Riding the Rockies – October 11 2017

Those readers who are long-time clients and friends of Alpha Beta Gamma Wealth Management know that my blog is called Riding the Rockies first, because I view the capital markets quite similarly to trekking through the most majestic mountains in the world and second, because, as a ‘flat-lander’ Florida cyclist, there is little I enjoy any more than a few days cycling in high altitudes. Within this blog, however, it is my hope that I occasionally impart some insight into our thinking and how that plays into our portfolio performance.

First, a quick update.  We had an excellent quarter from a performance perspective, in part, because of my belief that bonds, as an asset class, are very overbought and that equities (stocks) should provide meaningful outperformance.  As a result, we have been overweight stocks and alternative investments, relative to bonds.  We have now fully integrated the transition of our old service provider’s platform onto our new integrated platform.  You should be noticing better communication, performance reporting and, above all, service.  We have hired another administrator for the firm who will augment the great work that Joanne has been doing.  She will be joining us in 3 weeks if all goes as planned and we are looking forward to her arrival to help shoulder some of the load that has been occasioned by good growth, attributable to the efforts of Mike Robinson, Hayden Dawes, and Reg Robinson.  All have shouldered extra burdens during this transition and I want to publicly thank each of them for doing an excellent job in their appointed tasks.

Finally, I ask you to sign up for at least a couple of our “Market Radar” afternoons.  The first one is coming up on October 17th and will be hosted at The Capital Grille in Palm Beach Gardens.  Space is a bit limited but, we are asking that you bring other friends or family members if they might have an interest in our perspectives.  You can register on our website.  At this first Market Radar of the season, I’ll review the 3rd quarter market metrics and provide you with some insight as to our thinking for the coming quarter.

While I am still preparing my remarks for the 17th of October, I will provide you with a brief preview here:

The U.S. stock market ‘has legs’.  In spite of North Korea, Charlottesville, Harvey, Irma, Maria, and the dreadful shooting in Las Vegas, the U.S. capital markets continued to advance on the expectations of higher earnings.  Without factoring in any kind of major tax cuts, we believe that reasonable estimated earnings for the S&P500 in 2017 should be roughly $129 and should top $135 in 2018.  Dan Clifton, head of the Washington office for Strategas, an independent macro-economic research firm believes that every percentage point of decline in the effective tax rate in 2018 would result in an additional $1.30 in S&P 500 earnings next year.

While nothing is etched in stone, and there could be an unexpected ‘Black Swan’ event at any time, we are constructive on the U.S. stock markets for the foreseeable future.  We believe that the Trump administration’s actions with respect to reducing business-choking regulations and taxes will create an environment which allows economic growth over the remaining three years of his term.

Bond yields remained low in the third quarter with the 10 year U.S. Treasury averaging 2.33%, just about 0.13% higher than the expected rate of inflation as measured by Core CPI.  This means that you can loan your money to the U.S. Government but in real return terms, you’re going to earn very little once you factor in inflation.

One of the most common questions we receive from clients is “How much longer can this last?”.  Our response is probably a bit longer, and since most recessions have been triggered by exuberant Fed rate increases in the past, we believe that Fed watching is a very important activity going forward.  As well, we are mindful of some of the downright unpredictable events that might derail this progress, such as an electro-magnetic pulse initiated by a high altitude nuclear detonation, or a series of severe storms such as the hurricanes we have ‘enjoyed’ this season.  Inflation is low, however, and that doesn’t give the Fed much justification for increasing lending rates to any significant extent.

We are a bit cautious about the “FAANG” (Facebook, Apple, Amazon, Netflix, and Google) stocks.  There is an international armada of regulators who continue to be increasingly concerned about the size and power of these companies.  I believe that, like AT&T of years ago, there will become increasing pressure to break some of these monopolistic companies up into smaller, less powerful pieces, as Judge Greene did years ago when he broke up AT&T.

We believe that, while certainly high, U.S. stock valuation metrics are reasonable.  We don’t believe that valuations have reached bubble proportions, and the number of hesitant buyers or bears has remained at levels which give us the confidence that valuations remain at levels which will support equity market gains.

We have recently begun adding some small cap stocks to our portfolios, either using ETF’s or individual companies.  We have done this because, historically, small caps are the only asset class which has, over the past 9 decades, outperformed inflation in every period.  Small cap companies tend to pay higher effective tax rates than large cap companies.  They have less revenues from international sources so are less likely to park money offshore.  We also believe that value investing in companies which tend to have lower valuations than growth stocks and which have distributable free cash flow (i.e. dividends) may be making a comeback.  As a value oriented firm, we will generally underperform in stocks during periods of time when growth is in favor and we will generally outperform when value-investing is back in style.

That said, we believe that global earnings growth is continuing to accelerate.  This is beginning to result in better returns offshore and as a result, we have begun adding international exposures in many of our accounts.

In short, we don’t think that the harbingers of a recession, which include a dot.com boom, heavy inflows into stock funds, an increase in M&A activity, high IPO activity, rising interest rates, weakening upward earnings revisions, an erosion in the number of stocks making new highs, a shift towards defensive leadership or widening credit spreads are present and thus, we think that we will see U.S. stocks continue to advance higher.

For more detail on our view, please join us for our Market Radar Series on October 17, 2017.  You can sign up here:  www.abgwealth.com/events-calendar

If you have any comments or questions, please feel free to call me.

Curt Lyman

(561) 227-5099