Week In Brief: Week of May 19

May 22, 2017

Stocks drifted lower last week. Largely on Wednesday's single-day collapse. A consequence of the market's exhaustion with D.C.'s interminable Kabuki theater.
If we elect politicians in order to pursue the interests of the people, then something is wrong. In the end, you either learn to enjoy the absurdity or you drown in it.
Stocks usually don't dally over superficial political wrangling. So we don't expect this to continue. In fact, markets usually prefer political infighting. Because it oft leads to gridlock and indecision. So preventing the political class from the purveyance of further mistakes.

So, what does drive markets?
Since early March, the FAANG stocks. Those being Facebook, Apple, Amazon, Netflix and Google. Which have grown $260 billion in market cap. Meanwhile, the other 495 stocks have lost $260 billion. This winnowing of gainers provides an ominous sign for U.S. markets. As so much of the market's productivity has been confined to so few. Companies having a collective market cap of $2.4 trillion. Equating to the GDP of France.
From our perspective, such tea leaves are sweet and sour. As we've participated in the upside of these bellwether positions. But what their concentrated performance portends for future market movements? Perhaps signs of a slowdown. A handful of leaders can only carry a market for so long.
Let's not jump to conclusions. Despite the pricey nature of U.S. equities, the market "melt up" could continue. As we've not yet achieved the levels of investor apathy indicative of market tops.
That said, we're beginning to more aggressively allocate capital to attractive foreign markets. Locales with lower valuations and better tailwinds. Nor are we unique in so doing. Global money managers' allocations to U.S. stocks slumped to a nine-year low in April. And U.S. equity funds saw outflows of $22.2 billion during the seven weeks ending May 3rd, the largest seven-week redemption in a year
In Asia, valuations appear much more reasonable. Hong Kong's Hang Seng Index sports a PE ratio of 14x. Well above the 9x posted this time last year. But, well below the 23x of U.S. stocks. The broader MSCI Asia Pacific Index's PE ratio is around 16x. Also cheaper than the U.S.
A lot of investor capital has moved into Europe. With Q1 net inflows into Euro funds hitting a five-year high. Makes sense. As economies there appear to be heating up.
The 19 EU countries grew by 0.5 percent in the first quarter. Equating to an annualized growth rate of 1.8 percent. Comparatively, U.S. Q1 output grew at an annual rate of 0.7 percent.
Further, European valuations are more attractive. With equities sporting lower price-to-book ratios. Sitting right at their long-term averages. While those in the U.S. have crested their long-term average.
Emerging markets have also been the beneficiaries of capital inflows. Strong manufacturing, industrial production and trade data in the developing world helped attract the strongest three-month stretch of net inflows to emerging market funds since 2014.
India, China, Asia and Europe all appear attractive. And could provide investors with sufficient ballast when U.S. markets finally roll over. Be that in three months, or three years.
Cyclically adjusted price-to-earnings ratios, known as CAPE, is 22 times in the U.S. That compares with 16.7 in Europe and 13.7 in emerging markets.
U.S. equities have largely outperformed the rest of the world since the end of the Credit Crisis. Accordingly, we may be looking at wholesale mean reversion. As cheaper, less beloved global indices grab the baton and finish what U.S. stocks began in 2009. Historically, such occurrences could bring big returns for those positioned properly.
2002 was the last time the U.S. outperformed by nearly 50 percentage points over an eight-year period. Following, we saw a massive multi-year bull market in European equities. Had you bought European stocks in mid-2003, you would have earned 172 percent by late 2007. U.S. stocks returned just 74 percent over that period.
Similarly, another opportunity to profit overseas occurred in late 1998. When European stocks moved 64 percent in 18 months.
Today? We believe the opportunity could be every bit as exciting as previous cases.
Let's shift for a moment to the other side of the ledger. From returns, to fees. For as we know, two things impact net returns incurred by investors. The income and appreciation portfolios produce. And the fees paid in the act of achieving such returns.
So, it stands to reason that fees can be every bit as important to investor performance as returns.
Last week, a new client was in the office. Having spent the previous eight years working with UBS, he was largely invested in mutual funds and money managers. Studying his accounts, we made some interesting observations regarding the fees for which he was on the hook. Much of which he was largely unaware.
Here's what we found:
* He was paying an average 1.44 percent annual fee on the 12-20 mutual funds and money managers in which he'd invested.
* He was paying a one-percent annual fee on the portfolio to his advisor.
Going a step further, we perused the fine print in our new client's former relationship with UBS. Enabling us to discern a variety of other fees that were impossible to decipher:
* Trailers and 12-b Fees
* Networking Fees
* Finders Fees
* Omnibus Processing Fees
* Revenue-Sharing Payments
* Account-Services Fees for Affiliated Fund
In all, the client was paying 2.44 percent in disclosed fees to UBS. Bad enough, right? Yet, to worsen matters, he was likely paying more when you consider the hidden and/or hard-to-decipher fees. All being paid to an advisor and his firm for essentially delegating the client's portfolio management efforts to various mutual funds and money managers.
Sadly, the new client had not outperformed the blended indexes since the beginning of his relationship. While assuming almost as much risk (standard deviation) as the S&P 500 index.
All of which is akin to paying a tutor for helping a student earn straight Ds. But, that's the Wall Street Marketing Machine at work. Those guys have more gimmicks than a traveling carnival. And with so many investors not willing nor able to properly benchmark services rendered for fees paid? There's no end to the high-priced chicanery.
Finally, an aside.
Two weeks ago, Ann Dick, former wife of the celebrated American writer and éminence grise Philip K. Dick, passed away. Ms. Dick had long continued to serve as a muse and model for the writer. Who went on to become one of the most celebrated in 21st Century American literature.
In the early Eighties, Mr. Dick wrote a novel entitled, "Do Androids Dream of Electric Sheep." The book was critically acclaimed. And was eventually adapted for the silver screen in 1982 under the name, "Blade Runner."
I've long wondered why this cinematic force majeur was never reappraised. Given the advancements in film-making technology and special effects. Because the narrative has never been more relevant. Not that it ever lacked punch. It was a great movie from the beginning. One that deserved a modern-day adaption.
So it was with great joy that I recently learned that a Blade Runner sequel will be released this fall. Movie and science fiction fans, rejoice. And offer up thanks, yet again, to Mr. and Ms. Dick.
Weekly Results
Major indices finished lower last week. As the DJIA lost 0.44%. The S&P 500 fell 0.38%. And the Nasdaq dropped 0.61%. 10-year Treasury bond yields fell 3.95%. And gold futures closed up 2.22%.

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