- Back to Macro Investing Basics
- Recent Economic Numbers
- New Ruling from the Department of Labor
The blog today is primarily written for investors that are in a quandary to understand why some tactical managers outperform over the long term. The basics begin with cycles; and everything runs in a cycle-the weather, the seasons and economic and investment cycles. For roughly 222 years the stock market in the U.S. has correlated to fundamental and economic cycles-with the exception of the past few years due to overreaching Central Bank action. With respect to the QE since the 2009 financial meltdown, the initial QE did not distort those cycles. However, due to the increasing amount of QE combined with the diminishing return from that QE, the markets disconnected, derailed or diverged from that normal pattern. The normal pattern is as common as the seasons in the year, and we should all desire, expect and trust that markets correlate to the economic environment and to the actual fundamentals of the companies. If they didn’t, quite simply, the market would be reduced to a crapshoot. The distorted situation in the U.S. markets is changing and we discussed some confirmations of this change in the blog yesterday. Markets are becoming more fairly valued and more in line with the subpar economic conditions of our country. When these three cycles come into correlation, managers that have the flexibility to go anywhere at any time have a great advantage. These managers are free to enter into asset classes with low risk of losing money and more importantly to add appreciation. During declining markets, managers that are locked into a specific asset class or are asset allocated are constrained and almost all of them lose money. These managers are greatly exposed to downside risk which may become more intense in the next few years, as the equity market cycle is presently in a sideways and down trend. This extremely risky time in the equity market comes during a time of great risk and low yields in the bond market as well. And now, the firepower from Central Bankers ranges from weak to almost non-existent to move the equity markets any higher. This was not the case just a few years ago.
The Fed is not going away-despite the fact that a greater number American citizens are now becoming both aware of the Federal Reserve and dislike the control that the Fed wields over our lives. The Fed intervention encouraged mal investment and made it extremely difficult to forecast an outcome in markets. This cycle is almost complete. Over the past six months there has been a recurring theme, even on the popular financial TV shows like CNBC and Bloomberg that, “The Fed is boxed in a corner or helpless.” Professionals have been aware of this situation all along the way; and finally the mainstream has caught on.
A natural question would be- What happens to markets now that the downtrend has started? What can reverse this trend during a time of slow global growth, decreasing earnings, decreasing revenue and poor economic numbers? Can anyone help the situation to improve the economy and pull the equity markets back into a positive trend? (Again, positive trending markets are only needed by the buy and hold crowd-not the tactical group.)
At this point, our county must depend on Congress for a bail out via fiscal policy. An effective bail out via fiscal policy would include massive tax cuts, for both corporations and individuals; in combination with massive spending through an issuance of a huge amount of bonds-trillions of dollars-for infrastructure programs and other programs. When implemented correctly, this is basically the only scenario that could pull the U.S. back from the brink of a recession. There are two other more likely scenarios that could unfold. They are as follows: one is that our country continues on the same path we are on today-moving a stall speed. This could happen if there is no change in fiscal policy. Expect continuing weakening economic numbers, few real jobs created, no new infra structure which will result in a country meanders for years. The third and worst case scenario is the mal investment from the Fed does develop into full blown credit crisis, which will result in a recession and a true washing out of the system. This last scenario has happened about every 70-80 years and happened in the Great Depression. If the Fed did not step in and embark on QE, the system would have washed out and most likely by this time in the cycle; our markets would be on a path to repair, not in a downtrend. Capital markets that are allowed to function as truly free markets would have cleared the system via a massive implosion, greater than the 50% drop in the equity markets we experienced in 2008/09.
In summary, the United States needs a combination of Republican tax cuts and Democratic spending programs combined and implemented quickly to move our economy forward in the manner that is needed for sustained growth and economic recovery. The spending programs needed would not be ones that “give citizens a fish” through Food Stamp programs; but ones that invest in infrastructure and long term projects which provide citizens with jobs so they can purchase fish or anything else they desire, to stimulate the economy in all areas. Most likely, we all agree that this combination of Republican and Democratic ideas is unlikely to happen at this point in time. The mood in the country is polarized and the choices for Presidential Candidates are limited. Without this type of fiscal stimulus, we will witness a stall speed economy or full blown wash out.
All three of the above outcomes are positive for tactical managers to enter and exit markets. What did affect all tactical managers in the last few years are the huge distortions from QE. As we have repeated many times, the market has experienced a trend change in the last year. The new trend is sideways and down. There is more downside risk than upside risk at this point for buy and hold portfolios. We expect the U.S. equity markets to make a series of lower highs and lower lows as the market continues to transition to fair value. During this time, MCS expects to enter more trades in different asset classes and follow our parameters that allows for both protection and appreciation.
Quick Summary of recent economic releases:
- The second adjustment Q42015 GDP was released today at 1.0%. There is nothing we can add to this poor number.
- Durable Goods reported yesterday at 4.9% and on the surface the number seemed strong with one of the largest monthly jumps in years. One item that made absolutely no sense in the number is the difference in Aircraft orders which are seasonally adjusted. In January, Boeing reported a 70% drop in aircraft orders but according to numbers from the Dept. of Commerce-nondefense aircraft orders soared by 54% due to these seasonal adjustments which increased the durable goods number. Per Bloomberg, the durable goods number was 1.8% with the seasonal aircraft piece stripped out.
- PCE came in at 1.3% which is the primary indicator of inflation. It should be at a minimum of 2.0%, but 2.2-2.3% would be better.
- Earlier in the week the Richmond Fed Manufacturing Index came in at a minus- 4. This is important for all of us in the DC area as our manufacturing base weakens.
- PMI slipped below the breakeven 50 to 49.8, the weakest reading since Oct 2013.
Finally, some information on a proposed new ruling from the Department of Labor:
- The Department of Labor is set to finalize a regulation as early as April of this year that may affect investors with retirement and IRA assets regarding how these investors work with Financial Advisors. The regulation is intended to protect retirement investors by eliminating the potential conflict of interest between the investment guidance an Advisor gives to a client; and the way he is compensated. RIA’s are not expected to be affected by this rule since RIA’s always have a fiduciary responsibility to their clients. In most cases a broker is not a fiduciary; but operates under the suitability standard. The regulatory change will highlight ‘fees’ that some retirement accounts have been paying unbeknownst to the account holder. It could possibly limit retirement accounts to certain asset classes depending on the final wording of the proposed rule. Many brokerage firms have charged accounts more for equity allocations than fixed income allocations; thus the ruling may call for equal charges for either asset class to eliminate conflicts of interest-(recommending an equity allocation over a bond allocation to put more money in the broker’s pocket). We want our readers to be fully informed on the matters of both conflicts of interest in the financial industry. We also applaud the move for the brokerage industry to be more transparent on ‘fees’. This ruling will certainly make the news once it is finalized; illuminating once again the dark side of the industry- conflicts of interest and hidden fees. Again, this ruling should not affect our firm at all (or most RIA’s), as our fees are transparent and level. Many of your friends and family may be affected by this ruling and may be asked to move to a different pay scale for their retirement plan depending on which brokerage firm holds their assets. We will keep you posted once the final ruling is passed.
Enjoy the weekend.