Thursday, February 6, 2020

I Ignore the Headlines - Just Show Me the Money!

As I sit in my office every day and watch the results of the earnings of the major corporations of America report for the fourth quarter of 2019, I am actually blown away as to the absolute dollars in profits they are showing. I watched the other day as Apple reported earnings of $22 billion. Not gross revenue, but net income. Other earnings that have been reported are nothing short of outstanding. Yet, I also sit here every day watching the market go down over totally meaningless non-economic events.

We see the nonsense of the geo-political impeachment hearings, which everyone knew the outcome before it even began. We tried to make the Coronavirus in China important, yet anyone who has any level of reasonableness knows it is not. What I do see, though, is an incredible earning machine in America that is coupled with historically low interest rates and a fabulous economy moving stocks higher.

 Ava drinking from CiCi’s water – Age 3

I want to report things that I find of interest this month, but I want to reassure the readers that economically things are just fine. It may be true that the market goes up and down based upon non-economic events, but anyone investing should realize that in the long-term these things mean nothing. As the short-term traders push the market down, they short the stock indexes and buy treasury bonds. For a day or two, both the stock market equities and the bonds are distorted due to the traders’ actions. However, a few days later the traders reverse that action and nothing has actually really happened. It went down one day and up a few days later. Why anyone would think that they need to do trade around this event overemphasizes how quickly they could move to accomplish that goal. They cannot!

I will attempt to discuss these items and the effect of the economy due to the Coronavirus. Mainly, I want to emphasize how profitable U.S. corporations are and how lucky we are to live in a country where the economy is nothing short of spectacular. While I want to cover all of those important subjects, I need to give you the scorecard for the month of January.

37-year clients Randy and Kathy Wittman, their son, 
Ryan, and their first grandbaby, Robert James Wittman

For the month of January 2020, the Standard & Poor’s Index of 500 Stocks was actually exactly zero. No gain or loss at all during the month of January. Obviously for 2020, it was also zero. It is important to note over the last three months, the S&P of 500 Index is up 6.7%. During the month of January, the Dow Jones Industrials were negative 0.9%. Also, for the year to date, the return is exactly the same. Over the last three months of the year 2019, this index was up 5.1%. The NASDAQ Composite was the big winner for the month of January, up 2.1%. Over the last 90 days this index has jumped higher by 10.7%. These are extraordinary numbers.

The Bloomberg Barclays Aggregate Bond Index was up a very satisfying 2.1% during January and for the year 2020 so far. Averaged over the last three months, this index is up 1.8%. I think it is truly informative to look at the long-term return on these indexes and your portfolio. The S&P 500 Index over the last ten years is up 14% annually. The NASDAQ Composite is up 16.9% and the Dow Jones Industrial Average is up 13.7% annually. If you compare all of these indexes to the bond index, the Bloomberg Barclays Aggregate Bond Index is up 3.7% over the last decade. As you clearly can see, each of those indexes were up mid double-digits, while the bond index was basically 25% of the equity indexes.

One day, I was flipping through the channels and I came across a left-leaning 24-hour news program. If they were reporting news, then clearly they had not checked the facts. This particular day, the two commentators were making fun of the U.S. economy as it currently existed. Their comment was that the GDP in the United States at 2.1% for 2019 was a joke. In fact, they said that it was not even as good as the economy during the President Jimmy Carter years. I almost burst out in laughter at the ridiculous and incorrect comparisons to the U.S. economy today, which is extraordinarily good compared to the Jimmy Carter years, which were extraordinarily bad.

Ava and a Rockette at the Christmas Spectacular – Age 4

So, in order to properly evaluate the two economies, I went back to look at the economy during that time. We all seem to forget that when Jimmy Carter took over the Presidency after the Watergate Scandal, we had very high unemployment and very meager growth. In fact, in 1980, which was the last year of the Jimmy Carter presidency, the unemployment rate was 7.2%, the GDP was a -0.3% and inflation was 12.5%. If you recall the famous “Misery Index” promoted by Jimmy Carter, he would add unemployment to inflation to determine how bad the economy was. Therefore, as he left office, the Misery Index was a very high 19.7%, even though it had only been 12.7% when he took office. You may recall President Ronald Reagan using the “Misery Index” against Jimmy Carter when he ran against him in 1980. When Ronald Reagan left office in 1988 the “Misery Index” was 9.7%.

To compare the economies today to the President Jimmy Carter years is almost laughable, if it weren’t just outright wrong. I am not exactly sure why the commentators bothered to quote economic factors that, clearly, they do not understand. Today, the “Misery Index” is 5.8%, one of the lowest ever registered under this hypothetical theory. When President Trump took office the “Misery Index” was 6.8%, and it has improved over the last 3 years.

MiaRose Musciano-Howard’s son, Mitch (15), 
Staff Sergeant with the nationally recognized 
Fayette County High School Drill Team

We are enjoying a time of truly economic good times. We have an unemployment rate that is at a 60-year low at 3.5%, inflation under control at 2.3%, and an economy that is growing just right at 2.1%. I will further clarify those terms later in this posting.

We have the trifecta of good news at the current time. You may recall the high price of oil during the President Jimmy Carter years, which saw oil at $20/barrel in 1973, but in late 1979 it jumped up to $107/barrel. Primarily this was due to the conflict with the United States and the Middle East, which temporarily cut off the supply of oil to the United States. Most of the people reading this posting do not even realize that during the 70’s we imported 40% of our oil from the Middle East. Today, in the United States, we import less than 10% of our oil and that number is declining annually.

In fact, for the first time ever, the United States is exporting oil and energy around the world. This transformation of energy is due to the technology that has allowed the oil industry to produce oil at a lesser cost. Even after 40 years of inflation impacting the price of oil, it is lower today than it was in the 1970’s. Which is a major economic boost to Americans by saving on gas cost.

It is hard to even fathom that in 1980, as President Jimmy Carter was leaving office, the rate of inflation was 12.5%. The rate of inflation affects every asset that we own, touch, and feel. The price of housing was going up in double-digit rates and not until 1986 did the inflation rate drop to just 1.1%. Therefore, to assume that the current economic environment could be compared in any way to the economic state during the Jimmy Carter presidency is “fake news” at its very best. Compare 19.7% “Misery Index” to 5.8% now.

I cannot comment on the stock market and its performance without going through in greater detail the economic effect of the Coronavirus and the effect it might have on the whole economy. What is interesting about this particular news item is the dramatic effect that China has used to combat the virus. It is hardly possible to believe that China built a full 25,000-foot hospital with over 1,000 beds to isolate the virus in just eight working days. Is their intention to use this facility until the virus is under control and later destroy the hospital in its entirety? If we had tried to build that hospital in the city of Atlanta, it would have taken a minimum of six months just to get a permit from the city. In China’s case, they completed it, start to finish, in eight working days.

Hysteria has taken over the news in a way not likely seen in decades in the United States. I fear that having three full-time 24/7 news channels has raised the hysteria level to a point of facts no longer being comprehended. It has been reported that Google has been flooded with inquiries about the virus being linked to Corona beer.  I cannot even make up these stories since it was reported in USA TODAY. It is hard to believe that anyone would consider Corona beer and the virus to be related, yet clearly that has become a problem for Google in their search for information.

The effect of the virus clearly has no potential of ever dramatically affecting either China’s economy or our own to a great degree. However, the sell-off in Asian stocks and the subsequent retreat by the U.S. markets make investors think there might, in fact, be some sort of worldwide economic negative impact.

Ava enjoying the snow – Age 8

In trying to illustrate this point, I will quote an illustration from this week’s Barron’s magazine; “In order to have any major effect on the U.S. economy, you would have to understand the magnitude of the downturn that would have to occur”. The U.S. economy this year is expected to generate $22 trillion in GDP. In order to have a 0.1% effect on the U.S. economy it would have to decrease the GDP by $22 billion. Understand that we are talking about one-tenth of 1% effect on the huge U.S. economy. It is believed that if Starbucks closes all of their stores in China that it would affect their revenue by $25 million per week while they are closed. If you do the simple math, it would take 880 weeks to even reach this 0.1% threshold. Basically, it would take almost 17 years before the closure of the Starbucks stores in China could reach the 0.1% threshold. To draw a conclusion of this particular virus having that effect borders on the absurd.

Unquestionably, there will be disruptions with manufacturing, and the effect that laying off employees due to the crisis will have. However, one of the major benefits has been that virtually all manufacturing in China has been closed for the last two weeks due to the Lunar New Year. As these factories get back to manufacturing, the effect will be more widely felt. However, to this point, the current economic effect is virtually zero.

The difference this time versus prior outbreaks of infectious diseases is the swift and positive effect the Chinese government has pushed through their economy. The incubation period for this virus is believed to be only two weeks. As two weeks pass, fewer and fewer cases will be reported. To this point, as I write this commentary, there have been only 400 deaths around the world reported from this newly discovered virus. As a comparison, in the 2017-2018 years in the United States over 80,000 Americans died from the common flu.

Once again, you can draw a parallel to understand the hysteria as reported in the media. Another interesting fact regarding this virus, that few people seem to understand, is that at the current time only 2.2% of the people that contract this virus actually die. Back when we had the problem with the SARS outbreak, 9.5% of those people that contracted the virus died. Even the more deadly MERS death rate was 34.5%. All I am trying to emphasize here is that, while not to be minimized, the effect of the virus on worldwide economies is miniscule compared to the $14 trillion Chinese economy or the $22 trillion U.S. GDP.

 Long term client from Nashville, Dr. King, in Kenya

As my headline reads, I have been truly astounded at the level of earnings that have been reported for the fourth quarter of 2019. As you may recall, the so-called “learned experts” were calling for an earnings decline in 2019, as compared to the prior years. In fact, great hysteria was created in the summer of 2019 when the bond yield inverted, forcing all the so-called authorities to predict recession and an earnings decline. Once again, the so-called experts are not so expert in predicting the future.

Earnings have been nothing short of spectacular for the fourth quarter of 2019. When you read about the earnings reports of Apple, Microsoft, Amazon, Google, etc., you just have to shake your head in amazement. These companies are putting up earnings that have never been seen in American finance. There are clearly companies struggling to keep up, such as all of the oil companies, and, of course, Boeing with its current problems. If you average in these lower returning oil companies with the high-flying tech companies, it looks like the fourth quarter of 2019, contrary to perception, will actually show a net positive increase in earnings.

When I look back on earnings and hear the commentary regarding the markets being overvalued, I almost have to chuckle to myself. At the lows of the financial crisis in 2008, the S&P 500 earnings were $49.51. Each year since 2008, these earnings have gradually grown, and in 2019, it is expected that the S&P 500 earnings will be $162.35. In order for stocks to continue to grow, earnings must continue to grow. It is now anticipated that the earnings for the S&P 500 will grow at 9% in 2020. Even more remarkable, it is expected that earnings for the first quarter of 2020 will grow at a sterling 4% from the 2019 levels. There are a lot of reasons for this anticipated growth. Primarily, though, it is due to the strong U.S. economy and an economy around the world that is starting to strengthen. I anticipate earnings for 2020 to be at $180, even higher than the forecast by most experts. A 360% growth from 2008.

Therefore, to assume that earnings have peaked, you would have to evaluate the other external events leading to a strong economy. Most interestingly, bond yields have collapsed to where the 10-year treasury is at 1.5% today. If you have not refinanced your house recently, you should seriously consider it. Interest rates are now at historic lows at the point where refinancing will create billions of dollars in cash flow to homeowners. In addition, oil prices are dramatically lower, freeing up even more billions to consumers. The economy at 2.1% GDP is just great. “Not too hot, not too cold.” This rate should smooth out the economy so that the Federal Reserve does not have to get involved. Therefore, we look forward to a period of flat and constant interest rates throughout all of 2020.

Did you realize that for the first time in two decades manufacturing employment in the United States is actually on the upswing? Did you realize that illegal immigration from our southern border has virtually stopped in recent months due to changes the United States government has made in combination with the Mexican government? President Trump promised lower taxes, a higher economy, immigration control and bringing jobs back to America, and in only three years, he has succeeded in accomplishing all of these things. All things financially and domestically are very good at this time.

When you realize that the dividend rate on the S&P 500 is greater than the rate currently earned on the 10-year treasury, you realize the potential growth that stocks could have over the next decade. It is hard to fathom that investors would actually buy a 10-year treasury bond knowing that the rate of inflation currently exceeds the dividend rate. Therefore, if you buy a 10-year treasury at a rate lower than the rate of inflation, you are guaranteed a loss in purchasing power over that decade. Yet, every day, people make that conscious decision to lock in losses.

 Gorgeous sunset from my deck in Florida

Even though the deficits in the United States are extremely high, there is an interesting phenomenon going on in government finance. The Treasury is now starting to issue 20-year bonds and refinancing the government debt to much lower rates. While we have not addressed the issue of ballooning deficits in the economy, by locking in lower rates, they have reduced the negative effect of higher rates impacting the economy going forward. The government is doing a great job handling the debt of the economy for the betterment of its citizens. If we can reduce the overall cost of financing the deficit in the long-term, everyone benefits.

Yes, it is terrible that the U.S. government cannot finance its operations. It looks like we are going to have one trillion-dollar deficits for years to come. However, I do not fear the deficits as long as the GDP continues to grow. As long as the GDP will exceed the amount of national debt, we should be on solid financial ground, notwithstanding the deficits. Currently, the GDP and the deficit are approximately one to one. If the GDP continues to grow as anticipated, these debts should create no financial risk to the U.S. economy over the next few years since the GDP is growing faster than the debt – much faster.

Notwithstanding the almost-hysteria regarding the Coronavirus, business and the economy in the United States remain excellent. However, the highest growth rates in the world continue to be in Asia. I anticipate that as soon as the hysteria passes in China, they will meet their projected economic growth of 6% in 2020. Economies in Vietnam, Indonesia and Malaysia are exploding with industrial activity as many companies move out of China to other Asian cities. India is just now starting its growth. It is believed that GDP will exceed 5% growth in 2020 in the aggregate for all of Asia. When you compare that with 2.1% in the United States, you can see the fastest growth in the world is in those Asian coutries. Despite the negative downturn in the markets due to the economic impact of the fear of the Coronavirus, my opinion is that those markets will turn around quickly and will start to move higher as this hysteria passes.

As I look forward in 2020, with the known qualities that we know today, I cannot see how the market could not move higher. If we continue with a perceived growth rate of the GDP at 2% or greater for all of 2020, the earnings growth of the S&P 500 of 9%, and with a treasury yield below 2%, all of that adds up as truly positive momentum for the U.S. markets. As we move into spring and summer, it would not shock me to see that the GDP would actually improve and earnings could accelerate. Almost assuredly, these three strong economic predictors will force the stock market to a higher level in 2020.

On that note, come 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