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The Crooked Pathway…

Highlights:

~ Net worth records.

~ Debt/asset % back to late 80’s levels.

~ Oil draws – supplies still bloated – with more to come.

~ Housing dwindling

~ “The Robots Are Coming”

~ Comedy Break  (Don’t miss the cartoon)

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Beige, Red, and Blue

Good Morning,

Hope this note finds you well.  I am sorry for the late note – am flying back from overseas after a 4-day conference – jet lag and all.  Back to normal schedule each day to start the week.

So the last couple days were filled with new Apple colors and Beige Books.  Today – it’s all about this noon-stop enchantment with the Fed and rates.

The beige book told us things were pretty steady – not much different than a normally slow August.  A couple regions were slower, a couple faster and the consumer was steady. Bank of America’s Moynihan told everyone this morning that the consumer is healthy with retail sales up 4.7% YOY in the latest data.

Here’s an idea:  Stop paying attention to the world in 30-day soundbites.  You have much better things to do.

Meanwhile, the media is telling us what they always tell us:  dreadful things await. My hunch is they speak of nightmares packaged in 25-basis point rate hikes.  Geez.

As I have suggested for months – pray for a correction.  Could this be it?  Maybe.  If so, fantastic – in a word.  We get another great sentiment washout (watch how quickly fear spikes), finish up these ridiculous election campaigns, gag on which ever one of these morons wins – and then…boom:

We all get on with life and the very surprising growth demand ahead.

Don’t worry, the howling at the moon will continue all the way up the mountain.  The need to sell fear and the readiness for the crowd to buy it is like throwing a bag of crack into a drug house.

A Big – Rapidly Changin’ World

As I peer over the harbor of Hong Kong and watch a storm roll in, the city lights go dark behind the clouds and rain.  I am listening to a rehash of the other news of import in the last few hours:  the long awaited Apple announcements.

I’ve picked up a couple interesting tidbits and some really, really idiotic comments from experts covering the release.  I mean this is numbskull kinda stuff.  Check it out:

As they were covering the new Apple Watch, Version1 was called – and I am quoting, “Nothing to write home about yet.” That reference came from a reporter on CNBC.  He then went on to say, “Well, Apple has only sold a little over $5 Billion in watches in the first 15 months…”

Just to be clear:  My brain went numb after that.

Two thoughts:  We have “reporters” giving us news who feel a brand new product revenue launch of $5 billion is not good enough?  and – Investors actually listen to this crap still? While I am no Apple hype guy, let’s be real:  name one other company in the history of companies which has created multiple multi-billion products from scratch – this quickly.

The best news about Apple is not their product – it is more important to contemplate what their product does, how it empowers, what it unleashes and the wave of productivity it pushes – non-stop.   But that’s for another note…right?

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Another interesting piece:  Apple now does $28 Billion a year in service revenues alone. All by itself, their services unit would be a Fortune 100 company.  Put a 15 cap on that net and add in their $260B in cash (I think the reporter above overlooked that little asterisk). You get $540B of their $560B market cap.  Someone missed something somewhere.

The Pentium Chip from Intel which powered Microsoft Office back in the mid-90’s had 3.2 Million transistors on it – a mind-bending number back then.  The new iPhone 7’s chip carries 3.2 BILLION transistors.

And we are bitching that they took away the earphone plug?   I cannot decide whether to laugh my ass off or leap from the nearest first story ledge.

I find it stunning we have reporters asking from their perch just outside real work whether or not Apple “under-delivered”.  Are we forgetting the $260 Billion in cash again.

My point?  We have gotten way, way too lost in data and noise and impatience and media “expert” stupidity.

Brexit Who?

For those on vacation this summer it would have been easy to miss market selloff surrounding the UK’s vote to exit the European Union near the end of June.

Recent economic data seem to support the idea that the UK is quickly rebounding from any economic slowdown in the immediate wake of the June 24 vote. A service sector index rose to 52.9 in August, up from 47.4 in July.

The 9/5 WSJ reported, “Monday’s results follow a strong reading of the manufacturing sector PMI index, which last week posted the joint-largest month-to-month jump in 25 years, placing it above June’s pre-referendum level. Official data last month on retail sales showed Britons shrugged off the referendum result in July and kept spending, while a long-running household survey carried out by market research firm GfK Ltd. found consumer confidence recovered in August after collapsing in July.”

For those needing something to fret over, not to worry:  the EU economy’s expansion slowed slightly in August. IHS Markit’s Purchasing Managers Index for the Eurozone fell to 52.9 from 53.2 in July.

Best idea to come from this menagerie of unwarranted fear?

Next summer, let’s remember that going to the beach can be a good business decision – for you and your portfolio.

Tight Quarters

For those feeling a bit hemmed in the last few weeks, it appears we have set yet anther record in the technical followers camp.

Check the chart below:  For the last 40 trading days – a window spanning back to mid-July – the difference between the S&P 500’s highest and lowest daily closing price has been a razor thin distance of just 1.75% (today is the exception – but should run stops pretty quickly – perfect).

Shocker?  It should be – it’s a level of thin sideways trade the US stock market has never experienced before.  The chart shows the 40-trading day high/low closing price spread for the S&P 500 since the index began in 1928.  Never has a 40-trading day period seen a lower spread.

Think about it:  as the all-too-feared Brexit vote unfolded and we edged into the tail-end of this terrible Presidential run, the stock market embarked on its flattest trek ever.

The chatter is having its way.  The noise is once again clouding judgment.  How many times have we seen these fits?  This is good for the market.  Give us a week or two – or three of red ink.  Maybe even a mini-panic.  Then, study history – your best results come right after the worst nightmares.  They feel bad for a little while – and then pass.

Like it or not – every single market return number you have ever reviewed – was riddled with these same types of “setbacks” hidden in the trail up the mountain.

Take a deep breath – red ink is a friend to the long-term investor.

Think demographics – not economic.  We are in great shape folks.  Just takes patience, planning, discipline….and a steady 8-week supply of the new fruit-flavored TUMS.

Did I mention patience and focus.

Have a great weekend…the fog will lift sooner than we fear.

Until we see you again – may your journey be grand and your legacy significant.

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Jason No Comments

Hidden Improvements

It would be easy to overlook that markets have stayed in a fairly thin band since breaking out to new highs in early July.  Indeed, it has been over a month of trading days since the S&P 500 has seen a 1% move on a closing basis.

To give some perspective, if you dozed off on 7/18/16 and woke up right now, 6 weeks later, you would find the SPY had moved a grand total of 82 cents – on a $217.24 cents base – or roughly 37 basis points.

The news cycle has been active indeed.  Brexit has come and gone (with implications still to be seen), Zika is running its course now, chatter about China is sure to rebirth after summer and now, elections will be front and center as we burn off the last three months of that process.

Self-Created?

This new crop of monsters has been birthed and cycled across the stage of our minds under always glaring media attention.  That has caused many to miss a few facts which are quite positive for all of us.  We covered many below for you.

The net effect?  Once again, we find ourselves steadily working through and around problems.  Keep in mind – in the grander scheme of things – if our problems stop occurring, so to does our forward movement and accompishments.

Think about it.

As much as many fret continuously over problems, mayhem, setbacks, roadblocks and other perceived failures, we miss the notion that many of these are perspectives built around a 90-day earnings cycle created by analysts on Wall Street. Imagine for a moment that we went to a 6-month earnings cycle.  In essence, we created our own monster – and now we must feed it.

I digress…

Good Stuff Missed

Meanwhile, the chatter of our earnings recession has been covered for too many quarters now.  Almost right on time, improvement is sprouting on the horizon.  Let’s share some stats (with a couple charts to follow).

Revisions for Q2’s National Income & Product Accounts (NIPA) were released on Friday. They included revisions for GDP, which weren’t significant and were highlighted for you in yesterday’s note.

The Net Effect?

A vast – and I mean vast – majority of the data, no matter how one slices it, brings one to the same result:

The epicenter of the recent profits recession was clearly the US oil patch.  Yes, there were some parallel industy impacts but those were mild overall.  The remainder of the economy was merely suffering a slower pace of growth – not an actual drop in growth.  This is an important element which is too easy to overlook.

The bottom-line story is that while the doomsday crowd worked very hard to concoct the vision of a broad profits recession in the data since mid-2014, these notes have been very clear since:  it was a profits recession rolling mostly through the energy sector.

Last but not least:  Forward earnings and revenues are now both at new, all-time highs looking into 2017 and beyond.  Dips, corrections, swoons, setbacks and panics are all your friend for those focused on long-term value over time.

The Barbell Economy will continue to be your key foundation for steady growth given coming demand in the pipeline.   Let’s take a look:

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The first chart above shows you the important NIPA summary data and the other two help one see that the earnings ebb driven mostly by energy.  It is now being overcome in forward data. This data comes straight from Thomson Reuters – and importantly – tells us the same from the S&P 400 and 600 as well.  Small, mid and large cap sectors seem to be almost completely beyond their heaviest headwinds brought on by cheaper oil.

In Closing

I read a piece yesterday from Josh Brown which caused me to laugh so hard, I had to include a few points from his note for you today.

Long-time readers know that these very same issues have been comically noted here for you before but his list was all inclusive and reads well – enjoy:

Consider the following insane things that are believe on Wall Street, which make no sense whatsoever in the real world:

1. Falling gas and home heating prices are a bad thing

2. Layoffs are great news, the more the better

3. Billionaires from Greenwich, CT can understand the customers of JC Penney, Olive Garden, K-Mart and Sears

4. A company is plagued by the fact that it holds over $100 billion in cash

5. Some companies have to earn a specific profit – to the penny – every quarter but others shouldn’t dare even think about profits

6. Wars, weather, fashion trends and elections can be reliably predicted.

7. It’s reasonable for the value of a business to fluctuate by 5 to 10 percent within every eight hour period

8. It’s possible to guess the amount of people who will get or lose a job each month in a nation of 300 million

9. The person who leads a company is worth 400 times more than the average person who works there

10. A company selling 10 million cars a year is worth $50 billion, but another company selling 40,000 cars a year is worth $30 billion because its growing faster

You know you want to laugh.

Away from Wall Street, no one believes in any of this stuff.  It’s inconceivable.  On Wall Street, these are core tenets of the collective philosophy being read to the masses on the news.

If you are already off for Labor Day as we close up the summer of 2016 – travel safe and enjoy family and friends.

Until we see you again, may your journey be grand and your legacy significant.

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Jason No Comments

Lost in the Haze

The chop of August – as well as price setbacks for many of the year’s leaders to date – has all been pretty normal this summer for the run we have had.  This week and next should end the hazy feeling we have been sifting through – capped off of course by the Jackson Hole speeches on Friday.  That surely provided plenty of chatter around the media circuit.  The fact of the matter is the Fed is no different – they don’t “know” what’s going to happen in the future either.

That did not stop them from coming up with an equally hazy looking chart complete with wide bands of where interest rates were possibly headed.  I admit, the words “could not hit the broad side of a barn” slipped into my mind while I was reviewing it and Ms. Yellen’s comments on same.  Let’s take a gander:

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This chart will get a lot of traffic and be used my many media sources.  When you figure out what it means, let me know.  From this end – it’s all clear as mud.

In a nutshell, Ms. Yellen joined the chorus of Fed officials who have been saying it is time for another rate hike.  She was semi-clear: “Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Seems to us that is the same email sent around to others as the Fed’s new line.  It has been also recently expressed by Fed Vice Chair Stanley Fischer and FRB regional presidents William Dudley (NY), John Williams (SF), Dennis Lockhart (ATL), and Loretta Mester (CLE).

She did not stop there though:  In order to make sure that we are all left with no reason at all to be certain about what the Fed will do, she added, “And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course.”

Then she really let the listeners in on the big secret in the back room when she posted the chart above.  It shows a line tracing the median path for the federal funds rate through the end of 2018 based on the FOMC’s summary of economic projections in June.  The labeled Figure 1 also shows a shaded region on either side of the line, which is based on the historical accuracy of private and government forecasters.

The dizzying result is that get this now:  there is a 70% probability that the federal funds rate will be between zero and 3-1/4% at the end of next year and between zero and 4-1/2% at the end of 2018!   Now that is what we call a trial balloon.

What is she really trying to do?  We stand by the comments made for years now:  Interest rates are here because of fear.  All this chatter, I suspect, has one goal in mind: a dim-witted effort to burn away the fear.  The dominos would then fall as such:

Fear fades – long rates rise – leaving curve properly shaped and permitting the Fed to follow the market as it always does – and raise the short-end.  If they raise now, we risk seeing an invested yield curve, engineered not by the buyers of bonds but by arbitrary setting of rates by the Fed.  That is not policy.

Keep it simple:  fear burns away – rates rise.  Fear stays in place (as we should be hoping it will with a swoon or two sprinkled in for good luck) – rates stay low, Fed remains on hold – for any number of 7,117 other reasons.

Dr. Ed reminds us that “Yellen did provide some explanation for her vast range for the federal funds rate outlook: “The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted. When shocks occur and the economic outlook changes, monetary policy needs to adjust.  What we do know, however, is that we want a policy toolkit that will allow us to respond to a wide range of possible conditions.”  Fed officials call that “forward guidance.”

In other words, she is sounding more like a Wall Street banker every day, and – it says we are on our own.

Don’t fret though: through all the chatter, we have always been on our own.

Speaking of Growth

GDP revisions got hidden under the intense scrutiny of Jackson Hole chatter.  It was revised to a growth rate of 1.1% for Q@ while Q3 at GDPNow is still clocking at around 3.4% with the latest date.

As one might expect the 1.1% brought out the doomsday hunters and they had a field day all their own.

I have a better chart which might hint at why the markets are not listening to all the Black Swan Preachers.  It’s another look at the paltry GDP output we are suffering through:

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Each quarter, Dr. Ed has a great chart covering all the chatter in one picture.  That tiny little ripple where I placed the red dot is the “end of the world” version 987 called the Great Recession.  As one can see, it;s pretty hard to see in the overall GDP growth that has been going on since the late 40’s on this chart.

Here is my hunch:  The next 50 years will have unspeakable events unfold.  Events that will make everything we have already experienced in the last 50 years seem tiny in retrospect.  Meanwhile, GDP will create a bigger mountain, on a longer chart, at higher market values.

And on to earnings…

We know we have heard about the earnings recession for 6 quarters now.  We have been consistent – it was all about pace of growth for most of the marketplace while the energy sector was taken to the woodshed.  Energy masked it all for the masses and the media. The only way to prove that out was to be patient enough to round-trip the worst portions of the energy setbacks.

Our take?  Once we did – “growth” would magically return.  We are almost there – we had it pegged for end of Q3 numbers marking the return to residual growth from a new base:

The first chart above shows you the latest in the FactSet data with most now reported. Slowly but surely the trough will erase itself.  It takes patience, focus and discipline to stay on the course however.  That is why so few arrive where they planned – they are too easily swept off course in the always rough seas of an investment lifetime.

The second chart provides the latest snapshot of an overlooked, unheralded part of the economy – chemical activity and sales.  It is pretty easy to see that chemical activity tends to be a positive sign about future growth.

The latest data?  A new record high.  (pray for a swoon ini the markets and a new wave of fear)

In Closing

While everyone has basically been at the beach or on the road or traveling with family – incomes went up again – also a new high.  Don’t forget to review that GDP chart above again – notice the red dot – and our progressively higher record levels.

Sadly, even as we see the highs being set – even allowing for the sloppy internals of the August haze which I understand, admittedly dings numbers in the near-term – the investor crowd is still in a funk.

I will put this chart in below again from Friday to drive home the point – but today, I am adding the 8-week moving average going all the way back to 1990 – with a few markers added to help you visualize:

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The top chart is from Friday after a Thursday late release.  As noted then, it saw a significant fall in bullish sentiment even as markets chopped around about a percent or so below all time highs.  In other words, just a pause gave the masses altitude sickness.

The second chart is a clean version of the 8-week moving average of this same sentiment survey with some of the noise removed.  The gray areas are recessions.

The last chart is the duplicate of the second – with dots added by me.  Note where we are now in red and where that matches history.  Further note that we are merely 3 weeks away from lows in this data which were equal to the lows seen back in the early 90’s when we lost 1500 banks and S&L’s from the commercial real estate setbacks at the time.

The DOW back then?  Around 3,100.

The Bottom Line

As long-term investors, we must stay focused through all the haze.  It happens every summer.

We must understand chop, churn and setbacks are normal.  We must stay disciplined and patient.  Without the latter, odds become vast that one ends up in the masses – with frustration and setting the stage for results, over time, which tend to pale in comparison to what the market actually delivers.

Check your emotions at the door.  There is no place for them here.

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Jason No Comments

Simple is Tough…

Hard to believe that we are approaching the end of August – nearly 2/3’s of 2016 is already in the history books.   One more weekend and then the official end of summer Labor Day weekend will be here.  Before you know it, we will be getting warnings about “early Holiday Season shopping” traffic or worse, the pain retailers will go through while we hit yet more new records in overall sales.  You will be convinced that sales are down – pay attention.

Lost in Records

The problem with all the records we are setting is the crowd gets lost in percentages of the pace of change and numbers.  The media reporting process, drowned out by too many experts available every minute of the day, is the confusing use of percentage changes.  It goes something like this:

Me:  “Bob, that’s a new record low in jobless claims – we have never had more people working in the US.”

Bob:  “Mike, the year or year percentage change has fallen for the last two quarters – and on a month over month basis.”

Me:  “Bob, do you realize that the latest new home sales show numbers not seen since 2007?”

Bob:  “Mike, that’s only because interest rates are low.  Wait for them to tick up and Yellen will crush the economy.”

Me:  “Hey Bob, corporate dividend increases are setting new records for the next 12 months – still far higher than the 10-year treasury.”

Bob:  “Mike, corporations are just going deeper in debt and sticking it to the little guy selling them bonds that will blow up later as rates rise.”

Me:  “Bob, the masses have been terrified for the wrong reasons.  Markets are at record highs yet the AAII bullish sentiment has been under its long-term average of 40% for 44 straight weeks – a record unto itself.”

Bob:  “Mike you don’t get how bad it is out there.  Earnings, the consumer is dying, retailers are getting crushed, Zika is here and getting worse – it will make Ebola look tame. You got China in a secret pact to devalue, a terrible election choice, we still don’t know about Brexit and industrial output is in the tank.”

Me:  “But Bob, markets are at record highs.”

Bob:  “Yes and that means they can fall an awfully long way….anyway, you missed my point.”

Me:  “Bob, cash flows are at record highs.  Cash levels are too.  Consumers haver $9 Trillion in the bank – that;s a “T” Bob.”

Bob:  “Mike, the pace of increase has been falling for the last 6 months and missed estimates last month by .02%.  Corporations have amassed cash because they cannot find anything worth investing in.  Consumers have cash because, well, look how unclear the future remains.”

Me:  “Bob, that miss was on top of 6 straight quarters of exceeding estimates on higher cash flows by a cumulative 14%.”

Bob:  “That’s not the point.”

The point to all that chatter?

While theatrical, Bob sounds like he knows what he is talking about.  Bob sounds like he is really paying attention to the very latest, making certain every snippet is covered.  It sounds smarter.  It feels like it is more solid.  Whereas, I just sound like I am being too simple.  I mean, it cannot be that way can it?  It can’t be simple, right?

I have said this often before – too many wrongly relate simple with “easy” or worse, “stupid.”

Both scenarios are gravely incorrect and lead the masses to assume that investing and building for the future must be difficult.  It must be mixed with very twisted views of simple facts and dizzying layers of comparable month-over-month, quarter-over-quarter or year-over-year changes and their collective pace of change.

The Energy Trick

A perfect example of all of this is the most recent 6 quarters of turmoil in earnings as it related to the energy sector setback.  That sector’s earnings were decimated. Restructure, bankruptcy and debt problems have been the focus.  There was knock-on effect in some industrial channels as equipment orders plummeted.  But, other sectors of the economy kept right on growing.

Overall, we are now already closing in on new highs in collective earnings – including the energy setbacks.

By ignoring the facts outside of the energy focus – too many missed too much.  Fretting has remained the only game in town as stress is the key.  Stress must be present for Wall Street to create its “value” over time.  If investors stepped back and slowed the pace of taking data in – simplifying the process – history tells us they would realize doing less often ends up being more.

Not reacting to every element that rolls over the bow is tough – but following that effort simplifies.  In the end, you will find that keeping things simple and overlooking the madness of the crowd will be one of the tougher things you will ever accomplish in building for your family’s future.

The Real Estate Wave

As we all know, real estate and mortgages were the primary culprit in the Great Recession meltdown of 2008-2009.  We know now that we built too much for too few buyers.  Simple really – but when you stacked on complete fabrications in the financing market – the problem compounded geometrically.

Then, experts said it would take decades to get out of trouble.  Today?  Well – not really.

We have a new “problem” – not enough stuff to sell to the coming wave of people and expansion.  Yes – I know – that is hard to pull out of the avalanche of noise as it relates to all the problems we face.

But let’s take a look:

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As much as everyone wants to assume otherwise, this summer is like most:  People are away – focused on family, friends and vacations.  It’s normal to be slower than usual.  Be that as it may, we learned this week that US consumers are alive, well, and spending mightily on homes and everything needed to fill them.

New home sales jumped a shocking 12.4% in July m/m to an annual rate of 654,000 units, the highest level since 2007 (see charts above from Dr. Ed).  Vacations interrupted things a bit as existing home sales fell 3.2% m/m in July to a seasonally adjusted annual rate of 5.39 million units BUT that was off the new cyclical high of 5.57 million in June.

As we noted at the time:  The first decrease since February was blamed on a lack of supply rather than a lack of demand.

Poof….

Supply in the new home market remains tight as well, indicating that the market should stay strong going forward.  “Tuesday’s report showed there was a 4.3-month supply of newly built homes available at the end of July. That was the smallest supply in three years. The median sale price of a new home sold in July was $294,600, down slightly from $296,000 a year earlier,” was the quote from an 8/23 WSJ summary.

The 654,000 annualized rate of new homes sold in July remains well below the peak of 1.39 million in July 2005 but it does return the market to levels last seen in 1992, when the US population was much smaller.

In fact, last month’s annualized rate remains well below the 900,000 to 1 million homes sold from 2001 to 2003, as was noted by Toll Brothers’ executive chairman during the company’s recent Q3 conference call.  Like KB Homes in the weeks prior, first-time shopper demand was “surprising” and he added,

“Just imagine what the housing market would look like for us if we began to approach those numbers again?”

Take a gander at those charts above – take the data in quietly without all the headline noise.  It is very hard to find something bad in those charts unless you are looking for ghosts.

Even more valuable?  Gen Y is just getting started – tens of millions more will move out and start their own lives over the next decade – setting the stage for a wave of demand we have yet to witness.

Reality Check

Look – the economic world we all fret with each day has been ending since the first day I arrived in this business.  This phenomena is unlikely to change in my lifetime.  We will continue to face peril if we focus on the garbage of life.  This is not rocket science.

Instead let’s realize this:  Since 1982 (I reference only because that is when I started), an endless stream of problems have fallen on our doorstep.  Each one was worse than the last – surely to create multiple reasons for impending doom.

This is good.  We should hope for it to continue.  Why?

Simple again:  while all of those terrible things were unfolding – as they are sure to continue to unfold over the next 33-34 years as well – markets went up over 18 times.

The key word?  “While”

Closing Thoughts

Let’s hope for those setback all the experts are shouting about.  Let’s hope for technical test and washout of the breakout.  Let’s embrace the red ink for the long-term investor value that it almost always becomes over time.

As stated yesterday, I still Ms. Yellen spooks us with some reference to a coming rate hike.  The setbacks to come afterward would likely serve as another opportunity to build for the future.

One more thing on elections:  A chart first – and then notes:

I have been told that the average stock market return during a presidential year is 11.2% and the median has been 13.5%.

Of the 22 presidential elections since 1926, stocks were down in 4 of those years; 1932, 1940, 2000 and 2008.  If you feel those elections caused the Great Depression, the dot-com bubble or the Great Recession, there’s no need to continue reading.

Now, with stocks near all-time highs, you’re probably seeing some gains in your portfolio. That’s excellent but makes this next idea tougher:  Reacting to election chatter is the same culprit we cover often:  sounds smart indeed – but it is (again) letting your emotions drive decisions.

Guess what: Stocks fall before, during and after elections.

Why?  Because that chance always exists with risk assets.

Listen, welcome the nervous chatter – and those elections coming up.  We tend to worry when no one is nervous.

When red ink comes stay focused on the Barbell Economy.

The data above continue to confirm it is doing just fine thanks.

Bottom Line Summary

Do NOT be surprised by chop and even louder, scarier news events.  As stated, Yellen, the Fed-head chatter and rate hike fears should fill the volume dial for the next several days.  Be assured her Jackson Hole speech will be sliced and diced all day and into the weekend.

Volume in markets will likely remain choppy and is set to get even lighter for the last 10 days of summer.  This can set the stage for odd, knee-jerk reactions.

Stay focused, be patient, remain disciplined.  As has been the case for sometime now, the more important underlying data remain strong.  This market is set for continued surprises to the upside as sentiment remains tepid (see above) at best – and shrinks back immediately with any red ink.

Use the hoped for setbacks to your advantage.  An early Fall swoon is just fine as well. Keep the elements below in mind as a more simplified, larger-view backdrop to your planning:

The demographic structure of the US is significant, world-leading and rare.

This slow-moving but persistent strength is set to overcome the processes we are seeing near-term – positioning us well for the decades of demand ahead.

When under stress, pause for a moment and think demographics – not economics.

The future is far brighter than many care to accept today – even as trouble will always be included in the pathway, whether we like it or not.

Until we see again, may your journey be grand and your legacy significant.

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Jason No Comments

Talking Heads?

It began with the usual fretting over “selling in May and going away.”  It then ebbed into the Memorial Day kickoff to summer and meandered its way here – now, seeing the last few weeks of the thickest summer haze unfold.  We made it through Brexit, several medium size “Black Swans” and now seem to be inching closer to yet another mother of all BS – the US elections.

JP Morgan is out with a piece this morning suggesting the elections are setting the stage for a major market setback.  The chatter is endless.  We have suggested one remain prepared for a setback – we hoped for a summer swoon.  It may have been hidden in the 2-day setback from the all too feared Brexit vote.  It may indeed still be ahead in the assured fretting as we get closer to a vote.

Either way, red ink is set to be opportunistic to long-term investors for several reasons.

Heartbeat and Trepidation

How many times have you heard something like this?:

“Up next is Ralph Jones who warned us of impending market doom just before the recent two-day, 1.27% selloff from record highs in the markets.  With growing concerns still present over Brexit, the expanding breakout of the Zika virus, Fed Minutes unrest and the sure to be nasty surprises on the upcoming US election, where do you see markets going from here Ralph?”

Come on – you gotta chuckle at this stuff – even as markets have still not traced back into the previous trading range.  By the way, I find the latter quite surprising – but still hope to see it unfold.

The point?  It is this very type of talking head banter that keeps so many believing in the crystal ball.  There is this constant search for that magic pathway which will provide solid returns with no risk, no pain while completely side-stepping anything remotely painful.

I once typed in an equation for this:  E – R = S

Expectations – Reality = Stress.

If we plan effectively, focus on the proper waves of change ahead, do so with patience and discipline and EXPECT only that we must take the ugly with the good on the pathway toward investment accumulation success, then we might be utterly amazed at the reduction of stress levels.

Surprised?

We have suggested for quite some time that the baton is being passed in the demographic power-drivers of the US economy unfolding ahead.  Much will change – much is changing.

This process is being mixed in with poor fiscal policies and far too much focus on the Fed and rates.  Meanwhile we have turned this potent mix of misunderstanding into a toxic level of fear, surely capable of causing a short-term, rude interruption at any stage along the way.

Not, mind you, because of economic momentum but more because of fear.

One can almost feel the itch…the sensation of something about ready to break.  We have feared for so long that if too much time goes by without a problem to fret over – we will create one if need be.  Like a junkie looking for the next hit – painful as it may be – the mass audience is addicted to fear.

It will likely be years from now that we will look back and understand more clearly.  In the meantime, long-term investors can be immensely grateful for the fear, the impact of which has kept rates at record lows and should do so for longer than currently anticipated.  This has permitted a complete remake of the underlying debt burdens (and more importantly cash flow costs of same) for corporations and consumers across the land.

Earnings Recession Banished?

Sure seems that way to us.  Just as the worst of the summer haze envelopes us all – and while new fretting is over the elections and Zika – the old monster of earnings recession seems to be suffering the same death all other monsters have in years past.

Let’s cover some data:

The chart snapshots following this brief summary are from Dr. Ed and his great team. They show very helpful perspectives on reported earnings, margins and revenues.  It provides you a confirmed sense that the bigger picture on the recent “earnings recession” was an event almost completely driven by the setbacks in energy.

The headwinds associated with the setbacks have now mostly abated and almost completed their round-trip of the worst numbers.  As such, improvement is in the cards.

As we all know, S&P compiles both revenues and reported (unadjusted GAAP) earnings for the S&P 500.  Dr. Ed’s charts highlight that the latter peaked at a record high of $27.47 per share during Q3-2014.  The ensuing nearly six-quarter earnings recession coincided with the collapse in oil prices and in the S&P 500 Energy sector’s earnings as noted here many times.

A review of the stats shows these elements seem to have troughed late last year. Since then, earnings have rebounded steadily during the first half of this year as crude prices stabilized.  This is yet another sign suggesting that the worst of the energy-led earnings recession is behind us.

Note this is also confirmed by S&P 500 revenues, which was negative on a year-over-year basis for most of 2015.  During Q1 and Q2 of this year, that growth rate turned positive – to 0.3% and 1.1%.

If one excludes energy earnings from aggregate revenues, they actually rose a larger 2.2% y/y during Q2.

Importantly – and missed by a vast portion of the expert crowd – growth rates in aggregate S&P 500 revenues (excluding Energy) remained in positive territory throughout the recent earnings recession.

More important as one can see from the chart summaries:  The bottom line is that excluding the energy sector setbacks, this last 18 months has been more about a “recession” in the pace of growth of earnings rather than an outright recession in earnings.

Re-read that last sentence…let it sink in.

A note on Margins

The overall S&P 500 profit margin edged back up to 10.3% during Q2.

While the bearish chant during the “recession” was that margins would assuredly fall, this has simply not been the case.  As shown in Dr. Ed’s charts below, they continue to hover in record-high territory around 10%, as has been the case since Q1-2014.

Note lastly that forward earnings and forward revenues seem to be on the verge of achieving new highs – even as they have been chopping around near records during most of the time since the late 2014 peak.

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In Closing 

These next few weeks will be the murkiest of the summer.  That is not new – they always are just before the final Labor Day break.  Do NOT be surprised by chop and even louder news events.  Volume in markets will be very choppy – while volume on market stories will be loud, designed to get your attention.  This type of thing can set the stage for odd, knee-jerk reactions.

Stay focused, be patient, remain disciplined.  As has been the case for sometime now, the more important underlying data remain strong.  This market is set for continued surprises to the upside as sentiment remains tepid at best – and shrinks back immediately with any red ink.

Patience in the Doldrums

Use that to your advantage.  Even as we still root for a summer swoon – an early Fall swoon is just fine as well.

The demographic structure of the US is significant, world-leading and rare.

This slow-moving but persistent strength will overcome the processes we are seeing near-term – positioning us well for the decades of demand ahead.  

Pause for a moment and think demographics – not economics.

The future is far brighter than many care to accept today – even as trouble will always be included in the pathway, whether we like it or not.

Yes, so far, the hoped for summer swoon has evaded us.  But elections are still ahead.

Alas, maybe that summer swoon to take advantage of can be hidden instead in the Sept/Oct time window.  I say – Be ready.

Tomorrow a review of this year’s growing revolt against hedge funds – and more on sentiment advantages.

Until we see again, may your journey be grand and your legacy significant.

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Jason No Comments

Blind Spots

Blind Spot: “an area where a person’s view is obstructed.”

Fearing the collapse of our economic system has been a running theme for many years now – it is not unique or new. It is also very, very crowded.

First – welcome to the end of another week. We are down to 4 left until the official end of summer – Labor Day weekend. Many would not be blamed for missing that volume has already slowed to a trickle. Reactions – good or bad – to the tail-end of the current earnings season (always choppy – unless in raging bull markets), are being driven by the 4th-string team on various trade desks around the country. Vacation is the name of the game in August – lack of attention is a normal companion.

Blind Spots are everywhere. They are expensive – but effective.

The main cause of blind spots in the minds of investors? Simple: F.E.A.R.

Let me give you some stats – with the help of a few nice charts from Dr. Ed and others:

First – as noted in the last couple of jobs report reviews and graphically shown in the chart below from Dr. Ed – we have never had this many people working:

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It is easy to digest and hard to make look ugly. Be certain though – this will be ignored by the media – because, after all, how in the world can you scare someone by saying its never been this good?

GDP is at record highs.

Forward earnings are at record highs as the round-trip approaches in energy.

I listed many more records here earlier in the week.

The Kicker?

Blind spots abound. How do we know? Fear. How do we know there is fear? Watch money and sentiment. Let’s take a look in four charts below:

The first chart at the top shows the “P/E’s” being exchanged for capital risk. Can anyone explain why we hear massive discussion about “risk” in stocks when the multiple being paid for Bonds is 65 times earnings?

Blind spot anyone?

The second chart is often used here – it meshes well with the $9++Trillion not sitting in banks and money market accounts. It also meshes well with a report put out by UBS last month showing that even its wealthiest clients now expect 25% of their assets ot be in cash. What cash? The dollar. Bottom line – the demand for cash has no other explanation. It is driven by one element in a world flush with low borrowing costs: fear. Fear of the future, fear of perceived risks.

More blind spots.

The third chart is another stunner. We use it often – the AAII data on bullish investors. It gyrates back and forth across the chart over the years – except for the last few. This data was released on the same afternoon which saw all three averages eek out a new all-time high for the first time since 1999.

Imagine that – the 41st straight week of bullish sentiment below its long-term average and yet – record highs.

The comfortable numbness of blind spots.

That last chart feeds off the chart above but takes out some of the noise. An 8-week moving average of the bullish sentiment data shows a more compelling contrary view. Note the current reading – at the aforementioned all-time highs – is within 3% of all of the lowest readings in this data going back for a decade!

It is a single-digit percentage point toss from the raving-mad fears in March of 2009 – now some 12,000 DOW points ago.

Yes – blind spot.

One More Thing on GDP

We often hear the chatter about “stall speed” and how things only go bad from here. The economy is not an airplane. It’s a catchy phrase and surely a surreal view pops up in ones mind when speaking of stall speed (right? try it), but alas, it is useless in this sense – and leads the masses into more blind spots.

Let’s look:

That red circle is added by me. You see, we are told we are at stall speed. We are led to believe that there is something wrong with the economy. Worse – for the last 8 years we have been told that only government can fix that – and fix it they have.

The facts? Trillions of dollars of collective GDP growth have been created by hard-working American workers and businesses. Incredible break-throughs have been bestowed upon us – so many, it would be hard to count.

Yet, that red circle of this “stalled” effort in output has been created by one thing:

That “Change has come to America…” still reverberates across every accomplishment, black, white, red, orange or purple. Trillions and trillions of dollars — which would have gone to further expansion and an otherwise explosive economy (not stalled) – have been raked off the top of those growth lines – effecitively sliced from growth – and re-distributed.
We haven’t seen government actions drive growth. We have seen suffocation in return for misguided social programs – which have sadly only created more poor people. More on that later.

But here is the real deal – and a more productive view:

Our economy is strong, vibrant and diversified – because of all Americans.

Our demographics are hugely significant, slow-moving and set to be very powerful for years to come.

As such, we have grown the GDP and expansion in spite of those trillions and trillions in costs of regulatory burdens (stealth taxes), huge tax increases, massive errors and choking costs in Obamacare and social experiments being shaved off the top.

Release those back into the hands of all very capable citizens and let them flow into the economy. That experiment would see less government and an explosion in growth and opportunity, the likes of which would break all records – benefitting everyone – no matter their color or beliefs.

Some Closing Thoughts….

The terms “invest” and “risk” (and all their various derivatives) have been thrown around so long that most – if not all – reading this may think the two words mean different things.

They do not.

Make no mistake.

Invest and risk are different for only one reason: their spelling.

Other than that – know this at all times: whenever you invest – you risk. Period. End of story. Risk is part of it all.

But here is the secret which can help you be comfortable with that: risk has meant the same as invest since the beginning of time.

We only think someone took a risk when they lose. Not true – every single outcome in the investment world – good, bad or ugly – carried with it, during every moment of its existence, risk.

They are one in the same. Always have been – and always will be.

Accepting that helps you accept the required ups and downs of building assets over time and it keeps you out of your own blind spots.

The Bottom Line

As stated yesterday:

I wrote at the start of summer – “the August doldrums are the worst. Volume will dry up, internal chop will be clear and earnings season’s end will bring plenty of emotional reaction – almost all of it wrong when seen months later.”

Don’t worry – as soon as we get through August we are set to get the annual “You do know that September and October are the worst months of the year for investing” charade.

So take heart – and enjoy your last weeks of summer.

Remember – large or small – all of this takes patience and discipline. As such, records show most get far less by acting too much, making too many different choices, moving too many thing, listening to too much garbage.

Red ink is normal in August….so let’s still pray for that swoon.

Stay focused on the long-term – demands are building within the long-term structure of our consumer economy.

The Barbell Economy remains the focus – it is working just fine – and in several spots, even getting better. But know it is also normal to ebb and flow there too.

Think demographics – not economics. We are in fine shape folks.

Until we see you again, may your journey be grand and your legacy significant.

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Jason No Comments

Lessons from 2015: Premiums

Dimensional Vice President Joel Hefner uses historical index data to illustrate why, despite periods of underperformance, investors should continue to expect equity, small cap, value, and profitability premiums to continue.

Jason No Comments

Swedroe – Buffetts Advice Widely Respected, Seldom Followed

If investors were asked, “Who do you think is the greatest investor of our generation?” I’d bet an overwhelming majority would answer, “Warren Buffett.” If they were then asked, “Do you think you should follow his advice?” you might think that they would say, “Yes!”

The sad truth is that while Buffett is widely admired, a majority of investors not only fail to consider his advice, but tend to do exactly the opposite of what he recommends.

Buffett has said that “investing is simple, but not easy.” He has also said that “the most important quality for an investor is temperament, not intellect.” By that he meant the ability to stay disciplined, ignore recent events and returns, and adhere to your well-thought-out plan. He explained: “Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

While financial economists consider 10 years of data as nothing more than “noise,” my more than 20 years of work as an investment advisor have taught me that, when contemplating investment returns, the typical investor considers three years a long time, five years a very long time and 10 years an eternity. (What inspired me to write this piece was a new record set when an investor expressed concern over the fact that a fund had underperformed in the 11 weeks he owned it.)

10 Years Is Not A Long Time
For investors to be successful, they must understand that, in the market, even 10 years is a relatively brief period. No more proof is required than the -1.0% per year return to the S&P 500 Index over the first decade of this century.

That’s an underperformance of 3.8% a year relative to riskless one-month Treasury bills and a total return underperformance in excess of 40%. Investors in stocks shouldn’t have lost faith in their belief that stocks should no longer be expected to outperform safe Treasury bills due to the experience of that decade.

The following table shows the annual premium, Sharpe ratio (a measure of risk-adjusted returns) and the odds of outperformance for the six equity factors (beta, size, value, momentum, profitability and quality) that have provided persistent premiums, not only in the U.S. but around the globe.

Note that these six factors also explain almost all of the variation in returns between diversified equity portfolios. With a single exception, what the table shows is that, no matter the investment horizon, there is always some probability that the factor will deliver a negative return. The sole exception was the momentum premium, which was positive during each of the 20-year periods. Of course, even this is not a guarantee that it will be positive over all future 20-year periods.

buffett1

There are two other important takeaways. The first is that, no matter what the investment horizon may be, you are putting the odds into your favor by gaining exposure to these different factors. The second takeaway is that, as demonstrated in Table 2 below, the factors all have low-to-negative correlations to each other, resulting in a diversification benefit.

buffett2

Benefits Of Diversification
The diversification benefits can be seen in Table 3. This table shows the mean premium for each of the factors, the volatility of the factor and its Sharpe ratio. It also provides the same information for three portfolios.

Portfolio 1 (P1) is allocated 25% to each of four factors (beta, size, value and momentum). Portfolio 2 (P2) is allocated 20% to each of the same four factors and adds an allocation to the profitability factor. Portfolio 3 (P3) is allocated the same way, substituting the quality factor for the profitability factor.

buffett3

The low correlations among the factors resulted in each of the three portfolios producing higher Sharpe ratios than any of the individual factors. Furthermore, we can see the benefits of diversifying across factors in the table below, which shows the odds of underperformance over various time horizons.

buffett4

As you can observe, no matter the horizon, the odds of underperformance are lower for each of the three portfolios than for any of the individual factors.

Playing The Odds
There is one other important takeaway that relates to an issue I am often asked to address. Some investors will see this data and say: “But I don’t have 20 years to wait for a premium to be realized.” The best way to think about this, however, is relatively simple.

Unfortunately, there are no clear crystal balls in investing. Thus, the best we can do is to put the odds of success in our favor as much as possible. As the above tables show, regardless of your investment horizon, be it one year or 20, you are always putting the odds in your favor by gaining exposure to any of these factors. It’s just that the odds grow increasingly in your favor the longer the horizon.

Because any factor can deliver a negative premium over even long horizons, the prudent strategy is obvious: Diversify across factors and don’t put too many of your investment eggs in any one of them. But, as Buffett said, while investing really can be that simple, it’s not easy to ignore what feels like long periods of underperformance. And that leads to impatience and the loss of discipline.

The bottom line is that an investor’s worst enemy is staring right back at him when he looks in the mirror. One of my favorite expressions is that knowledge is the armor that can protect you from making bad decisions. You have the knowledge. Now all you need is the discipline.

This commentary originally appeared June 10 on ETF.com

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