Monthly Archives: January 2018

Although Friday’s early estimate of annualized real (inflation-adjusted) Q4 2017 GDP growth was below expectations (2.6% actual vs. 3.0% consensus), it was, nonetheless, a strong report. Final sales (domestic and sales to international consumers) were up 4.3%, and Personal consumption rose 3.8%, the strongest reading in 18 months. The main drags on GDP in the fourth quarter were the higher number of imports (which detract from growth in the GDP calculation) and a lack of inventory investment, as highlighted in the chart below. The weaker US Dollar (leading to higher exports) should help alleviate the former and as producers invest in inventory to meet surging demand, inventory investment should increase as well in Q1.


Source: FTN Financial

We will be distributing our semi-annual Economic Review and Outlook in a couple of weeks, which will include a detailed examination of the current state of the economy and explore the likely impact of the recently implemented tax reform. Spoiler alert: good news in the short term, but exacerbating longer-term problems in the form of entitlements and national debt levels. Kind of like Wimpy and his famous promise “I’ll gladly pay you Tuesday for a hamburger today.” In the meantime, economic growth has accelerated over the last year and that is not a bad thing.

True North – The indefatigable equity market is the gift that keeps on giving. The S&P is off to its best start (+7.55%) to a calendar year since 1987 and the strongest on a risk-adjusted basis since 1967 (thanks to continued low volatility). At 398 days (and counting), the S&P set a new record last week for the longest stretch without a 5% pullback. The previous records were in 1996 (394 days) and 1965 (386 days). In the 12 months following those historical stretches the S&P rose 42% and declined by 1%, respectively. The moral of the story is that no matter how vociferously some talking head on TV tells you where the market will be 12 months from now, he/she doesn’t really know. The decibel-level with which someone expresses their opinion about the market is not an indication of their prognostic skillset, though they would like you to believe so. For example, Goldman Sachs forecasts the S&P 500 will end the year at 2,850 (only 0.4% higher from here), while others see the market rising 20% or more. From an investment perspective, the best course of action, proven time and again, is to stick to your asset allocation through rebalancing….adding to less-loved (i.e. relatively cheaper) assets and trimming exposure to expensive assets. Your asset allocation is your financial compass showing where true north lies. In unfamiliar territory (and markets are always as unfamiliar as they are uncertain), that compass is the best tool to keep you on the path to achieving your financial goals.

NAFTA – President Trump’s America First slogan is beginning to make its way into tangible trade policy actions. Last week the administration announced new import tariffs on solar panels and washing machines while continuing to negotiate new terms for NAFTA. Investors reacted quickly to the tariffs as publicly traded stocks of solar companies that manufacture solar panels abroad declined, while those that manufacture in the good ol’ US of A rose (America First!). With regards to NAFTA, which is causing greater concern, the outcome remains uncertain. Negotiators from Mexico, Canada and the U.S. met for the sixth of seven scheduled rounds of NAFTA talks. President Trump is talking tough, following his proven negotiating style of staking out an extreme position to establish an advantaged starting point for compromise. Indeed, it would not be surprising for his administration to announce an intent to withdraw from NAFTA. Not only would the action be consistent with The Art of the Deal, but the President is already negotiating from a position of strength. First, trade between the U.S. and Canada would likely be unaffected by a NAFTA withdrawal because of a prior free trade agreement between the countries. Second, most estimates conclude that exports to Mexico comprise only 1% of U.S. GDP and sales to all of Latin America make up just 3% of S&P 500 sales (source: Goldman Sachs). In isolation, the NAFTA renegotiation is tailor made for the master dealmaker to extract extraordinarily positive terms for the U.S. However, the President needs to be careful that he does not go too far and touch off a broader trade conflict that extends beyond NAFTA. The global economy has become more efficient and consumers have enjoyed lower prices for goods and services as a result of global commerce, which requires some give and take among all participants. Protectionist policies that are too strong will throw sand in the gears of the global economy (for example South Korea reinstated levies on US imports in response to President Trumps announced tariffs), slowing the economic machine and reducing efficiencies decades in the making… a suboptimal outcome for everyone.

Monkey Business – This fable will likely upset Bitcoin bulls. Yet, I’m not a Bitcoin basher (full disclosure, I speculated on a small amount in early 2017 that I still own), I just think this is a humorous take on cryptocurrencies that, like most fables, contains an important principle….caveat emptor.

A lot of monkeys lived near a village.  One day a merchant came to the village to buy these monkeys!   He announced that he will buy the monkeys @ $100 each.   The villagers thought that this man is mad.  They thought how can somebody buy stray monkeys at $100 each?  Still, some people caught some monkeys and gave it to this merchant and he gave $100 for each monkey.

This news spread like wildfire and people caught monkeys and sold it to the merchant.  After a few days, the merchant announced that he will buy monkeys @ $200 each.  The lazy villagers also ran around to catch the remaining monkeys!  They sold the remaining monkeys @ $200 each.  Then the merchant announced that he will buy monkeys @ $500 each!   The villagers start to lose sleep! …

They caught six or seven monkeys, which was all that was left and got $500 each.  The villagers were waiting anxiously for the next announcement.  Then the merchant announced that he is going home for a week.  And when he returns, he will buy monkeys @ $1,000 each!

He asked his employee to take care of the monkeys he bought.  The employee was taking care of all the monkeys in a cage.  The merchant went home.

The villagers were very sad as there were no more monkeys left for them to sell it at $1,000 each.  Then the employee told them that he will sell some monkeys @ $700 each secretly.  This news spreads like fire.  Since the merchant buys monkey @ $1,000 each, there is a $300 profit for each monkey.  The next day, villagers made a queue near the monkey cage.

The employee sold all the monkeys at $700 each.  The rich bought monkeys in big lots. The poor borrowed money from money lenders and also bought monkeys!  The villagers took care of their monkeys & waited for the merchant to return.

But nobody came! …. Then they ran to the employee……But he has already left too.  The villagers then realized that they have bought the useless stray monkeys @ $700 each and were unable to sell them! 

The Bitcoin will be the next monkey business. It will make a lot of people bankrupt and a few people filthy rich in this monkey business.

Be well,



198%. That would be the S&P 500’s gain at the end of 2018 if the index continues to appreciate at the same rate as the first two trading weeks of this year. Of course, extrapolating results from short datasets are not statistically significant (that is, the forecasts are unreliable – but if anyone wants to make a friendly wager, I’ll take the under). Yet, this simple calculation highlights the ongoing strength of this rally that maybe (just maybe) is exhibiting some signs of euphoria. Last week the S&P 500 rose 1.6% and after two weeks has already gained 4.3% year-to-date (inclusive of dividends). Other broad equity indices in the U.S. and internationally have kept pace. It’s a bull market of global proportions for risky assets. On the other hand, fixed income investors are not celebrating thus far in 2018. As equity prices move ever higher, prices of traditional safe-haven bonds have fallen. For example, the benchmark Barclays Aggregate U.S. Bond Index has returned -0.5% year-to-date. It’s worth noting that even as the yield on the U.S. Treasury 10-year bond has creeped higher, it remains at the upper end of its 2017 trading range of (2% – 2.6%). A sustained breach above the key technical level of 2.63% will be interpreted negatively by the market, resulting in additional selling.  This scenario would put the 10-year UST on a course to test a 3% yield (a level not seen since January 2014). Wrapping up the weekly market review, precious metals were mixed on the week (gold +1.4%, silver -0.1%) and WTI Crude gained 4.8% to $64.40 per barrel.

For more detail on weekly, month-to-date and year-to-date asset class performance please click here.

Inflation’s Mystery Factor – Inflation has remained stubbornly below the Fed’s 2% target rate since the Financial Crisis.  A fact that, while not newsworthy, remains vexing nine years into an economic recovery. Some of the shortfall is readily explainable by a four-factor model that includes food/energy prices, import prices and labor-market slack. Indeed, as the chart below highlights, labor market slack (the purple-shaded area) accounted for nearly 100% of the shortfall from 2008-2012 as declining demand for goods and services forced massive layoffs in the aftermath of the Financial Crisis.


Source: FTN Financial

In more recent years, namely 2013 – 2016, food/energy, import prices and labor slack have all had a disinflationary impact on the economy to varying degrees. The fourth component to this four-factor inflation calculation is an error term in the Fed’s model – that is, the unexplained difference between the sum of the first three factors and the realized level of inflation. As can be seen in this chart, the error term is volatile both in magnitude and in direction (it’s sometimes positive and sometimes negative). According to Fed Chair Yellen, the error term captures the “one-offs” such as the widely cited decline in cell phone prices at the beginning of 2017. Yet, some members of the Federal Open Market Committee and non-FOMC economists are not convinced this is the case. Indeed, FTN Financial’s Chief Economist Chris Low points out that “Maybe we’re going about this inflation forecasting thing the wrong way. Rather than asking what will make inflation rise…maybe we need to ask what has prevented inflation from rising for the last 10 years, and whatever it is, if it is likely to go away any time soon.” Chair Yellen’s explanation of one-off’s notwithstanding, apparently a contingent of the Federal Open Market Committee members are spending a lot of resources trying to answer this very question. The results of their research have the potential to dramatically alter the course of future monetary policy.

One potential outcome would be a shift from the Fed’s current strategy of inflation-targeting to a price-level targeting approach. Under the inflation-targeting strategy, 2% inflation is treated as a level that the Fed seeks not to exceed.  While they do not overtly state as much, the 2% target has inadvertently evolved into an inflationary ceiling.   As such, the Fed’s natural reaction function to an inflation level approaching 2% is to raise interest rates to keep inflation at the 2% level. This approach is increasingly viewed as preventing the Fed from achieving its target as monetary policy is an extremely blunt tool and, more often than not, the Fed overtightens pulling inflation further below their target. Moreover, it is extraordinarily difficult to engineer a specific growth rate in any facet of the economy, let alone in an economy with the size and complexity of the U.S. With price-level targeting, however, the Fed would still target a 2% inflation level, but that target would be based on the average inflation rate over an intermediate timeframe. Under this strategy, the Fed would be more tolerant of inflation rising above 2% for a period of time if it had remained below that level in the preceding period (kind of like now).  This would slow the pace of future rate hikes and is a policy methodology championed by Minneapolis Fed President Neel Kashkari and an increasing number of FOMC members. Monetary policy academics are geeked-up about the research and investors are eager to understand a potential transition as few things have more impact on the business cycle and asset prices than Fed policy.

Non-bank Banking – Private lending, direct lending, peer-to-peer lending, shadow banking… obtaining loans from non-traditional sources (i.e. banks) goes by many names. While once dismissed as a fad, the speed and convenience of leveraging technology to obtain credit from non-bank lenders has made them increasingly the first choice for consumers and small businesses seeking a loan. From an investment perspective, the rise of private credit is creating opportunities for investors to access what is typically the most valuable piece of a bank’s business. Compared to buying stock in a bank, investing in private loans enables investors to avoid the less profitable aspects of a traditional bank including the costs of physical locations, staffing, and regulatory compliance. In a low interest rate environment, short-term (1 – 5 year) loans generating yields of 8% – 15% look attractive relative to the yield on U.S. Treasuries of similar maturities (1.8% to 2.3%) or high-yield debt coupons of approximately 5% (as measured by the yield on the iShares IBOXX HYG ETF). Moreover, relative to the longer-term return expectations for domestic equities of 5% – 7%, private lending presents an opportunity for portfolio diversification without giving up performance. Institutional investors (e.g. pensions, endowments, insurance companies and private partnerships) have certainly taken notice of the opportunity and in the first quarter of 2017 alone, committed $5.2 billion to private credit – more than 2x the commitment level to other forms of alternative credit such as distressed debt.


Source: Pensions & Investments magazine

The opportunity is also set to expand, especially as younger entrepreneurs (having grown up with technology) eschew the idea of traditional banks as highlighted in the chart below.


The space is not without risk; a couple of key factors for potential investors to consider is illiquidity and defaults. However, the return vs. risk ratio appears attractive. If you are interested in exploring the space further, we authored a white paper entitled A New Investment Frontier on the topic.

Be well,


BANG!  Equities came off the starting line in 2018 like Usain Bolt in a 100-meter dash (or Carl Lewis, for those of us who remember his storied career in the 1980’s).  The Nasdaq sprinted ahead by 3.4% last week, smashing through 7,000 for the first time, while the Dow Jones Industrial average also breached the big round number of 25,000 (climbing 2.3% to 25,296).  In addition to those all-time highs, the S&P 500 gained 2.6% to close at 2,743. Reflecting the optimistic market view, international developed market stock indices gained 2% or better for the week, while the MSCI Emerging Markets Index rose 3.0%. The U.S. Treasury Curve shifted higher as 2, 10 and 30-year bond yields all rose by about 0.07%. The yield on the UST 10-year, at 2.48%, is near the top of the 2.0% – 2.6% trading range it inhabited for all of 2017. Many argue that rates will move meaningfully higher due to strong economic growth and a more hawkish Fed. We agree with the sentiment, but with international bond rates at meaningfully lower levels (e.g. the 10-year German Bund is currently yielding 0.41%), investor demand for relatively juicy yields on U.S. Treasuries should temper domestic yield levels. WTI Crude rose 2.9% on the week to $61.55 per barrel, a boon for energy stocks which rose 3.7% (as indicated by the iShares Energy ETF).

For more detail on weekly, month-to-date and year-to-date asset class performance please click here.

Loosey Goosey – As most know, the Federal Reserve uses the Federal Funds Target Rate as a tool to try to manage the growth rate of the economy and fulfill their dual mandate of maximizing employment and stabilizing prices. While there are a variety of factors the Fed considers when setting monetary policy, a simplified example demonstrates how the Fed uses interest rates to manage economic growth and smooth the impact of natural business cycles. When growth in the economy is slowing or negative (e.g. during a recession), the Fed will typically cut interest rates in an effort to spur economic growth. On the other hand, when economic growth is strong enough to create the potential for high levels of inflation (i.e. a lack of price stability), the Fed will raise interest rates to make credit more expensive and slow the pace of growth in the economy. The Fed began its current rate hiking cycle in December 2016 as low unemployment levels generated concern that inflationary pressures would start building in the economy (the Fed also wanted to move rates off of the 0% level where they had been since the Financial Crisis).  Since that initial hike, the Fed has raised interest rates three additional times for a total increase of 1.0%. Interestingly, economic Financial Conditions have gotten looser, not tighter, as the Fed has pushed the Fed Funds Target rate higher. (Note: in the chart below the Bloomberg Financial Conditions Index is the white line – higher levels equate to looser financial conditions; the Federal Funds Target Rate is shown as the orange line).


Sources: Bloomberg Finance, LP and Covenant Investment Research.

Even in the absence of pressing inflationary pressures, the Fed is also concerned with the health of the financial system. And ultra-loose financial conditions can lead to asset bubbles that, when popped, can destabilize the system. This “macroprudential” perspective should keep the Fed on pace to raise interest rates 3-4 times in 2018, even if inflation remains relatively muted.

Tranquil Waters – In many, many ways 2017 was a remarkable year in financial markets.  From record setting highs in the Dow Jones Industrial Average, S&P 500 and Nasdaq, to record setting lows in volatility as measured by the VIX Index, it was smooth sailing.  Indeed, of the 60 times in history that the VIX Index has closed below 10, 50 of them occurred in 2017.  Underscoring the low volatility, the S&P 500 has gone more than a year (385 days to be specific) without declining 5% or more from its 52-week high.  Not only is that the longest streak on record, but on only three occasions in history (1965, 1994, 1996) has the market gone 370 days without such a drop.  Yet, perhaps the most impressive feature of 2017 is that the S&P 500 completed its first ever perfect year of monthly gains.  At 14 months and counting, the S&P 500 is currently enjoying its longest streak of uninterrupted gains in history. How long can this continue?  Well, we know it won’t go on forever, but after the first week of trading in 2018 it sure seems like the record breaking streak will extend to 15 months by the end of January.  Enjoy the run, embrace the run, but don’t take the run for granted.  Trees don’t grow to the sky and, pardon my English, markets don’t not decline forever.


Be well,


Out with the old and in with the new… welcome to 2018! Following a banner year for stocks, the consensus view is that the S&P 500 and many international stock indices will rise in value to the tune of low-double digits in 2018.  It is also a nearly universal view that inflation will return, traditional fixed income investments will face headwinds and perhaps, for the first time in a long, long time (say, 30 years?), generate negative returns in 2018.  Buying commodities is also a consensus view.


Notes: Stock index returns are inclusive of dividend reinvestment.  Click here for detail on weekly, monthly and year-to-date asset class performance.

There are a host of reasons to be bullish as there is a reasonable probability that this expansion will become the longest on record (in excess of 10 years).  While the U.S. is leading the expansion, domestic economic activity is being bolstered by international economic progress and the term “global synchronized growth” became commonplace in 2017.  Indeed, 94% of all countries generated positive year-on-year growth and 61% experienced accelerating growth (source: Goldman Sachs).  Harmonized global growth is a real thing and historically some of the strongest market returns have come in the latter stages of economic expansions.

Yet, it is important to recognize that each economic expansion is unique and defined by a myriad of macro variables.  Blindly relying on historical averages in any endeavor is fraught with peril, especially when it comes to your finances.  There is a reason that the SEC requires investment managers to stamp some version of the phrase “Past performance does not necessarily predict future results” on every physical and electronic marketing piece.

Remember, the path forward is unique… it always has been and always will be that way as the future is unknowable.  This reminder is not intended to be bearish.  Rather, the message is to be prudent.  Don’t chase returns.  Be selective with your investments.  Recognize fear of missing out for what it is.  And, above all else, remember the first and best rule to successful long-term wealth creation is to avoid losing a lot of money.  Hence, risk management should remain in the forefront of your mind even as the bull appears ready to make another run.

That all being said, as we kick off a new year together I could think of no better wish for you (and me) than that captured in this verse by Mateusz.

In 2018, I hope you get rich. 

Rich in knowledge.

Rich in adventure.

Rich in laughter.

Rich in family.

Rich in health.

Rich in love.


Godspeed in 2018.