On this week’s podcast, Karl Eggerss discusses the recent pullback in the stock market and how it affects some, but not others. When the stock market is volatile, some investors are forced to sell. If you’re not, you can use pullbacks to your advantage.
Welcome to Creating Richer Lives where living a richer life goes beyond the balance in your bank account. In fact, it’s about what you do with your dollars and how the choices you make with your money not only define your lifestyle now, but impact your legacy for years to come. Whether you’re working towards retirement or seeking ways to make philanthropy your goal, there is a road to get you there. It’s time to redefine what it means to have a richer life. Welcome to Creating Richer Lives. Here’s your host, Karl Eggerss.
Hey. Good morning everybody. Welcome to the podcast. This is Creating Richer Lives, my name is Karl Eggerss. Our telephone number, (210) 526-0057. And our website is creatingricherlives.com. And of course, the podcast is always brought to you by Covenant. Lifestyle. Legacy. Philanthropy. Just celebrated Covenant’s 10 year anniversary, as a matter of fact. So lot of things Covenant does. If you need any help in the financial advising realm, give us a call. It could be family wealth planning in terms of how to transition and move money from one generation to the next. It can be things like social security analysis, Roth conversions, investment management, 401(k) management, cash flow planning. All those different things Covenant does. Again, (210) 526-0057. Well, let’s jump right in. I would suspect that you probably know what this particular podcast will be about this week. A little bit different than last week. We ended last Friday, a week ago Friday with the markets … had a down day, a pretty down day on Friday. And corona had reared its ugly head again, right?
There was a point at which the coronavirus was renamed COVID-19 and we saw it start to decelerate. So we were still seeing new cases, but they were starting to slow down in China. And then of course China changed the calculation and that caused the market a little scare. But the tipping point this week seems to be when it accelerated outside of China, mainly in China. Once we started to see South Korea, Italy really accelerate, we started to see the stock market have some much, much bigger losses and a big delayed reaction. Because we saw this in early January and yet the market continued on to new highs with the Dow Jones going up over 29,000. I think the high this year was 29,568. And we saw a big drop on Monday, and then we saw big drop on Tuesday, and another drop on Wednesday, and another big drop on Thursday, and another big drop on Friday. In fact, this is one of the biggest drops that we have seen since 2008 over this short amount of time.
Now, what’s interesting about this is that the selling really snowballed and people were speculating why now? Why so much? What’s going on? Remember the market was getting extended, we were seeing earnings had been flat. And so what happened was with the stock market going up and earnings flat, it was becoming more and more expensive. We were seeing the stock market a little more concentrated in some of these bigger technology companies primarily. And we continued to see the fed on the sidelines and the market was continuing up. But once we saw this really start to accelerate, this virus, you started to see people get a little more concerned about it. And it led to some profit taking, which led to very fast selling. And it was indiscriminate selling across the board. What I mean by that, it wasn’t just technology, it wasn’t just industrial or cruise ships, it wasn’t any of that. It was all of that. It was energy. Even the stuff that had been beaten up went down this week. So we finished the week down quite a bit.
I mean I won’t go into all the numbers, but let’s just call it 12, 13% on the major indices. Some of them down 10%. So now of course, the pundits say we are officially in a correction because that’s a greater than 10% drop. So let’s talk about the specifics first, and then what we’re doing about it and what you should be doing about it. And I’m saying that generally speaking, because I don’t know your situation, so I don’t give you advice because I don’t know you. I know some of you, but I don’t know exactly who’s listening right now. So the statistics are this, the stock market on average will pull back, let’s call it 13 or 14% on average during the year at some point. Sometimes it’s more, sometimes it’s less. But on average you’re going to get … and you’re going in, you’re also going to get three on average 5% corrections during the year. So it’s not a surprise that we get market pullbacks. That’s not the surprise here. What’s a little different is the fact of the speed at which this has occurred.
In fact, if you go back to December of 2018, if you remember Christmas Eve 2018 to be specific, which wasn’t that long ago. We’re talking what? 14, 15 months ago, the stock market went down almost 20%. We haven’t gone down 20% yet. So of course you hear on the news that Dow Jones has lost the most points ever. That’s true. But again, let’s look at percentages. So we are still in a normal correction. Drops of 10-20% are going to happen. That’s why over the long term you get paid a premium to be in stocks, you put up with volatility. Those that are opportunistic take advantage. Those that are fearful and overextended have to sell into the lows. But you do get a correction from time to time. This one was interesting because of the speed at which it happened. And again, at one point we saw a big, big rally from the lows Friday, which wasn’t a huge shock given how bad the week was that you would see some short covering. For those that were short, were locking in their profits into the close. Not a huge shock.
But at one point it was the worst week, the worst seven days, six days, however you want to look at it since the financial crisis. And you’re thinking about that saying, “Does that make sense?” And I have to say, I mean, I was asked to do a podcast this week, I was asked to do a TV interview this week, and I was asked to do three radio interviews this week, all about the market, coronavirus, the economy. So people are very concerned, and it spread. But I have to say … And this is just my opinion, that the news is really scaring people. And I’m not one to always say that because … I mean, a lot of stuff that comes out is scary. But there have been well over 20 different items just since 2009 that you could point to and say, “That should have ended the bull market.” I mean, I’m talking about countries that may not make their debt payments. I’m talking about missiles being fired. I’m talking about flash crashes. I’m talking about worried about a yield curve inversion, worried about a recession, oil going to $26 a barrel.
Those are all things that have happened since the great recession and yet the stock market was at an all time high what seems like forever ago, but it was only just a few days ago. Fascinating, right? How could we go from an all time high to really giving up four months of gains within this week? So whether you want to call it a crash, a multi-day crash, it doesn’t really matter what it is. It is what it is, which is you think about why is this really happening? This is my opinion why this is happening. The media and people watching TV are scared about the actual virus, right? Forget about the flu that kills tens of thousands of people every year and we know that. That’s a known, this is an unknown. People worry about unknowns. So everybody’s scared about the virus. Wall Street and the reason stocks are getting sold is they’re not so much worried about the virus, they’re worried about the impact on the economy. Not the virus itself, but how you and I act.
I have talked to numerous people this week, canceling trips, canceling cruises, staying home for this, staying home for that. I mean, numerous people. So that’s happening all over the world. That’s going to have an impact on the economy. And as I’ve been saying … and I should say, we’ve been saying this because Covenant has been pretty consistent in the messaging that this economy was good, but it was … to use an analogy, flying at 10,000 feet as opposed to flying at 30,000 feet. The plane flying at 10,000 feet has less room for air than the one flying at 30,000 feet. And we’ve always said that it’s subject to some type of shock. This could be it. This could be something that puts us in a recession, but it’s definitely going to slow down the economy. Here’s the kicker though, is it going to slow down the economy permanently? Is it going to slow down the economy for a week? Three months? That’s the part we don’t know. So what happens, what Wall Street does … And this is important to understand. When they can’t have visibility, they sell.
So what does that mean? Let’s just take a stock for example, and we’ll just … I don’t even want to use this specific stock. Let’s just say it’s a leisure stock. The leisure stock is getting trips booked that are being canceled. So nobody knows what their earnings … they could project out their earnings for the next couple of at least four quarters.
So Wall Street knows what their earnings are going to be within a few pennies per share. But because we’re in the middle of it, that company can’t tell us, “Well, our earnings are going to be bad for a quarter and then they’re going to be fine again.” They can’t tell us that. So Wall Street sells first because what we’re doing is we’re trying to discount future cash flows. That’s what you’re buying.
When Starbucks closes half of their stores in China for two weeks. Okay, we know that, but is that permanent? Is that going to permanently impair their cash flows for the next several years? Or is that going to impair their numbers for two weeks? Because if it’s for two weeks, how much should the stock really go down? Not much, because you’re buying year’s worth of cash flows, not days, and that’s what’s important.
But right now, we don’t know because it’s not as if these companies are coming out saying, “Okay, now we know our earnings were going to be $2. Next quarter they’re going to be a dollar. But after that, we think they’re going to resume back to normal.” If we knew that, then we could start projecting, but nobody knows that. So we don’t know the true impact on the economy. We don’t know the true impact more importantly on the companies and the profits of those companies, which is what we’re buying.
That’s really to me why the sell off has accelerated. Outside of that, why else has it accelerated? Fear, right? Here’s the other reason, and this is important, and this is why I titled the podcast, Are You a Forced Seller? There are people that have been conditioned in this market that you buy every dip since 2009, and it has worked fabulous. Every sell off has been a V bottom and I ultimately think this one will be too.
However, if you get conditioned to think we’re in a bull market and it just goes straight up, there are some people who take advantage of that by using leverage, that buy more than they should. They borrow money to buy more stocks, more ETFs, more mutual funds. When margin calls come, in other words, when the market goes down and they say, “You either give us more money…” The brokerage house is saying this, “…or you have to sell your position,” they have to sell, and a lot of them do.
So you see this end of the day, I think Thursday was a great example. It’s down about 600 points, and then in the last 30 minutes we finished down 1200 on the Dow Jones. That just that reeked of margin calls and forced selling.
You have to ask yourself, are you a forced seller? If you are, you had too many stocks. For the money that you need today, a month from now, even a year from now, that shouldn’t be in the stock market. Two years from now, shouldn’t be in the stock market either probably. We know the statistics when money’s going to be used for the next, won’t be used for five years on out. The stock market does extremely well over five year periods if you have a five year holding period.
That’s really important for you to understand how you build your investment portfolio is really important because if you have it in buckets, then you don’t worry about the short term like this because you’re not a forced seller. It’s those people that have 100% of their money in stocks and they need to live off of that money. They’re forced to sell this week. They needed that money. You may not be that person. I wasn’t that person.
In other words, what if your stocks are down and you say, “Well I really need five years worth of withdrawals. The next five years, where am I going to get that?” You should be getting that from bonds, from cash, from other investments that aren’t stock market related. If you have enough to live off during that time, you can let those stocks recover because ultimately they will.
Again, I believe a lot of this is a fear based sell-off. Let’s think about this. We had some selling this week as fast as it was that we haven’t seen since the financial crisis. Do you honestly believe we’re in a financial crisis right now? We have record, record employment right now. We had an economy that up until a few weeks ago, everybody was saying was pretty good. We have a housing market that’s doing extremely well and getting better. There’s some really good things going on. Does that feel like 2008 to you? Because if it doesn’t, then something’s off here.
So again, I go back to, is this a permanent disruption? If you think the Coronavirus is going to spread and a quarter of the population is going to get killed off, then maybe you’re right. But if you think this is temporary and eventually, whether, even if it’s three months from now, they come out with a vaccine, which they will, then we should get back to normal earnings.
By the way, on a side note, I saw capitalism at its finest this week. All these drug companies rushing as fast as they can to get a vaccine. That’s awesome. That’s the way it should work. A lot of competition, these drug companies get beat up all the time. They’re investing their own money to try to come up with a cure for you if you have Coronavirus. If they don’t come up with it, nobody’s bailing them out. So I thought it was cool to watch and we will have a vaccine.
Look, whether it’s SARS, Ebola, there’s always going to be something. It’s going to be something else. You have to have a plan. As I’ve been saying for weeks, you have to stress test your portfolio as best you can. You have to, what does that mean? That means pretend in your mind, “What if the market were to go down 10 or 15 or 20%. How would my portfolio react?” It’s easy to say that and think, “Eh, probably not going to happen.” But it did happen. The market did fall 10-12-13% this week. If you know that’s coming at some point, then you ride through it.
Now let’s also talk about being opportunistic with it. Because I was rebalancing for certain clients and certain accounts that had cash on the sidelines, had maybe an over allocation in some safe things when it was supposed to be in because it got out of whack a little bit. That’s how you take advantage of, you buy fear, you buy when “There’s blood in the streets,” as Warren Buffett says, and there was this week. This is what that is, this is what he’s talking about.
When you wake up and your stomach hurts because the stock market’s so bad, and you stop looking at your portfolio because you don’t want to look at it, that’s when you jump in the deep end if you can. Again, you don’t go outside of what you should do. But you really, again, take the money that you don’t need anytime soon and that’s the money that you go and invest with.
We have almost everything down eight to 10, eight to 11% for the year now. Not to mention from their highs but from the year. There were things down 10-12% this week. I’m talking about major indices. There’s plenty of stocks down, much, much more than that. They’re all went down the same.
Now, just a quick recap, and it was pretty much the same each week. Monday, Dow down 1,000 points, spread of Corona outside of China. Tuesday another 1,000 points, and it down about 875. You saw the losses in the airlines, casinos, cruise ships. Bonds are doing fabulous. We also saw oil go below 50. We’ve had multiple days now with these all or none days, which I’ll get to in a minute. Wednesday, we see the market up about 400 points, but it fades.
Again, every day the market was up and tried to rally, there was another headline. Another headline that was about Corona that would push the market back down. Most of the data this week was pretty good economic data, but nobody cared about it because a lot of it didn’t include stuff that’s happened here recently. So we’ll see how that goes along.
But here’s what we need to see. I’ve had people ask me, “Where’s this going to bottom?” as if I’ve got the answer. I say, “I don’t know,” but here’s what I know a bottom looks like. A bottom looks like generally you usually get a reversal, mid day reversal, which we haven’t had yet. Yeah, you could call Friday’s a reversal, but not really. It was a short covering rally to close the week out for those that were on the right side of the trade.
Here’s what it looks like. We’ve had at least three all or nothing days this week, where it’s just lopsided, everything’s getting sold. No safe haven other than let’s say bonds. You get two or three of those. We’ve had three, so that’s exhaustion. That’s just given up. That’s forced selling.
We need to see the other side. What does the other side look like? In other words, when we get the up days, which will come I promise you, we will get some up days. What does that look like? Is it a weak rally or a strong rally? Does it have multiple days or one day?
It’s not just about the points. It’s not about the Dow could rally 500 points and it may be a weak rally. The Dow could rally, probably wouldn’t rally 1,000 points be a weak rally, but it can rally several 100 points without it really having a good quality rally.
How many stocks are participating? How much is up volume versus down volume, the points gained versus lost? All these things I analyze every night. If we get a couple of those in pretty quick order here, that shows you that the selling was exhausted and that people say, “The bargains are too good and I got to go in and get these at whatever cost.” Then the psychology starts. People start to say, “Man, I should have bought it when it was down.” Then it changes very quickly.
We don’t know. But if we get the weak rally, then we’re not out of the woods. What we end up having is what could end up looking like a W. It could end up looking like December of ’18, where we did rally hard and then we fell back down to new lows. Then there’s another capitulation. This could end up being a 20%. We don’t know, could end up being 25%.
I can tell you this, that studying a lot of bull and bear markets in the transition between them, bear markets don’t start this way. There’s always a top. That’s not what I’m saying. They don’t go up making new highs and then just reverse course and head straight down and that was it. There is a deterioration.
For those of you that have been listening to the podcast for over 10 years, you know I’ve said this numerous times. It’s like the car’s fallen apart, hubcaps fallen off, paint starts to flake as you’re driving down the road, and pretty soon the wheel falls off, and bumper falls off, and pretty soon the whole car falls apart. That’s what a bull market becoming a bear market looks like. We didn’t see that couple of weeks ago at all. We didn’t see that. We saw an ongoing bull market that was pretty healthy. So it’s very rare for the market to be cruise along and then out of nowhere it gets hit. That’s usually a news driven sell-off. They’re all scary.
They all act … feel as if they’re going to last forever. They all are justified, and like they feel like this is real. No, Carl, you don’t understand. This is real. This is coronavirus. We’ve never seen this before. We have seen this before. Have we seen this particular thing? No, but we’ve seen, I could name 20 things we’ve seen in the last several years and guess what? We have been at all time highs a couple of weeks ago, so that means we got through everything. We’ve been through world wars. We’ve been through 911. We’ve been through the greatest recession we’ve seen. We’ve been through the depression and the Dow Jones was that all time highs?
So does it pay to buy when there’s fear? Absolutely. We’ve got proof of it. Again, it depends on what you do, depends on your situation. So I can’t answer what you should be doing, but I know what I’m doing for certain clients in certain situations. Now also want to remind you just briefly that I want to be very focused here on diversification because I’ve seen and heard some things very recently that to me are very interesting. And by the way, before I get to that, did you notice energy started to turn up on Friday? Even when the market was way down. We started to see cruise stocks, cruise ship stocks, they were in the green even when the market was down. So there were some interesting things and we’re seeing emerging markets outperformed significantly over the past couple of weeks. And that gets me to my point. Asset allocation.
Right now I’m starting to see people abandon major pieces of asset allocation because it hasn’t been doing well. And that is a capitulation, and I’ve seen it before. First thing I saw was I’ve seen plenty of 401k plans start to abandon commodities. Well, hasn’t been doing well so we’re just going to get that out of the portfolio. So now you don’t have an option for commodities. Commodities have been doing horrible the last few years. I care about the next few years. Right? And then I heard this week of an endowment, college endowment, that was thinking about abandoning, at least some of their view, was to abandon international. Not saying they’re going to do it, but there was discussion that maybe we don’t even need international. Let’s go back to 2000 through 2009, the argument could have been let’s get rid of the S&P right? Because the S&P didn’t do anything that decade, but plenty of other areas did fine. Now you go from 2010 to 2020, S&P and bonds have worked great. Domestic bonds and the domestic stock market has been the only thing you’ve really needed.
But where you’re not investing for the next five or ten years, you may be investing for the next 20 or 30 years. And I would prefer to have a complete diversified portfolio. You can underweight and overweight. And even if you told me, “Well, I don’t want to own commodities right now and I’m waiting for a certain signal, or I’m waiting, I’ve got something. That’s fine, but to just abandon it … so that’s, that’s capitulation. I’ve started to see a little bit of that. So continue to be diversified. And also, again, what’s your time frame here? Do not be a forced seller. And if you’re not, you have to look in the mirror and say, “How many times has it benefited me from selling from fear?” And these are scary days. They’re scary days for individuals looking at their accounts. They’re scary days for a wall street. They’re scary days for people that have been in the business for decades.
Don’t let anybody fool you. These are not fun days. But having said that, you have to stick with the plan and the strategy because we got history on our side to know what this looks like. And markets are going to go up and down and they’re fun when they’re going up and they’re no fun when they’re going down. But you can take advantage of it too. That’s the interesting part and the fun part is you can take advantage of it, and when it rebounds had you bought in December of ’18 which I was fortunate to buy some for our clients, Christmas Eve of ’18, which I don’t know if I’ve ever done any trading prior to that on Christmas Eve, but we were in a free fall and we had cash on the sidelines. And when you do that, you look at what that chunk of money has done since, and you go. “That was a good buy.”
And it didn’t feel good at the time. I remember it didn’t feel good, but it does once it starts to recover. And if you’re … whether you’re buying stocks, individual stocks, or you’re buying bonds or buying mutual funds, you want to get a good deal. And it sounds a little cliche, but stocks are a much better deal now than they were a week ago. But what a week. I mean, really an amazing week. For those of you that have been listening for years, we’ve been through some interesting times, right? I can remember vividly 2011 when our debt was downgraded, we lost our AAA rating and the Dow Jones moved 4% up and down four days in a row.
So that would be the equivalent of a thousand points down, a thousand points up, a thousand points down, a thousand points up. We almost kind of got that this week, right? But it was almost one direction. So every time’s a little different. But we’ve seen volatility and we’ve been through two flash crashes just in the last few years. And I really believe that a lot of the volatility we’re seeing is being exacerbated by the fact that we have target date funds, ETFs, we have online trading on your phone. We have technology that’s phenomenal that … program trading. I think that leads to volatility and it’s scarier and I think we’ll have more flash crashes and more volatility as we move along in life. But I think we can also really take advantage of that, whereas we may not have been able to in the past because we didn’t have quite the volatility.
I mean again, having a 12, 13 14% pullback, very, very common, very common. That is not unusual. What’s a little unusual is the speed at which this happened and I think it has to do with how we are trading nowadays, and all the technology, and you could say that’s a bad thing, but again, if the market recovers and you are able to take advantage of it, then it turns out to be a good thing.
All right. Lot of information and I hope that was helpful. I hope that … I mean I’m curious, I’m always curious during these times, what did you do during this week? I ask you that oftentimes. Some of you email me. Let me know what did you do? Did you sell early in the week and buy back at the end of the week? Did you do nothing? Which was probably the best course of action for most. Did you add to some things? Did you sell some things and increase the quality of what you own? I’ve been saying along the lines here, know what you own. Remember I’ve said that numerous times, know what you own. And this is why. Because you need to know how certain things are going to react within reason, but know how they’re going to react so that again, you can have a portfolio that you can sleep with at night coming into this, not being reactive, being proactive.
All right, thank you guys. Have a great weekend. Go relax. Take advantage of the nice weather at least down in South Texas, nice weather. Have a wonderful weekend. Don’t forget creatingricherlives.com is our website and our telephone number, 210-526-0057. Appreciate all you guys. Thanks and have a great weekend.
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Karl Eggerss was on CBS discussing reasons to have a will. There are many reasons to have a will, but Karl gives 3 important ones.
Sharon Ko: Whatever your age or circumstance, here are the reasons why you should have a will. First, this legal document puts you 100% in control.
Karl Eggerss: After your death, you’re able to still decide how your estate is distributed. Whether it’s family, friends, you get to decide, and if you don’t have a will, you’re leaving it to a judge to decide that for you.
Sharon Ko: That could mean a long, drawn out process for your loved ones.
Karl Eggerss: Your will also enables you to really lower the chances of fighting between people because you can put no contest clauses in there and basically it says that if somebody contests the will, they’re out of there.
Karl Eggerss: Third thing would be, who’s going to take care of your kids? Again, do you want to leave it to a judge to decide who? It may be a family member the judge wants to leave the kids to, when you may want a friend.
Sharon Ko: If you haven’t gotten around to making a will, you’re not alone. 45% of people 55 and up do not have one. You don’t necessarily need an attorney to draw one up. There are online will writing services and we’ve got options for you on kens5.com.
On the Trey Ware Show, Karl explained to Trey that while the market is pricing in deflation because of the Coronavirus, perhaps the bigger concern for consumers should be inflation as the supply chain is disrupted.
Trey Ware: Well the President answered some questions in India this morning about the coronavirus, so I’m going to go back to Karl Eggerss from creatingricherlives.com and we’ll talk about what happened with the stock market yesterday.
Trey Ware: You know, one of the things that I started to say months ago when this first appeared on the scene, Karl, is that economically the impact won’t be felt for months down the road, and certainly that’s exactly what’s happening here, is that with all of the manufacturing that is not going on in China today.
Trey Ware: I was reading earlier a report about all these tanker containers, these shipping containers that are full and sitting at the ports in China that they can’t get shipped out. Food is rotting in these containers and all these goods that they have manufactured to send around the world, but they’re just sitting there. That with that going on, this is something that you don’t feel today right now in the economy, but something that’s weeks or months down the road.
Karl Eggerss: Yeah. You know, our listeners need to really watch out for prices going up. The market is acting as if this is deflationary. This actually could be inflationary, because if you can’t get products here the products that exist sitting on the shelves become worth more. So we need to watch for inflation, which is really interesting because the market’s not really pricing that in, not a lot of people are talking about it. But let’s look over the next few months to see if prices start to go up on some of our goods, and that could be another kind of… You know, a gut punch to the economy, is everybody looking around and their prices are higher.
Karl Eggerss: Again, as we talked about yesterday, if you start to see some layoffs, if you start to see some furloughs and people temporarily not working, temporarily even that puts a dent in the economy, and at the same time if prices are going up that could really hurt for the consumer.
Trey Ware: Well, and politically too. It could really hurt politically because we’re dealing with a political year and to have this hit now… You know the President has asked for another $2.5 billion to fight this. They started out with 130 million. They realized that that price tag is going to be way too low. They’re going to need 2.5 billion or more to be able to fight the coronavirus, and now it’s having a huge effect in Europe. We just saw again overnight they’re now up to seven dead in Italy. Many parts of Italy have been shut down now.
Trey Ware: In Iran, the official count out of Iran is 12 dead, but there are those in Iran right now who are saying no, it’s more like 55 or 60 dead in Iran right now.
Trey Ware: So we’re dealing with a global pandemic, something that has stretched beyond the borders of China right now, which is one of the reasons I believe the President is in India today, because India is another manufacturing hub, and being in India today to make sure that we have a manufacturing partner and to shore that up, as well as a partner to help us deal with Afghanistan, is a really smart move for the President to be making right now.
Karl Eggerss: Yeah. Let’s also watch… If the Federal Reserve really wants to retaliate against President Trump, which we know Jay Powell’s not a big fan, they’re not big fans of each other, they will not lower interest rates, and even though the market is begging for it.
Karl Eggerss: If you look at the bond market, it’s pulling down what the Feds should do. So the Fed behind the… They actually should be lowering rates right now, but they don’t want to look political one way or the other this year. They really should be lowering rates. If they don’t do it, that would be a political statement in and of itself. So watch for the Fed to not only lower rates, but do something else creative to try to give confidence globally.
Trey Ware: Only a couple seconds left. What are the futures looking like today?
Karl Eggerss: Probably down to about 100 right now. Keep in mind we’ve got about 50… Since 1950 we’ve had over 50 days where the market has fallen about 3.5%. I did some research. On average the market has bounced the next day and a year out 100% of the time on average.
Trey Ware: Sounds good. Thank you Karl Eggerss.
On the Trey Ware show, Karl discussed how the spread of the coronavirus OUTSIDE of China is what’s causing the recent sell off in stocks. But, Karl also reminded investors to focus on the percentage of the Dow Jones, not the points.
Trey Ware: The Dow is down close to 800, right around 800, give or take a few. We want to have Karl Eggerss from Creating Richer Lives.com on the show this morning. He joins me every Monday at 6:50. We want to have him back on now to talk about this. Karl, they’re saying in the mainstream media a lot of this has to do with coronavirus. As you and I have talked though, it also has a lot to do with Bernie Sanders being on such roll and the free market doesn’t like the fact that he’s on a roll. So your thoughts. Go right ahead.
Karl Eggerss: Yeah. Thanks, Trey, appreciate it. You know, we’ve seen, obviously the coronavirus has been there for the last few weeks, but the fact that if you look at the overall, the new cases have slowed down a bit. But if you look at it outside of China, that’s really one of the issues that the market’s dealing with. And again, when you look at countries like South Korea, how much stuff do we get from South Korea? They’re a huge exporter, right? We get a lot of cars from South Korea. And so, I mean there are companies. I’ve talked to some people in San Antonio that have companies and say, “I can’t get parts right now.” So they’re shut down temporarily and that’s here. So magnify that globally. We know China’s about tripled the size their economy has on the global economy, the impact is triple what it was back in ’03 during SARS.
Karl Eggerss: So that’s why the market’s struggling. And look, the market had been going up pretty persistently for the last several months. So we’re getting a sell off. What’s interesting to note is that you look at the Dow Jones and we hear 800, 900, 1000 points. Those are big numbers. But again, we’re not at Dow 10,000. We’re at Dow, 28,000, 29,000. So percentage wise we had three drops in similar magnitude in just last August, and most people don’t even remember that because we just bounced back and kept on moving along. And ultimately I think this bull market will last. But there’s no question that the reason the markets sell and Wall Street sells is because they’re trying to discount what they know about the future. When people invest, it’s always about trying to predict the future in terms of profits and earnings and you don’t know that right now.
Karl Eggerss: You don’t know is the supply chain disrupted for three weeks? Is it just disrupted for three months? And until we know some quantifiable measure of what that is, then you see people sell stocks now, and I’ll figure it out later. So you’re seeing some of that move to the sidelines as we speak. And again, for those that are longterm investors, this was where you started cherry picking. You start looking, saying, are there things out there that I’ve been waiting to buy? You know, everybody wanted to buy Apple stock for example. Well guess what? It’s down 5% this morning. But what happens is when it does fall, then people say, well maybe it’s going to fall another 5%. It’s all this wait, and they keep waiting until it bounces back.
Trey Ware: We have no idea how long this is going to take. Even the medical community doesn’t know how long this is going to take because they’re not real sure what they have. And now that it is escaped China and we’re looking at a full fledged pandemic. Wiped out five people in Italy. Wiped out eight people in Iran. Iran is a closed society. When we are looking at that kind of thing go on, we don’t know when this is going to end. So worst case scenario, what happens?
Karl Eggerss: Worst case scenario is that it goes on much longer and in a global economy that is cruising. As opposed to a plane cruising at 40,000 feet, the global economy has been cruising at maybe 10,000 feet. So we don’t have as much room to spare. And so worst case scenario it tips us into a mild recession. That is a worst case scenario. And when you have a mild recession, there’s nothing magical about that other than the fact that company’s profits are all sudden not growing. And if they don’t grow, people don’t pay a premium for them. They don’t pay a premium. The stock market doesn’t go anywhere. It goes down. One benefit that you’re seeing, not only from the gasoline going down for drivers, not so good for those in the energy space, but you’re seeing interest rates at all time lows right now. All time lows.
Karl Eggerss: So if you’re buying a house, if you’re buying a car, if you’re looking to refinance, it’s an awesome time. And furthermore, if you’re sitting there in CDs and money markets, you’re about to get another cut in what you’re getting for that. So it entices people to go do something with their money. To go buy a house, right? To go invest those dollars. That’s kind of why the federal reserve always lowers interest rates during some kind of crisis. Because they want to entice our listeners to go out and do something with their money instead of just sitting in the banks with it.
Trey Ware: Well, part of the danger though is that these businesses that are on the sidelines now rendered powerless. Well you know Hyundai is a prime example. They can’t make cars right now because they can’t get the parts out of China to make the cars. And this is something we’re starting to see spread around the world. Well eventually if those companies can’t sell their products, well then they’ve got to start laying off workers.
Karl Eggerss: Well that’s it. Exactly. And we know that we’ve had a great employment situation here. But some people have argued it’s as good as it gets and we know frontline workers sometimes are the first to go, especially when factories are shut down. Even if they say [crosstalk 00:04:59].
Trey Ware: If you’re employing widget makers and you can’t get the widgets for the widget maker use, well then you’ve got to let the widget maker go because you don’t have any income coming in to pay the widget maker. It’s that simple.
Karl Eggerss: Yeah. And you know, Trey, I’ll tell you what’s scary, and you probably have already mentioned this is they’re apparently quarantining people and letting them go because they’re saying, “Well, after 14 days if your symptoms aren’t there, we’re good.” And now we’re hearing the quarantine should maybe be 24 days because it’s incubation period.
Trey Ware: 28.
Karl Eggerss: 28 days. So you may have people that are leaving these facilities that have it. It’s just the symptoms haven’t shown up yet. [crosstalk 00:00:05:39].
Trey Ware: I’ve said it a million times on the show, Karl. I’ve said it a million times on the show that it’s not 14 days. And these people that we let go out of Lackland last week, it was premature to let them go. I’m not saying they have it, but they allowed them to go to the bus stations and to go to the airport here in San Antonio and it was premature. The minimum now, and we’re not even sure if 28’s long enough, but the minimum now we know that somebody should be quarantined is 28 days. Minimum.
Karl Eggerss: You know for if we’re really being honest though, shouldn’t we be quarantining people with the flu as well? It’s kind of interesting how many people die of the flu every year. It comes every year and we know that.
Trey Ware: I can answer that though and I can tell you that if this is allowed to continue, this is going to be worse than the flu. The reason the flu kills so many people is it has been around longer and it is more dangerous. This is, as far as commonality and widespread, this is just now getting a toe hold in many of these countries. The flu has been in these countries forever in different strains. It just mutates all the time. I’ve talked to these immunologists. I’ve talked to these endocrinologists. I’ve talked to these guys. Epidemiologists.
Trey Ware: I can tell you their concern is the potentiality for it being worse than the flu is out there. It’s just a baby disease at this point in terms of its life. The flu’s been around since we have been around. So I hear people make those types of comparisons, but it’s apples and oranges. It’s not the same thing. We have something here that is extremely dangerous and can be extremely dangerous, not only to mankind and the health of mankind, but also to the economy. It’s a hell of a thing, Karl, to try to get people to wake up and do something about it, people in positions of power to take this seriously.
Karl Eggerss: Yeah. And you do have companies scrambling, some of the best minds in the world scrambling to come up with a vaccine. There’s a couple of stocks that are actually up today because they were working on that. And they’re trying to get more people to adopt it and do through trials. But this stuff takes time. It is scary. It’s the fear of the unknown is why Wall Street typically sells stocks.
Trey Ware: Absolutely. All right Karl. Thank you man. I appreciate your time this morning. We’re down 809 now and it’s just bouncing around right there. One quick thing before I let you go. What kind of territory does it have to get into before those automatic shutdowns come into play? We’re not even close to that, are we?
Karl Eggerss: No, we’re not close to that and there’s three layers. I won’t go into it, but there’s three percentages. One is kind of a pause. One is kind of a shut it down for the day type of thing. So we’re not near there. Again, all this was based on percentages rather than points. So the fact that we’re at 29,000, let’s think about that. A 10% drop would be 2,900 Dow points. In 1987 the Dow Jones dropped 22%. think about that, Trey. That would be like 7,500 points on the Dow just to put it in comparison.
Trey Ware: Very valid point.
Karl Eggerss: You have to look at the percentages.
Trey Ware: Yeah. These percentages on 29,000 versus, say 3,900, which is where it was in 1991. That’s a big difference. Yeah, you’re right. Okay. Thank you, Karl. I appreciate it very, very much. Creating Richer Lives.com and we’ll be in touch with him over the next couple of days. All right. Let me punt here. Chris, go right into traffic.
By Justin Pawl, CFA, CAIA
In this week’s edition: Numerous market segments are overextended, increasing the importance of managing risks through true portfolio diversification.
Last Week Today. Japan posted a shocking -6.2% growth rate for Q4 2019. In late September 2019, the government increased its VAT (value-added tax) on nearly every good and service in the country from 8% to 10% to fund social services and pay down the country’s enormous debt load, a move economists forecast would only have a modest effect on the economy. | China reported car sales were down 92% in the first half of February due to Covid-19 quarantines and plant closures. | U.S. Markit Purchasing Manufacturing Indexes were lower than expected, with the services PMI falling below 50 (i.e., contraction) for the first time since 2013 as new orders declined in response to the spread of Covid-19. | The Atlanta GDP Now model’s forecast of Q1 GDP increased from 2.4% to 2.6%, while the “Blue Chip” economists average estimate is closer to 1.5%.
In a holiday-shortened week, domestic financial markets illustrated the dynamic tension between investors’ concerns about Covid-19’s effect on the global economy and the ability for central bankers to overcome those effects. Domestic equity markets hit record levels before falling to end the week in negative territory. International stocks followed a similar path (though they remain well below historic peaks as shown below). U.S. treasuries also hit an all-time high in the form of rising bond prices producing the lowest yield on 30-year treasury bonds in history (1.91%), and the yield on the benchmark 10-year bond moved back below 1.5%. Moreover, the U.S Treasury yield curve moved further into inversion – a sign that bond investors believe the Fed will cut interest rates.
For detailed weekly, MTD, and YTD financial market performance, click on the table below.
Stranger Things. Our investment team has had a lot of internal discussions of late, highlighting various extremes we’re witnessing in the financial markets. Extended moves are not without precedent, as financial market prices do not fit a normal bell curve (or for those who remember Statistics 101, a Gaussian distribution). However, financial markets are also known to mean revert. That is, prices move to extremes (high or low), and then revert to a level that resembles the long-run average. Mean reversion is a well-known phenomenon, and below, we’ll discuss how to take advantage of it in your portfolio, but first, let’s take a tour of some of the stranger things we’re seeing in the markets today.
Whether you consider Tesla, Inc., a car company or technology company, the stock price of Tesla has gone parabolic. Tesla’s market capitalization is now larger than Ford and General Motors combined.
Sources: Bloomberg, L.P., and Covenant Investment Research.
Market breadth is a measure of the number of stocks advancing relative to those that are declining in a given index. Positive breadth means more stocks are rising than falling and is generally considered a bullish indicator. Breadth over the past six months has been the narrowest since at least 2005, with only 38% of S&P 500 constituents outperforming the index, yet the market has risen more than 10% over this timeframe.
Higher stock market prices are stirring FOMO (the Fear of Missing Out). Call options (which give the owner of the call the right to buy stocks) are one way for investors to bet on higher prices. Speculative positioning in calls is the highest since…ever.
Turning our attention to relative valuations, two anomalies stand out. First, the valuation of U.S. stocks vs. foreign stocks is historically wide when measured by the Cyclically Adjusted Price-to-Earnings (CAPE) ratio. The CAPE ratio is simply the average inflation-adjusted P/E ratio looking back 10 years. A variance of this extreme last occurred when Japanese stocks rose 244% from 1985 – 1990. Since the Financial Crisis, domestic stocks (as measured by the S&P 500 Index) have gained 269% vs. 75% for international stocks (MXEA Index).
The other relative value relationship of interest is Growth vs. Value. Investors pursuing a Growth style of investing seek companies offering strong earnings growth potential. In contrast, Value investors pursue stocks whose prices appear to be selling at a discount in the marketplace. Throughout history, there is a fairly regular rhythm of one style outperforming the other, but the relative outperformance of Growth over Value is more extreme now than at any time since the Dot.com Bubble.
Finally, while U.S. stock markets hit new highs last week, bond investors are less optimistic, pushing yields in the belly of the Treasury curve lower than the front end. It’s also worth noting that the yield on the 30-year U.S. Treasury hit an all-time low of 1.91% on Friday. There are a lot of factors contributing to the unusual shape of the yield curve and historically low rates. In sum, bond investors are telling the Fed that monetary policy is too tight and forecasting slower growth and lower inflation ahead.
So, what is the point of sharing all this data? The point is to highlight that extreme moves in markets generally mean revert to historical levels. To be clear, this is not a call that financial markets are about to crash. It’s not an all-clear sign either. Financial markets can and do crash, often without warning.
Instead, this message is intended to illustrate that many markets and market segments are overextended. While the natural pull for investors is to invest in what’s worked lately, over the long run, you will be better off diversifying your portfolio beyond the confines of domestic growth stocks and traditional fixed income. For example, the chart below illustrates the performance of what most consider a diversified portfolio consisting of 60% S&P 500 stocks and 40% traditional bonds. On an inflation-adjusted basis, this well-respected portfolio strategy delivered flat or negative returns regularly over the last 120 years. “Lost Decades” of flat portfolio returns may not seem important, but when one is withdrawing capital to fund their lifestyle or retirement, flat portfolio performance translates into negative wealth creation. Note also, that when viewed on a risk-adjusted return basis (e.g., returns vs. volatility) the last ten years are tied for, if not the best performance ever, for a 60/40 portfolio. Will the next ten years be the same, or might there be a reversion to the mean?
The desire for portfolio diversification has waned as few investments, active or passive, have kept pace with domestic growth stocks. Reflecting the human tendency to think the future will look like the recent past, investors are increasingly shunning diversification. After all, if equities have been good recently, why allocate to investments that haven’t? While we understand this motivation, running away from diversification, particularly at present, is a dangerous idea. Rather than concentrating further in domestic growth stocks, we favor increasing portfolio exposures to include real estate, private equity, uncorrelated trading strategies, long-volatility positions, private lending, Value styles, and international equities.
Diversification, as a theoretical concept, is not controversial. In practice, however, building and maintaining truly diversified portfolios can be more challenging as behavioral biases, and career risk concerns filter into the investment decision-making process. The magnitude of these non-productive influences increases in proportion with domestic equity market performance, making the latter stages of market and business cycles challenging for investors. It is worth keeping in mind that diversification is most powerful when a cycle ends, not in the final stages leading to the end of the cycle. Unfortunately, these latter stages of a cycle are precisely when it is most intellectually challenging to stick to a plan by resisting the “Siren Song” to increase exposure to what has been working recently.
In the current environment, investments that have been working recently have largely become expensive. No one knows what markets will do or when they will do it. But, unless you believe this time is different, history shows that markets tend to mean revert. Investors must make a decision. Invest as they have done recently and hope for the best, or move to embrace the wide variety of alternative investments available in the market today.
On this episode of Creating Richer Lives, Karl discusses how two different decades in the past gave investors very different results depending on how they were allocated. What will this decade bring?
Plus, an update on the Coronavirus and the stock market.
Hey, good morning everybody. Welcome to the show. This is Creating Richer Lives, the podcast. My name is Karl Eggerss. Hey, don’t forget, you can check us out on creatingricherlives.com is our website, and our telephone number, (210) 526-0057. If you have a comment about the show, if you have a topic that you want covered, if you need help in the financial planning realm, anything in your life regarding your finances, investment management, you have some questions regarding when to take social security and stock options maybe, maybe you were given grants at work and you don’t understand the tax ability of that or the impact, give us a call. That’s what we do here. (210) 526-0057. And of course on the podcast we are trying to make your life richer in many different ways, so we talk about a lot of different things on the show. Jam packed show. And by the way, the show is brought to you by Covenant Lifestyle Legacy Philanthropy.
A lot of stuff going on this week. We’re going to touch on that, and then we’re going to talk about the lost decade. A tale of two decades. We’ll get into that just a minute. Quick little tease there. So of course this was a four-day week, because Monday markets were closed in observation of Presidents’ Day, but it was interesting, even though the markets were closed, we got Apple saying that, “Hey, there’s a warning our revenue’s not going to come in what Wall Street thought.” And the markets were closed, and so it was one of those situations where we thought, “Well, what are we going to see Tuesday morning?” Because that’s a big deal, right? One of the biggest companies that we know of, Apple, is saying that the coronavirus is going to affect their revenue. So was this going to put a dent in all the other companies out there? So that was a big deal.
And again, if you’re looking at this and saying, “Well, this is just China, and we’ve looked at SARS in the past and we got over that,” that’s true. A couple things to consider is that China, and the reason everybody’s making such a big deal about it, is China’s about four times as large from an economic standpoint as they were in 2003. Four times. So the losses there are going to impact the global economy a little more than perhaps they did back in 2003. So yes, it’s a comparison. Yes, we got over that. The markets have done just fine. But having said that, China is a big deal. I mean, their gross domestic product was about 16% of the global GDP for last year. Again, about four times the size of their economy that was there back in 2003. That was only 17 years ago. So that is why people are making a big deal about this. And again, we hear evidence that it’s slowing down. Then we hear, “Well, it’s speeding up in areas outside of China,” right? So you have all these concerns.
So we come in Tuesday morning, not really know what to expect. And what’s interesting is Walmart came out and said they’re going to miss their sales estimate just like Apple. And yet despite that, Walmart was up on Tuesday. Now, the market was down about 250 points for most of the day, but it pretty much still took, even Apple really took some of that news in stride. So again, very persistent, strong bull market.
Wednesday, we get some inflation data coming out, and inflation a little hotter than expected. And immediately the economists were digging into the numbers and saying, “Well, here’s why. There are some unusual things like retailers, their margins have increased, and so therefore they could pass on those expenses,” so to speak. “Those higher prices down. They have room to do that.” You know, sometimes economists rationalize things. Sometimes they are accurate. Sometimes they give you the reason for things. At the end of the day, PPI was stronger than what was expected, but so were housing starts. So the housing market’s still doing extremely well. Building permits, housing starts, very, very strong. So the housing market’s a really bright spot for this economy.
And then we heard about the Fed on Wednesday. The Fed came out with their minutes and essentially said that it looks like they’re going to leave things on hold. They’re comfortable on hold. Now, some of the things that are a concern for the market is that the Fed hasn’t seen the full effect. When these minutes took place, remember, these are the minutes from a prior meeting, when that meeting took place, there were some things around the coronavirus that weren’t fully put in or they knew about at that point. So they mentioned the coronavirus, but let’s see. So the market’s pricing in, this is important, they’re pricing that the Fed’s going to cut rates again later this year.
So we have a stock market that’s near an all-time high. We have an economy that people think is great, and yet the Fed’s acting as if we’re in a recession. What’s going on here? These two things seem to oppose each other. But the Dow was up that day. Yield curve continues to flatten. That’s another thing. Remember, 10-year treasury rates, what those rates are compared to two-year treasury rates. Very little difference now. So again, people worrying, “Are we going to have a recession?”
Thursday, China cuts interest rates, and we’ve talked about that huge deal. One reason why I do think the stock market is sitting near all-time highs is because China has provided more stimulus to try to prevent a global recession. We also saw Morgan Stanley buying E-Trade. That whole deal continues, right? Schwab’s been in the news, TD Ameritrade’s been in the news. We’ve had Morgan Stanley buying E-Trade. I mean, a lot of consolidation going on in this industry, and the Dow fell 400 points very quickly on Thursday. That was something that it was very … Had a little flash crash feeling to it. Now, for those of you that don’t know, remember, 2010 we had a flash crash. The Dow fell 1,000 points very quickly. And that was when the Dow was much, much lower. Then in 2015 we had flash crash 2.0, I call it. We woke up, it was a Monday morning, markets fell drastically and then bounced back. Very interesting to watch.
This wasn’t as much. It was 400 points. Again, the Dow’s almost at 30,000, so 400 points, not a huge deal, but how fast it happened. And there was rumors the reason that happened so quickly was because algorithms kicked in, computers, and started to sell based on a headline of a newspaper in China about coronavirus. So that’s how fragile sometimes the markets are. Dow finished down about 130 on Thursday.
And then Friday we got a lot of news. Yesterday we got news that we saw an economic indicator called the Markit Services PMI came in, and it was under 50. That may not mean much to you, but under 50 means contraction. Over 50 means expansion, and their manufacturing number missed as well. So people are clearly worried about the economy right now. Continuing, we continued to see issues about coronavirus. Again, there was news out of Italy that it’s spreading there. So again, it may be getting a little more contained in China, but you have people traveling still and spreading it. So we’re watching that.
And look, the 30-year treasury rates, 1.9%, which is probably going to translate down to record low mortgage rates. Refinance, refinance, refinance if you can. Take advantage of these low rates. Yes, they’ve been around for a while. Maybe they’ll be here a little longer, but do yourself a favor, go check. Can you refinance some of that debt out there? And so we saw the market kind of struggle most of Friday, and James Bullard, and maybe this was one reason, James Bullard, who’s a member of the Fed, was on CNBC saying, “Maybe we don’t need to lower rates if the impact of corona is temporary.” And that’s really the struggle here, is because you have some economists saying, “We think this could put us into recession.” I mean, there’s no question that we’re going to take a little slowdown hit because of China, mainly with supply disruptions. Those of you who own businesses know that. There’s other economists who say, “We’re going to take a little bit of a sucker punch into the gut, but we have enough room to spare that we will not go into recession.”
You know, again, we know we’re going to slow down a little bit because of this. How long it lasts, we don’t know. The thing is, most economists have never managed money, so the effect on the stock market is the thing that we care about, right? That’s what you care about. The economics behind it, who really cares? It’s, “How does the stock market react?” If I told you the economy was slowing down six months ago, you would have said, “Well, that sounds really bad,” but yet the stock market has done fabulous. Why? Because there’s been a lot of money put into the system by the Federal Reserve, by China, and by other countries around the world. So that’s what we’re focusing on right now. So let’s continue to watch. Clearly the market’s still a little nervous about the coronavirus and how bad things are going to get, but we’re still hanging around the all-time highs.
Now, as we do that, we continue to see this interesting market where you’re really seeing things that are performing very well, and some things that are performing are lagging, and they’re performing poorly and lagging behind. What are those things? Well, we know foreign markets have been that way. We know value stocks have been that way, and people are getting trapped, I think, into buying what is working as opposed to staying diversified, rebalancing. Continue to buy the international stocks and small cap value. You know, those areas, for example, if you are way, severely underweight.
I mentioned the tale of two decades. There was a piece that came out from Dimensional Funds, and full disclosure, we have and and do own some Dimensional Funds along the way, but they put out some good research, and they had a piece last month called A Tale of Two Decades, and it was lessons for long-term investors. And it was really interesting how, if you look at the 2000s, 2000 through 2009, the S&P was down almost 1% per year for 10 years. Here’s the things that were up, though. Their international small cap value fund, for example, made almost 14% per year that decade. Emerging markets, over 10% per year. So they had five other funds that were listed here that did very well during that decade. It was the S&P 500 that lagged.
Now, let’s fast forward. The 2010s. January, 2010 through December, 2019, it’s the S&P that has performed very well, about 13 and a half percent per year. Meanwhile, if you look at those other areas, they’ve underperformed pretty significantly. The point of this is if you look at the broad context of the last 20 years, you put those two periods together, those other areas have still outperformed the S&P 500, and right now what you have is three or four stocks really lifting the markets right now. They are responsible for most of the market’s gains in 2020.
As we move forward, it’s going to be very important, in my opinion, to continue to have a diversified portfolio, because it’s not always going to be the US bond market and the US S&P 500 that are the main places to go. There are going to be other places. The divergence between value and growth has never been larger in the US, and we’re really seeing the same thing. We did some research. We’ve really been seeing the same thing internationally in terms of value and growth. So this becomes important when you look at your 401k allocation, when you look at your overall investment allocation, that you don’t get sucked into just owning what’s working and saying, “Well, when something else changes, I’ll change my allocation too.” Because you probably won’t do it in a period of time. So really interesting, because it really was a tale of two decades, depending on what you own. So as we move into 2020 to 2030, what is that decade going to look like? And it’s probably going to look different than what we just experienced. So what does your portfolio look like? Extremely important to analyze that now.
Now, one other thing I wanted to mention too is that we saw, last week we saw the Democratic debate. We have another one coming up Tuesday. You know, it’s interesting, if you look at the Trump odds of winning the presidential election on predictit.org, there’s a high correlation between his odds and the S&P. When his odds go up, the S&P does well. Why is that? Well, clearly when you look at who’s leading in the Democratic race, Bernie Sanders, he’s an open socialist that does want higher taxes. His highest marginal tax rate, according to the Wall Street Journal is 69%. So for folks that are looking at that and running businesses and so forth, they don’t like that.
And I think again, if you’re looking at change coming, which there would be some significant change if Bernie Sanders won the general election, then you would see that change. And so obviously people, the way they do business, the way they invest in things would change, and so that’s why you’re seeing the market sometimes move the way that is. Now, the markets are bigger than elections. Let me be clear about that. But in the last few months, it’s been clear that as these polls change, the markets change. Multiple factors, multiple factors in moving stocks for the longterm, okay? Stocks have done well under Democrats and Republicans, they’ve done poorly under Democrats and Republicans. Doesn’t have to do with that. It has to do with what the policies are today, where they might be going, and what that can do to our investments. So that’s really what we’re watching.
So continue to watch those, and as we get closer and closer, but as I’ve been saying, take your portfolio, assume one president’s going to win, assume another candidate’s going to win, what the market might do, and have a portfolio that really is balanced and you can weather any type of storm. Yes, you’re going to make modifications based on all kinds of things. That’s what we do, but to be saying, “Well, I’ll just keep a lot of stocks now, and if somebody else wins, I’ll change it,” it doesn’t work that way. By the time you do that, things will have drastically changed. You’re not going to get the timing right on that, so be very careful with that.
All right, guys. Have a wonderful weekend. Really busy week, we had, of course in the markets, and let’s look forward to next week. Don’t forget creatingricherlives.com, and our telephone number (210) 526-0057. Have a wonderful weekend. We’ll see you back here next week on the podcast.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, including the investments and-or investment strategies recommended or undertaken by Covenant Multifamily Offices, LLC, Covenant, or any non-investment related content will be profitable, equal any corresponding indicated historical performance levels, be suitable for your portfolio or individual situation, or prove successful.
Moreover, you should not assume that any discussion or information serves as the receipt of or is a substitute for personalized investment advice from Covenant. To the extent that a listener has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with a professional advisor of his/her choosing. Covenant is neither a law firm nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of our current written disclosure brochure discussing our advisory services and fees is available upon request or at creatingricherlives.com.
Karl Eggerss was interviewed on CBS and discussed how to avoid making mistakes with your money the closer the election gets.
Sharon Ko: Election season gets people fired up on both sides of the aisle. Consider how changes to the oval office can affect your money. First, expect fluctuations.
Karl Eggerss: We tend to see a weak stock market after a new president takes office, which makes sense because they may have a different philosophy. Obviously, it could lead to a different Congress. So again, you could have all types of changes happening and that… Wall Street doesn’t like uncertainty.
Sharon Ko: But with that, financial advisor Karl Eggerss says, “Don’t let your emotions muddy your strategy.”
Karl Eggerss: We saw that back in the last election, as a matter of fact. Nobody really knew what was going to happen, who was going to win, and the market went one direction then changed violently the other direction, started to go up and people were caught that made too big a moves. They were caught on the sidelines not really knowing when to get back in.
Sharon Ko: So what is the best action to take? Eggerss says stress tests that portfolio of yours.
Karl Eggerss: Think about possible scenarios today because things can change, right? If we do have a different president, if we have a different Congress, tax rates could change. So it’s best to have a diversified portfolio. Sounds a little cliché, but a diversified portfolio that can weather the storm, and that’s one that you can sleep at night with, regardless of the outcome of the election.
Sharon Ko: The top assets he recommends to invest in, stocks and real estate, they perform the best long term.
On the Trey Ware Show, Karl explained why stocks have continued to move up recently despite what seems like bad news.
Trey Ware: Well, let me get my friend Karl Eggerss in here from a creatingricherlives.com joining here on the Stevens Roofing Newsmaker Hotline like he does every single Monday. And Karl this thing over with the coronavirus, it has been growing and spreading and most of China is basically shut down now. It’s a big, big economic story, isn’t it?
Karl Eggerss: It is. What’s interesting though is why is their stock market, it’s erased all of the losses, when the Corona virus first came out and people are wondering, why is that? And it’s because they’re cutting interest rates, they’re injecting capital, and they’re doing these things to stimulate their economy because they are fearful that this is going to spiral down and cause the massive recession. But the stock market has recovered its losses and then you look at our stock market and it’s pretty much near all time highs as well, and it’s pretty much for the same thing. People look at the Federal Reserve and what are they doing? The Federal Reserve is not going to raise interest rates anytime soon. In fact, they’re probably going to cut them.
Karl Eggerss: And so that’s the key to making money in this market, is not necessarily reacting to the news. Take the news into consideration, but with your portfolio look at what’s going on behind the scenes and figure out why are stocks [inaudible 00:01:10] the way they are. And it’s really interesting to watch. I mean, you have these countries injecting all this money as if we’re in a recession and Wall Street’s loving it and putting a ton of money in there. Now, again, I want to be clear, I’m not saying that is the healthiest thing long term, so I think that could lead to long term issues, but short term, Wall Street’s loving it.
Trey Ware: Yeah. We haven’t reached the 30,000 mark. Any doubt in your mind that we’re going to get there before long?
Karl Eggerss: I think we’ll get there. I really do. And I do think we’re starting to see a little bit of complacency on the part of investors, which is interesting to watch. So I expect they pull back at some point here, again, because we have one almost every year in some form or fashion. But, again, as long as the Fed’s staying and their minutes are going to come up this week from their meeting, as long as they say, “Hey, we’re concerned about the coronavirus, we’re concerned about a recession, and we’re not going to raise interest rates,” then the market probably will surpass 30,000 in short order here.
Trey Ware: Yeah. And meanwhile, the fundamentals are the same, so stay in there, hang in there, if you’re going to be a long term investor. Thank you, my friend. As always, Karl Eggerss from creatingricherlives.com. Check him out and he’s here with us every Monday at this time.
By Justin Pawl, CFA, CAIA
In this week’s edition:
- Fed Policy Update – The Covid-19 virus may force the Fed’s hand.
- Losing Altitude – The January retail sales report was crummy.
- Rising Optimism – Not all economic data releases last week were bad.
Last Week Today. The Treasury auctioned 30-year bonds at 2.061%, the lowest yield in U.S. history, a sign of low inflation expectations as well as an indication of how low/negative global interest rates are pulling down rates here at home. | With Q4 earnings announcements nearly complete, we now have a pretty good understanding of the profit picture. As it turns out, management teams did a good job of sandbagging as S&P 500 company earnings were +2% vs. expectations of -1% at the start of earnings season, boosted by a lower than anticipated effective tax rate of 17% (vs. 20%). | The World Health Organization officially named the disease caused by the corona virus Covid-19. | The U.S. raised tariffs on European Union aircraft imports from 5% to 15%. | On Friday, the U.S. reduced tariffs on $120 billion of Chinese goods as part of the Phase I trade deal.
Two weeks into February, and global equity markets are, so far, shrugging off the negative news and global growth implications of Covid-19, though updates on the pandemic still move markets. The major domestic indices all hit new highs, propelled by growth stocks. The tech-heavy Nasdaq Index is up +6.5% for the month and +8.6% for the year. The more balanced S&P 500 Index gained +1.6% for the week and is +5% YTD. Meanwhile, international stocks are experiencing ‘failure to launch’ thus far in 2020 – the MXEA Index (developed international equities) is up on the month, but it’s flat for the year. Yields on U.S. Treasuries ended the week relatively unchanged, but exemplary of the risk-on appetite, the spreads on high yield bonds ratcheted lower. The price of WTI Crude bounced +3.4% for the week, but remains down -15% for the year at $52.05 per barrel.
For detailed weekly, MTD, and YTD financial market performance, click on the table below:
Fed Policy Update. Federal Reserve Chair Jerome “Jay” Powell spent two days testifying before Congress last week as part of the Fed’s semi-annual Humphrey-Hawkins testimony. Powell’s message was one of confidence that current interest rates are appropriate, similar to his message following the January FOMC meeting. He was, of course, asked about Covid-19’s impact on the U.S. economy. Powell’s response was honest and accurate, and can be summed up as the Fed doesn’t know what the effect will be, but it’s “very likely” to have some impact on the U.S. He went on to say that the Fed will act if the virus “leads to a material reassessment of the outlook”. This stance is consistent with the Fed’s messaging since they stopped lowering rates last October: interest rates are in a good place and will stay here unless the Fed is forced to act. Careful Fed watchers pointed out that Powell’s comments imply the Fed is more likely to ease than raise rates this year, since his original remarks in October preceded Covid-19. Which brings us to the week’s economic data…
Losing Altitude. The retail sales report for January was flat out bad. Although headline sales increased by the consensus forecast of +0.3%, the GDP influencing “control group” was flat (the control group excludes sales receipts from more volatile retailers including auto dealers, building-materials retailers, and gas stations). Adding insult to an already weak report, the previously reported robust retail sales of +0.5% for December were cut by more than half to +0.2%. In sum, consumers began stuffing their hands in their pockets in the fourth quarter, and as of January had still not pulled out their wallets. With consumption making up nearly 70% of GDP, Q1 growth is starting out on shaky ground. Keep in mind that this data preceded the outbreak of Covid-19 and its attendant disruptions to global supply chains, which will not have a positive impact on the U.S. economy.
The chart above highlights the volatility of retail sales (note the gray line), so it’s possible that next month’s revisions will show an upward adjustment and the troubling trend will reverse. However, if the consumer does not get in gear soon, the Fed will be hard pressed to refrain from cutting interest rates (Presidential election or not) without risking a recession. Moreover, outside of inflated asset prices, the Fed is clear to cut rates as inflationary pressures (as measured by the Fed) are subdued. If the economy were a plane, it would be flying uncomfortably close to the ground. At 2%’ish growth it’s more vulnerable to a recession than if it were growing at 3% or 4%. It’s not time to brace for impact, but the plane did lose some altitude with this latest retail sales report.
Rising Optimism. Economic data released last week wasn’t all bad, though data from even a month ago needs to be taken with a grain of salt since much of it reflects information prior to the spread of the Covid-19 virus. Nevertheless, both the NFIB small-business optimism index (rising from 102.7 to 104.3) and consumer confidence data improved.
The University of Michigan’s consumer confidence measure improved to a near two-year high of 100.9. This closely monitored measure of consumer confidence consists of two sub-indexes:
- The Present Situation Index – consumers’ assessment of current business and labor market conditions
- The Expectations Index – consumers’ short-term outlook for income, business and labor market conditions.
Importantly, much of this month’s bounce came from the expectations index, which has been trailing the current conditions index by a wide margin. The general pattern for these two indices is that during periods of economic recovery, the Expectations Index will be higher than the Present Situation Index, as consumers anticipate better times ahead. On the other hand, in the mid-to-late stages of an economic cycle, the Expectations Index tends to lag the Present Situation Index as consumers grow increasingly skeptical about the future. While both data series are volatile, wide gaps between the Present Situation Index and the Expectations Index have presaged economic recessions as illustrated in the chart below.
Sources: Bloomberg, L.P. and Covenant Investment Research.
In February, the Expectations component jumped from 90 to 92.6. While the Expectations Index remains well below current conditions, if consumers are becoming less concerned about the future, they are more likely to spend money now and that could augur for a rebound in retail sales. Every journey begins with a single step.
On this week’s podcast, Karl Eggerss explains why the rest of the world is just figuring out what we already knew about China.
Hey, good morning everybody. Welcome to the podcast. My name is Karl Eggerss and this is Creating Richer Lives, the podcast version. Of course, if you want the other version, the website version, just go to creatingricherlives.com. And you also can give us a call at (210) 526-0057. And a just a reminder, the show is brought to you by Covenant, lifestyle, legacy, philanthropy. I had somebody this week as a matter of fact, I had a meeting with them.
We were talking about different things, and one of the things regarding social security, I’ll mention in just a minute, but they said, “We always like talking to you because we always realize or learned something that we didn’t know before.” And I said, “Well that’s our goal.” Because yeah, it’s easy to say Covenant does financial planning or does investment management or does tax preparation, but at the end of the day we are a financial advisor really helping you extract value any way we can.
In fact, this particular client didn’t know that they could claim their ex husband’s social security and nobody was going to tell them that except for us, and so we did that. And also speaking of social security, that same individuals got confused about the tax ability of social security. And it got me thinking how many other people out there have this same concern?
And here’s what it is. If you’re single, you can make, I believe it’s $25,000 a year and your social security is not taxable. And then between 25,000 and 34 and change, it’s taxed at half. And then above that, 85% of it’s taxed. She thought that the tax on her social security was 85%, like the tax rate. And I said, no, no, no, 85% of the social security is taxed. So when you look at your tax return, there’s a box that says, what did you get on your social security?
They look at the rest of your income and then a portion of that is going to be taxed and that number gets added to the rest of your income before your deductions and so forth. So big clarification there. And again, she might’ve filled out her tax form incorrectly if she was doing it herself. So watch that. That is something that, I don’t know. Did you think that, and it’s interesting because I’ve had people over the years tell me, my social security is, almost all of it’s taxed.
And I’m wondering if they’re thinking that it literally, we don’t get almost all our social security because it goes away to taxes. That’s not the case, it’s how much of it is taxable. So I wanted to clarify that. Hopefully, you don’t think that. Anyways. All right, well let’s jump right in to the week here, because we had another interesting week, didn’t we?
We had really, we thought Coronavirus was kind of in the rear view mirror and it kind of was, it seemed like at least Monday and Tuesday we saw the market pretty strong on Monday, pretty strong on Tuesday, and really the big news Monday and Tuesday was Jay Powell, head of the Fed of course saying, “Hey, we’re monitoring the Coronavirus.” And the market kind of sold off a little bit, but nothing major, right?
And I was, by the way, I was watching these politicians ask Jerome Powell these questions, and they’re kind of comical because they ask questions that sounds like a third grader asking questions, where they’re trying to ask a question about the economy or interest rates, and they just don’t know what they’re talking about, but they’ve got their time and they’re trying to sound smart, and unfortunately they don’t, and I was literally laughing listening to some of these questions.
So, but he testified and nothing major there. And then of course, Wednesday we had another strong day up almost 300 points for the [inaudible 00:04:53]. So we’re rolling along during the week. And then it got interesting. After the bell, we get some “updated numbers” on the Coronavirus from China. And they said, there’s actually a few more cases because we’ve been, we changed the way we calculate it.
And I had to laugh because the rest of the world’s like, “Oh my gosh, China change their numbers on something? How could they have been so wrong?” And I had to laugh because in the finance world, and you guys know this, because most of you have been listening for a while, China changes their numbers all the time on stuff, and a lot of people don’t believe a lot of the numbers coming out of China, right?
Do you trust the growth rate? Do you trust some of the earnings coming out? Do they use the same accounting methods? Do you trust all of these things? And most of the finance world has always taken some of their data with a grain of salt and now the rest of the world says, “Yeah, maybe we should take all of their data with a grain of salt in terms of the Coronavirus.”
So it got people thinking, is this a bigger problem? Again, is the slowdown that we saw with the Coronavirus, is that really not happening? So we saw a little bit of weakness on Thursday, little bit of weakness on Friday, kind of a flat day during the week. Now Friday, there was a huge divergence between growth, we’ll call growth momentum. We’ll throw that in the same bucket versus value.
And this is no, really nothing new under the sun, right? We continue to see that, but big big divergence on Friday and for the year, we’re sitting here with value stocks down on the year. Meanwhile, the NASDAQ is up quite a bit over 8%, and so what’s going on here? Well, I saw an interesting thing this week talking about previous bubbles. I don’t know if you think we’re in a bubble or not. I don’t think the market is in a bubble, but I do think there’s pockets of bubbles, but they called this particular bubble, the disruptors bubble.
And I think that makes sense. I think if you look at the companies that are getting rewarded. Amazon changing retail, that’s a disruption. They’re changing the way retail is happening, not new. They’ve been doing it for a while, but changing it.
Tesla, the stock that’s gone vertical as of late. Why now? Well, disruption, right? Changing the way automobiles are running from a combustible engine to battery technology. Google, right? I can look up any information in less than a second on Google, and the way they really have monetized advertising.
Microsoft, how much more productive has Microsoft made us. You see though that most of these are technology companies and that’s pretty much what’s been working, but they’re not cheap. That’s the key. Why don’t we just go and dump money in that if that’s the key?
Well they’re not cheap. I mean, I frankly think Microsoft is very expensive right now. And I understand why it got to this point, but very expensive and that’s… Microsoft is a fascinating and great company, all of these companies are, that’s not really the issue. It’s what are you paying for these companies. Had you overpaid for some of them during the dot-com bubble, you had to wait 15 to 20 years just to break even.
So I think that’s the decision as investors we have to make is, we want to continue to participate in the market. The market has been strong, we’re still in a bull market. The Coronavirus is for the most part being shrugged in terms of the financial markets. So we want to participate, but we have to continue to participate in a smart manner, because things are getting more and more expensive. And so you have to really continue to know what you own.
But look, let’s switch gears, why is the market continued to go up? Why is it shrugging off Corona, and it is. How do I know that? Because we were at an all time high just a few days ago. The reason why it’s going up, let’s go look at the Fed’s balance sheet, the Federal Reserve, go look at their balance sheet. They were trying to shrink it in 2018.
Now, yes we had tariffs, but they were trying to shrink it and they were shrinking it in the market through a tizzy, right? And the fed was raising rates, and we had that 20% decline in the fourth quarter practically of 18. Why did it turn around so dramatically? Yes, it was oversold. Right? But the Fed stopped raising interest rates and not only that, they started increasing their balance sheet. Go look at a picture, it’s a V-bottom.
I mean it literally turned around and now they’re increasing their balance sheet, doing these repo agreements and all of that. They are injecting money into the system and as they continue to do that, that’s all the market seems to care about. That is the main thing driving stocks right now.
Now, are companies going up in their stock prices because their profits are rising? Yes, there’s plenty of companies doing that, that’s why stocks go up. But when you look at the overall market and see the persistence it has had you wonder why this is. I mean, Morningstar put out a piece the other day saying that there has not been a 2% trading day up or down for stocks since August 23rd of 2019, 110 trading days. Why is that? The Fed’s injecting capital.
So, as investors it confuses us sometimes. We look and say, but what about the news? But what about world war three? Remember that a few weeks ago? What about politics? All of this trumps that. And that’s the key, is to understand what’s moving the stock market more than why you think it should be moving the stock market. A lot of people have been sitting out this rally because they don’t agree with it. You can do that, but at your own peril, because it has been going up and it’s been strong, and it’s primarily been because the Fed has been injecting more money in there.
Now let’s spend a couple of minutes. I got this question earlier in the week. How do politics factor in to the stock market? Well, we know over the next few months, things may get a little more volatile, especially if the poll numbers start to change a little bit. And the reason why is, nobody likes change, right? Even if you don’t like the current president or love the current president, or like the current policies or hate the current policies, you know what you’re dealing with.
And when they’re stumped in changes coming, that’s when markets get a little unsettled. And that’s why you tend to get a weak stock market after there’s a change in the presidency, because there’s a change. Something is going to change. That president who got in there didn’t run on, “I’m going to keep everything in exact same.” Right? That wouldn’t get anybody elected. They say, I’m going to fix this and fix that and I promise this promise that.
And therefore markets tend to struggle in the first year after a change. So if we get a change, yes, could we see some, a weak market? Absolutely. But there’s other factors in there. Right? I just mentioned the big one, which is the Fed. What is the fed doing? And then right now the Fed is keeping rates very low and they probably will all through the election and look, another reason they’re keeping them low, by the way, is got some pretty crappy retail sales report on Friday.
So we need to continue to watch the consumer. Next week, we’re going to get housing coming out. Watch that. Watch the consumer here. Watch the hours worked, watched their wages. That could give you an indication on, yeah, the fed may not be raising interest rates, but if the economy gets too weak, is the Fed not lowering enough? So yes, the market’s loving the capital injection right now, it just may not love how slow the economy may get.
So let’s watch that, too early to predict, right now the market loves the Fed injecting money even though the economy is kind of cruising along. But getting back to these politics. Look, if you try to predict what’s going to happen in the election and drastically change your portfolio, you could get hurt.
Look what happened in the last election. People tried to bogey that, really really got hurt. What I would suggest, be proactive, not reactive. Have a portfolio that you automatically say, if the market fell 10%, 15%, 20%, if interest rates rose a little bit, how would mine react? And there’s ways to test that. But if you look at that and you build a portfolio you can sleep with now that’s built on not only can you sleep with it, but is it really accomplishing your goals for the long term?
If you have that portfolio, then you don’t worry as much about the election. Could it be stressful and bumpy times? Yes it could. But what you don’t want to do is say, “I’m going to be very aggressive right now while things are good and then when the election comes, I’m just going to sell and then I’m going to buy back in the low.” It doesn’t work that way. Again, go back and look when’s the last time you did that successfully?
So, have a portfolio that can withstand some of that. I hate using the term all weather, because that makes it sound like it’s bulletproof and that’s not what I mean, but an all weather portfolio that at the end of the day is diversified. A little tip here, as you get ready for tax season, you’re gathering your things, all of that. One of the best ways to do it, obviously make a file as the year goes along, but go ahead and make a checklist of things that you’re providing to your CPA or you’re doing yourself, and then next year you’ll have that checklist so you know what you’re waiting on.
Are you waiting on a K-1, are you waiting on a 1099? And that way it’ll be a little easier and you can check those off as they come in. So tax organization, big, big dealers, there’s portals to do it. If you’re working with a CPA, maybe they’re providing that list to you, but the more organized you get, the easier it will be.
And nowadays with everybody using the standard deduction, it seems like taxes are a little simpler than they used to be. At least that was the goal. And we got news late Friday that, speaking of taxes, that the white house is proposing that we may be seeing some tax incentives for Americans to buy stocks, that was the late news on Friday. Basically, who knows what it is, but outside of your 401k, maybe getting a tax deduction for investing.
So it almost work like an IRA, I suppose. I don’t know what all the rules are, they didn’t really say what all the particulars are tossing things out there. And you’ll probably see this as we move along the rest of the year, where you’re going to see all kinds of proposals being tossed out there, because tax cuts get votes, right? So we’re going to hear a lot about that. We’re going to hear a lot about, we’re going to get drug prices down. We know the usual game coming into the election season on both sides.
So let’s see that, but that was interesting, came out late in the week regarding taxes, but stay organized and don’t let it overwhelm you. We’re sitting here on February 15th, so we got a couple of months still. Hey, by the way, don’t forget Monday the stock market is closed in recognition of president’s day. You guys have a wonderful weekend and don’t forget creatingricherlives.com. Our telephone number (210) 526-0057, if Covenant can do anything to help you and your situation, don’t hesitate to reach out to us. Take care everybody, have a great weekend.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy or product, including the investments and or investment strategies recommended or undertaken by Covenant Multifamily Offices LLC, Covenant, or any non-investment related content will be profitable, equal any corresponding indicated historical performance levels, be suitable for your portfolio or individual situation or prove successful.
Moreover, you should not assume that any discussion or information serves as the receipt of or as a substitute for personalized investment advice from Covenant. To the extent that a listener has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with a professional advisor of his/her choosing.
Covenant is neither a law firm nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of our current written disclosure brochure discussing our advisory services and fees is available upon request or at creatingricherlives.com.