Caution: Service Line Insurance

Guest Article by Marco Briceno from The Starr Group, a  Summit Pinnacle Provider

I wanted to share something with you that an account manager brought up.

Thousands of people call their water utility companies after receiving very concerning letters from Service Line Warranties of America (SLWA) to see whether or not they are a scam. These letters claim to offer insurance for the water lines connecting your home to the street. Most people are concerned because the letter makes this insurance sound like a requirement, when in fact is not required by either municipal or state governments.

Since the average Homeowner’s policy in Wisconsin does not provide any coverage for this kind of loss, there are two things you need to know before you buy this insurance.

You can read the full article on LinkedIn.

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The Hierarchy of Financial Goals

Hand writing financial goals on chartDuring their initial training, financial advisors are taught to ask about a client’s goals for incorporation into their personal financial plans. Some of these goals can be “retirement at a certain age”, “a comfortable retirement”, “putting the kids through school”, “a condo in Aspen, Florida, Spain”, etc.

While it is very important to engage with clients and create a plan that incorporates their tangible goals, I believe that it is incumbent upon us to guide them through their goal setting so that over time, investment positioning is truly in harmony not only with a client’s financial goals, but their financial risks.

To create this harmony, the purpose of each investment position needs to be aligned with the block of money allocated to any single or set of related goals. Just as important though, is for the goals to be established in a logical hierarchy of building a client’s “financial house”. In other words, you don’t start digging a swimming pool when you haven’t first funded and then completed the bathrooms and kitchen.

Every client has goals that are made up of a combination of wants and needs. We refer to these as “life’s aspirations” as they are highly individualized. These aspirations must be prioritized for the plan to be robust in all kinds of personal economic situations that the client may face throughout their life.

The first step is to work with the client to define their life’s aspirations so that they are both tangible and easily measured in terms of cash flow. For example, a comfortable retirement needs to be defined as spending $X thousand per month accounting for inflation while putting the kids through college would be $X thousands per year, for a certain number of years starting in year Y. It is important to understand that this list is highly dynamic and that items will most likely be added or removed as life’s journey continues.

Once this list has been sufficiently developed, these aspirations must be identified as either a need or a want with respect to the client’s financial situation. For instance, while they may feel that paying for an education from Stanford is a need, one can argue that even the desire to pay for tuition at the local community college is really a want as there are resources available to kids who desire to continue their education beyond high school. However, having enough life insurance to protect your assets in the event of your untimely death is clearly a need as a shortfall there could result in financial devastation for your loved ones.

Financial Goals Depicted as a Colorful PyramidTherefore, prioritization must always favor needs over wants. While that may seem self-evident as you read this, I can assure you that many clients have a difficult time discerning needs from wants and an even harder time accepting the need to prioritize them, especially during times of financial abundance. Once the list has been divided into wants and needs, the prioritization can then take place starting with needs. In our Foundations of Wealth model, we define three levels of wealth that a client can attain:

  • Financially Secure
  • Financially Comfortable
  • Financially Affluent

It is through the creation of an initial financial snapshot that we determine what level of wealth a client has attained, if any, and; what gaps exist between where the client is and their next level of attainable wealth.

Financial security prioritizes two specific areas of investment:

  • Asset protection
  • Income

At the most basic level of personal finance, the first priority is to be properly insured, including not only property and casualty insurance, but also life and disability insurance as well. Nothing will derail a financial plan faster than damages from an untimely auto accident, even a small house fire, a lawsuit, or injuries that cause you to miss work.

After insurance, the next priority for asset protection should be a stash of emergency funds equaling at least six months to one year of living expenses. These funds should be kept in cash equivalent investments whose purpose is to store wealth, so that they can be accessed quickly and easily. Some advisors have suggested having credit lines available so that you don’t have to keep as much cash around, however, in the event of job loss, any borrowed funds could quickly become another headache if the duration of the layoff is longer than initially thought.

It is also important to adjust emergency funds to keep up with changes in lifestyle, as annual expenses change and usually increase so, therefore, should the emergency stash. I have used my emergency funds for even small emergencies such as a sudden appliance breakdown or new tires and minor medical payments. As a matter of habit, I just automatically add 5% of my take home pay to my emergency fund every month to make sure that it is always replenished when I use some of it.

The next priority is income. We believe Financial Security means that you can pay your basic living expenses without the need of a W-2 paycheck (50% income as Robert Kyosaki’s rich dad called it). It’s not any more complicated than that. Income can be derived either from capital gains or distributions also known as passive income. While each advisor will have their own opinion, we believe that the accumulation of good, income-producing assets is the foundation of any investment strategy.

The next level of wealth is the state of being financially comfortable. This simply means that on top of having enough income to cover our basic living expenses, we can now also cover what we call event based expenses.

It is here that the goals start to naturally shift from needs to wants. In the pursuit of financial security, we are generally focused on needs. Event based expenses start to creep into the category of wants, although some event based needs may also be identified. Events are temporary and usually one-time occurrences, although paying college tuition for three kids, while temporary, is a longer duration example.

The goals that consume event based expenses fall into typically consist of college expenses, weddings, once-in-a-lifetime trips, second / vacation homes and milestone birthdays. Nothing should be considered too small to fit in this category.

Family Happy after Ordering their Financial GoalsAchieving a financially comfortable state is the longest and most difficult goal to reach. The reason for this is that it is usually the hardest state to define. Financial comfort for a single person making a six-figure income is much different than a two-income family with three kids, and as we have either seen or experienced ourselves, single people can become married and childless couples can become parents in a very short period of time. On the flip side, married couples can become single through death or divorce and one-child families can become 4-child families through second marriages or similar events.

This highlights the importance of the annual financial snapshot. From year to year you may find the gap between where you are, and financial comfort has narrowed or widened. That means that adjustments and even compromises must be made. It is also important to use the snapshot throughout the year as you are faced with circumstances and decisions which can impact your ability to achieve your goal. A few minutes reviewing a what-if analysis can provide objective clarity to most financial decisions.

The third and final level of wealth, affluence, is made up entirely of wants. We call these life issues “Dreams and Visions” and they hold the least priority in your personal finances. Many clients dream of having a wing at a hospital or university named after them or establishing a charitable foundation to keep funding their favorite causes after they are gone. What ever these goals may be and whatever amounts are desired, they should only be addressed after all the previous goals have been attained.

In summary, the hierarchy of goals places needs over wants, the client over others (including family members) and security over luxury:

  • Asset Protection – invest to protect wealth
  • Emergency Funds – invest to store wealth
  • Living Expenses – invest to derive income from wealth
  • Event-based expenses – invest to grow and derive income from and to store wealth
  • Dreams and visions – invest to grow and derive income from wealth

With life’s aspirations clearly defined and placed in the proper categories, investment choices become subject to a much easier analysis and the anticipated outcomes become much better aligned with the expected plan performance.

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Third Quarter 2019 Market Review

Q3 2019 – The Trend is Still Up

There was a quirky show in the late 1980’s titled “Twin Peaks”, where one of the main characters, a young FBI investigator, was known to say,

“Every day, once a day, give yourself a present.”

While I found this line of thinking to be too expensive for my lifestyle, it is essential for us to find something to celebrate and associate it with our activities, schedules and responsibilities. In this way, just like that once-in-a-while, great hit I make on the golf course, these positives keep us moving forward through the valleys on our journey.

With the idea of seeking something to celebrate in the face of whatever life throws at you, let’s go to the markets.

With all the headlines about recessions, tariffs, interest rates, impeachment, air strikes and Iran, no one would blame you if you were afraid to look at your investments. But the truth is that, despite the ongoing volatility, and this is a volatile market, we sit here today just a few percentage points below the all-time highs ever reached by the stock market. In fact, on the first day of the quarter, the S&P 500 set a new closing record.

In the graph above, the middle line is a trend line and the two outside lines form a channel that is one standard deviation from the trend line. These tools make great visual aids for demonstrating market volatility.

Overall, our portfolios have held up well through the volatility, with quality dividend-paying stocks, real estate investment trusts (REITs) and even quality Master Limited Partnerships, (MLPs) attracting investment when the stock market gets choppy. Now this is not to say that these investments will not experience a price drop in a bear market, history shows otherwise. But, because the purpose of these investments is to derive income, a technical, not fundamental, drop in price will typically be an investment opportunity and money flowing to any investment will eventually lead to a rise in price.

As the trend is still up, our focus is maintained on those investments that will perform well in uptrends and watching out for any potential catalysts which may cause for a substantial short-term trend reversal. We refer to those issues as the things that keep us up at night.

Recession Watch

While we were not able to find reliable data about the number of news stories warning about a potential recession, they seemed to hit a crescendo in August coinciding with the volatility we saw in the market. Key drivers of many of these stories were the ongoing inversion of the yield curve as well as the impacts a prolonged or escalating trade war with China would have on the economy.

Almost on demand, Bloomberg published a rather well put together, data driven article regarding the current state of the economy.

Without republishing the whole thing, we highlight the following:

The Bloomberg Economic Surprise Index has reached an 11-month high after four indicators released Thursday, including existing home sales and jobless claims, each surpassed expectations. The gauge continued to advance after swinging to positive from negative on Tuesday for the first time this year. The data also pushed a similar measure produced by Citigroup Inc. to the highest level since April 2018.

In addition, an industry report on August existing home sales sailed above all forecasts following a report Wednesday showing the strongest pace of housing starts since 2007, signaling that residential construction may add to economic growth in the third quarter for the first time since the end of 2017.

Last quarter, we discussed The Conference Board Leading Economic Index® (LEI) for the U.S. and the readings we were getting from that. Again, from Bloomberg:

Elsewhere, the unchanged reading on the Conference Board’s index of leading economic indicators — a barometer of future growth — compared with projections for a decline.

Based on the data, while we may see some slowing in the growth of the economy, we are still seeing growth. A recession is, of course, a contraction of economic activity, not a slowdown, and; as we have asserted in prior letters, recessions are usually caused by negative economic events. Without a discernible catalyst to retard economic activity, there is no reason at this time for the economy not to keep moving forward, although possibly at a different, perhaps lower, rate of growth.

We are not alone in our position. In a recent video titled “Expansions don’t Die of Old Age”, Steven Dover, the Head of Equities for Franklin Templeton, a major investment management firm, notes that the record for the longest economic expansion is not 10 years or even 15 years, but now over 20 years in the country of Australia, which likely coincides with their proximity to the Asian continent, particularly China.

He then makes the point that, at least for the foreseeable future, interest rates have stopped rising while inflation remains tame by historic standards which is bullish for stocks, and; while both China and the Eurozone are experiencing tepid growth, it is still growth.

One other piece of data that gave us a positive surprise was household debt service payments as a share of disposable personal income. As ongoing observers of the economy, we are often reminded that total household debt has reached record levels as depicted by the chart below.

But another chart, courtesy of, gives a much different perspective on household debt. The chart below depicts the debt service payments of household debts as a percentage of disposable personal income.

As you can see, as a percentage of disposable income, debt service payments have been trending downward. While an overall growth in debt, especially auto and student loan debt is always troubling and ill advised, the growth in personal disposable income seems to be keeping up with the debt load.

This aligns with the increases we observe in consumer spending data, which is seen as a key driver of economic performance.

Interest Rates and the Yield Curve

As noted above interest rates, as driven by the Federal Reserve’s monetary policy, have stopped increasing for the foreseeable future. At its latest policy meeting on Wednesday, the Federal Reserve cut interest rates by 25 basis points to a new target range of 1.75% to 2.00% and telegraphed a strong likelihood of one more rate cut by the end of the year.

Not only did the Fed cut rates, but their members actually increased their expectations for the domestic economy. An article posted on the Yahoo finance site reported:

Despite all the noise, the committee’s economic projections on components of the U.S. economy paint a brighter picture domestically. Policymakers raised their projections on U.S. GDP growth, with the median member now projecting GDP growth of 2.2% in 2019, a notch up from the median projection of 2.1% in the last dot plot release in June.

Much of this is buried in the cacophony of outrage over President Trump’s criticism of Fed policy and his call for interest rates below zero.

In theory we can make the point that interest rates on U.S. government debt should be lower than that of other issuing countries. If we think about the concept of credit risk, it would make perfect sense that the strongest financial entities would be able to issue debt at the lowest rate of interest, and vice versa.

However, it is our belief that negative interest rates are generally the result of fiscal policies that have been a wet blanket on most of the world’s largest economies for well over a decade. Governments that already place high taxes and burdensome regulations on their industries and populations have no other means of getting the consumers to spend whatever money they have left than to make it more costly for them to store it in a bank. They believe that over the long run, doing this will stimulate growth and more importantly, raise inflation, which is the only way most countries will ever deal with their ballooning levels of national debt.

Since interest rates now seem to be a tool for financial manipulation, it is impossible to apply economic principles to the current environment. We would at least hope that Chairman Powell has learned the lesson that you cannot play catch-up with rates as he tried to do over the last two years. The Fed started aggressively raising rates while reducing the size of its own balance sheet in the hope of rebuilding its ability to deal with the next downturn. As we stated back then, the Fed was on a course to be the cause of the next downturn.

Many investors, particularly retirees, use government debt, particularly 10-year Treasury Bonds, as important components of investment portfolios. Therefore, driving interest rates down to keep up with the rest of the world’s central banks could have adverse economic consequences on a substantial portion of the US population. The Federal Reserve must walk a very narrow tight rope in trying to balance its policies across a diverse range of economic needs.

In the short term (as noted above in the Recession Watch section) the current pause in interest rate increases is already stimulating the housing market and will continue, rightly or wrongly, to drive investment in higher risk assets such as stocks, corporate bonds and REITs.

The yield curve made headlines several times this quarter as, along with China trade, the purported reason for a market sell-off. However, many financial observers are coming around to a conclusion like ours, that U.S. Treasuries are one of the few places left to store cash.

According to CNBC:

About $15 trillion of government bonds worldwide, or 25% of the market, now trade at negative yields, according to Deutsche Bank. This number has nearly tripled since October 2018. Historically, people give the government their money, instead of spending it, with the promise of being paid back, with interest. Now, governments are essentially getting paid to borrow money, as people become increasingly desperate for a safe haven for their wealth.

In a scenario like this, it’s just logical that U.S. Treasuries – which many investors view as the ultimate “safe haven” apart from gold, would be in strong demand.

There are very few laws in economics, but one that has stood the test of time is the law of supply and demand. As demand for positive-yielding treasuries increases, the price of those bonds will go up which means that yields will go down. In the CNBC article, which was published in August 2019, the writer notes:

The yield on the benchmark 10-year Treasury note, was lower at 1.595% on Wednesday, the lowest level since October 2016 and 40 basis points lower than it was one month ago. The yield on the 30-year Treasury bond also dropped as low as 2.164%, near an all-time low hit in 2016.

With 10 and 30 year Treasury bond yields dropping so precipitously, while short term yields, which are more highly impacted by Fed policy, were staying steady, or slightly increasing, it should be no surprise that we would see an inversion between the short- and long-term rates.

This is not to say that an interest rate inversion is no longer a harbinger of bad economic news. The prolonged negative rates we are seeing in major economies around the world including India, New Zealand, Thailand, Japan and the European Union (ECB) are a reaction to the ongoing weak economic data coming from those regions. At some point, these weak global economies will have an impact on ours, potentially to the point of contraction. Even if it’s mild, given the lingering memory of the 2008-2009 crash, a market over-reaction is not inconceivable.

China Trade

The on-again, off-again negotiations between China and the US are on again as the two sides have agreed to resume talks in October. In September, President Donald Trump delayed the next round of tariff increases on Chinese goods until after trade talks that are scheduled for early October while the Chinese announced that they will exempt US soybeans, pork and some other agricultural products from additional tariffs according to reports in The Business Times (September 14, 2019).

Public brinksmanship by either side is often met with a knee-jerk sell-off in the US markets, while acts of “good faith” have an opposite and often equal affect. In each case, the impact is short lived and doesn’t even show up on the daily stock index charts.

We continue to see evidence that the tariffs have exasperated Chinese economic ambitions, however, this is a government that can afford to play the long game if they can keep their citizens at bay.

If they can maintain control, they are more likely to wait until the 2020 elections in hope of a more agreeable administration taking over.

India – Pakistan

In a different time, the threat of nuclear war would dominate headlines and the world would be actively campaigning to bring about a peaceful resolution between the two sides. To our surprise, there were few headlines recently as the conflict between India and Pakistan spilled over into the annual U.N. General Assembly that took place in New York City in September.

As reported in the Albany Times-Union, Pakistan’s Prime Minister, Imran Khan, pointedly accused Indian leader Narendra Modi of “cruelty” in the Muslim-majority region of Kashmir and warned of catastrophe if the two nuclear-armed nations tumbled into war. Saying the United Nations had a responsibility for robust involvement in the problem, he said inaction would produce bad results.

Modi, in his address an hour earlier, took a starkly different approach: while raising the specter of terrorism — a nod to the reasons he cited for clamping down on the region, angering Pakistan — he never uttered the word “Kashmir” and focused on India’s economic and infrastructure development.

The two countries have been locked in a standoff since Aug. 5, when Modi stripped limited autonomy from the portion of Kashmir that India controls and it was hoped that the move toward some type of resolution could be revived during the U.N. meeting. However, it looks like the anticipated progress fell way short of even the most modest goals.

While the threat of nuclear war is still a long way off, the potential for escalation of armed conflict is very real.
North Korea and Iran

Like many, we are disappointed that the U.S. has not been able to bring North Korea closer to a more peaceful position in the world. Just like “Lucy with the football”, every time we get close to the winning kick the ball is pulled away.

There are several theories offered for this. They range from North Korea being nothing but a puppet regime for China to the North Korean leader, Kim Jong Un, being fearful of giving up totalitarian control and placing his position and his life at risk. We may someday learn what is really going on in this country, but it is important to remember that these regimes can last a very long time, especially if they are being propped up by economically stronger trade partners.

Iran presents a rather interesting situation. A decade ago, the recent attack on Saudi Arabian oil facilities, which have been attributed to Iran, would have sent the markets into a tailspin. But now that the United States is a net exporter of oil, it produced only a slight and temporary uptick in oil prices and has had negligible impact on the US markets.

Like North Korea, Iran’s regime is also propped up by more economically stable trade partners, including the European Union whose member countries have signed numerous trade agreements with Iran since the signing of the July 2015 nuclear deal. Are they dealing with Iran because they believe the threats we hear about are overblown, or do they hope that by increasing economic cooperation, they will be able to persuade the regime to play a more constructive role in the Middle East, especially in Syria, and to engage with the Gulf states?

These issues, Pakistan and India, North Korea, and Iran, present risks based on their abilities to create instability throughout the regions they inhabit. However, we believe that this type of risk is nothing new and is already priced into the markets. If, on the other hand, there was a significant break-through, meaning lasting agreements that were both enforceable and verifiable, that would be an unexpected positive development.

Strange Happenings in the Repo Market

In what was a disturbing reminder of the 2008 – 2009 credit market upheaval, the New York Fed was forced to intervene in money markets due to a sudden surge in short-term borrowing costs in the morning of September 17th.

As reported by Bloomberg:

The Federal Reserve took action to calm money markets, injecting billions in cash to quell a surge in short-term rates that was pushing up its policy benchmark rate and threatening to drive up borrowing costs for companies and consumers…

Money markets saw funding shortages Monday and Tuesday, driving the rate on one-day loans backed by Treasury bonds – known as repurchase agreements, or repos – as high as 10%, about four times greater than last week’s levels, according to ICAP data.

More importantly, the turmoil in the repo market caused a key benchmark for policy makers – known as the effective fed funds rate – to jump to 2.25%, an increase that, if left unchecked, could have started impacting broader borrowing costs in the economy.

What is the Repo market?

The Repo market is not really a place, but a financial system that allows participants that own lots of securities (usually Treasury bonds) but are short on cash to cheaply borrow money. And it allows parties with lots of cash to earn a small return while taking little risk, because they hold the securities as collateral for the loan. A key feature is that the cash borrower agrees to repurchase those securities later, often as soon as the next day, for a slightly higher price, hence the name “repo”. That difference in price determines the repo rate.

Think of someone who may be debt free with $100,000 in the bank but needs $2000 cash to make a transaction and has found that the local ATM is out of order. That person may pledge their car to someone who has the cash in order to make the $2000 transaction and then, when the bank is open, withdraw the cash from their account and pay off the loan, releasing the lien on their car.

The financial media pointed to several potential causes for the sudden dearth of liquidity:

These include the Fed’s recently concluded quantitative tightening (“QT”) program – which saw the Fed shrink its balance sheet by more than $1 trillion over the past couple of years… the dramatic increase in debt issuance by the U.S. Treasury this year… post-financial crisis rules requiring banks to hold greater reserves… and even Monday’s corporate-tax payment deadline, among others.

There are several good articles about this published by several credible organizations and each one provides one or more reasonable explanations as to the cause. However, the reality is no one is really sure why it happened.

Still, the consensus among most financial professionals – including the Fed itself – is that this is merely a temporary problem that can be easily corrected by the Fed’s short-term interventions. We will keep an eye on this.

In Summary

As the title suggests, our approach is to continue to invest in the uptrend until we have strong confirmation of a trend reversal by the market. The economic backdrop remains favorable. We have low inflation, low interest rates, cheap energy, a strong dollar, wages at a 10-year high and unemployment at a half-century low. Yes, second quarter corporate profit growth slowed a bit from the first quarter. But the earnings outlook is still positive.

Until things change, the trend is still our friend.

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Thanks to you we did it!

By Ron Chandler

A little less than a year ago, Paul Neuberger the Chairman of the 2019 Greater Milwaukee Heart & Stroke Walk / 5K Run asked me to join him on his Executive Committee to help raise money for this year’s event. Paul is a very passionate about this cause as his family has been touched by the disease and he set a very aggressive goal of raising $1,750,000, nearly double the highest amount that had ever been raised.

After months of meetings, phone calls and emails, I am thrilled to report that as of the day of the run, the 2019 Team had raised over $1,396,000. While short of our goal, it is certainly an impressive effort, and; even though the Heart Walk took place on September 21, donations are still being are collected through October.

For our part, between personal donations and the support of our friends and colleagues, Team Summit was able to raise $17,744.00 for this cause, far outpacing several larger investment management firms in the area.
Thanks to everyone who supported us in our efforts this year, without you, none of this happens!

Team Summit

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Surfing the Stock Market

by Ron Chandler

Last weekend, I went to the beach with my oldest daughter to let her play in the waves. The area we visited is apparently a prime area for surfing and there were many people out that day riding the waves.

Stock Market Candlesticks as Surfing WavesAs time went on, I noticed that most of the people surfing were in a state of constant motion. With each wave that rose up, they would scramble to get in front of it and stand on their boards, only to end up back in the water within seconds. They would then retrieve their boards and try to catch the very next wave, often not even making it back out to their original starting point before attempting another ride.

There was little thoughtfulness to what they were doing, just a mad scramble to catch each wave that came by. It didn’t take long for exhaustion to overcome them and any hope of a sustained ride disappeared.

Out a little farther out from all of this was someone I would call a more seasoned surfer.

By that I mean his hairline had receded quite a bit and his hair color was more gray than any other color. He was sitting, almost idly, on his board as wave after wave passed by. He was out there just sitting on his board for so long, I started to wonder if he was intending to surf, or just float out on the waves all day.

After a great deal of time had passed, a rather large wave started to form, and he quickly turned his board and started paddling. When the wave reached him, he stood up with very little effort and surfed for quite a distance before turning back into the wave and cannonballing into the water. He then retrieved his board and proceeded to paddle back to his original spot and once again, just drifted along as wave after waved passed under him.

In the time we were there, about two hours, he may have only surfed four or five waves. But each ride was long and seemed to be both effortless and enjoyable.

As my mind never seems to be too far from investing, it seems like this was a perfect metaphor for what we see in the investment world today.

Since the advent of cable TV and on-line brokerage accounts, we have increasingly been conditioned to engage in trading strategies versus investments. If you have the volume off, it is hard to tell if you’re watching CNBC or ESPN. People are encouraged to buy the latest market analysis tools and pay for training courses and subscriptions promising “$30,000 in 30 days flat”, or “90 days to six figures” (these are actual email subject lines) offered by the latest investing superstars.

Then, loaded up with all their new tools, they wade into the markets intent on making a killing. And just like most of the surfers we watched, trying to catch every wave and ride it in to shore, these newly minted traders begin trading everything based on technical analysis, trading programs, “expert” recommendations, stocks of the day announcements, etc. And like those many surfers, exhaustion and frustration soon sets in, causing them to either seek more tools and subscriptions, or give up on the “rigged market” altogether.

All the while, the legendary investors like Warren Buffett, Howard Marks, Peter Lynch and Bill Miller invest with the patience of that seasoned surfer who only surfed the best waves when the time was right. Instead of throwing money at every hot idea that passes by, they only invest in the right stocks when the situation is in their favor.

Man Surfing Representing Expert Stock Investing

Let’s take the metaphor one step further with Buffett, for instance. Like the surfer who only rode four or five waves in the time I was watching, Buffett has, according to Yahoo Finance, a stock portfolio with 20 stock positions. Given his decades of investing, 20 stocks is not a large number, but even those are highly concentrated in only five stocks; Apple, Bank of America, Coca Cola, Wells Fargo, and American Express. Apple alone makes up a whopping 23% of his total capital portfolio. In other words, when you catch the great wave, ride it with conviction until it no longer meets your need.

I don’t know what makes a great wave to surf and it will take some time watching great surfers (and probably taking a lesson or two) to learn their criteria. But I have watched great investors for decades and I do know what they think makes a great company to invest in:

  • Provide a product or service that fulfills a need or want in ways that are difficult to duplicate
  • Strong balance sheet
  • Consistent revenue growth
  • Consistent profit margins
  • Consistent positive free cash flow
  • Trading at a discount to its warranted value

For that last item, I use Cash Flow Return on Investment (CFROI) to determine whether a stock is trading at a premium or discount. When I find a stock that meets these criteria, it’s time to yell, “Surf’s up!”

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Top 3 Things to Know When Hiring Help

Guest Article by Marco Briceno from The Starr Group, a  Summit Pinnacle Provider

The other day I was talking with the IT Director at The Starr Group about how I don’t like to mow our yard or shovel the snow. He asked me why not hire a neighborhood kid to help me and pay him a few bucks (something I did not consider).

Millions of Americans with all kinds of financial means hire out occasional household services, ranging from babysitting, to housekeeping and yard work. Many do not know when they hire someone, you open yourself up to certain liabilities if something goes wrong.

You can read the full article on LinkedIn.

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Second Quarter 2019 Market Review

Q2 2019 – The Fed Rides to the Rescue

The US market as measured by the S&P 500 continued the upward trend with a gain of 3.93% in April but then quickly reversed course in May, falling 6.58% for the month.

While many people want to point to the “trade war” between the US and China for the market volatility, we would like to remind you of what we noted in our Q-1 letter. The markets turned around from their disastrous December finish after the federal Reserve Board undertook a more dovish stance on raising interest rates. In it we said:

The best explanation, in our opinion, was the March 20th decision by the Federal Reserve to hold interest rates steady along with an indication that there will be no more rate hikes this year.

Buried in the headlines underneath all of the daily chatter about tariffs, the Mueller investigation, and severe weather was the May 1st Federal reserve meeting where the Federal Reserve announced that they were going to hold the benchmark interest rate steady at a target range of 2.25% to 2.5%,

Prior to that meeting, there were rumblings, albeit premature in our opinion, that the Fed would actually move to cut rates.

The market seemed to be climbing in anticipation of such a move as well. When it did not happen, the market did what it has done since the Fed started their interest rate intervention back during the Great Recession; it threw a tantrum. Moreover, according to an article published on Yahoo.Finance:

The central bank’s statement walked back its March view that the economy had “slowed” from the end of last 2018, noting that recent developments show that economic activity “rose at a solid rate.

Which the market took as a signal that rate cuts would not be forthcoming at the next meeting or possibly for the entire year.

We’ve given you the statistics on the trade war before and they simply do not, in our opinion, account for the violence of the sell-offs that we have seen as, according to S&P Dow Jones, only 4.3% of all S&P 500 revenues came from China based on the latest data reported.

However, we have seen the markets highly reactive to the Fed and their statements. A broad sell-off over disappointment over no coming rate cuts seems to be a much more plausible explanation for the market’s selloff in May.

This theory is further reinforced when, on June 3rd, the market had its best day in the last five months after Chairman Powell announced that policy makers will ‘act as appropriate to sustain the expansion’.

Powell’s remarks came after St. Louis Fed President James Bullard said on June 2nd that rate cuts “may be warranted soon” amid the U.S.’s international trade disputes.

All of this “coincided” with a June gain of 6.89%, the best month since January of this year. For the first six months, the S&P 500 is now up a healthy 18.5% While the Dow and the Nasdaq are up 15.4% and 21.3% respectively (source: FactSet).

Looking at the yield curve concerns, the 3 month and the 10-Year Yields are still inverted, however both the 2 and 10-year and the 10 and 30-year are not, so we will see what happens both with fundamental economic data as well as interest rates during the second half of the year.

One such measure of economic activity is the The Conference Board Leading Economic Index® (LEI) for the U.S. From their website,

The composite economic indexes are the key elements in an analytic system designed to signal peaks and troughs in the business cycle.

The ten components of The Conference Board Leading Economic Index® for the U.S. include:

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders, consumer goods and materials
  • ISM® Index of New Orders
  • Manufacturers’ new orders, nondefense capital goods excluding aircraft orders
  • Building permits, new private housing units
  • Stock prices, 500 common stocks
  • Leading Credit Index™
  • Interest rate spread, 10-year Treasury bonds less federal funds
  • Average consumer expectations for business conditions

The last measure for the U.S. was unchanged in May, remaining at 111.8 (2016 = 100), following a 0.1 percent increase in April, and a 0.2 percent increase in March. Their interpretation of that reading is that:

While the economic expansion is now entering its eleventh year, the longest in US history, the LEI clearly points to a moderation in growth towards 2 percent by year end.

Economic indicators are a way to take the temperature of the U.S. economy. One or two negative readings could be meaningless. But when several key indicators start flashing red for a sustained period, the picture becomes clearer and far more significant. In our view, that time has not yet arrived.

Nearly all recessions in our lifetimes required a catalyst of some sort to reverse economic growth. Possibilities could include war with Iran, a 2008 style credit collapse, or a severe global slowdown. We will stay vigilant.


The latest news on the “Trade Wars” is really no news at all. It looked in March that some kind of a deal was imminent, and then (from CNBC):

The diplomatic cable from Beijing arrived in Washington late on Friday night, with systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations between the world’s two largest economies, according to three U.S. government sources and three private sector sources briefed on the talks.

The document was riddled with reversals by China that undermined core U.S. demands, the sources told Reuters.

In each of the seven chapters of the draft trade deal, China had deleted its commitments to change laws to resolve core complaints that caused the United States to launch a trade war: theft of U.S. intellectual property and trade secrets; forced technology transfers; competition policy; access to financial services; and currency manipulation.

U.S. President Donald Trump responded in a tweet on Sunday vowing to raise tariffs on $200 billion worth of Chinese goods from 10% to 25% on Friday – timed to land in the middle of a scheduled visit by China’s Vice Premier Liu He to Washington to continue trade talks.

The US began planning to hit an additional $300bn of Chinese goods but, at the G20 in Japan in June, President Trump called that off and said he would continue to negotiate with Beijing “for the time being.”

We still believe that some type of a deal is possible as does Alexander Green of the Oxford Club who on July 10th wrote:

China sells a lot more to us than we do to them. Our economy is the envy of the world. Theirs is slowing – and the growth they do have is almost certainly overstated in their official numbers.

Every day the Communist leaders are hearing from disgruntled manufacturers, distributors and exporters, and from foreign companies and investors who are voting with their feet, moving operations to Vietnam, India and Taiwan, or simply forgoing investment in China as too risky or uncertain.

That’s why you should expect a trade deal, not just before the election but before the end of this year – and perhaps in a matter of weeks.

We don’t believe that you can time the stock market, much less a deal with a foreign nation. However, we are happy to see many trade deal skeptics starting to agree with us. If a trade deal does happen, it will most likely spark a further move upward in the market.

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First Quarter 2019 Market Review

Q1 2019 – Climbing the Wall of Worry

The stock market these days seems to be a little like spring time in Wisconsin. If you don’t like what’s happening, just wait a day and it will be better or worse.

After enduring a really, tough December that saw the S&P 500 fall by an unsettling 9%, January came in with an impressive 8% rise and ongoing gains to close the quarter up 13.65%. That’s oftentimes a good year!

Just as we heard many reasons for the end of year downdraft (which technically nearly became a correction), we heard several reasons for the recovery this past quarter. The best explanation, in our opinion, was the March 20th decision by the Federal Reserve to hold interest rates steady along with an indication that there will be no more rate hikes this year.

The announcement comes three months after the central bank raised rates for the fourth time in 2018 and said two hikes would be appropriate in 2019. The central bank also says it will complete its balance sheet roll-off program at the end of the September which we considered to be an additional “stealth” rate hike in terms of decreasing liquidity.

This reversal in policy began long before the FOMC meeting at the end of January. On January 4th, Fed Chairman Powell mentioned muted inflation and a patient Fed in his remarks at the American Economic Association meeting in Atlanta. A week later, he was proclaiming patience again, this time before the Economic Club of Washington.

Apparently, “patience” had been on Fed policy-makers’ minds for some time. The minutes of the December FOMC meeting, released in January, already contained the word ‘patient’ and the ‘muted inflation pressures’ that crept into the January statement. They were attributed to ‘many participants’ who may have been chafing in the aftermath of Powell’s December press conference which preceded (and may have been the proximate cause of) a market downturn.

Anatomy of a Fed Backpedal

We have no claim to knowledge as to why the Fed reversed course so abruptly. Was it President Trump, Goldman Sachs or the Rothschilds? All we do know is that, as far as monetary policy goes, the Federal Reserve has removed itself as a stumbling block for further gains in the market.

Of course, when one door closes, another opens and the Fed’s actions were not without consequences, perhaps unintended.

The Yield Curve Inverts!

Thanks to a sudden surge of buying that pushed long-term rates sharply lower after the March announcement, the yield curve is now “inverted.” This warning has preceded “seven of four” recent bear markets (more on this in a moment). Time to be safe and sell everything?

That’s been the cry in the financial media the last few days as we faced the dreaded inverted yield curve.

Should we be scared? Should we change our investing strategy?

No and no.

The yield curve – especially an inverted yield curve – is a legitimate economic indicator and we should not dismiss it.

But, at the same time, it’s not as simple as the headlines make it out to be. Nothing ever is and it’s critical that we put things into the proper context.

What is an Inverted Yield Curve?

In case you’ve never took an economics class, let’s start with an explanation of what the yield curve is.

Basically, the yield curve is the measure of interest rates (or yields) from short term to long term. As a rule, short-term yields should be lower than long-term yields. This is known as a normal yield curve. If you’re going to park your money in a long-term bond, you want a higher yield to offset any risks that may develop while your money is invested.

The yield curve “inverts” when short-term rates become higher than long-term rates. So, if a short-term rate is higher than a longer term rate, that part of the yield curve is inverted.

This is what just happened by one measure. The yield on three-month U.S. Treasury bonds ticked higher than the yield on 10-year U.S. Treasury bonds.

In simple terms, the U.S. government is paying you more for lending them money for three months than if you decided to loan them money for 10 years.

This created short-term turbulence because an inverted yield curve is often associated with a looming recession.

Before we go any further, let’s make two critical points: First, a recession is not a given. Yes, there is a business cycle and someday we will have a recession but, and this is the second point, all indications are that it’s still potentially a long way off.

Critical Context

Information without context is almost as bad as no information at all.

Without the proper context, you are more susceptible to bad decisions that can cost you money from bad investments, missed opportunities, or both.

Here are two critical points of context to keep in mind:

Critical Context Point 1: There are large number of interest rates that are considered either “short-term” or “long-term.” That means there are also a large number of different rates to compare in search of a yield curve inversion.

All the recent headline noise came from the 10-year yield dipping below the three month yield.

Another yield comparison that gets a lot of attention is between the 10-year and 30-year yields. That part of the yield curve has not inverted. In fact, just the opposite. The spread between the two has increased, which is considered very healthy.

A third yield relationship that is frequently referenced is two-year yields versus the 10 year yield. This has not inverted either. Interestingly enough, the last five times it has inverted, the S&P 500 continued higher and peaked 19 months later. If that scenario happened today, we’d be looking for a peak in October 2020.

There’s a lot of money to be made in that time. The mean return from when the two year/10-year relationship inverted to the market peak is 22.3%.

Now is not the time to get all defensive.

Critical Context Point 2: You must look at which end of the yield curve is moving.

In this case, the yield on three-month Treasuries was moving higher more than the 10 year yield is falling.

There’s a very simple explanation for that: The Federal Reserve has raised interest rates nine times in a little over three years.

The Fed has much more control over short-term rates. Long-dated yields are more market driven.

You need to watch both ends. The Fed last pressured short-dated bond yields in the 1990s, according to LPL. The short end of the yield curve inverted twice in that decade but the 10 year/30-year never did.

Fundamental Capital’s Troy Bombardia, a favorite source of historical finance information, has run the numbers on what happens to the S&P 500 when the 10 year “long” yield dives below the three-month rate:

  • In 1966, 1973, 2000, and 2006, an inverted yield curve indeed preceded a big stock market pullback (usually by a year or two).
  • Meanwhile in 1978, 1980 and 1989 it didn’t mean much. Investors who sold on this indicator likely regretted it.

From this analysis then, the record of yield curve inversions as an indicator of an imminent bear market is no better than mixed.

Nuclear Winter Warnings

While all eyes have been on the nuclear showdown between Trump and North Korea, our eyes have been looking at another area of the world that is not getting much attention.

India and Pakistan have long engaged in a festering conflict the veteran foreign reporter Eric Margolis has called “the world’s most dangerous crisis.”

Even so, this is the first time we’ve seen fit to make it a lead item on our list of what keeps us up at night. That’s how big a deal it is. If it went nuclear, there’s no telling what the impact on the world might be.

“It is almost unprecedented for two nuclear-armed countries to carry out air strikes into each other’s territories,” reports the BBC’s correspondent in Delhi and yet that’s what’s happened in recent weeks.

The trouble began on February 14th — well, really it began in 1947, but we’re getting ahead of ourselves — when a suicide bomber killed at least 42 Indian troops in the disputed territory of Kashmir. India’s government held Pakistan’s government responsible.

Events have escalated to a point that the Pakistani government claimed it shot down two Indian military jets and captured a pilot.

“India and Pakistan, both nuclear-armed, have fought four wars over divided Kashmir since 1947,” Mr. Margolis explains. That’s when the Indian subcontinent won independence from Britain.

Kashmir is a majority-Muslim territory. Two-thirds of it sits in Hindu-majority India. The other third lies in Muslim-majority Pakistan.

As international conflicts go, Kashmir is probably more intractable than Israel-Palestine and it’s way more perilous.

India’s conventional forces would overwhelm Pakistan’s in the event of all-out war. Pakistan’s only means of effectively fighting back would be tactical nukes. “Both sides’ nuclear forces are on a hair-trigger alert, greatly increasing the risks of an accidental nuclear exchange,” Margolis writes.

“Rand Corp. estimated a decade ago that such a nuclear exchange would kill 2 million immediately and 100 million in ensuing weeks. India’s and Pakistan’s major water sources would be contaminated. Clouds of radioactive dust would blow around the globe.”

A more recent estimate by Physicians for Social Responsibility pegs the numbers at 20 million dead in the first week and 2 billion from the resulting global famine.

The risk that hostilities could rapidly spiral out of control eased slightly after Imran Khan, Pakistan’s cricket-star-turned-prime-minister, announced he was returning the pilot to India in a “goodwill gesture.” Commander Varthaman was duly handed over to India. Mr. Khan — elected with military support just last year and still wrestling with a severe economic crisis — has also implored New Delhi to engage in dialogue and avoid any “miscalculation” that could lead to greater conflict.

So that’s a thumbnail sketch of both the background and the latest developments. If you want to know more, Google is your friend. Or you can read Margolis’ excellent book War at the Top of the World — complete with his firsthand accounts of getting shot at along the “Line of Control” in Kashmir at 16,000 feet above sea level.

Sub Prime Debt Bomb

We’ve seen a lot of news coverage and internet postings recently that work to rekindle investors’ worst fears of a return to the dark days of the financial crisis. Several articles have warned that consumer debt and loan delinquencies are rising, particularly in the auto space. But this doesn’t mean a crisis is brewing. Delinquencies and losses are only part of the story for subprime autos.

Loomis-Sayles’ Senior Mortgage and Structured Finance Analyst, Jennifer Thomas, provided the analysis below recently as to why Loomis-Sayles thinks that the subprime auto sector is in better shape than it gets credit for:
Borrower wage gains – worth the wait

Subprime borrowers tend to be lower-income earners. For this group, wage gains usually don’t materialize until late in the economic cycle. This has certainly been the case with the current cycle. A decade into the recovery, lower-income groups are only now enjoying strong income growth. But higher wages are worth the wait. Recent earnings relative to expenditures can have an impact on borrowers’ payment and default behavior. And compared to other workers, wage increases are especially meaningful for subprime borrowers, many of whom live paycheck to paycheck.

The chart below illustrates the late-recovery bounce in wages for retail workers (a proxy for lower-income earners).

Lenders and issuers adjust with the cycle

Borrowers aren’t the only group that influences loan performance. Lender and issuer trends vary throughout the economic cycle, which can affect credit patterns. But these aspects of subprime auto ABS get much less attention than the consumer angle.

In the middle of the cycle, as the benefits of monetary stimulus spread, lenders tend to “broaden the credit box.”

This means extending capital to non-prime borrowers. For the current cycle, this happened from 2015 into the first half of 2017. As the share of higher-risk borrowers grows, increased delinquencies and losses typically follow with a lag, which we saw in 2017 and 2018.

This latest rise in delinquencies and losses got plenty of media coverage. What got almost no attention were efforts by lenders to account for higher anticipated defaults and delinquencies. As the credit cycle matures, subprime lenders adopt more conservative underwriting practices. These lenders are credit specialists who price loans (by setting appropriate interest rates) to reflect late-cycle risks and cover anticipated future losses.

Asset-backed securities themselves also prepare for expected negative events with high levels of credit support.

This includes measures like excess spread—or the difference between the interest an ABS deal takes in and what it pays out to investors. For ABS investors, this extra capital is the first line of defense against losses.

Where we are today

Though headlines focus on the downside, auto loan quality is actually up on the whole. The Federal Reserve has commented on this, saying: “… the overall auto loan stock is the highest quality that we have observed since our data began in 2000.”[1] That said, I am always watching for risks. Right now, I am monitoring how pressures like rising rents and healthcare costs could affect subprime borrowers over time.

The chart below sums up subprime ABS throughout the cycle. It shows the impact of prior changes in underwriting practices (first loosening credit from 2015 through early 2017, and then tightening credit) and the recent benefits of stronger income growth among subprime borrowers. In fact, as wages rise, losses for the 2016-2017 vintages and recent ABS deals are improving. The shift to more conservative underwriting also appears to be underway, and I believe this will meaningfully impact future delinquency and ABS credit performance.

Fundamentals, not fear

It’s important to remember that subprime lending has not always had a negative image. It was originally heralded as the “democratization of credit,” extending capital to a new demographic of borrowers. But a broader borrower base brings with it more delinquencies and defaults. When the statistics look scary, investors shouldn’t lose sight of fundamentals. I think borrower health, and lender and issuer behavior are a much better yardstick for investors trying to determine how subprime auto ABS measures up.

While this is one opinion from one analyst, at one company, it is important to know that this is a company that has been around since 1926 and currently manages approximately $250 billion in assets across four different types of investment vehicles. They have been trading the fixed income markets for over 25 years. So, it is critical for them to get things right with respect to their own business interests.

China Trade Talks

While the Federal Reserve, India-Pakistan and sub-prime auto loans may not be getting many headlines from the various financial news channels, not a day seems to go by without something about China trade talks flashing across the screen (we keep the volume on mute to preserve our sanity as well as objectivity). It reminds us of an old Brady Bunch episode when the middle sister complained that all anyone ever spoke about was “Marsha, Marsha, Marsha.”

Our position on China remains the same. Economically, the tariff tussle hurts them more than it hurts us and that will lead to some sort of compromise deal that will be better than what we have in place today but will be short of the goal of a world of free trade. President Trump will meet with China’s Vice Premier Liu He as speculation grows that negotiations over a trade deal between the world’s biggest economies are entering the final stages.

We have learned from experience that it is unhealthy to hold our breath over these reports but, given Wall Street’s penchant for buying the “Devil you know”, if a deal is signed, regardless of its quality, it will be another speed bump removed from the current upward trend.

We Understand

If you’ve been reading our quarterly missives for a while, you can see that we never run out of things to keep us awake at night. We know that someday, there will be another recession and when that recession comes,

  • Unemployment will rise.
  • Government safety nets won’t prevent widespread hardship.
  • Safety net spending will scare bond market investors.
  • Interest rates will rise.
  • Economic problems will get worse.
  • The Fed and the federal government will quickly run out of policy tools.

We also know that the recessions in our lifetimes began with a triggering event:

  • 2009 Great Recession:

Collateralized Mortgage Debt

  • 2001: bubble burst + ENRON

  • 1990 RECESSION:

Oil shock (we went to war in the Middle East)

Junk bonds (a financial innovation from Wall Street at the time which was born from Michael Milken’s realization that arranging lending to companies with miserable credit ratings was a lucrative strategy for Drexel Burnham but which proved to be less lucrative for the actual lenders)

  • 1980-82:

Oil shock / Iranian revolution (oil was a much bigger part of our economy and we didn’t have hybrids or the level of US production that we have now)

Inflation (never fully cured from the early 70’s when we left the gold standard)

We can go back: 1973 (war + oil crisis + no gold standard). 1969 (Vietnam), etc., but the point is that recessions don’t just happen out of thin air, so we keep our eyes on the horizon and look for things that could cause our economy to reverse course.

In the meantime, there will be fluctuations in the market as fear continues to scare people into a run for the exits.

We continue to position our investments into strategies that take advantage of pull-backs and we constantly research and test ideas that would not only take advantage of pull-backs, but also add additional protections in the face of an eventual recession and the possible bear market that could accompany it.

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Fourth Quarter 2018 Market Review

Q4 2018 –Will we have a recession in 2019?

We love the holiday season as it gives us time to visit with family and friends and step away from the market for a while, unless of course we have a market like we saw in this fourth quarter and people realize what we do for a living. With headlines like:

“U.S. stocks post worst year in a decade as the S&P 500 falls more than 6 percent in 2018”

“The S&P 500 and Dow fell for the first time in three years, while the Nasdaq snapped a six-year winning streak.”

“Major stock indexes posted their worst yearly performances since the financial crisis.”

“The Dow and S&P 500 record their worst December performance since 1931 and their biggest monthly loss since February 2009.”

We found ourselves pulled aside and being asked for investment advice or our opinion in hushed voices while celebration went on around us.

In fact, the S&P 500 and Dow Jones Industrial Average were down 6.2 percent and 5.6 percent, respectively, for 2018 which are their biggest annual losses since 2008. The Nasdaq Composite lost 3.9 percent in 2018, its worst year in a decade as well. However, these losses are not in the same ballpark as those recorded in 2008, when the S&P and the Dow fell 38.5 percent and 33.8 percent, respectively, and the NASDAQ dropped 40 percent.

For the fourth quarter, the S&P 500 and NASDAQ fell 13.97 percent and 17.5 percent, respectively, their worst quarterly performances since the fourth quarter of 2008. The Dow notched its worst period since the first quarter of 2009, falling nearly 12 percent.

A sizable chunk of this quarter’s losses occurred in December. The indexes all dropped at least 8.7 percent for the month. Traders on television and in the news had trouble pinpointing the cause of the extreme volatility: the S&P 500 was down more than 20 percent from its record high on an intraday basis on Christmas Eve, briefly meeting the requirement for a bear market, and then roared back the next session. The Dow jumped more than 1,000 points on Dec. 26 for its biggest ever single day point gain. The consensus seems to be building to chalking up December’s volatility to computer-driven trading.

Likely reasons given for the sell-off include:

  1. Concerns of an economic slowdown
  2. Fears the Federal Reserve might be making a monetary policy mistake
  3. Worries over ongoing trade negotiations between China and the U.S.

We’ll address each of these ideas below.

Reading the headlines and listening to the commentary during the December decline, you would have been led to think that the bottom had fallen out of the U.S. economy and that we were on the brink of the next Great Depression. We do not believe either to be the case. Before we provide our reasoning, let us first make sure that we are using these words properly instead of provocatively as many media sources tend to do.

The standard definition of a recession is two or more consecutive quarters of declining GDP. Since a depression is understood to be something worse than a recession, many people think it must mean an extra-long period and deeper level of decline. But that is not the definition of an economic depression.

Possibly the best definition ever offered came from John Maynard Keynes in his 1936 classic, The General Theory of Employment, Interest and Money. Keynes said a depression is “a chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or towards complete collapse.”

Keynes did not refer to declining GDP; he talked about “subnormal” activity. In other words, it’s entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or allow a government to stay ahead of the national debt.

According to the website Trading Economics, the GDP Growth Rate in the United States averaged 3.22 percent from 1947, the end of the Great Depression, until 2018. However, according to the website Statista, the average real GDP growth from 2000, when we were in the middle of the crash, until 2017, the last annual datapoint we have to examine, was 1.97%.

Over the first three quarters of 2018, US GDP advanced at an average rate of 3.3%. If growth in the fourth quarter continues at or near that rate, one could argue that, by Keynes definition at least, we might just be emerging from an eighteen-year depression.

This does not, however, mean that the market will continue to rise unabated. As we can see the chart below of the S&P 500 from 2000 to 2018, in both 2011 (1.6% GDP growth) and 2015 (2.9% GDP growth) the stock market temporarily swooned despite continued economic growth. Again in 2018, the stock market reminded us that, in the short term, it can have a mind of its own.

S&P 500 Monthly Chart 2000 to 2018

Interest Rates are Still Key

Despite what you may be hearing during your ride home, seeing on the news, or reading in your news feed, the Federal Reserve’s interest rate policy is still the number one issue driving the markets. In December, the policymakers raised the central bank’s benchmark borrowing interest rate to 2.5%. This was the fourth rate hike of 2018. Previously, they had only raised the rate four times since December 2015.

In a press conference following the December meeting, Jerome Powell also noted that rates this year were raised more times than expected because the economy was stronger and healthier than anticipated. But the Fed went on to lower its expectation for gross-domestic-product growth in 2019 by 0.2 percentage points to 2.3 percent.

Low interest rates have been the key ingredient in the almost 10-year-old market uptrend we have experienced since 2009 and the prospect of rising rates is if it makes other investments look more appealing, it makes price appreciation-driven growth much harder to come by. Recall that it was immediately after the January 2018 meeting when the Fed announced their plan for three rate increases that the market immediately experienced a two-week sell-off.

In addition to the rate hike and the projection of at least two more increases in 2019, Chairman Powell also stated that the Fed’s quantitative tightening would continue at its current pace. Quantitative tightening is the reversal of the quantitative easing policy the Federal Reserve, along with several other central banks, engaged in after the near financial collapse of 2008.

Quantitative easing is the process whereby central banks essentially create money by depositing money at private banks and other financial institutions and then buying securities from them, with the money remaining in those institutions. The intention, the central banks hope, is that this money will be loaned out to corporations and consumers in order to spur business activity.

In reversing the process, the central bank sells securities back to the financial institutions, thus draining money from the amount that the banks have on hand. That reduces the amount of money they have to lend, which, again, other things being equal, should raise the cost of money to borrowers, or interest rates.

In the U.S., the Fed ended its asset purchases in 2014 but continued to reinvest interest payments and the proceeds of matured bonds into new securities, leaving the size of its portfolio mostly unchanged. On June 14, 2017, the Fed announced it will begin reducing its portfolio holdings as the U.S. economy has finally shown sustained growth. The current pace is running off as much as $50 billion of the Fed’s bond portfolio each month. However, like QE before it, QT has never been done before, especially on such a massive scale. This worries many investors because the likely effect is that it will raise the cost of borrowing and reduce asset prices.

The impact of the rate increase and the chairman’s comments afterward started the reversal that wiped out the gains of 2018.

Some pundits have claimed that the Fed needs to raise rates so as to have more “ammo” to respond to the next slowdown. To that, our response is that it would seem rather foolish if, in the act of preparing for the next slowdown, the Fed’s actions directly cause one. Additionally, given the recession discussion above, we would point to how ineffective the Fed’s past accommodative policy (low interest rates plus quantitative easing) was for the economy.

We believe that individual stocks and the broader markets are driven primarily by corporate earnings and interest rates and so we would expect the volatility in the market to continue to rise and fall with every Fed statement and speech.

To punctuate this point, as we sit here writing this, the market is now up over 3% today “after the Federal Reserve chairman, Jerome H. Powell, said the central bank’s approach to monetary policy would remain flexible in the face of market turbulence and signs that the global economy is slowing.” – Source: Marketwatch

One last comment about market volatility, while causality is difficult to prove, we do believe this volatility is being driven mostly by computers.

According to an article this week in the Wall Street Journal, about 85 percent of all trading is controlled by computers. And I don’t mean that humans use computers to make the trades, I mean the computers are monitoring trading activity, market data and even political rhetoric and then making instantaneous decisions on what and how much to buy or sell. As the WSJ article put it, the volatility we’ve been seeing in the stock market is being driven mostly on autopilot.

This explains the speed with which these swings in the market are happening. Whereas a human might wait to make a move, perhaps being intimidated by the impact a big purchase or sale would have on the markets, computers are programmed to act the instant the market changes.

It is impossible to know how the stock market would have reacted over the last month if humans were still in charge. But the thought is that losses that occurred in a day may previously have taken a week, or month, etc.
The other thing speeding up trading is that the majority of the remaining 15 percent of investors who make their own trades trust the computers. When the computers start selling one thing heavily, these investors tend to jump on board, moving together like a herd.

Economists are having a tough time interpreting market volatility because of the computers. They can’t tell if the market is showing us the reality of the global economy to come, or if computers are simply amplifying normal “year-end nervousness.”

Regarding China and Trade

We believe that with news channels running 24 hours per day, they have an ongoing need to find something new and interesting to explain market activity. The trade war with China has been a favorite go-to explanation ever since President Trump announced tariffs on Chinese steel exports and other goods coming into the U.S.
First, let’s examine the facts as we know them:

According to the financial website, The Balance, in 2017, (the date of the most recent data available) U.S. exports to China were only $130 billion while imports from China were $506 billion.

The United States imported from China $77 billion in computers and accessories, $70 billion in cell phones, and $54 billion in apparel and footwear. A lot of these imports are from U.S. manufacturers that send raw materials or components to China for low-cost assembly. Once shipped back to the United States, they are considered imports.

China imported from America $16 billion in commercial aircraft, $12 billion in soybeans, and $10 billion in autos.
According to the World Bank, in 2017, Chinese exports were $2.3 trillion and accounted for 18.48% of China’s GDP, which was approximately $12 trillion in 2017. For the United States, total exports were $1.5 trillion, representing 7.94% of our GDP.

So, doing some very simple math, adding a 25% tariff to Chinese imports would represent a $126 billion tax hike to the over $19 trillion U.S. economy. While certainly not insignificant, it does not seem as important as the 46% increase in the prime rate of interest since 2016.

As far as which side has leverage in the negotiations is concerned, in 2017 China accounted for approximately 9% of our total exports while we represented nearly 22% of theirs. So, while certain multi-national businesses may be hurt in the short-run, as we saw with Apple, it is pretty clear that other than slightly higher prices for computers, cell phones, apparel and footwear, our economy is not very sensitive to any possible Chinese retaliatory measure. Additionally, many other countries would be more than capable of absorbing the demand for these goods, should the current situation drag on and the multi-nationals choose to relocate their operations in order to reduce cost.

While we don’t like making predictions, given the constant table pounding by the large U.S. companies, we believe that we will probably end up with another last minute New-NAFTA-like deal with better terms than we had before, but still with less than the President desires (a tariff-free world). Of course, post-deal enforcement is another issue.

In any event, we expect 2019 to be a very interesting year!

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Third Quarter 2018 Market Review

Q3 2018 – How Long will the party last?

The stock market has many old sayings, from “buy the rumor and sell the news” to ”as goes January, so goes the year.” And let’s not forget this memorable one: “Bulls make money. Bears make money. Pigs get slaughtered.”

But one old saw from Wall Street that you probably heard recently is “sell in May and go away.” It means that you should sell your stocks in May, and come back to the market in the fall, specifically in November.

According to the folks at the Fiscal Times: “The full quote dates to 1930s London, when stock traders would tell each other to “sell in May and go away, stay away till St. Leger Day.”

St. Leger Day is dedicated to the St. Leger Stakes, the final leg of the British version of the Triple Crown in horse racing that’s held each year in late September.

Basically, English traders wanted to enjoy a long vacation—and ended up altering stock market behavior in the process.

Why? Because stocks have historically underperformed between May through October, compared to returns seen from November through April. Since 1950, the Dow Jones industrial average has returned an average of only 0.3 percent during the May to October period, compared with an average gain of 7.5 percent between November and April, according to the Stock Trader’s Almanac. A less-pronounced “sell in May” effect is present in the Standard & Poor’s 500-stock index as well.”

However, in the past 6 years from 2012 through 2017, following this strategy would have made you miss gains ranging from just 0.27% to 12.99% in the DJIA. And in 2018, while we haven’t yet reached the start of November, the stock market rewarded those who stayed invested with the DJIA returning 10.64% through the end of September. During that same period, the S&P 500 and NASDAQ Composite were up 10.98% and 14.42%, respectively.

It is interesting to note that, in a turn-about from recent history, this past quarter saw the Dow Jones Industrial Average (+9.6%) and S&P 500 (+7.70%) outperform the technology heavy NASDAQ Composite (+7.4%). This was a result of weakness in some of the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) that have been propelling the markets, especially the NASDAQ, higher for so long,

Bonds returned 0.08% in the quarter as measured by the S&P U.S. Aggregate Bond Index. This index includes U.S. treasuries, quasi-governments, corporates, taxable municipal bonds, foreign agency, supranational, federal agency, and non-U.S. debentures, covered bonds, and residential mortgage pass-throughs. Commodities returned -2.08% based on the Dow Jones Commodity Index.

As we sifted through the news, two themes kept popping up as the major equity indices set new all-time highs

  1. How long can the longest running bull market in history continue, and;
  2. Which marijuana stocks will create the next generation of millionaires?

We will address these two items first before updating the real issues that concern us.

Welcome to the Longest Bull Market in Wall Street History

That was actually the title of an article posted on MarketWatch on August 22nd, along with the obligatory table of “Bull Markets Since WWII” showing that “Since March 9, 2009, which marked the low of the financial crisis and which many consider the birth date of the current bull market, the S&P 500 SPX…has advanced 320%, the Dow Jones Industrial Average DJIA…has risen 290% and the NASDAQ COMP…has soared 520%.”

But there is a problem with this article: there is no hard and fast definition of what constitutes a bull market or when it begins. As a writer at “The Reformed Broker” points out:

“It’s become likely that we are in a secular bull market for stocks. We do not measure secular bull markets from the bear market low of the prior cycle. The 1982-2000 secular bull market is measured from the day in 1982 when stocks finally took out their 1966 high. It had been a 16 year secular bear market until closing above those highs, and stocks never looked back. We do not date that bull market from the lows of 1973-1974 that were the nadir of the prior bear. Nor should we use 2009 as our starting point for the current bull market. 2009 was merely the cycle low of the prior bear, not the starting point of the current bull.”

So, according to the analysis by The Reformed Broker, the current bull market is actually only three years old, not seven and, if it were to end today, only three other bull markets measured this way would have shorter durations. This viewpoint should be solace for investors who find reason to worry about the age of the current bull market, despite the axiom that bull markets don’t die of old age.

Pot Stocks Continue to Go “Higher”

Just like bitcoin and other cryptocurrencies last fall, “pot stocks” are now skyrocketing as the general public has suddenly become enamored with the possibility of explosive profit potential within this new industry.

On September 19, Tilray (TLRY), a Canadian medical marijuana company, rose more than 50% in a single trading session. At one point, its shares had more than doubled in just a few days. It’s currently valued at roughly 500 times sales, about 300 times book value, and around 800 times its negative earnings before interest, taxes, depreciation, and amortization (“EBITDA”). It has a market cap of roughly $14 billion and sales of less than $21 million. No business anywhere, in our opinion, is worth such valuations.

If you recall, last year there were a dozen companies that reaped rewards by putting “bitcoin” or “blockchain” in their name. Long Island Iced Tea Corp. rocketed 458% after changing their name to Long Blockchain Corp.

The Tilray example is part of the wider bubble in marijuana-related stocks. The number of cannabis news stories recently overtook the number of cryptocurrency news stories, according to data compiled by Bloomberg.

It is apparent that the crypto mania that gripped the investment world last year has now been replaced by a manic demand for marijuana related stocks.

Of course, it goes well beyond crypto and marijuana. From the housing bubble in 2008, to the dot com bubble in 2000, Gold in the 1970’s all the way back to the tulip bubble of the 1700’s, humans have always had a tendency to be gripped by investment manias.

Manias like these don’t end well for most of those involved. Parabolic rallies are typically followed by huge declines of 50%… 80%… or more. That’s exactly what’s happened to bitcoin and other “cryptos” over the past several months. And we expect pot stocks will eventually suffer a similar fate.

The aftermath however, can present buying opportunities for the patient investor who is willing to accept that the fast money has already been made. Amazon, after all, was trading for $40 per share as late as December of 2004, long after the market had started to recover from the “dot-com” bust.

We believe that if we continue to analyze the universe of stocks for those companies with better than average sales, earnings and profit margins, marijuana companies with solid long term potential may eventually make it to our screens. In the meantime, we are happy to watch from the sidelines.

Trade (Wars)

On the trade front, Mexico, Canada, and the U.S. reached a new trade agreement. Most opinion makers seem to think the new accord is better than NAFTA. The market breathed a sigh of relief.

Earlier in July President Trump and Jean-Claude Juncker, the chief of the EU’s executive arm, the European Commission, held a joint press conference in which both leaders promised to work towards zero tariffs on non-auto industrial goods; to reduce barriers and increase trade in services, chemicals, pharmaceuticals, medical products, and soybeans.

They also agreed to reform the WTO and that the European Union will buy more liquefied natural gas from the United States. Perhaps most importantly, they agreed to refrain from imposing new tariffs on one another while they work together on these issues.

While this agreement sounds promising, it should be noted that nothing specific was established or signed and as Goldman Sachs put it:

“The lack of specifics in today’s U.S.-EU announcement raises the possibility that the negotiations could falter at a later stage, as U.S.-China negotiations did earlier this year.”

Hopefully, with an agreement with Mexico and Canada completed (although not approved yet by the congress), momentum will build toward reaching an agreement with the EU which would then put pressure on China to possibly rethink their current strategy.

Each agreement which takes away the implementation or threat of tariffs will be positive for the market and, hopefully, beneficial for US companies most impacted by these agreements.


Interestingly, the dollar has appreciated sharply this year despite the various “trade wars” referenced above. Coincidentally with the US imposing tariffs on Chinese solar panels and washing machines on January 22nd, the dollar began a sharp run higher.

A rising dollar makes imports cheaper which could, at least for those imports priced in foreign currencies, offset to some degree the inflationary impact of tariffs.

North Korea

Talks with North Korea continue as both sides jockey for a win-win outcome that makes neither side look like they surrendered. This is a situation that has been festering since the 1950’s so a quick solution, like the Mexico and Canadian Trade agreement, would seem highly unlikely. However, it is promising that both the North and South have continued to work towards a de-escalation of border tensions and we haven’t seen a North Korean missile test since November of 2017.

Federal Reserve Policy

In our Q2 letter, regarding the Federal Reserve Bank’s policies on interest rates, we wrote: “We see these Fed moves as the #1 driver of the overall volatility in the market for several reasons:….”

Our opinion has not changed, interest rates not only impact consumer spending decisions about homes, autos and luxury items, but they also impact business investment as well. Businesses typically finance their large capital expenditures with debt so an increase in interest rates will either increase the cost of the expenditure or curtail spending altogether. Either way, neither is good for the continued private sector economic growth that we need for both higher wage growth and a larger workforce.

Since August 20, the yield on the 10 Year Treasury has leapt from 2.83 to 3.22 on October 1st. This is not an insignificant move and signals a dramatic increase in borrowing costs which eventually make their way into the economy. For those of you wondering, the ten-year yield was 3.43 on January 1, 2008.

We have written before that the Fed feels that they need higher interest rates in order for the Fed to “reload” in advance of the next economic downturn. It is our opinion that they should have started this back in 2010 at a much more gradual pace to reach a “neutral stance”. In the Fed’s terms, those are rates that are neither accommodative nor restrictive to economic growth.

We readily admit that we have no idea as to when rates reach a level of neutrality, which is why we will never be nominated to serve at the Fed. We only observe that historically it appears the Fed didn’t know what level neutral was either and only found out when it went too far and sent the economy into a contraction. Motivations driving the Fed aside, the speed and magnitude of further rate increases demand ongoing attention.

One last comment on interest rates is in order. A lot has been made in the press recently of the yield spread between 10 and 2-year maturity Treasury bonds. Over the last 30-40 years, when this spread went negative, meaning that short term (2 year) yields were higher than mid-term yields (10 year), a recession followed in fairly, short order. While this spread is still positive, it is quite close to going negative. If, as it has in the past, this foreshadows an imminent recession, then it’s time to be extra cautious on the stock market as well.

Trade negotiations, geo-politics (short of nuclear war) and even election cycles will continue to create volatility shocks in the market. However, we believe that the biggest threat to the market remains the Fed’s monetary policy. In a recent article posted on MarketWatch, researchers calculated that stocks have suffered around $1.5 trillion in losses following speeches from the Fed’s Chairman Jerome Powell.

Powell has hosted three news conferences this year following meetings of the rate-setting Federal Open Market Committee. which were followed by an average decline of 0.44 percentage points in the S&P 500. Other talks and speeches have resulted in an average fall of 0.40 percentage points, with losses coming in five of the past nine prominent speeches or Congressional testimonies Powell has delivered.

The stock market knows that, over the long term, it is the economy that drives growth in sales and earnings and that sales and earnings growth ultimately drive long term performance in equities.

We believe it is our role to continue to identify those companies who can thrive in different economic conditions and buy them when they are trading t a favorable price. Watching business fundamentals instead of charts, newsletters, or headlines, we expect to be rewarded over the long term with less volatility and better sustainability.

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Second Quarter 2018 Market Review

Q2 2018 – Tightening and Tariff Tantrums

The major indices performed much better in the second quarter than the first as very positive earnings reports produced gains of 3.44% for the S&P 500. Bonds, as measured by the S&P US Aggregate Bond Index were down only 0.12% for the quarter and commodities as measured by the Dow Jones Commodity Index were up 1.06%. Finally, Bitcoin recovered a little bit in April and May before continuing its 2018 swoon (we haven’t gotten a call from anyone wanting to invest in Bitcoin or other Crypto currencies in several months).

While market volatility as measured by the VIX was nothing compared to the first quarter, the second quarter gains were not at all smooth and the number of one-day moves, up or down, of 1% or more was 26 out of 64 trading days in the quarter.

In our Q1 Letter we noted that, “There are four major factors driving the market. The factors are growth, trade wars, geopolitics and regulation of technology. “, and that opinion has not changed although trade wars and growth (and interest rates in particular), are having the greatest short-term impact on the markets.

In March, all eyes were on the Federal Reserve Bank and their monetary policy in the face of strengthening economic data. After a two-day meeting, the Federal Open Market Committee unanimously voted to increase its benchmark fed funds rate by 25 basis points, to a range of 1.50% to 1.75%. The Fed signaled two more rate hikes in 2018 amid speculation that it was considering adding a third increase. It did, however, raise its forecasts for hikes in 2019 and 2020, citing a stronger outlook on the economy. And then, in June, they voted to lift the target range for the federal funds rate by another 25 basis points to between 1.75% and 2% and signaled plans to do so two more times this year. That would be more than originally projected for this year, based on the risk of faster projected economic growth and low unemployment driving inflation beyond their 2% target.

We see these Fed moves as the #1 driver of the overall volatility in the market for several reasons:
The strategy of using interest rates to fight inflation is called “Contractionary Monetary Policy” and usually results in the Fed over-tightening by squeezing the buying power of households without a corresponding increase in wages. This, of course, can negatively impact revenue growth for businesses which can lead to negative earnings growth which, in turn, is a negative influence on stock prices.

As interest rates rise, savers have the opportunity to earn more interest on their debt instruments. Typically, higher rates draw money out of stocks and into interest bearing investments, adding another negative influence for stocks.

Higher rates also increase borrowing costs for businesses which may curtail business investment. Business investment is a driver of economic growth. Slowing economic growth would be, yet again, negative for stocks.
In their June statement, the Fed said that “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will consider a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”

We tend to live in the camp that economics is more art than science and believe we are all at risk when a governing body (Fed members are called “governors” after all) treats economics more like a science, believing that it can move levers and adjust the economy with scientific precision. Since the June 13 meeting, the S&P 500 has dropped approximately 2.5%. We don’t believe that this is coincidental and will continue to monitor Federal Reserve policies.

Regarding trade, the rhetoric is heating up as additional tariffs have been announced by the administration beyond those announced on Chinese imports. These new tariffs include a 25% tariff on imports of steel, and a 10% tariff on aluminum, from the European Union, Canada, and Mexico.

The tariffs angered U.S. allies, and have resulted in retaliatory measures taken by these countries as well as India. As these various measures and counter measures have been announced, we have seen brief market sell-offs in those sectors most likely to be affected. These sell-offs have been called “Tariff Tantrums” by some market pundits because of the panicked reactions to what could happen as opposed to reasoned action based on the fundamental data of what is actually happening. A recent article in USA Today went so far as to say that the tariffs in total will add over $5,000 to the price of every car sold in America! Interestingly, however, the article contained no analysis of actual cost data to support this claim.

We still do not think a full-scale trade war is in the cards as the risk of real economic slowdown is too high for all players involved. On July 2nd, Bloomberg ran an article showing how China is zooming to a record year of corporate-bond defaults in 2018. The article states, “Corporate profits have worsened this year and are unlikely to improve against the backdrop of an economic slowdown…” Therefore, it is not in China’s best interest to prolong any uncertainty regarding trade agreements with the US. Meanwhile the EU’s growth continues to disappoint. In 2017, the 19-country zone showed a decade-high rate of growth of 2.5%. By first quarter 2018, though, their growth had slowed to just 0.4 percent and Q2 results are not expected to pick up enough to sustain the 2017 performance.

We believe that the economic risks of a prolonged trade war are far too great for politicians to gamble with. How this gets resolved is still anybody’s guess. In June it was reported that President Trump proposed to the United States’ closest allies the idea of completely eliminating tariffs on goods and services. Apparently he did not get a very encouraging response. It may be that we start establishing separate trade deals with individual countries that contain better (but surely far from perfect) terms for the United States.

Concerning geopolitics in general and North Korea in particular, President Trump did meet with North Korean leader Kim Jong Un and the pair signed a document stating that Pyongyang would work toward (emphasis ours) “complete denuclearization of the Korean Peninsula.” While this is a far cry from final and ever-lasting peace, it is nonetheless a significant step forward. It must be noted that missile test launches and underground bomb tests in North Korea have ceased for the time being and there is certainly less concern around the possibility of an imminent nuclear world war than there was a year ago at this time.

Finally, we continue to watch the potential collision course between the FAANG companies (Facebook, Amazon, Apple, Netflix and Google, or it’s parent, Alphabet) and Washington D.C. While we are concerned that any legislation will create an increase in volatility of the major indices which are market cap weighted (the FAANG stocks make up 27% of the 2,595-security Nasdaq Composite), our bigger fear is the longer-term ramifications of legislation on growth and innovation.

For example, the Supreme Court’s decision on South Dakota versus Wayfair (now known as the “Wayfair Decision”) over South Dakota’s application of its sales tax to internet retailers who sell into South Dakota but have no property or employees in the state could have a chilling effect on the further development of e-commerce. Regardless of any opinion about whether this decision is right or wrong, we note that sales taxes, which exist in 41 states, apply to most purchases of retail goods within the state. The seller has the responsibility to collect the tax and forward the money to the state. E-commerce businesses will now have to collect the same sales tax collected by all other retailers. As e-commerce’s strengths over brick-and-mortar are more about convenience, wider selection, and lower costs, it’s unlikely this decision will hurt the larger e-commerce firms. As sales tax collection on e-commerce grew from almost zero to half of all sales, e-commerce has continued to grow sharply.

Our concern, however, is the ability of small e-commerce sellers to collect and pay sales taxes in a simple way. So, while the Amazons of the world will be able to absorb the costs of complying with sales tax initiatives, smaller retailers, as Amazon once was, may ultimately get squeezed out of the e-commerce channel. While this is just one example, one can see how government regulation can serve as a moat for the large, established tech companies to protect their market share from competition, whether it be in e-commerce, social networking, or healthcare.

During his March 2018 testimony before Congress, Facebook founder Mark Zuckerberg made clear that he was open to the government regulating Facebook in some way. “The question isn’t, ‘Should there be regulation, or shouldn’t there be?’ It’s ‘How do you do it?’” Zuckerberg told Zuckerberg knows that any legislation would not only impact Facebook but would also impact any small firm trying to compete with them and when it comes to business and regulation, the firms that can afford the best lawyers, accountants and technology will have a clear advantage over anyone else.

In conclusion, we continue to be cautiously optimistic, especially regarding US equities. A modestly bullish path forward is most likely. Net profit margins, fueled by the reduction in the corporate tax rate due to the recently passed tax reform, were at ten-year highs in 2017 according to FactSet. It is important to note, though, that net profit margins were improving on a sequential basis during all of 2017, prior to the tax bill becoming law. In any event, it appears the lower tax rate is more than offsetting any impact of higher wages and other cost increases, and many analysts expect even higher net profit margins for the S&P 500 for the remainder of 2018.

We believe that the best approach is to assess incoming data and update our opinions accordingly, stick with higher quality investments in correspondingly suitable allocations based on each investor’s financial and emotional tolerance for risk, and stay nimble.

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First Quarter 2018 Market Review

Q1 2018 – The Roller Coaster is on the Track

At the time of our last quarterly update, we had just finished a great year for the stock market.

Accordingly, we wrote “…we do not expect 2018 gains to match those of 2017.” So far, we have been more correct than we really wanted to be with the S&P 500 showing a modest decline year-to-date despite the exceptionally strong start in January.

The “modest decline” doesn’t adequately describe the very sharp moves, both up and down, by the S&P 500 and the Nasdaq Composite in the first three months of 2018.

Those sharp moves translate into an increase in market volatility starting in early February, as measured by the VIX, after spending a year below 12; a reading that is historically very low for the markets.

Some people who read stock market charts are describing the move in January as a classic “Blow-off Top” which, according to Investopedia is “A chart pattern that indicates a steep and rapid increase in a security’s price and trading volume followed by a steep and rapid drop in price and volume. While we see a steep and steady rise in price followed by a steep and rapid drop in price, when we add volume to the chart, we do not see the type of volume behavior that the definition is calling for.

According to wealth management company Gluskin Sheff’s Chief Economist, David Rosenberg, the S&P 500 Index is on pace for an incredible 100 sessions with a daily move of 1% or more. It’s still early, and there’s no guarantee this pace will continue. But it would place 2018 in rare company. In fact, this has only occurred in five previous years over the past 70.

Two of those years – 2001 and 2008 – occurred in the middle of a serious bear market decline. The other three – 1974, 2002, and 2009 – marked significant multiyear bottoms. But all five were incredibly volatile periods for investors.

What’s Going On?

There are four major factors driving the market. The factors are growth, trade wars, geopolitics and regulation of technology.

Each of the four factors has several potential outcomes, some being positive for the markets and others being negative. With each tweet, speech, data point and action that takes place, traders and investors recalibrate their outlook and adjust their positions accordingly only to have a contradictory tweet, speech, data point, etc., follow which forces them to recalibrate their viewpoint once again. No wonder the market seems confused.

US Economic Growth

With regard to growth, the bulls expect a boost from the Trump tax cuts. They are also anticipating inflation due to strong job creation, rising labor force participation and a low unemployment rate. They expect interest rates to rise but consider this more a sign of economic strength than a cause for concern. Strong growth is good for corporate earnings, and a little inflation is usually good for nominal stock prices, at least in the early stages.

Bears point to an economic slowdown in the first quarter (most projections are around 2% or less and by the time you read this the actual results should be known). This is consistent with the dismal average of 2.1% growth since the end of the last recession in June 2009. Stronger growth is impeded by demographic and debt head winds and the impact of Chinese labor and technology on global pricing power.

Tax cuts are not expected to help, because the drag on growth caused by increased debt will outweigh any stimulus from lower taxes.

The market is also concerned that the Fed is giving a weak economy a double dose of tightening in the form of rate hikes and the unwinding of several years of quantitative easing (loose monetary policy). We don’t think the Fed will push the economy to the brink of recession before they get the message and pause on rate hikes, probably after the November elections.

Trade Wars

To many, the possibility of trade wars are another conundrum. There is little doubt that a true trade war would reduce global growth. But many are wondering if we’re facing a trade war or just a series of head fakes by Donald Trump as he pursues the art of the deal?

For example, Trump imposed tariffs on steel and aluminum imports and then almost immediately carved out exemptions for Canada and Mexico pending progress on renegotiating NAFTA. Then the President trumpeted a trade deal with South Korea that imposed quotas on steel imports but almost immediately said that deal was conditional upon South Korean help in dealing with North Korea.

Trump has also threatened over $50 billion of penalties on China for theft of U.S. intellectual property, but within days China and the U.S. calmed market fears by announcing plans for bilateral trade negotiations.

So, is it really a trade war, or just a set of negotiating tactics?

We don’t believe a trade war is the real end game for the President. Trump is a New York businessman and he approaches the office of President like a New York businessman versus a politician. If his real goal is to create a more level playing field and address the burgeoning trade deficit we have with China, then a trade war would be a step backwards. We also question China’s strength in direct negotiation with the United States, While the news media would have us believe that China holds all the cards, the scenario changes when you actually look at the hand they have been dealt.

While it is true that China is the world’s fastest growing major economy, much of its growth has been from investment in an export-based model and now that strategy, wrought with examples of poor investment that we have mentioned before, may prove detrimental to their global ambitions.

China’s total debt has been building up in the economy during the last several years to support growth. China’s debt surpassed 300% of GDP in 2017. The People’s Bank of China has enabled the buildup of debt with “huge lending” to commercial banks. Debt-fueled consumer demand accounted for 71% of China’s economic growth in the first three quarters of 2016. China’s economic growth is being held up through extremely high credit generation. That is probably not sustainable for long without substantial damage to the economy and financial system.

Overcapacity in industrial enterprises is the biggest problem that China is facing today. China now has far more capacity than it – or for that matter, the world – needs. In some cases, overcapacity exists to the level of 30% of domestic need. The overcapacity problem has been exacerbated in recent times by the clear slowdown of China’s economy. Particularly, the slowdown in infrastructure projects and in the real estate sectors. Overcapacity in the manufacturing sector could take far longer to be sorted out, especially given the state of the global economy.

To tackle such conditions and avoid an impending crisis, China faces a very serious need to boost exports, as its domestic demand cannot absorb the goods that would be produced at the higher capacity utilization levels needed to sustain the economy. In such a scenario, any fall in Chinese exports due to a trade war has the potential to cause a huge setback to China’s plans and strategies.

Will the threat of a trade war work to level the playing field? Chinese President Xi Jinping has just promised foreign companies greater access to China’s financial and manufacturing sectors and pledged Beijing’s commitment to further economic liberalization despite (or because of) rising trade tensions with the U.S.

The news that China intends to try to do better is welcomed, but it’s nothing we haven’t heard before. There was no clear schedule for implementation of the proposals. Barring concrete progress on a trade deal, we suspect it’s simply a matter of time before tensions rise again.

Trump has left enough wiggle room to indicate he could back off the trade wars if he can attain enough concessions from China and the NAFTA countries. Our expectation is that trade talks and skirmishes are likely for some time to come. China will probably stall concrete action until the outcome of the November election to see if voter support for Trump increases or decreases. The advent of a Democrat majority in one or both Houses of Congress could change the political calculus.

Real Wars

Geopolitics is another on-again, off-again market driver particularly concerning war with North Korea.

If anyone had suggested, even three months ago, that North Korea would end up participating in the Winter Olympics and subsequently request a meeting with the U.S. to discuss nuclear disarmament, the suggestion would have been rejected outright as naïve. And yet, a rapid round of diplomacy involving summits including North and South Korea, China, and Japan, are all leading to a summit between Donald Trump and Kim Jong Un. Quite possibly these developments may point to a possible peaceful resolution of the impasse.

If you believe Kim Jong Un is dealing in good faith, you’ll be encouraged by these developments. If you believe Kim Jong Un is dealing in bad faith and just playing for time as he perfects his weapons technology, then you’ll expect that war is just a matter of time.

Take your pick.

Technology Wars

The final factor that is confounding markets is the potential for regulation of technology. Investors do not need to be reminded of the outsized impact of the FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) on markets overall and the Nasdaq-100 in particular.

Suddenly, Facebook is facing scrutiny because of misuse of personal customer data and for acting as an accessory to alleged Russian meddling in U.S. elections. Amazon is under the gun on possible antitrust grounds, alleged government subsidies for shipping and Trump’s visceral dislike for the “fake news” Washington Post owned by Amazon founder Jeff Bezos.

There has already been a congressional hearing on one of these matters with a high likelihood of more to come. It’s possible that hearings could lead to legislation. Will Silicon Valley lobbyists dilute the legislation? Will antitrust allegations go up in smoke? Or will populist outrage with the tech giants lead to a sea change and aggressive enforcement as we saw with the Rockefeller trusts in the early 1990s?

The correct answer is that no one knows. This will be a battle between corporate lobbyists and populist outrage. Usually the lobbyists win, but this time may be different.

None of these four issues will be resolved quickly. It may take six months of data before the Fed realizes the economy is weak despite tax cuts or before growth bears throw in the towel.

Trade wars usually play out over years, not months. If Kim Jong Un wants peace, we should know fairly soon. If not, the countdown clock to war, currently on pause, will resume ticking.

The hearings and legislative process involving technology regulation could easily take a year or more to play out. Members of Congress like to milk these issues for campaign contributions from both sides before resolving them, so quick results here are unlikely.

Summing Up

The problem for investors is they have to wake up every day and commit capital whether they know the outcome of these issues or not.

If growth is strong, trade wars fizzle, North Korea wants peace and the tech lobbyists prevail, then Dow 30,000 is a possibility.

If growth is weak, trade wars escalate, North Korea is dealing in bad faith and popular outrage hamstrings the tech giants, then Dow 20,000 is the more likely market destination.

Of course, other combinations of these factors are more probable than a uniformly positive or negative scenario. Mixed results, though in unknown combination, are entirely possible.

Our estimate is that a slightly more optimistic, modestly bullish path is most likely. Money is still going to flow where it is best treated. We do not believe the economy is so strong that interest rates will rise enough to trigger an immediate mass inflow of investment into bonds. But it’s unwise to put a stake in the ground on any particular outcome. The best approach is to assess incoming data and update our opinions accordingly, stick with higher quality investments in correspondingly suitable allocations based on each investor’s financial and emotional tolerance for risk, and stay nimble.

It is highly unlikely that market volatility will go away any time soon because the issues now driving that volatility, if history is a guide, will not be resolved soon.

An update on Cryptocurrencies

For those who were worried last quarter that they were going to miss out on the next great wealth making investment, we have good news. Bitcoin, still the leader of the cryptocurrency revolution has dropped dramatically from its most recent run up.

This is not the first time this has happened, nor do we believe it will be the last. The cryptocurrency market is still in its infancy and has been compared to the Wild West. We do believe that in the long term, the promise of the underlying technology behind these currencies, Blockchain, could prove to be beneficial to a number of industries, but many of the companies involved in Blockchain are being valued on hopes and dreams instead of fundamentals.

In such an environment, picking winners from losers is still more closely related to picking numbers on a roulette wheel than it is to common sense investment principles.

We continue to monitor the markets for real opportunities based on the value-based approach that has served us well all these years and if the right company comes along, we will not hesitate to add it to our universe of stocks.

Until that time, we still regard investments in these currencies or blockchain start-ups as strictly speculative and not suitable for any core portfolio strategy.

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Fourth Quarter 2017 Market Review

Look Both Ways as You Cross the Street?

Stocks rose for a fourth straight quarter with a gain of 6.34%. Bonds, including treasuries, were up 0.39% even with the Federal Reserve hiking interest rates a quarter of a point in December. Commodities (as measured by the Bloomberg Commodity Index) again had a strong fourth quarter led by energy and metals. And Bitcoin…….well, despite its unprecedented increase in value, we still consider Bitcoin to be a medium of exchange and better suited as a store of wealth versus a growth or income-producing investment.

2018 Outlook:

As you recall, one of the key variables we identified as impacting the market was meaningful tax reform and, while far from perfect in our view, it is hard to argue that the reforms are not meaningful.

For those of us old enough to remember, the tax reforms of the 1980’s impacted the economy positively through deep cuts to personal tax rates. This bill delivers only modest personal relief for most of us who pay taxes, but it does create a much more favorable business climate than we’ve seen in many years through significant corporate tax reduction.

While we may see only modest gains in our personal tax bills, we will all certainly benefit from any gains in real economic growth that may be spurred on by these tax changes. If demand exceeds capacity, as it often does when economic growth is robust, that will fuel the need for capital investment in new and expanded factories and facilities across the nation. That expansion could push up the demand for labor and increase hiring and wages.

Economic growth should translate into increased revenue which, if companies hold their costs in line, would result in enhanced rates of earnings growth. Faster growth would have a positive impact on one of the fundamental components of stock pricing.

Interest rates will still be favorable for borrowers and near historic lows even if the Federal Reserve proceeds with its three projected interest rate hikes in 2018.

Couple all that with an already improved business regulatory climate and you have a constructive environment for continued market gains in 2018.

But while these catalysts typically signal that stocks have more room to run, there are still risks worth watching and we do not expect 2018 gains to match those of 2017.

The first question pertains to the effect of the tax cuts on the market from this point. We have heard opinions from “experts” that the reforms have been fully priced into the market or not priced in at all. We believe the truth is somewhere in between those two extremes, but there is a strong possibility that prices have gotten at least a little ahead of fundamentals. So, it would not be surprising if the market pauses until earnings announcements enable investors to better calibrate how “cheap” or “expensive” stocks really are.

Another common assumption is that major companies will repatriate the billions of dollars currently held overseas and use that capital for domestic investment, acquisitions, and share buy backs. While we do believe that this will occur to some degree, we also think that at least some of the repatriated cash will be applied to debt reduction.

Reducing debt would strengthen balance sheets which is good in the long run but it doesn’t necessarily drive increases in stock prices in the short run. Since these companies will determine what is in their own best interest, it is impossible to draw any macro conclusions about the impact of repatriation. We would prefer to err on the side of caution.

The risk of some sort of military conflict with North Korea still exists. The missile tests continue, bomb tests continue, military drills continue, and rhetorical spats continue. We do not see a peaceful path to eliminating the nuclear threat presented by this regime. Any resolution that results in a nuclear exchange occurring anywhere in the world will certainly rock the markets for some period; how significantly and for how long is open to debate.

International Economies – China

China’s growth rate has taken a hit this year which makes sense since you can only build so many empty cities. Unfortunately, GDP calculations in China have long been suspect making it difficult to determine the soundness of the Chinese economy. For instance, if the government spends money to have a hole dug, then spends more money to have that whole filled, economic measurements will show GDP growth even though there was no need to have the hole dug in the first place. Add to this slowing growth extreme debt levels, capital flight, corruption, and pollution, and you have a large economic house of cards that may become impossible to stabilize. The Chinese economy is now so large that even a moderate slowdown will negatively impact economic growth in much of the world with a likely knock-on effect for stock prices.

The Fed

With all major economies expanding, there is a possibility that central banks begin raising rates overly aggressively; particularly our own Fed as well as the European Central Bank.

We know that the Fed has already started to unwind their balance sheet and is now gradually ratcheting down the quantitative easing by $20 billion per month in January and further to $50 billion by October. As the Fed’s appetite wanes, the Treasury will need to issue more debt into the market, putting upward pressure on rates. We also know that the Fed wants to raise interest rates at the short end of the maturity spectrum sooner rather than later in preparation for the economic downturn that will inevitably occur at some unknown point in the future.

Meanwhile, the ECB announced in October that it would cut its quantitative easing to €30 billion a month in January 2018. That’s a 50% cut from the prior level of stimulus. At least some portion of that has found its way to the stock market over the last decade.

Couple these actions with the Fed’s projected interest rate hikes and it’s clear there is a risk that the Fed might “hit the brakes” too hard and too fast and adversely impact economic growth. If there’s anything that we have learned over the years, it’s that monetary policy is just as much art as it is science.

Yet another reason to believe that 2018 will not be like 2017 is that 2018 is an election year. As we have seen in the past, elections can bring market volatility. If the special elections last year are any kind of an indicator, we expect the 2018 political scene to be as contentious and over the top as anything we have seen in our lifetimes. The markets don’t like uncertainty, so we could very well see a bumpy ride starting sometime during the run-up to the elections.

When we look at all these factors we do not believe that we should be taking a defensive posture with our investments, but at the same time it would be a mistake to be complacent. Timing the markets is a dangerous game; in this environment, it makes more sense for investors to focus on making sure they are well-positioned to pursue personal goals. Our risk-based allocations are constructed using the historic performance of the component strategies in varying market conditions as a guide and, in our opinion, represent a rational approach to dealing with market uncertainty.

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Second Quarter 2017 Market Review

With the current stock market uptrend now the second longest bull market on record, and the economic expansion the third longest since the end of WWII, there’s been a lot of talk and, in some cases warnings, that both of these trends are in danger of coming to an end. Our short answers to these two questions are no and no.

First the economy. While we admit that very recent economic releases have come in somewhat below expectations, there are a number of solid reasons to believe that economic growth will continue to move forward. First and foremost, the Federal Reserve, while gradually bringing short term rates up to more normal levels, continues monetary policies that are far from being restrictive and has no desire to slow or stop economic growth since inflation is well below the target of 2%. The Fed, of course, also understands that the continuation of economic growth is important to lowering government deficits.

And because U.S. Corporations today derive about 50% of their profits from overseas, we are also benefiting from the recent upturn in Europe and Japan, as well as from the policies of their Central Banks which are on the same growth objective as our Federal Reserve. This synchronization of global markets presents a strong case that economic growth will continue to grow in the U.S. despite having already achieved one of the longest expansions over the past 70 years. In our opinion, there is a near zero percent chance a recession will present itself in the next 12 – 18 months.

That’s very good news for the stock market which tends to react to, with leads and lags, to the ups and downs of the economy. Other factors, such as a major geopolitical crisis or a financial crisis, can also cause a bear market. At the current time, however, we do not recognize there to be any critical financial issues or serious geopolitical risks.

While it’s unfortunate that North Korea apparently has nuclear weapon capability, they suffer from shortages of motor fuel, food, equipment and sanitation and health care for troops in the field. The Kim family regime recognizes they would lose control of the country should they start a war they have no chance of winning against the U.S. and its allies.

We have been positive on the outlook for U.S. stocks over most of the past eight years. One day we will turn bearish, but that won’t happen until we believe a recession is on the horizon. Right now we see more positive factors than negative ones. U.S. business and consumer confidence and corporate earnings are at record levels.

The number of available jobs is near record levels and more people are returning to the workforce. Consumer and business sentiment are near record highs while low inflation and interest rates justify (support) current stock prices, in our opinion.

Other issues that could temporarily derail the current uptrend of the market are unfortunate events like the recent Virginia disturbance and past Government shut-downs due to politicians bickering over the nation’s debt ceiling. These and similar issues tend to cause only short term disruptions for the market.

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First Quarter 2017 Market Review

Equity investors began their celebration immediately after the November elections. On the other hand, fixed income investors made an initial exit from the bond market only to cautiously creep back in after November’s shock. The markets were reacting to President Trump’s determination to “make America great again”, partly by reviving an economy that never was able to fully recover its momentum after the Great Recession of 2008-2009.

While a bit off of its closing high on March 1st of 2395.96, the S&P 500 has risen 13.3% from a closing low of 2085.18 on November 4th to end the first quarter at 2362.72. The Barclays Aggregate Bond Index dropped approximately 3.5% from its pre-election level to its bottom in mid-December. It has since recovered 2.2%.

Interestingly, the stock market has begun to falter ever so slightly as the Republicans’ failure to repeal and replace Obamacare has caused second thoughts about their ability to reshape the economy, especially through broad based changes in tax policy. The reasoning seems to be: “If they can’t agree on something that touches 14% of the US economy, how will they be successful on taxes which touch every aspect?” Only time will reveal their ultimate level of success.

As has been the case over the last months, the economic outlook is not without a mix of positive and negatives. Consumer confidence is at its highest level since 2000, and small business confidence remains high and at levels not seen since before the financial crisis.

The Federal Reserve is confident enough to have raised rates in March and is talking about ongoing rate hikes over the course of the year. Nonetheless, there are some signs of possible trouble ahead. Retail sales remain weak, with the latest report showing just a 0.1% rise. Prices of used cars are in steep decline and manufacturers are offering large incentives to move new cars off the lots.

Meanwhile, pending sales of existing homes reversed course to rise sharply (+5.5%) but were outdone by new home sales (+6.1%) and new home construction (+6.5%). Conversely, multifamily starts fell 3.7%. Demand for oil looks to be somewhat weak as evidenced by recent oil price drops. Ominously, we have also seen the biggest jump in unemployment claims in six months, yet today a very strong jobs report showed companies added 263,000 to their payrolls in March, far surpassing the 185,000 expected. Our conclusion is that while economic reports are a bit muddled, we don’t see much risk of an imminent recession.

Despite looming interest rate increases, long term bond prices rose in the first quarter and short term bonds fell. The fixed income holdings in your portfolio were up a respectable 0.41% with the government holdings detracting from a stronger showing by the portfolio’s corporate bonds.

The stock market did finish a consolidation phase in late January and continued its upward move to reach new highs. Valuations remain stretched, but the market has already had a minor correction in the wake of the healthcare reform debacle and that may be all we get for a while. In all likelihood, as long as a generally positive view on government reforms and modest rate hikes stays in place and corporate earnings don’t disappoint, we would expect the stock market trend to remain upward.

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Fourth Quarter 2016 Market Review

Investors spent much of the last few years concerned that the economy might slip back into a recession given the slow growth environment we were experiencing. This perception changed abruptly during the fourth quarter as indicated by the surveys for consumer confidence, investor confidence and small business expectations which all turned strongly positive. Since better economic growth usually results in higher inflation and interest rates, financial service stocks dominated with a 21.1% gain during the fourth quarter while the energy sector (inflation beneficiaries) was the second best with a 7.28% increase. Dividend stocks, on the other hand, were held back by an increase in inflation expectations and increased only 0.49% for the quarter.

Value stocks significantly outperformed growth stocks during both the fourth quarter and for the year, while small stocks also easily beat large cap stocks during both periods. Value stocks benefit the most from better economic conditions and the new administration’s plan to lower corporate tax rates would benefit small companies more as they tend to have higher effective tax rates. The S&P 500 increased 3.82% for the quarter and 11.96% for the year. And finally, with interest rates moving higher, 5-year municipal bonds declined 2.76%, while Intermediate Gov’t/Corporate bonds dropped 2.1% for the quarter.

We believe the sudden and sharp improvement in business and investor expectations has played an important role in the stock market’s success of late. As such, it may be that prices (stocks) have advanced too far ahead of the improvements investors are looking for. Under these circumstances, stock prices typically tend to consolidate or even correct lower as investors wait for the improved expectations to become a reality. This looks to be what has been happening during the month of January thus far. From our perspective, we see economic conditions and corporate profits already improving and this higher level of growth will continue throughout the coming year. As a result, it should be a favorable environment for the stock market.

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Third Quarter 2016 Market Review

The stock market shifted gears during the third quarter as investor concerns over the economy faded. As a result, growth oriented equities (like Technology stocks) moved from the worst performing (-2.84%) economic sector during the second quarter, to the best (+12.9%) during the third period. And because higher inflation and interest rates are highly correlated with faster economic growth, interest rate sensitive stocks such as utilities and telecom issues both declined almost 6% during the quarter. Third quarter corporate earnings came in above estimates and interest rates started an uptrend which accelerated over the next several weeks. The S&P 500 stock index increased 3.85% while the bond market, based on Barclays Intermediate Government Corporate Index, increased 1.21%.

Despite the near complete absence of fiscal stimulus, the economy showed good improvement during the third quarter and given the recent strength of the stock market, investors appear to be betting that the improved trend will continue. Corporate profit growth improved in the third quarter and forward earnings estimates rose to a record high during the first week in October. The CRB raw industrial spot price index has recovered smartly of late. That’s good news since there’s a very strong correlation between the level of inflation and earnings growth. Jobless claims are at their lowest readings since 1973 and wages are beginning to improve which should support higher levels of consumer spending going forward. Finally, history shows that the absence of political gridlock in America has been good for economic growth and stock prices no matter if it be Democrats or Republicans in control.

As always, we value your business and our relationship with you. Please don’t hesitate to call if you have any questions or comments, or if there’s any way in which we can be of service.

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Second Quarter 2016 Market Review

In all our years of working in and studying the stock market, we cannot recall when so many investors got it wrong. “Power to the People!” was a widely heard slogan in the U.S. during the 1960s. The U.K. citizens seemed to reflect that sentiment in late June when they voted to exit the European Union. Shortly after the vote it was found that many of the voters didn’t understand what they were voting for and that the advocates supporting the exit didn’t have even a rough outline of a plan as to how to accomplish an exit. Talk about creating a negative investment environment. The stock market, after moving in a modest uptrend for most of the second quarter, moved sharply lower in response to the results of the U.K. vote which was almost completely unexpected.

Fortunately, the U.K. accounts for only 3.9% of U.S. exports and the economic numbers for the U.S. were above expectations in the weeks following the market decline. In the end, the S&P 500 increased 2.46% for the second quarter and 3.84% during the first half of the year. For the second quarter, last year’s beaten down Energy sector posted the strongest gains at +11.62% while the Information Technology sector came in last place with a decline of 2.84% for the quarter and near the bottom with a decline of 0.32% for the first half. In the fixed income arena, interest rates in general declined to record or near record lows influenced by concerns over global economic conditions, especially in Japan, and in parts of Europe where a number of government rates are below zero. The U.S. 10-year Government Bond rate recently hit a record closing low of 1.395% while the Intermediate Government/Corporate Bond Index increased 1.59% for the quarter and 4.07% for the six months.
While the economies of most free world countries are not running on all eight cylinders, we are encouraged by the progress we see in the U.S. at the present time. Consumer spending has picked up, jobs are being created at a reasonable rate, wages appear to be firming, the Energy sector looks to be stabilizing, and monetary policy (i.e. low interest rates) continues to have a positive influence.

Importantly, all these factors are contributing to a better earnings picture. Compared to a somewhat dismal earnings trend of 12 months prior, analysts have been raising their earnings estimates for the
past 11 of 12 weeks. While valuations are not overly compelling, they are lower than they were at the beginning of the year, clearly lower than the peaks recorded in 2015 and they should be supported by the positive direction of the economic and corporate profit trends that we expect. Barring some obvious unforeseen political or terrorist event, the investment environment should be favorable for most of the time over the next 6 months.

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First Quarter 2016 Market Review

To say that the past three months have been a volatile period for the market is not an exaggeration. With terrorism in the background, oil prices plummeting, negative interest rates in Europe and Japan, and economic growth in question throughout most parts of the world, January got off on a terrible note, sending the Dow to its worst 10-day start to the year on record going back to 1897! Although the market began to turn back up during the latter part of January, it started to decline sharply again in early February, eventually bringing the market down to a year to date total return of -11.4% by mid-February. Fortunately, the fears of an economic meltdown gradually dissipated from that point on and the market actually ended the quarter up a modest 1.35%.

Nonetheless, the first quarter was one of those nervous market periods where so-called defensive stocks (as opposed to growth stocks) took their place on the leader board given the perceived stable nature of their operations. The Consumer Staples stock group (Proctor & Gamble, Coke, Clorox, etc.) is a perfect example of defensive type stocks. This sector accounted for 47% of the gains reported for the S&P. On the other end of the spectrum, Consumer Cyclical stocks ranked near the bottom during the period in terms of returns.

In the end, what matters most to investors is that economic growth remains healthy enough to increase consumer paychecks and grow corporate profits within a reasonable inflationary environment. The stock market began to move higher again in mid-February in response to what turned out to be an improvement in U.S. economic conditions. In addition, inflation is beginning to move higher and, excluding food and energy, is close to the Federal Reserve’s 2% objective for perhaps the first time since the stock market began to move higher in 2009. The velocity of money is also beginning to improve (+8%) which means the economy is finally making use of the extra money the Fed has been printing over the past several years. Barring a rash of terror attacks, talk of interest rate hikes, or another hit on oil prices, the investment environment should be OK for at least the short term.

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Fourth Quarter 2015 Market Review

Having finally taken the plunge to initiate a cycle of rising interest rates, the question uppermost on many investors’ minds is whether or not the Federal Reserve will follow through and continue to raise rates over the course of 2016. While the recent performance of the US economy is less than uniformly supportive, policy makers indicate that they believe it is strong enough to support increasing rates.

But there is more to consider than just the domestic economy. As you know, with the advent of the internet, instantaneous global communications, and increased cross border trade, no single country is immune to what is going on in the world around it. We have seen a significant slowdown in the growth of the Chinese economy, collapsing commodity prices (particularly oil), and a startling drop in international freight rates and traffic. On top of these fundamental issues, there are political issues including terrorism and huge immigration flows into Europe (and the US).

Interestingly, the Fed is caught in something of a lose – lose position from a market perspective. If it continues to raise rates, investors may view that as too much of a headwind for securities prices. On the other hand, should the Fed back down from rate increases, that climb down may well be interpreted as a lack of confidence in the economy, both at home and abroad. One thing that we can be reasonably sure of is that, should the Fed continue on its course toward normalization of interest rates, the necessary increases will be slow. Under either scenario, a low rate environment is expected to persist for some time.

The stock market repeated its August swan dive in December driven primarily by declining oil prices and China fears. This drop, unfortunately, was not enough to enable your Rydex fund holding to remain above its end of September value. For the quarter, it fell 7.34% and 4.39% for the full year. Fixed income holdings also show a negative yearly return of 0.66%. This reflects the effects of the rate increase as well as investor aversion to anything but the very highest quality issues.

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It’s Never too Early to Start Investing for Dividends

“The three worst things that ever happened to Investing are Ameritrade, E*Trade and Scottrade!”

Stock Market Data Showing Constant FluctuationsThat’s how I usually get started when I’m ready to climb on my soap box and discuss building wealth with anyone willing to listen. While I believe all of these institutions are reputable (in fact I have an account with Ameritrade), the “trade” in each of their names represents what I feel is a disturbing aspect of the investment industry; short-term thinking.

Instead of focusing on building a foundation for sustainable wealth, the focus tends to be one of beating the markets on a monthly, weekly, or even daily basis. Instead of finding well-run businesses that could eventually provide a predictable source of income, many investors are looking to derive income from trading, jumping in and out of the market; sometimes in minutes.

The Short Term Day-Trading Mindset Puts Long Term Financial Security at Risk

The day trading and active trading phenomenon has been a huge boon to the various discount brokers. Each transaction puts money in their pockets, regardless of whether it was profitable for the trader or not. There are a lot of disasters that result from the “trading your way to financial independence” mindset, but none are on the brokerage side of the business.

Even today, after two devastating stock market sell-offs in 2001 and again in 2008, individual investors are still looking to maximize their “total return” by whatever means is available to them. This is particularly true for pre-retirees who believe the best approach is to build up as much wealth as you can and then convert it over to “safer” investments after you retire.

Anyone following this approach saw their accounts drop considerably in value in 2001 and 2008 (and in the case of 2008, take nearly five years to recover if they stayed invested and performed like the broader market). But for those who manage their own accounts, there is a substantial risk of over-trading as market perceptions (read emotions) change. This often results in buying near market tops and selling near market bottoms: with the predictable result of wreaking havoc with your portfolio and your financial plans.

When you know you can sell something almost as soon as you buy it, it affects how you think about the purchase in the first place. You can be careless because you can get out quickly. With constant measurement of returns and the oppressive 24/7 media cycle, the pressure to act is immense.

You see a stock like Tesla (TSLA) start to run up and, remembering what happened in 2013 (the stock more than quadrupled), you buy in and try to ride the trend up just when it suddenly reverses (as it has three times since 2014) and hands you a short term trading loss.

Less Glamorous Dividend Investing Can Be a Great Long Term Investment

Check for Dividend Payment from Dividend Focused Investment PortfolioCompared to the excitement of finding the next moonshot stock, dividend investing is boring. In using dividends to secure financial independence, a portfolio of securities is run like a rental real estate portfolio. Each investment is made in anticipation of a future cash flow and judged versus the initial cost of that investment. The investor does not make any assumption of the future price of the stock as that price could be momentarily “unfairly” impacted by the market’s lack of enthusiasm for the business.

One of my favorite examples of this is Clorox (CLX). Clorox is almost never in the news; even during earnings season it hardly gets a passing mention. Yet Clorox has been paying a dividend since 1968 and has increased its dividend payment for 38 straight years.

In fact, based on numbers I took from Yahoo Finance, if you had started in 1990 with a $5,000 investment in Clorox and then made annual $5,000 investments plus the reinvestment of all dividends received, after nine more years you would have approximately $211,970 in your account. Your total investment would have been $53,614.33.

For the next 10 years from 2000 to 2009, if you only reinvested the dividends from your Clorox stock, the value of your shares would have grown to approximately $246,000. More importantly, the dividend income stream starting in 2010 would have grown from $9,574 per year to $12,572 in 2015. That’s a little over $1,000 per month that you would have received in 2015 by holding the stock. Let’s be clear: you would not have had to sell shares to have realized that monthly income.

For those of you keeping score, that’s an annual return of over 13% on your total investment of $92,743.72.*

Smaller Dividend ETF Investing Still Provides Strong Returns

Some would argue that this is a bad example since no one in their right mind would maintain such a large concentration in only one stock (assuming the $5000 invested is an IRA contribution). So let’s look at a more “realistic” example. Instead of investing in one stock, we will invest in an Exchange Traded Fund (ETF) called the SPDR S&P Dividend ETF (SDY).

This ETF “seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P High Yield Dividend Aristocrats™ Index. It has over 100 holdings comprised of companies from 10 different sectors that have a history of at least 20 consecutive years of dividend increases. It selects companies from the S&P 1500, which includes midsize and small-cap companies. That means the High Yield Dividend Aristocrats probably has some balance of both growth and income, as smaller companies are usually assumed to be faster growing than larger companies on average. With over 100 holdings, the risk of over-concentration in any one should be eliminated for all practical purposes.

Again using data from Yahoo Finance, I ran a ten-year study starting in 2006 using just $2,500 as the initial investment (assuming the other $2,500 would be invested in a non-correlated asset). Additional annual investments of $2,500 were made and all dividends were reinvested at the end of each year. By year-end 2015, the total annual contributions equaled $25,000 and reinvested dividends totaled $8,179 for a total investment of $33,179. The account balance at the end of 2015 was $42,099 and the total amount of dividends paid in 2015 was $2,436 (which is 7.3% of the $33,179 total investment).**

Again, we see that an investment plan focused on growing long term dividend income can be a very effective way to conservatively build a future income stream.

Try Summit’s Dividend Based Portfolio and Absolute Return Allocation

Can we do better than SDY? Sure! Summit has a dividend-focused portfolio consisting of 30 or so dividend paying stocks that are judged to be undervalued and therefore represent an opportunity for capital appreciation in addition to dividend income. We also combine this portfolio with a low correlation volatility-capture strategy in our Absolute Return Defensive allocation for those investors who are seeking dividend returns with less year-over-year volatility than equities alone.

In any case, the most important element of successful dividend investing is time. Time for accumulation and dividend compounding to start producing significant monthly payments that can supplement your other sources of retirement income. When it comes to dividend investing, time is the one thing that you can never get enough of.

So what are you waiting for?

Contact Summit for a free consultation on a long term dividend focused investment portfolio.
* In this study, for illustration purposes only, shares were purchased on the first trading day of each Calendar year. Your results may vary depending on the assumptions you make in trying to recreate this study. No assertion is made as to the accuracy of data provided by Yahoo Finance.
** In this study, for illustration purposes only, dividends were reinvested at the end of the week following the last dividend payment and additional shares were purchased on the last day of the Calendar year. Your results may vary depending on the assumptions you make in trying to recreate this study. No assertion is made as to the accuracy of data provided by Yahoo Finance.

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Beat the Market but Lost Money? Absolute Return May Be the Strategy for You

You Measure Investment Success in Absolute Terms, Does Your Financial Advisor?

Investing has never been easier to do and more difficult to understand than it is today. Back in the early 1980’s when I first started investing, the mantra was: buy stocks for the long run. Then, after the crash of 1987, the message evolved into: build a balanced portfolio with 60% in stocks and 40% in bonds to protect your portfolio from any bumps in the road while growing your capital.

Nearly 30 years later, we have seen an explosion of investment products available to us. The two basic securities known as stocks and bonds have been sliced and diced by market cap (large, medium, small, and micro), growth versus value, yield, industry sector, country, quality (high or low), taxability (taxable, tax free, tax deferred), maturity (from long to short), coupon (again high or low), etc. Additionally, investors today also have access to options, futures, FOREX, precious metals, and real estate either directly or through mutual funds, Exchange Traded Funds (ETFs), or Exchange Traded Notes (ETNs).

Investors also have a seemingly never ending variety of advice on how they should be investing their personal assets. Some of these sources directly contradict each other!

Investment luminary and Vanguard’s founder John Bogle admonishes investors that matching market-based returns, especially when using his low-cost Vanguard branded funds and ETFs, yielded better results for most investors than picking individual stocks, market-timing, or any other investment strategy.

At the same time, Bloomberg columnist and wealth manager Barry Ritholtz reminds us that numerous studies have pointed out that weighting indexes on just about any fundamental basis other than market capitalization not only outperforms market-cap-weighted indexes (think S&P 500 and the like), they do so with less volatility.

Relative Performance: Success Is Beating the Market, Whether You Make or Lose Money

In all cases though, the assumed basis for measuring the merit of such sage advice is the performance of your individual account relative to some kind of benchmark, usually a broad-based market index like the S&P 500 for stocks and the Barclays U.S Aggregate Bond Index for fixed income.

The theory is that as long as you beat the index, you are doing fine. But is that really the best way to measure how you are doing when it comes to building and protecting your personal wealth?

In 2008 the S&P 500 lost 37%, so if you had started the year with $100,000 invested in a passive S&P 500 index fund, your account balance would have been reduced to $63,000 by the end of the year. Assuming you didn’t panic and just held on to the same fund, you would have waited until 2013 before your account was back over $100,000 in value. So, the question is: would you have felt much better if you were invested in a market beating fund (a relative out performer) that “only” lost $30,000 (for example) of your money in 2008?

While performance relative to a benchmark has become the generally accepted standard in the investment industry, most individual clients, whether they realize it or not, still focus on absolute returns. In other words, they really don’t care as much about beating a benchmark as they do about growing and preserving the money in their individual accounts. Many managers lost clients after 2008 even though they beat the market. Reason? They still lost an unacceptable amount of the client’s money!

The Absolute Return Alternative: Success Is Measured in Dollars Made

An alternative to the pervasive relative performance measure is absolute return. Absolute return is simply the appreciation or depreciation of the asset (stock, bond, fund, or portfolio, etc.) over a given time period. For example, if you invest $1,000 in a single stock and one year later that investment is worth $1,100, your absolute return is $100 or 10%.

Unlike traditional investment strategies, a strategy that pursues an absolute return is not measured against traditional market indexes but rather against its own return goals.

For example, an absolute return strategy may seek to outperform Treasury Bills by a certain margin since T-Bills are considered to represent the risk-free rate of return by many investment professionals. As such, absolute returns focus the investment manager on the most basic concern of the client – achieving a positive real return that enhances the client’s purchasing power.

Absolute return strategies are different from tactical strategies which dynamically increase or decrease exposure to asset classes in anticipation of or in response to changing market conditions. Instead, a manager deploying an absolute return strategy will use various asset classes and/or various hedging techniques, which may include derivatives and shorting, to attempt to achieve stable returns with moderate volatility.

The stability of returns is critical; they are trying to achieve an investment objective of positive annual returns with a consistent level of volatility, year after year regardless of what the market is doing. Remember that an unending string of positive returns is the goal, not a guarantee, and that the risk of incurring some level of loss or missing the goal is never truly eliminated regardless of what investment tools the manager may be using.

There are many absolute return strategies and each one offers its own unique approach to meeting a desired goal. Interested investors should try to understand the underlying strategy, its inherent risks, and its track record (in absolute terms of course!) before committing capital to any investment product.

Contact our financial advisors for a free consultation on starting an absolute return portfolio.

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There is Still Time to Fund Your 2015 IRA

Many of us view April 15th*, the date by which we must file our tax returns for the preceding year, as an important deadline. However, for all of us, it actually represents a much more significant deadline:

Tax Day is the last day that we can make our 2015 contributions to our Individual Retirement Accounts.

Even if you have a 401(k), you can still have either a Traditional or Roth** IRA to make the most of your retirement savings. Your contributions may also be tax-deductable, which means they could reduce your taxable income and, therefore, the amount of tax you have to pay. If that’s the case, then each year you make a contribution, you could reduce your income tax and any gains in your account in your account will grow tax deferred.

The earlier you start saving with an IRA, the sooner you can start reaping the benefits of compounding and increasing your potential retirement income. Using the financial calculators at****, you can see the potential results.

Results Summary for 30 Year Old Investor Contributing $5,500/Year

Graph Showing Results of Max IRA Contributions for 30 Year Old by Age 65

An individual age 30 with an initial $5,500 contribution and a $5,500 contribution every year thereafter can potentially accumulate a significant amount of money for retirement by age 65.***

  • Starting balance: $0
  • Contribution for 2015: $5,500
  • Total contributions by age 65: $192,500
  • IRA total before taxes: $813,524
  • Total for an equivalent taxable account: $413,051


Results Summary for 30 Year Old Investor Contributing $300/Month

Graph Showing Results for 30 Year Old Investing in IRA

Even if you cannot contribute the maximum allowable to your IRA, you can still make substantial progress toward retirement with smaller amounts. For example, even with a contribution of $300 per month, the benefits of tax deferred compounding become readily apparent.***

  • Starting balance: $0
  • Contribution for 2015: $3,600
  • Total contributions by age 65: $126,000
  • IRA total before taxes: $532,488
  • Total for an equivalent taxable account: $270,361

Opening an account with Summit Investment Management is simple and easy.

You can either open an account online and access portfolios designed to align with your individual risk profile or you can contact us for a New Client Enrollment kit that gives you access to our advisors for a more personal experience.

Either way, you can benefit by investing your retirement savings with an experienced investment team that actively manages your portfolios making investment decisions that are based on our highly disciplined, rules-based selection process.

So what are you waiting for? April 15th is just a few weeks away, start investing in your future today!

*April 15th, 2016 is the District of Columbia Emancipation Day and is considered to be a legal holiday so the due date for the 2015 tax returns is the next business day April 18th.
**If your income exceeds $131,000, you cannot contribute to a Roth IRA.
***These examples are for illustrative purposes only and do not represent the performance of any specific product. They assume a hypothetical 7% annual rate of return in a tax-deferred account.
**** is an independent, advertising-supported publisher and comparison service. Bankrate may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on certain links posted on this website. Learn more by visiting their site.

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Third Quarter 2015 Market Review

History shows us that the greatest threats to a bull market are recessions. So when the market fell quickly (-11%) one week in August, investors and the financial press were quick to round up the usual suspects to blame for the recession that was likely to occur. Heading up the list was once again China which is struggling to keep its growth rate from declining too much due to the structural changes underway in that country.

Europe was also not progressing as well as hoped for despite the quantitative easing efforts their central bankers adopted a number of months ago.  And lastly, the talking heads on CNBC, etc. once again pointed to the perceived threat of Fed interest rate hikes that would “surely” pull the economy in the wrong direction.

The Dow Jones Industrial Average, S&P 500 and NASDAQ all declined in the 6%-7% range for the third quarter and brought the year-to-date results to minus 7-8%. Fortunately, the stock markets rebounded during October, which completely recouped these losses.  In addition, Intermediate Term bonds inched 0.95% higher during the quarter as the rates on 10 year U.S. Government Bonds declined from 2.33% to 2.06% for the period.

While we were surprised to see the market recover its losses so quickly, we did not believe a recession was imminent and, therefore, thought the August market decline was one of those “normal” corrections that most market gurus have been forecasting at one time or another over the past 2-3 years. In our opinion, China is doing an okay job of transitioning to a consumption based economy. Trends in Europe are still positive and their central banks are on alert to provide additional monetary stimulus if necessary.

And, finally, we very much doubt that a modest rise in interest rates will do noticeable harm to our economy. However, we rate the overall investment environment only good at the present time and we wouldn’t be surprised to see a bump in the road before global economic growth becomes more certain.

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Second Quarter 2015 Market Review

The U.S. Economy rebounded from its modest decline of the first quarter that suffered from inclement weather on the East Coast, a prolonged dock strike on the West Coast, an abrupt decline in oil prices and the negative impact on exports caused by a strong dollar. The rebound seemed to return economic growth to the 2% – 2.5% range, modest by historical standards, but at a level that could prove sustainable for the longer term.

Unfortunately, a number of additional negative factors external to the U.S. began to restrict economic growth again late in the second quarter. These included a replay of the Greece fiasco, an escalation of Mid East violence, Chinese economic and stock market problems, and the fears of pending Fed interest rate increases.  As a result, the S&P 500 stock index increased just 0.28% in the second quarter and only 1.23% for the first six months of the year.

Consumer Discretionary stocks increased the most (+4.78%) for the quarter and once again the Utility sector turned in the worst return at -5.78% following its first quarter decline of 5.17%.  In the bond market, interest rates turned back up during the second quarter, resulting in a modest 0.62% decline for Barclays U.S. Intermediate Government/ Credit Bond Index.

As we look into the prospects for the second half of the year, we are encouraged by the improved health of the labor market and consumer balance sheets, but at the same time, believe the economy may struggle a bit over the next few months resulting in a less than perfect investment environment.

The resurgent strength of the dollar (up 15% vs. last year) and weaker oil prices (-49%) are exerting a greater than expected negative impact on corporate sales and profits.  While these factors might keep the market from moving appreciably higher near term, we continue to maintain a positive outlook for both the economy and the stock market.

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First Quarter 2015 Market Review

The first quarter turned out to be one of the more volatile periods for the stock market we have seen since early 2012.  With the dollar strong and inclement weather a deterrent, investors first became concerned that economic growth was moving at a dangerously slow rate.  But then job growth picked up nicely, oil prices seemed to stabilize and investors began to regain confidence during February.  However, investors became concerned again, this time worried that the strong job gains would soon convince the Federal Reserve to raise interest rates.

The almost 0% short term interest rates that the Fed put into effect a few years ago have been the primary drivers of the economic recovery and especially important to the very good stock market we have experienced over the past 5 years.  As a result, investors have been highly sensitive to any potential upward adjustment in interest rates for quite some time now.

As a result of these on again, off again concerns, the S&P 500 stock market index rose just 0.95% during the first quarter despite no change in short term interest rates and good, albeit sub-par economic growth.  On the other hand, longer term rates did decline for the period as quantitative easing programs accelerated in Japan and began in Europe with some 10-year country government bond rates going to zero or less during the period.

This persuaded many global investors to convert their currencies into dollars and use these dollars to buy U.S. Government Bonds, thereby pushing prices higher and in turn, lowering interest rates.  As a result, the Barclays U.S. Intermediate Government Credit bond index increased 1.45% for the quarter.

Shifting gears back to the stock market, there was a relatively high degree of performance dispersion among the economic sectors during the period.  Benefitting from Government subsidies, Healthcare stocks performed the best (+6.5%) while the fear of rising interest rates hurt the Utility sector as stock prices in that category declined the most at -5.2%.

Finally, there was also a very clear performance distinction between growth and value stocks and between small, medium and large capitalization stocks.  Growth stocks outperformed in general and small capitalization stocks placed first overall.

The first quarter was a good period for active portfolio managers (i.e. stock pickers) given that the market was less correlated during the period than it has been in recent history.  According to a Barron’s article, “the 8,212 diversified equity funds tracked by Lipper…returned 2.48% for the January –March period, compared with just 0.8% for S&P 500 Index funds”. As noted earlier, the S&P 500 Index itself increased 0.95%.

The outlook for the stock market for the remainder of the year will continue to be importantly dependant on what happens to interest rates.  Overall, the global economy is still showing more signs of stagnation than not.  On the margin, the Eurozone’s economy appears to be improving, though barely.  U.S. economic growth has slowed this year and it’s not for certain that it was due primarily to bad weather.  The Japanese economy looks to be on its way to its third lost decade and China is slowing as are other major emerging markets.

This all suggests deflation is more likely the issue and raising rates would only slow business conditions further. We are also pleased to see that corporate earnings, excluding energy stocks, should increase about 8% this year, oil prices appear to be near a bottom, and the changing fundamentals of the Energy Industry promise to positively affect the economy and stock market long term.

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Fourth Quarter 2014 Market Review

Wall Street forecasters believe the U.S. economy started off 2015 with the strongest momentum in at least a decade and is in better shape today than any other developed country in the world.  Importantly due to the full scale resurgence of the U.S. Energy Industry, economic growth has averaged 4.8% over the past two quarters, the highest rate in over a decade

With this non-farm payrolls are increasing at the fastest rate since 1999.  As a result, most stock and bond prices rose last year with the S&P 500 up 13.7%, the Dow Industrial Average at +10.4%, the average domestic stock mutual fund up 7.5% and the Barclay’s Government/Corporate Intermediate Bond Index rising 4.9%.  Large and middle sized stocks performed much better than small cap stocks during the year, but in the foreign stock arena, emerging market stocks declined 2.06% while foreign markets with developed markets were off 6.43%.

The equity markets in the U.S. were unusually volatile last year as investors negatively reacted to a number of events including the abrupt slow down in the economy early in the year, followed by Russia’s takeover of Crimea (March) and then the Ebola (October) crisis.

While the market recovered from all of these events by the end of October, another blow to investor confidence surfaced in December as oil prices declined sharply prompting many to assume that the global economy was in trouble. The outlook for 2015 will have a lot to do with how well the European economy holds up next year and what happens to the price of oil.

European officials recently announced quantitative monetary easing program similar to what the U.S., U.K. and Japan have been using to stimulate economic activity.  At a minimum, their efforts should keep the Eurozone from slipping into a recession, ward off deflation, and perhaps help to modestly grow the economy.  This should be enough to remove the negative aura from the market.

We’ve several times in the past made mention of the very major and positive changes expected to incur in the energy industry, and these expectations are quickly becoming a reality.  The fact that the U.S. is near or at energy independence and prices have declined, has major positive long term benefits for the U.S. and many other parts of the world.  A near term perceived problem, however, is that the sharp drop in oil and other energy prices reflects a very weak global economy.

While we do not believe that to be the case, the stock market might prove volatile until it becomes clear that oil prices have at least stabilized. Longer term, the changing complexion of the Energy Industry promises to have fundamentally positive effects on the U.S. economy and its stock market

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Second Quarter 2014 Market Review

The stock market continued to move higher in the second quarter of 2014 despite the abrupt halt of Japan’s economic turnaround, the geopolitical issues in the Ukraine and the Middle East, and concerns that US economic growth was in jeopardy. But in the end, what matters most to the US Stock market is that our economy moves in a positive direction and that inflation does not get out of hand to the upside. Fortunately, government estimates of inflation indicate that it is well under control and the recent upturn in the economy is a clear signal that business conditions are moving in a positive direction.

As a result, the S&P 500 Composite Index of stocks increased 5.23% during the second quarter and 7.14% for the first half of 2014. Mid and Large Cap stocks easily outperformed small cap issues in both the growth and value categories for the second quarter. All ten economic sectors posted positive results for the quarter and the three biggest contributors to the first half were Technology (1), Health Care (2), and Energy (3).

Looking into the months ahead, it’s important to recognize that recessions are primarily caused by the Federal Reserve when it tightens credit conditions (raises interest rates) to slow economic growth that in turn helps to slow inflation rates. We do not believe a policy to tighten credit is imminent, especially given today’s circumstances. The obvious reason is that inflation trends have been modest in most cases and there also appears to be a good deal of excess productive capacity available in today’s global market place.

A second, and possibly more important reason, is that many major governments of the world need inflation (read higher taxes) to help service their debt obligations which have increased substantially over the past several years. On the other hand, should the Fed and/or other central bankers of the world tighten credit availability too soon, deflation and an extremely difficult financial environment would likely result. Fortunately, Central Bankers around the world are keenly aware of this scenario and, therefore, not likely to let the world fall into a deflationary mode.

As a consequence, it may be quite some time before interest rates are increased worldwide given the slower growth in China, the almost recessionary conditions in Japan and parts of Europe, and the relatively modest growth we are experiencing in the US. For the most part, the Federal Reserve has been on its own when it comes to reigniting growth in our economy and even though our economy is in better shape than others, it is evident that the Fed’s efforts have not led to an environment of self-sustaining growth.

And even if the Fed moves to increase rates sometime in the future, their influence on world markets is lessening given increased globalization. For instance, today’s U.S. 10-year Government Bond trades at an extremely low rate of 2.41%; heavily influenced by Spain’s 2.15% rate even though it is obviously a much riskier investment.

If world interest rates remain low and the investing public begins to believe they will stay low for more than just the short term, stock prices could move higher from current levels since history shows they are undervalued based on today’s interest rates. For example, a recent study by a well-respected financial firm indicated that based on current interest rates and consensus earnings estimates, the S&P 500 is currently about 7. 5% undervalued.

Please understand that there are a lot of “ifs” included in this scenario and that the implied revaluation is likely to unfold over the next year or so. In the meantime, our economy has improved, corporate earnings are improving, and the overall environment for stocks on balance appears positive.

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First Quarter 2014 Market Review

Volatility and a higher level of anxiety returned to the markets during the first quarter. The primary catalysts were the “evil empire’s” invasion of Crimea and a severe slowdown in the economy induced by colder than normal temperatures. The inclement weather kept consumers away from the shopping malls and Russia’s political aggressions clearly detracted from investor confidence. Fortunately, business conditions appear to be getting better with the cold weather behind us and the political issues could be dealt with by adopting some intelligent U.S. energy policies.

Value stocks clearly outperformed growth stocks during the period while midcap stocks outperformed both large and small stocks. Following several months of underperformance, utility stocks posted the best sector gains for the period and consumer discretionary stocks performed the worst, reflecting the sharp drop in economic growth.

Despite the economic slowdown, the majority of corporate earnings reported were above expectations and analysts have recently been raising their numbers for the second quarter. Overall, the market moved modestly higher during the quarter. The S&P 500 increased 1.8%. With business conditions sluggish, interest rates declined during the quarter and this provided a rebound in bond prices following last year’s 0.86% decline, the first fall-off that has occurred since the mid-1980s.

There seems to be a much higher than normal number of people calling for a severe market correction. One of the reasons often cited by naysayers is that the market is too expensive and therefore vulnerable to a bear market. The most recent earnings estimate published for the S&P 500 is $121.86 and at today’s stock prices, the market sells at a PE of 15.8x compared to 18.8x during the last market peak in 2007.

History shows that major downward moves are primarily influenced by economic recessions, not by valuation. The soft first quarter was a temporary weather-induced setback from the uptrend; recent activity has clearly improved; and with excess capacity available and no labor shortages, higher inflation is not a threat for the Federal Reserve to contend with. While this is not to say that we can’t have a meaningful correction, it’s difficult to see a full-fledged bear market on the immediate horizon.

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Fourth Quarter 2013 Market Review

A year ago today, investors were losing sleep over a number of issues that appeared to be legitimate concerns. Fortunately, almost none of these concerns materialized. There was no fiscal cliff, the U.S. did not default on its debt, Europe did not disintegrate, and while China’s growth slowed, there was clearly no hard landing.

The result was an outstanding year for the U.S. stock market. The S&P 500 posted its best gain (+32.39%) since 1997 and all ten economic sectors reported gains for the period. Growth stocks outperformed value stocks and that was especially evidenced by the modest returns earned by dividend yield stocks, many of which are found in the utility and telecommunication sectors.

Both of these sectors increased less than half as much as the S&P 500! The bond market struggled through most of the year as everything but savings rates and the lowest government rates moved higher. The Intermediate Government/Credit Bond Index declined 0.86% last year and the Aaa -A Rated Corporate Bond Index fell 1.94%. A legendary baseball coach once said “never make predictions, especially about the future.”

Having said this, we believe the economic outlook is good enough to support another positive year for stocks, despite the very strong gains the market has already achieved since 2009 and the current complacent mindset of investors. The latest survey shows that a 25 year low, 15% of market forecasters are bearish on the market. This is a contrary opinion indicator which currently suggests the market is due for a correction.

On the other hand, the economy should do better than 2013 as monetary stimulus continues and last year’s fiscal tightening from increased payroll taxes and the sequester lessens. Bottom line, any correction that might occur is not likely to reverse the market’s longer term uptrend.

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Third Quarter 2013 Market Review

After suffering through a plethora of negative events for more than three years, almost nothing appears to meaningfully raise the anxiety level of investors these days. We commented early in the year that a better housing market, permanent changes to our tax code, and fixes made to the European banking system should substantially lessen the market’s volatility and risk exposure.

The virtually crisis-free environment over much of the past twelve months has resulted in good stocks going up and problem stocks going down. This more normal investment environment is expected to continue the majority of time over the next several years. The good news is that our company-specific, fundamental type selection process tends to perform well during periods like these.

Growth stocks significantly outperformed at all market capitalization levels and for the second quarter in a row, while the higher dividend paying utility, telecommunication and consumer staples stocks collectively lost money. Small Capitalization stocks outperformed both mid-cap and large-cap stocks. The S&P 500 Indexes rose 6.02% and 5.24%, respectively.

Interest rates rose slightly during the period, resulting in a modest 0.62% gain for Barclay’s Intermediate Government/Credit Index and a 0.72% gain for the S&P 2018 Municipal Bond Index. Looking into the fourth quarter; U.S. economic growth is slower but not negative; Europe seems to be gaining some traction for the first time since 2007; the political wrangling has been put on hold for 90 days; the sequester is reducing Government debt; and the appointment of Janet Yellon to head up the Fed may provide even more stimulus to the economy and markets than “helicopter Ben” bestowed upon us.

Short term, the market is overbought and investor sentiment is a bit complacent. While these last two factors have typically resulted in a temporary market consolidation, we haven’t had a meaningful correction since the market began its turnaround in 2009, and this pattern might just remain the same this time around.

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Second Quarter 2013 Market Review

Events like the IRS scandal, Egyptian political problems, Obamacare missteps, NSA phone taps, China’s credit crunch, the Benghazi disaster, and Japan’s economic instability were not significant enough to disrupt the stability of the U.S. stock market in the quarter just ended.

On the other hand, most foreign stock markets were noticeably weak during the period, and the abrupt increase in interest rates caused a temporary 6% correction of stock prices and an even greater correction for stocks that pay above average dividends. This hurt prices for stocks like utilities, which declined 2.73% for the quarter. On the other end of the spectrum, financial stocks led the way with a 7.25% gain followed by consumer discretionary stocks at +6.81%.

Overall, the S&P 500 increased 2.91% for the quarter. Growth stocks outperformed in the small and mid-cap space, but it was value stocks that took first place in the Large Cap arena. The average U.S. domestic mutual fund increased 2.29%, the average Foreign Stock fund was off 2.2% and taxable bond funds declined 2.43%.

Our experience in the most recent quarter continues to bolster the opinion held by many fund managers that the market continues to be decoupled from the overall economy as a result of unprecedented intervention by Central Banks worldwide. This is evidenced by the spike in volatility we observed at the mere hint that the US Federal Reserve may begin tapering its current stimulus effort known as QE3. Moving forward, we expect Federal Reserve policy to remain accommodating as the fundamentals of the economy have leveled off and in some areas have even begun to deteriorate.

While these policies have been bullish for stocks to this point, the longer they continue without substantial improvement in the economy, the greater the risk of periods of higher volatility for which our newly revised hedge is well suited. Add to this the uncertainty over the continued implementation of Obamacare, the first major city bankruptcy in Detroit, the ongoing tax and budget battles in Washington DC, and you have an environment where unhedged portfolios could experience uncomfortable P/L swings.

Still, over the near term, we do not believe we are on the verge of a new recession and that equities, with proper protections in place will continue to be the place to be invested.

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First Quarter 2013 Market Review

The investment climate was remarkably good during the first quarter.

With the exception of the financial melt-down of the tiny island, Cyprus, and some late in the period saber rattling by the North Koreans, investors benefited from a virtually crisis free environment. The housing industry continued to improve. Corporate profits were modestly higher and above expectations. Economic growth was mostly steady and only softened with the uncertainties created by the sequester. And finally, stock market volatility dropped sharply and more than half of the ten economic sector stock price indexes posted double digit gains for the quarter.

The Health Care sector led the way with a 15.22% gain while both Technology and Basic Materials came in below 5% for the period. The S&P 500 reported a total return of 10.61% for the period and the average diversified domestic stock mutual fund was up 10.2%. Small Cap stocks outperformed large company stocks and value (defensive) stocks outperformed growth issues in most areas. In the fixed income area, the Intermediate Government/Credit Bond Index increased just 0.26%.

Given the above average strength of the stock market over the past six months, it is not unusual for the market to pause or pull back for a period of time.

In addition, the April to May period is a typical seasonal period during which such corrections have occurred in the past. It is not necessarily usual, however, for the markets to undergo a major decline unless stocks are extremely overvalued, economic conditions deteriorate substantially or something catastrophic like another financial meltdown occurs. Stocks are not excessively expensive based on historical standards, and in our opinion, economic conditions are holding and another financial meltdown is not in the cards.

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The Stock Market’s Pre-Halloween Horror Show

A Five Part Chill Ride

From an attitude of complete complacency throughout 2013 and through the summer of this year, investors are suddenly beginning to take fright. But, what, exactly, are they afraid of? Here’s a short list of things that seem to be going bump in the night.

  1. October

    This is probably the least frightening thing, but it is true that historically, October is the most volatile month of the year. Whether this has to do with mutual fund jockeying before the end of the fiscal year or pre-holiday jitters, no one knows for sure. What the market has shown so far this month is not out of the norm.

  2. Fed tightening

    The Federal Reserve continues to rumble about eventual tightening. At the same time, it repeatedly assures that any interest rate increases will be slow and measured to make sure the economy doesn’t crumble in response. Can we trust them? Do they know how to deliver what they promise? If the past is any guide, rate increases will probably provide something of a bumpy ride for the market.

  3. Geopolitical problems

    From ISIS, to Russia, to China, to our own southern border,there seems no end to geopolitical worries now that our government has stepped back from its traditional center stage role in international affairs.

    • ISIS has taken large chunks of territory in both Iraq and Syria. It sits on the border of Turkey, a member of NATO and is threatening Jordan and Lebanon. ISIS has announced their intention to bring down the government of Iran and to hijack that country’s own contentious nuclear program. Furthermore, they have ambitions to infiltrate terrorists into the US through our virtually unguarded border with Mexico. Certainly, if they can destabilize Turkey, take down Iran, or manage a large scale terrorist attack within the US, the fallout could be damaging to the market. Russia and China have both taken much more aggressive military postures of late.
    • Russia, of course, has annexed Crimea and is making at least a small scale war in eastern Ukraine. Obviously, part of the motivation is pure opportunism, but at what point will the West call Putin’s bluff. If it is a bluff. Russia’s economy runs on oil and with the oil price having come off signifcantly of late, it will be intereting to see if that take the wind out of Putin’s sails, or, on the other hand, further motivate him to be adventurous abroad to divert his public’s focus from a stalling economy.
    • China, too, is flexing its military muscles. With tens of millions of young men with no chance of finding a bride, thanks to its misguided “one child policy”, the testosterone levels in China’s armed forces must be unbelievable. So far, China has been limited to bullying Japan and trying to push the US Navy around a bit in the waters off the Chinese coast. Nonetheless, China’s tone and actions have been worrying enough to push Japan to the point where that country is rethinking its commitment to post WWII pacifism.
    • So much has been written about our southern border problems that it’s hard to add anything new. Nonetheless, it should be repeated that a lack of control of who enters the US could lead to severe internal security problems in a worst case scenario.


  4. Ebola

    With the first reported US fatality, a fatality and confirmed case in Spain, and worries about suspected cases in the UK and Australia, the fear of Ebola and its possible consequences is certainly onthe rise. Beyond the health fears, though, lies a fear that points a potential dagger at the heart of the market. The economies of the countries hardest hit by the plague, Liberia and Sierra Leone, have virtually collapsed. Could a similar chain of events bring the US economy, or the world economy, to a standstill?

    Western medicine is certainly light years ahead of the healing arts in west Africa. The medical authorities in developed countries claim that they are prepared and that there will be no pandemic in Western nations. But the apparent bungling of cases in Spain and here in Dallas leave the public, and the market, skeptical.

  5. Global economics

    While the US seems to be making slow but fairly steady progress, things are not so good in other corners of the globe. The European economy is definitely slowing, as are Japan and China. Can a weak, but recovering, US economy withstand the headwinds from the rest of the world? At 10/9/14’s close of 1928.21, the S&P 500 is only 4.5% off its most recent intra-day high of 2018.66, set back on September 19th.

The market was certainly ripe for a correction, at least, and whether this dip turns into more than that may well be known by the time Halloween arrives.

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The Importance of Avoiding Losses

Avoiding Stock Market Losses Yields Huge Returns

One of the most important investment issues facing an equity (stock market) investor, if not THE most important, is the avoidance of investment losses. Oddly, this is rarely discussed by investment advisers despite the fact that, in our opinion, it is far more important than virtually any other variable affecting long term investment returns. Topics discussed include an explanation of how losses cripple returns, common strategies used by investment managers to counteract this problem and why they are ineffectual, and lastly, a description of how Summit Investment Management deals with this issue.

Any discussion of this topic must begin with an understanding of the variability of stock market returns. We will use price only returns to the Dow Jones Industrial Average (DJIA) to illustrate our points.

Graph Showing Dow Jones Industrial Average over 113 Year Period

In the one hundred thirteen (113) years since the turn of the 20th century, the DJIA has produced positive annual price returns (excluding dividends) seventy-three (73) times. In other words, there have been forty (40) years of negative calendar returns.

This means that the DJIA has declined approximately thirty-five percent (35%) of the time on an annual basis.

An investor, therefore, should expect that on average, over a 3 year holding period, there is likely to be one year with a negative return. While that is a statistical fact, it doesn’t always play out that way in reality as the DJIA has had winning streaks of 4 or 5 consecutive years and even one (in the 1990’s) that lasted 9 years as well as losing streaks of 3 or 4 straight years in duration.

“So what?” the investor might well ask. The DJIA produced a return of 19,731% over that time period or 4.79% annually. An initial investment of $1,000 would have become $197,307. Isn’t that good enough?

To answer that question, let’s see what happens to results when we manage to avoid those 40 years of negative returns. We will assume that when the historical market return is less than zero (0%), instead of a negative return our DJIA portfolio return is now zero (0%). No losses are allowed. Obviously, the returns will be higher, but how much higher?

It turns out that by staying even when the market declines makes a world of difference in performance. The results, in fact, are so good that they are difficult to comprehend.

Instead of a compound return of 19,731%, this “no down year” DJIA garnered a total return of 24,151,084%.

Chart Showing DJIA Prices

That equates to an average annual return of 11.59% or 6.80% more annually, on average, than the DJIA actually returned with both up and down years. That initial $1,000 investment would have grown to $241,510,837.

Over a century is a very, very long time for an individual. It can be within the investment horizon of a wealthy, multi-generational family, a corporation, foundation, or trust, however.

But to bring this concept into focus for most investors, let’s look at the experience since the turn of the 21st, rather than 20th, century. In the thirteen (13) full years that have passed since New Year’s Eve 1999, the DJIA has had eight (8) years of positive returns (2003, 2004, 2006, 2007, 2009, 2010, 2011, 2012) and five (5) years of negative returns (2000, 2001, 2002, 2005, 2008).

Graph of Dow Jones Industrial Average Annual Return 2000-2012

This is slightly more negative than our full period would have led us to expect, with about a thirty-eight percent (38%) occurrence of negative results (35% over the 113 year period). The DJIA produced a total return of just 13.98% in that time, or a paltry 1.01% per year on average. Without any loss years, those figures become 138.89% and 6.93%, respectively.

Let’s take this one step further. Rather than limit our study to calendar years, we will now eliminate any market declines of 10% or more, whenever they may happen during our study period. Our analysis shows that since 1900, the DJIA has tumbled ten percent (10%) or more on seventy-seven (77) different occasions. That equates, on average, to once every 536 days or approximately once every eighteen months.

The worst uninterrupted decline of –64.71% came, not in 1929, but between November, 1931 and July, 1932. The market plunge in 2008 – 2009 was the second worst on record, dropping 49.86% from top to bottom.

Starting with our latest 2000 – 2012 period and eliminating those falls of ten percent (10%) or more has an even greater effect than our calendar year experiment showed. Over the course of those years, there have been eleven (11) periods in which the DJIA dropped more than ten percent (10%). By eliminating these losses, the total return for the thirteen year span increases to 1,597.66% or 24.34% per annum. An initial investment of $1,000, therefore, would have become $15,976.61 rather than the $1,139.80 that was possible through the loss including DJIA.

For the full one hundred thirteen (113) year period, the elimination of any market declines of ten percent (10%) or more results in a truly “jaw-dropping” return. If you wish to learn more about the full period effect, please contact Summit. It is clear that, solely from a return perspective, there is a strong case for the importance of avoiding losses.

But there is another perspective that is also quite compelling in its own right.

To understand this additional perspective, consider the following scenario. One million dollars ($1 million) has been amassed to fund a future project. That project can be of any nature whatever; retirement funding, or philanthropic giving for example.

When a severe market downturn hits, long held plans can be jeopardized. Often the sponsor/investor is left with one of two poor choices. To preserve the principal of the fund, disbursement amounts can be cut. This can ensure the survival of the project longer term but may cause severe disruptions near term as funding is reduced.

Sometimes, as is the case with mortgage obligations, disbursements cannot be minimized. In such cases, the principal amount can be irreparably damaged as the periodic fixed payments represent a much larger percentage of the remaining principal. Principal can be prematurely exhausted, leading to an untimely project end. In either case, the project being funded will suffer. The only real difference is in the timing.

Common Investment Management Responses

Investment managers, recognizing, at least to some extent, the problem posed by losses, commonly resort to the use of three common “remedies”. The first remedy, and the oldest, is diversification. Market timing, or the moving of funds from one asset class to another in the hopes of avoiding a decline is the second. The third remedy is to restrict equity investments to “value” stocks.

If we look at the major asset classes of Treasury bills, bonds, and common stocks we are struck by a dilemma. The most attractive asset on a return basis, common stocks, is the least attractive on the basis of return variability. Conversely, Treasury bills are the most attractive asset in terms of return variability but least so when it comes to returns.

The typical manager response to this conundrum is to recommend a diversified portfolio.

The investor thereby gains some return stability at the cost of lower returns. Ah, but the manager will say, because these asset classes sometimes move independently of one another, the risk-return tradeoff is superior as measured by something called the Sharpe ratio!

Unfortunately, you can’t spend your Sharpe ratio. Lower returns are lower returns and that means that, at the end of the day, you will end up with less money in your account than you would have had you owned only equities, unless, of course, your accumulation period happens to end coincidentally with a stock market decline.

Investment managers who market time are working to keep their clients’ funds invested in the most attractive asset at any given moment. There are many variations of this strategy from managers who will completely exit an asset class to those who will slightly tilt their asset weights in response to whatever types of signals they may use.

Those signals can be based on economic changes, interest rates, price movements, seasonality or any of a host of possible indicators or combinations of indicators. What they all have in common is that they tend to miss crucial turning points in market direction. Therefore, assets are often unexposed or under-exposed to some of the biggest return days.

In the stock market it has been estimated that missing just the best 25 days of returns to the S&P 500, for example, would reduce the return of an investor from 9.8% to just 6.1% (for the period 1970 through 2011). That’s twenty-five (25) days out of a total of ten thousand six hundred thirty-seven days (10,637), or just .24% of the days over the period of the study. That is an incredibly small margin for error. To miss less than one fourth of one percent of the possible investment days and wind up with an annual return that is reduced by thirty-eight percent (38%) is shocking.

Timing the market, therefore, is highly risky as it could lead to the missing of those crucial return days.

Value investing has a long and successful history. It has shown itself generally superior to a growth based approach to the stock market in periods of market decline. But it is not a panacea as the most recent severe stock sell-off illustrates.

The Summit Approach to Loss Avoidance

We have now seen the nature of the problem and the most common steps taken to deal with it. Returns can be greatly enhanced if losses are avoided. Diversification, while it can reduce losses, can also result in reduced returns. Market timing is highly risky. A value based portfolio doesn’t always provide its owner with protection from a generalized market decline.

Through its expertise in options, Summit has developed an approach that addresses the issue of avoiding losses without diluting returns through diversification, taking on the risk of market timing, or blindly trusting in the shield of value investing.

What Summit has done is to develop a technique whereby it hedges an equity portfolio by building various option positions around it. The portfolio hedging strategy employs exchange listed options that increase in value as the market retreats, thus reducing losses incurred by the underlying portfolio.

The portfolio is hedged in a manner calculated to build a cash reserve as the options approach expiration.

This cash reserve is then reinvested in the under-lying equity portfolio. As the market moves up or down, the option positions are adjusted to compensate. All hedges, reinvestments, and adjustments are governed by a set of rules so that the risk of poor decision making in times of stress is eliminated. Funds are fully invested (except for any minimal cash reserve) at all times, thus removing the risk of missing crucial market return days.

Avoiding Losses Turns the Stock Market into a Wealth Creating Machine

The stock market is an excellent vehicle for the creation of wealth. Unfortunately, it is also a vehicle that is subject to frequent “crashes” which act to retard or undo the wealth creation process.

We have seen just how powerful an engine of wealth it could be if only losses could be avoided.

Standard investment management efforts to avoid losses come with their own problems of diminished return and risk. Summit has developed an approach which, while it does not eliminate losses, shows great promise in its ability to significantly reduce the adverse effects of market declines.

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Kendra L. DeBaets

Portfolio Manager Kendra DeBaets

Kendra has been employed by Summit Investment Management, Ltd since May 2001, and has many years experience working in the Investment management business.

She handles all of the daily operations and administrative needs of the office.

She also works with our clients on a variety of issues from account set up to funds distributions and beyond.

Prior to joining Summit, Kendra gained her initial experience in the investment industry while working at Ellenbecker Investment Group as an Administrative Assistant.

Summit Investment Management, Ltd. (2001 – Present)

  • Operations and Client Service Manager

Ellenbecker Investment Group (1999 – 2000)

  • Administrative Assistant


  • B.S. (Early Childhood Education) – University of Wisconsin – Milwaukee





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Thomas J. Czech, CFA

Financial Advisor Tom Czech

Tom serves as Chairman of Summit.  He came to Summit from Blunt, Ellis and Loewi/Kemper Securities in 1991, where he was employed as the regional brokerage firm’s First Vice President and Investment Strategist.

Tom brought Summit his concept of disciplined fundamental investing that forms the basis for many of the company’s equity strategies. Under Tom’s direction, these strategies were first offered to clients in late 2002. Tom was named Chairman of the Board in 2008.

After earning his MBA at Northern Illinois University, Tom was hired by Blunt Ellis & Loewi as an equity analyst in 1972. He was tasked as a generalist to discover attractive small growth companies across all industries. His success as an analyst brought him to the attention of upper management, and in 1984 he was made the company’s Director of Research. In that position, Tom oversaw the work of a dozen analysts that included pioneer work in the water industry for which the firm became nationally recognized.

He also served as the Chairman of the Stock Selection Committee which decided the designation of the rating that Blunt Ellis & Loewi gave to companies – buy, hold, or sell. Additionally, Tom was a member of the Due Diligence Committee which reviewed companies prior to their Initial Public Offering (IPO) to make sure that they met the brokerage firm’s standards.

Summit Investment Management, Ltd. (1991 – Present)

  • Chairman (2008)

Blunt Ellis and Loewi (1972 – 1991)

  • First V.P. and Director of Research


  • MBA – Northern Illinois University
  • B.S. Finance – Northern Illinois University

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Ronald E. Chandler

Portfolio Manager Ron Chandler

Ron has many years of option trading and strategy development experience. Before joining Summit in 2012, Ron had worked as an option instructor for Optionetics Inc., as well as Managing Partner for Chandler-Wiles Group, LLC, a management consulting firm and Big Dog, LLC. a  private investment firm. Ron is Summit’s President.

Ron has executive experience across a wide variety of industries (automotive, pharmaceutical, petrochemical, service, food retail and financial) and disciplines (sales, engineering, program management, product development, and operations).
After selling his manufacturing business in 1994, Ron established himself as a turnaround consultant working with troubled companies.

Ron holds a Series 65 Securities Licenses as well as State insurance licenses in Life and Health in the state of Wisconsin. He is also certified as a Lean Manufacturing Expert and a Six Sigma Black Belt by the University of Michigan-College of Engineering and has co-authored a book on those subjects.

He has been a featured speaker at investment conferences across the country and volunteers his time teaching financial literacy to school age children and young adults.

Summit Investment Management, Ltd. (2012 – Present)

  • President

Chandler-Wiles Group, LLC (2002 – 2012)

  • Managing Partner

Bankruptcy Turnaround Management (1996 – 2001)

  • Consultant


  • M.B.A. (Marketing, Finance) – University of Detroit
  • B.S. (Chemical Engineering, Bio-Chemical Engineering) – University of Michigan

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