SunLakes of AZ Blog

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September 2017

On To The Next Year

by Karl Schroeder for Finance

The end of every year brings the desire to recount the good and the bad of the year ending and look forward to the year about to begin. It is natural to think is those terms, this period is ending and the next beginning. But, the market doesn’t do that. The market is always looking forward to the next thing. Most of us are just now beginning to think about the new year, but the market has been looking toward it (and the next one) for a long time. Unless something really surprising happens, the market already has a pretty good notion of what is going to happen next year. Generally, the notion is that next year will be a pretty benign period for the world, the various economies and most markets. It may not be all that great for bonds, but it should be pretty good for stocks, commodities and maybe even property. That is why we’re setting new recovery highs all the time these days.

The idea that the market came with into 2010 was about the same. There was more anxiety about the European sovereign debt situation, but that has been largely fixed now. There was concern about just how strong the US economy would be, but few thought it would revert to recession or bound ahead. The muddle-through scenario was pretty widely held. The majority on Wall Street were surprised by the early strength of bonds, but by the time the year is out we will have barely earned the coupon on most bonds, having given back much of our principle gains in Treasury bonds.

It takes a surprise to change the outlook. What that surprise might be is unknowable. That’s what makes it a surprise. If you sat down and thought long and hard about what would surprise the market, you could probably come up with a handful of ideas. Some farfetched and some more mainstream. Believe us when we say that only the bizarre stuff would truly be a big enough surprise to shake the market.

The last big surprise that hit the market was the collapse of Lehman Brothers. Few even on Wall Street thought that a large brokerage firm like that would be so vulnerable. We wish we could reassure you that the same couldn’t happen again, but even with the new re-regulation act passed by the last Congress there is no improvement in that area. Capital controls weren’t really addressed by the bill, nor were other constraints on leverage. It was leverage that brought Lehman down as much as anything else. The simple fact that each and every day they had to scrounge up billions of dollars to keep their operations funded and once the true extent of their leverage and the weakness of their balance sheet became widely known, there was no one to front them the cash. Wall Street is somewhat better capitalized today, not because some benign regulator demands it, but because lenders have learned to ask the right questions before providing funds. There are fewer sources of funds for the brokers, so the brokers are less leveraged.

Before Lehman, the last surprise was the 9/11 attacks. The idea that a bunch of box-knife wielding Jihadists could bring New York to a standstill was in nobody’s econometric model. Now, it is (or some other bizarre terrorist action). There was an exodus of operations from Manhattan after the 9/11 attacks. Now, much of that day to day work gets done in Jersey or Boston, or Philadelphia, some even gets done in places like Salt Lake City and the suburbs of Los Angeles.

We are not going to list off a whole bunch of wild guesses of what could surprise the market. It is better to think about what is already discounted and might not come to pass. Last year, there was a risk of a double dip, not a probability but a possibility. As the year passed, that possibility became more and more remote. So, the market that had kept a little bit of cash for that eventuality had to reassess and boost their buying through the year. There is a lot of that kind of stuff that will make 2011 just as rewarding as 2010 for the market. Europe will not collapse. China will continue to grow. The US will manage its debt. As these potentialities subside, we will collectively breathe a sigh of relief and mark-up our favorite stocks.

This is just another way of phrasing our long-held conviction that a reduction in risk premiums will be the biggest driver behind the stock market for quite a while yet. In the arcane math that underlies the markets, compensation for risk in the biggest swing factor there is. We demanded a huge premium when Wall Street was collapsing, the economy was in tatters and your house wasn’t worth what you owed. The same premium isn’t required when Wall Street is back to its old self, the economy is advancing albeit modestly, and the value of your home has stopped going down. Just like kids grow up to become adults, economic and market cycles mature to be a lot less risky than they appear at the start.

We still have to worry about short-term gyrations in the market. Just because we are in a well-established bull market doesn’t mean we can’t have some pretty erratic day-to-day action. But, looking back from the perspective of this time next year, we will see that 2011 will turn out to be a pretty good year for investors. Or, maybe not.

Economic News

We had some, but nothing big enough to really move the markets. GDP was revised somewhat higher, but not as much as some had hoped. Case-Shiller numbers argued that the real estate morass will continue for a while longer. Oh well, nothing to worry about so long as it’s Christmas and the credit card limits aren’t exceeded.

Weekly Stuff

Last week was about as benign a week as we could get, no big shocks either up or down, quietude with a touch of gains. Once again with our absence the market seems to put itself on cruise control and rolled on down the highway.

The gains of roughly one percent might surprise some who looked every day as there was nothing really to point to which would indicate such a gain. But, little wiggles each day, mostly in a positive direction added up to those gains. If only every week could be so benign. Actually, if every week were the roughly one percent gain we saw last week, this would be a very nice business to be in. What do you think about gains of 67.76% a year (1% compounded 52 times)? If only it could be that easy.

We are in the heart of the easiest part of the year to be an investor. The months from October through April average over 1% gains per month over years and years. The old saw “sell in May and go away” comes from the simple fact that over many, many years almost all the gains one gets from investing in US stocks come from the months October through April.

So, last week wasn’t totally uneventful. The fears of China raising interest rates or doing something else to slow their economy did impact a couple of days and then today we see that they took the opportunity provided by the quiet of the Christmas weekend to pull the trigger on that move. They raised their deposit interest rate 0.25% to 2.75%.

It wasn’t so benign for bond holders with losses in many bond areas. Foreign bond markets slipped, Treasury bonds melted, high grade corporates faced resistance and high yield followed stocks higher.

Commodity prices were the real stars last week. Oil prices gained roughly 3% but were outdone by some agricultural prices. An earthquake in Chile which damaged a copper ore loading facility caused a scare in that vital mineral, but by week’s end the crisis had passed. Precious metals largely sat out the rally as with a more benign world, the need to hedge against problems seemed to recede.

Real estate securities gained.

Happy New Year

Karl Schroeder, RFC CSA

Investment Advisor Representative

Schroeder Financial Services, Inc.

480-895-0611

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