Chart Talk {11.29.17}

We've recently discussed the lack of volatility in the markets this year.  This chart does a pretty good job of showing its hiatus in 2017.   We've roughly seen a 3% pullback in the S&P 500 earlier this year.  You have to go back to last summer's worries over "Brexit" to find a little over a 5% decline.  Prior to that, the worst showing was late in 2015 through early 2016.  That decline was a bit over 13%.  Declines over 10% have been rare over the last 6 years.  Some day that will end but probability and market seasonal factors  suggest that right now that will not be anytime soon.

We own ETFs related to the S&P 500 in client and personal accounts. Short S&P 500 in a personal account as part of a separate individual strategy. Positions can change at any time without notice on this blog or via any other form of electronic communication.

Link:  Disciplinedinvesting.blogspot.com, "Answering Market Questions Over Thanksgiving" via Abnormalreturns.com: /2017/11/26

Back Friday.

Stocks Follow Earnings

Stock prices follow earnings estimates, pure and simple.  If you doubt that premise than look at the chart above.  You can see how stock prices respond when earnings estimates are increasing versus declining or flat.  It's hard for stocks to move higher when earnings are going nowhere and they go in freewill when earnings collapse as they did back in 2007 through early 2009.  Current forward estimates for the S&P 500 are in the $142-143 range for 2018.  That gives the S&P 500 a forward PE of roughly 18.20.   That may be considered high by historical standards but it's not as high as it was at the peak of the last bull market and it's not considered by many as high in an environment where interest rates are likely to stay lower than their average mean, where the economy is growing around 3% and where earnings have the potential to increase by 10% year over year.

We own ETFs related to the S&P 500 in client and personal accounts. Short S&P 500 in a personal account as part of a separate individual strategy. Positions can change at any time without notice on this blog or via any other form of electronic communication.

Link:  Disciplinedinvesting.blogspot.com, "Answering Market Questions Over Thanksgiving" via Abnormalreturns.com: /2017/11/26

Happy Thanksgiving

We're going to be taking some time off the rest of this week as we do the traditional Thanksgiving thing.  We'll pick things up Tuesday or Wednesday of next week.  Of course we'll break away from the food table though if anything important comes over the transom.   For me the most important thing will be spending time with family and having my bride and three children together from all parts of the country.

It has certainly been an eventful year and I hope {as I suspect many of you do as well} that 2018 is filled with less drama and divisiveness in this country.  In that vein I'm going to leave you with something I wrote last year around this time.  

"And finally, contrary to what you may read at other places or see on TV, I believe that we as Americans have much more in common than what we perceive as our differences.  We may not agree on the best way to get to certain places but I believe we all for the most part want to get to the same destination.  It is my hope that we remember that in the coming months and years.  Tomorrow is Thanksgiving.  It is the most American holiday with traditions that extend as far back as the first European colonists and was thrust onto our national consciousness by President Lincoln during our most terrible of wars.  No matter how you feel about the election, and in particular if you are feeling negative or scared remember if we can live through and recover from our Civil War then we'll probably get through this.  Whether you are elated about the election results or depressed or perhaps even indifferent then know through whatever lens you view the outcome, America has dealt with better or worse Presidents and survived."

Someone who seems to agree with me is Politico's Ken Stern.  In that vein please go read his excellent article, "Americans Aren't As Divided As You Think".  

Until after the break I want to wish each and every one of you a Happy Thanksgiving!  May your travels be safe if you're going over the river and through the woods to Grand Ma's house, your belly's full of laughter brought by family and that the rest of 2017 is a wonderful year!  

God Bless!

What's In That New Tax Bill

I haven't spent a lot of time studying or worrying about the differing tax plans making their way through Washington because it's hard for me to waste the time on something like this until it becomes reality.  Still with the House passing their version of the bill last week we're starting to see on paper some outlines of what might actually be in a final bill.  The Chicago Tribune last week had a pretty decent synopsis of what passed the House.  You can read that article here.  My readers might be interested in the status of certain deductions and I've include that information below:

"....{T}he House bill also does away with many of the credits and deductions and replaces them with a larger standard deduction, a slightly larger child tax credit ($1,600 per kid versus $1,000 now) and a new Family Flexibility Credit worth $300 a year for individuals and $600 for couples. The larger standard deduction means the first $12,000 for individuals and $24,000 for couples is tax-free.

Say goodbye to most deductions. Almost all itemized deductions are going away, except for three. The final House bill keeps the deductions for charitable donations, property taxes up to $10,000 a year and the mortgage interest deduction. The mortgage interest deduction would be capped at $500,000 for mortgages (down from $1 million now).

About 30 percent of filers itemize. Most of the people who itemize claim the state and local tax deduction (SALT) where they deduct their state and local sales, income and property taxes. Under the House bill, only the property deduction would remain. This hurts people living in high-tax (and often blue) states like New Jersey, New York and California. Several GOP representatives from these states plan to vote no on the bill in protest.

- The adoption credit stays. The 401(k) exemption stays. But . . .

- Say goodbye to the tax credits for plug-in motor vehicles. It gets repealed in 2018.

- Say goodbye to the deduction for medical expenses. It goes away in 2018.

- Say goodbye to being able to write off the costs of your tax preparer. That goes away in 2018.

- Say goodbye to the deduction for moving expenses. It goes away in 2018, except for members of the military.

- Say goodbye to most tax benefits for college. At the moment, low and middle income Americans can deduct up to $2,500 a year in student loan interest. That benefit would go away in 2018. In addition, grad students who get tuition waivers because they teach or do research would now have to pay income tax on the waiver, a big change. For students currently in school, the American Opportunity Tax Credit would remain, which allows a $2,000 credit for higher education expenses.

- Say goodbye to the deduction for theft or loss of valuables. Right now people can write a lot of their losses off on their taxes, but that would be gone in 2018. The one exemption is losses for a natural disaster such as Hurricane Harvey. Those would stay."

Some, all or none of this may make into the final bill so I wouldn't spend too much time worrying about this yet unless you're an accountant.  Still at this point we should probably begin to pay more attention as we now have an actual bill making its way through the legislative process.

Chart Talk:

This chart shows the performance of US markets vs. foreign on a rolling three year basis.  Blue means the US is doing better than overseas and orange means the opposite.  You can see that the US has clearly been the place to be since 2009.  We have for the most part increased our international exposure in client accounts in the past 18 months, largely on what you see above.  This underperformance to the US has also meant that on a relative basis these markets are fundamentally more attractive than the US.  Their dividend yields in general have been attractive so we have been paid to wait.  Note that so far in 2017 this relationship has started to change.  Foreign markets have by and large outperformed the US so far.

Link:  Abnormal Returns via Factor Investor.

*Long ETFs related to international markets and the US in both client and personal accounts. 

An Autumn Review. Also, Stock Market Questions and Answers

It is hard to believe how quickly the year has marched on, but we are well on our way through autumn and the holidays are quickly approaching. With less than two months left in 2017, the investment world is already looking ahead to 2018. As we focus on finishing out this year strong, let’s look at some common questions that come up when it comes to the markets.

          

Why Does The Stock Market Continue To Trade Higher?

The stock market has risen to new highs through much of the fall, following the upward trend that began when President Trump was elected in November 2016. This unexpected increase has confounded the bears and frustrated traders.

Frustrations And Volatility

The bears are confused because they see dysfunction in Washington, the volatile situation in Korea, high market valuations, and the President's own bombastic personality as disruptive factors that should be negatively affecting the markets.Traders are frustrated by the disappearance of volatility and the lack of stock corrections that allow those with a trading mentality to profit from price declines. In fact, it has been months since the market corrected by over one percent.

                                                           

The disappearance of market volatility is a unique occurrence. This year is on track to be one of the least volatile on record, a trend that is unlikely to last forever.

Taxes And World Economic Growth

There seem to be two main reasons for much of this year's gains. One is a belief that we will see some type of tax reform in 2018. Regardless of where you stand politically, any significant reworking of the tax code should be good for corporate profits and theoretically good for economic growth. The other, and perhaps the most substantial reason for the advance, is that both the U.S. and world economies are finally seeing sustained economic expansion.

For years the U.S. economy limped along with subpar GDP growth, sitting at just 1.6% in 2016. To show the difference between then and now, preliminary reads of 2nd quarter U.S. GDP growth for 2017 were 3%. That number has long been pegged by economists as the magic number that creates jobs and grows wages, which definitely seems to be happening right now.

                                                           

Today in many places you see help wanted signs on windows and hear job ads on the radio and companies are raising wages in advance of minimum wage adjustments. Some of this reflects a changing view of how employees perform in the marketplace, but it also reflects a reality that the job market has become tighter, which is to be expected with unemployment under 5%.

                                                           

Higher economic growth means more money for consumers to spend and they're doing just that, even if it's not in traditional ways. Malls may be hurting for customers but online companies are growing like weeds. Amazon is growing so fast that it's scouring the continent looking for a location for a second headquarters. For now, higher economic growth and corresponding higher corporate earnings are trumping everything else that would normally be bringing the stock market down.

But Doesn’t This Situation Sometimes Lead To A Correction?

We know that stocks won’t grow at this rate forever, and even in a bull market stocks have periods when they correct or trade sideways. Also, the uncertainty with North Korea could escalate into something serious very quickly. But if things stay close to where they are currently at, then it looks like conditions are supportive of equities in the long-term.

Correction Vs. Bear Market

Let’s again clarify the difference between a correction and a bear market. A market correction is when the markets decline 10-20%, often to adjust for overvaluation (when the price of a stock is inflated) and usually lasts two to six months. A correction forces investors to be disciplined when they’ve become a little too aggressive in their portfolios and it allows valuations to adjust to levels where fundamental investors again become attracted to stocks. When economic conditions warrant it, the markets will eventually reset and stocks should go back to trading higher.

                                                           

Corrections can also occur by time instead of price when stocks trade in relatively tight ranges for longer periods of time until fundamentals and valuations again become aligned. This is the stair- step action one typically associates with a secular bull market. We saw this happen with the bull market in the 1980s and 90s (minus the 1987 crash).

                                                           

On the other hand, a secular bear market occurs when economic conditions deteriorate. They can last for years and take the stock market down by as much as 50%. Sometimes they are triggered by a sudden economic dislocation, but usually occur when the world’s economic situation falls apart. Currently, there is no evidence of a coordinated economic contraction around the globe.

                                                           

But to use the cliche of the canary in the coal mine, what emerging markets do could be an early warning sign for any changes. Emerging markets have been dormant for years but have come to life in 2017 with stellar market performance. This trend shows that worldwide economic growth is advancing. Yes, we'll have corrections, and yes, at some point volatility will return, but that does not necessarily mean a bear market has arrived.

The Media Says The Bull Market Has Run Its Course. 

What Happens Next?

Investors should have an asset allocation that fits into their unique goals and lets them sleep at night. Various factors go into this analysis, but the major one is how soon you will need access to the money you’ve invested. Many investors worry about having a repeat of the 2007-2009 bear markets where the average value loss was 50%. Since markets are cyclical, there will be a secular bear market again someday. Absent a sudden dislocation this will occur when worldwide economic conditions or geopolitical concerns bring about a severe adjustment to stock prices. But as we stand right now, it is unlikely that current conditions will result in this.

Let’s take a longer view by reviewing the total return chart of the S&P 500, focusing in particular on everything that comes after 1982, the start of the last great bull market. Since 1982, stocks have experienced five down years, averaging just a bit under a 17% decline. That’s just slightly above the long-term yearly volatility average for stocks, which is about 14%, meaning stocks will yearly experience a period where prices decline on average about 14%.

                                                           

Now, let’s imagine what would happen if that level of decline were to start now and carry forward over the next six months:

                                                           

The S&P 500 currently trades around 2,575. An average volatility decline would bring the index down to the point stocks traded at in November 2016. A 17% decline would take stocks back to October 2016. A 20% drawdown moves the averages back to the summer of 2016. If we imagine a repeat of 2008 when stocks declined 37%, then stocks would trade about the same levels as they did mid-2013. A 37% decline would sting, but given where we are in the current economic cycle, it would probably take a major, unexpected event for that type of drop to occur. Even if that were to happen, it is unlikely that conditions would deteriorate too fast for us to become defensive towards the markets. The good news is that even with that much of a decline, we still don’t lose those hard-fought gains since the lows of 2009 in the major averages. Instead, short of a catastrophe, we’d experience a normal correction followed by a period of backing and filling before stocks could advance again.

October Was The 30th Anniversary Of The 1987 Crash. 

What Can We Learn From This?

Although I was a barely minted young stockbroker at the time, the lesson I learned from that event is that risk can happen fast and it’s essential to ensure that your investment approach is aligned with client’s risk profiles. The broker that sat behind me sadly wiped out many of his clients because he’d been using an aggressive options strategy. That approach had netted him big returns in the proceeding years but was disastrous when the bottom fell out. I learned not to do that and I learned to only use margin in client accounts with caution if at all.

                                                           

The day after Black Monday, as prices started to rise again, one of the older brokers called me into his office and said, “You need to go out and make some calls to clients and buy something. Stocks are on sale and they’ll never be this cheap again!” So I made the calls. ETFs didn’t exist at the time, so I went out and told clients to buy the safest company I knew at the time, General Electric. Some took me up on the offer, some didn’t. Those that did made many times their money as the company ultimately went from a split-adjusted price of around $4.00 a share to near $60 in the summer of 2000.

                                                           

As hard as that period was to stomach, the day barely registers as a blip on a long-term chart. It took stocks some time to recover from the event and we managed to fight the first Gulf War not too long after it occurred, but when the economy found its footing, we experienced one of the greatest bull markets in history. As long as economic growth continues, stocks have the ability to recover from such events and, if history is a guide, these are better bought than sold in a panic.

What To Look For Next

I hope these answers shed some light on our markets, what history teaches us, and how to approach your investments. If you’re curious about my thoughts on what I believe to be the greatest engine for economic growth, stay tuned for an upcoming post! As always, if you have any other questions or just want an update on how your money is doing, you are welcome to call my office at 708.488.0115 or email us at lumencapital@hotmail.com.     

                                                           

*Amazon and General Electric are components of several different ETFs we own in personal and client accounts. Certain clients own individual shares of General Electric as well. We own ETFs related to the S&P 500 in client and personal accounts. Short S&P 500 in a personal account as part of a separate individual strategy. Positions can change at any time without notice on this blog or via any other form of electronic communication.

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing him at lumencapital@hotmail.com.

Posting Schedule

I have to be out the next few days on appointments so I'll likely not be posting until later this week.  Hopefully the length of the most recent letter we've sent out to clients and posted above will tide you over until then!

Two Quick Thoughts On Student Loan Debt

Student loan debt now is over a trillion dollars and counting.  While I'm sure most students would have preferred to walk out of college not owing anything here's a few things to consider.  

This site says the average student loan is slightly over $26,000.  The other number I've seen is around $30,000.  Obviously students going on for graduate studies take on more debt.  Medical school debt for example can easily range in the hundreds of thousands, but that's the exception.   That's about the price of an average new car these days.  The car though is a depreciating asset.  In theory, the higher wages students can potentially earn with their college or graduate degrees should show a positive return on the investment spending from the debt incurred over the course of a student's career.

There are three kinds of debt in my book.  The first is stupid debt-borrowing money for example to go on vacation or buying things you don't need on credit cards and paying hefty interest charges because you can't afford to pay off each month what you've spent.  The second is debt of necessity.  This is debt you might take on because you have no choice.  An unexpected medical expense comes to mind or buying a car because you need it to get to work.  The third, and the best kind of debt, is investment spending debt.  This is debt you incur to buy something that shows a positive return on the money spent.  A farmer buying a piece of equipment that allows him to plant and harvest crops more efficiently is an example of this.  Student loan debt, because the student is investing in herself over the long course of a career is another.  Think of it this way.  If borrowing $30,000 means a student can earn say $2,000,000 more over the course of a 40 year career then the return on that debt is astronomical.  Go here to see a graph representation of this.

I know this won't make you feel any better as you write the monthly check on your loan but I hope the perspective helps.

Back early next week.

Hmmm....

From ghoulies and ghosties

And long-leggedy beasties

And things that go bump in the night,

Good Lord, deliver us!

{Traditional Scottish prayer}

The market's are up something close to 5% since around Labor Day.  Sometimes that is enough, along with factoring in dividends, to be considered an OK year.  There has not been a real pullback in stock prices in months.  Volatility has collapsed.  There seems to be only one direction for stocks to move and that's higher.  Investors rejoice at this.  They hate volatility,  or at least the part of it that leads to price declines.  Presumably they don't mind volatility spikes when it results in higher prices.  Traders hate this because there never seems to be a moment when the markets let them in.  

It's autumn now and we're not far removed from the spooky season that is Halloween and in that spirit I'll share a few of the things going now "agoing  bump in the night" that have my antenna up.

I'm being asked more now by folks out at parties or dinners what I think of the markets.  The medical marijuana folks are also back asking my thoughts on the industry.  The last time I noted this was back in March and that's also the last time the market corrected somewhat.  That correction was paltry, about 2.5%, and shows the power of the move we've seen this year.  I didn't see many such questions over the summer but they've picked up as the temperature's started to fall.

I'm being asked more and more about bitcoin.  One client asked if he could buy it in his IRA {No you cannot do this per the custodian.}  Another wanted to buy a bitcoin ETF or mutual fund {No-I will not tell you the symbols if they exist.}.  An acquaintance  claims to have made $10,000 in bitcoin.  When pressed he refused to go into specifics.  For the record I have no opinion on bitcoin and no real knowledge of the nascent marijuana industry.  If you want to speculate in these areas then you'll have to do so on your own.

I was asked by another gentleman I know recently about spread strategies in options.  This guy, based on what I know and have seen over the years, has no business trying to invest this way.  Irrespective of whether it's bitcoin marijuana or options, nobody asked me about these things the past few years.  In fact nobody showed much interest in the markets outside of business prior to 2017.  

A client tells me about a friend of hers who claims to have made 66% buying stocks this year.  That's all she knows.  She doesn't have specifics.  Another client asked me if I thought his asset allocation the other day was too conservative.  He's in his mid-70s.  Last year he was convinced markets would crash after he found out Mr. Trump was going to be President.

In that vein, the AAII Investor Sentiment Survey shows its highest bullish reading in 11 months.  The bulls came in last week at 45%, a five percentage point change from last week and well above its historical average of 38.5%.

All of these things make me go hmmm..... Honestly, if we weren't in seasonally the best period of the year for stocks I'd be thinking that the probability of a more significant sell-off would be much higher.  As it is I wonder if performance chasing might carry us into the new year.  I off course don't know but while there may be now a hint of frost on the ground outside there's now to me more than a hint of froth in the markets.

Back Friday.

Chart Talk {11.06.17}

One question that I'm frequently asked is when will rising interest rates crimp stock prices? My answer to that is someday but probably not too soon.  Take a look at the chart above and I'll explain my reasoning.  

The above chart comes to us via Tradingview.com although the annotations are mine.  It is a yield chart of the US 10-year treasury bond which as of this writing yields 2.32%.  Now if you look in relation to last year, specifically the summer of 2016, interest rates have climbed substantially.  They are up nearly a full percentage point.  However, for most of the last year 10-year rates have been locked in a range of roughly 2-2.50% on this bond.  Currently we are trading around the mid-point of that range.  Since many other interest paying vehicles price off of this bond then it is very probable that rates have to rise higher than where we're trading now in order to become competitive with stocks.  

My guess and the number I've been using for quite some time is that we need to see rates above 3% on the 10-year before bonds become more competitive to stocks.  At a 3% yield other interest rate investments would most likely see 4-5% plus payouts.  A 5% yield, particularly in a tax deferred account like an IRA, starts to become pretty competitive with the longer term likely return on stocks over the next few years.  We're along way from 3%.  The yield chart above of the 10-year doesn't even show that number off to the left. 

Someday bond yields may again become competitive to stocks but I think we're a long way from that.  I'll worry about other things first.

Back Wednesday.

Chart Talk {11.02.17}

They say the hallmark of a strongly trending market is that it never lets you in by giving you the opportunity to buy on a pullback when stocks are rising or sell on an uptick during a decline.  2017 is a classic bull market example of that premise.  There's just never been an opportunity to wait for a pullback in order to establish positions at more attractive prices.  Someday that will obviously change but at least up till now this has been an extremely powerful advance.  

Data on length of this current bull market rally is via Charlie Bilello over on Twitter.  Mr. Bilello is Director of Research at Pension Partners.

Chart is of the S&P 500 ETF{SPY}.  Long ETFs related to the S&P 500 in client and personal accounts.  Short S&P 500 in a personal account as part of a separate individual strategy.  Positions can change at any time without notice on this blog or via any other form of electronic communication.

Chart is from Trading View.com although the annotations and trend lines are mine.  You can click on the chart to make it larger if you want a better view.

Back Monday.