Fall 2015 – Newsletter

You better cut the pizza in four pieces because I’m not hungry enough to eat six – Yogi Berra

My 17 year old son recently got his driver’s license, which suggests the ligament stretching finger crossing campaign is in full bloom. So far he’s done all the right things. This is a child that’s never been in trouble, has always been respectful and survived the Manhattan bred cab driver lane changing lessons administered by his father.

He also paid for half the costs of the hoopty he now operates, even if he did initially lobby for a new car on the grounds of “safety features”. I suppose it was worth a try. In the end, however, he must have figured out that college is right around the corner and things happen when they’re supposed to, which means an old Nissan Altima that I can fix in the back yard will do just fine.

It’s perfectly acceptable to remain optimistic. Everybody reading this newsletter is blessed. I spent three years being pursued in court by my former employer and I consider myself the second luckiest guy in the world (right behind my lawyer, who has an insurmountable lead). With that said, we should also acknowledge that there are market cycles, bouts of financial engineering and data points that cannot be ignored.

In my last newsletter I discussed why I thought the economy was deflating. It’s worth noting that the impact on the market cannot be pinpointed to an exact time or place. Nobody knows how long the music will play in a game of musical chairs, even if we all know it will eventually stop, and the reason we suspect it will stop is because it already happened twice in the last 15 years.

graph17Keep in mind that when we say the market, a logical response would be “which market?” To date there have been 25 stock market crashes around the world, dropping more than 20 percent from their highs, and that doesn’t even include the commodities markets. You’ll find all sorts of canaries flying around the mouth of a coal mine; some are in good spirits while others can’t stop gasping for air.

Stock prices, for example, are a function of how much money the company makes. If one were to take a scorecard of the 3rd quarter earnings season, you would notice that of the 341 companies that have reported (as of this writing), revenue has declined by 3.6 percent and earnings by one percent. Even if you were to review the earnings growth on a rate of change basis, the economy is decelerating.

This, of course, has happened during a time when companies have purchased shares of their own stock that increased the demand for shares, reduced the supply of shares and made the earnings per share look more attractive. From the looks of things you can spruce up earnings, but revenue is hard to manipulate. To give you a sense of the buyback volume, since 2010, corporate America has spent $296,000 on stock buybacks for every one job they created.

Once again, nobody knows when this practice will end (we actually own a position that benefits from buybacks), although they’ll need revenue to do it and revenue is decelerating. Under normal conditions, wage growth would be a boost to economic activity because consumers would have more money in their pocket; except that data point has been slowing as well.

graph18As a consequence, I have reduced exposure to the U.S. market. October saw a bounce, but I believe it was a short squeeze, a condition where institutional investors bet heavily that the market would drop and are forced to close those positions with a purchase that accelerates a rebound. It is cosmetic in nature and I elected not to chase it. The market subsequently dropped again, went back up and then, well, you get the picture.

All of this takes place in the backdrop of a potential interest rate hike by the Federal Reserve. Here’s what’s interesting: Ben Bernanke, the former Federal Reserve Chairman, recently wrote the book “A Courage to Act”. Naturally, the title reflects his response to the 2008 financial crisis. What he left out was his unwillingness to raise rates when the economy was accelerating in 2012 and 2013, something many expected him to do.

The current Federal Reserve Chairwoman, Janet Yellen, is in a bit of a quagmire. Were she to leave interest rates where they are, it would be an admission that the economy is weak and send a negative signal to the market. If on the other hand she raises rates when the economy is slowing down, good grief, anything could happen.

Loose monetary policy, defined as one round of Quantitative Easing after another, must be like the stench of cigarettes noticeable to everyone except the smoker. Every drag, that brown stain on the filter, a subtle reminder of the poisons we’ve inhaled that slowly damages our economy.

For all of his accolades, Ben Bernanke was the cool dad that allowed his children to eat candy before dropping them off at the daycare center knowing the teachers would have to deal with the sugar high. I can make a case for why that’s a good idea if there’s more sugar, but outside of more quantitative easing, mom’s coming home and there will be no more candy.

It is a familiar paradigm, one where we understand both the magnitude of the problem and the consequences of fixing it. Our hearts go out to the victims of France who were subjected to the cowardice of ISIS. This too, however, is complicated from a historical and tactical standpoint.

It would appear that ISIS is attempting to spread Wahhabism, a strain of Islam so strict that most Muslims are noncompliant, and as a consequence, have suffered the greatest atrocities. It manifests itself from Abd al-Wahhab; an 18th century Sunni preacher who went so far as to believe those who erected tombstones were Muslim imposters.

This Wahhabi strain has existed in Saudi Arabia since its inception. The Royal Family knows all too well they are a target of radical Islam as a consequence of their relationship with the west, although any attempt to eradicate their presence would create a violent backlash within their borders and they have instead chosen to moderate its growth and impact. Besides, any enemy of the Shiite Iranians is a friend of the Sunni Saudis.

With that said, Saudi Arabia is a country known to harbor groups sympathetic to the spread of puritan Islamic ideologies, who often finance their operations through the Arab Gulf Charities, among other avenues. Moreover, if you recall, 15 of the 19 hijackers were citizens of Saudi Arabia. According to a poll conducted by a DC think tank, five percent of Saudi adults support ISIS, which amounts to half a million people. And while security concerns make it difficult to scrub data, it has been estimated that Saudi Arabia is among ISIS’ most fertile recruiting grounds.

This is not an indictment on Saudi Arabia, although it’s worth noting that there have been over 500 drone attacks in Pakistan, Somalia, Yemen and Afghanistan and we have pursued military operations in Iraq and Afghanistan. Saudi Arabia has not only been untouched, but we just sold them smart bombs.

The reason for this is simple – they sell oil in U.S. dollars. Where we to sever those ties, the petro-dollar arrangement would be in jeopardy and the demand for U.S. dollars would decline, which could have devastating consequences on a country with $18.6 trillion in debt.

It bears noting that observers of the Wahhabi ideology revolted in the 19th century, except that at some point the Ottoman Empire had seen enough and ended the uprising with overwhelming military force. We could pursue the same course of action, if only it were that simple. Or said another way, we benefited economically from the petro-dollar, but now that mitigates our ability to protect ourselves from this deadly virus.

This is the sinuous dilemma facing the financial markets, albeit with much lower stakes. We engaged in Quantitative Easing, stock buybacks and other forms of financial engineering and the looming breakup will be a bit messy.

graph19Keep in mind that the recent market bounce might very well reflect confidence that an earnings and growth recovery is right around the corner when the numbers do not suggest anything of the sort. If you need further evidence, look at China, Europe, emerging markets, copper, iron ore and oil- all down double digits – not to mention 70 percent of S&P 500 stocks that are 10 percent below their 52 week high.

One of two things are bound to happen over the coming months: either the Fed raises rates, increases the value of the dollar and accelerates deflation in a slowing economy or they do not raise rates because they connected the dots and realized the economy is already losing steam. Neither is an occasion to celebrate.

My son got pulled over by the police within two months of getting his drivers’ license. Apparently the officer wanted to make sure he was ok after he left the school parking lot. No traffic violation or bad headlight; he was just checking in. Given today’s headlines, little Ivory immediately jumped to conclusions until I reminded him he was coming from a high school dance and the police were probably just checking for drunk drivers.

What appears to be offensive is not always that big of a big deal. For what it’s worth, one of the reasons my son got home from the dance without incident is that he followed two very simple rules – stay calm and don’t do anything crazy. There’s cause for optimism after all – if a 17 year old can do it, maybe there’s hope for us yet.

Securities offered through LPL Financial, Member FINRA/SIPC (http://brokercheck.finra.org/). Investment advice offered through Delancey Wealth Management, LLC, A registered investment advisor and separate entity from LPL Financial.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

1 Malaysia, Brazil, Egypt, China, Indonesia, South Korea, Turkey, Chile, Colombia, Peru, Bulgaria, Greece, Poland, Serbia, Slovenia, Ukraine, Ghana, Kenya, Morocco, Nigeria, Singapore, Taiwan, Thailand, Germany and Spain.
2 S&P 500 Profits On Track For First Drop In 6 Years; Investor’s Business Daily; 10/30/15 3 Data be damned; Wall Street says all is well, 11/2/15; CNBC
4 Our Islamic BFF, Saudi Arabia; New York Times; 9/8/15
5 Fearing ISIS, Saudi Arabia Turns Back to Washington; Newsweek, 1/13/15
6 The names: Who has been recruited to ISIS from the West; CNN; 2/26/15
7 U.S. Said to Approve Selling Saudis $1.29 Billion in Smart Bombs; Bloomberg; 11/15/15
8 Expect a market meltdown before the 2016 election: Stockman; CNBC; 11/18/2015