Negative economic data weighed on the market this week. Through the Friday close, the Dow fell just 0.1%, the S&P fared worse with a 1.0% drop, and the Nasdaq plunged 2.0%. Reports of more money printing did little to help gold, which closed the week down 1.2%. Oil plunged on the weak economic data and reports of refiners increasing production. The U.S. oil, WTI, closed down 4.7% to $92.70 per barrel. The international Brent oil hit its lowest level since November, closing down to $104.
Source: Yahoo Finance
Up. Down. Up. Down. Friday was the 13th straight day of markets moving the opposite direction of the day before. There were several factors affecting the market this week that kept stocks on their toes. Economic reports released were poor, Japan announced a staggering new stimulus program, and North Korea threatened the U.S. with a “merciless nuclear strike…using cutting edge weapons” (while a serious problem, the language struck us as humorous).
The big story of the week came on Friday with the employment report. The U.S. economy added only 88,000 jobs over the last month, the lowest number since June and well below estimates.
The unemployment rate fell from 7.7% to 7.6%, which may sound good, but the reason for the improvement was far from positive. More people are leaving the labor force, with the labor participation rate hitting its lowest level since 1979. If we were to measure unemployment using the participation level of just a year ago, unemployment would stand at 8.3%. Using the participation rate from the beginning of the recession, unemployment would be closer to 12%.
This disappointing report had many asking what more can be done to boost employment. After all, we’ve embarked on a massive stimulus program with little to show for it.
The typical responses focused on government solutions - more spending and more stimulus. The problem is, it doesn’t work. History is littered with evidence of this, but past several years should be proof enough. Policymakers continue to ignore the private sector and improving those conditions.
That brings us to the other big news of the week, Japan. This story is actually quite important because it is the exact path we are on.
For a little background, the Japanese economy has been declining for decades, never gaining traction. A dozen years ago they began stimulus programs, similar to what we are doing here. It has failed to revive the economy while piling up massive debts.
Thursday was the first meeting of the new leadership at their central bank, the Bank of Japan (which is like our Fed). They announced a surprising and dramatic increase in their stimulus program to boost their economy, doubling down on policies that have failed to work so far. They will print even more money to buy their own government bonds and push down borrowing rates. Also, they aim to double the amount of money in circulation over the next two years.
Remember, our Fed is printing $85 billion a month. Though we have become numb to these large numbers recently, this is a massive number. Japan, which is a third of our size (economically), will print the equivalent of $200 billion a month. $200 billion a month! The amount of money being printed is mind blowing and extremely dangerous in our view.
Many commentators described this as a very positive step, though. One poetically noted “the dawn is awakening in Japan.” They see the positives of increasing borrowing which should increase consumption. Plus it will weaken their currency, which is designed to make their exports more attractive.
But it ignores the negatives. First, it ignores the fact similar policies have failed. Doubling down on failed policies aren’t likely to work, only speed up the inevitable.
Plus, while exports become cheaper, imports will cost more and the cost of living will rise. We have seen this already over the past several months (while their official inflation metric shows a decline, the cost of living has increased significantly. LINK).
Not to mention, it is very possible for this currency war to be pushed to a new level. South Korea has already expressed concerns and may weaken their currency as a result. They already have enough to worry about with the “cutting edge weapons” of North Korea, after all.
The big story of the week came on Friday with the employment report. The U.S. economy added only 88,000 jobs over the last month, the lowest number since June and well below estimates.
The unemployment rate fell from 7.7% to 7.6%, which may sound good, but the reason for the improvement was far from positive. More people are leaving the labor force, with the labor participation rate hitting its lowest level since 1979. If we were to measure unemployment using the participation level of just a year ago, unemployment would stand at 8.3%. Using the participation rate from the beginning of the recession, unemployment would be closer to 12%.
This disappointing report had many asking what more can be done to boost employment. After all, we’ve embarked on a massive stimulus program with little to show for it.
The typical responses focused on government solutions - more spending and more stimulus. The problem is, it doesn’t work. History is littered with evidence of this, but past several years should be proof enough. Policymakers continue to ignore the private sector and improving those conditions.
That brings us to the other big news of the week, Japan. This story is actually quite important because it is the exact path we are on.
For a little background, the Japanese economy has been declining for decades, never gaining traction. A dozen years ago they began stimulus programs, similar to what we are doing here. It has failed to revive the economy while piling up massive debts.
Thursday was the first meeting of the new leadership at their central bank, the Bank of Japan (which is like our Fed). They announced a surprising and dramatic increase in their stimulus program to boost their economy, doubling down on policies that have failed to work so far. They will print even more money to buy their own government bonds and push down borrowing rates. Also, they aim to double the amount of money in circulation over the next two years.
Remember, our Fed is printing $85 billion a month. Though we have become numb to these large numbers recently, this is a massive number. Japan, which is a third of our size (economically), will print the equivalent of $200 billion a month. $200 billion a month! The amount of money being printed is mind blowing and extremely dangerous in our view.
Many commentators described this as a very positive step, though. One poetically noted “the dawn is awakening in Japan.” They see the positives of increasing borrowing which should increase consumption. Plus it will weaken their currency, which is designed to make their exports more attractive.
But it ignores the negatives. First, it ignores the fact similar policies have failed. Doubling down on failed policies aren’t likely to work, only speed up the inevitable.
Plus, while exports become cheaper, imports will cost more and the cost of living will rise. We have seen this already over the past several months (while their official inflation metric shows a decline, the cost of living has increased significantly. LINK).
Not to mention, it is very possible for this currency war to be pushed to a new level. South Korea has already expressed concerns and may weaken their currency as a result. They already have enough to worry about with the “cutting edge weapons” of North Korea, after all.
So how did their markets take the news? Japanese stocks soared. Their market was up more than 6% in the last two days of the week. Stocks are up over 50% over the last six months when new stimulus programs began. But the currency has weakened considerably.
Six years ago, Zimbabwe was in a similar situation. They printed money in order to get out of a hole (which came about by different circumstances, a different story in itself) and the stock market soared (seen left). But the economy suffered and the currency kept weakening. So they continued to print and the downward spiral continued, though the stock market soared. Eventually, though, it all collapsed.
Looking at the performance of the stock market doesn’t always reflect the underlying conditions of the economy, as we saw in Zimbabwe. This scenario may play out again with Japan, and could happen here, too.
At any rate, central banks around the globe will be keeping a close eye on the situation in Japan. Could it succeed? Possibly. But we see the endgame playing out much like Zimbabwe.
No country has ever deflated and printed its way to prosperity. Only one method has been proven to work, and that is the free market. Cut government spending, lower taxes, and allow capitalism to work. Until we move in that direction, we will continue to falter and follow in the footsteps of Japan.
Next Week
Next week marks the beginning of earnings season. According to Factset, estimates for this earnings season are the worst they’ve seen since 2006. However, that’s how the earnings game is played. Warn of bad earnings, then beat the estimate by a slight amount, and the market cheers. What is often overlooked is that the earnings are still poor; they just beat an even worse estimate. Macro conditions have continued to deteriorate over the past quarter, though, so it could be a rough one for earnings.
There will also be a few economic reports worth watching. We will get info on inventories, import and exports, retail sales, and inflation at the producer level with the PPI. Several more Fed members will be speaking, too, which always has the ability to move the market.
Investment Strategy
The market still looks expensive here, though it has looked that way to us for a while. Economic conditions are very weak and earnings have not been as strong as people perceive. Plus they are forecasted even lower. It’s hard to justify stocks being at record highs.
That is where the Fed and other central banks around the world come in. An unprecedented amount of money is being printed, fueling the markets higher. A glance at the stock market of Zimbabwe reminds us how high a market can climb. Before crashing, of course.
One other point to note, many, many people believe a pullback is coming after the run we’ve had. When that many people are looking for the market to behave a certain way, it often does the opposite.
That said, yes, we remain cautious on the market. We’d avoid investing in broader indices, though. We’ve pulled money out of the risker indexes and prefer lower volatility ones.
We favor investing new money into undervalued individual stocks. As for what we are looking for, we like higher-quality and dividend paying ones. Companies with operations overseas have seen better earnings than those who don’t. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has suffered despite the massive amounts of money being printed. Typically the price rise mirrors the growth of the Central Banks balance sheet (the money printed is added to their balance sheet), but has failed to do so recently. We like it for the long run as central banks around the world devalue their currencies, despite its failed recent performance.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, we think yields on Treasury bonds will rise in the long run (so prices will fall) and a short position (bet on the decline in prices) provides a nice hedge. These bonds rose sharply this week (so yields fell), showing just how unpredictable these markets can be.
We also think TIPs are important as we still expect inflation to increase. Municipal bonds provide a nice way to reduce taxes, though new itemization laws may reduce their benefits in some cases.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
Looking at the performance of the stock market doesn’t always reflect the underlying conditions of the economy, as we saw in Zimbabwe. This scenario may play out again with Japan, and could happen here, too.
At any rate, central banks around the globe will be keeping a close eye on the situation in Japan. Could it succeed? Possibly. But we see the endgame playing out much like Zimbabwe.
No country has ever deflated and printed its way to prosperity. Only one method has been proven to work, and that is the free market. Cut government spending, lower taxes, and allow capitalism to work. Until we move in that direction, we will continue to falter and follow in the footsteps of Japan.
Next Week
Next week marks the beginning of earnings season. According to Factset, estimates for this earnings season are the worst they’ve seen since 2006. However, that’s how the earnings game is played. Warn of bad earnings, then beat the estimate by a slight amount, and the market cheers. What is often overlooked is that the earnings are still poor; they just beat an even worse estimate. Macro conditions have continued to deteriorate over the past quarter, though, so it could be a rough one for earnings.
There will also be a few economic reports worth watching. We will get info on inventories, import and exports, retail sales, and inflation at the producer level with the PPI. Several more Fed members will be speaking, too, which always has the ability to move the market.
Investment Strategy
The market still looks expensive here, though it has looked that way to us for a while. Economic conditions are very weak and earnings have not been as strong as people perceive. Plus they are forecasted even lower. It’s hard to justify stocks being at record highs.
That is where the Fed and other central banks around the world come in. An unprecedented amount of money is being printed, fueling the markets higher. A glance at the stock market of Zimbabwe reminds us how high a market can climb. Before crashing, of course.
One other point to note, many, many people believe a pullback is coming after the run we’ve had. When that many people are looking for the market to behave a certain way, it often does the opposite.
That said, yes, we remain cautious on the market. We’d avoid investing in broader indices, though. We’ve pulled money out of the risker indexes and prefer lower volatility ones.
We favor investing new money into undervalued individual stocks. As for what we are looking for, we like higher-quality and dividend paying ones. Companies with operations overseas have seen better earnings than those who don’t. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has suffered despite the massive amounts of money being printed. Typically the price rise mirrors the growth of the Central Banks balance sheet (the money printed is added to their balance sheet), but has failed to do so recently. We like it for the long run as central banks around the world devalue their currencies, despite its failed recent performance.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, we think yields on Treasury bonds will rise in the long run (so prices will fall) and a short position (bet on the decline in prices) provides a nice hedge. These bonds rose sharply this week (so yields fell), showing just how unpredictable these markets can be.
We also think TIPs are important as we still expect inflation to increase. Municipal bonds provide a nice way to reduce taxes, though new itemization laws may reduce their benefits in some cases.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
