the fiduciary rule; the UK election

advisers as fiduciaries

The fiduciary rule for retirement assets issued by the Labor Department goes into effect today, despite intense lobbying against it by the brokerage industry.

The rule requires financial advisers involved with retirement assets–with the notable exception of the 403b pension assets of government workers–to put their clients’ interest ahead of their own in dispensing investment advice.

In essence, this means that the financial adviser will no longer be permitted to recommend high-cost products with poor performance records to clients simply because they pay a high commission or that the broker gets an “educational” weekend for two at a beach resort for doing so.

The conceptual defense (such as it is) for such practices, which are still allowed for non-retirement assets, by the way, is that while the client is still not well off, he’s better off than if he had no advice at all.

No wonder Millennials are willing to take a chance on robo advice.

the British election

The British prime minister, Theresa May, called the election held yesterday with the intention of increasing her party’s four-seat majority in Parliament in advance of the first Brexit talks with the rest of the EU.

With one seat not yet decided, the Conservatives have lost 12 seats instead, according to the Financial Times.

As exit polls came out overnight predicting this unfavorable result, both Asian stocks with interests in the UK and sterling weakened.

Interestingly, as I’m writing this an hour before the US open, both sterling and the FTSE 100 are up slightly.  S&P 500 futures, which had also dipped slightly in Asian trading as the UK news broke, are trading two points higher this morning.

To me as an outsider, it looks like UK citizens are having serious second thoughts about Brexit (politicians in Scotland advocating it’s breaking with the rest of the UK lost, as well).  My point, though, is that except in extreme circumstances–like when Republican opposition torpedoed a proposed economic rescue plan in early 2009 and the S&P dropped 7%–politics make little day-to-day difference to stocks.

Employment Situation, May 2017

As usual, at 8:30 edt this morning, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation.

The May results were ok, but not great.

The economy added 138,000 new jobs during the month, a reasonable number although one below recent reporting trends.  In addition, results for March and April were revised down by a total of 66,000.  Ouch!

Wage growth remains at an inflation-beating pace of +2.5% but continues to show none of the acceleration one might be hoping for,  given that the unemployment rate has fallen another notch to 4.3%.

my take

Let’s separate what’s going on from why it’s happening.

On the second question, I have inklings/prejudices but nothing that I’d care to act on.  My guess/fear is that jobs are being created, but in lower tax-rate foreign jurisdictions (meaning just about anywhere other than the US), and that machines are substituting for domestic labor, thereby keeping wages low.  If that were so, it would imply US employers believe President Trump won’t be able to advance his tax and infrastructure agenda.

But, really, who knows.

On the first, the signs are that after eight years, the US is finally at full employment again.  This would imply what other indicators seem to be showing–that’s there’s no reason to bet that there’ll be any “pent-up,” cyclically unfulfilled demand showing itself in surprisingly strong future consumer spending.

If so, the stock market should move away from cyclical ideas to secular growth and structural change beneficiaries.  In addition, overall annual upward movement in the broad indices should be limited to, at best, 1.5x the growth in nominal GDP.

The way I see things, this is the way Wall Street has been acting since early in 2017.  So this ES report is not new news.  Rather it’s confirmation of the direction the market has already recently taken.

 

 

the stock market cycle–where are we now?

As I wrote yesterday, stock market price-earnings multiples tend to contract in bad times and expand during good.  This is not only due to well-understood macroeconomic causes–the effect of higher/lower interest rates and falling/rising corporate profits–but also from psychological/emotional motivations rooted in fear and greed.

(An aside:  Charles McKay’s Extraordinary Popular Delusions and the Madness of Crowds (1841) and Charles Kindleberger’s Manias, Panics and Crashes (1978) are only two of the many books chronicling the power of fear and greed in financial markets.  In fact, the efficient markets theory taught in business schools, which denies fear and greed have any effect on the price of financial instruments, was formulated while one of the bigger stock market bubbles in US history, the “Nifty Fifty” years, and a subsequent vicious crash in 1973-74, were taking place outside the ivory tower.)

Where are we now?

My take:

2008-09  PEs contract severely and remain compressed until 2013

2013  PEs rebound, but only to remove this compression and restore a more typical relationship between the interest yield on bonds and the earnings yield (1/PE) on stocks.

today  The situation is a little more nuanced.  The bond/stock relationship in general remains much the way it has been for the past several years, with stocks looking, if anything, somewhat undervalued vs. bonds.  But it’s also now very clear that, unlike the situation since 2008, that interest rates are on an upward path, implying downward pressure on bond prices.

In past plain-vanilla situations like this, stocks have moved sideways while bonds declined, buoyed by an early business cycle surge in corporate profits.

Since last November’s presidential election, stocks have risen by 10%+.  This is unusual, in my view, because we’re not at the dawn of a new business cycle.  It comes from anticipation that the Trump administration will introduce profit-boosting fiscal stimulus and reforms.  The “Trump trade” has disappeared since the inauguration, however.  Our new chief executive has displayed all the reality show craziness of The Apprentice, but little of the business acumen claimed for the character Mr. Trump portrayed in the show–and which he asserts he exhibited in in his long (although bankruptcy-ridden) career in the family real estate business.

Interestingly, the stock market hasn’t weakened so far in response to this development.  Instead, two things have happened.  Overall market PE multiples have expanded.  Interest has also shifted away from business cycle sensitive stocks toward secular growth stocks and early stage “concept” firms like Tesla, where PEs have expanded significantly.  TSLA is up by 76% since the election and 57% so far this year–despite the administration’s efforts to promote fossil fuels.  So greed still rules fear.  But animal spirits are no longer focused on beneficiaries of action from Washington.  They’re more amorphous–and speculative, as I see it.

Personally, I don’t think we’re at or near a speculative peak.  Of course, as a growth stock investor, and given my own temperament, I’m not going to be the first to know.  It does seem to me, however, that the sideways movement we’ve seen in the S&P since March tells us we are at limits of where the market can go without concrete economic positives, whether they be surprising strength from abroad or the hoped-for end to dysfunction in Washington.

 

discounting and the stock market cycle

stock market influences

earnings

To a substantial degree, stock prices are driven by the earnings performance of the companies whose securities are publicly traded.  But profit levels and potential profit gains aren’t the only factor.  Stock prices are also influenced by investor perceptions of the risk of owning stocks, by alternating emotions of fear and greed, that is, that are best expressed quantitatively in the relationship between the interest yield on government bonds and the earnings yield (1/PE) on stocks.

discounting:  fear vs. greed

Stock prices typically anticipate or “discount” future earnings.  But how far investors are willing to look forward is also a business cycle function of the alternating emotions of fear and greed.

Putting this relationship in its simplest form:

–at market bottoms investors are typically unwilling to discount in current prices any future good news.  As confidence builds, investors are progressively willing to factor in more and more of the expected future.

–in what I would call a normal market, toward the middle of each calendar year investors begin to discount expectations for earnings in the following year.

–at speculative tops, investors are routinely driving stock prices higher by discounting earnings from two or three years hence.  This, even though there’s no evidence that even professional analysts have much of a clue about how earnings will play out that far in the future.

(extreme) examples

Look back to the dark days of 2008-09.  During the financial crisis, S&P 500 earnings fell by 28% from their 2007 level.  The S&P 500 index, however, plunged by a tiny bit less than 50% from its July 2007 high to its March 2009 low.

In 2013, on the other hand, we can see the reverse phenomenon.   S&P 500 earnings rose by 5% that year.  The index itself soared by 30%, however.  What happened?   Stock market investors–after a four-year (!!) period of extreme caution and an almost exclusive focus on bonds–began to factor the possibility of future earnings gains into stock prices once again.  This was, I think, the market finally returning to normal–something that begins to happens within twelve months of the bottom in a garden-variety recession.

Where are we now in the fear/greed cycle?

More tomorrow.

yesterday’s S&P 500 stock price action

Yesterday may have marked an inflection point in the US stock market.  Today’s potential follow through, if it happens, will give us a better idea.

Domestically, Mr. Trump appears to be moving on from pressing his social program to tax reform–and, maybe, infrastructure spending, both of which are issues of potentially great positive economic significance.  At the same time, results of the first round of the French presidential election (which pollsters got right, for once) seem to suggest the threat that France might leave the euro, thereby reducing the fabric of the EU to tatters, is diminishing.

yesterday’s S&P 500

How did Wall Street react to this news?  The sector breakout of yesterday’s returns, according to Google Finance, are as follows:

Staples          +1.7%

Finance          +1.6%

Industrials          +1.4%

IT          +1.4%

Materials          +1.2%

Healthcare          +1.1%

S&P 500          +1.1%

Energy          +0.8%

Consumer discretionary          +0.7%

Utilities          +0.6%

Telecom          +0.3%.

winners

Staples led the pack, presumably because this sector has the greatest exposure to Europe–and a rising euro.  Financials advanced significantly also, on the idea that stronger economic growth will lead to rising interest rates, a situation that benefits banks.

Industrials and Materials perked up as well.  Again, these are sectors that benefit from accelerating economic growth.

losers

Energy marches to the beat of its own drummer. The rest are consistent with the story behind the winning sectors, either defensives or beneficiaries of moderate (that is, not rip-roaring) economic performance.

My guess is that this pattern may continue for a while yet.  Personally, I’m most comfortable participating through Financials and IT.