Last month we wrote here about "Divergence" due to stocks and bonds seeming to be headed in different directions. Here we will look back over 2019 for stocks and bonds both as well as comparing 2019 to 2018. There was divergence between the 2018 and 2019 market movements, as well as their differences in overall performance. It could not hardly have been more divergent and this persisted all through the year as 2019 marched forward. The stock internal valuations from a fundamental stock analyst viewpoint which are underlying their view on stock prices don't support the current pricing in stocks as a whole. In terms of a macro view of markets coupled with fundamental analyst research and the overall direction of the markets, here is what we are seeing;
1) Stocks are diverging from traditionally accepted price supports as prices move up and profits either flat or down;
2) The average investor is divergent in their historical approach to accepting more risk (#2 is fully related to #1) than they have during the past decade.
As of late.
With the previous month (November) putting in a strong and smooth showing, it might have had the tendency to lull some investors back to sleep and if that is what investors did for December, their long winters nap turned out to be very restful and they awoke to a nice surprise as December drew to a close. Stocks had a solid "Christmas Rally" which is quite divergent from what happened last December if you recall.
But before we dig into some longer term perspectives, let's review and enjoy December and what it did for markets. As you can see below, the S&P had a nice smooth and steady performance last month. Real volatility was almost non existent during the month so the S&P 500 index gave investors a smooth ride up of more than 2.5%+.
The S&P 500 index for the Full Month of December 2019.
In our newsletter covering November, we also mentioned the recency bias and how it can be something which lulls people to think all is well with markets (or the reverse being that the world will collapse like the recency bias which existed in 2008/2009). Recency bias still holds true today (it actually always stays in place) as we enter 2020. Recency bias never tends to serve investors too well, causing them to move from one polar opposite to the other. In the early part of 2019, markets rose nicely but it is important to remember markets were simply trying to rebound from the huge downturn which occurred just 12 months ago in the 4th quarter of 2018 as markets finished the 4th quarter down -14.7 %! So though the S&P 500 appeared to have a "banner year" in 2019, when we put the year into perspective of a longer term time frame, the "banner year" was needed to make up for the damage done to markets late in 2018.
We are acknowledging the smooth and steady gains during both November and December but it is also important to look back over two years instead of just two months. We do acknowledge markets really needed some "smooth and steady" upside returns to keep the two year performance from being flat or negative for this longer time frame. That smooth and steady November/December rally truly saved the day in terms of the past two calendar years. The graph immediately below shows the last two years and while there are many months with positive returns, the market managed to be above the baseline (red line) only about 6 out of the last 24 months.
What is driving the recency bias?
The full on presence of recency bias is due to the fact that consumers seem to be confident, too much so in our view, but the December consumer confidence did slip back just a bit. While consumer confidence has slipped, delinquency rates on loans have not slipped and conversely, delinquency rates on loans are rising. A very interesting note about loans, credit card lending delinquencies are about the same as mortgage lending delinquencies. Both are in the 2.5% range and inching higher.
What this really says it that consumers overall are more confident than they need to be based on either monthly income or based on financial habits. The Christmas retail season was up by about +3.8% during the Christmas shopping season this year DESPITE there being six shopping days less in 2019 due to a later than normal Thanksgiving. So, six less days to spend it all and yet we still saw a rise of more than 3.5%! This points to consumers wearing out the credit cards. Again, credit card and home mortgage loan delinquencies are inching up a bit. This kind of combination rarely aids the consumer very well.
Professional investors don't typically like situations where prices of stocks get ahead of their traditional support mechanisms and then it gets coupled with consumer details on spending and saving which begin to weaken.
A Prime Example
One noted professional investor, Warren Buffett, has been cautious and has been sitting on a large amount of cash for well over a year. The last reported accounting of cash for Buffett is that he is holding $128,000,000,000.00 (Yes, it is supposed to be 11 zeros.) of cash. Would you ever be willing to keep more than 40% of your personal "market cap" in cash for more than a year? Buffett seems to be quite willing! While many now see him as having really missed the mark on investing in 2019 (he made just over a 1/3 of the return of the S&P 500 in 2019) when you really study his historical returns, he actually does not have a stellar record of market beating returns.
Below is a matrix we put together with some help from the people over at Morningstar. We looked at the three year, five year, ten year and fifteen year record of Buffett versus the S&P500 and not only did he fall substantially short of the market return in 2019, he has consistently come up short over most every major time-frame we looked at in this scenario. Take a look below and see what the "Oracle of Omaha" has actually done for himself and his shareholders over the years. He actually lagged the returns of the S&P 500 for every time frame except the 15 year time frame and then he only beat it by 0.19% per year.
Now I am only in my 34th year in the financial services arena but during all that time I have never heard anyone make truly derogatory remarks about Buffett. He is very unique for an investor who uses lots of fundamentals in his evaluations of where to and what to invest in, and yet he will hold large percentages of cash for extended periods of time. This willingness to hold high percentages of cash is a very notable difference about Buffett and others who live in the fundamental analysis camp of the investment world. Some people use different methodologies than he does or different processes than he does but never have I heard anyone really cast a dispersion on the fellow. Yet, for all of his notoriety, he has missed the mark repeatedly.
At Capital Research, we use completely different methodologies (we're not a fundamental shop, we use much more of a technical construct to what we do) from what Berkshire Hathaway uses and while we are at complete opposite ends of the spectrum in terms of methodologies and processes, we do feel they have a solid setup and somewhat predictable outcomes for what we know of their processes.
Our quantitative (non -fundamental) models take daily math inputs, so what we focus on using is very "data rich". We then let the data tell us where to focus our attentions. We do not have a traditional "stick with it no matter what" long term investing thesis which we put out, defend and stand by it come hell or high water. We do have a strong investment philosophy here at CRA which we have enjoyed operating by for the last 2 decades.
This little cartoon below came our way and I thought it was a humorous depiction of our take of some in the investment world who hold fast, no matter what the information might say. Remember, research is our middle name, it is what we do and it drives our decision making.
We remain watchful.
Ken Graves, Chief Investment Officer
Capital Research Advisors, LLC
Capital Research Advisors, LLC,
4185 B Silver Peak Parkway,
Suwanee, GA 30024
800 -767- 5364
All rights reserved
Mortgages- Just an FYI on Rates:
Mortgage rates have for the moment seemingly stabilized. This is true over the last 2-3 months. They are still very much on the low end of their range and our view is that there is more downward shift in rates to come. The economy in the U.S. is still about the best thing going as compared to the rest of the world but rising rates for mortgages would really begin to derail home construction numbers. Due to this, rates are short term likely to stay in this range with a greater possibility of moving lower rather than higher. STAGFLATION may already be on the delivery truck for the global economy and that could push rates for mortgages lower from this range.
JOBS, INFLATION & MORE
Last month we also mentioned the jobs issue and the fact that fewer jobs were actually created in November (67,000) and now we see (below) some larger work forces are being cut back resulting in layoffs. Most cut backs are not in huge numbers at this point in time but with ISM (Manufacturing) slipping month over month and being lower than it has been in 127 months, more layoffs are likely soon to follow.
The good side of where we are today with jobs lies in the fact, even with layoffs starting to show up, we are near all time lows on unemployment so the ability of the current U.S. job market to absorb these early layoffs is relatively strong and should stay reasonably strong for the time being.
Though the Federal Reserve raised interest rates four times in 2018 they also turned around 180 degrees and lowered interest rates three times in 2019. This quick change of mind by the Fed may have helped stave off a recession for a bit but it still appears that the likelihood of a recession is still greater than 50% by the end of 2020.
We have also brought up inflation in the last two months simply because that is what the data has pointed us towards. If you wonder if there is any strength to the idea of inflation happening, look at this graph below. In this we are looking at the last 90 days noting the change in price of OIL, Lumber and the Gold/Silver mining indices and comparing them to the S&P 500. While the S&P 500 index rose nicely during the 4th Q, these three commodities have almost doubled the percentage price change of the S&P. It has been an amazing push by oil, lumber and gold/silver but none of them seem to show any real signs of slowing their rise or giving away to solid elements of weakness. (Commodities are known for their volatility though so it could be a bumpy ride).
"If you can't describe what you are doing as a process, you don't know what you're doing."
Inflation is beginning to come to life but in terms of what the Fed would want, it seems to be coming to life at exactly the wrong time. Inflation was slowing/dropping for multiple years and the Fed has tried to get inflation going for many of those years without any success. Untill now. So, if the job market is starting to falter and inflation is beginning to get a foothold, we could see ourselves entering into a period of STAGFLATION. Also, suffice it to say, the 67K jobs added in November against a negative revision to the October jobs numbers could be causing Fed members to miss a few hours of sleep? They could all be stuck with realizing the old saying from Steve Urkel applies to them, "Did I do that?"
The real problem with stagflation is we typically see prices rising and economic growth slowing. We do have this slow steady decline in economic growth here in the U.S. which is clearly seen in the continual slowing of manufacturing, a decrease in profits of U.S companies (US corporate profits peaked in the 3Q of 2018) and a slowing of commercial construction in some areas of the U.S.). So, if prices rise and people are spending less money, this can truly cause an economy to "lock down" somewhat, which will in turn cause the economy to struggle all the more.
I have stated here many times before that "hope is not an investment policy and though many might hope inflation is not starting and they might hope the economy is not slowing, hope does not help in investing. You have to have information or data to run though a process and turn that into actionable decision points. Then you have to execute on the results of that process to either grow assets or protect assets or both.
– W. Edwards Deming