Jason No Comments

Next Fear Please?

Good Morning,

Ok, so now we “know” what the Fed will do – uh – and that was, well, um, nothing!!!

After 2.8 seconds, the slicing and dicing began as machine traders were programmed for trades for both the words “raise” and “no change” – the average John Doe had no chance.

So what does it all mean for you and me – focused on long-term structures in place driving our economic growth ahead?

Little to nothing.

The next time the world tells you to fret over a 25-basis point rise in rates – please think about it for a moment.  By the way – the media headlines are already conjuring up “Well, so now we need to prep for a December rate hike.”

Leave the nonsense on the side of the road.

Your portfolio and your blood pressure with both thank you.

Step Back for Review

It is imperative that we consider this whole interest rate thing.  This monster that seems to be ever-present on our doorstep.  I will say again – it is a pitch in the dirt.

Rates will rise – for good reasons.  When they do it will be because the economic might of the US is slowly but surely healing from the deep emotional scars of the Great Recession.

As we stated then, “The emotional scars to our economy will last decades longer than the financial damage.”

Here is the Larger Point

When the Fed raises rates by 25 basis points, does it really matter to a well-run company?  Really?

For example, does it matter if they raise rates when companies, left and right, continue to refinance bond debts at lower and lower costs for very lengthy periods of time?  Will a rate hike – no matter when it comes – actually change anything for most companies?  The answer – very, very little.

For example, many shudder in fear that their dividend stocks will be crushed.  Nonsense.

Yes, dips and corrections will come.  But make sure you focus on this instead of fear:  If the Fed raises rates by 25 basis point in a year and your dividend producing stock does the same – are you worse off?

Keep this simple folks.  And by simple – I am not implying easy.

It can be hard if you choose – but why would you choose that?

Let me give you a real-life example which took place just this week.  One company – one set of bonds – one small debt refi in a sea of corporate debt refi’s:

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Now, I underlined a few items which are helpful as you review the bullet points.

I will highlight:  ATVI took action in a bond market filled mountains of fear-driven capital.  It refinanced $1,500,000,000 in bonds.  They were previously paying 5.625% on that tranche of money.  They will now be paying a blended rate of 2.85% on the same level of debt – further extending 55% of that debt for another 5 years!

So what does all that mean?

ATVI saves $42,000,000 EVERY year in interest going forward.

Make sure you don’t read over that too quickly:  $42,000,000 each and every year which previously went to bondholders will now stay with shareholders.  Savings that fall to the bottom line in the next five years alone?

A staggering $210,000,000 – nearly a quarter billion dollars

Again – 1 company, 1 debt tranche, 1 refi episode

This is being repeated by CFO’s across the land

I ask you simply:  Do you really think ATVI cares whether or not the Fed raises rates by a quarter point?

Your Best Actions?

Instead of fearing rate hikes, do as corporate America does.  If you want debt – go get it. Bigger house?  You have never been able to buy more house with less money on a monthly costs basis.

The fear-mongering needs to be left to others – and leave it out of your future thinking / planning process.

“But Mike – Aren’t You Missing It?”

“But Mike, companies are not investing as much.”

That’s right – you know why?  They don’t have to invest as much!!!

The blessings of a slow and steady economy are many.  One is that all needs are being satisfied by the investments already being made.  Why?  Technology falls in price every quarter.  Every new 2.0, 3.0 or 4.0 model does more with less.  The change is geometric.

The cloud – apps and software tools are doing things today which require far less expense, less investment and their output is rising.

“But Mike, manufacturing has been gutted.”

Baloney.  We just got better at it.  We have record output – we lost nothing.  Those that used to work at plants and facilities got better jobs with more pay and our output for us all went up!

So then, how could all that be correct?  What about all those things I am told I should be afraid of?

Let’s blame the proper thing – and it is a good thing by the way:  In a 2014 article from the MIT Technology Review, Erik Brynjolfsson, coauthor of a prominent 2014 book on the subject, is quoted as stating that “technology is the main driver of the recent increases.”

Supporting evidence for that theory, highlighted by Cato, was found in a 2015 Ball State University study in which economists attributed nearly 90% of the US manufacturing job losses in recent years to productivity gains.

Very important point here:  They observed: “Had we kept 2000-levels of productivity and applied them to 2010-levels of production, we would have required 20.9 million manufacturing workers. Instead, we employed only 12.1 million.”

There is no ghost in the machine.  It’s fabricated – like a movie set on a stage.  Do you really want to live in the world that would have required the 20.9 million factory workers of 2000 levels?

Think about that the next time you even ponder buying into the garbage being spewed out there about the end of life as we know it coming soon.

 So What’s Next?

More fears of course.  As we layer on the analysis of the latest Fed statement, every syllable will be sliced and diced.  Every report will be measured against it for weeks. Political analysis will tell you how the world will change ahead based on every sound-bite coming from either candidate.

Expect chop to be the norm as we go through the testing process unfdoling in markets which we have covered for weeks – and included in this simple video review for you here last week.

Closing Thought for The Day

Take a deep breath.  Yet another monster has been vanquished.  There are many more to come.  Do not fret – if there is ever an open space in the pipeline of fears to come – we will find a monster to replace it with – even if it needs to be completely manufactured out of thin air.

Until then – we need to remain focused on the long-term data at hand.  Short of an extinction event – in which case your account balance will matter to no one – tens of millions of new households will form in the US over the next 3,5, 7 and 10 year periods. Assuming birth rates remain stable, we will have Generation Z backing up Generation Y with back-to-back record breaking generations of demand.

Everything becomes new again.

Be confident of this – as we focus steadily on the long-term horizon:

This “weak recovery” economy of ours is far stronger than most understand it to be. Even though it is messy at times, we do continue to overcome many hurdles.

Our momentum is driven by a very significant and rare generation “baton shift” in a very long race.

But here is the deal:  People make markets.

As stated before, we can make it more difficult if we choose – but why would we?

The Barbell Economy is an effort to simplify the noise and even work to eliminate some of it.   Chop is fine, corrective action is also a plus at times.

Long-term reward tend to be delivered to the patient investor willing to live through the process of markets.

Stay on your plan, stay focused and patient.  We are in great shape for the long-term growth waves at hand.

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

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Jason No Comments

Nothing But Needles…

Good Morning,

The Fed is on tap – and the various nail-biting contests are officially underway.  Office pools seem to be split down the middle as to whether a 25-basis point hike will bring on Armageddon…or a yawn and then a nap.  Fighting through the various elements in the media cycle to find anything under the category of “positive” is like trying to find a specific needle in a stack of needles.

There are a couple of things we may want to keep in mind – they are relatively simple butrequire a degree of faith in both history and the future:

Markets generally do not plummet when the entire planet is expecting them to do so.  No matter where you look, sentiment stinks.  Investors, managers, cash balances, conferences, hedge fund guys, experts getting airtime – it is across the board.  I have yet to hear anyone on air or in print celebrate that we continue to make it over the mountains ahead.  Life has not ended, the apocalypse has not arrived, black swans are not falling from the sky – and markets a a tiny bit off their most recent all-time highs.

By the way – “all-time” is Italian and it means, “it has never ever, ever better before this moment in time.”

Since about six weeks ago – markets have been doing the tightening for the Fed.  Once again, if they finally pull the trigger today – they will be following markets – not leading or controlling them.  Yet another example of why this years long effort to blame the Fed for low rates has been such a bunch of sh… – uh, hogwash.  I would have used another word but I have promised to no longer speak in that manner.

I will state this as clearly as I can.  There is a reason the markets are on highs:  it’s simple. Keeping it that way in all this crazy mess we call markets is the very difficult task at hand. Here it is:   B.a.r.b.e.l.l. E.c.o.n.o.m.y.

Review Stats

Since most are overlooking that simplicity, markets continue to struggle far too much with concerns over interest rates.  The Fed may have itself in a pickle but not for the reasons so many assume.

As noted often, fear is the driver of rates in our society for the better part of the last decade.  An avalanche of money “seeking safety” has decided that this safety they long for comes to us in the form of bonds at near record low rates – or negative rates in some places.  How a vast crowd could get so twisted in their thinking is still beyond me but be that as it may, it has become so.

The issue the Fed is faced with is how does one unwind that fear in a manner where the short-end (typically the quickest to react to Fed rate hikes for example) can rise without triggering a negative yield curve while the long-end is pressured to the downside via the fear-driven rampage of buying.

In recent weeks that adjusted only slightly with the long-end rising ahead of a feared rate hike.  That noted, vast amounts of money continue to roll into bond funds at the expense of equity funds as we noted in notes for you late last week.

Volatility?

Are we really at the stage of underlying fear where a 3-5% fallback in major averages is defined as “volatility?”  I grabbed a snapshot below to give you a feel for what these pullbacks from highs have appeared as – in percentage terms – since the Great Recession lows of March 2009.  Let’s take a look:

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Seen from this perspective, recent “volatility” seems – well – not very volatile at all.  Let’s see if we can continue to keep our wits about us as all others lose theirs.

More Data – Solid Foundation

While way too much energy will be expensed this week on the issues of will they hike or not, be assured that no matter the decision – it will leave at least half of the audience disappointed.

If they hike, a rash of headlines will usher in terrible events coming our way due to 25 basis points more in interest costs.

If they do not hike, a rash of headlines will flood our screens about how the Fed is stuck, it has run out of tools, debt is out of control, QE is still haunting us and all that is left is to finish our underground shelters and buy more guns.

While more fret over that, what do you say we focus in on the barbell economy issues which are set to continue to drive us forward:

Builders Feeling Pretty Good

I still find it rather comical that the Great Recession we still fear a repeat of on any inkling of red ink, was wrapped around the real estate world and fraud in the debt markets.  While obvious to everyone now, the expert view back then was we would never use up the supply of homes available to live in.

The good news is we now know what forever is:  About 7 years.

Home supplies are wilting to levels not seen since the early 80’s – with population demand rising rapidly.  The NAHB just noted this morning that builders are feeling good and its index jumped 6 points to a new one-year high – leaping over expectations of just a marginal increase.

Here is the deal:  We are at a 50-year low on home ownership rates – and we have the largest generation in the history of the US just beginning to buy homes – in a vast landscape of depleted inventory.  Here in Chicago, buildings for condos and rentals are going up everywhere one looks downtown.

With cap rates on most deals still ranging from 6 to 8, one can assume more and more capital will move into real estate as bonds begin to sting more and rate-starved investors look for the next pool of investment capital to exploit.

Bottom Line:  There are tens of millions of kids who will move out over the next decade – and our shrink-wrapped, Fedex style economy with little supply ini the pipeline is not ready for the demand wave coming.

Speaking of Money

More good news – we have more of it than ever before.  Even as asset managers and investors alike see their sentiment swoon as though a multi-year bear market has already unfolded, wealth has reached levels never before seen in the US – on an overall and per-capita basis.

Keep in mind that well before all the ink dries on the various charts showing these new data points worldwide, be assured we will be told it’s all really bad news anyway, based on some “outside reason” which will surely not last – so enjoy it while you can.

Check it out:

Calafia shows us that as of June 30, 2016, the net worth of U.S. households (including that of Non-Profit Organizations, which exist for the benefit of all) reached a staggering $89.1 trillion.

Get this:  that’s about 40% more than the value of all global equity markets, which were worth $63 trillion at the end of June, according to the latest stats on Bloomberg.

Importantly, household liabilities have not increased at all since their 2008 peak

The value of real estate holdings now slightly exceeds that of the “bubble” high of 2006

And, obviously, financial asset holdings have risen since pre-crash levels, thanks to the $9 Trillion in savings deposits and gains in bonds and equities alike

One last thing:  you may recall back in housing bubble days, we were told our real problem was we were not saving enough.  Well guess what – we fixed that item.  And now?  Yes, that is correct – we are now told our problem is the consumer is not spending.

If this twisted process of media expertise was not so sad it would be funny.

Hard to Ignore

Life in the U.S. has been getting better and better for generations.

While the naysayers and those who prefer you remain afraid of the future will tell you it is all about debt and bubbles, the facts provide a far more productive view.  The typical household has cut its leverage by over 30% (from 22% to 15%) since early 2009.

Debt as a percentage of assets is back to levels seen in the late 80’s!

Households en masse have been the beneficiary of strengthening balance sheets over the past seven years with a cushion of the previously noted $9 Trillion now sitting idle in the bank.  Unfortunately, as social programs have expanded under very poor fiscal polices, our Federal government has more than doubled its debt burden over that same period.  Well, there is a legacy for you I suppose.

The Bottom Line

I could make these morning notes go for pages.  The data that one should be focused upon remains solid – but that does not mean we escape all pullbacks and chop.

Finding and focusing upon that data in a sea of negative, gut-churning, fear-mongering headlines is today’s more difficult emotional challenge.

Think I am kidding.  Check this graphic from CNBC over the weekend.  I just had to include it:

Yes – that is a train included in the picture to make sure you get the point.

Closing Thought for The Day

This remains the reason driving our morning notes:  stay focused on the proper horizon – and the growing portions of our economy.

This “weak recovery” economy is far stronger than most understand it to be.  Even though it is messy at times, we do continue to overcome many hurdles.  Recall the momentum is being driven by a very significant and rare “baton shift” in a very long race.

The fact that portions of our economy are changing so rapidly could even be driving some of the deep-seeded angst and recurring fears.  Masses don’t like change – but adapt we must.

But here is the deal:  People make markets.

We can make it more difficult if we choose – but why?

The Barbell Economy is an effort to simplify the noise and even work to eliminate some of it.  If we can focus upon the areas of the economy which are growing – and which have vast channels of demand in their pipelines, then we can begin to step back far enough from the markets to escape the emotional hand-wringing.

Chop is fine, corrective action is also a plus at times.  Long-term is the reward to the investor.  Stay on your plan, stay focused and patient.  We are in great shape for the long-term growth waves at hand.

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

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Jason No Comments

End of the World…

Good Morning,

Fifteen years ago today – the entire world was numb.  Most had not moved from their television screens for many hours as the fires from Ground Zero still burned and reality was just setting in.

What a pathway we have been on since.

Yesterday, as I recovered from jet lag coming off the Hong Kong trip hours before, I watched “Sully” as we were at the same time marking the 15-year anniversary of the 9/11 attack.  It was a blessing to recall the Miracle on the Hudson with the New York skyline in the background.

All at once, we were able to remember how we call came together at one time – twice.  It was a flood of emotions seeing how well Americans can do things together when all the chips are on the table.  Oddly, as I relived the real-life events the world watched on the Hudson that day, it struck me that without the lessons of 9/11 years before, the miracle may have had a different ending.

Numbers

Everyone is likely focused on the 400-point drop in the DOW on Friday.  Here are some interesting numbers as well:

Flight 1549

Souls on Board:  155

Length of Flight:  208 seconds

Deaths in Accident:  0

Incredible.  If you have not yet seen the movie – do so.  Take a box of tissues.  Enjoy.

Fear Returns

Last week we covered the consistency of fear seen in many indicators for months on end. We have covered the record-breaking lack of bullishness in the crowd even as record highs were reached.  I stated three things throughout the summer lull:  a) more red ink would make them even less bullish, b) fear would be quick to return and c) pray for a correction.

Well, Friday’s abrupt about face sure woke everyone from their summer slumber.  The Friday evening media flood and weekend articles in anyway related to markets or the economy were filled with the expected dire projections.  I love this one – it was the ominous theme of the weekend:

“A Correction is Coming and There is Nothing You Can Do About It”

Let’s hope so anyway.   Readers of these morning notes are not surprised by the events of Friday.  It is perfectly normal to see a market move back into previous breakout ranges for support.  The summer bounce was shaved by a chunk in one day as volume spiked and the crowd quickly showed their real feelings about risk: they want none of it.   Oddly enough, this is just what you want to see.

The problem?  The structure of corrections is changing.  Machines, stops, too many “hedging” tools and public fear all work to make these seem more volatile than they really are in the larger picture – but they end quickly.

The reality?  Most investors are in cash and bonds – extremely underweight stocks.  As a percent of the large crowd – few likely did anything on Friday though the media process will lead you to believe it was massive.

Don’t fall for it.  It’s a game that has been played since time began.  While all that we fear unfolds – parallel to that same track – history proves markets rise over time.

I have stated the same for years here.  Show me some red ink – days or weeks – and I will show you a crowd quickly become as afraid as they were in the final weeks of the Great Recession bear market.

Put Away Your Sharp Objects

Ok – yes, Friday was a bad day for bonds and an ugly day for stocks. The S&P 500 plunged 2.5%, managing to find support at 2015’s highs (see chart below).  The VIX rose from 12.5 on Thursday to a 10-week high of 17.5 on Friday.

Any Good News?

Long-term investors need to remain focused on the cushion provided by the Barbell Economy.  It shows consistency as well:  Yes, it sells off along with markets – but the cushion remains steady.

Don’t overlook this unrelenting fact:  The Barbell is where most economic energy is being exerted as the two largest generations in the history for the US churn forward – slowly and steadily.

Better News?    

The forward P/Es of the S&P 500/400/600 dropped sharply on Friday to 16.5, 17.5, and 18.3.

Meanwhile, the forward revenues of these three stock indexes rose to new highs during the first week of September.  Forward profit margins also continue to firm as we edge closer to the energy debacle round-trip.

The bottom line?  Well, while most fret over short-term price action and run again from stocks, the top and bottom lines of the S&P 500 are looking very good according to the consensus of reports – even as struggles will continue.

The overall business environment remains extremely competitive and that process increases at each turn.  Companies main focal point remains simple:  stay laser-focused on cutting costs and maintain/improve profit margins.

Oddly, these are not events history suggests investors should be running from.

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 Two Charts Above

The first chart shows you the trade ranges we covered for close to two years as the markets worked through their “earnings recession” and fears became deeply embedded.

I had recently noted being surprised we had not yet seen markets go back and test the breakout region from mid-summer.  In the long run, it is very positive to see this unfolding now.   I am confident we will find this to be a productive step in markets even though I do not expect it to cause anyone to rush in and buy stocks (also a good thing).

On the contrary, if it can last for more than a couple days (the Brexit panic), I suspect we see continued outflows from equities, inflows to bonds and a more bearish tilt in sentiment.

Note the red line at the bottom of chart 1 above.  It highlights volume levels.  After being paltry all during August (expected) they quickly rose on Friday as selling ensued.  Why point this out?  We reached into the region of volume pace which typically goes along with the end of things – not the beginning.  How quickly we panic these days.

The second chart is a great one from Dr. Ed.  As noted above, forward multiples fell sharply on Friday as markets shaved points and the forward earnings increased.  As such, take an extra moment and let your mind-eye gaze backward across the paths of green, blue and red lines on the second chart.

You will note that forward P/E ratios have now fallen back in all three weighted indices:

For the large caps – we are back to levels first seen in late 2014.

For the mid caps – we are back to levels first seen very early in 2014.

For the small caps – we are back to levels first seen in late 2013.

Pretty soon – all we will be discussing is 2017 and 2018 projections.  Let’s face it:

Time flies when you are witnessing a secular bull market grind its way higher as almost no one believes in it.

Generation Y is Deflationary

Years from now this will become more clear for many.  The technologies, from apps to the cloud, which are being unleashed on our economy by Generation Y – are very deflationary.  That’s not something to fear – as it creates a nice balance in the structure of things.  It also helps margins expand and – in time – they will flourish as Gen Y moves higher up the corporate ladder.

We can see it real-time today.  After being warned for years that QE would destroy the value of the US dollar and that inflation would burn us all – the exact opposite has unfolded.

Today we are told the strong dollar is hurting overseas profits and experts are nearly begging for inflation.

Far from the beckoning fears and expert calls for the ghosts of inflation, rates remain subdued near zero. There continues to be significant undershooting of actual inflation rates and the 2% inflation target of the BOJ, ECB, and Fed for their favored measures.

In the US, the core personal consumption expenditures deflator, excluding food and energy, was up 1.6% y/y for July.

Meanwhile:  average hourly earnings rose just 2.4% y/y during August, the competitive pressures of which were covered in your notes last week (see links above).

Silent Period?

As the window of time closes for any FedHead to chatter about US rate hikes, all eyes now nervously await the idea of whether or not 25 basis points will crater life as we know it.

Please guys –  take a breath – count to 1000.

Check your Barbell Economy Portfolio data and relax.

Let them chatter, let them meet, let them raise.  How many times have we collectively (and unproductively) been convinced to fear things since 9/11?  It struck me over the weekend that the correct answer is:  far too often.

A rate hike or two will mean almost zero to the average company – even less to many others.  Our fears have become monsters that wreak havoc only on emotions – and because of that, very poor long-term investment decisions are being made.

As much as I know many do not feel this way:  these fits of mini-panic tend to be good for the market.  Study history – your best results come right after the worst pricing nightmares.

They feel bad for a little while – and then pass.

In Closing (Broken Record Warning)

Step back and focus on demographics – not economics.

We are in far better shape than understood by most.

Effectively navigating this massive “baton shift” underway between powerful generations requires patience, planning, discipline….and on days like Friday, a steady 8-week supply of the new fruit-flavored TUMS.

Did I mention patience and focus?

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

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