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The Market Awakens!

| November 16, 2015
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THE LIGHT HAS NOW TURNED GREEN?

Yoda in the Star Wars movies cannot predict the future with great certainty, but he is incredibly attuned to the present.  Likewise, we can read when things have already improved to the point where we are comfortable re-engaging, but knowing when this is going to happen weeks or months in advance is akin to guessing the daily temperature highs and lows on Signal Mountain six weeks from now.  We are currently more aggressively positioned and have been for the last few weeks.  The S&P 500 moved past its mid September rally high during the second week of October and we started repositioning in an effort to take advantage of this soon after.  Being more conservative and playing defense during the off months protected us during August and September.  We can always wish we were more defensive just after the crisis strikes but it is good to have repositioned in any event.  We did not expect this recent correction to develop into much more than it did, primarily because our economy is still relatively stable.  Yield curves and Leading Economic Indicators give us a good precursor to when things are deteriorating in these areas and we are still looking good. 

What tends to do best during this time of the year?  Look to the Chart below from the Stock Trader's Almanac to see what has worked since 1990.

Click Here for a larger version of this chart.

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EARNINGS LOOKING GOOD

Over 1,200 companies have reported their results for the quarter.  The percentage of companies beating their revenue estimates for the Q3 of 2015 stands at 46.9% which is currently below the average of the 60% that we’ve seen since 2000. It’s been a really poor showing for revenue over the past three quarters.

The percentage of companies beating their earnings estimates stands at 63%, which is now above the average of 62% dating back to 1998.  Last week we stood below the average so it was a nice move to the upside over the past week.  If the 63% reading holds, it will be the best reading since the Q4 of 2010.

Below is a chart that shows the spread between companies guiding future earnings higher or lower on a percentage basis. Up until the Q1 of 2014, the spread had been negative for the ten previous quarters, meaning there were more companies stating they would earn less in the upcoming quarter than the same quarter a year prior. That’s 2.5 years of pessimism coming out of corporate America.

Of the last 17 quarters, two were about flat and the rest were negative.  It’s interesting to me that companies are guiding lower as the market goes up.  If I see this invert, it will have my attention – it could be a good indicator of corporate over-confidence.

RISK HAS PAID OFF RECENTLY

Investors who want to take on the most risk have generally been rewarded the last few years.  The most aggressive investors and our most aggressive clients have fared well, especially if they owned primarily U.S. Investments last year and shifted somewhat to more international holdings this year.

Those who are more moderate investors and those who are primarily investing for a high level of income may be wishing they want to be more aggressive until they see a market drop like we saw in late August to early October.

Conservative investors have become more and more uncomfortable, however.  Yields have continued to decline.  Ben Bernanke coming out of late 2008 early 2009 did everything he could to get people away from hoarding cash and bonds and taking on more risk.  No longer does it make sense to hold these assets the way it used to, if someone needs to make greater than 4%.  The inability to get decent yields from bonds has forced some people higher into the risk spectrum with more volatile portfolios in an attempt to achieve their goals.

Those late to move funds from bonds to other types of investments received a wake up call in 2013 when they learned that bonds were no longer as steady and stable as they thought.  "Conservative" bond portfolios suffered mid year losses in the "bond panic" of 2013, but recovered over the  next few months as interests rates settled back down.

If a client wants to be relatively conservative but needs to achieve a rate higher than 4%, it is hard to do this without taking on more volatility these days.  We still advocate shifting from a slightly more aggressive posture to a slightly more conservative posture when danger signals start flashing as they did earlier this year.  "Safe investments" outside of short term holdings and insured products will fluctuate more widely in value in this current environment.   Of course if you did not catch the meaning of the quotation marks above, we know there really is no such thing as any investment without some sort of risk involved.

For this reason we have been looking for more bond substitutes for portfolios that pay good interest and dividends.  These holdings are less subject to being influenced by a "bond panic" but are somewhat susceptible to the stock market.

 

Below is what we wrote in September. Click here for the entire blog.

  1. We don’t see this correction leading to a bear market (defined as a loss of 20% from the high) because the U.S. economic data remains solid, commodity prices and inflation are low, and monetary policy will remain extremely accommodative … even if or when the Fed hikes rates.

 

  1. Do an autopsy on your recent behavior. Let’s just say that you sold at the very bottom on Monday. Okay, it turns out that there is something very valuable to be learned from this.  People who find themselves in this situation are going to set themselves up for success going forward because they are either going to realize the true benefit of having and sticking to a longer term plan, or they are going to realize that they never had the stomach for the risk in the first place and will do a complete reassessment of their entire situation.  There is nothing wrong with anyone determining that the level of risk they had was much higher than what they were comfortable with.  Go back to the drawing board and figure out the right combination that supports the plan and overall objective.

 

  1. China and the Emerging Markets (EM) – We think that sentiment in general is at a rock-bottom level and this despair is overblown. We are not putting cash to work in either place, but are just pointing it out.  China reminds us of Japan in the late 1980s currently.  While we believe they should recover faster than Japan, we also remember the Japanese stock market malaise of the early 1990s having little impact upon us here in the U.S.

 

  1. With all of this volatility, it’s important to pay attention to two huge global economic engines: the U.S. and Europe. While it’s hard to really focus on this, both are in good cyclical shape and foreshadow better global trade ahead.

 

  1. We have noted high dividend paying stocks have suffered more than the rest of the market.  We would expect many of these types of investments to look much better over the next few years than they have over the last few.  It has been a long time since we have seen dividend yields of over 7% in our Income Model.  To explain this more simply, the stocks are paying out interest in the form of dividends (typically quarterly) that currently amount to over 7% of the current value of the portfolio.  So for those income investors who own these stocks, they would have an addional amount of cash in their account at the end of a year that would cause the value of the portfolio to go up by 7% if the price of all the holdings stayed the same.  We can make no assurances that the price of the holdings will stay the same, go up or go down at this point, but we are encouraged by a 7% current dividend yield nonetheless.  Many of the holdings are also trading at multi-year discounts to their Net Asset Values currently.

 

WHAT DO WE DO NOW?

There is really nothing new to tell an investor who has a good plan.  Here’s why – there is nothing to do now unless you have recently deviated from the original plan.

We are accountable to you for making sure your investment strategy is meeting the goals and objectives of your plan over the long term and keeping you focused on what you need to be doing to achieve those goals over the long term.  Which by the way, is not a month or quarter or usually even a year or two.  We spend a good bit of our time with people to help them avoid shooting themselves in the foot, helping them realize where their blind spots are and keeping them on the correct path.

So what should you do now? The same thing we would have told you to do in 2009, 2011, 2012, and even three months ago.  Have a plan, be disciplined enough to stick with it and know your need for short-term liquidity.

People who are always doing something end up doing poorly.  How do I know this?  Well there is an annual study called the Dalbar Study.  The study says that as of last year, the 30-year annualized return of the S&P 500 was 11.06% versus the average asset allocation investor who realized an annualized return over the same time of 2.47%.

Do you know why? Because of psychological factors that drive poor decisions and a lack of discipline.

Here’s a chart of the S&P 500 since March 9, 2009.  Think about how many things have happened that the press, the market, investors and advisors could have (and probably did) react to over this time and ask yourself how bad anyone could have done by having a solid plan, a good investment strategy and the discipline to stick with it and do no harm.

 

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CURRENT QUESTIONS YOU MIGHT WANT TO ASK YOURSELF

  • Now that the market has basically made up all of the summer panic sell-off, are you okay? Did it keep you from sleeping at night?  If it did, have you asked yourself why?

 

  • Did you realize that you didn’t like the riskiness of your plan when the market sold off? If so, have you now gotten lazy about fixing it because the market has rebounded?  Have you called and talked to us about it?

 

  • Did you feel like you didn’t have a good fire drill in place?

 

 

"Patience you must have my young padawan"  - Yoda

Data as of 11/13/2015

Joe D. Franklin, CFP is Founder and President of Franklin Wealth Management, a registered investment advisory firm in Hixson, Tennessee. A 20-year industry veteran, he contributes guest articles for Money Magazine and authors the Franklin Backstage Pass blog.  Joe has also been featured in the Wall Street Journal, Kiplinger's Magazine, USA Today and other publications.

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