Yep, More of the Same, Which is Terrific

Published at Sep 7, 2017, 12:00 AM in wealth management by Buğra Bakan

Whatever has the nature of arising, has the nature of ceasing.” – The Buddha

One key concept of Buddhism is “impermanence.” That which changes cannot be real, and so we shouldn’t concern ourselves with what is not real…right?

Given the stock market’s impermanent nature, which is bound to cease at some point (as resilient as it has been), should we still concern ourselves with its potential next move?

I hope so, because I don’t have much else to offer in this newsletter other than offering a forward-looking analysis to global equity markets. I hope you feel the same, will continue to read, and share with others, because otherwise, this has been a disastrous marketing effort.

Let me start with giving myself a pat on the shoulder, as I wrote this in April and it proved to be correct:

“…I will address these concerns, and conclude that the stock market still has room to grow, pullbacks are likely and they should be used as buying opportunities.”

Repeating one’s self is rarely a value-added proposition, but what’s a man to do when you’re exactly at the same spot: pull backs are likely as we enter the seasonally weak period of September- October, and given that long-term trends are intact, these pull backs should be used as buying opportunities.

Why? (Glad to see you’re still here. Buddha would be proud, if pride was an acceptable trait, that is.)

Following on the theme of gracefully repeating myself, I can’t tell you how many newsletters I have written about the infamous “Wall of Worry”. Everybody is worried about a recession, a market crash, a nuclear war, natural disaster…and more.

A few weeks after the 2016 presidential elections, I joined an investor round table at City National Bank in San Francisco; 7 out of 10 investors were bragging about going to cash with the anticipation of a correction. Since election day Tuesday, November 2016, the S&P 500 index market price went up 13%. (No, I wasn’t a part of that seven, and yes, I am proud, as I’m pretty far from being enlightened.)

The question isn’t, what potential problems are out there, which are almost always plenty. The question is, what current regime’s market drivers are out there and what do they tell us about the foreseeable future?

Current Market Drivers

Different market conditions create different winners and losers. My job as an investment strategist is to identify current drivers, track them closely, put them up against historical precedence and come up with a strategy that has a higher probability of being correct than otherwise.

**The US dollar has been getting weaker** against major currencies, especially the Euro. This favors large companies as they derive some (or the majority) of their income from exports. A weak dollar makes their products relatively more affordable and attractive to potential buyers.

Conversely, it hurts smaller companies because as input prices go up you get less for your dollar and small companies usually have less export exposure.

So, one would expect to see large companies do better in this environment, and that’s exactly what has been happening.

A dollar that is too strong makes US goods too expensive. This is especially true during a time when the US Fed is raising interest rates, strengthening the dollar. A little bit of weakness is welcome news. Of course, there is a line in the sand not to be crossed when it comes to this downside. Looking at macro indicators, the US dollar will most likely continue to deal with a strengthening problem, as opposed to crossing the line of getting too weak, in the short to midterm.

Rising interest rates hurt stocks, or do they? Like the case of the value of dollar, there are lines not to be crossed and within those lines, we can play happily in the sand box. The current slow pace and level of rate increase is far from damaging to the US equity markets. In fact, the positive correlation of bond yields and stock prices come in to play, and the market sees this as a byproduct of strengthening economic conditions. Until when? We’re probably a year or two away from a red zone.

At 4.3%, the current unemployment rate is probably at, or very close to its trough. Unlike the earlier years of this nine-year-old recovery, wages are improving. This may create inflation, and that’s bad for stocks. (We should all get used to a simple way of conveying our message with words like good, bad, disaster, terrific and fantastic. That’s about it. Five is plenty, plenty good, and very terrific.)

That being said, just as the unemployment trend is at a low point, so is the productivity. This implies, with increasing capital expenditures (Capex), companies can invest in their productivity gains and control their costs. This creates a headwind for the inflation rate, which is good, almost terrific.

Trump’s administration has disappointed markets with its lack of commitment to tax cuts and deregulations. So far, beyond some crazy tweets, a disasterous hair style and not so terrific rhetoric, if judged by actions, the executive branch hasn’t done anything a traditional Republican wouldn’t. Markets expected more than that, hence the surprising (or not) Trump Trade. But this disappointment has been somewhat baked in the cake. The excitement has faded, but albeit late, the possibility of corporate tax cuts and lower regulations, a party punch bowl for the markets, has formed a sidesway trend.

Valuations are stretched. Yes, but when was the last time US equities offered good value? The fact is, valuations don’t have a reliable record when it comes to market timing. Eventually, when the correction does happen, someone will say “I told you so.” This has been said for quite some time. Relative valuations however, especially in relation to bonds, still make a compelling argument in favor of stocks.

Global recovery/growth favorable. Markets that count, Emerging Markets in general, China, the Eurozone and Japan, have all been signaling for a path of growth and/or recovery. Speaking of valuations, on a global scale, equities are not overpriced, especially in the Eurozone, China and Japan. In fact, some good value can be found in those markets. Now of course, there are reasons why investors flock to the US markets, but a Blackrock research of the next 5-year equity returns shows the best results will come from the Emerging Markets and Europe.

US consumer and business confidence is high. In fact, Bloomberg Consumer Confidence Index reached a peak level since 2001. There are good reasons for this; low commodity prices, rising wages, overall stable economic conditions, low rates and improving net worth. Thanks to rising asset prices, the US household net worth has reached an all-time high of almost a whopping $95 trillion. In my career, if there is one lesson I have learned, it is to never discount US consumers’ resilience and their appetite for consumption. Under these conditions, if 70% of the US economy is driven by the consumer, the US economy has plenty of gas to push forward for another year or two.

Saving the best for last; the US and global economy is growing. Rainy days do come and they are needed, both literally and figuratively. But in general, they last a shorter time during summer months, and conversely sunny days are fewer in the winter. Similarly, pull backs and corrections tend to be controlled while the economy is in a growth mode. On August 30th it was announced that the US economy has grown 3% in the second quarter. This was expected, as the first quarter growth rate was a dismal 1.2%. Nevertheless, this is clearly favorable and in conjunction with similar results anticipated from overseas. My cautious, yet, optimistic view on the stock market remains intact. For an investment strategy, until proven otherwise, buy the dips, and start looking at international markets as well (if you haven’t already done so).


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.