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As we head into 2020, all of us at Global Wealth Solutions, LLC (GWS) wanted to make a few comments in regard to the last year and decade, as well as what might take place over the next few years.
Looking in the rearview mirror, it has no doubt been a historical decade, one for the record books on many fronts. Without getting into a topic of politics, I’m sure everyone would agree the last decade brought us unprecedented historical changes that will be in textbooks and studied for years to come. Today’s technology has armed the sitting president with a method of reaching the masses, not through railroad travel or television news waves, but rather, social media. Would former hierarchies ever have predicted that one? The financial markets have needed and taken time to digest this Social Media onslaught and come to grips with this new form of direct, in your face communication. Never before has news traveled at literally light speed. Is it for the greater good? You can ponder that question on your own.
A few quotes that I think will set the stage for the remainder of this update are some of my favorites. Investors have certain tendencies that persist over time. We love the markets when they are going up, “bull market,” and hate them when they fall, “bear market.”
“To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up in price, we weep. For most people, it’s the same with everything in life they will be buying – except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
– Warren Buffett, Fortune Magazine (December 10, 2001)
Mr. Buffet has 2 rules to investing:
“I must say, after more than 30 years in this business, the stock market remains as manic as ever.”
– David Rosenberg, Chief Economist & Strategist, Gluskin Sheff + Associates Inc.
There is futility in trying to predict the future and the understanding of the current market risks headed into the next decade. The reality is that we can’t control outcomes. The most we can do is influence the probability of certain outcomes through the management of risks and investing based on probabilities, rather than possibilities, which is important to capital preservation and investment success over time. The last decade is about as interesting as it gets in the financial markets. In 20081, the Federal Reserve decreased interest rates from 3.50% to 0.25%, and over the course of seven years, didn’t raise interest rates until December 2015 to 0.50%. From 2015 to 2018, they raised at eight separate meetings 0.25% at each
meeting to bring the federal funds rate to 2.50%, still below the 2008 pre-financial crisis levels. Then after the turbulent stock market in the final months of 2018, they began to lower rates for the first time in August, September and October. The president was calling for this, referring negatively to the Federal Chairman Powell’s actions in several social media posts.
“The most important message from the financial markets in 2019 was, ‘Don’t Fight The Fed.’ The 180- degree turn in Federal Reserve policy…the Powell Pivot…caused markets to realize that it was, once again, ‘All About The Central Banks.’
In December 2018, the Fed raised interest rates and indicated that they expected to be raising rates in 2019…but instead of raising rates, they cut rates three times…stopped their quantitative tightening policies and wrapped up 2019 by pumping vast amounts of liquidity into the market.
The Fed’s policy reversal inspired Central Banks around the world to step up their own monetary stimulus programs. That global shift to easier monetary policy may or may not have kept the world economy from slipping into recession in 2019…but it certainly helped drive global stock and bond markets to big gains. Bond yields hit All Time Lows, the ‘stack’ of negative yielding bonds soared to a high of $17 Trillion and major stock indices kept making ‘New All Time Highs.'” Victor Adair Polar Futures *2
There is a nagging voice in my head that continues to make me wonder how this is really going to end over time. Yes, euphoria can go on longer than we can expect. Talking with many clients over the past year, the common theme seems to be, “When this party ends, its going to end badly.” Many that had that same nagging feeling in 2008 didn’t understand just how to act on it, but they had the feeling nevertheless. When you look under the hood of the internals of the S&P 500, for instance, you notice much of the gains come from a few numbers of companies such as Amazon, Microsoft and Apple *3. Reminiscent of 1999?
Some might ask, what has been fueling this stock market over the past decade? In part, it can be referred to as “financial engineering.” When interest rates remaining at historic lows for long periods, corporations may issue debt and use the portions of the proceeds to buy back their own company stocks. Genius when you think about it. Raise debt in a low interest rate environment, use proceeds to purchase company stock which reduces number of shares outstanding, lowers price to earnings ratio, potentially increases the value of the shares, which in turn increases the value of corporate execs’ large amount of stock options. All in all, while the party continues, it’s a beautiful win for everyone. What could cause the party to end?
The Corporate Debt Bubble
This bull market's excess is undoubtedly in the corporate debt sector. Corporate debt has doubled since the 2008 crisis *4. Corporate debt to GDP is at its highest level in all of recorded history. Naturally, too much debt lowers your credit quality. This is evident by the fact that roughly 50% of the corporate debt market is BBB, or just one level above junk. AT&T has amassed $191 billion of total debt. Ford has $157 billion of debt, but a much-less manageable approximate 450% debt/equity ratio *5.
Thus, the nagging fear is when the party comes to a screeching halt, what happens next? Another one of Warren Buffet sayings, “It’s only when the tide is going out that you learn who’s been swimming naked.” In other words, not if, but when the next recession hits, there may be less buyers of BBB and junk-rated corporate debt and those that are currently exposed may run for the exits.
The current buybacks propping up the stock market could come to a screeching halt, leaving the S&P 500 and other indices to more traditional market forces without the influence of central banks. At the same time, the Federal Reserve may have very little tools remaining in its toolbox to offset the recessionary forces. The financial markets could be caught unawares as they have spent the majority of the last decade intoxicated on the easy money “fix,” referring to quantitative easing.
Individual investors tend to follow the herd, with no strategy in place. Euphoria, to complacency, to despair, to “I’ve had enough” mentality. At GWS, we continue to have confidence that over time, a diversified portfolio with time-tested strategies to navigate financial markets will provide a less volatile portfolio (standard deviation) with a potentially higher win ratio. Remember, it’s not so much how much you gain in any given year, it’s how much you keep that’s important in the long run. Precisely why it’s imperative to have
strategies to exit and re-enter the markets, rather than just leave it completely to chance.
History of financial markets over the past 2 years:
Since January 2018, the S&P 500 has increased roughly 20%, while treasury yields as measured by the 10-year bond have fallen roughly -22%; European markets are flat with little-to-no increase in value; gold has increased roughly 15%.
United States 10-year Treasury yield is 1.87%, compared to the German 10-year Bund at -0.253%, and the Japanese 10-Year is -0.01%. Gold is currently over 1500 per ounce *6.
One measurement of the valuation of the stock market, whether it appears expensive or inexpensive, is Robert Shiller’s CAPE Ratio *7. Mr. Shiller is Yale University’s economic professor and 2013 Nobel Laureate in economics. He developed a method of measuring the valuation of the stock market that incorporates factors beyond traditional Wall Street methods. You can find more information about Robert Shiller in my book, The Informed Retiree. It can be downloaded at www.TheInformedRetiree.com. The website has a video section highlighting strategies such as this, among other financial topics.
I want to highlight in this letter the current ratio, which stands at 31. To put this in perspective, Black Tuesday, October 29, 1929, the ratio would’ve been around 30 had this tool been developed. Black Monday, October 19, 1987, the ratio was around 18, which is considered just above the mean. So today’s stock market is the second most expensive market measured by the CAPE ratio, next to the technology crash of March 2000.
Where does this leave us currently? Predictions again are futile, as so many factors can change over the course of a year or two. Will China fail to comply with phase one of the trade deal; will earnings growth and corporate profits continue to falter or reignite and catch up with lofty valuations; will interest rates rise, tripping up high-levered consumers and corporations? There are many more factors to consider, ones we could never put into a short update. We are watching these carefully, among other developments.
There have only been four election years that have produced negative returns since 1928, two of which have been in the last five elections, 2008 being the largest *8. After coming off a strong 2019 for the markets, it will certainly be interesting to see how the year unfolds. It’s my thinking it might be a year for the history books once again, one that stands out for years to come.
Advisory services offered through J.W. Cole Advisors, Inc. (JWCA). Global Wealth Solutions and JWCA are unaffiliated entities.