated when my mother and I were sent home on September 3, 1949, reflected a total amount due of $50.64. It even set out the circumcision fee of $2 which was low since it “wasn’t that big of a deal.” What is interesting about this piece of memorabilia is that attached to it are the receipts from the church members who actually paid the bill, with one gentleman paying $5 and some of the others paying more. The note attached reads, “Because we love you we hand you herewith your hospital bill mark paid.”

What is interesting is that I had never seen this bill until after my father’s passing. I did know, however, my father was a beloved figure in Norton, Virginia, even though I was only a child. The church had very small memberships and could not afford many nice things. But I do remember that my father became the general contractor and actually built the sanctuary of the church during our stay in Norton, Virginia. I also remember as a child, going back there often for weddings and funerals long after he had left that particular church. This hospital bill was prior to the time of medical insurance and even though my mother was there for 3 days, the total bill was only $50.64. The important part was the show of kindness from the members of the church who actually paid the bill and the fact that my father was so touched by that kindness that he kept the bill and the receipts for the remainder of his lifetime. Hopefully this gives you some insight to what he considered the important things in his life.

I also wanted to give you a quick update on some of the items I wrote about in the last posting related to tariffs. It seems now less than a month later, the European Union has agreed to play nice with the U.S. and to reduce tariffs so that they are equal. It also appears that Mexico has jumped on board and has agreed to re-write NAFTA; Canada not so much. It didn’t take long for two of our largest trading partners to agree with President Trump that free trade means exactly that. Its free for both sides. As I forecasted in that last posting, it will not be long for the rest of the world to agree also. Frankly, they have no choice.

Many commentators are writing that the contentious trade negotiations with China would have catastrophic results in the equity markets. They just do not seem to understand that the only loser in this trade war will be China. Since they sell to us five times as much goods as we sell to them, the hit on their financial markets will be substantially greater than the minuscule change to our economy. Oh yes, I fully understand the issue of trade barriers creating inflation but the economy in the U.S. is so strong at the current time that we need to get this straight and if it means we must suffer some inflation to bring China into the 21st century, then so be it. As the President so correctly pointed out recently, the U.S. economy is playing with the house’s money and we can not allow this golden opportunity to go by without satisfying the problem with China when it comes to intellectual property and state supported enterprises. We have made great progress in only a few months and I expect to see the rest of the countries fall into line shortly.

You may wonder how I can express so much confidence in my headline that the Dow will reach 45,000 in the next decade. A lot of my optimism is reflective of the current, strong U.S. economy. Of the first 275 companies in the S&P 500 Index, 81% have already reported earnings that top estimates. If these numbers hold up for the rest of the reporting period, it will be the highest win rate on record since 1994. So I got to thinking the other night what exactly it would take to reach such a lofty number as 45,000 within the next decade. Simple arithmetic proves the point that even a 6% average annual yield on the S&P 500 would reach a number well in excess of 45,000 within the next decade. And, oh yes, for your doubters out there, I will give you some comparisons to reflect on this number.

Just so you don’t assume I picked some arbitrary number, I looked at the S&P 500 Index which is a much broader index than the Dow. The Dow only includes 30 stocks, while the S&P 500 includes 500 of the largest stocks in the U.S. I think this index is much more reflective because it includes a much broader group of individual companies. So how has this index performed over the last few years?

Through the end of 2017, the S&P 500 Index has had an annualized yield of 15.79% over the last 5 years. Over the last 10 years, which included the year 2008, where the S&P lost 38% the average return over that 10-year period was 8.49%. If you look at the 15-year annualized return, that number comes in at 9.92%. If you go back over the last 20 years, which included multiple recessions along with the meltdown of the dot-com era and of course 9/11, the annualized yield is 7.19 % and for the 25-year average return that number comes in at 9.69%.

If you look at all of these examples above you will note that all are substantially above the 6% hypothetical number I have proposed. And as you also will note, some of these average returns are significantly greater than my 6%. The one thing that investors just can not seem to get their heads around is that it is perfectly possible for the index to go down and go down significantly in a year. However, when you talk about average returns, you are averaging those negative returns yet you still get outstanding long-term results.

I think I am perfectly comfortable with assuming a 45,000 Dow within the next decade, since I have assumed a relatively low annual gain, and given the strength in the U.S. economy it does not appear that a recession is anywhere in sight for the next several years. Even though I have picked a decade as my benchmark, in all reality we are likely to reach that threshold if not years, then maybe months earlier. Save the date!

I guess there are just some things about the economy and the way it is reflected by the financial news that I cannot understand. It seems there are reams of paper written on the subject of the collusion between the U.S. and Russia. While this is a hot topic, we can rest assured that at least Russia does not pose an economic threat to the United States.

As I reported in my last post, we spent two weeks in the wonderful country of Italy. What is true of Italy is that no one really works that hard. It’s a country based upon reflecting on its beauty, drinking fine wine and eating delicious food. No one ever accused Italy of being an industrial giant and I suspect that there are not many Italians, if any, that die from being overworked. However, there is a parallel that you should recognize.

Did you realize that the GDP of Italy is greater than the GDP of Russia? Last year Italy posted a GDP number of $1.9 trillion. While Russia posted a GDP of $1.57 trillion. Who would have ever thought that a country like Italy not known for its industrial growth would actually have more GDP than Russia. I am a little baffled why the financial news makes such a big deal of the threat of Russia. Yes they have their nuclear weapons but their economy is weak and could easily be crushed by sanctions from major countries.

The U.S. had a GDP of $19.4 trillion in 2017, 10 times the size of the economy in Russia. Additionally, Russia has vast natural resources, but not the money or the capital to exploit them. Due to the harsh weather in Russia, their agriculture is weak and they almost export nothing other than natural resources to other countries. How anyone migh classify them as a financial threat ignores the actual facts.

Also, did you realize that the state of California GDP at $2.7 trillion is almost double the size of the economy in Russia. Even the states of Texas and New York have GDP greater than the entire country of Russia. Maybe we need to find another threat to our economy since Russia clearly does not measure up.

I continue to be very optimistic for the financial markets for the rest of the year, and in 2019. It looks like we are well on our way to meet our double digit returns for 2018. Many critics said I was out of my mind to propose such a huge increase in the markets after the S&P went up 21.83% in 2017. But my optimism is not based on sentiment or the alignment of the stars. Its based on the absolutely solid economic data that the U.S. is reporting.

For the S&P companies reporting so far this year sales are up 10% year-over-year. It is fairly remarkable that sales continue to go up in light of the so-called tariff battle ongoing. But the most important component is earnings are up 28% and are currently projected to go up 29% in the third quarter of 2018 and 25% in the fourth quarter of 2018. If we come close to making either one of those estimates for the remaining quarters of 2018, then the markets are significantly undervalued today.

GDP was reported at 4.1% for the second quarter, which was extraordinarily good. No one has any idea what the rest of the year will bring but most assuredly the GDP for 2018 will be above 3%, making it one of the best years in recent memory. The unemployment ratio continues at 3.9%, virtually an all-time low. There is no question inflation is making its way through payroll and employers are having a harder time finding qualified workers. From an employer’s standpoint that is certainly a negative, but from the employees standpoint it is a true positive. As employees make more and more money then consumer confidence goes up, more consumer goods are sold and the economy only gets stronger. How someone sees a negative in this positive ratio defies basic common sense.

And what is happening in residential real-estate is quite remarkable. There is a pronounced shortage of residential homes in America, and homes cannot be built to accommodate the rising demand. But there are certainly regions of the country where valuations are stretched - a large portion of the country is underutilized and can afford to build many more houses without increasing the inflation of the cost of housing.

Just so that you don’t think that I am oblivious to the negatives, I read them also. I know that at a certain point unemployment will create wage inflation and that’s an overall negative. I also understand that a demand for housing will increase the cost of housing which corresponds with a decrease in the demand. I understand that economic theory, but we are not there yet. I also understand the inverted bond-yield where short term interest rates are higher than long term rates. We are not there yet either, but history tells us even when we get there the effect is not negative in financial markets for 2 to 3 years. Why on earth would we be worried today about something that is not likely to happen for 2 to 3 years from now?

In summary, the positives so far outweigh the negatives and you cannot help but be totally optimistic. As I often mention, the three components of higher stock markets are firmly in place. Interest rates continue to be low, although higher than they were a few years ago, and earnings are extraordinarily high and only getting better. That’s the most positive of the positives. And as we sit here today, the economy is stronger than it has been in many years. Therefore, we still have in place the trifecta of the economic components that make markets higher. So as I read the negative financial headlines on a daily basis, all I can ask of you as investors is to sit back and enjoy it.

As always we encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email. I had a client who came in the other day who expressed complete optimism regarding the equity markets. He emphasized to me his goal was to have S&P type results in his portfolio but the one thing was he never wanted to lose money. If you expect those types of financial results it is unlikely you are looking realistically at how markets work. Give me an opportunity to explain.

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

Best Regards,
Joe Rollins