We have noted on many occasions within the confines of these reports that capital markets thrive on certainty and struggle mightily when confronted with uncertainty, because investors know how to properly price securities when they understand the perceived risks and potential rewards associated with any given market environment, but tend to price in the perceived worst case scenario when confronted with market environments that are fraught with uncertainty.
This is why markets rallied very strongly into the “Brexit” vote once the betting platforms and British pound started reflecting a virtual certainty of a decision to remain within the European Union, and why the global capital markets lost a massive $2.6 trillion of value in only one trading day, once this perceived certainty was shattered. This is sum is greater than is the size of the entire Canadian economy.
How could the “smart money” have gotten everything so wrong? Many have offered explanations, almost none of which we find very satisfying. One of the most common is that the torrential rains that hit the London area (which has a very pro-EU leaning) on the day of the referendum held down voting numbers.
Instead, we attribute the referendum’s shocking results to a perhaps less obvious fact, which is that Boris Johnson, Nigel Farage and the rest of the pro-“leave” faction did a remarkably effective job of convincing the voting public that the dire warnings coming out of the International Monetary Fund (IMF), the World Bank, and virtually anyone who has ever successfully passed an economics class were simply fear-mongering being perpetrated by the existing establishment in order to protect their own power and greedy self-interests.
Despite these assurances from the “leave camp” the two days following the referendum produced a greater than $3 trillion loss in global capital markets, which represents the worst two-day loss in history.
It also left both the Liberal and Tory Parties in absolute disarray, and left Prime Minister David Cameron with little choice but to resign. It also cost Britain its AAA credit rating, it caused 12 of Britain’s banks to be downgraded for credit quality, and catalyzed the British pound to collapse to a 31-year low. That is not even to mention that Britain seems headed for a deep recession when and if it does ultimately withdraw from the EU. Indeed, Britain entered the “Brexit” referendum as the fifth largest economy in the world. As a consequence of the outcome, it just ceded that position to France, primarily as a result of the collapse in the value of its currency.
Obviously, the British population was misled by the “leave” camp, which is why there is already a petition with more than 4 million signatures on it asking for a second referendum. By law, this means that Parliament must discuss the issue. However, on June 27th, Prime Minister David Cameron pronounced in Parliament that, while he still thinks that “Brexit” is a terrible idea, the outcome of the referendum should be passed into law.
Importantly, he also said that he would not invoke Article 50 of the Lisbon Treaty (which starts the withdrawal process), and that he would leave that step for the new Prime Minister, who is not likely to come to power until September at the earliest. Technically, the new Prime Minister could elect to never even invoke Article 50, as the referendum is not legally binding.
To emphasize, Britain is still a member of the European Union (EU), and is likely to remain as a member for at least another two years. Indeed, once Britain invokes Article 50, it starts a two-year process of negotiation regarding their exit, and despite their vehement protestations, there is nothing that the remainder of the EU can do to force Britain to accelerate the process.
While we believe that one must assume that a “Brexit” will ultimately take place, there are a number of reasons why it is far from being a foregone conclusion.
For example, based upon the Scotland Act of 1998, the Scottish Parliament must agree to any measure that eliminates the application of EU laws in Scotland. Since Scotland (and Northern Ireland) voted overwhelmingly to stay as a part of the EU, it should be no surprise that factions in both countries are attempting to put in place constitutional challenges to the United Kingdom’s (UK) right to force those two countries to withdraw from the EU. Of note, if “Brexit” does take place, it is highly likely that Scotland will hold another referendum about remaining as part of the UK, and it is fully expected that it would be successful this time. This would effectively end the 300-year-old history of the “United” Kingdom.
In addition, the law firm Mishcon de Reya has just filed a lawsuit that would require the British government to get Parliamentary approval before it can invoke Article 50, and it is estimated that 75% of Parliament’s 650 members favor remaining in the EU.
Further, Theresa May, who is an overwhelming favorite to be elected as the new Prime Minister in September or October, has stated that, while she would plan on invoking Article 50 (despite being a strong opponent of “Brexit”), she would not do so until 2017 at the earliest. There is a lot that can happen between now and then.
Of interesting note, since 2001, France, Ireland, and The Netherlands have all held referendums on European-related issues which were ultimately just ignored by politicians. The same is true of a 1992 referendum in Denmark. There is certainly historic precedent for Britain to do the same.
However, despite these and other obstacles to the actual implementation of “Brexit”, we believe that, at this point, it is only prudent to assume that it will go through as planned. However, that outcome is nowhere near as dangerous as it would have been a week or two ago, when the markets fully reflected everyone’s confidence that “Brexit” would be defeated. In other words, so much of the post-“Brexit” losses just retraced the powerful rally that preceded the referendum based upon overwhelming confidence that Britain would stay in the EU. Now, almost everyone expects for “Brexit” to take place, which means that much of its associated risks are already reflected in prices. If, for some reason, “Brexit” does not take place, it would likely be an even more powerful bullish influence than the “Brexit” vote was a bearish influence.
This is a political crisis, not a financial crisis, and we do not view it as a 2007-style systemic risk. Indeed, on many levels, “Brexit” is just part of a broader phenomenon that includes Donald Trump, Bernie Sanders, “Occupy Wall Street” and the “Tea Party Movement”.
We view each of these as manifestations of a backlash from the global financial crisis, the broad perception that the wealthy were bailed out at the expense of the less fortunate, and the fact that those most responsible for the crisis were never held accountable for their actions. There is a resulting distrust of the status quo and the nebulous “establishment”.
It is this perspective and the growing trends towards nationalism, isolationism, protectionism, populism and xenophobia that have so many European leaders worried that a “Brexit” could catalyze a chain reaction with France, Finland, The Netherlands, Greece, and Italy each of which want their own EU referendum that could ultimately undo 70 years of European integration.
Indeed, an Ipsos MORI poll taken in nine EU countries showed that 45% wanted a referendum on EU membership and that 33% would vote to leave the EU. This poll was actually taken a full three months before the “Brexit” vote.
Like the election indecision in the 2000 Presidential vote, even a political crisis can roil markets with the uncertainty that they create. However, unlike in 2000, this political crisis carries with it some rather draconian economic risks.
The British Treasury estimates that the “Brexit” will cause the loss of 500,000 British jobs, a 10% decline in British home prices and a decline in the size of the British economy of 3.5% (a deep recession). Estimates are that it will shave approximately 1% off of the remaining EU economy and between 0.25% and 0.5% off of the economy of the United States.
Given the low economic growth rates that prevailed prior to the “Brexit” vote (the World Bank just cut its global growth forecast from 2.9% to 2.4%), the “Brexit”-related headwinds pose a risk of pushing the global economy perilously close to recessionary levels.
This is one of the reasons why the Fed Funds Futures contracts are showing a greater likelihood of a Fed rate cut in 2016 than a rate increase this year. Similarly, Bank of England Governor Mark Carney just announced that economic conditions in Britain are already deteriorating and that further monetary stimulus is likely over the summer. British Chancellor Osborne has also just announced a proposal to cut corporate taxes to 15% in a bid to keep companies from pulling out of the U.K as a result of the “Brexit” vote.
From our perspective, all of this comes down to two big questions. The first regards the severity of a risk of contagion (that other countries will follow Britain’s lead). The second regards the impact on the global capital markets and whether or not changes need to be made to portfolio allocations in light of the “Brexit” referendum.
In regard to the risk of contagion, the fact that in the Spanish election, which was held almost immediately after the “Brexit” referendum, the conservative Partido Popular party gained seats against the far-left Podemos and Ciudadanos parties suggests that “Brexit” may have at least temporarily scared voters away from further anti-establishment moves. In addition, according to the latest poll from the European Commission, 37% of all EU citizens currently have a positive view of the EU versus only 23% with a negative view (38% are neutral), which suggests that the contagion risks are not as high as have been feared.
Even in the UK itself, the 52% to 48% split for “Brexit” was due almost entirely to voters above the age of 55, whose lives and job prospects will be least impacted by leaving the European Union. Of voters under 24, 75% voted to stay in the EU and, of those between 25 and 49, 56% voted to remain as part of the Union.
In regards to portfolio adjustments the first reaction is probably to get very defensive, and to stay away from the affected markets by shifting to the relative safety of the United States. We agree that foreign allocations should be reduced, but not eliminated, as Europe is already trading at a valuation discount of between 20% and 25% versus the U.S. In addition, the weaker pound and euro should greatly benefit exporting companies by making their exports more competitive overseas. This should be especially beneficial to British companies (and their stocks), as they make only 22% of their revenues from their home market. This largely accounts for the fact that, after experiencing severe losses in the days immediately following the “Brexit” vote, the British blue-chip FTSE Index rebounded to set a new 2016 high by the end of June.
In stark contrast, the stronger dollar is likely to be a stiff headwind in the face of domestic blue-chip earnings, as will the relatively protectionist agendas of both Trump and Clinton. Indeed, S&P 500 companies derive approximately half of their revenues from exports and foreign operations, which means that the expected slowing of the global economy and the stronger dollar are likely to significantly impact domestic blue-chip earnings. While the S&P’s direct exposure to Britain is only a modest 4%, its direct exposure to continental Europe is a very substantial 17%, which is notably concerning.
Japan also faces currency-related challenges, as its economy depends overwhelmingly on its ability to export. Despite all of the economic headwinds faced by Japan, and the fact that almost two-thirds of the world’s negative yielding debt is originated in that country, the value of the yen keeps climbing higher and higher, and this trend is exacerbating Japanese deflation and hurting Japanese corporate profits.
In contrast, the world’s emerging markets may actually benefit from the “Brexit” vote and all of the turmoil and economic slowing that should come about as a result, as these markets tend to be very influenced by the level of interest rates, and these European issues should keep interest rates lower for longer than almost anyone would have expected just a few weeks ago.
In many regards, current conditions are largely unprecedented, which certainly complicates any attempts to anticipate future market leadership. However, if one ignores most of the political issues and just concentrates on the prospects for interest rates, currencies, and global economic growth, one can craft a reasonable market hypothesis.
This process suggests that one emphasize large capitalization exporting companies out of Europe and Britain and smaller-capitalization companies out of the U.S., which tend to cater to a domestic consumer base. Similarly, one should reduce one’s exposure to smaller capitalization foreign companies and large-capitalization domestic exporting companies.
It also suggests that one should emphasize defensive consumer staple stocks over more economically sensitive (cyclical) stocks. Despite the fact that they are already quite over-valued on a normalized basis, it also argues for either high-yielding stocks or companies growing their dividends. This would include real estate investment trusts (REITS) and even utilities. An exception would likely be banks and other financial companies in light of our expectations for rates remaining near historic lows for an extended period of time and the fact that there is a banking crisis emerging in Italy, which may create the next challenge to the sustainability of the EU (because Italy wants to use public funds to bail them out in violation of EU law that requires stock and bondholders rather than taxpayers to foot the bill for any bailout). Despite all of these aforementioned issues, we continue to prefer equities, REITs and even high yield bonds over virtually any other asset class over the longer term.
Bob Phipps currently serves as company Director and lead manager for two of Per Stirling’s SMA portfolio strategies. He also authors the monthly Per Stirling Capital Outlook, which details the firm’s macro-economic perspective. In addition, he works directly as an advisor for a select group of individual investors, which includes primarily physicians, executives of technology-oriented firms, and retirees.
Per Stirling Capital Outlook – June 2016
We open this writing with a 1912 photograph of a man crash-testing a football helmet not only in recognition of the fact that the long-awaited start of football season is finally approaching, but also because there is probably great similarity between how this product tester felt 104 years ago and how most global equity investors felt in mid-June.
In many regards, the domestic markets running into major resistance at their old all-time highs was almost as predictable as was the collision into the wall back in 1912. As we had noted in the June 6th e-lert sent to clients in the Per Stirling Core Growth Portfolio, “With most of the domestic equity markets back at the top of their long-standing trading ranges, the seasonal weakness often associated with the summer months, the upcoming risks associated with the “Brexit” vote (that will determine if Britain remains in the European Union) and a potential summer interest rate increase in the U.S., we believe that there is a decent chance of a modest, short-to-intermediate term decline in equities, and we want to have some cash available to take advantage of it”.
You can see the investor fear related to these fundamental concerns manifested in a variety of ways including the recent decline in global equity markets, the surge in the price of gold, the virtual doubling in the prices for defensive options, and the parabolic move higher in the value of alternative currencies like Bitcoin.
On top of these fundamental challenges, there is also a very strong technical reason to have expected the equity markets to run into major resistance almost exactly where they did. In its simplest form, “markets have memory”.
To explain, investors (and people in general) have a very strong tendency to repeat behavior that has been pleasurable or rewarding in the past, and to avoid behavior that has been unpleasant or harmful in the past. As a result, it is very common for markets to have areas of support and resistance.
In essence, an area of support is a price range which has repeatedly been a “pleasurable or rewarding” level at which to invest. It is a level in the markets at which investors have been trained to invest additional assets based upon both intuition and human nature. An area of resistance is the exact opposite, except that they can often be even harder to break through.
Due to these tendencies, it is not unusual for cash to sit on the sideline until support levels are retested, at which point money pours into the market, ending the decline and launching the next leg higher. The exact opposite is true of areas of resistance (a.k.a. overhead supply). Many investors will sell at old highs simply because it has been profitable to do so in the past. This brings a new supply of shares on to the market, and often catalyzes the next decline.
Markets (or securities) cannot break above these resistance levels until such time as buying power is more than sufficient to absorb all of that pent up selling pressure. Similarly, markets (or securities) cannot break below these support levels until such time as selling pressure is more than sufficient to absorb all of the pent up buying power.
You can see this illustrated perfectly in the chart of the Standard and Poor’s 500 Index. Support (underlying demand) is found in the grey-shaded area, and resistance (overhead supply) exists in the green-shaded area. This “tug-of-war” between supply and demand has been ongoing since 2014, and has created one of the longest and tightest trading ranges in modern market history. Again, this trading range will persist until either the bulls or bears become sufficiently dominant to overwhelm either the overhead supply or the underlying demand (respectively).
The area of resistance currently confronting the U.S. equity markets is proving particularly resilient, which we attribute largely to the market’s historically high valuations. Further, we expect that valuations are likely to remain as a formidable headwind for equity prices for so long as productivity gains remain quite muted and earnings growth is only modest at best.
Of note, the Dow Jones Industrial Average is also facing psychological resistance at the 18,000 level, where it has continued to run out of steam. While it is not at all unusual for equity markets to really struggle breaking through and staying above either technical or psychological resistance, it is important to remember that it has been over a year since the domestic markets have seen new highs, which is remarkable in a bull market cycle.
To explain, areas of support and resistance have historically proven to become increasingly formidable with each failed attempt to break through them, and there have already been more failed attempts to break through resistance over the past eighteen months than can be easily counted. This is why potential big, broad topping patterns can be so ominous. As the old saying goes, “the broader the top, the greater the drop, the broader the base, the greater the space”.
With the last new high put in place back on May 19th of 2015, we believe that it is critically important for the markets to reach new highs before the year is done, which is our expectation. However, if the markets do not break out as expected, this has the potential to be a very broad top indeed.
The likelihood is that someone who is purely a technical analyst would maintain that it is purely this technical resistance and overhead supply that have caused the recent market decline, and that the “Brexit” vote and the concern over the prospect of the Federal Reserve raising short-term rates are simply the excuses that investors are using to rationalize what the markets were going to do anyway.
While there is an element of truth in this perspective, these two factors are classic “tail risks”. Either a vote for Britain to leave the European Union or a surprise rate hike by the Fed would have the potential to roil the capital markets. However, we believe that the likelihood of either event taking place is low enough to justify both maintaining existing risk market exposures, and even using the recent weakness to increase equity weightings.
The “Brexit” Vote: As is illustrated in the Bloomberg chart, the campaign to withdraw from the European Union had been gaining significant ground over recent weeks, which, with all deference to our technically-oriented colleagues, was clearly having an impact on global equity prices.
All of that seemed to change dramatically with the tragic murder of British Member of Parliament Jo Cox, who was a staunch supporter of the “remain” vote, and who was killed by a right-wing, pro-“leave” activist. Immediately following the murder, the betting markets slashed the chances of a “Brexit” from 42.4% to 34.0%. Moreover, polls taken over the weekend for The Mail and The Sunday Times show a lead for the “stay” camp of 3% and 1% respectively. This is reflected in the consolidated polling data’s fall to a 37.4% likelihood of “Brexit”.
In addition, the betting markets have a much better history of predicting election outcomes than do the British polls, and they have never given the “leave” vote as much as a 50% likelihood of passing, and currently assign it only a 34% likelihood. Indeed, the British have a reputation for “polling with their heart and voting with their head”. A recent example of this is found in last year’s Scottish referendum on remaining as part of Britain, where polls predicted a very close vote only to have an overwhelming majority of Scots vote to stay as part of the United Kingdom. In sharp contrast to the polls a year ago, the betting (prediction) markets were overwhelmingly predicting a “stay” outcome, just as they are today.
In addition, it is important to remember that this is a non-binding referendum that would actually need to be passed through Parliament (where 75% of members favor staying in the European Union) before it could become effective (although a landslide “leave” victory would likely be perceived as a mandate for change).
Even if it did pass Parliament, Britain’s relationship with the EU would not suddenly end. Instead, a two-year negotiation between the parties would begin. How those negotiations would go is hard to anticipate. There is one camp of analysts who believe that the rest of the EU needs Britain’s involvement (as the world’s fifth largest economy) and will need to make concessions to maintain close economic ties between the two parties.
There is another camp of analysts who believe that the European Union must punish a “leave” vote from Britain by making an example of them, via hurting the British economy in every way possible, so to keep other countries (probably starting with France and Finland) from attempting to follow Britain out of the Union.
A “leave” vote would certainly cause us to reexamine our outlook, as it could ultimately catalyze the unwinding of the European Union. However, in the meantime, we are working under the assumption that the “remain” vote will prevail and that, even in the event of a “leave” vote, we have already seen some preview of the market reaction over the past week or two when a “Brexit” seemed inevitable to everyone but the prediction (betting) markets.
In regard to the Outlook for the Federal Reserve and monetary policy, a recent slowing in the U.S. economy in general and in the labor market in particular has caused the Fed to adopt a much more “dovish” perspective. In other words, they are rapidly backtracking on their recent guidance that they were likely to raise rates this summer.
As a result of this change in guidance, the markets have now taken the likelihood of any 2016 interest rate increases off of the table, with even a December rate hike being assigned less than a 50% likelihood, and we know that, since the days of the Greenspan-led Federal Reserve, they have never changed interest rate policy until after the change was already anticipated by the markets.
Put another way, due to the recent slide in the domestic financial environment, the markets are now pricing in less than one rate increase in 2016. For the time being, we believe that you can safely move the risk of a tightening by the Federal Reserve off of the table.
In regard to the U.S. elections, the latest polls show Clinton taking an increasingly commanding lead over Trump, which is being perceived as bullish for domestic equities. As we have noted over recent writings, investors tend to strongly prefer “bad news” over uncertainty, as they at least know how to price “bad news” into the capital markets. While most investors tend not to like Clinton’s policies, they at least know what those politics are, and they don’t worry that those policies will change on a whim, which is a perceived risk with Trump.
The other perceived risk of a potential Trump presidency that is very troubling to both investors and the economic outlook in general is the fact that his campaign has emphasized a message of isolationism and protectionism. This philosophy has traditionally slowed economic growth and exacerbated inflation, and was a key driver of the passage of the Smoot–Hawley Tariff in 1930 that greatly exacerbated the Great Depression.
While there are some appealing components of the Trump economic platform, most investors (ourselves included) are concerned greatly by Trump’s demonstrated ignorance of macroeconomics and his unwillingness to learn the lessons of history.
You can clearly see the fact that investors are more comfortable with Clinton than Trump in the very tight correlation (84%) between Clinton’s poll numbers and the price action in the equity markets themselves. We do wonder if investors will remain as comfortable with Clinton if she, as is rumored, picks Elizabeth Warren (who rose to prominence by bashing the investor class) as a running mate. We worry about this as well, but suspect that she will need to pick a different candidate, as the selection of Warren would likely cost the Democrats a seat in the Senate, due to the fact that the Republican Governor of Massachusetts would get to select her replacement.
Moreover, unlike in the United Kingdom, the U.S. prediction (betting) markets and the polls are in agreement, with the prediction markets assigning a 68% likelihood of a Clinton victory in November.
In summary, the equity markets still face a variety of challenges. They are confronted with massive overhead resistance. Valuations are quite high on a historical basis. Earnings and productivity growth remain quite poor, and capital gains taxes are at risk of moving much higher in the event of a Clinton presidency.
At the same time, markets thrive on clarity, and investors should get greatly improved clarity of the “Brexit” situation over coming days and on the U.S. elections over the coming months. In fact, equity prices may be a leading indicator of that election outcome. Since 1944, if the S&P 500 rose in price from July 31st through October 31st, the incumbent party was re-elected 82% of the time. When it fell over that period, the incumbent party lost the White House 86% of the time.
This improving clarity, when combined with the fact that the primarily negative-yielding world of the debt markets leaves very few viable alternatives in which to invest one’s money, keeps us rather constructive on the global equity markets through this year and into 2017. Moreover, if the “Brexit” vote turns out as we expect, we believe that the recent angst-related sell-off will prove to be a wonderful buying opportunity for longer-term investors to build upon their allocations to the foreign equity markets.
-Bob Phipps is a GLO member and currently serves as company Director and lead manager for two of Per Stirling’s SMA portfolio strategies. He also authors the monthly Per Stirling Capital Outlook, which details the firm’s macro-economic perspective. In addition, he works directly as an advisor for a select group of individual investors, which includes primarily physicians, executives of technology-oriented firms, and retirees. To contact Bob please email firstname.lastname@example.org.
Latest Crop of Farm Machinery Software is Planting the Seeds for Strong Copyright Growth
But, I’ve noticed a recent trend that is worth consideration for some new ideas: Copyrights seem to be moving into the money-making spotlight. At the same time, there is less talk of patents as financial security.
How patents may be losing their luster
Two large companies recently announced that they’re loosening the strings on their patent rights somewhat:
- Elon Musk of Tesla fame stated that “these days they [patents] serve merely to stifle progress, entrench the positions of giant corporations and enrich those in the legal profession, rather than the actual inventors.”
- Ford Motor Company’s intent was expressed in a commentary that it “believes sharing its patented technologies will promote faster development of future inventions as all automakers look toward greater opportunities.”
Regardless of Ford’s or Tesla’s written reasoning, both are almost certainly attempting to expand their own electric vehicles market to make more money. Nothing wrong with making money! That’s what companies should do and it’s quite likely some serious business strategy decisions went into each statement.
NASA has also weighed in about sharing patents, but it’s quite likely that their intent is their own market growth, since they’re a government agency. NASA states that their belief is that sharing its patented technologies will promote faster development of future inventions.
On top of all this, there has been a lot of negative press about patents in regards to lawsuits from Patent Trolls as well as some general fear/disrespect for patents in general.
How copyrights may be gaining appeal
John Deere, the tractor manufacturer best known for its trademark green color, is receiving a lot of attention about copyrights lately.
As you might have guessed, tractors have been around a really long time and there are several companies that are well known in this industry. So, in a saturated market, how would you choose to beef up (agricultural pun intended) the bottom line?
According to Fortune magazine, one row to hoe is software services. While feeding the bottom line, these services also add a lot of complexity to the products they’re improving and the lives of the people that use them.
A recent article in Wired points out how the do-it-yourself culture of farmers is getting interrupted. Modern farm equipment includes sophisticated information gathering, but farmers can’t pull down the data their equipment generates and they are unable to fix minor or major problems without the permission of John Deere.
The reason is software copyrights. Certainly password protection and other hardware barriers limit the ability of people to log into their tractor’s computer systems, but ultimately it is the copyright that says you are violating the law during any attempt to do so.
Is this example unusual? Not at all. Ford is asserting their copyrights, among other methods, in an attempt to control the activities of competing diagnostic reader Autel which “decrypted a list of parts used in Ford’s vehicles and included it in its own product.”
The problem for Ford is that Autel’s “aftermarket diagnostics tools [are] meant to help consumers identify problems with their vehicles without requiring them to visit a manufacturer-sanctioned automotive shop in order to do so.”
Perhaps the Internet of Things (IoT) will push copyrights ahead in importance for years to come.
My thoughts and predictions
Let’s wrap up this discussion of patents versus copyrights with some analysis.
I predict that companies in the agricultural and construction equipment segments will continue to move forward to refocus their profit margins on copyrights, especially as their products get even more laden with sensors and computerization.
Already, Caterpillar, known for the famous yellow color on its line of construction equipment, has been noted as “installing all kinds of cameras, sensors and satellite-based positioning control and guidance systems on its machines to help customers increase their productivity and efficiency and eliminate workplace accidents.”
While this data is very useful, it is potentially most valuable to the company as it promotes services and tries to stifle competition. I predict that the buyers of these products will start becoming more vocal about gaining access to any and all data that they have generated but may not be currently available to them.
Why are patents losing their luster while copyrights begin to shine for future business profits? A few ideas:
- Patents are more time consuming and expensive to obtain and maintain than copyrights.
- “Software” patents are being more rigorously examined by the USPTO and, therefore, have become much harder to obtain since the “Alice” decision in 2014 by the U.S. Supreme Court.
- In the U.S., the term for patents is 20 years while the term for corporate copyrights is 120 years.
- Patent infringement is more difficult to detect while detecting copyright infringement in software can be much easier when the software has to connect with the company’s server for authentication, updates, or data storage.
- Software development seems to be getting a lot more attention than hardware in recent years. At least that’s my perception.
Are either of either of these trends real? If so, are they related? What are your thoughts?
With thanks to David Tuttle, Research Fellow in the Energy Institute at The University of Texas, for his contributions.
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Warren Buffett famously noted that “only when the tide goes out do you discover who’s been swimming naked.” This quote has particular relevance today as we are finally starting to see free-market pricing mechanisms at work, as market-distorting forces ranging from the Federal Reserve’s expansive monetary stimulus programs to the O.P.E.C. oil cartel are increasingly loosening their grip on the markets.
It is a slow adjustment, and its full impact will not be felt for some time to come, but prices are increasingly being set by more traditional factors such as supply and demand and the unique fundamentals of each individual security. This has implications that are both impactful and far-reaching.
For an example of this concept, one needs to look no further than the energy markets, where the O.P.E.C. decision to abandon its role as “swing producer” has caused oil prices to collapse by over 67%. In other words, O.P.E.C. decided to let market forces like supply and demand set the price of oil in lieu of their normal practice of conspiring to reduce supply as a means of keeping prices high.
This decision was made to protect their market share, to crush the emerging U.S. shale-drilling industry, and to punish and weaken their traditional enemies (Russia and Iran). It will be very interesting to see just how long free-market forces will be allowed to prevail (especially after Iranian production returns to the market en masse), as Saudi Arabia is already needing to issue bonds to support its $100 billion annual deficit, and the International Energy Agency just announced that it will likely still take several more years before O.P.E.C. can effectively price out high-cost producers like the domestic shale-drilling companies.
However, O.P.E.C. is a relatively minor player in the market manipulation game when compared to the global central banks, and now their “tide” is slowly going out, first by “tapering” (i.e. reducing the size of) their quantitative easing programs from $85 billion per month to $0 (as of October of 2014) and second, by increasing interest rates in December, for the first time in almost ten years.
These programs were specifically designed to create asset class inflation, and they were very effective in that regard. Almost all asset classes, including equities, debt securities, real estate, and even certain commodities saw their prices rocket higher over this period of monetary stimulus. However, now that that stimulus is starting to wane, we are starting to see some signs that the opposite is taking place.
As noted, from the start of the Fed’s zero percent interest rate policy in late 2008 (shown in red) to the early months of 2015, almost all asset classes gained value. In sharp contrast, almost no asset classes made gains in 2015 as a whole. Indeed, as is illustrated by the following chart from Bianco Research, 2015 was an asset allocator’s nightmare, as virtually no asset classes outpaced the return on cash.
This is much more unusual than one might think, as there is normally at least one major asset class that produces, at minimum, high single- digit returns. However, according to Bianco’s research, 2015 is actually on track to become one of the five worst years for broadly diversified portfolios since 1926 and, if one expands the list to include other asset classes like small cap domestic stocks (-6%), developed foreign stocks (-2%) and emerging market stocks (-15%), 2015 ranks as the worst year ever from an asset allocation perspective.
Our point is not just that it was a difficult year in which to make money, but that we suspect that the across-the-board lethargy is probably largely a function of the aforementioned “tide” going out. With the Fed no longer purchasing $85 billion of debt securities every month, a historic, thirty-year bull market in bonds seems to have lost its last bullish catalyst. With short-term interest rates finally starting to move higher, equities are looking increasingly expensive, and unable to break out of the trading range that has restrained them throughout most of the year. Finally, the Fed’s decision to raise interest rates at a time when slowing economic growth and deflation are still a bigger risk on a global basis than are inflation and an overly-hot economy is simply throwing gasoline on a bear market fire in the commodities markets.
This massive reflation in financial and real estate assets was designed by the Federal Reserve and fueled by zero percent interest rates and an overly abundant money supply. The all-important question is whether or not the economy has seen sufficient improvement to sustain itself (and the prices of risk assets) in the face of stagnant money supply and incrementally higher interest rates.
It has been said that it is impossible to know where you are going if you do not know where you have been. With that sentiment in mind, let’s take a look at the impact that was had by the very policies that are now starting to be reversed. As we progress through these charts, two things will become very obvious. The first is just how dramatic the benefits of zero percent interest rates have been (and thus the potentials risks associated with higher interest rates). The second is just how much the economy has already recovered, which suggests that it should no longer be as dependent on the stimulus of zero percent short-term rates.
The Fed’s decision to adopt a zero percent interest rate strategy had an immediate impact on consumer confidence, as is reflected in the monthly University of Michigan Consumer Sentiment Index, and this boost in confidence had a direct impact on consumer spending and a follow-through impact on the strength of the U.S. economy itself (hardly a surprise when you consider that consumer spending accounts for about 70% of the size of the U.S. economy).
You will also note that the Fed’s announcement of a zero percent interest rate policy coincided very nicely with the bottom in home prices.
As noted above, this was all exactly according to the Federal Reserve’s plan, which was detailed in a November 4, 2010 Washington Post op-ed by former Federal Reserve Chairman Ben Bernanke.
In that article, Chairman Bernanke noted his belief that, “Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
With the benefit of hindsight, the Federal Reserve’s quantitative easing and zero percent interest rates policies were remarkably successful, particularly when one considers that, over the same period, the makers of fiscal policy (Congress and the White House) were so inept and so dysfunctional that no fiscal stimulus was ever introduced to help pull the domestic economy out of the Great Recession.
It is largely this lack of any type of fiscal stimulus that calls into question the sustainability of the economic recovery now that the first steps to unwind the Fed’s monetary stimulus are being taken.
Indeed, while the advent of the Fed’s zero percent interest rate policy initially had a very stimulative impact on both the manufacturing and service sectors of the domestic economy, there is a growing body of evidence that the manufacturing sector is already sliding back into recession. We blame much of this manufacturing sector retrenchment on the surge in the value of the dollar, which is a risk that we discussed in great detail in last month’s report.
To illustrate the impact of zero percent interest rates on the two major sectors of the economy, we will use two measures from the Institute of Supply Management (ISM). Both are oscillators, which means that any readings above “50” indicate positive growth while readings below “50” indicate economic contraction.
The first of these, the ISM Manufacturing Index, is based on surveys of more than 300 manufacturing firms, and monitors employment, production inventories, new orders and supplier deliveries. The second oscillator, the ISM Non-Manufacturing Index is based on surveys of more than 400 non-manufacturing (i.e. service-sector) firms’ purchasing and supply executives, within 60 sectors across the nation.
You can see that the manufacturing sector has now slowed into contractionary territory, which would have been extraordinarily concerning 100 years ago. However, as of 2015, the manufacturing sector only represents 12% of the size of the domestic economy.
At the same time, for every $1.00 spent in manufacturing, another $1.37 is added to the economy, which gives it the highest multiplier effect of any economic sector. Manufacturing also accounts for about one in six private-sector jobs and some of the highest wages in the country ($77,506 annually, in contrast to the average worker in all industries who earns $62,546).
The key question is whether the manufacturing slowdown is due to its own fundamentals (a stronger dollar, slowing growth in China, and the devaluation of the Chinese currency), or is it the canary in the coal mine that is flashing a danger sign for the U.S. economy as a whole. At this point, we are inclined to view the slowdown as being unique to the manufacturing sector, but that it certainly bears watching.
What we do know with certainty is that there has historically been a correlation between the performance of domestic equities and whether the domestic economy is strengthening or weakening, and this tendency is one of the factors that keeps us fairly bullish in our 2016 outlook for the domestic equity markets.
We remain even more bullish in regard to the major foreign equity markets in general and the European markets in specific, where both the manufacturing and service sectors continue to expand. Indeed, the European equivalent of the above ISM Manufacturing and Non-Manufacturing Indexes stand at 52.8 and 54.6 (a four and one-half year high). Recall that any readings above “50” indicate economic expansion. In addition, Europe, Japan and China should each benefit from large and growing monetary stimulus programs that are taking place in their home countries.
We are also assuming that we will continue to see increasing strength in the value of the U.S. dollar, as a result of the U.S. tightening policy at a time when most of the remaining industrialized world is pursuing increasingly accommodative monetary policies, and that these diverging currencies should also benefit foreign economies and international capital markets.
However, while it certainly makes sense that these divergent paths (and higher domestic interest rates) should serve to boost the value of the dollar, these two variables do not exist in a vacuum, which means that a stronger dollar, while likely, is still far from assured. Indeed, if you look at the past five times that the Federal Reserve raised interest rates, the dollar gained strength over two of those periods (1983 and 1984), but actually lost value during three of those periods (1987-1989, 1994, and 2004-2006).
Importantly, the domestic economy either held its ground or even accelerated subsequent to each of the past five monetary tightening cycles, so a domestic slowdown is far from assured. At the same time, it should be noted that most interest-rate-rising cycles are a byproduct of an over-heated economy, which is clearly not the case this time.
Another reason for our preference for the foreign equity markets relates to earnings generally and price-to-earnings (P/E) multiples in particular. There is a well-documented relationship between interest rates and P/E multiples. When rates are falling, investors are normally willing to pay more for each dollar of equity earnings than they are when rates are rising. As such, investors will normally tolerate higher P/E multiples when rates are falling and vise-versa. As such, with rates now rising, earnings may need to accelerate in order to justify current equity prices.
Current expectations are that domestic corporate earnings will end 2015 down 0.7%, after falling 4.9% in the fourth quarter, while top-line revenues declined by 3.4% (according to FactSet). If fourth quarter earnings do, in fact, decline as expected, it will mark the first year-over-year declines over three consecutive quarters since 2009.
As a whole, the year 2015 was notable for its very poor market breadth. While the 10 best performing stocks on the Standard and Poor’s 500 Index averaged impressive gains of 19% on the year, the other 490 stocks on the index actually lost an average of 4%. It was also a market dominated by growth stocks over value stocks.
Growth stocks, on average, gained 3% during the year, while value stocks averaged annual losses of 7%. Of interesting note, according to O’Shaughnessy Asset Management, value stocks have outperformed growth stocks in 14 of the past 17 rate-hiking cycles.
It should also be noted that current expectations are for the Federal Reserve to raise short-term rates by one-quarter of one percent three or four times in 2016. That is actually only about one-half as aggressively as rates have gone up on average during past interest-rate-hiking cycles.
Overall, the global economy is expected to accelerate from a 3.1% growth rate in 2015 to 3.4% growth rate in 2016, which is yet another reason for our preference for foreign industrialized markets.
However, we are also working under the assumption that the domestic economy has already recovered sufficiently to withstand the drag that is likely to come from higher domestic interest rates. The U.S. has largely recovered from the global financial crisis. Growth seems sustainable, the unemployment rate has been cut in half and all of the nine million jobs lost during the Great Recession have been replaced. Indeed, the weekly jobless claims numbers are now the lowest since 1973.
We believe that the price correlation between stocks will continue to weaken, which should allow adept stock analysts to add real value to investor portfolios. This would be a remarkable change from recent years, when very few active managers have been able to outperform the equity indexes themselves. We also expect for value stocks to rotate back into favor this year, particularly once we see sustainable signs of stability in the energy markets.
With reduced efforts on the part of the Federal Reserve to keep the markets stable, we also expect for equity market volatility to increase. At the same time, we believe that it will make sense to “hold on for the ride”, as we believe that equities will resume their role as the top-performing asset class in 2016.
Robert S. Phipps serves as company Director and lead manager for two of Per Stirling’s SMA portfolio strategies. He also authors the monthly Per Stirling Capital Outlook, which details the firm’s macro-economic perspective. In addition, he works directly as an advisor for a select group of individual investors, which includes primarily physicians, executives of technology-oriented firms, and retirees.
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In December, we are likely to witness an extraordinarily unusual scenario of a major economic power (the United States) not only raising rates for the first time in over nine years, but also tightening monetary policy at a time when virtually all of the remaining industrialized world is moving their monetary policy in the exact opposite direction.
This creates an environment in which many economic and capital markets factors (like currencies, commodities, interest rates, asset flows, corporate profits, etc.) may react in some important and potentially very unpredictable ways.
To put this impending interest rate increase into some perspective, in 2008, the Federal Reserve launched the largest monetary stimulus program in history with two well-defined goals in mind. The first was to drive interest rates on savings vehicles to virtually 0%, as a means of forcing money out of savings institutions and into the capital markets, where it could be put to work in the real economy. The second was to create asset class inflation under the premise that, if you increase the value of the American consumers’ homes and investment portfolios, it would create a sort of “wealth effect” that would encourage consumption and stimulate the economy.
We suspect that their plan was not as effective as they had initially anticipated, as a huge amount of the more than $3 trillion dollars that they injected into the financial system never made it into the economy through bank loans, as the banks instead just left it on deposit at the Federal Reserve (in the form of “excess reserves”) and remained content to make a low but risk-free return on the difference between what they were paying savers for deposits and what they were receiving on their own deposits at the Federal Reserve.
While clearly not as effective as the Federal Reserve had hoped, their zero percent interest rate policy (a.k.a. ZIRP) and quantitative easing (money creation/asset purchase) policies did serve to stabilize the economy and facilitate a modest, but seemingly sustainable economic recovery in the United States.
The critically important role of these policies is why the Federal Reserve has been so slow, so deliberate and so transparent in their efforts to wean the domestic economy off of its need for monetary stimulus. After all, the last thing that the Federal Reserve wants is for the capital and/or real estate markets to have a violently negative reaction to the withdrawal of stimulus which, in turn, creates a “negative wealth effect” that could put the economic recovery at risk.
In fact, the anticipated rate increase would actually be the third of four steps toward monetary policy normalization. The first was the summer of 2013 announcement from the Fed that they were preparing to “taper” (i.e. gradually reduce the size of) their asset purchase program that ultimately purchased over $3.5 trillion (roughly the size of the German economy) of U.S. Government debt and asset-backed securities. This announcement resulted in the so-called “taper tantrum”, which temporarily pushed both emerging market equity and global bond prices sharply lower (i.e. yields higher).
The fourth and final stage of normalization is the shrinking of the size of the Fed’s balance sheet, first by letting their existing holdings mature without replacing them, and then ultimately through outright asset sales from the Federal Reserve’s $3.5 trillion portfolio of debt securities. This will probably not start until after the interest rate increasing cycle is well underway, which may be as much as several years into the future.
As was noted in a November 19th speech by Fed Vice-Chairman Stanley Fischer to the Asia Economic Policy Conference at the Federal Reserve Bank of San Francisco, “We have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to ’just do it.’”
The Fed has been as open and obvious as possible, and this should help to dampen the impact of higher rates on the capital and asset markets, as something so well anticipated should already be largely reflected in prices.
That is a reasonable expectation, which is at least partially confirmed by the Fed Funds futures markets, which are now assigning a 74% likelihood of a December rate hike and an 82% likelihood that the first rate increase will take place at one of the next two Fed meetings. This expectation is further supported by the soaring value of the U.S. dollar, a surge in the yield of 2-year notes, and the near collapse of many global commodity prices.
On the other hand, while this first rate hike seems to be well anticipated, a comparison of the Fed Funds futures (the red and blue lines representing what “the markets” think) to the average expectations of the voting members of the Federal Reserve, as noted in the minutes of the most recent Federal Reserve meeting (the black dots representing what the Fed thinks), you will see that the dots are considerably higher than are the lines. In other words, the voting members of the Federal Reserve expect future rates to be higher than the markets expect, which suggests that, while the markets are in fact discounting some of the implications of higher rates, there is still more adjustment to come.
Moreover, this policy change has the potential to create great macroeconomic uncertainty at a time when the world’s capital markets have become extraordinarily dependent on expansive monetary policy. To illustrate this important and very close correlation between Federal Reserve policy and the capital markets, we offer two facts.
First of all, according to a recent Deutsche Bank study, during the period from 1994 to 2011, if you owned the Standard & Poor’s 500 for only eight days per year, you would have made 80% of the gains made in equities over those 17 years. Specifically, those days were the 24-hour period before each meeting of the Federal Reserve, when the average gain has been 0.5% per day.
Second, as is illustrated in the Bianco Research chart of the Standard & Poor’s 500 since the 11/25/08 start of the Federal Reserve’s quantitative easing programs, the S&P has gained a net 176.23% during periods when there was expanding monetary stimulus and has lost a net 33.69% during times when there was not increasing levels of stimulus (periods illustrated in grey).
While we do not believe that it necessarily follows that equity prices must fall in response to Federal Reserve tightening, it does illustrate the historic importance of the relationship and the headwinds that the rate hike is likely to create.
Importantly, because markets are forward-looking, we do not need to wait until the rate increase takes place to gain an understanding of its likely implications. Since the level of interest rates is a prime determinant of the global demand for a currency (and therefore the price of a currency), it only makes sense that the first place where you would expect to see expectations for higher rates reflected is in the currency markets, where the dollar has been soaring since May of last year, when former Federal Reserve Chairman Ben Bernanke first warned about “tapering” (i.e. the gradual reduction in the dollar amount of debt that they were buying every month).
As soon as the Bernanke comment was made, it became evident that the United States was on a very different path than every other major industrialized country, in that the U.S. was slowly moving toward tightening just as the rest of the world was increasingly committed to significant monetary easing. This divergence explains the parabolic rise in the dollar against the currencies of its major trading partners (the Dollar Index or DXY).
A strong currency can be very beneficial in the later stages of an economic expansion, as it helps to mitigate inflation and increases the purchasing power of the American consumer. However, due to the after-effects of the financial crisis, deflation (falling prices) remains a much bigger risk than is inflation, and domestic inflation remains well below the Fed’s 2% target rate. Indeed, if you compare the difference in yield between inflation-adjusted treasury debt and non-inflation adjusted treasury debt of the same duration, you will see that inflation is expected to remain below 1.3% over the next three years and below 1.6% over the next ten years. In this case, the risk of a stronger dollar is that it will exacerbate these deflationary trends, which would retard consumer spending and put additional downward pressure on both interest rates and domestic growth.
Another problem associated with the stronger dollar is that it makes the prices of U.S. exports uncompetitive compared to similar products made in other parts of the world. Similarly it puts domestic companies at a competitive disadvantage with the U.S. consumer, as the prices of foreign goods get lower and lower. As a result, a strong dollar will tend to stifle growth in manufacturing sector employment.
The strong dollar should be of particular concern for big U.S. multi-national companies, which derive approximately 45% of their total revenues from exporting to other countries, and this is already having an impact on U.S. corporate profits.
Indeed, profits from S&P 500 companies have fallen by about $25 billion in the first three quarters of this year, and a further drop is expected before the end of 2015, largely due to significant losses in the energy sector.
According to a just-released report from Bloomberg, the aggregate revenue for S&P 500 companies has fallen by $287 billion over the same period last year. On a share-weighted basis, S&P 500 profits were down 3.3 percent year-on- year in the third quarter, making this earnings season the worst since 2009, and marking a second consecutive quarter of negative earnings growth.
However, despite this trend toward declining earnings, we continue to like the domestic equity markets for a variety of reasons, including our expectations for foreign investment flows into domestic equities, a recovering economy, and improving job growth. Also important to us is the fact that the domestic equity markets have reacted to a growing array of both geopolitical and macroeconomic risks (expectations of higher interest rates, the Paris terrorist attacks, the Turkish downing of a Russian fighter jet, and the Russian response of moving advanced anti-aircraft weapons into Syria) by moving higher in each instance. One of the most useful definitions of a bull market is a market that advances in the face of bad news.
However, as much as we like the domestic equity markets, we like the European (and even Japanese) equity markets even more. They are less expensive relative to earnings than are domestic stocks, they have the benefits of increasingly stimulative monetary policies, and they are likely to benefit from a stronger dollar, as it makes their goods more attractive to the American consumer. The ongoing terror threats in Europe certainly have the potential to create great volatility, and we consider additional attacks to be quite likely. However, we also expect for these threats to keep governments and central banks even more supportive of the capital markets than they would otherwise be.
The least expensive of all global equity markets tend to be found in the emerging market space, and there are some well-respected analysts who are starting to make a case for investing in these developing economies. However, we still have two major concerns that leave us quite cautious. First of all, the recent devaluation of the Chinese currency has hurt the global competitiveness of most other manufacturing-based emerging economies. Second, since the external debt of most emerging markets is valued in U.S. dollars, each increase in the value of the U.S. dollar effectively increases the indebtedness of these countries.
While a stronger dollar will no doubt present a modest headwind for U.S. investors investing overseas, we do believe that the potential rewards of adding to European and, to a slightly lesser extent, Japanese equities is well worth the risk.
We also suspect that we are likely to see a shift in domestic outperformance to portfolios that emphasize securities selection and tactical allocations over simply seeking a broad exposure to the equity markets.
Frankly, since the start of the Fed’s quantitative easing programs, it has been very challenging for more tactically oriented managers to out-perform the broad indexes themselves. Nowhere is that more evident than in the hedge fund space which is, at least theoretically, comprised of the best tactical managers in the world. However, central bank policies have distorted the pricing of markets and frequently left more-tactical managers making the worst possible decisions at the worst possible times.
There are two reasons why we suspect that this relationship is likely to change over the intermediate term.
First of all, with the Federal Reserve continuing to “normalize” its monetary policies, markets should trade increasingly on their own unique fundamentals instead of central bank policies, and this should help to restore value to fundamental and technical analysis. Second, in light of the fact that active portfolio management tends to outperform the markets when rates are rising and underperform the markets when rates are falling, the anticipated Federal Reserve decision to start raising interest rates should breathe new life into the portfolios of “stock pickers” and tactical allocators. It will be interesting to see if history repeats itself.
Robert Phipps currently serves as company Director and lead manager for two of Per Stirling’s SMA portfolio strategies. He also authors the monthly Per Stirling Capital Outlook, which details the firm’s macro-economic perspective. In addition, he works directly as an advisor for a select group of individual investors, which includes primarily physicians, executives of technology-oriented firms, and retirees.
I have taught communication mastery and leadership globally for decades as the creator of the voice and leadership training program Vocal Awareness. As such, I recognize the critical distinction between teaching students how simply to be business leaders and, as I teach them, how to “embody a leader” in business.
“Embody a leader” is not simply a turn of phrase. There is a difference between training an effective speaker who merely conveys data/information, and teaching future leaders to become effective communicators/storytellers. In short, voice is power. It is not simply what we say but how we say it.
How often in business meetings does someone walk in and merely put up a PowerPoint deck and begin streaming verbal data? In that regard, the business-school classroom is a microcosm of the business-world boardroom. We teach the material but don’t consider what I call “the message and the messenger.” The information may be there, but strategic communication is not.
So, what does it mean to embody leadership? The first thing to consider is that speech is habit. We do not consciously or strategically think about breath, body language, eye contact, visceral language (communicating the emotion of words), vocal quality, pitch or timbre.
We don’t think about these things, we just speak. But, if we are teaching leadership, we must embody leadership, not only in what we say but how we say it.
Read more here: entrepreneur.com/article/249830
Arthur Joseph is the founder of Vocal Awareness and a member of Global Leaders Organization
Ask not ‘what?’ but ‘why?’ Your purpose lies in the ‘why?’ not the ‘what?’ Thus, ‘why?’ is the purpose … the purpose? Everyone knows what they do and many know how they do it. However, in order to inspire action in everyone in the community (organization), it comes from defining ‘why?’ you do ‘what’ you do. It is the core premise that underlies religions and great momentum shifting movements in their day … because there is a cause, a purpose, a shared belief. Basic human nature creates most folks the same in the sense that they all want to be a part of something larger than themselves … it is ‘why?’ we go to Church, a Synagogue, a Mosque, a Temple, etc. It is ‘why?’ we have a tighter circle of friends that we bond with more closely. Profitability (if that is an end result) is simply an end result because companies ultimately attract believers. However, the most successful leaders profit from their inspired beliefs and the financial benefits follow later. Even Steve Jobs sketched the iPad 30 years before it was created while out on one of his routine, daily, barefoot walks. He knew at that time that is wasn’t in his technical grasp at the moment, however, one day it would be and it would transform the world in some way.
At Smoothie King (smoothieking.com), we re-invented a 40+ year old company in about 1 year by defining the purposes around the company and then marketing those purposes to folks who believed in the same thing we believed in. I didn’t invent the ‘why?,’ as a marketer, I simply resurrected, re-tooled and told the story of ‘why?’ and made believers stronger believers and attracted new believers. Same store sales jumped dramatically in a short period of time and the franchisees prospered.
This video by Simon Sinek is short, yet profound … and is a must watch for any leader of any size organization. (ted.com/talks/simon_sinek_how_great_leaders_inspire_action?language=en). It is absolutely one of my favorite videos on Ted and my management philosophy and has been for many years. Leaders who are meant to lead will understand this intuitively or instinctively. One area where I wish this video could have gone a little bit further was to touch on and explain … ‘take the time to explain to every employee on every task ‘why?’ this project or task is important to the company.’ Yes, it takes a little extra time at the onset, yet will save you a ton of time on the back-end. When employees know ‘why?’ they are doing something vs. just being told what to do, they feel a sense of ownership and a sense of pride in the result. And, increasingly, you will be amazed at the results because they now feel a part of something larger than themselves.
About the 4th word my children ever knew was ‘why?’ First was ‘mama,’ then ‘dada,’ then ‘no,’ then ‘why?’ We all have a natural, innate curiosity about us that sustains through life. ‘Why?’ starts from birth and it is not only natural, it is motivating!
David Moore is a GLO member has motivated businesses from multi-national Fortune 500 brands to revitalization brands to start-up companies via strategic thought leadership and communications strategies combined with brand building execution.
Do you choose to focus on what is going right in your life? It seems pretty much everything follows the 80/20 law – and I bet it’s no different in our lives. 80% of our lives are good, great or ok and 20% are other than positive.
Joyful people focus on the 80% that is pretty right – not the 20%! They acknowledge that the 20% exists and do what they can about it but they don’t chose to focus on those things.
Have you ever seen a youtube clip called First World Problems? It has had over 10 million hits and is well worth watching. It is a great spoof on the habit many of us have of focusing on really stupid things! And complaining about them – it’s worth having your whole team watch it at least once every 6 months. Watch it with your family as well because once you watch it, you become much more conscious of the ‘first world problem’ nature of what we are complaining about!
Like…my computer is so slow; the pool keeps getting dirty; our fridge is not cold enough; we have no ice in our drinks; I don’t have shoes to match this outfit; I have too many tools to fit in the box! And so on!
Are you guilty of complaining about first world problems?
What about your partner in life if you have one – or your friends, siblings or children? When you first met your partner – they were wonderful – everything you ever wanted! 12 – 18 months later, you know them better and realize they are human! They have ‘warts’ – we all do. But they – and we – have had those warts all along.
The difference is that in the beginning we didn’t focus on the warts. Now we do! ALL the good qualities we loved are still there – we just focus on the things that annoy or irritate us! STOP IT!
Remember the good and focus on that!
Every day during dinner, have a conscious conversation around what went right in your day. Help others savor those moments by asking them questions about that experience and getting them to relive those great or good moments. It makes them feel closer to you and strengthens the relationships.
Maybe you can adopt a new greeting? Meet someone and ask ‘what’s going right in your world?’ I bet it sparks lots of great conversations and makes you a very popular person! LOL.
Once you start to focus on what is right you just might find yourself appreciating the small things more. Appreciate what people do for you and let them know; appreciate the love your family gives you; appreciate the beauty of nature and all the magnificence around you; appreciate the fact you have oxygen to breathe – heck just appreciate everything!
Even the difficult stuff in your life – it is there to teach you lessons! Appreciation is a powerful force in your body. The Institute of Heartmath does wonderful research on appreciation and shown how good it is for heart health, as well as other things.
Go forth today and focus on what is right in your world; what is right in the people around you (at work and at home) and truly feel appreciation for what you have.
Amanda is a GLO member and speaker, author at The Joy Project.
Capital markets are known for “reverting to the mean”, which is one reason why we have been predicting, since mid-summer, that the markets were overdue for a period of dramatic downside volatility. That prediction was proven quite prescient in the third quarter, when the equity markets followed the least volatile six months in U.S. market history (early February through mid-August) with the highest statistical volatility (and the biggest quarterly losses) since 2011.
With third quarter losses in the major domestic equity indexes ranging from 6.9% to 9.3%, and losses in Western European equity indices averaging 9.0%, these two regions actually offered a relative “shelter from the storm”. In contrast, the world’s emerging equity markets, on average, suffered a quarterly decline of 18.7% (their worst quarter since 2008). The S&P Latin America 40 Index dropped by a dramatic 24.1% during the quarter and the S&P Asia 50 Index plummeted a similarly remarkable 17.6%. The Japanese and Chinese stock markets fell by 14% and 25% respectively.
As a result of this decline, the equity markets of the United States, Switzerland, Italy, India, Canada, the United Kingdom, France, Japan, and Spain have now declined between 10% and 20% from their recent highs (a “correction”), while the stock markets in China, Germany, Portugal, Argentina, Brazil, Hong Kong, Russia, and Greece are all down at least 20% from their recent highs (the definition of a bear market).
Even as bearish as our commentary has been over recent months, the global reach of this correction has surpassed even our expectations, which begs the question of whether or not this is now the time to step in and start taking advantage of the recent carnage. At bare minimum, we believe that the time has come to step back from the proverbial “ledge”, sit down at your desk, and start making your shopping list.
On one hand, we are still waiting to see a few things fall in place before making a high-conviction call that the ultimate lows have already been reached. On the other, you will see from the following list of elements that normally occur in conjunction with a market bottom that this correction has already checked most of the boxes.
The first requisite for most market bottoms is the existence of extreme levels of bearish sentiment. This is based upon the premise that, if you are bearish (i.e. you are confident that the market is due to decline), you have already sold your shares. It therefore follows that, if bearish sentiment is very high (or bullish sentiment very low), then most potential sellers have already sold and very few potential buyers have already bought. This normally translates into high levels of sideline cash, and an environment with significant upside potential and reduced levels of downside risk.
There are a number of ways in which analysts measure market sentiment. One of the most useful is the Investor’s Intelligence Bull/Bear Survey of investment newsletter writers. This survey, which divides newsletter writers into three categories (bull, bear, and neutral), provides a very useful perspective due to its leveraged nature. In other words, because each newsletter can help form the market opinion of thousands of subscribers, it helps to measure the market sentiment of a very large sample size. At this point, bullish sentiment is as low as it has been since the depths of the financial crisis in 2009.
Further insight into the sentiment of the individual investor can be found through the American Association of Individual Investors (AAII) Bull/Bear Survey, which reflects expectations for six months into the future. The results of the most recent AAII survey (9/30/15) show a massive 11.2% jump in bearish sentiment, which is quite bullish from a contrarian point of view. To put these sentiment numbers into some perspective, the long-term average for bullishness is 38.8%, for bearishness is 30.3% and for neutral is 31.0%, so you can see that bearish sentiment is approximately 32% higher than normal. Indeed, AAII bullish sentiment readings have now fallen for the 30th consecutive week, which is the longest such streak in the survey’s history.
Moreover, over the past three months, investors have pulled $63 billion out of domestic equity mutual funds, which represents the biggest quarterly withdrawal in the past 30 years.
Indeed, in the latest Investor’s Intelligence Survey of Financial Advisors, only 25% said that they were bullish on U.S. equities, which means that there are fewer bulls now than there were in March of 2009, when the Standard & Poor’s 500 Index reached its bear market low of 666, and only slightly more bulls now than when the survey showed only 22% bulls immediately after the collapse of Lehman Brothers, when there were broad concerns about a potential collapse of the entire financial system.
All of this suggests to us that the selling has become irrationally extreme, that the vast majority of potential sellers have already sold, and that very few of the potential buyers have started deploying their sideline cash. While only time will tell if the ultimate low for this corrective phase has already been reached, we currently view the market as having significant upside potential coupled with somewhat limited downside risk.
In addition to excessive levels of bearish sentiment, one of the key components of most market bottoms is a successful retest of the initial reaction lows. This is something that we wrote about extensively in the September edition of this publication, when we illustrated that in seven of the previous eight times (dating back to 1934) that the domestic markets have experienced such a short, sharp correction, the market required a successful retest of the initial reaction lows (i.e. a double bottom) before they could make a sustained move higher.
As you can see from the chart of the Russell 3000 Index (which includes the 3000 largest domestic stocks), an apparently successful retest of the initial reaction lows has now taken place, and an attempt at a strong rebound is now underway.
Another factor that has turned in the favor of the bulls is the seasonal patterns that have been remarkably consistent in the past. Indeed, the most bullish six months of the year have historically taken place between mid-October and mid-April. According to the Stock Trader’s Almanac, the Dow Jones Industrial Average has, since 1950, averaged gains of 7.6% from November through April whereas, during the May through October period, it has only averaged gains of 0.3%. The relationship is even more dramatic if you measure from mid-October through mid-April.
There are a variety of reasons for this phenomenon, most of which are related to taxes. For example, because most mutual funds conclude their fiscal year in October, there is a tendency to sell losing positions in October to help offset the capital gains that they must otherwise distribute to their shareholders. These trades must settle by the end of the fiscal year, so there is a historic tendency for the first two weeks of October to be quite weak. We have a particular concern about tax-related selling this year, as fund managers may decide to sell as much as is necessary to offset all taxable gains, in order to prevent the need to present shareholders with a tax liability in a year when they are also likely to lose money. Among the other reasons for this seasonal tendency are the end of prior-year IRA contributions on April 15th, required minimum distributions (RMD) from IRAs and qualified plans, and the need to withdraw money from the markets in April in order to pay taxes.
From a seasonal perspective, this has been a textbook correction, as the third quarter is justifiably known as a period of violent sell-offs in the equity markets, and October is appropriately known as the month of major stock market bottoms.
Of note, it was in October that the critical retest of the initial reaction lows took place after the market corrections in 1990, 1998, and 2011.
A point of at least some concern to us is that, unlike in 2015, these (and many other retests) actually violate the initial lows. While it may seem nitpicky, history suggests that a violation of the initial lows is usually very important, as it is the violation of such a perceived area of support that tends to cause the capitulation selling that forces the last potential sellers from the market and puts in place the ultimate bottom.
For the record, we do believe that it is most likely that we have seen the lows for this healthy and very necessary correction, and that this will prove to be an excellent long-term buying opportunity.
However, without the existence of a high-volume, capitulation-type sell-off to confirm that the selling is, in fact, exhausted, we do have to allow for the possibility of another retest later in the month, particularly once the tax-related selling by mutual funds hits its stride. As strange as it may sound, we would have been happier to see a breach of the initial lows and the resulting bout of panic selling. Without that confirmation, it will take some time to confirm the existence of a sustainable bottom.
We will use the VIX fear gauge to illustrate our point. This tool measures fear as a function of how much investors are willing to pay for defensive hedges. As such, it is a great measure of the sentiment of professional traders. It is also an indication of how many “short” positions there are in the market, which is important, as traders are going to need to “cover” their shorts by buying the underlying stocks in the event of a rally.
The good news is that the markets tend to perform very well in the one and three-month periods after the VIX rises above the 20 level, which it just recently blew through.
The less than ideal news is that, while the spike in fear associated with the initial low (red arrow) was a classic example of how this index performs at a major market bottom, there was much less fear associated with the retest, which suggests that there may still be some pent-up selling pressure. If so, we suspect that it will be resolved over the very near term, after which we expect for the bullish seasonal patterns to take hold.
We started this report talking about the tendency towards mean reversion in the capital markets, and applied this concept to this year’s volatility in the equity markets. We would like to return to this concept, but to apply it instead to both short and long-term market returns. In regards to short-term (i.e. quarterly) returns, Bespoke Investment Group just produced a study showing both that weak third quarters are normally followed by strong fourth quarters, and that, with the notable exceptions of 1937 and 1957, the weakest third quarter returns were followed by the strongest fourth quarter rebounds.
If you apply the same concept to longer-term (15-year average) returns, you will find that, with an average annual return of only 3.76%, the new millennium has not been kind to investors. In contrast, if you also use 1945 as a start date, the actual average annual return for the Standard & Poor’s 500 has been 10% per annum, which shows just how substandard recent returns have been.
If you accept the premise of mean reversion, this should actually be interpreted as good news, as it suggests that the next 15 years should be much stronger than average. While this theory tells you virtually nothing about what is likely to happen over the remainder of October, it does provide yet another argument for taking the opportunity of the recent sell-off to purchase equities with a longer-term perspective in mind.
Regardless of whether the ultimate lows for this decline are already in place, or if we will still see more short-term volatility, there are a variety of other factors that give us reason to turn fairly bullish at this point.
To start with, the global equity markets actually sold off on the Federal Reserve’s decision not to raise rates in September. This is a 180 degree turn from recent history, when investors would panic whenever anyone from the Fed even talked about either ending their quantitative easing programs or raising interest rates. This suggests to us that, while not reflected in the Fed Funds futures market yet, investors have adjusted to the inevitability of a rate increase, which should make a rate hike much less dangerous.
We were also impressed by the market’s reaction to the terrible employment numbers on October 2nd. After selling off very hard initially, equities responded with the biggest upside reversal in four years. Few things in the investing world are more bullish than a market that rallies strongly in the face of bad news.
Whether we have seen the ultimate low or not, we believe that history will view current prices as an attractive entry point for equity investors.
Robert S. Phipps, GLO Member: He currently serves as company Director and lead manager for two of Per Stirling’s SMA portfolio strategies. He also authors the monthly Per Stirling Capital Outlook, which details the firm’s macro-economic perspective. In addition, he works directly as an advisor for a select group of individual investors, which includes primarily physicians, executives of technology-oriented firms, and retirees.