cyclical markets

The Next Recession is Coming, Continued

Federal Reserve Bank of St Louis
Federal Reserve of St. Louis

Once again it is time for our quarterly assessment of economic conditions. Is the economy growing or shrinking? This is the fundamental question.

The next recession is always out there, of course, as is the recovery which will follow it. The excesses that build up in good times lead to imbalances that get corrected by economic downturns. But what are the current indications?

• The Index of Leading Economic Indicators is supposed to point to the direction of the economy in the months ahead. It has remained solidly in positive territory.
• The bond market speaks to us about economic conditions through the yield curve. Although it has flattened somewhat recently, it remains in growth mode.
• The Current Conditions Index from LPL Research remains in positive territory.
• The “Overs,” a proprietary LPL measure of potential over-spending, over-borrowing, and over-confidence, point to continuing expansion.
• Details on the LPL Research work are available here.

Economic news is always mixed, and can always be better. But jobs and incomes and spending continue to grow in fits and starts. The weight of the evidence says we are doing OK, at least.

We do have challenges. Policy makers attempt to manage the economy from above, using a philosophy that was discredited long ago. Their interventions create distortions which we monitor carefully. Much of our work involves avoiding the problems created by people trying to “help us.”

We are on the job, doing the best we can to preserve your interests and take advantage of opportunities as they arise. Call or email us if you have questions or comments.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All indices are unmanaged and may not be invested into directly.

Human Nature Creates Investment Opportunity

© Can Stock Photo Inc. / soupstock

Economists like to believe that human beings act rationally. Those of us that know otherwise follow the theory of Behavioral Economics instead.

One of the key findings of Behavioral Economics is that the pain of a loss is twice as great as the pleasure of a corresponding gain. Rationally speaking, $5 is $5, whether it is gained or lost. But we still feel the sting of the loss as a bigger deal than the pleasure arising from the gain. This is human nature in its raw, untrained state.

Confounding this finding is an extremely pertinent point, one that is ignored by the academics and the finance types who trade off their work. They treat a temporary decline as a loss. There is no shortage of expensive products designed to pander to this tendency by selling the promise of stability at a premium.

In the real world, many successful investors treat a temporary decline as either an opportunity, or a matter of no long term consequence. For most of us it takes education and training to overcome our behavioral tendency to feel the pain of a loss over short-term volatility. We’re here to help you with that.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Things Warren Buffett Never Said

© www.canstockphoto.com / meikesen

Warren Buffett may be the most famous investor in the world. The annual meeting of his company is known as ‘Woodstock for Capitalists,’ and is attended by 40,000 people. Countless articles, essays, and books have been written (including by us) about the things he has said.

As far as we know, nobody has ever written anything about things Buffett NEVER said. But here are our top three things Buffett never said:

1. “The stock went down, so I sold it.” Buffett knows the market goes up and down. He studies companies, not stock ticker symbols. When the fundamentals are in place, he buys. Then he holds. Then he holds some more. If the price declines, he typically buys more. This is what ‘buy low, sell high’ is all about.

2. “I’m waiting to invest until we get more economic data to clear up the uncertainty.” In his seven decades of investing, Buffett has noticed that uncertainty is always with us. He reads and studies ceaselessly, and when he finds something to buy, he buys it. Frequently, this turns out to be when the price is depressed because of temporary factors. Others are paralyzed by uncertainty when Buffett is taking action.

3. “A lot depends on what the Federal Reserve does next month.” Buffett has run his company for more than five decades, while seven different people held the chairmanship of the Federal Reserve Board, through innumerable cycles of Federal Reserve tightening and loosening. He can tell you what he paid for his stake in Coca Cola and when it was purchased. He probably cannot say what the Federal Reserve did at the meeting before, or the meeting after, the transaction. Why? Because it doesn’t matter in the long run.

Warren Buffett does not wear a halo. He is a human being and that means he makes mistakes. But he has made more money investing than any other human being on the planet. We think it pays to listen to the things that he has said. But there may be even more value in understanding the things he never said.

If you would like to discuss these concepts or your specific circumstances at greater length, please write or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Stock investing involves risk including loss of principal.

The Next Recession is Coming… Again

chart from research.stlouisfed.org

Regular readers will recognize this headline. The next recession is always coming. Human nature being what it is, the economy will always have cycles just as the world will always have seasons. The excesses that build up in good times lead to imbalances that get corrected by economic downturns.

The most notable feature of the current economic expansion is its slow, plodding pace. Most people with jobs or in business are familiar with one of the reasons for this: unprecedented expansion of the regulatory state. Our shop and many others in many lines are coping with new kinds of nonsense that hampers production or service. (We are not arguing for a Darwinian, regulation-free society, of course.)

The silver lining in our plodding economy is the lack of a boom in any major sector that could create a big downturn. New home construction has not really exceeded the sixty-year average. According to the National Auto Dealers Association, vehicle sales–while near a record–only replaced 1/15th of our vehicle fleet last year. It seems to us that the peak in auto sales lies ahead of us. Capital spending and business investment, which has at times gotten too inflated in the past, has remained extremely subdued.

Energy, of course, did boom—and then busted. But our diverse and dynamic economy has largely absorbed the job losses, and consumers and businesses are enjoying unforeseen low gasoline and energy prices. Corporate earnings have not been great, but should strengthen in the quarters ahead.

The Index of Leading Economic Indicators points to near-term trends in economic growth, and it has flashed a steady positive reading for years. The bond market speaks to us about economic conditions through the yield curve, which remains encouraging and positive. LPL Research publishes a Current Conditions Index which measures economic vitality right now—and it has remained in positive territory. LPL Chief Economist John Canally draws mostly comforting conclusions from the latest labor market statistics (ht.ly/v7Co3003MvP )

So yes, the next recession IS coming. We just do not think it will arrive soon. Our plodding plow-horse recovery continues, no boom—but no bust either. This is good news for investors.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Times Have Never Been So Tough!

© Can Stock Photo Inc. / Jetrel

As humans, we’re generally self-centered by nature. We sometimes have an exaggerated sense of our own importance.

That’s not to say that there’s anything wrong with this. We happen to think that enlightened self-interest, with the understanding that the best way to make ourselves better off is through mutually beneficial cooperation, is an excellent principle to live our lives by. But sometimes it pays to keep the bigger picture in mind.

Our experience of the present century is one of turmoil. We’ve seen terrorist attacks of unprecedented scale, the biggest recession in a century, extremist political movements everywhere from the third world to the first world, terrifying epidemics, wars, natural disasters—the list goes on and on. In our egotism, it’s easy to fall into the trap of thinking that we must be living through the greatest crisis in human history.

In fact, we’re so stuck in the here and now of our lives that we’re willing to ignore evidence from our own lived experience—many of us have actually lived through just as many troubles before! The recessions of the 70s saw higher unemployment, lower growth, and vastly more inflation all while the Cold War raged on in the background. We know the 2008 crash was painful, but compared to lines at the gas station and 20% inflation things don’t seem so bad.

And yet, those of us who came of age during those troubled times still have nothing to complain about. Think of how our grumbling about gas prices must have sounded to the generation before us! They lived through the Depression and the rise of fascism, bled on the beaches of Normandy and watched the Iron Curtain descend. They saw a hundred thousand souls go up in nuclear fire and millions more die in the concentration camps.

Those that came before them had it no easier, either. The fact that the Great War’s casualties took place on the battlefield rather than in bombing campaigns and death camps would have been little solace to towns that lost an entire generation of young men, butchered by unprecedented machines of war and chemical weapons so terrible that not even the Nazis would stoop to using them.

Going back further there’s an almost infinite number of crises in human history we can look back to. Everyone thinks they’ve got troubles, and by and large they’re right. But as preoccupied as we are with our own troubles, we should strive to keep them in perspective. As it turns out, we have a once-in-a-generation crisis about once a generation. As a civilization we’ve gone through a lot of generations and a lot of crises and still kept going.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Next Recession is Coming, pt 2

© Can Stock Photo Inc. / albund

Regular readers will recognize this headline. The next recession is always coming. Human nature being what it is, the economy will always have cycles just as the world will always have seasons. We humans are great at this: taking a good thing too far. The excesses that build up in good times lead to imbalances that get corrected by economic downturns.

Because investment trends are based loosely on what is going on in the real economy, it makes sense to think about where we might be in the economic cycle. So from time to time we report to you the state of the economy as we see it, with an eye on that next recession. Hat tip to LPL Research, people who do a lot of work on topics we need to know about.

In his latest report, LPL’s chief economist John Canally looked at the current fears in the marketplace and compared them to the groundhog. Many people pay attention to the groundhog, but he actually isn’t worth a darn at weather forecasting. Likewise with the drop in the price of oil, the rise of the dollar, some shrinkage in one sector of the economy—people are paying attention, but these things are not good at forecasting recessions.

Canally also compares the current situation to the 2007 economic and market peak and how things look for consumers. The savings rate is more than double, the mortgage rate is better by a third, household debt is a lower percentage of income and falling, and gasoline prices are….well, you know. Bottom line, we’re in pretty good shape.

Did you know the bond market provides a recession forecast that has worked very well since 1950? The bond market speaks through the yield curve, a simple measure of whether shorter term rates are higher or lower than longer term rates. When short term interest rates get above long term rates, there has always been trouble ahead. LPL’s Anthony Valeri just released a study concluding that the yield curve is not indicating recession.

We’ve never had a recession in recent history that was marked by strong jobs growth. And here we are, with a record 64 straight months of jobs growth. Nor has a drop (or a crash) in the price of oil ever precipitated a recession. The oil price drop is a mixed bag: the energy industry has been hit hard with job losses and reduced corporate earnings. But the losses to energy are gains to the rest of us.

So yes, the next recession IS coming. We just do not think it will arrive soon. Our plodding plow-horse recovery continues, no boom—but no bust either.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

2015: Year In Review

© Can Stock Photo Inc. / welcomia

As we think about the year now ending, we would love to say “It was the best of times, it was the worst of times.” That would not be accurate. However, it truly was “the spring of hope, the winter of despair.”

Nobody has ever conveyed the concept of a mixed bag as well as Charles Dickens did in the opening lines of ‘A Tale of Two Cities.’ And nothing is more fitting when we think about 2015 in the investment markets.

The parts of the market that appeared to be cheapest at the start of the year mostly got cheaper, and cheaper, all year long. Meanwhile, interest rates remained at seemingly impossibly low levels—expensive bonds remained expensive all year. Natural resources that had been sliding for years continued to slide.

Back in the real economy, new jobs were created each month. Retail sales and most measures of economic activity moved higher through the year. Inflation remained quiet, and consumers paid astonishingly little for gasoline. The low prices for natural resources and energy fed into low input costs for businesses, which helped business profits remain near record levels.

The kinds of excesses that cause the end of the growth cycle were simply not present in 2015. The ‘irrational exuberance’ of investors that usually accompanies major peaks in the market is also scarce.

Our principles remain unchanged, but we are always seeking to improve our strategies and tactics. Avoiding stampedes, owning the orchard for the fruit crop, and seeking the biggest bargains are always going to make sense. Putting these principles into practice is the hard part. The new year will see a continuation of the increased attention to diversification, the search for new sources of portfolio income, and new ways to think about effective portfolio construction.

We are ready to say goodbye to 2015, a year when the S&P 500 crossed the breakeven line more than twenty times. But we do so with the spirit of “the spring of hope,” given what we know about how things work. Please call us with your questions or comments.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. </p>

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

What Happened to my Account?

© Can Stock Photo Inc. / SergeyKuznecov

2015 has been a difficult year, investment-wise.

Most of us know how this works. We have periods where we laugh and laugh about how much money we’ve made, and other times where we want to cry and cry.

In addition to the ups and downs of the market, our accounts have spells where they behave differently than the broad market averages. Everyone has noticed the divergence this year.

So 2015 reminds us a lot of 1999, when the tech stock boom was in full swing. Midyear, we turned negative on large growth companies. But that was what everyone was buying. We preferred the bargains in “old economy” stocks like railroads and food companies and tractor makers. They went down and down while technology stocks went up and up. We seemed awfully stupid as our favorites ground lower month by month.

Of course, that all changed when the bubble burst. The high fliers ended up declining about 80% over the next two and a half years (the tech-heavy Nasdaq Composite index slid from a high of 5,408 in 2000 to a mere 1,108 in 2002), while the “old economy” stocks staged a good rally. In other words, we turned smart.

In trying to understand the carnage of 2015, one glaring fact stands out. All year long we have held the strong opinion that the best bargains in the market could be found in the natural resource sector. Companies that had anything to do with extracting minerals or oil from the ground started the year at amazingly depressed levels—bargain prices, in our view. Then they became cheaper. Then they became cheaper. Then they became cheaper. We seem awfully stupid, again!

We know how this works. At some point the gluts that have been so painful for many of our holdings will turn into shortages. Higher prices and growing revenues are the likely result. We’ve been through this with other holdings in the past, watching values getting chopped in half before tripling or quadrupling.

What we do takes patience. We never wanted 2015 to require so much of it, to require an explanation of performance divergences. But we believe the tide will turn, as it always seems to. Thank you for your business.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Anatomy of a Bubble

graph

The above chart was formulated by Dr. Jean-Paul Rodrigue in 2006, in the middle of the developing housing bubble. It illustrates the general pattern that most market bubbles tend to follow.

Early on, a small number of money managers and other sophisticated investors begin speculating that a given asset may be undervalued and establish small investments in the hopes of future gains. As these initial investments start to pay off, other managers begin to notice their success and follow suit, slowly ramping up prices. There may be one or more temporary sell-offs as early investors decide that their speculation has paid off and pull out of assets that they now perceive as overvalued.

Sometimes, this is as far as a price fluctuation will go. When a rising price starts to attract media attention, however, it creates the potential for a true bubble. At this point the price may already be significantly over asset value and the original “smart money” investors’ reasons for buying no longer apply. But as the general public becomes more aware of the success stories that the rising prices have created, more and more people buy in. This drives the price up even further, reinforcing the public perception that an easy money-making proposition has been discovered.

As the bubble nears its peak, wise investors quietly pull out as it becomes clear that the price is unjustified and unsustainable. Latecomers with little understanding of their holdings invent new explanations to rationalize the extreme overvaluations the bubble has created. They believe the old rules no longer apply and the inflated price is the new “normal.”

At some point, reality sets in and triggers a cascade in price. The bubble begins to deflate, although bullish investors may try to deny that this is happening. They see the initial decline as a buying opportunity, creating short-lived recoveries before the bubble goes into its final plunge. Often, the aftermath of the bubble leaves the asset so despised it becomes badly undervalued, creating buying opportunities for savvy investors—which may eventually generate the start of the next bubble, many years down the line.

We already know the lesson here: avoid the stampede. When we hear everyone else is buying something, it’s tempting to join in. But even when it seems like the price just keeps going up and up, we know what’s eventually around the corner.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Next Recession is Coming!

© Can Stock Photo Inc. / svanhorn

The next recession is always coming—and the next recovery, and so forth. Like the seasons and the tides, the economy runs in cycles. But after reviewing all the evidence, we don’t think it will arrive any time soon.

LPL Financial’s Research Department put together a useful summary on this issue. This is the short version, with other thoughts on the topic.

The first thing to understand is that two of the most popular fears about the cause of recessions are unfounded. The growth part of the cycle does not end because of old age. And the start of interest rate increases usually marks the midpoint, not the end, of the growth cycle.

So what are the causes of recession? LPL Financial believes that imbalances are the culprit. “In a healthy economy, there is a balance of responsible levels of borrowing, confidence, and spending.” So recessions are likely to occur after we see over-borrowing, over-spending, and overconfidence.

LPL Research has actually constructed numerical indicators to test for these three “overs” and calculated back through history. But it doesn’t take a rocket scientist to know that confidence is poor and spending has been weak. Borrowing has not gotten anywhere close to danger levels, either. Their conclusion is that the probability of a recession in the near future is unlikely.

The LPL “Over” Index agrees with another set of recession warnings we monitor, the Four Horsemen: home building, auto sales, business investment, and inventories. When one or more of these areas becomes overheated, trouble may ensue. All four are all at fairly subdued levels, or close to long term averages—not overheated.

There is one other indicator which may be both instructive and profitable. The price of raw materials usually peaks at around the same time the economy does, near the onset of recession. Crude oil, iron ore, copper and other natural resources tend to rise during expansions. But the prices for these goods have been falling for more than four years. We expect to see a sustained move up prior to the next recession.

We look at the facts and act accordingly, after considering all the pertinent information we can find. Our conclusion is that optimism is warranted. We will continue to follow our principles: search for bargains, “own the orchard for the fruit crop,” and avoid stampedes in the markets.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk including loss of principal.