Trump – The Perhaps President
If you advocate high ideals and actions to others but do not embody them yourself, your influence will disintegrate for lack of proper foundation. Therefore, in order to inspire superior qualities in others, you must first instill them in yourself.
I Ching – The Book of Change
As many of our long-time readers may know, every year in January we do an outlook known as, “5 things You Need to Know”. The 5 things are the 5 asset classes that most likely have the greatest amount of influence on your net worth. The Stock Market, Interest Rates, Commodities, Real Estate and King Dollar are our focal points. Inevitably, after the start of the year and publishing of that outlook life happens and all sorts of things develop in real time. A great mentor once taught me that success is rarely found in Plan A. Success tends to find those that can transition to Plan B and C in the smoothest fashion. In this spirit, we like to revisit those outlooks when we reach mid-year to assess what may be changing in real time. There is always a lot to cover in these "5 Things" so let's not delay and jump right in.
Back in January 2017, we started 5 Things You Need to Know for 2017 with a parable called “Perhaps”, you can read it by Clicking Here. The premise behind the parable was that we had just come out of the 2016 Presidential election with Trump as the victor and the story line was how markets and economies were going to expand beyond belief due to the growth focused policies of repealing Obama Care, reducing regulations, investing in infrastructure and revamping the tax system. All of which sounded great and may still be the case. However, for this cynical market watcher it all was a little too rosy and lacked the reality that Trump is a D.C. outsider, inexperienced in the art of politics, hence the “Perhaps Parable” we shared with readers back in January.
Here we are nearly six months later and that cynicism seems to have been well warranted. Since this missive isn’t about politics, I won’t belabor the point that promises are easier said than kept and instead talk about how all this is influencing your investment portfolio.
Oh yeah, before I do, let me remind you that the views shared are based from the juxtaposition of an investor that is either retired or approaching retirement and doesn’t have or doesn’t feel they have that so called “long term” investment horizon. It’s important to remember that time frame is everything when it comes to managing risk within markets. With that being said, let’s jump in and start the conversation with talking about the equity markets.
Equities – Revisited
Bottom Line: Looks like markets and economies still have some near-term upside. Be careful with putting new cash to work at current valuations. Use strategies that manage/hedge risk.
Below is a long-term graph of the SP500 represented by SPY with some funny little numbers on it. I won’t bore you with the details of what the numbers mean other than to tell you they are “wave counts”. Ok, now you’re probably thinking “what the heck is a wave count”? Well, Wall Street is a funny place ran by people that are always looking for an edge on how to predict the unpredictable. Over the years there have been all kinds of theories and practices found/created to help investors gain some type of edge to the seemingly random moves of markets. Some of these theories and practices are more dependable than others and some aren’t worth wasting time on. Wave counts are one of those practices that has stood the test of time. The trick with wave cycles is that they contain repeatable patterns that can help investors gain an idea of where they may be within the cycle of rise and fall that naturally happens within any medium that energy travels through.
The basic concept behind wave counts is that the most efficient way to growth is a - 3 steps forward 2 steps back type of dance. In this fashion, growth is regularly pruned to produce more growth. For you gardeners out there you’ll get the concept of pruning to grow. At the end of each 5-wave sequence there is a period of correction or consolidation needed for markets to store up enough energy to make the next series of waves. So much for not boring you, right? Don’t worry I’m getting to the point, stay with me.
How are wave counts useful for your equity investments, you may be wondering? If we are correct in the way we are counting the waves on the chart then it would lead us to believe that we are approaching the end of this 5-wave period of growth that started in 2009. Which should be followed by a period of consolidation to correct the entire bull market that started at the devils bottom back in March 2009. If this were to happen there could be a significant market move that may cause a bit of pain to those that show up late to the party. For this reason, we have been voicing caution for anyone that is either 3-5 years from retiring or has retired in the last 3-5 years.
The funny thing with predicting market corrections is markets can stay irrational a lot longer than most of us can remain patient. Rather than obsess on when that next correction will be, I like to keep myself rooted in the fact that history has shown that investing long term capital at today’s valuations in equity markets is essentially assuring yourself very low forward returns. For more evidence Click Here.
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In the near term – let’s call it the next year or so -markets look like they will hold together and most likely grind higher with some increase in volatility compared to what we have seen in the last few months. Buying the dips appears will be the continued mantra, at least for a couple more dips ahead.
Keep in mind, time frame and psychology are the two main factors to having a good or bad experience with investing. Those who already have a long-term relationship with equities may handle this next inflection point different than somebody who is still in the courtship phase. For this reason, it is important to make decisions based on your personal situation and speaking with an experienced risk manager should be considered before putting new capital to work.
The great thing about investing is there are more choices than 31 Flavors and they don’t add to your waist line. While equities appear to be in the later stages of a growth cycle, there are other assets that may be at the early stages of their respective growth phases. Let’s look at one of those possibilities next.
Commodities – More specifically, Metals
Bottom Line: The low prices of 2016 may mark the beginning of a solid leg higher for the metals.
When it comes to Gold and precious metals I’ll let the pictures tell the story. Let’s start with the chart we shared of GLD back in January.
As you can see our premise was fairly simple. As long as the lows that were created at the end of 2016 hold, the path for the metals is most likely onward and upward.
Here is a closer look at GLD updated for the past few months of action.
So far GLD and most precious metals have had a nice start to the year and have behaved according to plan. Going forward, as long as the 114 level on GLD (noted on chart above) holds, the path of least resistance should be higher for the metals which hopefully will morph into a multi-year rally. We will keep you posted and encourage anyone that may have been thinking of adding commodities to their portfolio to contact us and we will help you create a plan that fits with your time frame and risk tolerance.
Bottom Line: King Dollar is either in the later wave of growth on its way to one more high or the spike it experienced into January was the last high for a while.
Back in January we were feeling pretty confident the U.S. Dollar had one more wave higher before the growth pattern it had started on back in 2011 comes to an end. Below is a picture from December 2016 we shared in our events.
Since the beginning of the year, The U.S. Dollar has been on a slide creating a dent in our confidence for that “one more wave higher” thesis. While we are still above the green support line noted in the previous chart, the action in King Dollar this year has left quite a bit to be desired for Dollar bulls. The future direction of the dollar most likely rests in two courts. The first being the FED and how they guide markets on future rate hikes and the second being Trump’s tax plans. No overhaul in taxes most likely means the Dollar remains challenged as we move forward.
Trends in currencies tend to be very long in nature so this year’s action in the Dollar isn’t out of the ordinary and nothing has technically happened to change the long term view that the U.S. Dollar is in an uptrend. Most fundamentals also seem to support a stronger Dollar as well (assuming the Fed continues its measured pace of rate rises and Trump can get some tax policy accomplished). Whether it has any material effect to your portfolio is another story. As of now it doesn’t seem to be playing a factor. However, pay close attention to the actions of The Fed over the next three months as well as the news surrounding any tax policy coming from the Trump administration, as those two things probably hold the keys to future direction for The Dollar. I have a sneaky suspicion that the weakness in King Dollar this year has more to do with what is going on with interest rates and the yield curve, so let’s transition there next.
Bottom Line: Most pundits are predicting higher rates. Since January rates have actually moved lower. The pundits may ultimately be right but they may have to wait a bit longer.
Anytime I get into conversations with clients and investors about interest rates the conversation inevitably goes to, “I thought interest rates have been rising… isn’t The Fed raising rates”? The simple answer is “Yes” The Fed has been raising interest rates over the past year or so. The more important factor isn’t so much what The Fed does but how markets react.
In the interest rate world the 10 Year Treasury note is the benchmark everyone uses. Mortgage rates and many other longer term loans are based on the 10-year Treasury note, so this is what you want to pay attention to as an investor.
Below is a chart of 10 Year Treasury Rates from December 7, 2016 when The Fed raised rates by .25%.
You should notice that since the Fed raised short term rates, this longer-term rate has moved lower. When this happens – short term rates rise and long term rates fall – it is called “Flattening of the Yield Curve”. So why would the flattening of any curve mater to anyone other than a plastic surgeon? It matters in the world of investing because typically right before the economy starts to expand the yield curve “steepens”. Meaning that long term rates rise while short term rates stay put. To the contrary, the yield curve tends to “flatten” prior to times of economic slowing. Just because the yield curve flattens doesn’t guarantee that the economy will then begin showing signs of slowing. However, it is one of those indicators that tells you that the market, which tends to be forward thinking, may be sensing a possible soft patch down the road. If this is the case you may continue to see longer term rates continue to trend lower.
Ultimately, if the reduction of regulations that the Trump administration is putting through can also be supported by change in tax policy, you could have a powerful 1-2 punch that most likely will get longer term rates moving back higher. I am not optimistic that the Trump crew will get much done on tax policy this year if at all. For this reasoning is why I think all the pundits that were screaming for higher rates back in December and January are going to have to wait a bit longer before their calls are answered.
When it comes to how our early year outlook for government bonds is unfolding - so far so good. The interest rate market has been behaving just about as we were hoping. Here is an updated chart of government bond prices we shared with readers at the beginning of the year. As you’ll see our call to wait for a bounce in prices has worked out so far.
The future direction of rates will have a pretty drastic effect for many different industries and sectors as we move forward so we will keep you up to date in future events and writings. Let’s wrap up this missive by being like Weezy and George and do some Movin On Up to our last asset class to discuss – Real Estate.
Bottom Line: When it comes to Traded REIT’s the future direction of interest rates will wag the dog. For Non-Traded REIT’s it will be about employment and access to capital.
When it comes to real estate investors have two choices in how they get their exposure. Non-Traded instruments are more like the house you live in or the rental property you may have invested in. Since they aren’t liquid, they are intended to be long haul investments and therefore less concerned with the short-term A.D.D. whims of equity and interest rate markets. The longer-term trends of interest rates, credit expansion and employment are the greater concerns for this space. Traded REIT’s on the other hand trade on a stock exchange and therefore have liquidity. Investors can move in and out of these investments with a push of a button so they tend to have greater short term volatility. Assuming someone has enough depth in their savings both can provide benefits to a portfolio.
For the purpose of this conversation I am going to focus the charts on the traded REIT arena. Let’s start with what we posted in our January letter with this chart of IYR, an exchange traded fund that intends to track the price of the traded REIT market:
And now an up to date version:
As you can see from the charts, the year of 2017 for traded REIT’s has been like your favorite Chinese dish – Chopsueyyy. A side-ways chop of indecision.
When attempting to prognosticate the outlook of this asset, I tend to default to the direction of interest rates. In the event rates continue to trend lower the remainder of the year, the likelihood would be that traded REIT’s would move higher (rates and traded REIT’s tend to have a negative correlation, one goes up the other down and vice versa). Based on this, I think traded REIT investors should become comfortable with eating Chinese food as this chop is most likely to continue for the remainder of the year. The good news is that if you own a Traded REIT that pays a dividend, you’ll be collecting some income while enjoying delivery from Mandarin Garden.
Outside of what has already been discussed, I would pay attention to the lines in the sand we have drawn on the charts as those should work as good road markers for the rest of the year.
Overall 2017 has been a pretty uneventful year for most assets. Equities are probably poised to grind a bit higher from here but look a bit pricey for anyone looking to put new capital to work. Metals markets have behaved well with the weak dollar which looks like this may continue for a while. Interest rates are probably going to continue to keep the pundits guessing while real estate enjoys the low rate fully employed environment.
It’s time to hit send and start to enjoy the Memorial Day Weekend with some shark dodging – that’s what we are now calling surfing down here in Southern CA. Until next time, I hope life brings you more peace and prosperity.
The opinions expressed are those of Colby McFadden and Quiver Financial as of May 26, 2017 and are subject to change due to market or other conditions. This is not a solicitation or recommendation of any investment; always consult a Financial Advisor before investing into any investment. Securities offered through WestPark Capital, Inc. - Member FINRA / SIPC / http://brokercheck.finra.org Advisory Services Offered through WestPark Capital, Inc. 18872 MacArthur, 1st Floor, Irvine, CA 92612 - 949.590.4200