By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave. Benjamin Graham
Labor day weekend is traditionally thought of as the end of summer. The onset of football season, both college and professional, stirs excitement all across the country, especially in those states which have approved sports betting. In the south, there is some trepidation because this time usually brings difficult weather, which is the case again this year with Hurricane Dorian. Back to school shopping takes place for many households as new clothes, books, computers, cell phones, and of course accessories, are mandatory for families across the land. It has been a long, hot summer, especially during the last month. In heat waves, people have a tendency to become irritable as the environment is uncomfortable. When individuals are irritated, sometimes they don’t think clearly, or behave with consistency. With this thought in mind, let us turn to global capital markets and what is transpiring across the globe.
Europe continues to be a decade long economic morass of little or no growth, excessive regulation, and an important region where trouble is the natural state, not a one off problem. Today it is Italy, tomorrow it is Spain or France. Brexit remains a big concern, and it should be, but I suspect more for Europe than the UK. Europe is no picnic, and Asia revolves around China. As we all know, China’s ongoing trade discussions with the United States have the world’s attention. The United States has legitimate arguments regarding several economic issues in these discussions, much of it related to trade and investment restrictions, along with intellectual property theft. These are not problems which are easily solved, especially with China’s leadership focused on their own economic fate, which can be seen through their Belt and Road initiative. If one considers the financing China uses to help ‘persuade’ other countries to see their point of view, the United States and it’s allies should be very careful with an authoritarian regime quite interested in it’s own ongoing strength. One only needs to look at their approach to Hong Kong as further evidence. Given these important geographic areas for global business, the investment community sees a difficult future on the horizon, so it reverts to the fallback position, which is safety, meaning bonds.
Last week, I mentioned the end of the world crowd and their favorite thesis, that bond yields would continue lower, so abnormally excessive bond prices will continue higher. Having lived through the internet bubble, and then the housing boom and bust, many investors rationalize these unusual fixed income prices as fitting with a new economic environment. Deflation continues to be the dominant theme, not inflation, so why not just accept negative bond yields and ultra high prices as our reality for the foreseeable future? For those of us interested in finding opportunity, the answer is simple. Mathematically, buying bonds at close to an all time high with all time low bond yields strikes me as an approach which makes little sense. There is very little value in paying a high price for something with the thesis it has to go higher for you to succeed, even though the price is already through the roof. So what is the alternative?
The strategy is finding areas of the market where you believe there is growth in the future, and are able to accept the mood swings related to global politics and trade discussions. Like what areas, you say? Well, two places to think about are energy and banks. Energy was the worst performing sector in the S&P 500 over the last decade. Energy is currently at it’s lowest weighting in the S&P 500 in many years, maybe ever. Why? Investors believe electric cars will be adopted in massive numbers across the globe. Many large institutional investors, including domestic and international pension funds, increasingly are putting pressure on the largest oil companies regarding climate change. In many cases, they are selling their large holdings of energy because of this difference in environmental philosophy. Banks may not have been the worst sector over the last decade, but they were not very good either. With bond yields negative across the globe, and historically low in the United States, interest margins are quite compressed. Historically, financial s and energy are two areas which lead stock markets. When they lag, equities struggle. Many of these stocks pay rich dividends and as many analysts rightly note, the dividend yield on the S&P 500 is greater than the yield on the 10 year treasury note. So, in an environment where income is hard to find, energy and banks offer much value, in complete contrast to those precious bonds many investors so desperately crave. Something to consider and certainly you should think about the context of your entire portfolio when looking at specific areas or stocks.
Over the last week, equities rose because of optimism over China’s remarks on trade discussions with the United States. Ulta Salon, a huge winner over the last decade, hurt consumer discretionary stocks when it reported earnings on Friday. It was drubbed by nearly 30%. Monday, a ruling for the plaintiffs in Oklahoma against Johnson and Johnson’s argument about opiod marketing was viewed favorably even though the judgment was for nearly $600 million. JNJ will appeal, and the government asked for $17 billion, so in that context, many saw it as a mere slap on the wrist, especially considering the severity of the opiod problem. Looking ahead, September and October historically have been problematic months for markets, but often times they wind up being much better, or less worse, than most expect. In the meantime, Mr. Graham (Buffett’s teacher at Columbia) offers sage counsel and are words to take to heart.
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Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation. The fact that Yale Bock has earned the right to use the Chartered Financial Analyst in no way means or guarantee performance better than market indexes.