Is there any reason to remain optimistic?

The markets are giving investors a rational reason to remain optimistic, but with investors' focus on the Fed's statement yesterday (and their interpretation of what they think it meant) seems to be clouding their vision.

The chart below shows the S&P 500's earnings per share (green line), which is what ultimately moves the stock market (blue line)higher or lower.  Looking over the last three years, we've seen consistent, stable earnings growth.  In early 2018, we can see the dramatic increase in earnings created by the new tax plan.  More importantly, since the the tax plan went into effect, we can see a stable and steady increase in earnings has been maintained. 

image.png

Source:  Thomson Eikon Datastream

 

Interestingly, since the market peaked in late September, earnings have continued to grow, but the stock market has contracted sharply, and the S&P 500's forward PE ratio has dropped to 16 times earnings.  Equity indices across the board are dropping into "corrections" (greater than 10% drop), and some are approaching bear market territory (greater than 20% drop), which is usually only experienced during a recession. 

While market pundits are beginning to speak of recessions and long-term bear markets, their is nothing to support their claims.  Because there isn't any economic data to support their position, many have turned to blaming the Fed, stating that the future path of rate hikeswill cause a recession and a bear market, seemingly oblivious to the fact that the Fed just communicated its belief that we are "near neutral rates,"(1) and that they have backed up their statement by announcing a reduction to their expectation of where rates should go this year.  

Others are blaming a sharp drop in earnings; the problem is that earnings have not yet dropped, and are not forecast to drop.  Thomson Reuters produces an earnings tracker for the S&P 500, and in their most recent data, earnings are expected to increase 15.9% in the fourth quarter of 2018 and another 5.6% in the first quarter of 2019.  At first glance, the 5.6% growth in Q1 2019 may seem anemic, but considering the level of earnings achieved through the tax cuts, it's actually quite impressive.  Further, growth is projected to increase to nearly 12% by the end of 2019.  This is hardly the outlook of a recession or long term bear market. 

Looking back over the last few years, this is not the first fear based reaction investors have been through.  From July, 2015 through February, 2016, the S&P 500 was in a downturn.  It corresponded with a drop in earnings that started in October, 2014.   As we followed the data then, we observed that earnings we predominantly lost in the Energy Sector as oil (brent crude) traded down from more than $110 / barrel at the end of 2013 to less than $50 / barrel in 2015.  Because a drop in oil prices is a natural stimulus to the rest of the economy (and stock market), the rest of the economy did well.  The earnings and jobs that were lost in the energy sector were more than made up for in other sectors of the market, and both the economy and the market ultimately followed earnings in an upward path.

 

image.png

 

After a disappointing 2015, the  earnings continued climbing and S&P went on to return 12% in 2016 and another 22% in 2017.  The challenges the market faces today appear less challenging than what was faced in 2015.  Despite various companies (and some sectors of the economy) facing headwinds from trade negotiations or other issues, earnings continue to climb. 

Because it's hard to see in the chart above, we'll mention that long before the markets came under extreme pressure in October 2008, earnings began to erode, and in fact, provided more than 6 months of advance notice to the dramatic market drop in October 2008.  Earnings actually peaked in June 2007 and fell steadily through the beginning of 2019. 

Today, unlike 2007, we have yet to see a drop in earnings, or any other metric that would indicate a recession lays ahead.  Rather, we are watching earnings climb while the stock market drops.  The economic data also contradicts what the stock market is doing. Employment and wages remain strong.  Consumer sentiment and consumption is strong.  Consumers debt burdens are considerably lower than they have historically been prior to a crisis, and the list goes on. 

Looking back to the first chart, and the impact earnings ultimately have on the stock market's price, investors who did not panic sell in February, March, and April were rewarded.  We believe that will happen again.  Looking to next quarter, if earnings continue their ascent, it is difficult to build an argument for why stocks would not rebound.

Please call us or email us with any questions.

The fed raises rates 0.25% and gives insight to future policy

As was widely expected, the Fed raised the Federal Funds Rate 0.25%, bringing it to 2.5%. The press release shows a balance of demonstrating a willingness to ease the previously outlined path of interest rate hikes and a desire to avoid giving the unintended impression that they view the economy as weak

Rather than stating today that there will be no rate hikes next year, their outlook changed from an expectation of 3 rate hikes to 2 potential rate hikes next year. In their statement, they said, "Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year

The Fed is clearly aware of the potential impact from a slowdown in Capital Expenditures. The drop from the market's highs today after the Fed's press release suggests many investors don't believe the Fed's position on slowing the pace of future rate hikes was a strong enough statement. We believe they are missing the Fed's message. By reducing the number of expected rate hikes next year from 3 to 2, the Fed has essentially given itself more time to observe more data before making a decision to raise rates again. With the path of 3 rate hikes next year, it was widely expected that the Fed would be raising rates in the first quarter of 2019, however with only two expected increases next year, the Fed can easily hold off on any further action until June or July. This will allow time to observe wage growth, employment growth, consumer spending, capital expenditures, etc.   

Additionally, the Fed said today "that risks to the economic outlook are roughly balanced, but they will continue to monitor global economic and financial developments and assess their implications for the economic outlook."  The Fed is laying the groundwork to delay rate hikes in 2019 if either US or Global market conditions do not continue to accelerate.

They gave further clarity to their position saying, "In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective." 

We have heard the Fed reiterate over the last year that it is surprised we have not seen higher levels of inflation.  We have also observed a lower wage growth than expected.  Essentially, based on current data and the Fed's statement, they already have the argument in place not to raise rates again, unless and until they see higher inflation and higher wage growth.

Looking back to how the Fed communicates and operates, we thought it would be helpful to review their path to raising rates back in 2015.  In Janet Yellen's press conference on March 18, 2015, she reaffirmed that the Fed had voted to maintain its target rate at 0 to 0.25%, but also said, "With continued improvements in economic conditions, however, we do not want to rule out the possibility that an increase in the target range could be warranted at subsequent meetings."  To temper her statement, she said, "Let me emphasize, however, that the timing of the initial increase in the target range will depend on the Committee's assessment of incoming information."  The Fed ultimately did raise interest rates, nine months later, at its December press conference. They allowed the idea to set in, and then over the remainder of the year, they provided the data points that would indicate to them the time had come.   

We highlight this because we see the Fed's behavior in 2015 as being very similar to the Fed's behavior under Powell. The Fed shared the data it followed and it remarked on what the data meant in terms of the Fed's future actions.  After reporting that the Fed's various targets had been achieved, it finally began raising rates. 

Three weeks ago, as some global economic data started to show signs of slowing, Fed Chairman Powell commented that he though interest rates were "near neutral."  The significance of neutral rates is that once rates are neutral, the Fed no longer needs to continue raising them.  Then in today's press release, the Fed highlighted that they still continue to see a great deal of strength in the US economy, but that they did observe weakness in Capital Expenditures.  To this observation, they added the that future rate increases would be dependent on the reaching of "expected" economic targets; some of which we know have not yet been met. 

Powell is creating the path to either stop raising rates or to continue, should economic data justify the action. He is giving insight into what they are watching, and what they view positive and negative developments. At Powell's next press conference, we anticipate he will again report on the positive and negative data the Fed observes.  If the data continues to weaken , we expect Powell to further reduce or delay future rate increases. 

The way in which the Fed communicated today is healthy for the markets. Sudden and dramatic shifts in policy can undermine confidence in the markets, whereas consistent, thoughtful actions have proven to be beneficial to the market.

 


 

Brian Amidei is Coachella Valley's only Barron's Magazine Top 1,000 Advisor in 2013 and 2014!

Brian Amidei, along with Partners Joseph Romano and Brett D'Orlando have also been named *2014, 2015, 2016, 2017 Five Star Wealth Managers!

Disclosures:

Awards and recognitions by unaffiliated rating services, companies, and/or publications should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if Fortem is engaged, or continues to be engaged, to provide investment advisory services; nor should they be construed as a current or past endorsement of Fortem or its representatives by any of its clients. Rankings published by magazines and others are generally based on information prepared and/or submitted by the recognized advisor. Awards may not be indicative of one client?s experience or of the Firm?s future performance.  Neither Fortem nor the recognized advisor has paid a fee for inclusion on a list, nor purchased any additional material from the award provider. The criteria for each award is listed below:

Barron's Disclosure:

The Barron's award is is based on the recognized adviser's assets under management, contribution to the firm's revenues and profits, and quality of practice.  Investment performance is not an explicit criteria.  Additional information about this award is available at http://online.barrons.com/report/top-financial-advisors. 

Five Star Professional Disclosure:

The Five Star Wealth Manager award is based on 10 eligibility and evaluation criteria: 1) Credentialed as an investment advisory representative (IAR) or a registered investment advisor; 2) Actively employed as a credentialed professional in the financial services industry for a minimum of five years; 3) Favorable regulatory and complaint history review; 4) Fulfilled their firm review based on internal firm standards; 5) Accepting new clients; 6) One-year client retention rate; 7) Five-year client retention rate; 8) Non-institutionalized discretionary and/or non-discretionary client assets administered; 9) Number of client households served; and 10) Educational and professional designations. The inclusion of a wealth manager on the Five Star Wealth Manager list should not be construed as an endorsement of the wealth manager by Five Star Professional or the magazine. The award methodology does not evaluate the quality of services provided.  Additional information about this award is available at: fivestarprofessional.com/2016FiveStarWealthManagerMethodology.pdf

Fortem Financial 2016. All rights reserved. 

Data Sources:  News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations.  Market Data: Based on reported data in WSJ Market Data Center (indexes); U.S. Treasury (Treasury Yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates).  All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. 

Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice.  The opinions expressed are solely those of the author, and do not represent those of Fortem Financial, LLC or any of its affiliates.  Past performance is no guarantee of future results.  All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.  Forward looking statements are based on current expectations and assumptions, the economy, and future conditions.  As such, forward-looking statements are subject to inherent uncertainty, risks, and changes in circumstance that are difficult to predict.  Actual results may differ materially from the anticipated outcomes.  Carefully consider investment objectives, risk factors and charges and expenses before investing.  Fortem Financial is a registered investment adviser with the SEC.  Advisory services are offered through Fortem Financial.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks.  The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.  The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.  The Russell 2000 is a market-cap weighed index composed of 2,000 U.S. small-cap common stocks.  The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide.  Market indices listed are unmanaged and are not available for direct investment. 

Nowhere to hide

There were very few places to hide by the end of last week, as even the “safe” stocks and groups got hit on Friday with Consumer Staples down nearly -2%, Utilities weaker on the day, Software under pressure, and even the Healthcare sector clipped -3.3% by day’s end.  Flows into Healthcare have turned particularly frothy over the last several months. Former leaders like Equipment and Managed Care are unlikely to be spared.  That’s the thing about corrective phases – ultimately, even the best companies are sold.  

With 10 trading days left in the year, the S&P again finds itself back below the 2,600 level.  More than 50% of constituents are down -20% from their respective 52-week high, but we’re reluctant to call price deeply oversold, at least compared to the 2011 and 2015/16 drawdowns.  The Value Line Index has continued to underperform as well, a decent barometer for the “average stock” and uncharacteristic of any big change to the market’s tone.  Absent any meaningful changes in leadership / momentum, we’d look for near-term rallies to be met with S&P resistance near the 2,730 level. 

It’s a big week for the FOMC (FED).  With solid retail sales (ex gasoline) and U.S. industrial production data last week, the Atlanta Fed GDPNow tracker is at 3.0% q/q A.R. for 4Q.  The U.S. economy can likely take another Dec rate hike.  But this could put interest rates above the level financial markets (U.S. & global) are comfortable with.  

The FOMC should be commended for bringing real fed funds out of negative territory. Negative rates are an emergency setting, and no longer necessary.  At the same time, the Fed should be well aware of the signal the markets are currently sending about the pace at which it is tightening. The interest rate the economy can take & the interest rate that makes financial markets consistent need to converge slowly, in our opinion.  As the Fed discovered in early 2016, it must tread carefully in a world of low interest rates. We believe the FED will slow on its interest rates next year as they have indicated. 

The equity markets have fallen in four out of the last five weeks as investors have paused, at least temporarily, in climbing the wall of worry.  The “risk off” sentiment continued with the Russell 2000® down 2.57%, S&P 500® Index lost 1.26%, Dow Jones Industrial Average lost 1.18%, and Nasdaq fell -0.84%.  All of the major indices closed the week in correction territory with losses of 10% or more from recent highs.  Weaker-than-expected economic data in China and Europe prompted Friday’s selloff as fears of slowing global growth dominated sentiment.  In China, industrial production fell to 5.4%, the slowest pace in three years; retail sales slowed to a 15-year low.  In the Eurozone, economic data also disappointed, and business optimism deteriorated; several issues, including demonstrations in France, Italy’s latest budget revision to avoid EU sanction, and the latest uncertainties over the Brexit, were no doubt contributing factors

More positive developments, though, include China’s announcement that it is reducing higher tariffs on auto imports, renewing purchases of oil and soybean products, and discussing other measures to open up their economy.   Also, Canada’s release of the CFO of Huawei on bail does not seem to be a factor in trade discussions.  U.S. retail sales rose in November; holiday sales should surpass last year’s level.  Unemployment claims this week fell to 206,000, the largest weekly drop since April, 2015.  Inflation remains in check with lower fuel prices increasing spending power.  This week’s meeting of the Federal Reserve will likely include a 25 basis point increase in interest rates; investors will parse the Fed’s commentary for insight into planned rate increases in 2019. 

Throughout 2018, some analysts have predicted the end of the bull market and a looming recession.  Through September, positive economic data, including corporate revenue and earnings growth, propelled the markets.  More recently, though, investors could not ignore the crescendo of concerns related to trade negotiations, the pace of Fed rate increases, Brexit votes, and excessive oil inventories that pushed oil prices down over 30%.  Certainly, the on-going headlines about trade disruptions have fueled anxieties about a global slowdown.  When sentiment turns negative, it typically endures until a change catalyst emerges.  Oftentimes, the catalyst may have been known, but ignored by investors, until an event occurs to ignite a rally.  Most recently changes in Fed commentary; the resumption of trade negotiations with China; and the OPEC agreement to cut production to rebalance supply and demand, have been significant positive developments.  At current levels, many small and midcap stocks are significantly oversold; many now trade at discounts of more than forty percent despite favorable business conditions.

Source: Pacific Global Investment Management Company

Chart reflects price changes, not total return.  Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

 


 

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Brian Amidei is Coachella Valley's only Barron's Magazine Top 1,000 Advisor in 2013 and 2014!

Brian Amidei, along with Partners Joseph Romano and Brett D'Orlando have also been named *2014, 2015, 2016, 2017 Five Star Wealth Managers!

Disclosures:

Awards and recognitions by unaffiliated rating services, companies, and/or publications should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if Fortem is engaged, or continues to be engaged, to provide investment advisory services; nor should they be construed as a current or past endorsement of Fortem or its representatives by any of its clients. Rankings published by magazines and others are generally based on information prepared and/or submitted by the recognized advisor. Awards may not be indicative of one client?s experience or of the Firm?s future performance.  Neither Fortem nor the recognized advisor has paid a fee for inclusion on a list, nor purchased any additional material from the award provider. The criteria for each award is listed below:

Barron's Disclosure:

The Barron's award is is based on the recognized adviser's assets under management, contribution to the firm's revenues and profits, and quality of practice.  Investment performance is not an explicit criteria.  Additional information about this award is available at http://online.barrons.com/report/top-financial-advisors. 

Five Star Professional Disclosure:

The Five Star Wealth Manager award is based on 10 eligibility and evaluation criteria: 1) Credentialed as an investment advisory representative (IAR) or a registered investment advisor; 2) Actively employed as a credentialed professional in the financial services industry for a minimum of five years; 3) Favorable regulatory and complaint history review; 4) Fulfilled their firm review based on internal firm standards; 5) Accepting new clients; 6) One-year client retention rate; 7) Five-year client retention rate; 8) Non-institutionalized discretionary and/or non-discretionary client assets administered; 9) Number of client households served; and 10) Educational and professional designations. The inclusion of a wealth manager on the Five Star Wealth Manager list should not be construed as an endorsement of the wealth manager by Five Star Professional or the magazine. The award methodology does not evaluate the quality of services provided.  Additional information about this award is available at: fivestarprofessional.com/2016FiveStarWealthManagerMethodology.pdf

Fortem Financial 2016. All rights reserved. 

Data Sources:  News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations.  Market Data: Based on reported data in WSJ Market Data Center (indexes); U.S. Treasury (Treasury Yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates).  All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. 

Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice.  The opinions expressed are solely those of the author, and do not represent those of Fortem Financial, LLC or any of its affiliates.  Past performance is no guarantee of future results.  All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.  Forward looking statements are based on current expectations and assumptions, the economy, and future conditions.  As such, forward-looking statements are subject to inherent uncertainty, risks, and changes in circumstance that are difficult to predict.  Actual results may differ materially from the anticipated outcomes.  Carefully consider investment objectives, risk factors and charges and expenses before investing.  Fortem Financial is a registered investment adviser with the SEC.  Advisory services are offered through Fortem Financial.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks.  The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.  The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange.  The Russell 2000 is a market-cap weighed index composed of 2,000 U.S. small-cap common stocks.  The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide.  Market indices listed are unmanaged and are not available for direct investment. 

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