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Archive for economy

Newsletter – April 2018

Posted by Koenig Investment on
 April 30, 2018
  · No Comments

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. 

  • Briefing.com, The Big Picture, April 30,2018
  • https://www.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=3&isuri=1&1921=survey&1903=1
  • https://seekingalpha.com/article/4162080-forward-p-e-says-stocks-now-fair-cheap
  • http://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart
  • http://investors.boeing.com/investors/investor-news/press-release-details/2018/Boeing-Reports-Strong-First-Quarter-Results-Raises-Cash-Flow-and-EPS-Guidance/default.aspx
  • https://data.bls.gov/timeseries/CUUR0000SA0L1E?output_view=pct_12mths
  • https://www.frbatlanta.org/chcs/wage-growth-tracker.aspx?panel=1

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.

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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.

  • https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
  • http://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/WEOWORLD
  • https://www.briefing.com/Platinum/InBrief/EconomicBriefing.htm
  • http://www.businessinsider.com/gop-tax-bill-american-companies-to-use-repatriation-to-pay-down-debt-2017-12
  • https://www.cnbc.com/2017/12/22/bank-of-america-is-giving-some-employees-a-1000-bonus-citing-tax-bill.html
  • https://www.cnbc.com/2017/12/05/bank-of-america-shares-rise-after-adding-5-billion-to-buyback.html

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

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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

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Market Brief – July 2016

Posted by Koenig Investment on
 July 28, 2016
  · No Comments

We’re in the midst of 2016 second quarter earnings releases and I wanted to share with you the picture of the U.S. economy that is becoming clearer as companies release data.  Overall earnings figures are a bit better than expected.  In general, companies made more money last quarter than most analysts expected.  The consensus amongst most analysts is for a better than expected second half of 2016 than originally noted in January.  Both plow horse and tortoise metaphors are common in reports as they sum up thoughts on the current state of the economy.  While this often makes for bland reading and tame headlines, it is good news that should be welcomed as slow growth means less volatility in how companies operate.  Companies that are growing slowly and adding jobs at low, steady rates are less likely to overproduce and need to cut those jobs in a hurry when facing some contraction.  This lower volatility within operations helps keep the company, and the economy as a whole, chugging along a slow growth path.

There are several data points analysts are pointing to as they upwardly revise their expectations for the rest of 2016.  Unemployment is decreasing, year over year retail sales are up, housing starts continue to increase, and average worker pay – a previously worrisome weak spot in the recovery – is increasing.1  In fact, the current economy is basically meeting the definition of full employment.2  The one figure that has been noted again and again in these analyses is the ISM Manufacturing Index.  This index is a survey of purchasing managers around the country and tends to quickly reflect any changes in employment, production, inventories and new orders.  This index rose from 51.3 in May to 53.2 in June.3  Historically, such rises indicate a period of economic growth.  Lastly, investors are largely bearish at the moment.  The contrarian view is often correct as we do typically see a rising market when investors are pessimistic and expect a pullback.  The combination of all this data points to an economy continuing on a path of slow, steady growth.  While there is nothing especially exciting to report, this should nonetheless be welcome news embraced by the average investor seeking portfolio growth and lower volatility.

 

 

  1. http://www1.realclearmarkets.com/2016/07/27/fed_policy_not_in_tune_with_data_181382.html
  2. http://money.cnn.com/2016/05/23/news/economy/us-full-employment-williams/
  3. https://www.instituteforsupplymanagement.org/ISMReport/content.cfm?ItemNumber=30524

 

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.

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Market Brief – Brexit June 2016

Posted by Koenig Investment on
 July 28, 2016
  · No Comments

I wanted to take a moment to comment on the Brexit leave vote and its effect upon world markets today.  Part of the movement we’ve seen in the markets is due to the surprise nature of the vote.  Polls had predicted British voters would opt to remain a part of the EU.  That drove gains in the stock market yesterday that are largely being reversed today.  The rest of the drop we’ve seen today can generally be linked to the uncertainty regarding how British decoupling from the EU will effect various corporations, as well as entire economic sectors.  There are questions regarding how difficult the EU will make the exit in order to deter other countries from making the same move.  UK companies will continue to trade with mainland counterparts as they have been doing since ancient times.  There will need to be adjustments in how economic activity is conducted though.  Times of change are always unsettling and markets generally do not respond well to change.  We expect to see the broad market regain ground as a path forward for affected companies is determined.

While volatility in the markets is often unsettling to watch, it does provide opportunities for account growth.  For example, we expect managed futures and fixed income positions to gain ground in the next few days, oil and gas sector assets to remain largely unaffected, and stock based assets to decline less than the broad market.  Please do expect some short-term volatility within your accounts.  We will be making adjustments to accounts if appropriate in order to capture price change opportunities if they fit with your overall financial profile and risk tolerance.

While the broad market has ended the day well in the red, that is not an indicator of long-term problems within the U.S. markets or economy.  The current unemployment rate is 4.7%.1  This figure needs to be put into the context of the people it does and does not capture as the official definition of “unemployed” does not necessarily match the common definition.  However, the current figure is seen to more accurately portray the current employment situation than it did during the recession and immediate aftermath.  I would note that the average unemployment figure since 1950 is a much higher 6%.2  The bottom line is that volatility creates opportunities and we do not see today’s drop materially affecting what you can expect from your accounts over the long-term.

 

 

  1.  http://www.bls.gov/news.release/empsit.nr0.htm
  2. http://www.tradingeconomics.com/united-states/unemployment-rate

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.

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March 2016

Posted by Koenig Investment on
 March 7, 2016
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Volatile Markets

This year has begun with market activity that has left many investors nervous.  Although economists noted the overall U.S. economy was performing at a decent level throughout January and February, the markets reacted sharply to fears over China and lower oil prices.  The S&P 500 declined by a little more than 10% as of mid-February, leading to talk of recession in some media outlets.  Economists as a whole did not endorse this speculation, but could not definitively say if or when the market would recover.

The decline in overall stock prices occurred in tandem with a falling of oil and other commodity prices.  Many parts of the world are expected to have slower economic activity in 2016, with China most notably experiencing slower economic growth.  Declines in commodity prices appeared to be a reaction to various projections of slowing overseas activity.  Data on the economy led to an uptick in commodity prices in late January and into early February.  The broad stock market followed suit and gained back some of the ground lost earlier in the year.  As of March 6th, the S&P 500 has regained most of its earlier declines, now posting a modest year-to-date decline of less than 2%.

It is difficult to call either a market high or low until well after the fact.  While few are willing to definitively state that the bottom has been reached and passed, a number of analysts are now stating we have likely passed the bottom.  There are a number of reasons for them to begin to make this call.  Both Canada and Australia have economies heavily reliant on commodities.  Canada has a large oil sector and mining is important to the Australian economy.  Both currencies took a hit starting in 2014 as we saw non-oil commodity prices begin a decline.

The graphs of both the Canadian and Australian stock markets mirror their currency graphs with declines from mid-2015 and then bouncing back in February.  Commodity based company stocks such as Freeport-McMoran (copper), Alcoa (aluminum), and indices like the Dow Jones U.S. Steel Index all show declines beginning in the summer or fall of 2015, with bottoms in late January.1 While it is too soon to definitively call a bottom to recent commodity and market activity, a number of signs are pointing towards this being the case.

United States Economy

Employment – The unemployment rate continued its slow decline to 4.9% in February.  This was accompanied by a small increase in the labor force participation rate, meaning that the decline in unemployment is a result of increased employment and not workers giving up on looking for jobs.2  In fact, the discouraged workers (defined as persons no longer looking for work as they believe they will not find any) figure is down 18% from the previous February.

An interesting development in the current labor market is wage growth.  The average wage in February 2016 is 2.2% higher than for February 2015.3  Costco is a notable example of this upward wage pressure, making national news with their increase of a minimum wage to $13/hr.  They are not the only company to note pressure to increase wages in order to stem employee turnover and attract desirable workers.

Corporate Earnings – Corporate profits remain steady overall.  We are seeing a smaller group of companies project earnings growth in 2016 compared to the number of companies projecting growth in 2012 and 2013.  This is a more mature market that is holding steady.  Dividend paying stocks remain attractive as investors seek alternatives to low interest rates paid by bonds.

Other sectors – Statistics for the overall U.S. economy continue to portray a boring, yet positive picture.  The economy is continuing its slow, steady growth with healthy levels of new-vehicle sales for February, greater than expected existing-home sales for January, and manufacturing and purchasing data in line with a GDP growing at about 2% annually.

Summary

2016 has gotten off to a volatile start, with markets regaining much of the ground lost in early 2016.  Commodities look to have been oversold in this period.  Recent price rebounds in commodity prices have been led by currency and stock market reversals in Canada and Australia, historically a signal of stabilizing or growing commodity prices.  The U.S. economy is in better shape, continuing its slow, steady growth.  We expect 2016 to continue to show steady U.S. growth and a recovery within a number of commodity sectors.

  • http://stockcharts.com/members/analysis/20160302-1.html
  • http://www.bls.gov/news.release/empsit.nr0.htm
  • http://www.bls.gov/news.release/jec.nr0.htm

 

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.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.

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January 2016

Posted by Koenig Investment on
 February 23, 2016
  · No Comments

China’s Economy

We ring in 2016 with a good dose of market volatility. The five year graph of the Shanghai Composite Index shows a bit of a decline in 2011, fairly flat in 2013 through mid-2014, and then a steep rise starting in mid-2014.  This rise coincided with the Chinese government encouraging citizens to buy stocks, even as monthly economic statistics were showing the economy was slowing and economic data was coming in below forecasts. Unlike the United States and Europe where pension funds, university endowments and mutual funds make up a large portion of stock ownership.  China is almost all affluent, individual investors.  Given this dynamic greater volatility is almost a given.

SOURCE: https://www.quandl.com/data/YAHOO/INDEX_SSEC-Shanghai-Composite-Index-China

In the latter part of the 1990s corporations were moving manufacturing to China from the United States and other countries to take advantage of lower labor costs.  This mass influx of manufacturing drove the Chinese economy for the last 15 years, resulting in annual GDP growth of 8-10%.  This is an almost unheard of figure, and one that eventually has to moderate.  Growth in the Chinese middle class has been fairly rapid and consumer spending will be a larger portion of their economy going forward.  The Chinese government is trying to transition from primarily a manufacturing and exporting economy to be more of a consumer based economy.

Currency – We continue to see China’s currency (Yuan) be devalued against the U.S. Dollar and Euro.  Although currency instability has rattled markets, it does have a positive impact on U.S. corporations purchasing Chinese products.  Walmart specifically should be a big beneficiary, as a weakening Yuan reduces the costs of Walmart’s extensive purchases from China.

Markets – The Chinese government has looked somewhat clumsy in their actions in dealing with a slowing economy and a stock market that had a huge one year run up from mid-2014 through mid-2015.  They imposed a circuit breaker to shut down the stock market if it dropped by 5%.  It took 29 minutes to reach that point during one day this week.  The government has now withdrawn that rule.  In addition, most of the individual investors within the Chinese market are also Chinese citizens.  Their market rules make entry of foreign money difficult to say the least.  This has created a situation in which large numbers of persons relatively new to stock market investing have driven up market prices to unsustainable levels.  We are seeing a drop in price as the President, Xi Jinping, has begun to change the government’s oversight of the markets.  These are long-term oriented reforms that are painful in the short-term, but should give better results than the patchwork stimulus implemented over the past summer.

While the volatility in the Chinese stock markets is attention grabbing, it likely would not impact the average investor elsewhere.  You may recall stories in the 1980’s about Japan’s rapidly growing economy.  Their economy was growing by leaps and bounds until 1989.  Their market peaked in that year and has never fully recovered.  Most U.S. companies and households did not notice this slowdown in the 1990’s even though Japan was a U.S. economic partner.  China is 0.7%1 of the U.S. export market.  A slowdown in the Chinese economy is likely not going to be felt in the broad U.S. economy.  It is simply not large enough to be felt.

United States Economy

Employment – December employment figures released today show a gain of 292,000 jobs. This beat a consensus estimate of 200,000 jobs.  The employment figures for October and November were both revised upward by 50,000.  Almost all sectors of the economy posted job growth except energy.  The unemployment rate remained steady at 5%.2

Corporate Earnings – Corporate profits are the life blood of stocks.  GDP projections are holding steady at low, but positive numbers. Some sectors are seeing typical cyclical contraction, but a company that made money in 2015 is likely to continue to make money in 2016. I would guess the year over year growth in 2016 will be a bit lower than recent years but still growing.

Starting the middle of January we will start to see the release of 4th quarter corporate earnings results.  These results should help support the markets.  In manufacturing employment gains in chemical and plastics are offsetting job losses in metals and energy. Retail sales show a migration of consumers to online firms over traditional brick and mortar retail.

Construction – Construction continues to hold up well in both commercial and residential.  New home starts for November rose 10.45% from October and 16.48% since one year ago.3  US existing home median sales prices are up 6.32% over the one year period.4  Housing is no longer a drag on the overall economy, but rather a healthy sector contributing to overall growth.

Summary

Bright spots in the market in 2015 were technology companies, including biotech.   Several companies have interesting new drugs, devices, or other technology based products that are likely to help company earnings.  REITs are another area to watch.  REITs tend to perform well in rising interest rate environments.  We’ve seen some healthcare REITs whose valuations have dropped far enough during the past year that early 2016 is an attractive entry point in these offerings.  Overall, the U.S. economy is in good shape.  The market activity in China is interesting to follow, but will not have a material impact on the economy here.

  • https://www.census.gov/foreign-trade/balance/c5700.html
  • http://www.bls.gov/news.release/empsit.nr0.htm
  • https://ycharts.com/indicators/existing_home_sales
  • https://ycharts.com/indicators/sales_price_of_existing_homes

 

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.

 

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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.

 

  • http://www.ftportfolios.com/Commentary/EconomicResearch/2015/12/4/nonfarm-payrolls-increased-211,000-in-november
  • http://www.ftportfolios.com/Commentary/EconomicResearch/2015/11/30/expect-strong-christmas-spending
  • http://www.bloomberg.com/news/articles/2015-10-28/saudi-net-foreign-assets-drop-for-eighth-month-in-september
  • http://www.reuters.com/article/us-opec-meeting-idUSKBN0TM30B20151204#FfHpQjZERcLB7dgO.97

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.

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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

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May 2015

Posted by Koenig Investment on
 May 11, 2015
  · No Comments

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

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