Here's your financial markets weekly report for February 23, 2018.
Where humans and the act of investing collide, we're often driven more by cognitive biases than by real knowledge or practical experience. Repeatedly making the same mental miscalculations. Swaying to and fro between fear and greed. With little to no attention paid to timeless, effective principles.
According to Wikipedia, cognitive biases represent systematic patterns of deviation from norm or rationality in judgement. Often studied for their impact on psychology and behavioral economics. The consequence of information-processing rules, or mental shortcuts called heuristics, the brain uses these biases to make rapid decisions or judgments. Many, having evolved over millions of years, can be directly tied to our survival instincts.
After the 2008 market meltdown, many investors allowed biases to engender in them a form of post-traumatic stress disorder. Recency bias. Gambler's fallacy. Neglect of Probability. Naive cynicism. Naive realism. Bandwagon effect. Just a few of the hundreds of temperaments, prejudices and irrational judgments that guided conscious and unconscious thought. Preventing them from being the most effective versions of ourselves -- and relegating them to downright poor investors.
In the investment world, where psychological success traits do not come naturally, such biases represent a huge barrier to success.
Consider one such bias fraying the nerves of late-to-the-game investors. FOMO, or "Fear of Missing Out," is an affliction affecting the psyches of fragile investors. FOMO typically occurs after an individual has long not participated in a bull market and -- fearing he'll miss out on the entire cycle -- jumps in during the game's later innings.
Unfortunately, Mr. Market (as Buffett mentor Benjamin Graham named him) loves to harass those lacking conviction. Those who, reeling from losses incurred during the previous bear market, avoid investing at all throughout 75 percent of the ensuing bull market. Only after the market has risen like a Phoenix do they succumb to temptation. Having already missed out on so much opportunity. The dot-com boom. The housing boom. The bond bull market. Bitcoin mania.
Having regained his composure, our FOMO-stricken investor (alas, and meekly) pushes all his chips onto the table. Whereupon Mr. Market notices our weak-minded investor regaining his confidence, and pulls the rug out from under him. Sending stocks 10-percent lower for the first time in 2.5 years.
Looking back on the early February correction, we've noticed how many weak hands had reappeared in equity markets. Why else would the VIX/Fear Index have rocketed from 10 to 50 on such a relatively minor market drop? Nearly $31 billion was pulled from equity mutual funds during the week of February 8. The largest such draining since 2004. Another $31 billion exited equity ETFs. Including a staggering $23 billion from the giant SPDR S&P 500 ETF.
Another telling tidbit? The financial news media blew a gasket. Speaking of the "Dow's largest-ever decline," though only in so much as the points lost. Rendered meaningless by the fact that it was by no means the largest-ever percentage drop (Higher the market goes, the more points it can lose and remain a smaller drop on a relative basis).
Another headline screamed "One quarter of S&P 500 stocks already in a bear market!" Again, true, but in a cap-weighted index, meaningless. But enough to feed the frenzy of the lemming class. Who, having just gotten back in, were ready to sell first and ask questions later. Even as sharply enhanced earnings aligned with falling prices to instantly solve what some were calling an overvaluation problem.
Let us explain.
The consensus 2018 earnings estimate for the S&P 500 is now just shy of $160 and rising. At roughly 2,749 (as we write) the forward P/E multiple equates to roughly 17.1, versus a 25-year average of 16.1. A bit above average. But not obscene.
Moreover, the earnings yield of the S&P -- the inverse of the P/E: earnings divided by price -- is now 5.8 percent versus the 2.9 percent yield on 10-year Treasuries. So, equity investors can expect to recoup roughly six percent versus a 2.9 percent return on 10-year bonds. Hhmm. Not a hard choice, eh?
All of which remains music to enlightened ears. Revealing, as it did, how the mass collective of weak-kneed investors remain too traumatized to fully commit to equities. Which serves as a contrarian indicator. One that tells us this ball game still has some innings left.
True, the S&P 500 suffered a long-overdue drop of 10.2 percent. But since, it has recovered roughly six percent. While the fundamentals have not changed one iota. The bottom line for stock price appreciation remains earnings. And they continue to come in strong as Q4 reporting ends.
Among U.S. companies that have reported so far, 71 percent have beaten forecasts. The last quarter that was this strong was Q3 2006. The beat rate for the S&P 500 is an astounding 80 percent. Revenue beats are coming in at a solid 73 percent. And even better among S&P 500 companies, where the revenue beat level is 77 percent. The best rate in 20 years.
Don't mistake our conviction for passivity. We're telling everyone that will listen: if you're doing nothing different than that which you did in 2008 yet expecting a different result? It's your problem... and you'd better figure out a way to solve it. Because nine years into a market recovery doesn't necessarily mean the bear's around the next corner. But it does mean he's lurking closer than he was a few years ago.
We have a blue print that we believe investors can utilize to weather the next storm. Whenever it rolls in. It begins with a healthy allocation to low-correlation alternative investments. And a mindfulness of moving averages You can read more on that in this white paper. Or schedule a conversation with us here.
In D.C., the goat rodeo continues.
Congress resolved its bitter spending conflicts by essentially allowing both parties to spend more on nearly everything. Republicans won an additional $165B in defense spending these next two years. Democrats received $131B in additional domestic spending. And this roughly $300B spending increase does not include any upcoming infrastructure program, which both sides hope to pass.
But wait. There's more!
Within days of the Congressional budget deal, the Trump administration released its longer-term budget blueprint. These documents specify presidential priorities for spending and taxes. And set the terms for Congressional debate over actual budget legislation. Shockingly, the blueprint revealed that a combination of tax cuts and new spending initiatives are expected to cause the cumulative budget deficit to increase over the next decade to $7.1 trillion. Effectively doubling the alarming $3.4 trillion increase in total debt that the Trump administration forecast in last year's budget blueprint.
The Trump budget blueprint assumes an ultimate cut in non-defense discretionary spending by 40 percent. Even though we just hiked it by over 10 percent!
The Committee for a Responsible Federal Budget (CRFB) notes that the U.S. budget deficit will nearly triple in 2019 from the decade low of $400B hit in 2015. The CFRB posits that the Trump plan is expected to produce annualized deficits of $1 trillion for the next five years.
That's trillions. With a T...
Economically, we've oft stated in the past the priority we concede to the monthly ISM data. Which truly serve as a barometer for the greater U.S. economy. The February ISM manufacturing index rose to 60.8 from 59.1. Beating consensus. And providing the highest reading since May 2004. Emphatically providing another piece of empirical evidence as to the strength of the U.S. economy. The 5.5-point rebound in employment, to a four-month high, was very encouraging. Having dipped unexpectedly by 3.9 points in January. This and other survey evidence point to 200K-plus payroll gains, provided firms can find the people they want to hire.
Bottom line? The U.S. industrial recovery continues.
In the Far East, Machiavellian maneuvers are afoot.
Chinese communist party executive Sun Zhengcai -- once viewed as President Xi Jinping's likely successor -- was charged with bribery. Shortly thereafter, the "people's party" floated the idea that Xi Jinping may remain in office indefinitely. Or at least past his second term, slated to end in 2023.
The ruling Communist Party on Sunday proposed to remove a constitutional clause limiting presidential service to just two terms in office. Meaning Xi, who heads the party and the military, might never retire.
The proposal, up for deliberation by delegates loyal to the party at next month's annual meeting of China's largely rubber-stamp parliament, is part of a package of amendments to China's constitution. Which will also add Xi's political thought to the constitution, already added to the party constitution last year. And set a legal framework for an anti-corruption "super-body," and more broadly strengthen the party's grip on power.
XI Jinping: "I'll strike graft and corruption from existence. In return? Eternal, unlimited power."
Chinese Populace: "Hhmm. Sounds eerily familiar..."
Isn't this China's Year of the Dog? Well, you can't teach an old dog new tricks.
It seems the party will have its work cut out trying to convince the population, where Xi is popular thanks in part to his war on graft, that the move will not end up giving him too much power. China's electorate, long fond of political stability, will be tested as it chooses between increasing political freedoms and the prospects of Xi's life-long leadership. Referred to as dictatorship, in more democratic circles.
Stay tuned for your next financial markets weekly update…
Financial Markets Weekly Recap
Major indices finished up last week. The DJIA gained 0.36%. The S&P 500 rose 0.55%. The Nasdaq climbed 1.35%. While small cap stocks gained 0.37%. 10-year Treasury bond yields fell 1 basis point to 2.86%. Gold closed at $1,328.75, down $18.35 per ounce, or 0.88%.
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