Archive for Newsletter

Newsletter – April 2018

Posted by Koenig Investment on
 April 30, 2018
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Pausing to Smell the Roses

Economic news often looks towards the future as investors try to predict both the best places to invest and avoid.  Today’s successes are often overlooked as investors look for clear indicators of trends and future activity.  Sometimes it is best to stop and look at the current environment, appreciate what is going well, and wait to judge the future.  The overall U.S. economy is doing quite well at the moment and there is no reason to expect this to change in the near future. 

Earnings, GDP, PE

We are now well into 2018 first quarter earnings release season. The picture being painted is one of solid growth and earnings.  The earnings growth rate has been much higher than anticipated, with the highest earnings growth reported since the third quarter of 2010.1  In fact, one research service we use predicted an earnings growth rate of 17.3% for the quarter as late as April 6th.  This has now been revised upwards to 23.2%.1 

As earnings rise they change the price-earnings (PE) ratio for companies.  This ratio explores how long it would take an investor to recoup their principal based on current company earnings.  Low PE ratios mean investors can expect principal recovery much quicker, high PE ratios mean investors are paying a premium for stocks and can be an indicator of a bubble.  As you can see from the below chart, current PE ratios are right in line with the recent historical average.

SOURCE: Seeking Alpha3

Finally, GDP is a good indicator of the health of the economy as a whole.  2018 first quarter GDP stands at 2.3% versus 1.2% for the first quarter of 2017 and 0.6% for the first quarter of 2016.2  The first quarter tends to be the low figure for the year, so it can reasonably be expected that GDP will increase before the end of the year. 

The Rest of the Data

If the key metrics noted above are all positive, why the fear and worry in the news?  The first reason would be inevitability.  The stock market will eventually see a decline.  It goes through up and down cycles, meaning wait long enough and you will see prices fall.  One should pay attention to changes and not expect good times to last forever.  Let’s explore a few topics of worry in the news recently.  A good place to start is the slow ratcheting up of interest rates by the Fed. 

SOURCE:  MacroTrends4

The above graph is a chart of the 10-year Treasury rate over the past 50+ years (recessions noted in grey).  As you can see, we are currently in a period of historically low rates.  It’s also clear that we had higher rates in the 1990’s, a time of good performance by the stock market.  A rise in rates tends to slow housing sales and some business expansions as credit tightens.  However, these will be slow changes that are already widely expected and factoring into the decisions of families and companies.  Interest rate rises have been slow, and are expected to remain so.  Slow change allows for adjustment and is not the same as an unexpected market shock.  Interest rates are not expected to rise to a level that will prohibit borrowing, but rather to return to more historical norms.  This is good news for savers and an anticipated change for future borrowers.

Other articles point to a few large companies lowering guidance as a sign we’ve reached peak earnings.  It’s true that Caterpillar recently noted 2018 earnings may be their best and 2019 will likely be lower.  At the same time, Boeing both had good earnings and upwardly revised estimates through 2019.5  The fate of one company is not the fate of the economy as a whole.  Aggregate S&P 500 earnings estimates for 2019 have been revised upwards as companies release figures and give forward guidance.  That means companies generally do not see 2018 as a year of growth plateau, but rather as part of an upward trajectory that is expected to continue into 2019.

The last area of worry for some pundits is both wages and inflation.  We are seeing an uptick in both categories.  These are areas to watch for future developments that may provide drags on the economy.  We’re not there yet though.  Inflation remains at about 2.0%6 and wage growth is still at a lower rate than before the recession7.  Rising wage growth and inflation can be expected to limit the acceleration of economic growth, but are not expected to be a drag on the economy.

Summary

Some clients reading this may be wondering why their portfolios are not skyrocketing upwards given that the economy is doing well.  The stock market is considered a leading indicator and typically moves in advance of economic news.  The S&P 500 was up every month in 2017.  That is unusual.  Much of the good news noted above has already been priced into the market, allowing account values to increase in 2017.  The 2018 market is expected to increase more slowly, with more volatility than 2017.  Investors are looking to sell companies that have not benefited as much from economic growth, capture gains, and move on to other companies with rosier outlooks for the year.

The overall U.S. economy is doing quite well.  Persons looking for a job can probably find one with relative ease.  Borrowing costs remain historically low.  Companies are making money and looking to make more over the next year or so.  Of course, the market will eventually change and we will continue to watch for indicators of that change. 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.

Newsletter – January 2018

Posted by Koenig Investment on
 February 27, 2018
  · No Comments

Year in Review

2017 has been a year of surprises.  An anticipated market pullback did not materialize this year.  Instead, we saw a year of above average growth in market price.  The S&P 500 (a widely followed basket of 500 U.S. company stocks) ended at 2673.61, a gain of 21.83% on the year.  A round-up of statistics shows GDP remained at a steady rate with the third quarter at 3.2%1.  Unemployment is at historically low rates, with December’s figure at 4.1% per the Bureau of Labor Statistics (BLS).  Lastly, foreign companies did well in 2017.  The International Monetary Fund (IMF) shows most mature economies with slow growth, while developing countries typically saw higher growth rates that bode well for their economies.2  2017 markets reflected this growth as the international sector posting its biggest gain since 2009. 

2018

What can we expect of the new year?  A recent issue of a research service we subscribe to summed up bull vs. bear market conditions in a helpful manner.  The market tends to contract when we see a combination of tight money, rising rates, high inflation, and rapid growth.  We do not currently meet these criteria.  The Fed is slowly scaling back measures taken during the recession at a measured pace.  Money supply is slowly tightening as the Fed increases interest rates.  Rates are inching up and do not have us in an era of either tight money or truly rising rates.  Inflation remains low, with the personal consumption expenditure (PCE) price index at 1.5%3.  GDP continues at measured rates in the 2-3% range each quarter.  The outlook for 2018 real gross domestic product (GDP) is in the 2-3% range as well.  All of this together shows a picture of slow, steady grow rather than the beginnings of a pullback.  There remains the possibility of a correction in the market, with analysts looking towards a temporary event like we saw in early 2016 rather than a sustained bear market.

There is an expectation of greater earnings due to the recent corporate tax cut, although much of this is seen as already priced into the market.  Increased earnings will largely result from balance sheet reshuffling in the form of debt reductions, stock buybacks, and mergers or acquisitions4.  These will be one-time events that will solely enhance 2018 earnings.  Analysts expect the resulting gains to be temporary, lasting perhaps 12-18 months.  This, in conjunction with historically high consumer sentiment, bodes well for the 2018 market. 

It is helpful to pick a company benefiting from the tax changes in order to see the details.  Bank of America has been in the news recently as they announced an additional employee bonus of $1,000 for about 145,000 employees5, a total cost of $145 million.  Goldman Sachs estimates that Bank of America will see earnings grow by 14% due to the cut.  That would translate into earnings increases of about $2.5 billion.  Roughly 6% of the $2.5 billion received by the corporate tax cut will go towards employee wages.

Bank of America also noted a $5 billion increase in stock buybacks, above the $12 billion repurchase amount announced earlier in the year.6  Stock buybacks are used to increase earnings per share, which results in higher stock prices.  In summary, Bank of America will spend an extra $145 million on employee wages and spend $17 billion on stock buybacks in 2018.

The real world results from the tax cut will become clearer in 2018 as accountants have more time to delve into the provisions.  As with any change, there will be winners and losers due to the changes. The overall effect does appear to be a boost for a number of companies that will increase near-term earnings.

Summary

Foreign markets saw meaningful progress in 2017 from both consumer spending and corporate profits.  We believe many international markets are 3 or more years behind the U.S. in their economic activity.  We expect to maintain a fair degree of international exposure in client accounts in order to capture this growth.

There are a number of fiscal unknowns due to the changing of the U.S. tax code.  Accountants all over the country are working hard to analyze the impacts.  However, the bottom line for stock market growth is always corporate earnings.  Earnings have been rising and are expected to continue to do so.  There will likely be a modest boost to corporate earnings and overall economic activity this year due to the cuts.  The full impact of these changes will become clearer as we move through the year. 

We agree with analyst expectations of low level growth within the domestic market next year.  We will continue to posture client accounts to capture some of this growth, while protecting against downside events.  It is important to maintain downside protection in portfolios given that growth is expected to be limited.  We may see a pullback in the markets in 2018 or an unplanned outside event that causes disruptions.  We would view these events as acquisition opportunities.  Overall, we expect 2018 to be another year in the plowshare economy.

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities

Newsletter – May 2017

Posted by Koenig Investment on
 May 4, 2017
  · No Comments

Interest Rates

This year’s economic activity actually started in December with a Fed announcement.  They expected to raise interest rates ¼ point at three different times in 2017, for a total expected rate increase of ¾%.  We then saw a large jump in the January inflation rate.  This news created a bit of a scare in the bond market as several analysts felt the Fed had underestimated inflation.  There was much speculation that more than three rate increases would be appropriate for 2017.  Subsequently inflation figures for both February and March showed much more subdued levels of inflation.  January is now viewed as a temporary spike that has not changed the overall expectation for 2017.  Rates should rise this year, but at the moderate pace originally outlined by the Fed in December.

There are two important metrics to keep in mind when evaluating bonds – interest rates and duration.  Duration is linked to how long a bond has until maturity.  The longer the duration, the less valuable the bond is during times of rising interest rates since newer bonds issued will pay an investor a higher interest rate.  We’ve rebalanced bond exposure to shorten duration given the anticipated rate rises.  We have also added exposure to floating rate bonds as their values hold up better during periods of rising rates.  Unlike traditional fixed rate bonds, floating rate bonds are tied to a benchmark such as LIBOR, Fed Fund or prime rate.  These benchmarks can adjust quickly with changes in interest rates. 

International

International stocks have underperformed U.S. stocks for the past few years.  It may come as a surprise for some investors that international equities have outperformed U.S. equities year-to-date in 2017.  The latest GDP figures coming out of Europe and Asia are starting to perk up and show signs of increased growth.  These improvements are represented in foreign stock price increases.  As of 4/28/17, the S&P 500 year-to-date return was 7.16%, while developed international markets (represented by the MSFCI EAFE index) have returned 9.97%.  The MSCI Emerging Markets index – which would include companies in such countries as South Korea, China, South Africa, and India – has returned 13.88% YTD.  Even with the recent move up in foreign prices, we find that international markets still have more attractive valuations and more room for growth than their U.S. counterparts.  Throughout 1st quarter 2017 we have increased our equity weightings in both international developed and emerging markets positions to take advantage of these growth opportunities. 

 Election Reforms

A reasonable case could be made that investors have been accumulating stocks in the aftermath of the November election in anticipation of a number of economic policy changes.  There is a wide expectation of a significantly lower corporate tax rate in the near future.  A reduction in individual tax rates could see discretionary income increase if personal taxes are reduced.  An opportunity to see a repatriation of a significant portion of the $2.5 trillion in U.S. based company profits residing abroad could benefit the economy if handled carefully.  Healthcare reform could be done in such a way as to benefit the economy.  Lastly, widely discussed infrastructure spending would be a shot in the arm to several economic sectors. 

Despite the widespread investor anticipation of movement on each of these items under a Republican president, congress, and senate the actually progress has been fairly slow to date.  It was hoped that tax reform would largely take shape in April.  That has not happened.  While some progress has been made on outlining changes to both the individual and corporate tax structures, many details have yet to be hammered out.  Previous foreign profit repatriation resulted largely in company stock buybacks rather than capital expenditures.  A plan that would both allow for repatriation and ensure that companies use this move for job creation has yet to be worked out.  Proposed healthcare changes ran into a very fragmented Republican congress and are still in limbo.  Tax changes may very well see the same multiple camps arguing over details, each demanding their view be adopted.  There are also concerns over the president’s tax changes significantly adding to the national debt.  Many conservative members of congress were elected on their pledges of fiscal responsibility and will only accept revenue neutral changes.  Finally, infrastructure spending involves a significant amount of planning and getting bids from various construction firms.  Analysts now do not expect to see the beginning of an infrastructure plan until 2018 at least.

 Economic Outlook

The outlook for 2017 real gross domestic product (GDP) is in the 2-3% range.  If tax reform is delayed until late 2017 or early 2018, the probability favors GDP to track towards the lower end of the 2-3% range.  Recent quarterly earnings have generally been better than expected.  While there are always winners and losers each quarter, our research services have shown a much longer list of winners than losers each day figures have been reported.  This does not mean we are seeing strong growth.  Technology companies in particular reported greater earnings this past quarter and the sector is poised for growth, but other sectors show a lack of revenue growth.  That lack of growth does not bode well for future earnings.

In summary, we are in a fairly mature economy, and are now in the 9th year of an expansion phase.  That does not mean we see any indications of a near-term precipitous drop in market values.  U.S. stocks are a bit expensive by historic standards, but not excessively so.  We did see an uptick in sentiment after the election amongst sectors of the population that buy stocks.  These positive hopes have yet to turn into concrete reality that will drive economic growth.  Positive sentiment is an emotionally based metric and can erode as easily as it grows, but that does not mean we should expect to see a market crash.  We are in a wait and see period in which economic policy changes that could affect the economy in several ways are pending.  It can be frustrating to wait for more concrete direction, but waiting periods do eventually end.  In the meantime, we have adjusted bond and international holdings for clients to reflect the movement we have seen in those sectors.  We remain in a “plow horse” economy, with slow, steady growth.  While that is not exciting, it is not a bad place to be.

 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities

December 2016

Posted by Koenig Investment on
 December 13, 2016
  · No Comments

The U.S. economy should finish 2016 with final GDP growth figures of 1.6-1.7%.1  This is hardly a barn burner, but has been a continuation of the slow, steady growth seen for several years.  Current 2017 forecasts estimate GDP in the 1.8-2.2% range.2  However, it would be wise to note that projections for future years have been somewhat optimistic since the recovery.  For example, The Wall Street Journal Economics Survey of December 2015 predicted 2.6% GDP growth for 2016.  We will have to wait and see how 2017 compares to the expectations.

2017 Expectations

The market will continue to focus on earnings, interest rates, inflation, and taxes as we move into 2017.  The year should keep analysts busy given the talk of significant changes to the tax structure.  President Elect Trump is proposing the lowering of personal and corporate taxes for most people and companies.  In addition, a proposal to allow U.S. companies to move foreign earnings held abroad back to the United States as a special, lower tax rate will be worth watching.  This proposal could bring back hundreds of billions of dollars to the United States.

Governmental spending at the state and local levels has been constrained by increased pension and healthcare costs for many areas of the country.  This has limited the spending of these local entities for other programs.  It is hoped that Trump stimulus programs could be a positive for state and local governments.  It is likely that such stimulus programs will contribute to the national debt.  Specific policy proposals will allow analysts to determine the probable effects of both spending and debt increases at that time.

Inflation and rising interest rates are areas to watch for as a drag on 2017 GDP.  A ¼ point rate increase (0.25%) by the Federal Reserve in December is widely anticipated.  Two further ¼ point increases in 2017 (as is anticipated) would bring the federal funds rate to 1.0% by year end.  Housing markets are expected to see less appreciation as a result.  Moving the national average for mortgage interest rates from 4% to 5% still leaves this rate historically low.  However, it is also a 25% increase in borrowing costs.  For example, a mortgage of $300,000 costs the borrower $12,000 annually at 4%.  It jumps to $15,000 annually at 5%.  This is enough of a change to price some buyers out of their local markets. The national real estate average shows price growth of about 6% last year.  Markets like Portland, Seattle, and Denver have seen much greater price rises.  Expectations are for these markets to slow their growth as buyers reassess what they can afford.

At the same time, the combination of full employment and likely increasing energy prices is expected to increase inflation in 2017.  Businesses are expected to raise wages, and prices, as they compete for skilled workers.  OPEC agreements to limit pumping are expected to hold and help drive up oil prices somewhat.  It is hard to gauge exactly how much impact any of these factors will have on next year’s economy, but all are expected to play a part.

The financial markets seem to be very confident that better economic news is just around the corner.  They seem sure that tax cuts and increased infrastructure spending is a done deal, despite any definitive proposals.  Some businesses are anticipating a reduction in regulations they have previously complained of.  The new optimism seems to be based on recent proposed appointments of anti-regulation proponents and the creation of the most conservative cabinet in decades.  The markets appear to be anticipating profits to be made from the changes these individuals – as well as other likely cabinet picks – would like to make to sectors of our economy.  New government policies, even with one party firmly in control, take longer to implement than most people expect.  Ideas get watered down and projects can take years to become shovel ready. 

Summary

The United States has been governed by a Republican Congress and President 22.5% of the time since the early 1900’s.  The Dow Jones Industrial Average has returned approximately 7% annually during those time frames.2  Markets don’t like uncertainty.  They began to move after the election results became clear and investors could trade based on likely governmental policy changes.  A number of analysts feel 2016 is finishing with some of next year’s expected gains already priced into the system.  We will have to wait and see which of these expectations become reality, and which have been unrealistic hopes.  It is certain that 2017 will be a year with some interesting changes to adapt to, and, hopefully, profit from.

We wish everyone a happy, enjoyable holiday season as we all reflect on 2016 and mull over the possibilities of 2017. 

  1.  http://news.morningstar.com/articlenet/article.aspx?id=784381; Economy Not as Strong as Consensus Believes, Robert Johnson 12/10/2016
  2. Bob Brinker’s Marketimer, 12/5/2016, Vol 31, No. 12
The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities

Newsletter – November 2016

Posted by Koenig Investment on
 November 21, 2016
  · No Comments

Legacy Planning

We thought it would be timely to depart from our usual market commentary and instead explore services our office offers that you may not be aware of. Financial planning extends beyond upcoming life events such as a new home purchase, a child entering college, or entering retirement. Most clients desire to leave a legacy for children, extended family, friends, or charitable institutions. Laying the foundation for a transfer of wealth, particularly to younger generations, should occur well in advance of the need, yet these can be difficult conversations to begin. We often see that, without proper planning, family wealth depleted within a generation or two.

Our office can help. We are a neutral third party who can explore the best way to discuss your wants and needs with family, attorneys, or other relevant parties. Addressing topics related to multi-generational family trusts, or even who to contact and where to find important documents in case of unexpected events, can provide clarity and assurance in advance of emotionally fraught times. Please let us know if you are interested in beginning a conversation between you, your heirs, and our office.

Quick Office Guide

We have attached a summary some people may find helpful when speaking about us to family, friends, or service providers.  It is a quick explanation of who we are and what services we provide.  Please feel free to send or print a copy of this page for your family members, close friends, CPA, attorney, or anyone else you feel should know about our office.  Let us know if you would like us to mail you hard copies of this explanatory page and we will be happy to do so.

We wish everyone a happy, enjoyable holiday season.  

Quick Office Guide

 

Market Brief – November 2016 

Posted by Koenig Investment on
 November 10, 2016
  · No Comments

Election Impact – Tuesday’s dramatic U.S. presidential election result has shocked the world.  A number of clients have expressed high levels of anxiety due to the outcome.  It is important to reiterate that elections by themselves do not decide policy outcomes, nor do they generally direct the long-term health of the economy and the businesses that operate within it.   Without knowing which policy proposals will eventually be enacted – and how implementation may play out – making preemptive, emotionally charged investment decisions is more likely to hurt one’s portfolio than help. 

We have carefully analyzed the performance of the stock-based mutual funds we own for their performance during the 2008-2009 sell-off, choosing funds that held up better than their peers and/or benchmarks during the downturn.  One can never assume past performance will be repeated in the future.  However, past activity can be a guide to probable reaction to similar future events assuming no great change in mission statement or portfolio manager(s). 

 Diversification – We cannot emphasize enough the importance of having a healthy level of respect for the highly unpredictable nature of the markets over the short-term.  We have learned this lesson over 30 years of managing money.  The start of this year saw equity markets decline across the globe.  Markets had regained the ground lost and returned to a 1-year high by May.  Then June saw a sharp Brexit related decline that now appears as a small blip on history graphs.  Managed futures holdings provided valuable diversification benefits and reduced risk to client portfolios during these events as they have almost no correlation to broad stock market activity.  A diversified portfolio, like that of most of our clients, should hold asset strategies that have positive expected returns and either low or no correlation to each other over the long-term.  As a reminder, correlated assets move with each other, while non-correlated assets move independently of each other.  For example, stocks and bonds tend to move separately, or even opposite of each other.  There are significant benefits to adding assets that have very low or no correlation, even if their expected returns are somewhat lower than that of existing holdings.  Managed futures is just one example of how we gain diversification and lower risk by adding assets with low correlation to an existing asset mix.

 Bonds – Bonds are another diversification tool we use in client portfolios.  We expect a gradual increase in interest rates over the next year.  Shorter term bonds and bonds with the ability to increase their interest rates, such as floating rate bonds, are sectors we are comfortable holding in client portfolios.  Bonds are lower risk assets to hold in case of a stock market sell-off, acting as a shock absorber as money flows from the stock market to bonds.  As with managed futures, we have been adding to these asset categories over the past year.  Media reports of a change in Federal Reserve policy regarding raising interest rates due to the election outcome are speculative in nature at this point in time.  This is currently an area of unknown policy shifts.

Summary – We have entered a period of uncertainty linked to possible and probable policy changes.  We do not know the nature of these changes yet. Trump’s most recent speech referenced infrastructure spending increases, indicating this is a likely front burner topic to be addressed by the new administration.  A measure of clarity in this and other areas will be obtained over the next 60 days as the outline of the new administration takes shape.  We have already seen some positive activity as the steep market drop predicted by after-hours and international trading failed to materialize.  Many stocks within the financial and energy sectors have seen large gains since the close of the election.  In contrast, tech based companies have seen some declines to their valuations.  It is too early to react strongly to any of the changes expected to materialize from this election.  It would not be prudent to react until new policy positions are noted and the details of these changes are fleshed out.  There will undoubtedly be a number of new positions to parse over the coming weeks, but we are not there at this point in time.  Now is the time to reflect on what this election shows about the country as a whole and to prepare for the general changes ahead.

 

December 2015

Posted by Koenig Investment on
 December 7, 2015
  · No Comments

Federal Reserve and Interest Rates

The long anticipated Federal Reserve increase in interest rates is expected to occur this month.  While the rate change itself is likely to be a modest 0.25%, the stock market does tend to get a little nervous over interest rate increases until two are behind them.  The second rate increase is expected for the first quarter of 2016, meaning we are likely to see increased market volatility through March.  A variety of factors influence the Federal Reserve on when to increase interest rates.  Three factors to note in this current cycle are employment, wage growth, and consumer debt.

Employment – Nonfarm payrolls are up 2.8 million in the past 12 months ending October.  This is the best growth in a 12 month time period since late 1999.  October’s employment report was released in early November with surprisingly strong figures.  This was interpreted as a further push towards the beginning of the Federal Reserve’s long telegraphed move to increase interest rates.  November’s employment report released December 4th was also strong, showing 211,000 new jobs with the unemployment rate steady at 5.0%.1

Wage Growth – The US economy is starting to see signs of accelerating wage growth.  Average hourly earnings have increased 2.5% in the past year.  This is the biggest increase since the start of the downturn in 2008.2

Consumer Debt – Measures of the obligations consumers take on each month for categories like mortgage debt, car payments and credit card payments, the current ratio of income to debt is one of the best since the early 1980’s.  Debt delinquencies – including mortgage debt, auto loans, credit card loans and home equity loans – combined are currently $50 billion lower than a year ago.2

In summary, more Americans are employed, their wages are rising and they are more likely to be meeting their debt obligations than they were a year ago.  The news at the corporate level is also largely positive.  Most analysts expect U.S. companies to post higher earnings in 2016 than they did in 2015.  The biggest factor in a company’s stock price is the company’s earnings.  We may see interesting price fluctuations as some investors react to the Fed’s interest rate increase, but the overall picture for U.S. stocks is one of modest gains.

Oil

Saudi Arabia has been the biggest factor in lower oil prices.  They felt themselves losing influence within the global energy sector and decided to throw their weight around.  The objectives were to inflict pain on Russia and Iran, while undercutting the U.S. fracking industry.  Russia has suffered, Iran has not due to the lifting of sanctions, and fracking output has declined in the U.S.  The Saudis did not count on the efficiency gains U.S. frackers have been able to achieve, thereby, causing less of a decline in the industry than had been hoped for.

Obviously, large state-owned oil producing countries can’t flood the world with cheaper oil without direct economic pain.  These nations are now drawing upon foreign reserve accounts in order to fill the gaps created by lower revenues.  Russia and Venezuela are experiencing more severe pain than other oil producing countries.  Saudi Arabia’s net foreign assets declined by $90 billion from February 2015 through September 2015 as they began to tap into reserve accounts, with the full year total drawdown total estimate at $120 billion.3  The biggest Arab economy is burning through financial assets needed to support domestic spending and could fully deplete these reserves within five years if current policies are maintained.  Even stable oil economies like Norway have started to draw on reserves due to lower oil prices.  At some point the ongoing economic reserves will be drawn down.  Analysts are currently looking to the end of 2016 or into 2017 before Saudi Arabia is willing to curb current output levels and revert to more typical production and pricing.

On December 4th OPEC stated that it was going to raise its oil output ceiling cap to 31.5 million barrels from a level of 30 million barrels.  Given that they have already been producing 31.57 million barrels a day in recent months this is largely a symbolic move rather than a real change in production levels.4

Summary

We continue to see a great number of media reports regarding the economy that do not accurately portray the financial outlook of the average American household and business.  While our economy is not growing at leaps and bounds, the picture is more positive than negative.  Not every family or business has recovered from the financial crisis of 2007-2008, but the overall economy has.  It has taken years, but slow, plodding growth adds up over time.  Stories speaking about imminent doom and gloom cherry pick data points in order to appeal to the emotions of readers.  They do not give an accurate picture of either the status of U.S. businesses nor households as a whole.  The U.S. economy is not perfectly poised and many families do have issues with making ends meet.  There will always be weak spots in an economy as large as that of the United States.  A country with a population of 320 million is going to see some members financially unstable.  However, most companies are currently experiencing growth and most family finances show improvement.  Trumpeting that reality does not generate excitement and often loses out to stories with eye grabbing headlines.

Please remember that the market is closed on December 25th and January 1st.  It closes early on December 24th and 31st.  We hope you and your families have a pleasant holiday season.

 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.

Market Brief – August 2015

Posted by Koenig Investment on
 August 24, 2015
  · No Comments

Market Sell-off

Stock markets across the globe went into selling mode last week, with stocks in the U.S. declining more than 5%.1  European markets saw a slightly higher level of sales.  The Shanghai Composite, the major Chinese stock market, sold off more than 11% last week.1  This activity is continuing this morning as we write.  The Dow Jones Index opened down nearly 700 points this morning, but then saw several hundred points gained back.  It is currently trading down by a few hundred points, with this figure likely to have changed by the time you read this Market Brief.  The recent devaluation of Chinese currency and concerns regarding further devaluations are front and center in this sell-off.

However, there is little evidence that the U.S. economy is about to slow, necessitating a large market correction.  Additionally, manufacturing activity in Europe and Japan has actually accelerated somewhat in recent months.  The economies in the United States, Europe, and Japan will all benefit from lower energy prices.  Oil price decreases from $104/barrel in June 2014 to the around $40/barrel price we are seeing currently significantly cuts energy costs for many sectors.  Recent data on retail sales and housing have been positive.  The Wall Street Journal surveyed economists recently, with the general consensus being an expectation of an upward revision of U.S. 2nd quarter GDP to around 3.3%.2  The Fed had been expected to raise interest rates in September because the U.S. economy has been performing well enough for inflation to begin to be of concern.  While this may now be delayed, the general indicators that show a strengthened U.S. economy have not changed.

China

China accounts for about 15% of the world’s economic output, with an economy heavily based on export activity.  While a slowdown will be felt in China, it is unlikely to impact the United States.  Exports to China from the United States comprise less than 1% of U.S. GDP.2  Japanese exports to China are greater at 2.7% of their GDP.2  European countries such as Germany, France, Italy, and Spain all have Chinese export figures similar to either the U.S. or Japan.  The bottom line for all of these economies is that a contraction in the ability of the Chinese consumer to spend will have little to no effect on the export economy of each country.  Countries near China, such as Korea and Vietnam, will likely see more significant effects to their economies from a slowdown in China.

Summary

I would remind both retired and near retirement clients that stock market sell-offs do not directly impact the level of income earned from their accounts.  Company profits determine dividend levels and other distributions, not stock prices.  The Price Earnings (PE) ratio for the S&P 500 is currently about 16.5,3 compared to a 60 year average of around 17.  In comparison, the PE of the S&P 500 in early 2000 – just before the market drop – was around 34.

Heavy fixation on the short-term can make it harder to remain focused on longer-term goals.  Each time the market has seen significant drops, a client or two has asked me to sell-off significant portions of their portfolio.  The plan is always to wait out the drop.  Unfortunately, this strategy has never worked.  In each case, the client sold at or near a low and waiting to reenter the market at a higher price.  This type of selling is emotionally gratifying, but cause real long-term losses.  Prudent homeowners do not sell their homes when Zillow dips as they know the value in the property is in the long-term.  The prudent stock market investor should view their portfolio from a similar perspective.  A well-diversified portfolio and a little patience helps the experienced investor ride out market volatility.

1) Wall Street Journal (weekend), 8/22/2015-8/23/2015, What Investors Shouldn’t Do Now, Jason Zweig

2) Wall Street Journal (weekend), 8/22/2015-8/23/2015, Economic Risk Varies Around the Globe, Greg Ip

3)  SPY PE for 8/21/2015 as listed by State Street and WSJ Market Data Center for 8/21/2015

May 2015

Posted by Koenig Investment on
 May 11, 2015
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May 2015

Last year we wrote a newsletter that referred to the U.S. economy as a plow horse – slow, but getting the job done.  While some of the details have changed, the overall picture of the economy has not.  The U.S. has been seeing steady growth, with some quarters turning out more attractive numbers than others.  While most investors would like to see greater growth, slow and steady growth is not bad.  The broad market is at record highs, but is not excessively valued.  While analysts are not predicting high rates of return from the U.S. stock market, nor are they expecting significant drops.  The general consensus is that we continue to see slow, steady growth.

Gross Domestic Product (GDP)

2015 1st quarter GDP figures were low and caught most analysts by surprise.  However, this is a repeat of the previous year.  The winters of both 2013/2014 and 2014/2015 were unusually harsh in the Northeast United States.  Charts that break out GDP figures by sector show drops in consumer goods and services both winters. This, along with falling oil drilling activity, took a heavy economic toll in the 1st quarter of 2015.  Just as GDP rose for the rest of the year in 2014, we expect to see an increase in the 2nd quarter of 2015.  While GDP was a mere 0.2% for the 1st quarter of 2015, that is much better than the -2.1% drop seen last year at this time. GDP rebounded nicely in the 2nd and 3rd quarters of 2014, and we would expect a similar rebound this year.

2014 GDP:

Q1 2014 Q2 2014 Q3 2014 Q4 2014
-2.1% 4.6% 5.00% 2.2%

Source:  Bureau of Economic Analysis

We will not see uniform growth across all sectors.  For example, auto sales are expected to grow at 4-5% in 2015 compared to 10% in 2014.  More incentives, higher inventories, and loans as long as 7 years all suggest that auto sales are starting to slow.  However, pending home sales in 2015 are showing a sharp acceleration after a slow 2014, with homes sales up 11.1% year-over-year in March.  Homes sales tend to drive purchases of retail goods.  On the opposite end, the drop in oil prices has made exploration and drilling of new wells less attractive.  This is expected to result in lower purchasing levels of the heavy equipment used in the drilling industry.  Sectors seeing growth are expected to outweigh contracting sectors for the near future.

Inflation

Inflation is expected to remain at the low end of the average range (2-3%)1 for the near future.  There are several large and contradictory contributors to the rate that make it an interesting back and forth story.  Of course, the most dramatic recent contribution to lower inflation is the price of oil.  The Consumer Price Index dropped noticeably from November through January, leaving March with a -0.1% annual rate.2  The drop in both gasoline and fuel oil prices are clearly responsible for this negative index rate.  Food prices are up 2.3% from last year, medical care commodities are up 4.9%, and shelter is up 3.0%.  There are other sectors that saw falling prices (used cars and trucks, apparel, etc.), but these are quite modest declines in comparison the energy sector figures which posted a -29.2% annual drop in gasoline prices and a -24.9% annual drop in fuel oil prices as of March.

We see upward inflationary pressure in the economy as sectors deal with the legacy of the housing crisis.  The economy has been operating well below capacity (labor, capital & productivity) since 2008, which has held down inflation rates.  It was nearly impossible for any business to raise prices in 2009 (at the trough of the economy) for the fear a competitor with excess capacity would not raise their prices, thus gaining market share.

Unemployment Rates:

2012 2013 2014 2015 est.
7.9% 6.7% 5.6% 5% – 5.5%

Source:  Morningstar Estimates

Excess capacity has shrunk considerably in 2015, due in part to lower unemployment rates.  This has allowed some manufacturers and service providers to raise prices and rates.  However, this is offset somewhat by long-term low population growth.  U.S. population growth has slowed from 1.8% in the 1950’s to 0.7% currently and is expected to slow to 0.5% over the next two decades.3  Most of the developed world is also seeing a slowing of population growth.  Less consumers automatically translates into less demand and less upward pressure on prices.

Low population growth is itself offset by pressures resulting from low unemployment.  2014 saw a shrinking excess labor force, resulting in labor shortages in regional airlines pilots, drywall installers and truck drivers.  These industries then saw pay increases to attract and retrain workers.  2015 has seen wage increases in the retail sector, with Target, Wal-Mart and Gap all implementing wage increases.  Wal-Mart increased their wages from $7.35 per hour to $9.00 per hour this year and noted plans to further raise them to $10.00 in 2016.3  The move at Wal-Mart will impact 500,000 employees.  As excess labor continues to decline, we’ll see continued upward pressure on both wage and price inflation.

Combine all of these factors with the current low lending rates by the Federal Reserve and it gives us a fairly stable, low inflation rate.  Analysts do expect to see an uptick in inflation and we agree with their overall theses – oil prices will rise at some point, the Fed will raise interest rates at some point, continued wage pressure will increase inflation to some degree.  What is uncertain is the timing and the degree to which inflation will rise.  We do not see any significant changes in the near future, but will continue to watch this area of the economy for the changes we expect.

Summary

The US bull market is starting to feel fairly mature as the market enters its 7th straight year of growth since the low in March 2009.  The historical broad market price-earnings ratio (PE) average is near 15.5, with a fairly wide range for normal activity.  The current broad market PE ratio of 20.65 is a bit high, but only at the high end of that average range.  It does not mean U.S. stocks are seen to be richly valued, but does make the hunt for undervalued stocks poised to grow a bit more difficult than at the same time last year.  This has narrowed the focus of the market as investors tend to look for more well-known stocks with growth potential and little chance of contraction, while avoiding much of the market that is felt to be fairly valued.  We see a shorter list of securities attracting new investment than we did at the same time last year, indicative of a more mature market.

Low interest rates make a shift to fixed income securities more challenging than during similar periods in the past.  There are bright spots for the investor though.  The PE equivalent for international markets is low, resulting in attractive entry points to many international sectors.  For this reason, we share a widely held viewpoint to continue to favor the international markets and add additional investments.  We agree that broad international markets are poised for greater rates of return than broad U.S. stock markets and have increased the international weighting of many accounts this year in order to capture these expected gains.  We are also looking at alternative investments like managed futures.  There are some interesting alternative oriented investments that are managed with an eye towards low levels of risk that are appropriate for some portfolios.  While we still look to U.S. stock exposure as the best way to grow client accounts, we are adding exposure to other sectors in order to properly diversify accounts in the current economic environment.  As always, we will continue to monitor economic developments and adjust client portfolios to take advantage of changes as appropriate for each client.

 

1) http://inflationdata.com/inflation/inflation_rate/long_term_inflation.asp

2)  http://www.bls.gov/news.release/cpi.nr0.htm

3) http://news.morningstar.com/articlenet/article.aspx?id=690965

January 2015

Posted by Koenig Investment on
 February 25, 2015
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Koenig Investment Advisory Market Update – January 2015

We would look for the U.S. economy to trend towards a steady, but moderate, growth status in 2015.  Industrial production in 2014 was 5.2% greater than in 2013.1  This is the greatest increase seen in several years.  These gains are broad based rather than heavily weighted towards any one sector.  One economic indicator we regularly monitor is capacity utilization.  This data point is helpful in determining how much unused capacity companies currently have.  The most recent data figures released are from November 2014.  November’s capacity utilization figure is 80.1%, about average for the U.S. economy over the past 40 years.1   In comparison, 2009 saw capacity utilization figures in the 50% range, indicating a large amount of slack in the system.

Housing sector – Other economic indicators appear positive as well.  For example, the housing market has stabilized.  The National Association of Home Builders Wells Fargo Housing Market Index (HMI) is a gauge created by surveying home builders and is widely viewed as a reliable indicator of housing activity.  This index ended December at 57.1  Readings above 50 have historically meant positive builder confidence.  November showed housing starts at an annual rate of just over 1 million units.  While that is still below the 10-year average, it is the highest level since April 2008.  The housing sector hasn’t turned around enough to be driving the current economy, but it is no longer the drag it was during the recession.

Stock Market Valuation – The S&P 500 Index finished 2014 at 2,058, and with a price earnings (PE) ratio of about 15.7.1  As a reminder, the PE ratio measures the multiple of earnings versus price.  For example, stock with expected earnings of $100/share and having a PE ratio of 15.7 would be worth $1,570.  The current PE is at the low end of average over decades of market history.  While the market has some room for growth, an increase in S&P 500 stock value above 2,150 would need to see a concurrent rise in earnings projections as the market is not likely to rise above an average PE ratio given current investor sentiment.

Oil – The energy markets have seen some rapid and notable changes in the last quarter.  Oil dropped to $35/barrel by the end of the year, quite a change from the $135/barrel high of 2008.  Neither this high, nor this low, have been near long-term price averages.  The U.S. rig count has recently seen a pullback in reaction to oil price changes, and we are likely to see more pullbacks over the next few months.  The excess capacity in oil production was estimated to be in the 1.5% – 2% range a few months ago.2  This is a historic low that is likely to rise as oil producers close the most expensive wells and idle those in the margin.  Just as oil dropped from its high to stabilize at lower prices, I expect to see oil prices rise and stabilize at levels closer to historic norms.  The general consensus amongst economists seems to be stabilization around $70 – $80/barrel later this year.  While that will be an increase from the current price of just under $50/barrel, it will be lower than the near $100/barrel price seen over most of the past few years.

 

The sharp decline in oil prices has been felt by all American consumers, but most sharply by working class families and retires on fixed incomes who by and large have not seen increases in wages or social security payments for some time.  A lowering of a monthly expense by 1/3 or more is greatly felt within these households.  The Federal Energy Information Administration recently estimated that the typical American household would save $750 this year directly from lower oil prices.3  This figure is $200 greater than the early December forecast and does not include indirect savings.  Heating oil and propane are regularly used commodities for millions of Americans living in the Northeast and Midwest.  These residents are expected to save about $750 per household this winter on top of their savings from falling gasoline prices.  These savings may not have a big effect on the budgets of the top 10% of households, but are substantial for families earning $50,000 or less annually.

The boost from lower oil prices will benefit the national economy, more than offsetting regional declines in North Dakota or Texas.  Household consumer spending contributes roughly 65% of gross domestic product (GDP), compared to about 4% of GDP coming from the oil and gas industry.   The January monthly consumer sentiment survey released by the University of Michigan reported its best monthly figure in 11 years.  The decline in oil prices is likely a main contributor to this rise.  As consumers feel more secure and have more discretion within their budgets, the more likely they are to spend and drive the economy forward.

Summary

The U.S. economy has come a long way from recession lows a few years ago.  While the effects of the recession still linger in some areas, the economy as a whole has moved on.  We have seen positive GDP figures for most quarters since late 2009.5  While this growth has not been felt by all citizens equally, we have moved past the declines of the recession as a whole.  Certain sectors may see surprise events, such as energy did in 2014, but the general economy is poised to continue its steady growth.  It will be interesting to see what changes 2015 may bring.  Will the Fed increase interest rates as is widely expected?  What will the inflation rate be, and how will the changes in energy prices affect this?  Will we see any game changing technological breakthroughs in any sectors?  I look forward to seeing what 2015 will bring and hope you do as well.

 

  1. Bob Brinker’s Markettimer, 1/5/2015, page 1
  2. https://strausscenter.org/hormuz/slack-capacity-in-the-global-oil-market.html
  3. http://www.nytimes.com/2015/01/18/business/economy/lower-oil-prices-offer-a-bonanza-to-us-workers.html?_r=0
  4. Mornigstar.com, The Upside and Downside to Low Oil Prices, Jeremy Glaser & Robert Johnson, 1/14/2015
  5. http://www.tradingeconomics.com/united-states/gdp-growth
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