Author: CIG Capital Advisors

Summary:

* U.S. equities before and after the March FOMC meeting

* A differentiated view and alternative assets can add value in difficult markets

Summary:

* Threat of a growing war, inflation and interest rate hike fears led equities lower

* Risks may be buried in your portfolio

* Will the “January Barometer” portend a bad year ahead?

Summary:

* US and developed international equities rallied

* The importance of remaining rational in an increasingly emotional environment

Commentary:

A Blended Growth Benchmark returned approximately 2.80% while a Blended Balanced Benchmark gained about 1.96% in December.[i] These benchmarks represent the theoretical performance of diversified passive portfolios blending indices related to geography and asset classes. During December, international stocks in developed markets were higher with the MSCI EAFE net index up +5.05%[ii], slightly besting the S&P 500 index (up +4.48%[iii]), while the MSCI Emerging Markets equities lagged, only gaining +1.62%.[iv] From an asset class perspective, Fixed Income was down slightly as with the Bloomberg US Agg Bond Index falling -0.26%.[v] Crude Oil recovered a little more than half of November’s losses, gaining +13.6% to close at 75.21 a barrel.[vi]

A recent Wall Street Journal article cited an American Psychological Association survey conducted last year that found that after two years of pandemic, nearly one-third of adults are struggling with basic decisions, including small choices like what to eat or wear.[vii] One of the experts interviewed suggested that one way to make decisions was to replace individual choices with all-encompassing principles that do the work for you. If you create and honor rules, for example, you can better assess risks, mitigate biases and act. The year ahead, as with any new year, will bring both challenges and opportunities. How we meet these challenges will impact, in our opinion, our ability to capitalize on the opportunities and manage the challenges we are presented in the market. Here is what we suggest.

Avoid looking in the rear-view mirror. While the newspaper may state that the S&P 500 has returned 8.4% each year since its inception in 1957 to December 31, 2020[viii], no one should put 100% of their retirement savings into the S&P 500. If one did, those savings could be exposed to potentially swift, unexpected losses. We explored this exposure in Risk Happens Fast. So, why would we consider the S&P 500 a benchmark for what your real-world, diversified portfolios have done? We should not.

Search for the best potential investments going forward, not what worked in the past. CNBC’s twice yearly “Millionaire Survey” discussed the inherent risk of buying and holding onto large technology stocks (FANGMAN) – “They [investors] haven’t got the guts to pull out.”[ix] For example, investors continue to ignore Apple’s missing earnings guidance in its recent quarter given the prospect of reaching a $3 trillion market capitalization. And the Apple car? Bulls have been trotting that one out since 2014. We’ve seen how a drawdown in technology stocks played out in 2000, and shared our thinking in What If the Bubble Bursts?

Pay more attention to what is going on beneath the surface. In December, Bloomberg ran a story when the S&P 500 closed at a 52-week high. It highlighted that 334 companies trading on the New York Stock Exchange hit a 52-week low, more than double the amount of those hitting 52-week highs on that same day[x]. The last time that the market experienced this Market Internal[xi] was just prior to the tech bubble collapse more than twenty years ago. We discussed other internals, as well – poor liquidity and retail trader’s share of stock market volume in Inflation and Fragility.

Consider that we are likely in uncharted territory. Over the last decade, the Federal Reserve has tried multiple times to end its various “money printing” programs, but it didn’t take long before a market downdraft caused a “U-turn.” This time, the difference is that the Fed is perceived to have lost control of inflation. On January 5, Federal Reserve meeting minutes[xii] indicated officials are considering an earlier timetable for shrinking their $9 trillion balance sheet – that’s not just raising rates or tapering buying (“printing”), that’s completely taking away the liquidity punchbowl. In our opinion, the most prudent prescription is The Return of Active Portfolio Management.

The Wall Street Journal article mentioned above concludes with advice from Annie Duke, a former professional poker player and author of How to Decide. She reminds us that many decisions can be tweaked later but we must ask, “What might be the early warning signs of an unpleasant outcome?” Active risk balanced investing can help identify potential problems, guide us through a volatile market landscape and help us in managing the outcomes.

In December, we presented our unique perspective on the current investment and economic environment via a small group gathering of select clients and prospects. To listen to the recording of our presentation, please reach out to your Wealth Manager or Brian Lasher <blasher@cigcapitaladvisors.com>.

You can find more information on this and related topics at https://cigcapitaladvisors.com/category/asset-management/.

As we enter 2022, we remain focused as always on ensuring that client portfolios are aligned with their planning objectives and long-term goals.

Summary:

   * US Equities surge while international equities lag

   * Tesla and the growing stock market bubble

   * What happens when a bubble eventually bursts?

Commentary:

The S&P 500 index gained +7.01% in October, bouncing back from its September decline and closing at an all-time high.[i] Overseas markets were up, but much less so versus the U.S., with the MSCI EAFE net index up +2.38% and the MSCI Emerging markets up +0.93%.[ii] Fixed income did not offer much in the way of returns for the month with the Bloomberg US Agg Bond Index falling -0.03%.[iii] Crude oil added to September’s gains, increasing +11.38% and closing at $83.57/barrel, a 7-year high[iv], despite global growth forecasts being revised lower.[v]

We continue to be concerned that U.S. equity markets may be in a bubble. Tesla, for example, gained +44% in October.[vi] In just 2 weeks, the company gained $310 billion in market capitalization. That gain is more than the market cap of 482 companies in the S&P 500 Index.[vii] Tesla’s current market cap is over $1.2 trillion, greater than the market capitalization of Toyota, VW, Daimler, GM, Ford, BMW, Honda and Hyundai combined![viii] Tesla isn’t the only stock that may currently be overvalued.

When we look at the market using several different measuring sticks, we find more extreme valuations. The Buffet Ratio, which we have talked about before and measures total market capitalization to U.S. GDP, is at 215.5%, double the 107.5% seen in May 2007, right before the Great Financial Crisis and 50% higher than the March 2000 dot com boom high of 142.9%.[ix] The current Shiller PE ratio for the S&P 500 is 40.09. The only other time that we saw the market trade at such a high price to earnings ratio was during the dot com bubble, when the S&P 500 traded above 40x from January 1999 through September 2000.[x] No one can predict with any degree of certainty just how much larger the current bubble can get or how long it may last, but we must take note of what has happened when previous bubbles finally burst.

How bad can things get when a stock market bubble bursts? During what was, prior to now, the largest stock market bubble, the dot com boom, the NASDAQ 100 hit its then all-time closing high on March 27, 2000. The broader market, as measured by the S&P 500, did not reach the bottom until October 9, 2002 with a peak to trough loss of -49%.[xi] As illustrated in the chart below, a lot of money was lost in different sectors and factors during this period while gold and consumer staples, which clients currently have exposure to, gained.

An investor would have to be extremely unlucky to buy at the top and sell at the bottom. What do returns look like if you bought one year before the top, on March 27, 1999 and held on for three years after the bottom, October 9, 2005? The S&P 500 was down -6.8%, and the NASDAQ 100 lost -24.7%. Notably, gold, energy, financials, industrials, utilities, materials, and value stocks were up.

As seen in the chart below, it took just over 7 years for the S&P 500 to get back to its March 27, 2000 high (from point (1) to point (2)). Just months after the market had recovered, the Great Financial Crisis began, and the market did not bottom out again until March of 2009. The S&P 500 did not fully recover until March 4, 2013 (point (3)). If you bought the S&P 500 on March 27, 2000, you had a very brief amount of time in 2007 to get out even, or you had to wait until March 2013 to recoup your losses, just under 13 years after the dot com peak![xii] “Do you have enough time?” was the title of a recent Asset Management Insight.

Source: barchart.com

During the dot com bubble in 1999 to 2000, many investors believed that traditional valuation metrics such as price to earnings and price to sales no longer mattered. “This time is different” was a phrase often used. During the pre-Great Financial Crisis housing bubble many believed again, “this time is different”, no money down mortgages and other financial innovations would forever change the way assets were valued, and residential real estate has never gone down on a country-wide basis. Ultimately, traditional valuation methods won out and both bubbles burst.

History has taught us to be very careful. We continue to stay the course of risk balanced investing – take enough risk to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets and the economy.

Summary:

   * S&P 500 declined for the first month since January 2021

   * Increasing economic and geopolitical uncertainty

   * Market volatility rising

   * Do we know?

Commentary:

The S&P 500 index fell -4.65% in September, its first monthly decline since January 2021 and the worst monthly decline since March 2020.[i] In overseas markets, the MSCI EAFE net index declined -3.19% and the MSCI Emerging markets fell -4.25%.[ii] Chinese stocks, represented by the SSE Composite Index, gained +0.68%[iii] and was one of the very few equity markets with positive performance for the month. Fixed income did not offer much protection against the decline in stocks as the Bloomberg US Agg Bond Index fell -0.87%.[iv]

What changed in the month of September? Economic and geopolitical uncertainty appears to have increased.

On September 3rd, the Federal Reserve Bank of New York issued a suspension notification for Nowcast, its official forecast for growth in the U.S. Gross Domestic Product (the total value of goods produced and services provided during one year) stating the following, “The uncertainty around the pandemic and the consequent volatility in the data have posed a number of challenges to the Nowcast model. Therefore, we have decided to suspend the publication of the Nowcast while we continue to work on methodological improvements to better address these challenges.”[v] Upon hearing this announcement, we were reminded of Yogi Berra, the great baseball player and sometimes philosopher who once said “It’s tough to make predictions, especially about the future.”[vi]

Later in the month, Federal Reserve Chairman Powell held a very unconvincing press conference after the FOMC meeting on September 22. Regarding inflation, Powell said the current inflation is “a very modest overshoot. You’re looking at 2.2[%] and 2.1[%], you know, two years and three years out. These are very, very – I don’t think that households are going to, you know, notice a couple of tenths of an overshoot.”[vii] Did investors notice on September 23 that the National Association of Realtors’ August existing homes sales report showed that the median sales price of existing single-family homes in the U.S. rose +14.9% year over year to $356,700?[viii] Did investors notice that the price of U.S. natural gas hit a 12-year high of 6.325 as of October 5, 2021?[ix]

Chairman Powell also said the current inflation is a “reflection of bottlenecks and shortages that…seem to be going to be with us at least for a few more months and perhaps into next year.” As of September 24, there were 600 large container ships waiting to dock at ports in Asia, Europe, and North America. In June there was an average 14-hour delay of ships arriving to Canadian and U.S. ports. Now the delay is almost 10 days![x] There is not much in the way of historical data regarding the current world-wide supply chain issues. But, as the Drewry World Container Index chart below shows, shipping prices have more than doubled year to date.

Source: Drewry.co.uk

Actionable idea: buy your year-end holiday gifts early and locally.

To make things worse, tensions with China are growing and Taiwan is extremely important to the world economy. Semiconductor companies in Taiwan generated almost 65% of global revenues from outsourced chip manufacturing in the first quarter of 2021. Taiwan Semiconductor (TSMC) alone accounted for 56% of global revenues. Most of the 1.4 billion smartphone processors are made by TSMC.[xi] On Friday, October 1, as China celebrated the National Day of the People’s Republic of China, the People’s Liberation Army (PLA) flew 38 warplanes into Taiwan’s air defense identification zone (ADIZ). October 2 saw 39 planes and on October 3, 16 more planes entered the ADIZ. On October 3 the United States State Department issued a statement urging Beijing to “cease its military, diplomatic, and economic pressure and coercion against Taiwan.” China responded on Monday, October 4, by sending a record 56 Chinese warplanes into the ADIZ. 

We do not know i) how much GDP will grow next year, ii) whether supply chain issues will abate soon, or iii) if China and the U.S. will lower tensions. This economic and geopolitical uncertainty appears to be contributing to stock market volatility. Historically we have observed that usually when volatility increases by a large margin, stock markets head lower. In market terms, it has been a long while since we had such volatility.

Meanwhile equity markets are near record highs and record valuations. So, we continue to stay the course of risk balanced investing – take enough risk to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets and the economy.