4th Quarter Outlook, 2016
A Disliked Bull Market
To say the stock market is disliked is an understatement. Investors have withdrawn money from actively managed mutual funds for over 18 months. The sentiment toward equities among our clients and colleagues is as negative as we have seen it. Perhaps this is because the market hasn’t made any real progress in 18 months. That happens sometimes. While the major market indexes are within 3% of their recent highs & trading above their respective 200-day moving averages of price (long-term uptrend), it has been a choppy period. If you just looked at the market index charts, you’d say there have been periods of extraordinarily high volatility, but the picture is still relatively positive. Yet investors, both individual and institutional, are very negative. Why?
We believe instant communications, via the smartphone in our pocket, is having an overwhelming negative impact on the psyche of Americans. The flat screen on the wall screaming “Alert” also grinds our gears. Sure, there are problems – some significant. There always are. Today the nation’s debt is over $20 trillion, wage growth is stagnant, the real rate of unemployment is 9.7%, and people feel uneasy about their economic futures. However, the pocket device multiplies the problems.
To get your attention, the social media advertising mavens know they must scare you with the negatives. To get you to click (so they get paid) they entice you with a short list, or a date. “The Five Things That Will Ruin Your 401(k),” “We’re Living In End-Times – see the 10 prophecies already happening,” “The Dollar Will Crash On This Day – click here to find out,” and on, and on. Social media mavens know exactly how to get your attention – right down to their digital statistics. They’re making millions multiplying the negatives. Here’s the thing: they’re doing none of us any good with all the negativity.
What is an investor to do? In addition to having a sound financial & investment plan, we recommend this: ignore the social media scare mongers and television doomsayers. Realize they’re just trying to get your click, grab your eyes, sell you a newsletter or make a political innuendo. It means money to them. The “Wealth Scare” industry is robbing investors of opportunities and playing havoc with well-designed financial plans. They’re costing investors money. Ignore the doomsters. Look only at the real numbers.
The Current Numbers
The best investing is done with the eyes, not the ears. We’re focused on: Gross Domestic Product, earnings, revenues, stock & bond market valuations, interest rates, inflation, and the unemployment rate. We’re not interested in listening to the latest opinion from an “expert” on the financial news channels. Good investment ideas are not discovered on television. We use our eyes and analyze numbers when we invest client capital.
Here is what we see in the current numbers:
- The economy is muddling through – GDP is growing at approximately 1.5% per year
- At 18x forward S&P 500 earnings estimates, the stock market is neither cheap, nor expensive
- Leading companies are growing their revenues; semiconductor sector revenues are forecast +8%
- Treasury Bonds, as measured by their inverse yield at nearly 70x, are most overvalued in history
- Inflation is moderate – slightly over the Fed’s target of 2%
- Real estate cap rates at 6.5% average, are down slightly from several years ago; but the cost of borrowing is lower, making many real estate projects even more profitable
- Consumer sentiment is fairly positive at 91
Takeaways From The Numbers
Putting it all together, we summarize the overall investing environment as “highly selective and choppy”. Some sectors, such as utilities and consumer staples, are overvalued. Others, like technology and energy, are attractive. Yield plays – outside of bonds – are working. This is a stock picker’s market. We do not see it as a time to invest broadly in market indexes and market ETF funds.
For decades, the strategy for income investing remained constant: ladder bonds over a set number of years and roll them at maturity. Same for bank certificates of deposit. Money market and savings accounts provided reasonable rates, as did annuities. However, for the last seven years this strategy has not worked, as investors have gotten nearly zero in returns.
We believe that to receive reasonable income, investors need to go in a different direction. Our income strategy calls for investing in preferred stocks, convertible corporate bonds, real estate investment trusts, business development companies and other alternatives. We foresee investing in these types of vehicles until a more normalized rate environment develops, which is likely several years away.
Bonds Are Very Risky Now – Likely A Big Opportunity Later
With investors clamoring for yield, many have forgotten the historical premise of bond investing: produce fixed income, not fixed losses. Think about this: If interest rates go back to where they were three years ago… approximately 2% higher… it would produce a 20% loss in the 10-year Treasury Bond and a 35% loss on the 30-year Treasury Bond. Bond investors are not accustomed to risk and taking losses like stock investors, yet they have put themselves in the same position as stock investors. What will bond investors do when rates inevitably rise? It won’t be pretty for them. However, it will be an opportunity for us; we’ll look to buy their bonds from them at discounts as they rush for the exits.
The Presidential Election & Our Outlook
We recently held two events for clients and friends where we presented
- Our outlook for interest rates
- The economic proposals of the two Presidential candidates
- Investment themes we see as “durable”
- Investment themes we see as “sensitive” to the election
(Please visit our website regularly at www.beckcapitalmanagement.com for notices on future “Wine, Cheese & Investments” events and investment information. Our next event will be in January 2017.)
Two of the takeaways from our presentation are: (1) we are avoiding big-cap pharmaceuticals, as both candidates advocate lowering drug prices, and (2) we will be looking for attractive opportunities in companies that benefit from infrastructure spending, as both candidates propose spending more on the nation’s roads, bridges and networks. We also discussed sectors which would be favored or disfavored under either Presidency.
We have also analyzed market data from the Third Quarter of election years, going back to 1992. One fact stands out: market volatility normally picks up before the election and diminishes following the election. With this in mind, we are relatively cautious ahead of November 8. We are spending time organizing our thoughts, researching companies within target sectors, and preparing for the upcoming earnings reporting season.
We hope you enjoy the upcoming holidays. Thank you for your ongoing confidence and for being a valued client. If you have any questions about your portfolio or our outlook, please do not hesitate to call.
Please feel free to forward this to friends who you believe might be interested.
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