INSIGHTS
JAN
4
COSTA’S CORNER 2019
A new year, new challenges.
After having made it through the last three months alive, financially, we can all look back and wonder, what the Hell just happened? While my column will be more about the present and the future and what I think will happen and why, I think it’s important to go back and try and explain the causes of this sudden turn around.
The Dow finished down 5.6% on the year and that pretty much took everyone by surprise. Not that we were down but how fast it happened. Mid September, everyone was talking 27,000 on the Dow and how strong the Bull market was and how record setting it had been. Then all of a sudden the bottom fell out and next thing you know, the R word is rearing its ugly head. Yes, economists from every corner of the globe were talking recession as the market turned over and all that good feeling was gone.
There are few things that scare investors more than a recession. It fundamentally strikes at the heart of everything we hold dear financially and causes a quick about face as to where your money should go.
Rising interest rates have a tendency to do the same thing. They strike fear in investors because of the belief that a rising interest rate environment is bad for equities. Its not, but that belief is strong and it causes minor panics among investors.
Another thing that spooked the equity markets is the notion that the Trump tax roll back has run its course and corporate earnings will start to slow down and even contract.
Let me give a seasoned traders perspective to the last three months and if anyone needs clarification on any of my points, all they need to do is email me and after I finish writing my white paper on each subject, I will send you a copy.
Point number one:
The fear of recession, which seems to be the end result of this selloff, might be a little off base.
The US economy is still on a steady trajectory. While GDP may slow down in the first quarter, it does not mean that recession is imminent.
I believe the most reliable indicator for recession is the housing market. Every full-blown recession we have had in the last 70 years has started with a slowdown in the housing sector. This slowdown was a combination of falling housing prices, new home starts, used home sales and increased inventories. These factors have to be apparent and consistent for at least three consecutive months. We have not seen that yet. We have seen combinations of the four but no pattern is emerging.
While stocks are usually a very good indicator of what the economy will look like in six to nine months, I believe it might not have gotten this one right.
Point number two:
The Trump tax cut has run its course. Sorry to disappoint but I have heard many smart people say that the corporations took advantage of this tax cut and repurchased more of their own shares than ever before and that support of their stocks will be coming to an end.
Oh really? Don’t get me wrong, I hate stock buybacks. I think if you are building your company for the future, why use freed up cash to repurchase shares? Spend more on R and D. Buy a competitor. Pay your employees more, give them skin in the game and see how well that transforms your bottom-line. Repurchases are strictly for shareholders and the executives whose compensation is directly related to the share price. I digress.
The fact is (maybe I’m wrong) but the lower tax rate is still in effect and corporations will still reap the benefits. The stupidity of stock repurchases and inaccurate PE multiples will continue.
Point number three:
This where my 37 years of trading comes in to be very helpful. Over the last four years we have seen a tremendous growth in ETF’s. Money has flowed from mutual funds into ETF’s consistently for much of that time and therein lies one of the root causes of the selloff.
The idea behind an ETF is simple: A manager puts together a portfolio of just 20-30 stocks that fit under the umbrella of the ETF. There are literally thousands of ETF floating around and if you like a certain group or an idea, there is an ETF for you.
Since your investment into an ETF is just like a stock. You place an order to buy a certain dollar value of an ETF and the ETF then goes out and buys proportionate amount of the underlying securities and when you want to sell, you either sell a number of shares of the ETF you own or a dollar amount.
The big difference between the buy and the sell is that when you want to buy an ETF, not every dollar has to be put to work. The manager can keep a small amount on the sidelines to be used at some point but when a person wants to sell an ETF, it must be sold. The seller wants his cash and the open market is the only place an ETF manager can get that cash.
Herein lies the major problem of the market structure we have now.
The market has very limited liquidity when it’s going down. There are few buyers and the markets are incredibly thin so when an influx of ETF sellers appear, so do algorithms that are designed to beat the ETFs to the market and this causes accelerated selling. Hence, the big, fast drops.
I firmly believe that this unwinding of ETF positions had a lot more to do with the selloff than rising interest rates or recessionary fears.
Kind of tells you that the market is a little bit broken but not so much that you will see 2008 all over again.
Enough with the 2018 tutorial. Lets see what the future may bring and how should we position ourselves for the rollercoaster ride to come.
There are some obvious things we will want to watch out for.
Fourth quarter earnings for one thing. Based on what we saw at the end of last year, I think you will have a fairly good fourth quarter earnings season. Companies are still hiring and wages are rising at a better pace and that translates into better consumer spending and companies will have the cash to keep the lights on and continue to expand.
The Trump tax cuts are still here and companies will still repurchase shares. That does lend support to a market and we will continue to see companies do what has gotten their executives nice pay packages once again.
No doubt there will be rough patches and mini panics will set in but all in all, the first three months of 2019 should be a prosperous one.
I do not think the Fed will raise rates anytime soon. I have been pretty vocal about the fact that I did not think the economy warranted any rate hikes at all. You had an economy that was just starting to get out of this middling expansion and get some gusto to it and they announced their first of many rate hike in December of 2017. The rate hikes really have not slowed down the economy one bit, so maybe their plan worked. Anyway, the Fed now has room to maneuver should that be needed and I don’t think they are looking to move into another phase of rate hikes.
One feature I would like to introduce is my weighting of investments.
Basically, if I were to put together an imaginary portfolio for all to view, this is what it would look like:
50% stocks
25% Fixed income
25% Cash
I know, I am crazy to have that much in cash but until I feel we have stabilized at a level I want to have money to take advantage of others misfortune. It’s a harsh truth but when others suffer there is money to be made, you just have to have the guts to jump in at a point that will hopefully be profitable.
A few notes:
Future columns will not be this long
If you want to be put on my email list to receive my column everyday, email me.
If you are interested in any of the White papers I write let me know.
Sign up for CIVL in the App store or in the Google store, eventually all my columns will be posted there.
After having made it through the last three months alive, financially, we can all look back and wonder, what the Hell just happened? While my column will be more about the present and the future and what I think will happen and why, I think it’s important to go back and try and explain the causes of this sudden turn around.
The Dow finished down 5.6% on the year and that pretty much took everyone by surprise. Not that we were down but how fast it happened. Mid September, everyone was talking 27,000 on the Dow and how strong the Bull market was and how record setting it had been. Then all of a sudden the bottom fell out and next thing you know, the R word is rearing its ugly head. Yes, economists from every corner of the globe were talking recession as the market turned over and all that good feeling was gone.
There are few things that scare investors more than a recession. It fundamentally strikes at the heart of everything we hold dear financially and causes a quick about face as to where your money should go.
Rising interest rates have a tendency to do the same thing. They strike fear in investors because of the belief that a rising interest rate environment is bad for equities. Its not, but that belief is strong and it causes minor panics among investors.
Another thing that spooked the equity markets is the notion that the Trump tax roll back has run its course and corporate earnings will start to slow down and even contract.
Let me give a seasoned traders perspective to the last three months and if anyone needs clarification on any of my points, all they need to do is email me and after I finish writing my white paper on each subject, I will send you a copy.
Point number one:
The fear of recession, which seems to be the end result of this selloff, might be a little off base.
The US economy is still on a steady trajectory. While GDP may slow down in the first quarter, it does not mean that recession is imminent.
I believe the most reliable indicator for recession is the housing market. Every full-blown recession we have had in the last 70 years has started with a slowdown in the housing sector. This slowdown was a combination of falling housing prices, new home starts, used home sales and increased inventories. These factors have to be apparent and consistent for at least three consecutive months. We have not seen that yet. We have seen combinations of the four but no pattern is emerging.
While stocks are usually a very good indicator of what the economy will look like in six to nine months, I believe it might not have gotten this one right.
Point number two:
The Trump tax cut has run its course. Sorry to disappoint but I have heard many smart people say that the corporations took advantage of this tax cut and repurchased more of their own shares than ever before and that support of their stocks will be coming to an end.
Oh really? Don’t get me wrong, I hate stock buybacks. I think if you are building your company for the future, why use freed up cash to repurchase shares? Spend more on R and D. Buy a competitor. Pay your employees more, give them skin in the game and see how well that transforms your bottom-line. Repurchases are strictly for shareholders and the executives whose compensation is directly related to the share price. I digress.
The fact is (maybe I’m wrong) but the lower tax rate is still in effect and corporations will still reap the benefits. The stupidity of stock repurchases and inaccurate PE multiples will continue.
Point number three:
This where my 37 years of trading comes in to be very helpful. Over the last four years we have seen a tremendous growth in ETF’s. Money has flowed from mutual funds into ETF’s consistently for much of that time and therein lies one of the root causes of the selloff.
The idea behind an ETF is simple: A manager puts together a portfolio of just 20-30 stocks that fit under the umbrella of the ETF. There are literally thousands of ETF floating around and if you like a certain group or an idea, there is an ETF for you.
Since your investment into an ETF is just like a stock. You place an order to buy a certain dollar value of an ETF and the ETF then goes out and buys proportionate amount of the underlying securities and when you want to sell, you either sell a number of shares of the ETF you own or a dollar amount.
The big difference between the buy and the sell is that when you want to buy an ETF, not every dollar has to be put to work. The manager can keep a small amount on the sidelines to be used at some point but when a person wants to sell an ETF, it must be sold. The seller wants his cash and the open market is the only place an ETF manager can get that cash.
Herein lies the major problem of the market structure we have now.
The market has very limited liquidity when it’s going down. There are few buyers and the markets are incredibly thin so when an influx of ETF sellers appear, so do algorithms that are designed to beat the ETFs to the market and this causes accelerated selling. Hence, the big, fast drops.
I firmly believe that this unwinding of ETF positions had a lot more to do with the selloff than rising interest rates or recessionary fears.
Kind of tells you that the market is a little bit broken but not so much that you will see 2008 all over again.
Enough with the 2018 tutorial. Lets see what the future may bring and how should we position ourselves for the rollercoaster ride to come.
There are some obvious things we will want to watch out for.
Fourth quarter earnings for one thing. Based on what we saw at the end of last year, I think you will have a fairly good fourth quarter earnings season. Companies are still hiring and wages are rising at a better pace and that translates into better consumer spending and companies will have the cash to keep the lights on and continue to expand.
The Trump tax cuts are still here and companies will still repurchase shares. That does lend support to a market and we will continue to see companies do what has gotten their executives nice pay packages once again.
No doubt there will be rough patches and mini panics will set in but all in all, the first three months of 2019 should be a prosperous one.
I do not think the Fed will raise rates anytime soon. I have been pretty vocal about the fact that I did not think the economy warranted any rate hikes at all. You had an economy that was just starting to get out of this middling expansion and get some gusto to it and they announced their first of many rate hike in December of 2017. The rate hikes really have not slowed down the economy one bit, so maybe their plan worked. Anyway, the Fed now has room to maneuver should that be needed and I don’t think they are looking to move into another phase of rate hikes.
One feature I would like to introduce is my weighting of investments.
Basically, if I were to put together an imaginary portfolio for all to view, this is what it would look like:
50% stocks
25% Fixed income
25% Cash
I know, I am crazy to have that much in cash but until I feel we have stabilized at a level I want to have money to take advantage of others misfortune. It’s a harsh truth but when others suffer there is money to be made, you just have to have the guts to jump in at a point that will hopefully be profitable.
A few notes:
Future columns will not be this long
If you want to be put on my email list to receive my column everyday, email me.
If you are interested in any of the White papers I write let me know.
Sign up for CIVL in the App store or in the Google store, eventually all my columns will be posted there.