December 31, 2019
New Year’s Day found us in a Thanksgiving mode, grateful for the bounty of astounding returns from financial markets for the year and for the decade past. So, we say goodbye to the teens and hello to what we hope will be the roaring twenties all over again.
Central Bank Stimulus Continues: We can thank Central Bankers in the U.S. and abroad for keeping rates low and in some cases below zero for most of the decade. After four rate hikes and the worst December since the Great Depression in 2018, U.S. markets were bracing for additional unwinding of the stimulus plans that had sustained domestic markets for most of the decade. However, realizing what many hail as an over reach on its part, the Fed reversed its policy, cutting rates thrice in 2019 to bring the fed funds rate back to 1.5-1.75%. The stock market has not looked back since. These rate cuts were supplemented by the Fed injecting billions in short term liquidity through treasury bill purchases and repurchase agreements to prevent overnight lending rates from spiking as they did in September 2019. This spurred the stock market to new heights in the fourth quarter despite tepid earnings growth.
The Fed is now expected to pause on adjusting rates as long as GDP growth and inflation stay subdued. Abroad, there have been baby steps taken to bring negative rates back to zero. However, addicted as we are to low rates globally, it will be difficult for any Central Bank to unwind from the ultra-low rates in anything but a measured fashion.
Inflation Stays Low but Creeps Higher: Thanks to low wage growth, inflation has been tamed for most of the decade. There are many reasons cited for this. Globalization has made it easier for companies to migrate manufacturing to the countries with the lowest cost of human capital. Robots and artificial intelligence (AI) applications are supplanting more of the routine and repetitive functions. We have also seen the power of labor unions decline throughout the decade, keeping a lid on blue collar labor costs. Further up the food chain is the migration of jobs to a “gig” economy. Many employers have supplanted permanent workers for “independent contractors” giving them the propensity and flexibility to keep payroll costs and benefits low.
The new decade brings increasing headline attention to the wealth gap. But there is hope. The January 6, 2020 issue of Barron’s points out that the bottom quartile of workers got a 4.5% increase in wages in 2019 versus a 2.5% rise for the top quartile. In addition, higher minimum wage rates start applying on January 1 in several states. Per the U.S. Bureau of Labor Statistics there were 7.3 million job openings at the end of October 2019, with a net employment gain of 2.4 million for the 12 months ended October. This gap is likely to widen as the population in the U.S. grew by a mere 0.5% in 2019, the slowest in a century, per Barron’s. Thanks to this Administration’s determination to keep immigration low, we expect
low unemployment to stay low and perhaps decline further. This may turn out to be too much of a good thing in the end. The inability to find qualified workers to fill open positions will eventually stall GDP growth, or chase U.S. production to foreign shores.
Demographics have Significant Impact: The last decade saw a gradual shift in focus from the Boomer generation (born between 1944 to 1964) to the Millennials (born between 1980 to 2000). As the Boomer generation took off, we saw huge shifts in demand that impacted schools, colleges, workplaces and now, retirement. Millennials will soon outnumber Boomers and similarly create disruptions and opportunities for products and services that appeal to their core values. Millennials are famously tech-savvy, frugal, diverse and socially aware. Financially burdened by student debt they have for the most part postponed having families and eschewed buying for renting.
In the next decade, we expect millennials to get serious about settling down, raising families, buying and furnishing homes. They are aware of their political clout and not afraid to use it. In the investing world, we have seen the rise in sensitivity to Environmental, Social and Governance (ESG) issues including investing for impact. Corporate America is paying attention. In August 2019, at the Business Roundtable, a cadre of 181 CEOs of some of the largest companies in the U.S. pledged to be attentive to the needs of all stakeholders; customers, employees, suppliers, communities and shareholders. This is a profound shift from the single-minded focus only on shareholder return of the previous decades.
Geopolitical Risk Continues: This decade will be no different from the past. Whether it is a match thrown into the Middle East tinderbox or a North Korean playing with nuclear toys, geopolitical risk has always been with us. The difference is events now make news immediately and are reported graphically and repeatedly on a 24-hour news cycle, keeping anxiety levels high. The test of our human ingenuity and perseverance is how our institutions (governments, markets, corporations) anticipate, plan and deal with them over time. Regardless, we expect market volatility to ratchet up from a relatively tame 2019.
Bottom Line: Change is inevitable, but we are confident that our economy will adjust to whatever the new decade throws at us. “Adapt or die” is a motto at least as old as Darwin, and corporate America has shown a remarkable resilience and ability to adjust despite the travails of the last decade.
At Fern Capital, we pledge to keep our clients invested, “in the game” to enable them to meet their long-term investment goals. We believe the securities of companies that have a track record of resourcefulness and ingenuity with the means to execute, will armor our clients for the next decade and beyond, regardless of what the future brings. That is our version of “brown paper packages tied up with strings…” offered to you this new year and new decade.
September 30, 2019
In our June 30, 2019 commentary (www.ferncapitalinc.com/commentary) we spent a good deal of time discussing tariffs. Unfortunately, the trade war with China, now over a year old, rages on. Undoubtedly tariffs add real cost to U.S. products. However, the long-term impact to our economy will be even greater if companies hesitate to commit capital to plans that may have to be changed depending on the ultimate settlement negotiated with China. The threat of tariffs on European goods further exacerbates the uncertainty.
U.S. Economy: Luckily, our economy is still strong on many fronts. The U.S. consumer remains confident, the job market is tight, and wages are ticking up. The August unemployment rate of 3.7% is at a 50-year low. With mortgage rates still attractive, the moribund housing sector is perking up. Pending home sales rose 1.6% for the month of August while home prices rose 2%.
So far consumers have been shielded from significant price increases, with individual businesses lobbying hard for exemptions to tariffs. But the pressure on profit margins may ultimately force companies to pass price increases on to consumers. Unless delayed again, the tariffs planned for December 15 could hit consumer confidence at the peak of holiday spending.
Global Economy: Ripples from the trade war are affecting Europe as well. In the face of slowing growth, the outgoing head of the European Central Bank, Mario Draghi has responded aggressively by lowering the deposit rate to -0.50% and restarting a 20 billion euro bond purchase program to inject more liquidity into their markets. With monetary tools stretched to the limit, it is incoming ECB President Christine Lagarde’s job to encourage the use of fiscal policy to further boost economies in Europe.
The Federal Reserve: As expected, Federal Reserve Chair Jerome Powell announced a 0.25% cut in rates in September to bring the target range to 1.75% - 2%. Fed minutes show the decision was not unanimous. While seven of ten governors supported the cut, two disagreed with the need to cut, while one advocated for a 0.50% cut. In the news conference following the rate cut announcement, Chair Powell made it clear the Fed would respond with more rate cuts if the economy weakens. Market pricing currently points to the expectation that short-term rates will drop to 1-1.25% by the end of 2020.
*We first heard the term “tariffied” used by Jim Cramer on his CNBC show Mad Money
The Political Landscape: Try hard as we might, it is nigh impossible to separate politics from the financial markets here and abroad. In the U.S., the impeachment inquiry has largely been shrugged off so far by the market which remains laser focused on the trade war. However, the heightened rancor all but assures that important legislation like the USMCA (NAFTA 2.0) or an infrastructure bill will not be passed anytime soon. Abroad, storm clouds continue to threaten Britain as it attempts to exit the EU with or without an umbrella. China has the protests in Hong Kong to add to its trade war worries. And the ongoing hostilities in the Middle East have the threat of nuclear weapons added in for good measure.
Recession Watch: Given all this turmoil, it is not surprising that we are frequently asked if a recession in the U.S. is imminent. Our short answer is “No”. The long answer adds that, prior to the Great Recession of 2008-2009, recessions were a normal part of a market cycle, and while unpleasant, were not dreaded as much as they are now. Recessions (defined as the drop of GDP in two successive quarters) are the economy’s way of resetting, wringing out “irrational exuberance” from the market. When a recession finally arrives, it will not be as earth shattering as the Great Recession, as our banking system is far healthier and better capitalized now. Also, we cannot discount the determination the Fed and the Administration have to keep a recession at bay at any cost through monetary policy or fiscal measures similar to those discussed by the European Union.
TINA: There Is No Alternative to stocks. With cash and bond yields at historic lows and heading lower, what is an investor to do? For most, stocks are the default option. Corporate stock buybacks continue, though at a lower level than 2018, which benefited from the tax cut. Dividend yields are now competitive with yields from investment grade corporate bonds, and earnings are growing, albeit at a slower pace. To put things in perspective, despite all the hand-wringing, the S&P 500 index eked out a small gain for the third quarter, ending up 19% for 2019 through September 30. That is a nice rebound from the 14% drop in the fourth quarter of 2018.
Bottom Line: To prevent getting too “tariffied”, we recommend investors stay focused on the long term, shutting out the noise and political posturing here and abroad. The President is known to view the stock market as a barometer of his success. Faced with an impeachment inquiry and elections around the corner, he will likely be pulling out all the stops to prevent the trade war from affecting the market’s trajectory for too long.
At Fern Capital, we see our job as keeping our clients invested for the long run, using market volatility to their advantage. With the stock market close to its highs, downturns are an opportunity to buy quality securities on sale. We stay diversified, keeping close to allocation targets. This is no time for heroics. A disciplined, pragmatic approach works well for all seasons, particularly this tumultuous a long form text area designed for your content that you can fill up with as many words as your heart desires. You can write articles, long mission statements, company policies, executive profiles, company awards/distinctions, office locations, shareholder reports, whitepapers, media mentions and other pieces of content that don’t fit into a shorter, more succinct space.
April 1, 2019
The S&P 500 stock index returned an astounding 13% in the first quarter of 2019, the best quarterly result since September 2009. Not unlike a procession of ants carrying multiples of their body weight, the 500 stocks in the S&P collectively bore the weight of global markets on their backs. This result is particularly surprising given the dismal drop it experienced in the fourth quarter of 2018, when the index gave up almost 20% from its peak reached in October. So, can we put fears of a recession behind us now? Not so fast, the pundits say, citing a number of concerns on the horizon.
Slowing Global Growth: Undoubtedly the U.S. economy is slowing. Consumer spending and income growth were below expectations, and fourth quarter 2018 GDP grew at a mere 2.2%. U.S. GDP is now expected to grow at 2.9% in 2019. In contrast, the International Monetary Fund forecasts the Eurozone to grow by 1.6%. But it would take little to tilt it to a recession. It could be seriously affected by U.S. tariffs on European goods or a no-deal exit of Britain from the E.U. Across the Pacific, the drop of economic growth in China has been well documented. Per MarketWatch, China’s GDP grew at 6.6% in 2018 but aims for 2019 to be between 6-6.5%. Though large on an absolute basis versus the rest of the world, it is a drop nevertheless. These growth rates assume that trade talks between the U.S. and China go well in the forthcoming months, something to watch closely.
Fed Speak: A major reason cited for the market’s drop in December was Fed Chair Jerome Powell’s statement that the Fed was determined to continue to raise short term rates to keep a lid on inflation. The rebound in the first quarter of 2019 can correspondingly be attributed to his stepping back from this stance, pledging to be “patient” in decisions to raise rates going forward. In fact, inflation is still tame, and the market is expecting that the Fed will stay its hand for the rest of the year. Just to make sure the Fed gets the message, National Economic Council Director, Larry Kudlow called for the Fed to immediately cut rates by 0.50% as a preemptive move to “protect the U.S. economy”. Although these remarks have been widely panned by the financial press, lower rates are undoubtedly good for stocks and will allow our aging bull market to keep charging ahead.
“Inverted Yield Curve”: Often considered a harbinger of a recession, an “inversion” describes the situation briefly experienced last week when long term interest rates dropped below short-term rates. However, to quote Bryn Talkington of Requisite Capital, a recent guest on CNBC: ”It is true that every recession is preceded by an inversion of the yield curve. But every inversion does not precede a recession”. Nevertheless, the relationship between bond yields bears close watching. One positive is that lower mortgage rates have finally perked up the moribund housing market which expects a robust home-buying season ahead.
Corporate Earnings: Per the Wall Street Journal of March 30, 2019, “Earnings from S&P500 companies are expected to decline 3.9% in the first quarter from the year-earlier period.” The raft of pre-announcements is already indicating an expectation of weakness in forthcoming earnings announcements. However, we should not be surprised by tough year over year comparisons, as earnings in the first quarter of 2018 benefited from corporate tax cuts. By contrast, this quarter’s earnings will reflect the impact of the government shutdown, tariffs and unusual weather patterns nationwide.
Fear of Missing Out (FOMO): Despite the angst described above, investors, fearing being left behind, showed remarkable enthusiasm for the Initial Public Offerings of jean maker Levi and ride-sharing service Lyft among others. In the pipeline is Uber, Pinterest and a slew of companies promising that 2019 could be the year of the IPO. Unlike the dot-com frenzy of 1999, these companies are more established than their counterparts were 20 years ago. One thing both eras have in common is they have little to no earnings. Buyer beware.
In 1897, Rudyard Kipling wrote a poem for Queen Victoria’s jubilee celebration entitled “Recessional”. It warned of the overconfidence and hubris of the British Empire in those times. “Lo, all our pomp of yesterday / Is one with Nineveh and Tyre! / Judge of the Nations, spare us yet / Lest we forget-lest we forget!”. His words are a reminder that our memories tend to be short. This is particularly true for investors who are prone to assume that markets will continue to behave as they recently have, indefinitely.
Bottom Line: Fern Capital is committed to making sure our clients are positioned to benefit from an unpredictable market regardless of its direction. So, although we enjoy the good times, it is wise to keep some powder dry and invest in quality securities that can outlast the short-term vagaries of the markets through good times and bad.