November 28, 2017
by Jed Sires
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Quarterly Market Commentary

On September 20th, 2017 Janet Yellen announced that the Federal Reserve’s 4 trillion-dollar balance sheet would start shrinking in October 2017. This signals the beginning of the end of the Fed’s Quantitative Easing program (QE), which was started on November 25, 2008. The Fed initiated QE (buying bonds) to help save the economy during the last recession. Near the end of 2014, the Fed ended additional QE, but maintained the size of its balance sheet by reinvesting all bond maturities and income. Starting in October 2017, the Fed will let some of the bonds they own mature, thus shrinking the size of their balance sheet, and reducing QE.

Quantitative Easing lowered interest rates, and boosted the price of almost all financial assets. Not surprisingly, there has been a high correlation between the size of the Fed’s balance sheet (QE), and the S&P 500.

I believe that over the long term, the winding down of QE will lead to:

  1. Higher interest rates (My fingers are crossed!)
  2. A headwind for US stocks, real estate, and other risk assets

However, it is important to note the following:

  1. Interest rates are unlikely to rocket higher in the near term
  2. I am not predicting an imminent stock market decline; the tapering of QE simply makes new all-time high prices less likely
  3. As of now, the European and Japanese central banks are continuing with additional QE, but it is believed that their QE programs may soon be put on hold

If history proves that October 1st, 2017 was not important, my guess is that it will be for one of the following reasons:

  1. The Fed reverses course, and adds to QE rather than decreasing it
  2. The European and Japanese central banks add to their QE programs offsetting the Fed’s decrease

Just as history shows that the beginning of QE on November 25, 2008 was important (the S&P 500 bottomed on March 9th, 2009) I believe history will eventually show that October 1st, 2017 was an important date. If I am wrong, US stocks may surpass the record extreme valuations set in the year 2000 despite the simultaneous headwinds of decreasing QE, and expensive valuations.

I purposely used the word ‘headwind’ above since this is not the time to make drastic moves; it’s a perfect time to wait and see what happens next. There should be plenty of time to react to what happens, rather than predict what will happen.

July 14, 2017
by Jed Sires
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Market Update

Stock Market

I find it hard to believe, but the S&P 500 continues to march higher. In my 3/31/17 commentary, I tried to show that US stocks are very expensive relative to history, and very little has changed in 3 months.

With hindsight, I can say that over the past few years, I should not have been so conservative: The famous physics axiom ‘an object in motion will stay in motion’ also applies to the markets. This axiom is the reason why we continue to own US stocks even though the risk/reward doesn’t look favorable. There will be a time in the future when US stocks stop going up, and that will be the time to take some profits.

While making money is certainly important, it could be said limiting losses is more important, and that’s why I don’t feel overly bad for being conservative. If an investor suffers a 20% loss, a 25% gain is needed to recover the money lost. Beyond a 20% loss, the return necessary to recover the money lost really starts to snowball:  30% Loss à 42.86% Gain. 40% loss à 66.67% gain. 50% loss à100% gain.

While now is a good time to be conservative, there will certainly be a time in the future to be more aggressive.

Economic News / Interest Rates

The Federal Reserve raised the federal funds rate (once again) at their June 14, 2017 meeting. As a reminder, the Federal Reserve controls short term interest rates, so in theory as they raise the federal funds rate, the interest you receive on cash should increase. Unfortunately, financial institutions only slowly pass on higher interest rates to investors & savers. To get around this, I have been using Treasury Bills to maximize the return on holding ‘cash’.

While shorter term interest rates have been going up, longer term interest rates have been going down. This is likely because the Federal Reserve historically has tried to slow down the economy with interest rate hikes. A slowing economy in turn creates less demand for loans, and the price of money (interest rates) drops to offset the decrease in demand…At least that is what an economic textbook would say. The other potential reason that longer term interest rates are so low is that interest rates in Europe & Japan make US interest rates look high.

I take managing investments very seriously, and I feel fortunate that going to work isn’t ‘work’ for me. I will always do my best to grow and protect my client’s investments while focusing on the long-term. I believe a longer-term view is becoming increasingly rare in investing, and having patience now so we can be impatient later will likely be rewarded.

 

Disclaimer: The commentary above is the opinion of Sound Investment Strategies. To the extent that information we provide is historical, it should not be considered predictive of future returns/circumstances. There is always a potential for profit or loss in the future. Nothing on this page is to be construed as an advertisement, inducement or representative of performance results.

January 26, 2017
by Jed Sires
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Market Commentary Fourth Quarter 2016

I am extremely fortunate to have chosen my profession. There are very few boring days when it comes to watching the markets react to economic & political events, and the fourth quarter of 2016 was no exception.

The biggest political news came on November 8th, but the result was not a surprise if you had believed the S&P 500 election predictor. There were many prognosticators that correctly predicted the stock market would collapse if Trump won the election. The problem is that the S&P Futures only collapsed momentarily. By the time the market opened on November 9th, the S&P 500 was almost positive, and it never looked back for the rest of the quarter.

Sir Isaac Newton, who lost a fortune in the South Sea Bubble once said “I can calculate the motion of heavenly bodies but not the madness of people”. That quote describes perfectly how I feel about the US Stock market: Valuations appear expensive based on many indicators, but that doesn’t mean stocks can’t continue to go up. If the ‘madness of people’ can drive valuations higher, it is likely that one day again they will do the opposite, and drive stock valuations lower.

Likely encouraged by a rising stock market, the Federal Reserve raised the federal funds rate at their December 14th 2016 meeting. Longer term interest rates, which are not directly controlled by the Federal Reserve (if you ignore their $4 Trillion balance sheet) rocketed higher starting November 9th.

For almost 8 years now investors have believed that low interest rates are good for asset prices and the economy. I agree that low interest rates are good for asset prices, but it is debatable that low interest rates are good for the economy. Speaking of the madness of people: Now that interest rates are moving up, investors seem to have forgotten that higher interest rates are not normally positive for asset prices.

October 24, 2016
by Jed Sires
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Nature and the Economy

Exercising for me consists of hiking the trails in a 40-acre forest near my home. Although, it would be nice to go on ‘real’ wilderness hikes rather than visit the same 40 acres every week, it is fun to see the same forest in different seasons, and the location can’t be beat.

Last weekend when I went hiking, it was between wind storms, and I noticed lots of new branches and trees on the ground. Most of the new trees and branches that were now laying on the ground were previously dead; you could say nature had done some pruning.

Immediately upon noticing all the new dead branches and trees on the ground ready to fertilize the remaining living trees, I thought about the economy and the parallels between it and a forest. If the economy was a forest, a damaging wind may be an economic recession.

It is possible that an economic recession and wind in the forest serve the same purpose. While a windstorm looks destructive at first glance, over the full cycle, the forest will be stronger thanks to the windstorm. Branches and dead trees will fall, and provide fertilizer and more light for the trees that survive. At first glance, a recession appears destructive to the economy, but it provides the catalysts for renewed growth. In a recession, companies go bankrupt, people lose jobs, and an economic reset occurs. Valuable assets are transferred from weaker companies, to the stronger surviving companies, making them even stronger.

Many people have questioned why the U.S. economy isn’t as strong as it should be. Getting back to the forest analogy, I believe the economy needs to be run by the free market, also known as ‘nature’. Instead, Central Banks across the globe have decided that they are smarter than the free market, and are trying to keep the economy growing with the following tactics: Buying assets to artificially suppress interest rates, and keeping interest rates low to raise asset valuations. I have no doubt that the Central Banks have good intentions, but I believe their actions are stifling long term economic growth in exchange for short term stability.

Think of the forest that has gone many years without a windstorm: Even healthy trees have a couple branches that the wind could prune. Those downed limbs would allow more sunlight to shine on the remaining living trees, and those limbs, will eventually provide the fertilizer for future growth. Now imagine not only dead branches, but a dead or weakened tree, that is still clinging to life, but is dying. The windstorm mercilessly destroys the weakened trees for the benefit of the remaining trees.

It could be said that the Central Banks actions have created an economy that is not as strong as it should be, and is vulnerable if ‘nature’ ever takes control.

July 21, 2016
by Jed Sires
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Student Loans and Debt

Quite often I create financial plans for people with excessive debt. Mortgage debt is typically the largest form of debt that I see, but student loans are certainly catching up.  Auto loans and credit card debt are also very common.

During my conversations with people that carry excessive debt, we typically talk about their budget, and potential areas where they can save money.

When you carry debt, a tight budget is even more important because every dollar you spend costs you more than a dollar.

My reasoning is as follows: Let’s say that over the course of a year you spend $1200 at restaurants, where instead you could have eaten the same number of meals at home for $200. How much additional money did it cost the individual to go out to eat? The additional cost was $1000, correct?

If the individual has debt, the calculation isn’t that easy. What if instead of eating out, you ate at home, and paid the $1000 towards your credit card debt that carries finance charges of 10% per year? Now, it should become more clear: The act of eating out instead of at home, not only cost you $1000, but $1000×110%, or $1100.

When you have debt it’s almost as if everything you spend money on costs more.

Next, let’s say you own an old boat that is worth $1000 that sits in your back yard for 365 days per year. Does it cost you anything to store in your back yard? Most people would say no. If you have credit card debt with finance charges of 10% per year, I’d say that boat ‘costs’ you $100 per year. The calculation is the same: If you sold the boat for $1000, and used the proceeds to pay off your credit card debt, you would save $100 per year in finance charges, so the unused boat sitting in your back yard costs you $100 per year.

With these two simple examples, I hope to have shown that when you have debt, it makes everything you spend money on, and even your assets more expensive.

June 16, 2016
by Jed Sires
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Weekly Market Commentary, June 15

The biggest market moving event of the week was the Federal Open Market Committee (FOMC) announcement on Wednesday June 15, 2016 from the two day FOMC meeting on June 14th & 15th, and subsequent press conference.

As expected, the FOMC left the Fed Funds Rate unchanged.

Above, I said left the Fed Funds Rate unchanged ‘as expected’, but it is interesting how quickly expectations change within the market, and more notably, within the FOMC.

On the week of May 16th, when the April FOMC minutes were released, the minutes were taken by the market as having very hawkish tone. Hawkish meaning that the FOMC was ready to hike rates at the June meeting.

Now, just a month later in June; we get no rate hike…Again.

I believe many investors give the FOMC (and other central bankers) credit for being omniscient, but in reality they are just people like you and I. Their ability to see the future, and make accurate projections is not very good. It has taken a while, but investors seem to be finally figuring this out.

Yes, Dorothy: They aren’t real wizards, and there may not be a fairy tale ending.

Exactly how this unfolds is anyone’s guess, but given the current high stock market valuations, and newly growing skepticism, the risk reward does not appear favorable.

June 5, 2016
by Jed Sires
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Weekly Market Commentary, June 3rd

The biggest market moving event of the week was the release of the Nonfarm Payrolls data on Friday June 3, 2016. The Nonfarm Payroll data measures the month over month change in the number of jobs, and the unemployment rate.

The Nonfarm Payroll number came in at 38,000, which was much lower than the market consensus. The previous month was also revised lower from 160,000 to 123,000. The Nonfarm Payroll data is closely monitored by not only market participants, and economists, but by the Federal Open Market Committee (FOMC). The weakness in this data, and the prior month revision, make a June FOMC rate hike very unlikely.

On May 27th (just last Friday), Janet Yellen spoke, and basically said that the Federal Reserve could raise interest rates in the coming months. Her speech caused short term interest rates to spike in anticipation of the coming rate hike. After today’s Nonfarm Payroll number, Janet Yellen has to be very concerned: Either she will be hiking rates into a slowing economy, or she may soon have to talk down her rate hike expectations.

I have to admit; I’m excited to watch this play out. Given that the FOMC makes decisions based on economic data and projections, and their optimistic projections continue to be dashed by poor economic data, it seems like just a matter of time before market participants question whether the Central Bankers, who are in charge of the economic world should continue to be trusted.

To me, it feels like market participants are watching a movie in which they are happy to suspend their disbelief. My only question: How long is this movie going to last?

On the week, the S&P was up 0.00% (flat), the DJIA was down 0.37% and the Nasdaq was up 0.18%.

May 22, 2016
by Jed Sires
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Weekly Market Commentary, May 16th

The biggest market moving events of the week were the release of the Consumer Price Index (CPI) data on Tuesday May 17, 2016, and the Federal Open Market Committee (FOMC) Minutes from the April 2016 meeting which were released on Wednesday, May 18, 2016.

CPI – The consensus was for a 0.3% month over month increase, and the data showed a 0.4% month over month increase. While this does not sound consequential, it is a data point that the federal reserve and market participants watch to determine if the FOMC will raise interest rates. It is thought that if inflation rises faster than the FOMC would like, they can raise short term interest rates to slow down inflation.

FOMC Minutes – The content of the FOMC Minutes surprised the market on Wednesday. Within the Minutes, it was stated that a potential June rate hike is still a possibility and that some at the FOMC believed that market participants had not properly assessed the potential for a June rate hike. This sent the stock market tumbling, and interest rates rocketing higher.

On the week, the S&P was up 0.28%, the DJIA was down 0.20% and the Nasdaq was up 1.10%

April 8, 2016
by Jed Sires
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First Quarter 2016 Market Commentary

Stock Market

The S&P 500 ended the first quarter of 2016 up almost 1%. The stock market during the first quarter was a roller coaster ride that just happened to end about where it started.

It is difficult to pinpoint what caused the market volatility in the first quarter, but here are my thoughts:

As 2016 began, the big winners of 2015 (mostly overvalued stocks) were sold. This may have been to delay large capital gains until Tax Day, 2017.

The Federal Reserve raised interest rates at their December 16th meeting. At the margin, higher interest rates make some assets less attractive. The selloff could have been a hangover from the Federal Reserve’s action and anticipation of more interest rate hikes.

Oil was crashing due to record inventory and high production levels. This called into question the viability of many energy companies and highlighted this potential risk to the economy.

Meanwhile, the economic data out of China, Europe and Japan didn’t look good, resulting in fears of a global recession.

At the low, these headwinds came together to knock the S&P 500 down about 10% on a year to date basis.

The decline was something we had prepared for, so as the stock market dropped, we added to our clients’ equity positions.

Typically, assets become cheaper during times of, or because of uncertainty.

It is my opinion that there is always great uncertainty about the future. To take that thought further, if the future is always uncertain, then you want to buy assets only when they are priced for uncertainty: When they are inexpensive. It must be said that I use the word ‘inexpensive’ as a relative, not an absolute term. Perhaps someday stocks will be inexpensive on an absolute basis, but I don’t believe we have seen that so far in 2016.

Economic News

In the 12/31/15 Market Commentary I said the following:

Unfortunately, the recent stock market volatility may cause the Federal Reserve to rethink the additional 2016 interest rate hikes.

This proved to be prescient (so far!). At the February meeting, not only did the Federal Reserve not raise interest rates, but they signaled that they expect two fewer interest rate hikes in 2016 than was previously thought.

We cannot know what the rest of the year will bring for the markets, but one thing is certain: If there is any turmoil, we will take advantage of the assets that are priced for uncertainty.

December 11, 2015
by Jed Sires
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The Oil Crash

Instead of ending this blogpost with a disclaimer, I will start with one. What you will read here is my opinion and is contrary to what the majority of investors and economists believe. It doesn’t always make sense to be a contrarian investor, but at inflection points, group think can be very dangerous.

You have probably noticed it at the gas-pump; prices are down substantially. If you ask most investors what caused the price of oil to collapse, they will correctly tell you that it is due to increased supply. Stated, simply, supply is greater than demand. I agree with that. The next question would be what caused the excess supply? Most investors would then say that it was OPEC’s decision in late 2014 to keep output high. I can’t argue with that either. What that answer doesn’t address is low interest rates.

Here is what I believe caused the massive oil crash in three simple words: The Federal Reserve. How you might ask? It’s simple: Interest rates have been too low for too long and have caused the misallocation of capital across the economy. When interest rates are low, it makes buying assets using debt cheaper. If the cost of capital for the energy companies would have been more expensive, many oil projects would not have happened. In my opinion, low interest rates, coupled with technological improvement (fracking), and OPEC caused the current oversupply of oil.

I also find it intriguing that the supply / demand balance of oil proved to be fragile and the resulting price reaction was non-linear. Nassim Taleb in his book Antifragile: Things That Gain From Disorder (an excellent book by the way!), uses vehicle traffic and commute times as an example of a non-linear reaction. For example: 10% more traffic doesn’t just add 10% to your commute time; it adds much more. Increasing supply coupled with moderately less demand has cratered the price of oil.

Oil is just the latest asset to implode. Remember the housing crash of 2008 & 2009? While most people assign blame to the lax lending standards, there was also another negligent party: The Federal Reserve held interest rates too low for too long.

I also believe that low interest rates are causing the misallocation of capital elsewhere: I’ve said it before, and I will say it again, US stocks look at least fully priced, but likely overvalued. You can also say the same for housing right now. The ‘flip homes and make thousands’ commercials should be disturbing. Low interest rates make assets more valuable and central banks around the world have done their best to bring down interest rates and pump up global asset prices. In time, I believe it will be clear that low interest rates have caused misallocations of capital. If this is true, crashing oil may simply be a warning sign.