Monthly Archives: September 2018

Last Week Today: The US administration reached out to China seeking to resume trade talks and then, later in the week, Bloomberg reported that Trump still wants to impose tariffs on an additional $200 billion worth of imports from China. These seemingly contradictory actions can be reconciled through the lens of President Trump’s aggressive negotiating style. In other words, tariffs are a means to an end. It is likely the Trump administration would like to avoid a lengthy trade dispute that would be costly to both sides and is using tariffs to bring China to the negotiating table. Speaking of which, weakness in the Chinese equity markets (the yellow line in the chart below) will likely make Chinese officials more amenable to some of the U.S.’s requests. | Economic data released last week was a bit of a Goldilocks report, pointing to high consumer and business confidence, a robust labor market, and lower than anticipated inflationary pressure – more detail is included below in “Economic Quick Hits.”


Reflecting positive domestic economic data and somewhat calmer conditions in troubled emerging market countries such as Turkey, global equity market indices closed the week in the black. The S&P 500 gained +1.2%, but for a change was outdone by international stocks with the EAFE Index rising +1.8%, and the beleaguered emerging markets MXEF Index rising +1.8% (“improving” to -9.3% year-to-date). Reflecting risk-on sentiment, US Treasury yields increased while the spread of high yield bonds to the 10-year UST declined to 3.27%. The U.S. Dollar retreated by -0.5%, copper gained +0.9% (-20.4% YTD), and WTI Crude gained +1.8% to close at $68.99 per barrel.  For more detail on weekly, month-to-date and year-to-date asset class performance, please click here.

Investing With Impact. It goes by many names, Impact Investing, SRI (Socially Responsible Investments), and ESG Investments (Environmental, Social and Governance). While their specific objectives are not identical, the common thread weaving through these investment styles is to evaluate corporate behavior in the context of future financial performance. Once a fledging movement considered in the same sphere as charitable giving, Impact investing is gaining momentum as investments earmarked explicitly for Impact investing increased by 33% from 2014 – 2016 in the U.S. Moreover, Impact investing is a global phenomenon, with an estimated $23 trillion in assets professionally managed under sustainable and responsible investment strategies as of the end of 2016 according to the Global Sustainable Investment Alliance.


Countering the “charitable” label, Impact investment returns are competitive, and in some cases better than, traditional investing where one solely focuses on the bottom line. Bearing some markers of George Soros’s capital markets Theory of Reflexivity, changing investor perceptions about Impact investing are influencing not only the share price of companies with a social conscious, but management teams as well, creating a positive feedback loop in which investment capital is flowing to companies in which capitalism harmoniously coexists with goals to improve society. Indeed, the number of publicly traded companies providing sustainability reports has accelerated from 20% in 2011 to more than 80% at the end of 2016!


Choosing investments through an ethical lens is set to accelerate further. While institutions currently dominate Impact investing, comprising approximately 74% of Impact investing assets under management (AUM), mass affluent investors increased from 13% of AUM to 26% of Impact-focused AUM in the three years ending 2016. Moreover, Millennials are one of the world’s largest demographic cohorts and Deloitte forecasts that their collective net worth will reach $19 trillion to $24 trillion by 2020. A large portion of that net worth appears destined to follow some approach to Impact investing as 90% of Millennial investors express interest in pursuing sustainable investments as part of their 401 (k) portfolios according to Morgan Stanley.

It’s not just investment capital that is being redirected; consumer preferences are changing as well. According to a report from consultant Roland Berger, 75% of consumers take corporate sustainability responsibility into account when making purchases. Companies that pursue responsible environmental and social practices along with sound governance should garner additional demand for their products and services, which in return can improve profitability that feeds into stock prices.

Wayne Gretzky famously said that the key to his success as a hockey player was that he skated to where the puck was going, not to where it had been. As investors and consumers increasingly seek to support companies doing well financially by doing good (with regards to governance, social, and/or environmental impact), adding Impact investment exposure to one’s portfolio may be the equivalent of skating to where the puck will be.

Economic Data Quick Hits. In sum, it’s all good on the Western Front:

  • August economic data released this week was mostly positive: U.S. industrial production rose 0.4% (vs. 0.3% consensus estimate); consumer prices rose 0.2% (below expectations of 0.3%), and the producer-price index came in lower than anticipated.
  • Confidence is sky high: The September University of Michigan sentiment index rose to 100.8 (from 96.2 in August), the second highest level since 2004; the Index of Small Business Optimism was 108.8 in August, the highest reading ever. August retail sales were below consensus, but July’s numbers were revised higher. Clearly, emerging market problems encountering are not impacting sentiment – it’s game on for consumers and small businesses.
  • For the first time in 10 years, buybacks are accounting for the largest share of cash spending by S&P 500 firms. Buybacks surged by 48% to $384 billion during 1H. Repurchases have been concentrated with ten stocks generating 78% of aggregate buyback growth, of which Apple, Inc. accounts for 24%. Capital spending is also on the rise. S&P 500 capex during 1H rose by 19% to $341 billion. GOOGL more than doubled capex to $13 billion and accounted for 13% of the rise in S&P 500 capex during 1H. (Source: Goldman Sachs)
  • The European Central Bank (ECB) made no change to its monetary policy guidance, as expected, but Mario Draghi did slightly reduce economic growth projections for the euro area (from 1.9% to 1.8% for 2018, from 2.1% to 2.0% for 2019). Though Draghi reiterated that risks are broadly balanced, he noted that uncertainty surrounding protectionism and emerging markets (EM) volatility had gained prominence. The central bank plans to begin reducing bond purchases next month and end all bond purchases by the end of the year, depending on incoming economic data. (Source: LPL Financial Research)
  • The number of U.S. job openings increased to 6.94 million in July, a record high and above consensus estimates of 6.68 million, according to the JOLTS report released Tuesday. Higher job openings signal a healthy labor market with motivated employers. Additionally, the quit rate, or voluntary quits as a percent of separations, climbed to a 17-year high. An increasing number of workers quitting their jobs can put upward pressure on wages, boosting inflationary pressures in the economy. (Source: Marketfield Asset Management)

Be well,


Last Week Today. Jack Dorsey (CEO of Twitter) and Sheryl Sandberg (COO of Facebook) provided testimony to the Senate Intelligence Committee about foreign influence on, and alleged political biases of, their respective social media platforms. Alphabet Inc. (aka Google) declined the committee’s request to testify. Their appearance on Capitol Hill seemed to crystalize President Trump’s criticisms of the companies, spooking technology investors as the Nasdaq declined 2.5% for the week. | August’s ISM manufacturing Purchasing Managers Index (PMI) jumped 3.2 points, reaching a 14-year high of 61.3, well ahead of the 57.6 consensus estimate. | The August payrolls report was another strong one showing employers hired an additional 201,000 workers. The big news, though, was the 0.4% rise in average hourly earnings, which combined with small upward revisions to June and July pushed year-over-year earnings up to 2.92%. It appears that tightness in the labor market is finally resulting in wage inflation, as this recent data point is the highest since 2009. In response to the employment report, bonds sold off (causing yields to rise), particularly on the front-end of the curve where the 2-year note reached a ten-year high of 2.7% as the labor data supports the Fed sticking with their plan to raise interest rates two more times this year.

It was a down week for equities, commodities, and bonds. The price declines weren’t uniform, but there is a lot of red in our detailed asset class performance summary. Domestic equities (-1.0%) fell less than developed international stock indices (-2.4%), and emerging market stocks were the worst performers declining more than -3% on the week. As mentioned above, bond prices declined relatively evenly across the curve, causing a shift higher in yields with the 10-year bond ending the week at 2.94% and the 30-year bond at 3.1%. Commodities offered little in the way of shelter as precious metals fell (gold -0.4%, silver -2.5%), copper got whacked (-3.2%; -21.1% YTD), and crude slipped -3.6% to $67.75 per barrel. About the only place to hide was long volatility, as the VIX Index rose +15.7%, but remains at a relatively quiescent level of 14.9.

Central Bank Policy and Asset Bubbles. Using quarterly Federal Reserve data since 1951, the following chart highlights the historically tight relationship between US Household Net Worth and US Gross Domestic Product. What’s notable about this chart, and something that should cause investors and investment advisors to review their portfolio allocations carefully, is that for 46 years household net worth was roughly equivalent to the output of the economy. This relationship makes sense as the measure of GDP equals the sum of total consumption, government spending, business investment, and net exports.  In other words, the overall wealth of the country and that of households should be closely correlated….and they were until the last 20 years which has seen two periods of spectacular booms and busts.


Sources: Federal Reserve, Ben Hunt, Covenant Investment Research.

What’s changed? In the last 20 years (beginning with Alan Greenspan) the Federal Reserve’s monetary policy has been focused on economic growth which has resulted in persistently low interest rates that, in turn, have promoted the use of leverage. Leverage pulls forward future demand inflating the price of assets. The more leverage employed, the more demand is drawn forward, and the higher prices rise….but there is always a day of reckoning as debt must be repaid (or defaulted on), which ultimately reduces demand and asset prices along with it. Focusing on the last 20 years, it is easy to see how the Dot-Com Bubble and the Housing Bubble were episodes in which household net worth greatly exceeded GDP for a period, before mean-reverting to a level more consistent with GDP. On each occasion when the gap between GDP and net worth closed, net worth declined to GDP, not the other way around.


Sources: Federal Reserve and Ben Hunt.

We currently find ourselves in another period of high leverage precipitated by the Global Financial Crisis and central banks’ remedy to the ensuing recession which included a combination of low interest rates domestically, negative interest rates internationally, and large-scale asset purchases globally that inflated central bank balance sheets. For example, the Federal Reserve’s balance sheet is currently $4.2 trillion, ballooning from $0.9 trillion before the Great Financial Crisis.

Government entities are not the only ones issuing debt. U.S. corporations have taken advantage of low interest rates to issue $9.2 trillion in bonds over the last five years and have used more than one-third of the proceeds to repurchase their own stock (Source: Barron’s). Stock repurchases are a tried-and-true form of financial engineering in which fewer tradable shares give the appearance of higher earnings per share, which is often rewarded by investors.   However, the actual growth in corporate earnings has been far less than the increase in stock market value. Total US corporate profits (before taxes) increased by 2.8% from Q3 2014 through Q2 2018. Meanwhile, over that same period, the S&P 500 rose 45% (not including dividends), or 16.3x the rise in profits. But wait a minute… that’s not a fair comparison Justin. You need to consider the effects of the new tax plan. OK, fair enough. Net of taxes, corporate profits rose 12.2% since 2014, meaning that the S&P 500 market capitalization increased 3.7x more than profits. Since financial markets are forward discounting systems, the stock market (as a whole) is optimistically priced for rising future profits to support current valuations.


The point is that leverage has once again permeated the economy pulling forward future demand. We are wealthier at the moment, but in a somewhat fragile state, like the Dot-Com and Housing Bubbles where household net worth was unsustainably high relative to GDP.

I’m not suggesting we are on the cusp of another crisis, though that outcome can never be completely ruled out. What I am suggesting is less controversial – significant demand has been pulled forward through leverage, which, in turn, has inflated asset prices. The effects are evident in the meteoric rise in the price of the S&P 500 vs. slower corporate profit growth and in household net worth dramatically outstripping GDP. It’s also worth considering that in contrast to the last nine years, where the Fed was an ally to investors, that is no longer the case.  The Federal Reserve is now reversing the course it has followed since the Great Financial Crisis, raising interest rates and reducing the size of its balance sheet.

The investment environment is changing, and traditional asset classes are no longer cheap.  Because the price you pay for something directly influences the expected financial return on the investment, forward returns are unlikely to match the experience of the last nine years. Investors should consider the potential paths the economy and market may take and how diversifying portfolios with strategies that invest in traditional asset classes in non-traditional ways can improve portfolio returns. And, importantly, how “alternative” investments can provide dry powder in the event we are in the midst of the third asset price bubble in the last 20 years as Mr. Hunt of suggests in his charts above.

Be well,


Last Week Today: Trade negotiations once again took center stage and progress was mixed.  The agreement between Mexico and the U.S., along with concessions to the U.S. from Canada and the European Union (EU) boosted markets early in the week.  However, trade optimism faded when President Trump delivered a one-two punch of announcing the EU’s proposal didn’t go far enough and that he intends to levy tariffs on an additional $200 billion of Chinese imports. In other news, Argentina’s central bank raised its key interest rate by 15% to 60% (no, not a typo and, yes, that is the highest central bank rate in the world currently) in an effort to arrest the peso’s decline, which has fallen more than 50% against the dollar this year.

Domestic equities finished the week in the black, marking the fifth consecutive month of gains for the major indices. Technology (represented by the Nasdaq Index) has been the best performer, gaining 18.3% YTD vs. 9.9% for the S&P 500. Small cap stocks are also performing well with the Russell 2000 Index +14.3% YTD. Growth stocks continue to outperform Value stocks, adding 5.5% in August – this brings YTD performance for the Russell 1000 Growth Index to 16.4% vs. 3.7% for its Value-focused cousin. By several measures, this is the worst period of underperformance for Value since the late 1990’s when sock puppets, mouse clicks, and Internet companies with huge valuations (but no profits) were the only game in equities. That period also saw legendary Value-oriented investors like Julian Robertson retire in frustration, just before Value stocks came into favor again.

Gains outside the U.S. have been tougher to come by this year. Developed international market stocks, such as those included in the EAFE Index, have lost 1.9% YTD, and emerging markets are downright ugly. China’s -15.5% YTD performance is particularly weak, though the broader emerging markets MXEF Index has declined 7%. Fiscal stimulus, accommodative monetary policy, and an economy largely insulated from the impacts of international trade are a successful formula for economic growth and stock market performance in the U.S. relative to the rest of the world.

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


GICS Changes to Alter Investment Landscape: The stock market taxonomy, known as the Global Industry Classification System (GICS), is about to get a major overhaul that will forever change sector-based investment strategies. On September 30th, S&P Dow Jones Indices will reconstitute its indexes, eliminating the Telecommunications Services sector and replacing it with a new sector called Communication Services (MSCI, the other dominant provider of market indices, will put the same changes into effect on December 3rd).  As part of the index shake-up, household name stocks like Facebook, Alphabet (aka Google), and Netflix will be reclassified, changing both the relative weighting of sectors within the S&P 500 and the concentration of specific companies in sectors.

  • Communication Services – A newly created sector that will be dominated by Alphabet and Facebook, which together will comprise nearly 50% of the market capitalization. This sector will also include AT&T, Verizon, and CenturyLink, the last three members of the soon-to-be-extinct Telecommunication Services sector. Rounding out the sector are media companies such as Netflix, Walt Disney, and Comcast (which will migrate from the Consumer Discretionary sector).
  • Consumer Discretionary – Losing the media companies, along with the addition of eBay and a few others, will increase the Consumer Discretionary sector’s focus on retail. The changes also mean that Amazon’s influence on the sector will increase, as Amazon’s market capitalization will jump from 27.7% to 35% of the sector.
  • Information Technology – With the departure of social media companies (such as Facebook and Alphabet), the Information Technology sector will be dominated by hardware, software and semiconductor companies. The business models for these companies are more capital intensive and cyclical in nature, hence the sector will be more susceptible to the economic cycle a la the Industrial sector.


In all, the reclassification will impact 1,100 companies globally and countless sector-focused ETFs and mutual funds. Investors should be aware of these changes and the impact it will have on their portfolio. The giant fund providers such as Vanguard, Fidelity, and BlackRock are already implementing changes. For example, if you bought an Information Technology ETF because you love Facebook or Alphabet, you’ll need to sell that position and purchase a Communication Services sector fund. It’s also worth noting that historical sector correlations will change with the new classification system and perceived portfolio diversification along with it.


Economic Data Update: Consumer Confidence (as measured by the Conference Board) hit an 18-year high in August. This measure of consumer confidence has only surpassed its current level one time previously, from 1997 – 2000. Like today, during the 1990’s equity markets and labor markets were both strong.


Source: Marketfield Asset Management

In another similarity to the late 1990’s, the spread between Present Situation confidence (the blue line in the chart above) and Expectations (the green line) is widening. We discussed this phenomenon in our Mid-Year Economic Review and Outlook. Although it is a lousy timing tool, this divergence combined with the elevated level of Consumer Confidence signal we are in the later stages of this economic cycle. However, it must be stressed it does not imply an imminent end to this stage of the cycle.

On that note, real annualized GDP growth for Q2 was revised up by 0.1% to 4.2%. In the revised data, a downward revision in Consumption (3.8% vs. 4.0%) was offset by a sizeable revision in intellectual property growth (11.0% vs. 8.2%). Pre-tax corporate profits rose by 7.7% year-over-year, while profits after tax rose 16.1% highlighting the effects of the tax cuts. On the negative side of the ledger, durable goods orders and the housing market continue to exhibit weakness.

Inflation (as measured by Core Personal Consumption Expenditures (PCE)) was 2.0% in the second quarter, in line with expectations, but higher than the wage growth rate, thus reducing real income growth. Anecdotally, several companies are reporting higher costs which are now being passed onto consumers, suggesting inflationary pressures are real and will keep the Fed on track with its near term rate forecast (meaning two more rate hikes this year).

In sum, the domestic economic backdrop is solid, but there are no indications the economy has found a sustainable higher gear. Although the Fed’s dot-plot suggests five rate hikes between now and the end of 2019, the Fed funds futures market is only pricing in three hikes. In other words, bond investors (who are very sensitive to inflation – stemming from growth or supply constraints) believe the economy will cool off enough for the Fed to slow their pace of rate hikes. We may see another quarter or two of above-trend growth, but beyond that, we expect the economy will glide back to a trend growth rate of between 2% – 3% per year….and there’s nothing wrong with that at this stage of the cycle.

Be well,