Stock prices began 2018 right where they left off in 2017 – measured by the S&P 500, stocks recorded a total return of 5.7% in January. The market’s buoyancy is uncharacteristic. The last true down month in the stock market was October 2016, 15 months ago. The steady month over month returns have in effect hypnotized investors into thinking this ongoing melt up is normal. The monthly variability of returns to stocks in 2017 was 1.1%, the lowest measure our research produced in any year dating back to 1982 (the average monthly standard deviation was 4.2% during that time).
While I am uncomfortable with the pattern of returns, I think there is a fundamental basis for the strength in stock prices; the primary factor being earnings. US corporations are delivering parabolic improvements in earnings, not seen in years. According to FactSet Research, 4Q 2017 corporate earnings reports are outstanding, coming in with a blended growth rate of 13.4%. In the last month alone, CY 2018 estimates for the S&P 500 earnings jumped 5.3% (from $147 to $155), representing the largest increase in estimates over the first month of the year since 1996.
Other factors supportive of the earnings inflection are the surprisingly weak US$ and turbo-charged global economic growth rates. The weak US$ is difficult to understand. Given the backdrop (Fed raising rates, wage inflation), one would expect the currency to strengthen. Equally supportive is a healthy global economic revival boosting economic output and trade. The IMF recently revised its global growth forecast to 3.9% – more customers buying more US made goods.
A fly in the ointment will inevitably appear, and the most likely catalyst of more normal behavior (regression to the mean) from stock prices will be higher interest rates. When rates rise, equity risk/returns often do not look as favorable. The yield on the US 10-year Treasury note rose to its highest level in nearly four years recently. Inflation and unemployment data imply the Federal Reserve will remain on track to raise interest rates throughout the year. The old adage, “don’t fight the Fed” may well lead stock investors to take pause.
The next spoiler to emerge will be skyrocketing US deficits. Estimates are the Treasury will have to borrow up to $955 billion to make it to the September 30th fiscal year end, more than twice the year prior. Lower tax receipts means we borrow more. To induce lenders, interest rates will continue to rise. Higher borrowing costs, on more debt with reduced tax receipts is a prescription for trouble. Akin to a gambler or addict, leadership in Washington has opted for economic (and political) bliss today, at the expense of our children and grandchildren. Eventually, someone will have to make hard choices.
Future investment returns are being pulled forward. On the back of the one-time tax cut benefit, consumers and corporate America have their wallets out. This will spur a flash of growth, but not long-term fundamental growth. Further, expectations are lofty, regulations (financial and environmental) are withdrawn, and animal spirits are now alive unlike any time since the late 1920s or 1990s. It’s no longer a fear of the stock market “crashing” or heading into a downward spiral, it’s now the fear of missing out, the age old driver of unbridled human behavior, greed.
Finally, the market place is changing in ways we cannot foresee. For example, the emergence of ETF’s as primary investment vehicles, the emergence of crypto currencies as the next big thing, and the devolution of asset class correlations have made for a “wild west” backdrop. A melt down, or at least some mean reversion is inevitable. Our hope is that any downturn is measured and stair-stepped. With this in mind, our effort is to guard against foolish impulses and focus our work on the investment policy we’ve discussed and put in place for you. We are rebalancing over exposure to stocks and trimming specific over-weight holdings. Changes to the tax code did not affect the favorable 15% long term capital gains rate. Please feel free to give us a call if you would like to discuss our views in more detail or any changes to your profile.
Bruce Hotaling, CFA
R.s.v.p. Valerie-Clark Roden (610)688-0697 or
On Friday, September 8th, Equifax (NYSE: EFX) announced a “cybersecurity incident,” where the birth dates, credit card numbers, and Social Security numbers for approximately 143 million U.S. customers were released to malicious hackers. With the U.S. population at an estimated 323.1 million, 4 out of every 9 Americans were affected.
Exposed users are at risk of having their identity stolen, with the possibility of risking financial loss. The Federal Trade Commission estimates that up to 9 million Americans have their identities stolen every year (before this unprecedented privacy leak).
Equifax claims to have discovered the breach on July 29th, with workforce solutions president Rodolfo Ploder, U.S. information solutions president Joseph Loughran, and CFO John Gamble Jr. selling a combined $1.7 million in shares in the trading days following the discovery.
In the uproar following the announcement, Equifax established a resource that allows you to check if you were affected. Attached to that resource was an agreement that by utilizing the website, you (the consumer) relinquish your right to sue Equifax directly, or participate in a class action lawsuit. Alternatively, you can use this chatbot to assist in suing Equifax, or you can wait to participate in a class-action lawsuit that will most likely be established in the upcoming months.
Unfortunately, you, as a consumer, are subject to the safety standards of the Consumer Data Industry Association, a trade organization representing the four national traditional consumer reporting agencies, Equifax, Experian, TransUnion, and Innovis. While these four companies help determine your overall creditworthiness and track your repayment history and behavior, they are for-profit with no government affiliation. You, as the consumer, don’t get to choose which of these agencies get access to your data, so you can’t insure individually against any one of their data breaches.
Because of this, our team at Hotaling recommends you check your credit report immediately and individually enact credit freezes at each of the four agencies.
While many credit reports are advertised with catchy jingles on primetime television, the only site that is endorsed by USA.gov is www.annualcreditreport.com. This site does not ask for credit card information, nor do they provide any service beyond providing your credit report. The US Government requires that the three major credit agencies give you a free copy of your credit report every year.
Freezing your credit prevents the use of your credit report by anyone. This means new credit cards and loans are immediately rejected due to inability to access credit scores. The freeze itself comes with a small cost (usually around $10 but varies state by state). In order to resume normal credit-seeking activities, a small fee (also usually around $10 but varies state by state) unlocks the credit report, either for short times or permanently. Four states (Kentucky, Pennsylvania, Nebraska, and South Dakota) mandate that these credit freezes fall off after seven years automatically.
Below are the individual links (with supplemental material) to begin these freezes.
Equifax Freeze Link: (Equifax is allowing anyone to freeze their credit for free for the next 30 days)
Innovis Freeze Link: (No Charge!)
It seems like everywhere you turn, someone is posting about Bitcoin, Ethereum, or blockchain in general, but like most people, I merely thought of this as a passing tech gimmick. Since starting at Hotaling, I wanted to find some way to make my mark on our client base, so as the resident millennial, I figured that the fledgling world of cryptocurrency would be a great place to start.
Cryptocurrency is a broad term to describe any digital, encrypted asset that serves as a medium of exchange. While concepts of cryptocurrency date back to the end of the 20th century, the term truly caught on with the invention of Bitcoin in a paper published in 2008 by the pseudonymous Satoshi Nakamoto in 2008.
In the paper, the author lays out a plan for a fiat currency build around “block chain”. Blockchain is an algorithmic way to securely and openly maintain a list of records. Ownership history is stored through a public record attached to the individual asset (the bitcoin), and the public record is adjusted every time the asset changes hands. These changes are then distributed throughout the entire network. Through this peer-to-peer storage and the NSA-created, one-way encryption algorithm known as SHA-256, the more widely adopted the currency, the more secure the blockchain. The supply of bitcoin is also controlled through this open-end encryption, as new blocks are only created as users are able to crack parts of the algorithm through a process known as “mining”. Instead of pick axes and hard hats, customized computers with multiple GPU (Graphics Processing Units) attempt to verify the blockchain. Successful attempts slowly decipher new blocks, and the discoverer is subsequently rewarded with new Bitcoins. While the most common usage of GPU’s has been for high-end video gaming, miners have found that these chips are better at doing many simple calculations (which is required for mining) than CPU’s, which traditionally do most of the labor in a home PC.
A change is coming to the Bitcoin encryption technology on August 1st, 2017. The change, called “Segwit2x”, increases the block size, as well as having many other stabilizing effects. Market participants are divided on whether or not to begin utilizing this code in their mining, with the dissidents believing this change will lead to a corporatization of bitcoin. They want to retain bitcoins status as a libertarian currency, which differentiates itself from Ethereum, a similar blockchain-based currency whose price has surged in 2017 due to its more corporate-friendly approach. If a majority of miners do not adopt this new technology, Bitcoin would split in two after August 1st, with a SegWit-only bitcoin, and a duplicated non-SegWit compliant bitcoin. Such a deviation is almost certainly bound to increase volatility in the already volatile cryptocurrency.
While investors may be enticed by the exorbitant returns in the currencies themselves (Bitcoin up ~140% YTD, Ethereum up ~15,000% YTD), the volatility and liquidity of these currencies makes them too risky for direct investment for most clients. However, there are many other ways to profit off the recent surge of interest in these currencies, if you believe this trend to continue. The surge in mining requires many more graphics cards to be sold, so a long position in the leading providers of these cards, could act as a proxy for Ethereum/Bitcoin. The surge of interest in these cards has left suppliers with limited inventory. Chipmakers with larger scale production already in place are in a better situation to profit from this short term burst of interest.
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