FINANCIAL REVIEW

Admit It

Sinclair Noe — January 8, 2015

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DOW + 323 = 17,907
SPX + 36 = 2062
NAS + 85 = 4736
10 YR YLD + .06 = 2.01%
OIL + .08 = 48.73
GOLD – 2.20 = 1209.90
SILV – .16 = 16.48

Since 1928, the Standard & Poor’s 500 has started the year with 3 straight losing days eight times. And only once has the S&P 500 finished one of those years in the red. During the 8 years since 1928 that the S&P started with 3-day losing streaks, the index has returned 8.3% on average. For all years since 1928, the S&P has returned 7.5% on average. Maybe it’s a good thing to start the year with 3 straight losing sessions.

Then there is the idea that the first 5 trading sessions of the year can be used to extrapolate the direction of the market for the year. If that is the case, then we might expect some rough sledding for the markets in the early part of the year followed by a strong second half of the year. This is a variation on the idea of the January barometer, which says (basically) that if January is positive, the year will be positive, and vice versa; that didn’t work last year, but it is accurate about 89% of the time. Of course, that’s just probabilities and tendencies. We don’t know where the market will go in the first half or the second half. Nobody knows. What we know is that the stock market goes up more than it goes down.

There is concern that the Federal Reserve will raise interest rates, essentially taking away the punch bowl from the party. The FOMC minutes released yesterday indicated the Fed will be patient about raising rates. Wall Street will likely throw a little tantrum when they do hike rates; and if they don’t raise rates, Wall Street will likely throw a tantrum because the concern would be that something is wrong with the economy that would prevent a rate increase.

Raising rates should not mean the end of the bull market. The economy probably is strong enough to handle tightening by the Fed. If that was all we had to consider, then this should be a good year for the markets. The reality is that the economy is much stronger than most people are willing to admit; it isn’t perfect; I’ve never seen a perfect economy, but it is decent and it’s getting better all the time.

Think about it, and try to be objective. Interest rates are low; the yield on the 10-year Treasury note is right around 2% and that means mortgage rates for a 30-year fixed mortgage are under 4%; you might even get a 15 year mortgage for under 3%. That’s fantastic.

Oil is under $50 a barrel and that means you’re paying less than $2 a gallon at the pump. One year ago, we were paying $3.25 a gallon. That’s a good thing on so many different levels. You save a few dollars on every trip to the filling station; it costs less to ship your food to the market; we have more money to spend on other things, or to save for a rainy day.

The lower prices for fuel helped put a cap on the trade deficit, now at an 11-month low. The trade gap narrowed even though the dollar is the strongest currency on the planet. GDP grew at a 5% clip in the third quarter. Growth estimates for the fourth quarter are currently between a 2.5% and 3.0% rate. We have a resurging economy. Detroit is building cars you would actually want to own and drive. In Las Vegas this week, the Consumer Electronics Show features exhibitions taking up 40 football fields’ worth of high tech stuff; and it’s not just gadgets and gee-gaws; we’re talking about things that are revolutionizing the way we live, increasing efficiency and productivity, and improving our quality of life.

Yes, you can still be dazzled by a zillion inch high def TV, but you can also find the latest in technology to provide practical healthcare solutions; fitness bands to monitor your heartbeat; hearing aids that use Bluetooth to connect to a smartphone or tablet. There is a scanner that allows you to scan food or medicine to determine the nutritional value and chemical components. The CES show has technology and new apps to teach kids math, science, and even computer programming concepts. There is also a resurgence of practical clean energy and green technology because we all know cheap oil prices won’t last forever. There’s a pocket sized solar charger that can grab a full day’s charge for your phone after just 90 minutes in the sun; devices to connect your house to the internet and make your home more efficient and smart, and of course electric vehicles, and even driver-less cars. And if you need something, a 3-D printer can make it while you wait.

And here’s the kicker: many of the vendors at CES this year were crowdfunded. While not all crowdfunded products are useful, the fact that the community has voted on them with their money makes the process more democratic and proves that the products have real demand. There is a whole pavilion dedicated to startups and crowdfunded companies and it features 375 of them this year, compared to 200 last year.

Now, tomorrow morning we’ll get the jobs report for December. Remember that last month’s report showed the economy gained 321,000 net new jobs in November and the unemployment rate is down to 5.8%. November marked the tenth consecutive month of job gains greater than 200,000, and an all-time record 50th consecutive month of job gains. Total employment is now 1.7 million above the previous peak. Total employment is up 10.4 million from the employment recession low. So far this year, the United States has added some 2.65 million jobs, putting the country on track for its best year of job growth since a 3.2 million gain in 1999.

That’s pretty good. We still need to see improvement. There are still 2.8 million long-term unemployed. And more than 6.8 million people are working part-time, even though they would like a good full-time job. And wage growth remains essentially flat, after adjusting for inflation. There is still slack in the labor market but compare our situation to the 11.6% unemployment rate for the Eurozone, or 25% unemployment in Greece.

And if you have had the good fortune to have a good job and you managed to save a few dollars, don’t forget what has happened in the stock market. Even though many Americans haven’t felt the surge in stock prices, the positive run on Wall Street is already the fourth-longest since 1928. To put another it way, a baby born at the start of the bull market would be entering kindergarten now. The bull market started in March 2009, as the S&P cratered to a low of 666. Today, we closed at 2062. That’s more than 300% gain in less than 6 years. Now, I know you didn’t catch the absolute bottom and ride it, but if you just caught a part of those gains you’re doing pretty good.

All of this has led some on Wall Street to fear the string of good luck could be nearing an end. Some even believe stocks are in the midst of a bubble that could pop in an ugly way soon. The odds are stacked against the current bull market dethroning the all-time record of 4,494 days, or just over 12 years. That remarkable run occurred between December 1987 and March 2000, impressively spanning parts of five presidential terms.

There is always a potential for shocks and with assets ranging from fully valued to expensive, investors may be vulnerable to potential setbacks. There are a few possible bumps in the road for 2015:
Geopolitical tensions could flare; pick your poison, Russia and Ukraine, Iraq and Syria, India and Pakistan. Yesterday’s terror attack in Paris reminds us that no place is entirely secure. Geopolitical tensions could intensify and rattle global demand, slowing down growth everywhere including the United States.

Europe is vulnerable. The EU is drifting into deflation. The ECB says they will do whatever it takes to stimulate the economy, including large scale purchases of sovereign debt. Meanwhile, Greece is getting ready to vote for a political party that promises to repudiate sovereign debt. It’s a sticky wicket. And there is even a possibility the Euro union could unravel; not the most likely outcome but a possibility nonetheless. Outright deflation remains a palpable risk. Even if the ECB can engineer a big stimulus package, the jury is out on whether QE measures will be enough to restart the currency union’s economy. And if the Eurozone can’t pull itself out of its economic malaise, that will hurt profits for many US companies that do business overseas.

And even though the US economy is on the upswing, it is one of the few major economies expected to accelerate in 2015. If wages remain stagnant in the US, that could undermine consumption and there is a chance that growth could disappoint. This has happened before and the most likely result is increased volatility, especially with stocks already on the pricey side.

And then there is the Fed, patiently waiting to tighten policy and raise rates. If their patience wears thin, if they hike rates too fast or too high, the markets would likely get a burst of intense volatility. But the reality is that the Fed has been very patient so far; they have done a decent job of telegraphing their intentions; they have floated trial balloons, and they will most likely move slowly and incrementally. And if that is the case, the bull market should survive. Bull markets end when the fundamentals get skewed and/or with a shock to the system. The bull market has been one of the longest in history and bull markets don’t just die from old age alone.

The economy is stronger than most people dare to admit. Fear sells and some people are just trying to sell fear. Sure, there is plenty of room for improvement and it will take a lot of hard work and maybe even a bit of luck and there are no guarantees, but the US economy is the strongest in the world. If anybody tells you different, don’t buy it.