Last week, the United States government might as well have hung a sign on the front door of the Capitol that read, “Gone negotiating. We’ll be back in…however long it takes.”
In 2013, the U.S. government closed for 16 days. About 850,000 federal workers were furloughed and 6.6 million workdays lost. The shutdown affected private companies that worked with the government, too, and the U.S. economy took a hit.
The prospect of kicking off 2018 with a government shutdown didn’t appear to concern investors too much. Barron’s reported the Dow Jones Industrial, Standard & Poor’s 500, and NASDAQ indices all finished the week higher.
The lack of response from investors isn’t all that surprising. Geopolitical events – from the Brexit vote to the U.S. bombing Syria to the North Korean nuclear escalation – have had little lasting effect on markets. The president of a financial research firm told The New York Times, “geopolitical events may be widely feared, and there will often be a knee-jerk market reaction when they’re unexpected, but seldom do they have a lasting impact. Underlying economic trends and monetary policy are far more important.”
That has been the case with previous U.S. government shutdowns. However, Investor’s Business Daily (IBD) wrote this time might be different:
“Government shutdowns always have been primarily over government spending, but this one will be mostly over an ideological divide on immigration, with budget issues playing a secondary role. That raises the risk that the partial government shutdown could be a long one and have more serious economic consequences than investors expect.”
IBD suggested it wouldn’t be long before the negative economic effects of dysfunctional government consume any economic gains delivered by tax reform. That may provide an incentive for our elected officials.
Data as of 1/19/18
|Standard & Poor’s 500 (Domestic Stocks)
|Dow Jones Global ex-U.S.
|10-year Treasury Note (Yield Only)
|Gold (per ounce)
|Bloomberg Commodity Index
|DJ Equity All REIT Total Return Index
S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT Total Return Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.
i’ll have an order of purchasing power parity, please! Purchasing power parity, or PPP, is a simple idea with a tongue twister of a name. When two countries have PPP, a basket of goods costs the same amount in both countries after the exchange rate has been factored in.
The Economist developed an entertaining measure of PPP. It’s called ‘The Big Mac Index.’ The index doesn’t measure a basket of goods. It simply considers the cost of a hamburger in 120 countries around the world. The index was updated for January 2018 and showed burger costs varied when translated into U.S. dollars. For example:
In Switzerland, a burger costs $6.26
In United States, a burger costs $5.28
In the Euro area, a burger costs $4.84
In Britain, a burger costs $4.41
In China, a burger costs $3.17
In Russia, a burger cost $2.29
The Economist reported:
“If the local cost of a [hamburger] converted into dollars is above $5.28, the price in America, a currency is dear; if it is below the benchmark, it is cheap. The average cost of a [hamburger] in the Euro area is €3.95, or $4.84 at the current exchange rate. That implies the euro is undervalued by 8.4 percent against the dollar.”
Overall, PPP is better aligned across the globe. One reason is the improving health of world economies. China remains the most undervalued currency among wealthier nations. In emerging markets, like Russia, currencies remain undervalued relative to the United States.
PPP provides economists with an apples-to-apples measure for comparing the wellbeing of countries and consumers.
Weekly Focus – Think About It
“For anything worth having one must pay the price; and the price is always work, patience, love, self-sacrifice – no paper currency, no promises to pay, but the gold of real service.
–John Burroughs, American naturalist and essayist
Value vs. Growth Investing (1/19/18)
2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results. Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase. This can only be done by prospectus and should be on the recommendation of a licensed professional.
2017 The Year In Review
Every January, it’s customary to look back at the year that was. What were the highlights? What were the “lowlights”? What were the events we’ll always remember? Most importantly, what did we learn?
Rather than write a long recap of the entire year, let’s first look at this chart:
||Donald Trump is sworn in as president.
||North Korea fires a ballistic missile over Japan.
||The U.K. starts negotiations over leaving the European Union (Brexit).
||A massive “ransomware” cyberattack strikes computers around the world.
||More tension as North Korea fires its first intercontinental ballistic missile.
||Hurricane Harvey strikes, the costliest natural disaster in U.S. history.
||Hurricane Irma hits, one of the strongest hurricanes ever recorded. Hurricane Maria follows soon after. Equifax announces a massive data breach. In politics, Republicans fail to repeal Obamacare.
||Fifty-eight people are killed in the deadliest mass shooting in U.S. history. In Europe, Catalonia declares independence from Spain.
||Republicans in Congress pass the Tax Cuts and Jobs Act, the most significant tax reform in over 30 years.
Obviously, this is hardly a full summary of everything that happened last year. And it doesn’t even mention any terrorist attacks or the ongoing investigations into different government officials.
It doesn’t mention the tidal wave of sexual harassment allegations that swept across Hollywood, the opioid epidemic, or any of a dozen other stories that dominated the news.
But let’s look closely at what it does mention. On the chart, you’ll see:
- National politics
- International incidents
- Natural disasters
These were all major developments, many of them affecting hundreds of countries and millions of people. Of course, some items weren’t necessarily bad, but each was significant in its own way.
And month after month, the markets kept chugging up the hill. In fact, the S&P 500 rose over 19% for the year.2
What Can We Learn from This?
Politically, culturally, meteorologically, 2017 was a volatile year – but not for the markets. As a result, 2017 taught us a valuable lesson about investing, which is that:
Major news stories don’t drive the markets.
Or at least, they’re far from the only thing that drives the markets. Time and again, pundits predicted the latest natural disaster, story about gridlock in Washington, or geopolitical incident would bring the markets down. In 2017, that never really happened. That’s not to say such events don’t ever affect the markets; just that they often don’t have the impact one would expect.
Earlier in the year, I wrote an article about the historical lack of correlation between major events and market performance. Take the Cuban Missile Crisis. The world has probably never been closer to nuclear war than during those nerve-wracking thirteen days in 1962, yet during that time, the Dow only fell 1.2%. By the end of the year, the Dow was up 10%.3
More recently, look at Brexit. When the UK voted to leave the European Union, it took most analysts by surprise, and many predicted it would lead to a major drop in the markets. At first, it did. The vote took place on a Thursday. The next day, the Dow fell over 600 points, and then another 250 points the Monday after.4
But less than a month later, the Dow climbed to a new record high.5
In 2017, the same thing occurred, with major events failing to impact the markets to any great degree.
What’s the Explanation?
In a sense, the markets are like baking a cake. If you’ve ever made a cake from scratch, you know the list of ingredients is fairly long. Flour and sugar. Baking soda and salt. Eggs and milk, oil and vanilla, and any of a half-dozen other things.
That’s complicated enough, but as any chemist would tell you, we’ve only just scratched the surface. Here’s what really goes into a cake: hydrogen, carbon, oxygen, nitrogen, sulfur, sodium, potassium, magnesium, molybdenum, manganese and more – all in the correct proportions, too, or else you just get a mess.
The markets are like that cake – formed by hundreds, perhaps thousands of moving parts, decisions, stories, and most of all, people. So, in this analogy, the major news events that occur in any given year aren’t even the sugar or the salt. They’re the sulfur and selenium. Just a few elements in a giant bowl filled to the brim with them.
Why the Markets Went Up in 2017
So, what are some of the major elements that did move the markets in 2017?
Expectation is one. From the beginning of the year, the expectation of fewer regulations and lower taxes has been a major source of enthusiasm. (Both expectations were rewarded.)
Economic growth is another. The economy has been growing slowly but steadily over the past several years, and progress continued in 2017. The unemployment rate ended at 4.1% for the year, a 17-year low.2 Wages increased for many workers.2 And many corporations reported strong earnings throughout the year, causing valuations in most sectors to climb.
Sheer momentum was also likely a factor. FOMO, or the fear of missing out, is always a strong motivator, and as the markets climb, more and more people want to hop on board.
So What’s the Takeaway from All This?
2017 showed us that the markets aren’t a weather vane for any set of morals, political views, philosophies, or breaking news. History has repeatedly demonstrated that the markets are relatively unaffected by who the president is, which political party is in power, or how the winds of cultural change blow. In a more modern sense, the markets are far too large to be moved by anyone’s tweets or which YouTube video went viral. In a way, that’s a comforting thought. And it’s a further example of why we must avoid assigning narratives to the markets, and then making decisions based on those narratives.
Throughout 2017, many pundits kept trying to pick this event or that event as the straw that would break the camel’s back. I imagine many investors spent a lot of time searching for clues as to when the next correction would occur, and so missed out on opportunities for growth. That’s certainly been the case for this entire bull market, one of the longest in history. It’s a bull market that many investors have failed to take advantage of. (Per a survey by Gallup, only 52% of Americans report owning stock today, compared to 65% back in 2007.)6
Of course, it’s also possible to make the opposite mistake: assume that good news, whether political or economic, will continue to drive the markets up. Nothing lasts forever, including bull markets, and it’s crucial that we avoid becoming irrationally exuberant, taking on more and more risk to chase higher returns. Investors who do that often make simplistic decisions based on specific news stories or trends that maybe aren’t as important as they appear.
Which brings us to the final part of this letter:
2018 Market Outlook
There’s no crystal ball to investing, and it’s impossible to truly know which “elements” will affect the markets most in 2018. Still, here are some of the trends we’ll be keeping an eye on:
- Will lower taxes mean corporate earnings continue to grow?
- Will the Mueller probe into President Trump’s campaign lead to any executive shakeup in the White House? (This only matters if it leads to policy changes that could impact the markets.)
- Who will control Congress after the 2018 midterm elections? (Again, this only matters so far as it affects policy down the road.)
- Many states are set to raise minimum wages in 2018.2 Will this lead to a rise in consumer spending?
At the moment, it seems reasonable to expect a kind of “Goldilocks economy” in 2018, in which economic growth is neither hot nor cold, but moderate. But again, we’re not going to make investment bets based on any storylines, nor are we going to react emotionally to future developments. Instead, we’ll continue to remember that the markets are large, complex institutions. We’ll continue to remember why we invest, which is to help you reach the specific goals you’ve set for your finances and your life. And we’ll continue to stick to our long-term strategy, which is designed to look beyond the headlines.
Have a Happy New Year!
One last thing, as you know, there’s no better time to plan your year than now. To that end, I’d love to sit down with you and plan for the months ahead. We can review your current strategy and portfolio. Do we need to make changes? Are you still on track to reach your goals? This is the only storyline that matters.
So please give me a call at 215-886-2122. We’ll set up a time to talk, and together, we’ll make 2018 exactly what you want it to be.
On behalf of all of us here at Schwartz Financial, we hope you had a great 2017! Here’s to an even better year to come.
Michael L. Schwartz, RFC®, CWS®, CFS
P.S. Please feel free to forward this commentary to family, friends, or colleagues. If you would like us to add them to the list, please reply to this email with their email address and we will ask for their permission to be added.
Michael L. Schwartz, RFC, CWS, CFS, a registered principal offering securities and advisory services through Independent Financial Group, LLC., a registered broker-dealer and investment advisor. Member FINRA-SIPC. Schwartz Financial and Independent Financial Group are unaffiliated entities.
This information is provided for informational purposes only and is not a solicitation or recommendation that any particular investor should purchase or sell any security. The information contained herein is obtained from sources believed to be reliable but its accuracy or completeness is not guaranteed. Any opinions expressed herein are subject to change without notice. An Index is a composite of securities that provides a performance benchmark. Returns are presented for illustrative purposes only and are not intended to project the performance of any specific investment. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is not a guarantee of future results.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
* Gold represents the London afternoon gold price fix as reported by the London Bullion Market Association.
* The DJ Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT TR Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Past performance does not guarantee future results.
* You cannot invest directly in an index.
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