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Quarterly Investment Newsletter OCTOBER 2016
1
by
STAY BULLISH MY FRIENDS
After seven consecutive
quarters of declining
earnings, the collective
earnings of the S&P 500
companies are expected to
start rising again in the
fourth quarter. As you can
tell from the chart below,
earnings have already
stopped declining and the
expectations are for a big
rebound next year. Some of
the factors holding back
earnings the past couple of
years have been a strong
dollar and the massive
decline in oil prices. These
issues have largely been
resolved as the dollar has
stabilized and the price of oil
has rebounded. If we do have
an earnings revival next year,
as expected, that will go a
long way to alleviating some
of the concerns investors
have with the lack of growth
and valuations. Since stocks
tend to take their cue from
earnings, it may help propel
the market on its next leg
higher.
Aside from the afore-
mentioned improvements in
the dollar and oil prices,
consumer spending will also
be a significant driver of the
earnings rebound. As the
true mainstay of the
economy, consumers have
been keeping the economy
afloat the past couple of
years, as other areas of the
economy struggled. They’ve
been able to do this due to
rising income. A recent
report from the Census
Bureau indicated that
household incomes rose
5.2% in 2015, which was the
first gain since 2007. It was
also the largest annual gain
since they started releasing
such data in 1967!
Source: S&P; Raymond James Research
S&P500 Operating Earnings
“An investment in knowledge pays the best interest.”
~ Ben Franklin, Founding Father
Quarterly Investment Newsletter OCTOBER 2016
2
If there’s one thing that keeps
me up at night (besides the
baby), it would be negative
interest rates. The fall of
interest rates worldwide the
past few years, has morphed
into negative rates through-
out much of the developed
world. As shown in the chart
to the right, as of July, over
$13 trillion bonds around the
world have negative yields,
up from practically none just
a couple of years ago. The
longest maturity Swiss bond
stretches almost 50 years and
now has a negative yield, as
do 80% of all German and
Japanese bonds. Lately we’re
seeing the yield grab
spreading to bonds with
riskier credit profiles. The
more investors search for
yield, the more bond yields
fall.
Some critics of the Fed and
other central banks around
the world have observed that
by keeping interest rates near
zero, or even below,
monetary policy may actually
be a significant factor as to
why growth has been so
sluggish. Savers are earning
less on their savings and are
forced to save more and
spend less. Corporations are
using cheap money to buy
back their shares rather than
invest in their businesses as
it’s a more cost effective way
to boost their earnings in a
low growth environment.
This reduced level of
spending and investment
leads to slow growth,
reinforcing the perceived
notion of keeping interest
rates low. Think of it as a
catch-22 for central bankers.
My big concern is how this
comes unwound. The current
trend of continuously falling
interest rates can’t last
forever. At some point the
pain becomes too much to
pay interest on your own
money. If interest rates finally
start to rise, then anyone who
owns a negative interest rate
bond stands to lose a great
deal of money. Maybe I
missed that day, but I don’t
recall learning about the
ramifications of negative
interest rates in my economic
classes. Maybe I needed to
have the head of the
European Central Bank Mario
Draghi as my professor.
Rising Tide
The pool of global negative-yielding debt is climbing.
$50 trillion
Positive -
yielding
debt
Negative -
yielding
debt
Source: Bank of America Merrill Lynch THE WALL STREET JOURNAL .
Negat ive Nancy
Quarterly Investment Newsletter OCTOBER 2016
3
Source: J.P. Morgan THE WALL STREET JOURNAL .
One reason why the stock market remains at these elevated levels is due to the declining number of companies that are publicly traded. Between the lack of new companies going public and the increase mergers and acquisitions (M&A) the amount of companies that are available to buy is roughly half of what it was a couple of decades ago. As shown in chart 1, according to the University of Chicago, the amount of publicly traded companies is just 3,267, which is the lowest since 1984!
Initial public offerings (IPO’s) have been the big culprit of late. As of the third week of September, just 68 companies have gone public so far this year, raising $13.7 billion according to Dealogic. At this point of 2015, 138 companies had listed, raising $27.3 billion, which was itself down 62% from 2014! There are numerous reasons why this has occurred, primarily due to cost associated with going public, but more recently from the increase in available funding for private companies. Additionally, the ability to grow their companies largely out of the public eye has great appeal to this recent wave of entrepreneurs. In years past, companies like Uber and Airbnb would have gone public long ago, but that is no
longer. I’m not sure if the IPO market is ever coming back as robustly as it once was.
Money Flows
Even with the stock market near record highs, the limited amount of speculation and palpable excitement is rather remarkable. Two major bear markets in the past 15 years will have that affect. Still, its surprising to see the amount of net new money coming into stock investments is actually negative on the year, while low yielding bond
investments have seen positive flows. As you can see in the chart below, this is the first year since 2008 that we’ve seen negative fund flows from stocks, and that was near the bottom of the bear market! With this level of cautiousness and apprehension towards stocks it would be highly unusual for the market to decline significantly from here. In fact, the contrarian in me sees this as a strong buying indicator. If everyone who wanted to sell has sold, then all that’s left are buyers!
Where Art Thou IPO?
ƚ Net flows into global equity and bond funds
Chart 1: Number of stocks in CRSP data lowest since 1984
Number Of Companies
Source: Center for Research in Security Prices (CRSP®), The University of Chicago Booth School of Business; Jefferies.
Quarterly Investment Newsletter OCTOBER 2016
4
Below is a chart of the Vanguard index of emerging markets relative to the S&P 500 Index. During
much of the bull market from 2003 to 2008, emerging markets were the place to be, far outpacing
domestic based stocks. In fact, even including the significant decline of 2008, emerging markets
outpaced the S&P 500 by an absurd 16.11% annually from 2003 to 2010! Since that time it’s been a
different story, with the emerging markets underperforming the S&P 500 by 7.85% annually.
That has started to change of late, with emerging markets breaking out of its long-term downtrend
and starting to outperform the S&P 500 once again. Considering the lengths of the previous cycles it’s
quite possible this reversal of fortune could last for years to come. At the very least, this indicates to
me that the long-term under-performance in emerging markets is likely over.
Source: StockCharts.com
Emerging Markets
One of the more surprising bits of news I’ve read lately is that Australia hasn’t had a recession in over
25 years! You have to go all the way back to 1991 to see the last time their economy has declined for
two quarters in a row, which is the general definition of a recession, according to the IMF. Amazingly
their 101 consecutive quarters of growth without recession isn’t even the longest ever, as they are
rapidly closing in on the Netherlands record of 103 consecutive quarters, which ended in 2008,
according to the chief economist at Commonwealth Securities. With the US’s last recession having
ended in March 2009, we’ve just reached 30 consecutive quarters without a recession, which seems a
rather long time, yet pales in comparison. So the next time you hear that this economic recovery is
getting on in years, just remember our friends from down under who have proven that if managed
correctly, economic growth can last a lot longer than ever thought possible.
“The trouble with committing political suicide is that you live to regret it.” ~ Winston Churchill, British Statesman
Crikey!
Quarterly Investment Newsletter OCTOBER 2016
5
Election Prediction
In this crazy election cycle,
it’s probably foolish to listen
to any one pundit’s prediction
about who may or may not
win. I don’t recall many
correctly forecasting how this
would all play out. The stock
market, on the other hand,
has a long history of
accurately making such
predictions. According to
Strategas Research Partners,
the stock markets trajectory
in the three months prior to
the election has correctly
forecast the outcome in 19 of
the 22 presidential elections
since 1928, and every year
correctly since 1984! That is,
if the stock market is up the
prior three months before the
election, then the incumbent
party wins and vice versa.
Reflecting the tight race,
stocks have traded about flat
since the beginning of August,
so no real indication yet as to
who the winner will be. But if
you want to know who will
win, the market’s likely to tell
you well before the votes are
cast. Looks like one way or
another we’ll get an October
surprise!
Stay Bullish My Friends
After nine years, one of the
most successful advertising
campaigns ever has come to
an end. Sadly, Dos Equis
“Most Interesting Man in the
World” has been retired. In a
relatively flat beer market,
Dos Equis managed to triple
their business during that
time, just as the stock market
has done since the nadir of
the bear market back in early
2009. With the way this
market has gone this year,
I would expect a choppy
market to continue,
particularly over the next
month before we all decide
who the leader of the free
world will be. If we do get any
significant pullback in the
market, it should be looked at
as a buying opportunity, as
historically the stock market
rallies after the election,
regardless of who wins. The
market abhors uncertainty
and generally rallies upon its
removal. With the ongoing
search for yield, income
stocks should continue to
outperform. So to paraphrase
the Most Interesting Man’s
famous tagline “I don’t always
buy stocks, but when I do, I
prefer dividends”.
Justin T. Adams, CFP® CPWA® CERTIFIED FINANCIAL PLANNER® Certified Private Wealth Advisor ® Managing Director Senior Vice President, Investments RAYMOND JAMES® (415) 538-5708 [email protected]
Sharlene Asuncion Sales Associate RAYMOND JAMES® (415) 538-5718 [email protected]
San Francisco Office 575 Market Street Suite 3900 San Francisco, CA 94105 (415) 538-5700 (800) 346-5544
Quarterly Investment Newsletter OCTOBER 2016
6
Opinions expressed are not necessarily those of Raymond James & Associates. The author's opinions are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. There is no assurance these trends will continue or that forecasts mentioned will occur. It is not possible to invest directly in an index. The S&P 500 is an unmanaged index of 500 widely held stocks. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ. The NASDAQ Composite Index is an unmanaged index of all stocks traded on the NASDAQ over-the-counter market. The Wilshire 5000 is a market capitalization-weighted index of the market value of all stocks actively traded in the United States. The Russell 2000 index is an unmanaged index of small cap securities which generally involve greater risks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. These international securities involve additional risks such as currency fluctuations, differing financial accounting stand-ards, and possible political and economic instability. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. Dividends are not guaranteed and will fluctuate.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER ™ and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC
Year-To-Date Index Performance
INDEXES 12/31/2015 9/30/2016 % Change
Dow Jones 17425.03 18308.15 5.07%
S&P 500 2,043.94 2168.27 6.08%
Nasdaq 5,007.41 5312 6.08%
Wilshire 5000 21,167.86 22576.67 6.66%
Russell 2000 1,135.89 1251.64 10.19%
MSCI EAFE (Intl) 1,727.47 1697.82 -1.72%