When I saw the 2% Pre-market jump in AAPL stock and the subsequent decline today:
I thought of this (brainless) daredevil:
In a world being introduced to robo-advisors, what are the benefits of a trusted financial team?
To help me answer that question, I just attended the Financial Planning Association's 2015 retreat at Chateau Elan outside Atlanta, GA. This was a great venue for bringing together nearly 400 of the top financial planning minds from around the world.
We came together to focus on this year's theme of Advancing the Art and Science of Financial Planning. Kevin and I were impressed with the quality of the speakers and presentations, and we were excited to be able to collaborate with these people to garner new ideas and refine concepts we were already using.
I walked away from this conference understanding that financial planning is both an art and some very complicated science. But the number one thing I walked away with is we are dealing with our client's financial future, and we need to work together to paint the picture of what they want the future to look like. We then work together to fit the pieces of their financial puzzle together to start creating that picture. Your picture will be unique, so we will need to develop a plan that matches your desired goals.
The conference reinforced my opinion that the so-called "4 percent rule" rule is a poor guide for your future financial needs. When creating your picture, focus on the things you plan to do in the early years of retirement and realize there's a time when you will slow down, so your spending will not be 4% per year through all stages of retirement.
When you understand how each person's financial picture is so unique, you quickly realize that a one-size fits all robo-advisor cannot listen and understand your needs in a way that combines the empathy, expertise and creativity of a concerned financial advisor.
I'm excited about all we've learned and the great people and resources we were able to connect with during our retreat, and I can't wait to share and implement these findings in our practice.
Accelerating or Decelerating
The Federal Reserve ended Quantitative Easing last fall and since then they have tried to prepare investors to expect interest rate increases this year. While the debate rages on the broader effect of QE on the economy, it was clearly responsible for putting a reliable lid on stock market volatility.
Believe it or not (and we don't) the Fed's reasoning for raising rates is based on their observation that the economy is accelerating rapidly enough that higher rates are needed to stave off inflation pressures. The Feds flirtation with rate increases was a primary factor in the massive rally in the US dollar/decline in the Euro since August:
Euro US Dollar
Earnings are the Focus
Without Fed intervention investors are finally shifting their focus back to market fundamentals. A string of macro-economic data points in the last three months is stirring concern about stock prices and valuations. The most concerning news is the dramatic decline in earnings expectations for the first three months of 2015
Reduced earnings expectations have brought renewed concern about corporate profitability as well.
As expectations are reduced, companies are getting their excuses in line. Unlike last year when weather was the go-to excuse for poor results, the strong dollar will be the primary scapegoat in 2015.
Corporate profits as a percentage of the overall economy are at the extremes of historical relationships. This heightens investors' attention
The consensus is building that the economy must pick up steam to justify both current prices and further gains in domestic stocks. The problem for growth going forward is that the market no longer has billions of dollars in Fed stimulus greasing the economic skids each month. Even if the Fed surprised investors with another round of QE it did little to stimulate the main street economy. The turnover of dollars in our economy is actually less stimulative now than after the recession ended.
Transportation stocks are a reliable barometer of economic trends and the Dow Transports Index has diverged negatively from the S&P 500.
Poor first quarter earnings and weak leadership from transports help explain why the S&P is stalling out in 2015.
Forecasters now expect the Federal Reserve to wait until later in 2015 to raise rates instead of the mid-year. So, investors and the Fed are waiting for a clearer picture of economic activity to emerge from spring. Clarity will determine if an aging bull market will make it 7 years in a row.
In the meantime, the risk of a mild market correction boiling over into something more aggressive grows as investors that relied on leverage to boost their returns become impatient.
The dollar rally created several compelling investment opportunities that look like a promising alternative to the earnings issues in our domestic economy. Relative to the S&P 500 global markets have underperformed for years.
As the Fed ended QE here the European Central Bank started QE in Europe. Already low interest rates there have turned negative.
Foreign markets have outperformed the S&P 500 in 2015
The US is six years into a bull market without the Fed stabilizing demand. The consensus view is that domestic earnings will disappoint. The silver lining is that the dollar rally has muted economic activity to the point that the Fed will postpone rate increases and contrarian bets that the dollar will reverse course are starting to yield results.
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As earnings season builds momentum and we risk being swamped with the minutiae of each corporate announcement, I wanted to share a longer term perspective on where company profits stand in relation to both our current and historical economic situation.
First I graph corporate earnings growth since the 1940. I am using the after tax data series from the St Louis Federal Reserve FRED:
In comparison to profits, GDP is a smoother data series.
Which leads to the comparison of the two:
We could continue to add complexity through additional variables but this simple comparison tells an interesting story. Compared to economic activity, corporate profits are stretched to the extreme. If profits are to wiggle higher from here, we need the economy (GDP) to grow. The takeaway seems clear.
I'm working on charting the profits/GDP relationship on several foreign markets as well. That should generate some interesting observations.
The Chinese government has spent billions on public projects in the past decade building the infrastructure to be the penultimate manufacturing center for the rest of the world. With the weekend revelation that exports unexpectedly collapsed 15% in March, the Chinese government may have to rethink projects like this unused airport:
Earnings expectations for the first three months of 2015 have plummeted. Since January analysts reduced their estimates for company profits so much that earning will be considered on target even if they are 4% less than last year. Stock market bulls who are comfortable buying the market at current levels believe that the second half of 2015 will see an acceleration of activity which will more than justify expensive PE ratios. The Fed was forced to rethink the timing of interest rate increases because of a series of poor economic data point.
For our part, we are positioned with a healthy cash cushion because we are suspicious about where this excess demand will materialize from. China growth is very weak, Japan is no better and other than Germany, Europe is resorting to artificial stimulus through the ECB to stave off a recession. Despite this overwhelming body of evidence, the S&P 500 is still trading at 17 times forward earnings - a valuation that is normally reserved for periods of steady, predictable earnings growth. The stakes for US stock investors couldn't be higher than right now.
Alcoa kicked off earning season last week with earnings per share that was 2 cents better than the reduced guidance but revenue that was less than expected. On the day the stock dropped 3% and is down more than 10% this year.
As more companies announce their financial results here are two key factors that investors should be paying attention to:
Over a three month quarter most competent CFOs can manufacture a decent report or at least offer a plausible excuse (weather, the dollar) for any shortcomings. Dig into their business to discern any change in demand trends. This is most readily measured through top line revenue and through inventory. If demand is strong, revenue will be up and they will be turning their inventory over faster.
Is the strong dollar helping or hurting business
Companies that have little international sales exposure should realize economic benefits from the strong dollar. They produce in dollars and sell in dollars. Domestic businesses are more focused on controlling manufacturing costs and inventory than their exposure to the strong dollar. The dollar rally was a primary driver in the decline of energy prices over the last 6 months and that should provide a cost savings to domestic producers.
US companies with a global footprint are still dealing with the effects of the strong dollar. The dollar rally has persisted long enough that these companies have had enough time to hedge some of the currency risk away. If they use the strong dollar as an excuse for missed expectations it likely means they aren't managing their business well and will subject their shareholders to more earnings uncertainty.