Thoughts {06.28.18}

A few quick hits as I have to be out this afternoon and will be on the road tomorrow.

There has been a pick-up in market volatility so far in 2018 as compared to last year.  A lot of that has to do with often and seemingly contradictory economic announcements coming out of the White House.  This has been most pronounced when discussing trade.  Frankly the Administration seems to be all over the board on the subject, particularly in its application regarding threatened sanctions and tariffs.  Probability would suggest that this will continue over the summer with markets and particularly certain sectors to continue to be buffeted by the fallout.  

Bank stocks and financial sectors have been down now for something like thirteen straight days until today.  This is unprecedented and is likely worrying some investors.  It is probably contributing to the general angst in stocks right now.

For all the commotion we've seen recently, the markets are still firmly stuck in that trading range we've discussed many times this year.  We're oversold now and tomorrow is the end of the 1st  half of the financial year so probability suggest we may see some support come into stocks the rest of the week and early next.  With the 4th of July falling on a Wednesday trading could be light and funky all of next week.  It may be hard to get a read on things until we're done with the upcoming holiday week over the 4th.

I think there's a possibility that the market is starting to experience a few headwinds that have the potential to impact things between now and sometime in the fall.  I want to take some time to gather my thoughts on this so expect something a bit more detailed in a future post.  What I would say today is that I think investors should take the time and opportunity that a slow period such as next week may afford to go over their portfolios and review their risk profile.  For some a more defensive profile may be warranted. I'm still quite bullish longer term but I think we have the potential for more volatility in the coming weeks and months, possibly at least until the mid-term elections get sorted out in early November.  Again, we'll have more on this in a future posting.

Back early next week.

*Long ETFs related to the financial sector in both client and personal accounts.  We reserve the right to change these investments without notice on this blog or via any other form of verbal, written or electronic communication.

My 3 Rules For Financial Success

By Christopher R. English, President of Lumen Capital Management, LLC

We live in an age of information overload. If we have a question, countless answers are at our fingertips and sometimes we just don’t know where to start. This can be especially true when it comes to finances. For example one of the most searched topics when it comes to finances is on how to reduce or eliminate debt.  We’ve discussed some of these strategies before when discussing student loan debt but the concepts apply to other loans as well.  A quick Internet search will give you the “snowball method” or the “avalanche method” as well as a plethora of debt reduction calculators. If you are worried about saving for retirement, multiple articles will give you a variety of different percentages you should be contributing to your retirement accounts and giving you advice on what accounts you should open. 

When it comes to investing,  I’ve included below three of my basic rules to help investors set up their finances for success and build a firm foundation for the future.  So step away from your search engine and consider my three rules for pursuing financial success. 

1. The Power Of Compounding 

One of the most significant benefits of saving early and regularly is the power of compound interest. Compound interest helps the money you put away grow faster due to interest building upon itself. For every year you delay in saving, you’ll have to contribute exponentially more to reach your savings goals because of compound interest. Here’s an example of how this works.  If you start saving $400 per month at age 25, you would have $1 million saved by age 65 (assuming a hypothetical constant 7% annual investment return, no withdrawals from the account and the gains are reinvested at that constant rate). If you don’t start until age 35, you’ll have to save around twice as much to reach $1 million by age 65. 

The magic of compound isn’t limited to your money though. The personal decisions you make throughout your life also compound and eventually make up your lifestyle, your habits, and your mindsets. Be intentional about what you are investing in and let the compound effects be positive, not negative! 

2. Understand Your Unique Risk/Reward Profile 

Have you ever taken the time to determine how much risk you are willing to take with your investments? It’s not as simple as choosing investments in the moderate risk category. Each person has their own unique risk level based on his or her personality, time horizon, and life circumstances. If you want to maximize your investment life, you need to know where you fall on the risk meter.  I believe this is one of the hardest things for most investors to conceptualize.  It is easy for many to say they might be willing to accept a 10-20% decline in their portfolio’s value.  It is another thing to stare at a monthly statement and see the losses in actual dollars.  This is especially true for many when markets go through longer periods where they either decline or at best churn in place while making no substantial progress towards the investor’s goals.  

Eventually markets will rebound when the climate improves but often investors don’t wait around to see that period of recovery.  The market bottom in March of 2009 saw some of the largest investor redemptions ever just as things started to improve.  Similarly many who were scared out of equities during that period have sat out one of the best and longest bull market periods ever because they were worried about a repeat of the last market collapse.  Having a more realistic view of their risk profile might have stopped some of this behavior occurring for many over the last decade.  

Similarly, you also need to have realistic expectations for how much of a return you will get based on the risk level you invest at. For example, if you choose high-risk investments, you might have a better chance at receiving better returns. But if the market goes sour, it could affect you more than if you invested at a different level and received more moderate returns. Helping clients and potential clients understand their own unique investment profile is one of the major roles of most investment advisors.

3. Stick To A Systematic Approach To Investment Portfolios 

Do you have an investment strategy or do you piece together your portfolio? Having an organized portfolio driven by a personalized strategy and philosophy will help you reach your objectives. Systematic portfolio construction is about structuring your investments based on your risk level and your investment goals. Not only does this help you achieve diversification and appropriate allocation, but it also allows you to be objective and rational about choosing your investments because your decisions are based on pre-set criteria. 

Next Steps 

There is a lot more to the three concepts addressed above that I would be happy to discuss with anyone on an individual basis.  A short letter like this doesn’t give us the space to go into detail on any of these.  Investing isn’t always easy or simple, but sticking to a set of core guidelines can help you make better decisions. At Lumen Capital Management, we can help you understand investments and assist you in holding to these core principles. Give us a call today at 708.488.0115 or email us at lumencapital@hotmail.com to schedule an appointment and set your finances up for success. 

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.

Valuation {06.20.18}

The S&P 500 closed yesterday at 2,765.90 which is a gain of about 3.5%  for the year without factoring in dividends. This represents a gain of 10.43% from a market close of 2,504.60 from when we  last reviewed these numbers back on September 19, 2017.   Below is our current valuation analysis.    We are currently using a mid-point $155 estimate for 2018 S&P 500 earnings and a rolling four quarter estimate of 163.    We also use a simple color code to give you some reference for these numbers.  Green will indicate that the valuation on the index on a strictly historical basis has become more attractive from the last time we did this review.  Red will indicate the opposite.  Black means unchanged.

Our Midpoint S&P 500 Earnings Estimate of $155. {Year End 2018}

Current PE:                       17.84% {PE has declined from previous review of 19.04}
Earnings Yield:                 5.60% {up from previous review of 5.25%}
Dividend Yield:                1.81% {Yield has declined from previous  1.90%}

Current Expected Price Cone of Probability {COP}:   2,450-2,975.  

Rolling Four Quarter Estimate for the S&P 500, Our Estimate $163:

Current PE:                     16.97% 

Earnings Yield:                 5.90% 
Dividend Yield:                1.75% {Estimated}

The current yield on the 10-year US Treasury is 2.93%.  That is an increase from our last update when the 10-year US Treasury was yielding 2.23%.  

The Cone of Probability {COP} is our current assessment of the trading range within which we think stocks have the potential to trade during the described time period.  It is a probabilistic assessment based on a many factors.  Some of these inputs are: Earnings estimates, also are those estimates rising or falling, dividend yield, earnings yield and the current yield on the US 10 year treasury.  This is not an exhaustive list of all of the variables that are used in creating the cone.  The Cone of Probability is used solely for analytical purposes.  It will fluctuate with market conditions and changes to the data inputs.  Index prices can and have traded outside of the range of the cone.  The data supplied when we discuss the cone is for informational use only.  There should be no expectation that this price range will be accurate and there are no guarantees that this information is correct.

*Long ETFs related to the S&P 500 in client accounts, although positions can change at any time   Currently short SPY and ETFs related to the S&P 500 in a personal account related to an options strategy not employed in client accounts.  We reserve the right to change these investments without notice on this blog or via any other form of verbal, written or electronic communication.

Back early next week.

On President Trump

I know that many do not understand how markets have so far continued to either advance or at least ignore much of the drama that comes out of the Trump Administration.  Often of course, especially in less conservative parts of the country, the economic advancement we've seen and the Administration's policies are met in a derisive way.  I understand how people can be bewildered by this, especially if they dislike Mr. Trump so I'm going to briefly discuss this and to a large extent republish something I wrote on this subject back in December as I think it's important to understand from the financial market's perspective.  

I get asked all the time how the market can continue to trade higher in the face of what to many is an incompetent President.  First off let me get a few things out there.  I don't do politics on this blog.  There are plenty of other places you can go to get that sort of fix.  If I discuss anything political here it is solely in trying to get you to understand how events in the political sphere bleed over into the economic environment.  A growing economy, and the resultant growth in corporate earnings is what ultimately moves stock prices.  I also don't believe Americans are as divided as those on the extreme right and left would have you believe.  Unfortunately though, they're usually the ones with the media soapbox.  We're a country of over 330 million people, living in multiple regions and coming from many different backgrounds.  There will always be somebody or some event that fits into the expectancy bias of the most vocal voices on both the right and the left.  For the most part though, the rest of us have opinions and beliefs that somewhat occupy the center.  With that being said here's my take on the President.

The markets went up last year on an elixir that includes an improving global economy, growing employment, an attack on government regulation and the possibility of tax cuts.   Of these four things, the seeds for the first two were planted early in the Obama Administration and have begun to bloom for the past few years.  It is a measure of how badly the last economic depression stung us that it took so many years to climb out of it's depths.  President Trump can really take no credit for those even though he will.  The attempt to rollback regulation and the passage of tax reform are things that are happening on his watch.  However, they also represent standard Republican beliefs on taxes and the role of government.  Tax reform in particular is largely happening on Capital Hill.  Of these four then the President can really only take credit for the rollback of certain regulations.  So what's changed?

In my opinion, what's changed for many investors is that the shackles of government are being loosed from business.  Note I said loosened and not removed.  The reaction to the Great Recession was perhaps an overreach on many businesses, particularly those like housing and the financial industry that may have played a large role in bringing it about.  I think there is now an attempt to get rid of the regulations that make no sense, while keeping the ones that have been shown to work.  I think all that plus a growing economy sends a signal that it's ok to make money again.  You won't be demonized by those in power if you do.  I think on top of all other things the markets like that.  You may not like that answer and I'm not trying to convert you if you don't care for what you just read.  I'm trying to tell you what I see.  Money goes where it's treated best and right now a large beneficiary of that is the stock market.

You of course will hear none of this from the American news media.  They hate Mr. Trump with a passion reserved previously only for Richard Nixon.  There's not one thing he has done or plans to do that receives anything but a chorus of boos from everybody out there but Fox News.  It's understandable.  They backed the wrong horse in the last election and now stand with a torn up winner's bet.  But, in doing so, they've shredded for the most part any mantle of impartiality they may at one point have held.  I say this again not to be on a soap box but as a way of trying to explain why stocks have for the most part ignored most of the negative news out of Washington.  If things continue to get better then stock prices have the potential over the next few years of moving higher as well.  That's because things will continue to get better.  I say this again without trying to preach or step on anybody's political views.   I care about any of this in the context of managing money how the political realm might impact my client's accounts.  I say don't get blinded by the rhetoric out of Washington.  Follow the money.  So far this year it's voted for stocks since Mr. Trump was elected.  If you don't like him or his policies take some of your market gains and give it to candidates that perhaps most closely reflect your views.  That's the great thing about America.  All of us are free to make that choice.

Back Thursday.

Market Seasonality-A Republish

I got some questions this week about my thoughts on market seasonality so I thought I'd reprint this piece that was originally posted to our blog on April 6, 2012. It was part of a set of articles done in a question and answer style and published serially back then.  {Note:  Highlighted bullet points.}

You place a lot of emphasis on market seasonality. Why is that?

We have touched on this in past client letters here  here and here. Basically there are seasonal variations or patterns that come into play in most years. The study of these bullish and bearish phases means that I accept as a given that stocks at some point this year will experience a sell off between 8-20%. This is simply the normal course of how markets behave in most years. It is part of the seasonal variation of how in a normal investment year stocks will cycle between bullish and bearish phases as measured by money flows. While market declines can come at any time, statistically stocks are most prone to major sell offs in between the months of March and October.

As I've said in the past one of the reasons I think this pattern works is the philosophy behind how most of what we refer to as institutional money is invested. Institutional money is a generic term for large institutions such as pension plans and large asset managers such as mutual funds. It is managed on a relative basis usually tied to a specific benchmark and is also managed so as to not give up the assets. By relative basis I mean as an example in a market that loses ten percent, institutional accounts that go down only 8% are said to have outperformed their peer group. That influences how their portfolios are set up. Institutions generally start a year with similar economic and valuation expectations for stocks.

Institutions have a very strong incentive to be heavily invested in the early months of a new year. They are afraid to fall too far behind their benchmarks. Their thinking is similar to that of a baseball manager at the beginning of a long season. The manager knows you don't win a pennant in April but you can lose one during that time. As the year progresses and in particular if stocks have advanced in the first few months, equities begin to look less attractive on year end expectations. Stocks will either need unexpected positive news {i.e. better than expected earnings news or higher economic forecasts for example} or prices will begin to stall out. One of my concerns right now is that the markets have had such a strong move that much of the economic expectations are already priced into stocks. If companies don't excessively move the needle higher on earnings and sales going forward than investors, especially those with a shorter term horizon, may begin to lock in their profits.

Stocks will fall of their own weight unless there are marginal new bidders for their shares. Summer is typically a down period for Wall Street as the news flow often dries up {unless it’s bad news. It is amazing how many international crises begin in the late spring/summer period. Both World Wars, the Korean War, 9/11, the First Gulf War and the 2008 banking crisis are examples of this.}

Summer is also when analysts begin to fine tune their expectations for stock prices as clarity begins to enter the picture about year-end economic activity. Stocks will also begin to discount any lower revisions or negative economic news during this period of seasonal weakness. Once this discounting process is completed stocks will usually then begin to rally sometime in autumn. The cynical amongst us also know that the only print that matters for most money managers is the one shown when the market closes on December 31st. To put it simply Wall Street wants to get paid. So there is a strong incentive to boost share prices during the 4th quarter of the year.

Back Tuesday

Summer And Elections

I was thinking about what I posted over the weekend and wanted to add two items that investors need to put in the back of minds as we begin in earnest the summer season.  The first has to do with summer itself.  The 2nd has to do with the elections.

The investment world is still dominated by the big financial city centers.  Here in the US these are mostly located on the east coast and are largely found in the Boston to New York City corridor.  London is the top dog in Europe.  These places view summer as a season to get out of the hot stuffy confines of their respective cities and head to whatever piece of sod or beach they call their vacation locations.  That means as we get closer to the 4th of July and then through Labor Day most of these places get real work done on Tuesday, Wednesday and Thursday.  Monday for many is a travel day and Friday is a day devoted to a long weekend if possible.  This means that the real decision makers are gone from their desks at the beginning and the end of the week.  Those that are left are given the job of monitoring things and to not screw anything up.  Unexpected news during these times has the potential to roil markets in a way it might not occur at other times.   This phenomenon will become more pronounced as summer advances.  Wall Street virtually shuts down the last two weeks of August unless some crisis comes to a boil.  London still takes most of August off.

The other thing I'll note is the upcoming elections will start to hang over the markets as we get closer to the fall.  Right now markets aren't really all that focused on this.  Instead they are still concentrating on the business friendly aspects of the Trump Administration even if they are frustrated with the President's constant tweets and seemingly day-to-day changes in things like trade policy.

I would guess that markets would assign the odds of the Republicans retaining control of the Senate as better than 60% and rate the House staying Republican as about 50-50%.  Changes in this perception would likely change investor's perception of economic and business prospects going forward.  A Democratic "wave election" has the potential to be a market negative event as investors could perceive this as a backlash to the Administration's economic policies and put in question the President's economic agenda through the remainder of his term.  Markets could rise or fall as we get closer to election day based on these expectations.

The elections are still far off in the minds of the investment world so this is not something per se to worry about today but it is something we'll monitor more closely the closer we get to that point in time.

Back Thursday.

A Chart On A Rainy Saturday Morning.

It's rolling rain here in Chicagoland this morning.  I'm a little bored so I thought I'd put up a bonus weekend post seeing as how all of us here are stuck inside for the time being.

What is posted above is a chart of the S&P 500 ETF {SPY}.  The chart is from Tradingview.com although it's annotations are mine.  What we're seeing is a index firmly stuck in a trading range, albeit trending towards the upper zone of where it's traded since this zone of congestion was established back in the winter.  So far the market continues to play into the thesis we've been talking about since February of being stuck in a trading range.  If that thesis is correct than the market should start to encounter more resistance as it approaches the upper level of the range.  Market is also oversold on a shorter term basis right now so I wouldn't be surprised if we see some profit taking at some point in the weeks ahead.  

Call the range on the SPY right now roughly between 258-285 on the index.  Don't treat these numbers as something set in stone but rather should be used as a frame of reference.  Markets can and probability suggests likely will at some point exceed these levels before falling back into the zone.  A decisive breakout from these levels would indicate a change of trend in the markets but we're not there yet.  

Back Tuesday.

*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.

Emerging Markets

The rising dollar and rising interest rates have combined to put a crimp in the performance of emerging market equities this year.  While the major US index ETFs we track are up about 4% excluding  dividends our emerging market universe is struggling to stay positive.  Charlie Biello over at Pension Partners on his Twitter account quantifies how certain individual countries have struggled so far in 2018.

You can see from the above chart that many countries considered by investors to be in the emerging market category have seen rough sledding this year.  Mr Biello notes that the average country ETF is down about 2% but a quick perusal of more emerging oriented countries shows average declines closer to double digits.  Of course what should be noted is the very strong performance this group put up in 2017, with emerging markets showing the lions share of double digit gains.  Folks this is the reason you have diversified portfolios.  Last years winners sometime underperform in the year or years that follows.  Nobody has a crystal ball on who exactly is going to do better on a going forward basis.  

Blackrock thinks you stick with emerging markets despite the strong dollar and higher US interest rates.  They think the underperformance so far this year has returned relative value to emerging markets.  They note that "based on price-to-book, the MSCI Emerging Index is trading at a 30% discount to the MSCI World Index of developed markets.  This represents the largest discount since December 2016....".

They also comment that the global economy is in fine shape and they are expecting a better second half of the year for global stocks.  Finally they think the strong dollar is a headwind for emerging markets and not a death sentence.  They note that, "There is no doubt that the rapid and surprising appreciation of the dollar has hurt EM assets. That said, the dollar is not the sole, or even primary determinant of emerging market performance. For equities in particular, changes in the dollar have historically had a modest impact on relative returns".

They may ultimately be correct on this but right now a strong dollar is clearly having a disruptive effect on some of these countries.  I'm holding on to what I have and have only been selectively picking with some new money and for some recently established accounts.  Otherwise I think for the most part you might be able to wait until the money flows tell you there's a better opportunity in this part of the world.   The only exception to this thought process is that June is a big month for ETFs to pay dividends.  Some emerging market ETFs have yields that now might look attractive as part of a dividend capture strategy.

Back next Tuesday.

Go Read

The new tax code is going to make many individuals rethink a lot of things regarding their taxes that they used to take for granted.  Because of that everybody should go read the article from The Wall Street Journal, "Should You Pay Off Your Mortgage?  The New Tax Law Changes the Math."  That's because under the new provisions there has been a significant change in the code to the standard deduction.  Here's what the article says:

"For many people, two revisions to non-mortgage provisions will have the biggest effects on their mortgage-interest deductions.  One is the near-doubling of the “standard deduction” to $12,000 for most single filers and $24,000 for most married couples. As a result, millions of filers will no longer benefit from breaking out mortgage interest and other deductions on Schedule A.

The other key change is the cap on deducting more than $10,000 of state and local income or sales and property taxes, known as SALT. This limit is per tax return, not per person.  These changes will hit many married couples with mortgages harder than singles. Here’s why: For 2017, a couple needed write-offs greater than $12,700 to benefit from listing deductions on Schedule A. Now these write-offs have to exceed $24,000.Assuming a couple has maximum SALT deductions of $10,000, they’ll need more than $14,000 in other write-offs of mortgage interest, charity donations, and the like to benefit from using Schedule A. 

Many couples won’t make it over this new hurdle on mortgage interest and SALT alone. According to the Mortgage Bankers Association, the first-year interest on a 30-year mortgage of $320,000 (the average) at the current rate of 4.8% is about $15,250. Interest payments are smaller if the loan is older or the interest rate is lower."

In some cases, based on this math, probable rates of return and individual financial capability, it may make sense to pay off that mortgage faster than the normal payment you might make each month.  This is especially true if you've lived in your house for a longer period of time and are paying much less in interest now than you did when you first bought the place.   Remember you pay more in interest initially than you do 10 or 20 years into the loan.  

Personally I took out a small mortgage when I downsized from our old home into our new place and am accelerating the payments each month.

A few other things the article notes that I'll mention. 

-Most buyers can only deduct interest on total mortgage debt up to $750,000 for up to two homes.  

-Home equity loans can only get a deduction now if you use the debt to buy, build or improve a home.

It is too early to say whether the new limits on mortgage interest deduction impacts spending on homes or pricing.  I don't think it mattered to the young couple that recently bought my home.  They have two kids and a third on the way and needed more room.  That likely outweighed the more nebulous and further out concern on whether they can deduct the interest.  Then again it is likely that the new provisions are still poorly understood by those in the markets for homes.  One would think that it should at least have a dampening effect on housing prices but there is an entire generation of millennials out there starting to have kids and needing places to raise them.  Perhaps their demand needs will outstrip all other concerns.

Back Thursday.