Recent goings on in Washington and the financial markets remind us (at least those of us who are old enough to remember) of a line in one of John Lennon’s hit songs titled “Nobody Told Me”. The line we refer to is “strange days indeed”. More on that later. The first three months of 2018 has been a wild ride, at least compared to the past few years of relative tranquility in the financial markets. The S&P 500 stock index blasted out of the gates with a 7% gain by the end of January, only to reverse course and give all of the gains up by the end of March. The economy is not to be blamed here as growth has been rather slow and consistent dating all of the way back to 2009 when the recovery first kicked in. Stocks (at least up until a couple of months ago) had been sailing along as well in a remarkably calm fashion and historically low levels of volatility. The winds of change are upon us.
There are many dichotomies happening in an economy that is said to be strong and resilient and poised for further gains. On the plus side, in a large portion of the Midwest companies are struggling to find qualified workers if they can find workers at all. Stories out of Iowa reference manufacturing companies turning away customers due to lack of man power. These companies are willing to pay and train kids right out of high school only to find no takers. Then there is the Recreational Vehicle capital of America, that being Elkhart, Indiana where the unemployment rate is essentially zero. RV sales have blown past the last peak set in 2006 and are over three times the level of sales in 2009. Wages have spiraled to $90,000 for assembly workers and over $100,000 for foreman, a lot of money by northern Indiana standards. Companies are offering signing bonuses for new employees to stay on board. For one month. $85,000 to $95,000 Ford Expeditions and Lincoln Navigators are flying off the lots. Dealers have little or no inventory. On the other hand, a recent study by a very reputable (by our standards) economics think tank paints a far grimmer picture. We all know borrowing, whether corporate, government, or personal has been strong and growing in the recent era of cheap money. Deeper analysis suggests that quite a bit of personal borrowing (think credit card debt) has not been for fancy new cars or to spruce up the house, but to finance purchase of basic essentials – food, energy, health care. This suggests a deeper structural issue where much of the middle class is being stressed just to pay their bills every week. The same study suggests that the U.S. economy cannot tolerate much of an increase in interest rates due to the level of debt already outstanding. Where an increase in rates from say 3% to 6% might not have harmed the economy much 20 years ago, today such an increase might be quite damaging.
Back to Mr. Lennon and another line from his song: “everyone’s a winner and no one seems to lose” harkens to the nice gains in the stock market in recent years and particularly those with an affliction to the largest technology or “FAANG” stocks. The market has been strong and the general economy seems to be in good shape and possibly getting stronger. Recent corporate tax cuts are allowing firms to drop more money to the bottom line without selling a dime more in product or services. But wait a minute, here comes Washington. As this letter is being written more tariffs are being threatened on China, far and above what was proposed just a week or two ago. China will not take this sitting down and will retaliate. None of this is positive. Tariffs do nothing but raise the price of goods and services that Americans use every day. Given the aforementioned stress many households are under to meet their obligations, higher prices are far from welcome. Remember wages are still growing at a fairly slow historical pace and certainly not enough to offset the higher prices that punitive tariffs might produce.
Making our jobs here at GSB Wealth tougher is deciphering all of the rhetoric coming out of Washington, not to mention the almost daily barrage of tweets. If I ever get fired I hope it isn’t via a tweet. We are good at analyzing the economy, setting client objectives, valuing individual stocks, etc. What is very difficult is to know whether a misguided tweet may cause the market to gain or drop 1000 points in any given day. That is why GSB Wealth adheres to high quality investments, sets reasonable client objectives, creates a solid long- term plan and sticks to that plan. Survey after survey has shown that trying to ”time” the market i.e. jump out then jump back in, is a losing proposition. Constructing a solid long-term plan with quality investments and sticking to that plan is the best means to an end. That is what we do.
As always, please contact us with any questions and/or concerns.
Your GSB Wealth Management team
2017 has turned out to be quite a year in the financial markets. We can think of few individuals who thought that the stock market (S&P 500) would return close to 20% when all were prognosticating in January of last year. We have to admit that GSB Wealth management was surprised as well but we are happy to take what we can get while we can get it. We have discussed in recent newsletters that the stock market seems fully valued, if not over valued yet there is nothing in the immediate future that looks to us to knock the market off of its perch. Many clients have called us with concern about recent goings on in Washington, threats from North Korea, the new tax bill, income inequality, and a myriad of other things reported in the daily news. In reality, these issues have little effect on the long-term health of the stock market and economy. What is reality is that the U.S. economy is picking up steam from the subpar growth trajectory we have been witnessing since the recovery began in 2009. Corporate earnings growth drives stock prices and earnings growth has been gaining momentum as interest rates remain at historically low levels. Should this continue in 2018, we may expect common stocks to log returns in line with the growth in corporate earnings, which would be a welcome sight coming off the solid gains witnessed in 2017. The strengthening economy is something we will be closely watching as stronger growth has the potential to start putting upward pressure on interest rates. We have been in a “goldilocks” economy for several years now. Not too hot nor too cold. Corporations have benefited greatly from low interest rates. Favorable borrowing costs have been a boost to earnings as firms refinance older high cost debt or borrow cheaply to invest in modern technology and new equipment. Low financing costs have also allowed companies to buy back their own stock, reducing shares outstanding to goose earnings growth. Finally, higher interest rates would give investors an alternative to owning stocks. Think back to 1987 leading up to the 22% drop in one day in October. The stock market had performed in a spectacular fashion through late summer and had become highly valued, as it is today. At the same time interest rates had been increasing and peaked with the 10-year Treasury Note hitting 10% by August. This in part contributed to the crash. Stocks now had serious competition in a 10% return from a guaranteed government bond. Such does not exist today but bears watching as the economy strengthens.
Changing direction, GSB Wealth Management intends to no longer distribute quarterly performance reports in the future, preferring to review such information on an ad hoc basis at client meetings or during periodic conference calls. Reporting quarterly seems to us to go against the very philosophy of GSB Wealth Management at its core. We structure client portfolios with a long-term view, taking each client’s risk tolerance into consideration and constructing portfolios with time tested securities of high quality. Constantly comparing against a particular index (and there are hundreds to choose from) doesn’t make sense to us and threatens to have one take his/her eyes off the ball or potentially change philosophy in order to chase an index that may have little resemblance to the securities in one’s own portfolio. We saw this happen in 1999 as many investors capitulated and bought into the internet stock craze in an effort to keep up with “the market”. Shortly thereafter the train went off the tracks and crashed. We made this decision only after careful consideration and thought, backed up by the thinking of Warren Buffet, John Bogle (founder of Vanguard) and other well renowned professionals in the investment management field. We will still have performance data at our fingertips at any given moment and are happy to share that data at any time and will do so on request.
As always, we of course are open to your suggestions and/or concerns and encourage you to contact us at any time for further discussion. We hope you have a great New Year.
Your GSB Wealth Management Team
This quarter’s newsletter will be somewhat abbreviated compared to previous newsletters as many of the trends we spoke about in June are still in place. The stock market, as defined by the S&P 500 has gained approximately 14% year-to-date. We are somewhat surprised by such a move given the ongoing political turmoil, risk of nuclear war, Federal Reserve interest rate hikes, and other concerns surrounding global markets. The stock market doesn’t seem to care and continues to plumb new highs. As a result stocks are now being valued, on a number of measures and ratios, near or above high points seen in 1987, 1999, and 2007. High valuations are a poor predictor of just when the next drop will come. However, the margin for error now looks to us to be fairly extreme so we are proceeding with caution. As we know, there is no insurance policy when investing in stocks and bonds. The closest thing to insurance is investing when stocks are depressed or trading at low valuations based on many decades, if not centuries of history. At the stock market lows in March of 2009, High quality blue chip stocks were trading at historically low valuations. If you were astute enough to put money in the market in March of 2009, you could have thrown darts at a stock board and done well. If you hit Procter & Gamble, Johnson & Johnson, Honeywell, McCormick – all have done well as stocks were cheap. Just the opposite is true today. GSB Wealth Management is being very selective in deploying new money and have been taking profits or trimming exposure to stocks where appropriate. Our bias toward quality is intact and we do not chase fads or “new eras”. We are cognizant that Amazon, Netflix and Tesla have been flying high and leaving many “blue chip” stocks in the dust. We saw this in 1999. Once the internet bubble burst, the high fliers were decimated and many of the stocks lost over 75% of their value. Some went to zero. At the same time, the stocks mentioned above held up relatively well and continued to prosper in the years to come. We have found repeatedly that sticking to our knitting makes financial sense, even if at times we look a little stodgy when the rocket stocks hit the launch pad.
Speaking of rocket stocks, we thought we would make a few comments on Amazon. Amazon is clearly a market disrupter, taking over market after market, the latest being the grocery industry. There is even a term for it called being “Amazoned”, as if Darth Vader comes in with his magic wand and suddenly an entire industry goes “poof”. Amazon’s share price is approaching $1000 and the market capitalization (the value of all Amazon stock outstanding) is approaching $500 Billion, one of the largest companies on the planet. What many folks don’t realize though is that Amazon makes very little in profit. For some reason Wall Street has given Amazon Carte Blanch to earn very little, year after year, as if one day they will flip a switch and earn billions. Doubtful this can happen. To flip the switch would mean raise their prices on goods they sell. And Wall Street continues to turn a blind eye. Imagine if Procter & Gamble were to come out and say they are lowering the price on Tide and Pampers and Gillette products until their profit nearly went to zero. The stock would likely get penalized harshly, falling from $90 to $50 overnight, if not lower. Yet Amazon continues along, earning next to nothing while its stock flies high. It almost seems unfair. While other companies must earn a healthy profit to garner a high stock price, Amazon gets away with earning little yet is able to disrupt industry after industry using its highly valued stock as currency. This same phenomenon was rampant at the top of the internet boom in 1999. Then it hit the wall. At GSB Wealth Management we prefer to stick with high quality companies selling at reasonable valuations, even it means giving up some relative performance in an aging bull market. We feel now is the time to focus more on managing risk than chasing return.
Sincerely, The GSB Wealth Management Team