Multiple Job Holders Increasing

Labor Market Dynamics

The lack of an increase in average hourly wages has led many to work additional hours, if not multiple jobs. Workers’ demand for higher wages has also translated into higher hours worked. More income is also needed for some to make ends meet, an indicator of tight circumstances for a portion of the working population.

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Data released by the U.S. Labor Department reveals that 20-24 year olds were the age group holding the most amount of multiple jobs, while 65 + year olds saw an increase in multiple jobs as well.

Economists believe that as younger workers expand their families, a lack of rising wages leads to both partners working with one partner having to work a second job in order meet rising expenses at home.

U.S. workers haven't experienced a wage hike in years, as the average household wage has essentially gone nowhere, from $57,423 in 2007 to $56,516 in 2015, the most recent data release.


Source: U.S. Department of Labor

Lower Dollar Helps Earnings Increase

Domestic Equity Overview

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A weakening dollar is expected to boost corporate earnings for U.S. multi-national companies as products sold overseas become less expensive and more competitive due to a cheaper dollar.

Earnings for the banking sector reported in July came in better than expected as banks benefited from a rising rate environment. Profitability for banks tend to increase as rising rates allow them to charge higher interest rates on loans.

It is expected that large technology companies may face regulatory scrutiny involving taxes, data privacy, and competition following a multi-billion dollar fine imposed by European regulators on Alphabet (Google).

Industrial sector stocks saw stronger earnings in their most recent release, leading analysts to conclude that economic growth is expanding slowly throughout the U.S. Industrial companies provide the infrastructure and materials essential for physical expansion.

Data from the NYSE shows that current margin debt levels, $540 billion at May end, are nearly double of what they were at the market peak in 2000.


 Sources: Bloomberg, Reuters, S&P, NYSE

College Is Not Just An Experience

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Not so long ago college was not only a place to continue a youth’s education, it was a time for growth, maturity and to simply experience and enjoy life with a little more freedom. The rising costs of college coupled with the challenging economic times has, for most, completely changed the emphasis on what is most important about sending a child to college.

Job security and economic independence are what families are now looking for from their tuition dollars. Mom and Dad are simply hoping that their kids can obtain education and/or training that will allow them to obtain a job that will provide them an income and standard of living that justifies the expense of college.

Because of these changes the college selection process needs to change also, and so does the approach that Mom and Dad take to pay for college.  It boils down to an investment decision. In other words, the school and major selection are components of the “return” that one will receive on their tuition dollars.

School selection should take into account the percentage of students that graduate, the percentage of students that graduate within 4 years, the placement ratio of graduates into jobs of their field, and the net cost of college after factoring in financial aid and scholarships. Certainly, a proper fit for the student based on size, distance from home and geographical location are all also very important non-financial components that should be included.

Career or major selection shouldbe a good fit for the student’s “hard wiring” or said another way, what suits his/her personality. Future job outlook and earning potential for a prospective career should also be taken into account.  Considering these factors will increase the likelihood of providing the student a future that they are looking for.

School costs should be weighed against income potential from the desired education from that institution. Furthermore, consideration should be given as to whether or not the prestige of the school that one may be paying a premium for is justified based on the income potential. For example, a private school that has an annual cost of $50,000 per year that will likely provide a student a similar job opportunity from a public school that costs $25,000 might not be a wise financial decision.

Mom and Dad need to also determine how much of their income and how many of their assets they can pledge toward college before it impacts their own financial future. Once that determination has been made the residual costs of college will likely be financed by the student through loans.   Parents should make sure that their student completely understands the financial impact of taking on student loans. Based on the horrendous state of the student loan industry it is quite clear that individuals are obligating themselves to debts that they will have no ability to pay back without serious impact on their future.

College is big business and should be approached that way. All parents want their students to enjoy their college years however the emphasis needs to be on preparing for economic success after college.


EWS is in the business of helping families through the major life transition of sending their children to college. For many, it will be the most expensive time of their lives and, if not handled properly, could cost them their retirement. If you or someone you know needs the help and guidance of a trained financial professional, don’t hesitate to contact us at 708-771-777. Remember, you shouldn’t have to choose between your child’s college and your retirement.

Macro Economic Overview

August 2017
Macro Overview

Markets seemed undeterred by political indecisiveness in Washington surrounding healthcare reform, which could affect upcoming tax reform in the fall that is hinged on the ability of passage by Congress. Even though lawmakers are coming under escalating pressure to demonstrate legislative progress, the inability of the House to pass healthcare legislation didn’t hold equity markets back from achieving higher levels.

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A political debate has begun behind mundane media noise, the debate to raise the federal debt ceiling in order to continue funding government expenses and operations. The debt ceiling, formally known as the statutory debt limit, is the country’s credit limit, which is a legislative restriction on the amount of national debt that can be issued by the Treasury.

The Fed said that it would start paring its $4.4 trillion balance sheet “relatively soon”, language interpreted by Fed watchers to mean possibly beginning in September. This continues to be a critical focal point for government bond traders gauging how markets will absorb the vast amounts of debt efficiently and without disturbing volatility. The Fed also reiterated that future rate hikes would be gradual, thus stemming the probability of erratic rate increases.

Global central bank chiefs and various market analysts believe that current low volatility may be hiding risk in the form of asset inflation engulfed within a low inflation environment. The concern is that investors and central bankers may be viewing circumstances from different perspectives. Low interest rates and international central bank asset purchases have greatly reduced volatility in the global markets.

The synchronized global increase in interest rates is elevating from unprecedented low levels, meaning that it may take some time before rates reach so-called normalized levels.

Oil prices rose after Saudi Arabia cut oil exports and OPEC said it would enforce production cuts among OPEC members. Higher oil prices, as tracked by the West Texas Intermediate Index (WTI), enhance economic activity in various oil related regions of the United States.

The Department of Labor reported that there were 222,000 new jobs in June, but more people were actually looking for work in June, lifting the unemployment rate to 4.4%.


Sources: Federal Reserve, OPEC, DOL, house.gov

 

Inflation Not An Issue Now For Fed, But Asset Inflation Is

Monetary Policy

The low interest rate environment spanning the global markets has been fueled by the accommodative monetary policies of central banks worldwide, creating a concern among many economists. The concern is that rather than central bank policies igniting global growth, asset prices have instead been stoked by the decline in global rates.

Asset price levels including stocks, bonds, homes, art, and collector cars have all been rising steadily since broad accommodations began nearly 10 years ago. Some believe that this may have led to demographical imbalances where those having the ability to borrow at low rates have benefited as their financed asset purchases have grown more than global GDP. The question is as to whether asset prices will continue to grow even as global GDP growth languishes.

It is believed that the Fed could alter this distortion by raising rates thus limiting the cheap financing of assets across all sectors. Inflation has also been below the Fed’s 2% target for some time, with the CPI core index annualizing an increase of 1.7% as of June.

Some see risk masked by elevated asset prices that could become susceptible to an increase in rates. As the cost of financing assets rises in the form of higher rates, asset prices tend to fall.


Source: Federal Reserve, BLS

More Americans Working Past 70

Demographics

Workers who were either poor savers or who perhaps experienced a dramatic life crisis are finding themselves short on funds in their retirement years. Some workers who did plan accordingly, didn't plan to live as long and be as healthy as they are, thus creating revisions to retirement plans late in their careers. As health and medical science have advanced over the past few decades, so has the lifespan of American workers.

Many Americans that retired with the notion that Social Security would suffice in their elder years, came to the realization that Social Security benefits alone weren't enough. A part-time job and even full-time menial jobs at minimum wage levels have become supplemental income for many retired Social Security recipients.

Almost 19% of people 65 and older were working at least part-time in the second quarter of 2017, the highest in 55 years. The share of older people in the workforce is higher than any point since before the creation of Medicare.

Baby boomers are increasingly ignoring the traditional retirement age of 65, with 32% of Americans age 65 to 69 still employed.  The Bureau of Labor Statistics also found that a growing number of seniors are unable to retire even past 70 years of age.  The most recent data shows that 19% of 70 to74-year olds were still working, up from 11% in 1994.

The irony of the data released shows that seniors who find it easier to continue working are the ones that are healthy, well educated, and highly skilled, tend to be the ones that are least likely to need the money.


Sources:  Bureau of Labor Statistics, Social Security Administration

China Produces More Cars Than The US

Global Trade 

Just as the U.S. auto industry mushroomed after WW II and during the 1950s, the same is occurring in China. It’s not just Chinese branded automobiles that are being made in China, but well known foreign brands as well. As the demand for cars has skyrocketed in China over the past two decades, foreign manufacturers recognized an expanding market and started producing their own brands within the country in order to sell directly to Chinese drivers.

Foreign manufacturers have found it more profitable and feasible to manufacture cars in China in order to meet exploding demand. German, American, and Japanese automakers now populate the manufacturing lines in China.

Chinese brands such as SAIC Motor, Dongfeng, BYD, Geely, and FAW have become household names throughout China, helping to popularize them and compete against well known foreign brands. Several joint ventures forged between foreign auto-makers and Chinese manufacturers have ramped up production as demand has increased. The history of China’s auto industry began with the involvement of the former Soviet Union in the 1950’s when the two countries collaborated on manufacturing and economic ideals.

 The world’s current largest auto producers span four continents with auto exports heading to multiple countries. Following the second world war, industry in Japan and Germany grew with automobiles becoming key exports. Ironically, several foreign manufacturers have various models produced in the United States, while some U.S. auto companies produce models directly in China and Mexico.


Sources:  U.S. Department of Transportation; World Motor Vehicle Production

Cities Where Student Loan Borrowers Struggle with Debt the Most

Via Credible

If you’re struggling under a load of student loans, you already know how hard it is to make ends meet.  So it’s important for borrowers, especially recent grads, to think about the best places to live — the cities in which they’re not only likely to find a well-paying job, but also where rents and other living expenses aren’t so exorbitant so as to add to their pile of debt.

To figure out which cities student loan borrowers struggled the most in, we took a look at the top 23 most populous cities in the U.S. based on U.S. Census data. We then compared the average income of our borrowers in each of those cities with the average monthly housing payment and their average monthly student loan payment, to see how affordable student loan payments actually are for borrowers across the country.

Key Highlights

5 cities where student loans borrowers struggle the most with debt:

  1. San Jose, California
  2. Fort Worth, Texas
  3. Boston, Massachusetts
  4. Los Angeles, California
  5. Denver, Colorado

5 cities where student loans borrowers struggle the least with debt:

  1. Dallas, TX
  2. Jacksonville, FL
  3. Houston, TX
  4. Columbus, OH
  5. Austin, TX

The key indicator for affordability was how much of a borrower’s monthly income would go towards their student loan payments and monthly housing costs.

In the cities that topped our ranking for the most affordable cities for recent grads —  Dallas, Jacksonville, and Houston — borrowers have more of their income left over after paying their monthly loan and housing bills as compared to the other cities on the list.

But even in these cities, nearly 27 percent of borrowers’ average monthly income is eaten up by their monthly housing payment and their monthly loan payment alone. That doesn’t even take into account other expenses such as taxes, food, or transportation.

That’s not all that different from the cities at the very bottom of our list — San Jose, Fort Worth, and Boston — where more than 30 percent of borrowers’ average monthly income is dedicated to loan and housing payments.

The following are the average monthly loan payment, monthly housing payment, and annual income for the nearly 9,000 borrowers in the cities we analyzed:

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Where borrowers struggle the most – compare all cities

The charts below visualize the differences among all 23 cities we analyzed. Browse through the metrics to see each city's average borrower monthly payment, average monthly housing payment, average annual income, and average student loan and housing costs as a percentage of income.

 
 
 
 

The average student loan debt load among those who borrow is $37,173.

Among the cities that are the least affordable, monthly housing costs do tend to be slightly higher as compared to the other cities, but not by much. This makes sense — while affordability might be one factor that grads take into account when choosing where to live, a lack of affordability doesn’t necessarily prevent people from flocking to cities like San Jose, Fort Worth and Boston, where jobs are plentiful.

Additionally, recent grads are likely to take into account a variety of other factors when moving to a new city. Smaller cities like Columbus or Jacksonville are less likely to be (or be near) hotbeds of industry or cultural attractions.

Seventy percent of college grads borrow to obtain their degree, and the average debt load among those who borrow is $37,173, according to Cappex.com publisher Mark Kantrowitz.

Cities with highest student loan debt burden

 
 

Methodology

To conduct the analysis above, we used actual (but anonymized) data submitted by 8,981 applicants living in the 25 largest U.S. cities seeking to refinance student loan debt through the Credible platform.

This study only considered borrowers with a monthly student loan payment of between $50 and $10,000, a monthly housing payment of less than $10,000, and those with an annual income between $1,000 and $300,000.

The study limited the analysis to the 25 largest cities in the U.S. El Paso, Texas and Detroit, Michigan were omitted from our analysis due to insufficient student loan borrower data.


The Ticker Tape Time Machine

Historical Note

Known as the primary source of stock information for nearly 100 years, the ticker tape was the earliest electronic device to transmit stock price information over telegraph lines.  In use from around 1870 through 1970, the ticker printed abbreviated company names as alphabetic symbols followed by numeric stock transaction price and volume information. The term “ticker” came from the sound made by the machine as it printed. Ticker tape machines started to become obsolete in the 1960s, as television and computers were increasingly used to transmit financial information.

The ticker tape was invented in 1867 by Edward A. Calahan, an employee of the American Telegraph Company, which was followed by numerous machines all performing the same basic function. Thomas Edison himself invented and patented a ticker tape machine, which he initially sold for $40,000 when he was 22 years old. He used the money, which would be closer to $1,000,000 in today’s dollars, to start a research facility at Menlo Park, and his career as a professional inventor was launched.


Sources: Library of Congress. NYSE, U.S. Patent Office

Rather Flat Yield Curve

Fixed Income Overview
July 2017

The slope of the yield curve has been flattening in recent weeks, with short-term rates rising faster than longer bond yields.  This typically occurs when monetary policy is tightening.  The difference between five-year Treasury notes and 30-year Treasury bonds flattened to 96 basis points in June, the narrowest since December 2007. Five-year note yields, which are highly sensitive to rate policy, rose to a four-week high of 1.80%.

Thirty-year bond yields, which are largely driven by future expectations of growth and inflation, meanwhile dropped to 2.72% in mid-June, the lowest since Nov. 9.  A key market dynamic are long-term bond prices that are set by the markets, while short-term rates are dictated by the Fed in the form of the Federal Funds rate.

Global government bonds sold off in late June as language from various central banks alluded to the end of monetary stimulus and a start to rate increases.  In reaction, government bonds in Europe, the U.S., and Asia fell in price in anticipation of rising yields.


Source: U.S. Treasury, Fed, Bloomberg      

 

Will Rising Rates Cause Stocks to Crash?

SYNOPSIS

  • Several investors have voiced the concern that higher rates are the beginning of the end for this bull market.

  • A rising interest rate, on its own, is not enough to estimate the future direction of stock prices.

  • The decision to sell stocks simply because rates are rising could risk leaving an investor out of attractive returns for quite some time.

THE IMPACT OF RISING RATES

The U.S. has not experienced a rising interest rate regime for over a decade, and several investors have voiced the concern that higher rates signify the beginning of the end for this equity bull market.

Consumer and business spending fuel the majority of economic growth, and since most major purchases are done on credit, interest rates are vital to the health of the economy. For example, if the interest rate on a car loan doubled from 4% to 8%, then fewer consumers will buy cars because the interest payment would eat up more of their monthly income.

High interest rates have historically led to recessions for this very reason, and we all know what recessions do to the stock market, so let’s see if history can offer any insight into the impact of rising rates on the stock market. The chart below is a good starting point.

The horizontal axis is the 10-year Treasury yield, which represents long-term interest rates, and the vertical axis measures the relationship between the S&P 500 and interest rate movements.

A dot below the 0.0 level indicates a negative relationship between the S&P 500 and interest rate movements. Meaning, when interest rates have been at 10% and moved higher, the S&P 500 has gone down. This behavior confirms the notion that rising interest rates can hurt stocks.

At 10%, consumers are mostly likely not spending much already, and to move them even higher is going to choke off the economy that much more. Less spending equates to lower profits for companies and ultimately sends stock prices down.

A dot above the 0.0 level indicates a positive relationship between the S&P 500 and interest rate movements. Meaning, when interest rates are at 2% and move higher, the S&P 500 goes up. This behavior contradicts the notion that rising rates hurts stocks.

At 2%, consumers are still spending because rates this low tend to equate to early stages in an economic recovery. This point in the cycle is very good for stocks because the economy is growing faster but not overheating to where the Fed feels they need to intervene.

“...a rising interest rate, on its own, is not enough to estimate the future direction of stock prices.”

Therefore, the only conclusion that can be derived from historical data is that a rising interest rate, on its own, is not enough to estimate the future direction of stock prices. We must also consider the current interest rate level because this is a critical factor in determining the health of the economy.

WHEN TO WORRY

The orange-dotted line at 5% indicates the threshold where an interest rate hike has gone from helping stocks to hurting them. Currently, the 10-year Treasury yield is around 2.2%, so we are far away from this line in the sand.

Unfortunately, it’s not as easy as owning stocks until the 10-year Treasury yield hits 5% and then selling. This threshold is based on historical averages, and there was nothing average about the aftermath of the financial crisis.

The last time the Fed moved short-term interest rates this low was during the Great Depression, and repeating these extreme measures most likely shifted the goalpost to where a 5% threshold may no longer apply.

This uncharted territory forces investors to consider other factors before estimating when stocks may start to feel the pressure from rising interest rates. The most important of all is inflation because this has become the Fed’s main focal point now that unemployment has reached all-time lows.

Currently, the Fed’s favored measure of inflation is below their target, and this has historically been a very good time to own stocks. Until inflation creeps higher and stays there for more than a few months, the Fed has little incentive to push our economy to the point where future rate hikes become a headwind for stocks.

IMPLICATIONS FOR INVESTORS

I enjoy traveling to meet with investors, and as a result, I spend a lot of nights in hotels. One thing I have learned during my time on the road is that hot water in most hotels is very dangerous. I will never understand why property managers allow the temperature to get to the point where it can melt aluminum, but it’s nearly universal across the country.

Therefore, every time I shower in a hotel, I follow an iterative process to ensure I don’t end up in the hospital. I turn the hot water knob ever so slightly, checking the temperature along the way before I move it higher.

The Fed follows a similar process when raising interest rates. They know that if they ramp up interest rates too far too fast, the economy will get scolded. This is why they have only been raising by 0.25% each time since December 2015. They want to see how the economy reacts before continuing, but this is incredibly difficult to get right.

When I test the water temperature in my shower, I get near immediate feedback, so I know exactly when to stop. The U.S. economy is too large and has too many moving parts for anything to be immediate, so a change to interest rates, no matter how big or small, can take up to a year to feel the effects.

This lack of timely feedback is the precise reason why the Fed continually screws up and drives our economy into a recession. At some point down the road, this will happen again, and stocks will fall into a bear market. But it is highly unlikely that this will happen anytime soon.

The bottom line is that stocks have experienced tremendous gains in the early innings of rising interest rates, and the decision to sell stocks simply because rates are rising could risk leaving an investor out of attractive returns for quite some time.

 

Median Refi Loan Age Drops

Housing Market

As rates have gyrated over the past 1-3 years, mortgagees have ramped up refinancing more often.

A significant contributor to the financial crisis of 2008 was the onslaught of lower quality mortgages, or otherwise known as sub-prime loans, which were “packaged” and sold as complicated products deemed as high quality.

The dramatic drop in mortgage debt from its height in the second quarter of 2008, to its low in the 1st quarter of 2013, was a drop of over 10.5%. Data collected by the Fed since 1951 has never seen such an elimination of mortgage debt of this magnitude.

The growth of the mortgage market has been compromised ever since the financial debacle of 2008, when new lending regulations limited loans. Growth in mortgages actually didn’t start again until the second quarter of 2013.

Economists see an improving housing market as a result of an improving job environment and stronger household finances. Such dynamics lend themselves well to the overall health of the economy.


Source: Federal Reserve

 

Equity Overview

Global Equity Overview

The equity markets started to experience what stock analysts call a sector rotation, when one or several sectors fall out of favor leading to funds flowing to other sectors.  This past month technology stocks fell as markets perceived that the sector may have become overvalued.  As this occurred, banking and financial sector stocks rose, as favorable regulatory related news lifted the overall sector.

The S&P 500 index posted its strongest first half of the year since 2013.  The Dow Jones industrial average index rose 8% in the first half of 2017, its best performance since 2013, while the S&P 500 was up 8.2% the first half of 2017.  The NASDAQ’s strong performance for the first six months of 2017 was predominantly led by the technology sector, its best first half since 2009.

Global equity markets had the best first annual half since 2009.  Overall improving sentiment in the euro zone as well as increasing international growth prospects helped propel global markets the first half of 2017.


Sources: S&P, Reuters, Bloomberg, Dow Jones, Nasdaq

 

How's The Market Doing?

Global Financial Private Capital
Thought for the Week

SYNOPSIS

  • When asked how “the market” is doing, the question invariably refers to the performance of the S&P 500 index.

  • Diversification should occasionally disappoint investors because there will almost always be a few under performers at any given time.

  • While the S&P 500’s performance may make for good banter on television, it should never be used to gauge the success of a diversified portfolio over time.

THE MARKET

When asked how “the market” is doing, the question invariably refers to the performance of the S&P 500 index. Since its inception in 1957, it has slowly become the de facto barometer for the overall health of global financial markets.

The index is also one of the most commonly used benchmarks for investors to assess their individual performance. Beat the S&P 500 and not only is one expected to build mass amounts of wealth, but any fees paid to active managers become justified.

The challenge for investors is that the S&P 500 has surged over the last eight years, and many are frustrated to see their portfolios return only a portion of “the market’s” performance since the end of the financial crisis.

While it is understandable that investors want to achieve the highest returns possible, the S&P 500 is one of the worst possible benchmarks to use for a diversified portfolio for three reasons:

  1. Concentrated: The index only comprises 500 large stocks

    based in the U.S. It is also highly concentrated since it is weighed by market cap. For scale, just four technology stocks (Apple, Amazon, Google, and Microsoft) currently make up more than 10% of the index.

  2. Aggressive: A portfolio consisting of only equities is nowhere near representative for most investors, particularly retirees because they tend to hold a wide range of investments that are more conservative in nature.

  3. Too Small: The total amount of investable assets in the world is estimated to be around $300 trillion, but the total market cap of the S&P 500 is closer to $20 trillion. Hence, the index only represents less than 10% of assets invested globally.

Consider a scenario where a conservative investor’s portfolio consisted of 30% in stocks and 70% in bonds. Comparing this portfolio to only the S&P 500 would be inappropriate.

Furthermore, any investor with a portfolio designed to generate income could never benchmark themselves against an index that is currently yielding below 2% annually and consists of a large portion of non-dividend paying stocks.

Simply put, the S&P 500 is by no means an accurate representation of global financial markets, nor is it a benchmark that should ever be used on its own.

THE GOLDEN RULE

Diversification is this “Golden Rule” of investing, and investors are to maintain broad-based diversification at all times1. There is simply no exception, and those who choose to ignore are playing with fire. The chart below demonstrates the importance of diversification by depicting the relationship between diversification and risk.

 
Source: Modern Portfolio Theory and Investment Analysis, Ninth Edition

Source: Modern Portfolio Theory and Investment Analysis, Ninth Edition

 

The vertical axis measures portfolio variance, which is a fancy word for risk, and the horizontal axis counts the total number of securities in a portfolio. The relationship clearly shows that as the number of securities increases, the risk falls exponentially.

Unfortunately, it’s not as easy as buying 20 securities and calling it a day. A basket of only healthcare stocks will not diversify an investor all that much. Instead, investors must consider other geographies and asset classes and then monitor how the relationships between these assets change over time.

Another challenge is the emotional toll it creates. A properly diversified portfolio should occasionally disappoint investors because there will almost always be a few underperformers at any given time, but this is the whole point behind diversification.

If we knew up front which investments were going to be homeruns and which would be duds, investing would be as simple as buying the winners and avoiding the losers. Crystal balls are hard to come by in this business, so the next best approach is to manage risk rather than take too much of it.

To achieve this goal of risk mitigation, diversified portfolios often hold investments that are designed to underperform the S&P 500 in a rising market so that it can provide a cushion when our economy falls into a recession.

This yin to the yang produced by the S&P 500 can deliver a smoother ride by mitigating the impact of major drawdowns, like the one in 2008 that drove the index down over 50%. The last thing an investor would want to do is to sell these invaluable tools because they are not keeping up with “the market” when it is rising.

THE RIGHT BENCHMARK

If the S&P 500 is nowhere near an appropriate benchmark for investors, then the question becomes why it is so often regarded as such. I believe the answer is the media.

One of the most fundamental economic principles is that we are all self-interested. We operate our lives and base our decisions on what will best serve us and the people we love. Recognizing this principle is critical to understanding the motivations behind most decisions by not just people but also corporations.

Within this context, the media represents a group of for-profit institutions that are in business to make money. The bulk of their revenues come from advertising, so they are highly incentivized to attract as many eyeballs and website clicks as possible.

More viewers translates to more advertising dollars, so they need to keep their audience hooked so they don’t change the channel. The S&P 500 just so happens to be ideally suited to achieve the media’s goal for two reasons:

1. Unpredictable: The inability to predict what will drive the market on a daily or even monthly basis means that a never-ending supply of storylines is readily available.  Much like watching a great mystery, viewers never know what to expect next.

2. Highly Volatile: In the short-term, emotions drive stock prices, and few subjects make investors more emotional than their money.  The sharp ups and downs cause investors to become fixated on what is moving their nest egg.

If this over-emphasized index is not a good measure of performance for a properly diversified portfolio, then investors need a more appropriate benchmark.  The problem is that no universal solution exists because each investor is different.

A benchmark is unique to an individual and should be established in a way that is designed to guide an investor to achieving their long-term return objectives.  Fortunately, constructing a proper benchmark is a relatively straightforward task for a trained professional.

IMPLICATIONS FOR INVESTORS

Imagine the opportunity to play a round of golf at Augusta National.  For those who do not golf (like me), this is the site of The Masters golf tournament, and most avid golfers would give up their first born to play 18 holes on this legendary course.

Before arriving in Augusta, a golfer would prepare by filling a golf bag with an arsenal of different clubs that all serve a unique purpose.  For example, there is a high probability that any golfer, no matter how skilled, will end up in a sand trap at some point.  Hence, a sand wedge becomes a necessity.

There will also be a need to hit the ball short distances to the hole, so a putter is another vital club that must be in the bag.  Longer shots off the tee will require a driver, and so on.

The point here is that any serious golfer will bring every possible tool to make the experience of golfing at Augusta as enjoyable as possible (no golfer wants to end up in a sand trap, but they also don’t want to ruin their score by leaving their wedge behind either).

Planning for a round of golf is analogous to a long-term investment strategy, and the driver in our investment golf bag is the S&P 500. This “club” hits the ball the farthest and creates the most excitement (any golfer will admit that few things in this world feel more rewarding than hitting a monster drive down the fairway).

However, seasoned golfers also know what can happen if a swing is off by even a millimeter. The slightest mistake can send the ball towards the moon, and it could take several strokes just to get back on course.

The point is that it takes way more than just one club to get through a round of golf, and it most certainly takes more than one investment to help an investor achieve their long-term goals. We need investments that can help us grow our nest eggs over time, but just as important, we need others that can guide us through the sand traps that are pervasive through financial markets.

Furthermore, no golfer beats themselves up for their inability to hit their wedge as far as their driver because a wedge is not designed for long drives. Assessing the performance on the golf course involves comparing a wedge shot to other wedge shots, and a drive to other drives.

The bottom line is that despite the adrenaline rush that comes with a big drive down the fairway, the key to a good score is having a strong short game.

 

Recent Fed Rate Hikes In Question

Monetary Policy
July 2017

Over the past 27 years, the Federal Reserve has raised it key rate, the Federal Funds Rate, 35 times, each to slow down inflationary pressures and to curtail elevating price levels.  The Fed increased rates aggressively and consistently in 1994 to hold off a rapidly expanding economy, lifting rates six times for the year.  A decade later, the Fed raised 8 times in 2005 in order to temper a rapidly expanding housing market where easy mortgage lending had essentially gone out of control.  The Fed’s most recent rate increases this year, in March and June, are the first since December 2016.  The Fed also raised in December 2015.

 
 

The level of the Federal Funds rate is much lower now than it had been during previous increases, with the Fed Funds rate reaching a target of 1.00-1.25%. The Fed Fund target levels reached 4.25 in December 2005, with the target rate reaching 6% in February 1995 following six increases in 1994.

The item at question during these recent rate hikes is where inflation actually is today.  The Fed has an inflation target of 2%, meaning that it wants to see inflation growth at 2%, which translates into some economic growth.  The concern among analysts and economists is the fact that current inflation, as measured by the Consumer Price Index (CPI), is running closer to 1.8%, as reported by the Bureau of Labor Statistics (BLS). Some believe that if the Fed tightens too much too soon, then the rate increases could create recessionary pressures, opposite of the Fed’s intent.  The CPI during the Fed increases in 2005 was 3.4% and in 1994 was 2.6%.

Some economists and entities, such as the IMF, believe that deflation, not inflation may become an issue again.  Over the past twelve months, the core CPI index has actually fallen, from 1.9% to 1.7%, still below the Fed’s 2.0% inflation target.  Deflationary factors are becoming more apparent throughout the economy in sectors such as finance, education, health care, and now food services and groceries.

Sources: Federal Reserve, BLS, IMF

CD Rate History

Historical Note

Not since the days of inflation and high interest rates have Certificates of Deposits (CDs) been perceived as a viable source of income for retirees and conservative savings for working individuals.

 
 

For years, banks used CDs as primary marketing products to attract new customers and help build deposit bases. As rates fell substantially, CDs became less attractive, incentivizing banks to find other products to sell. The historically low rates of today have created CD yield wars with rates from .25% to 1.00%, rates not seen since 2002.

Contrary to what most people think, a CD isn’t as liquid as many believe. Banks restrict access to the funds until the maturity date of the investment and impose penalties for early withdrawals.

Data compiled by both the FDIC and the Federal Reserve over the decades has carefully tracked CD rates offered by banks nationwide. The average 3-month CD as of this past month has a rate of 0.91%, roughly 1/10th of a comparable 3-month CD in 1983.

The primary drawback of using CDs as an investment is that a fixed rate over a short period of time doesn’t produce the growth that stocks may produce over a long period of time. So when a 3-month CD paid 13.78% in 1979, the inflation rateof 13.3% that same year translated into earning a meager half percentage difference in real terms net of inflation. The challenge today, even with low inflation of below 2%, is that the average 3, 6, and 12-month CD rate is still below the current rate of inflation.

Source: Federal Reserve Bank of St. Louis

Americans Are Working More & Sleeping Less

Demographics
July 2017

The Department of Labor in June released a survey, called the American Time Use Survey, on how much time Americans spend working, sleeping, and a host of other activities. Nearly 10,500 people were surveyed by the Labor Department nationwide for this latest report.

The survey found that Americans spent just over 4.5 hours each weekday working in 2016, an increase of 8 minutes from the previous year. Meanwhile, the average amount spent sleeping fell by 5 minutes from the year before, to 8.5 hours per day.

The survey results may not necessarily be representative of everyone, but for a basic government report, it does give employers and economists a rough idea of how we spend our day.

Such data may reveal that too much leisure time could be indicative of high unemployment or even excess reserves for spending. While an increase in hours worked may be an indicator of an increasing demand for workers.


Source: Department of Labor; American Time Use Survey June 2017

Should Investors Fear A Weakening Dollar?

Global Financial Capital
Thought for the Week

SYNOPSIS

  • The U.S. dollar (USD) plays an integral role in global economic activity, so its value relative to other major currencies is watched very closely.

  • A weaker currency does not imply a weaker economy, and the two often march to the beat of their own drum.

  • The USD is the most widely accepted, trusted, and stable currency in the world, and the odds of this changing anytime soon is extremely low.

DOLLAR FEARS

The U.S. dollar (USD) plays an integral role in global economic activity, so its value relative to other major currencies is watched very closely. Over the last several months, the “greenback” has fallen, and given its importance, investors are now starting to ask if an extended period of weakness will adversely affect their nest eggs.

To make matters worse, anytime the dollar weakens by more than a few percentage points, the fearmongering ramps up around two frightening outcomes:

  1. Imminent Crash: A weaker currency will drive our economy into a deep depression.

  2. Reserve Status: China or some other contender will take over as the world’s reserve currency and cause the value of dollar- denominated assets to fall apart.

Don’t believe me? Conduct a Google search on the subject, and you will be inundated with tall tales of an impending dollar collapse. Some have even filmed videos that look like fake talk shows in the same manner used by TV infomercials in the 1990s (until the government banned many of them).

The world does not end all that often, so before we discuss the implications of the recent dollar weakness, let’s first deal with the doomsday rhetoric.

IMMINENT CRASH

Most Americans who have traveled overseas would agree that a stronger dollar makes for a more enjoyable vacation. For example, let’s assume that a hotel in Paris is charging €300/night. Currently, one euro can buy approximately $1.15, so the hotel would cost $345/night (300 x 1.15 = $345).

A year later, the dollar strengthens relative to the euro, to where €1 can only buy $1.05. The hotel then becomes cheaper at $315/night (300 x 1.05 = $315).  The stronger dollar makes an American more confident because his/her money can buy more stuff.

A weaker dollar does the exact opposite. If a dollar can buy fewer euros, then an American traveler will feel less confident because hotels and anything else priced in euros will be more expensive.

When it comes to investing, most forms of weakness tend to carry a negative connotation. Falling revenues, shrinking profit margins, and a softening market for goods and services usually leads to bad outcomes for investors.

However, currencies are very complex instruments that often test the limits of intuition. There are times when a weaker currency can help an economy, and governments will often intentionally drive the value of their currency lower for two reasons:

  1. Increased Demand for Exports: If the USD has weakened relative to the EUR, then €1 can now buy more dollars. U.S. products become less expensive for buyers paying in euros, and the U.S. would expect to see increased demand for their exports.

  2. Reduced Demand for Imports: If companies in the U.S. buy goods from Europe, these costs have now increased because $1 now buys fewer euros. Americans and U.S. companies may start buying less from Europe and shift to domestic producers.

Both advantages lead to stronger international competitiveness and economic growth, but that is not to say that a weaker currency is always a good outcome for an economy either. Rather, the point is that the strength of a currency, on its own, is not enough to inform us one way or another on the true health of the economy.

LOSING RESERVE STATUS

The International Monetary Fund (IMF) is an international organization created back in the 1940s to foster global monetary cooperation, secure financial stability, facilitate international trade, and assist in global economic growth.

The IMF executes its mandate through various services and levels of support for member nations. For example, the IMF is one of Greece’s largest creditors, and they have given the country several billions of dollars over the years to help get their economy back on track.

Another function of the IMF is to set recommended guidelines on the use of “reserve currencies” by central banks across the world. A reserve currency is one that is held by governments and institutions in very large quantities to facilitate international transactions. Since the 1940s, the most widely accepted reserve currency has been the U.S. dollar (USD).

They currently recognize five currencies in a basket that is weighted based on their prominence and availability – U.S. dollar, Euro, Chinese renminbi, Japanese yen, and British pound sterling.
Most central banks like the Fed and the European Central Bank hold several currencies, but the bulk of their assets are in some combination of these five.

A reserve currency must be both desirable and available, and here is where the doomsayers’ prediction fails to hold water. According to the IMF, more than 85% of foreign exchange trading involves the dollar, and nearly all commodities are priced in dollars.

For example, if a company in Malaysia wants to buy a barrel of oil from Saudi Arabia, that transaction will need dollars to complete. Rewriting these contracts and redirecting so much international trade would take time and equal trust in a replacement currency.

Regarding availability, the USD currently represents 64% of all known central bank foreign exchange reserves. The next closest is the euro at 19%, so there is nowhere near enough euro in circulation, let alone any other currency, to replace the total value of dollars held.

China is even lower. The renminbi accounts for around 5% of international trade and less than 3% of central bank reserves. Given China’s blatant manipulation and strict currency controls, it’s virtually

impossible to envision how they could gain any real traction, let alone supplant dollar anytime soon.

Simply put, it took the U.S. several decades to create the level of trust and availability needed to become the world’s reserve currency, and there is little chance this will change anytime soon.

IMPLICATIONS FOR INVESTORS

Now that the fearmongering has been put to rest, let’s address what has been driving the value of the dollar down this year.

The first culprit has been expectations from investors that the global economy is improving. Foreign investors desperate for returns had invested heavily in the U.S. since the end of the financial crisis, and it appears that many are now packing their bags and heading home.

As they sell their dollar-denominated investments, they must then convert those dollars into their home currency, and this increases the supply of dollars available on the open market. Rising supply leads to lower prices, so the value of the dollar falls.

The second is lower expectations around President Trump’s ability to push his economic agenda through Congress. His policies are expected to stimulate the economy, so if they were to go away, this could weaken the demand for dollars.

While both make for good banter amongst the pundits on television, they are far too myopic for long-term investors to lose sleep over for three reasons:

  1. The Trend: Trends matter far more than data points, and the trend for the past six years has been an indisputable bull market for the dollar, where it has strengthened nicely alongside our economic recovery.

  2. Home Bias: Portfolios tend to have a “home bias,” which means that the bulk of the investments are in the investor’s home currency. Since most U.S. investors’ expenses are paid in dollars, the need to manage foreign currency risk is lower.

  3. Natural Hedge: A properly diversified portfolio should create a natural hedge, where the impact of currencies diminishes over time. For example, if the euro strengthened versus the yen, a portfolio’s European allocation should offset a portion of its Japan exposure.

There is no question that currencies impact returns, but the degree of impact to U.S. investors only becomes problematic when a portfolio is imbalanced and/or improperly diversified. If this is the case, then an investor has much bigger problems than currency risk.

The bottom line is that the USD is the most widely accepted, trusted, and stable currency in the world. Traits like these take decades to reverse, so ignore the ups and downs that happen over the span of a few months because any impact to your portfolio will likely be minimal over the long run.

 

 

 

The Good News About Banks Passing A Stress Test

Banking Sector Focus
July 2017

Imposed stress tests by the Federal Reserve for the nation’s banks resulted in a favorable outcome. A total of 34 banking entities were subject to the Fed’s stress test, officially known as the Comprehensive Capital Analysis & Review (CCAR). The better than expected results will allow banks to increase their dividend payouts and execute share buybacks.

Data from the Fed’s test results revealed that the average common equity capital ratio for the 34 banks was 12.5% for the first quarter of 2017, versus 5.5% in a stress test imposed during the financial crisis in 2009. The results of the tests provided data that the 34 banks would be able to maintain enough capital in a recessionary scenario along with 10% unemployment, allowing them to provide sufficient lending to businesses and individuals during a significant economic downturn. Banks act as an essential lubricant for the financial structure of the country.

Dividend paying banks had been restrained from paying larger dividends due to heightened regulatory scrutiny enacted by regulations. Because of improving cash flows and amassed excess cash, analysts expect banking sector stocks to have dividend growth surpassing most other sectors once the regulations finally release their grip.

Additionally, the forecasted rising rate environment tends to allow banks to become more profitable, permitting broader lending to consumers and businesses throughout the economy.


Source: Federal Reserve; CCAR June 2017 Release 

Mortgage Refi Cash Outs On The Rise

Mortgage Market Review

Nearly half of mortgage borrowers in the first quarter of 2017 opted for a cash out option when refinancing. The amount of cash outs is at the highest since the 4th quarter of 2008, when the financial crisis was in motion.

Cash outs were tremendously popular during the housing boom when almost 90% of all refinancing included a cash out option. Cash outs as a percentage of total refis dropped considerably to 12% in 2012 following new rules and regulations.

Also fueling recent cash outs is the rise in housing values that allows homeowners to extract a portion of their equity as cash. Before new regulations, cash outs were available on higher percentages of home values, whereas rules today limit cash outs to much lower loan to value loans.


Sources: Federal Reserve, Federal Housing Finance Agency