Clear thinking.
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Jul 1, 2026 | Commentary

Trends in IPOs and Indexes

• The recent Initial Public Offering (IPO) of SpaceX that valued the company at more than $2 trillion stands in stark contrast to the norm 30 years ago of bringing newer, smaller companies into the public markets. It also raised unprecedented issues about how to best treat these massive IPOs in widely followed stock indexes.
• In the 1990's IPOs regularly happened for young companies that had not yet proven their business proposition. These newly minted public companies were essentially irrelevant then to major stock index construction. Today that is rare. Ample venture and private equity capital has allowed private companies to wait until they are better established, and in some cases, so large as to create the phenomenon of the Mega IPO.
• Index providers often claim to construct their products to reflect "the market." The wide variation in the rules providers employ for index inclusion makes a mockery of those assertions. The disparate treatment of Mega IPO's highlights the need for investors to look through the indexes to confirm that the so-called passive investments they make are constructed and sized in a way consistent with their return and risk goals.

Jun 1, 2026 | Commentary

What Is a Normal Fed Funds Rate?

• All eyes are on the newly appointed Federal Reserve Chair, Kevin Warsh. As inflation persists well above the Fed's target of 2%, the markets are questioning whether the Fed will resume its lowering of the Fed Funds rate that has been "stop and go" since 2024 or be forced to increase rates.
• The first quarter of the 21^st century has seen all manner of economic conditions. Severe recessions caused by the correction of financial excesses and pandemic induced economic disruptions have led the Fed to largely be reactive and, in retrospect, often faulty in its rate setting decisions.
• Near-zero interest rates are not required for the U.S. economy to move forward. Rational capital market allocations are more likely to be made when real rates of interest are positive, reducing excesses in the market and generally promoting more sustainable, steady growth.
• The Fed's mandate is to promote a full employment economy with modest inflation. The best chance for this will likely come with a return to normal Fed Funds rates, applied consistently with a longer-term perspective. Success in achieving this goal will define Mr. Warsh's legacy as Chair.

May 1, 2026 | Commentary

A Closer Look at the S&P 500

• Market commentators often make forecasts based on where valuation metrics like the Price to Earnings (P/E) Ratio lie versus historical averages. Comparing different periods that exhibit different fundamentals using simple statistics can be a path to error.
• At the start of 2025, after two strong years for the S&P 500 and elevated P/E ratios, many analysts called for muted or perhaps negative returns for the year. The final return for the index was another above average outcome of 17.9%.
• The surprise was that earnings for the largest companies in the index grew faster than analysts' robust expectations. P/E ratios for the overall index and for a majority of the top ten companies are lower today than they were at the start of 2025.
• Forward P/E ratios and other simple metrics are not answers. They suggest questions for further analysis. Is the expected path for future earnings versus today's price well founded? The S&P Index is only a marker, today dominated by cap size concentration and high correlations between the largest tech companies, leading to the potential for greater volatility.

Apr 1, 2026 | Commentary

Transition in Global Energy

• The conflict in Iran and the effective shutting of the Strait of Hormuz is another geopolitical event that has once again disrupted the global petroleum market, causing higher prices and fears of macroeconomic consequences.
• This event echoes previous global disruptions caused by the Arab oil embargo (1973), the Iranian Revolution and Iran/Iraq War (1979-80), and Russia's invasion of Ukraine (2022). The nature of the U.S. petroleum industry has changed markedly over this window, reducing the worst macroeconomic risks for this country.
• 20% of the world's oil consumption normally exits Iran and neighboring Arab states through the Strait of Hormuz. The vast majority of this oil is destined for Asian countries, with very little sent to North America.
• Trade sanctions imposed on Russian oil after the invasion of Ukraine initially disrupted flows of oil on a scale comparable to today. The big lesson is that despite traditional conflict and trade warfare, global commerce in commodities is highly adaptable in working around obstacles.
• There are strong economic incentives for both Middle Eastern producers, including Iran, and global consumers to see a resumption of trade. How long this will take is still unknown, but while it may take years for oil prices to retreat back to pre-Iran War levels, history says this will happen.

Mar 1, 2026 | Commentary

The Cycles in Private Equity

• After three years of trailing the returns of public equity, private equity markets have been put under the microscope questioning whether they should continue to be major parts of diversified portfolios.
• The large public equity declines in 2022 stopped an overactive private equity industry in its tracks. Activity in all stages of private equity from venture to buyout to crossover slowed dramatically but have recently recovered, demonstrating their important role in the capital formation process.
• Just because there are lags and less transparency in valuations for private partnerships does not mean that cycles don't exist. These features may have led to more extremes in investor behavior, often leading to disappointing results.
• Private equity should be expected over time to continue to provide incremental returns over public markets, but not in every quarter or year. In determining the right allocation to private equity, investors should first ensure that spending needs are met in all environments by holding adequate liquid investments.

Feb 1, 2026 | Commentary

The Shape of the Municipal Bond Market

• At over $4 trillion in size, the municipal bond market is less than 10% of the total U.S. bond market dominated by government and corporate bonds. It is, however, a vital tool in public finance and in the portfolios of millions of taxpaying citizens.
• The U.S. Treasury yield curve has evolved since COVID from virtually flat at near zero rates, to a strongly inverted curve as the Fed increased its efforts to control inflation, to today being as close to a traditional upward sloping curve as we have seen in years. During this transition, the municipal bond market curve has moved similarly, but with important differences in the ultimate shape.
• Today's municipal bond curve is mildly inverted out to five years. It appears that investor demand for safety and minimal mark to market risk has outstripped available supply at short maturities pricing many of those bonds at uneconomic levels.
• Separately managed accounts with flexible mandates can take advantage of current market pricing by mixing taxable and tax-free paper, avoiding the most expensive maturities and managing risk and return positioning with an appropriate amount of longer-dated municipal bonds that offer both tax advantages and higher absolute yields.

Jan 1, 2026 | Commentary

2025, A Watershed Year for Crypto

• This past year saw meaningful advances in regulations involving cryptocurrencies and in applications to improve the efficiency of financial transactions. It also saw flourishing fraudulent activity and great interest in tokens designed to exploit a desire to get rich quickly.
• Stablecoins, tokens seen as a possible substitute for money market funds and bank deposits, are the subject of the July 2025 Genius Act. This legislation placed U.S. domiciled stablecoins under bank regulators with regular reporting and anti-money laundering protections.
• As this part of the industry was evolving, the world also saw a surge in more questionable activities. Meme coins, digital asset treasury (DAT) companies, and outright frauds costing investors tens of billions of dollars proliferated. This side of the crypto industry will continue to challenge regulators to try to bring safety and soundness to participants.
• Given that cryptocurrencies have no cash flows that can be modeled, incorporating them into investment portfolios raises all the challenges faced by art, collectables or yachts. Unlike those items there are no aesthetic or lifestyle benefits to crypto. The further challenge is that while any given coin can be designed to have a finite supply, there are no limits to how many different coins can be created, limiting potential upside. All this means is that they are simply a trade and should be treated accordingly.

Dec 1, 2025 | Commentary

What's Wrong With Credit?

• Recent headlines have focused on changes in consumer credit behavior and private loan defaults to suggest the economy is at risk. A careful look at the data paints a more nuanced and calmer picture.
• There will always be a meaningful part of the population that struggles with their budgets, but in terms of the amount of disposable income needed to service household debt, the average American consumer is in as strong a position as any time this century.
• Bank capital requirements increased dramatically, and probably appropriately, after the Global Financial Crisis. This left many riskier borrowers underserved, opening the door to the rise of private credit where risk is shouldered by private investors with no implicit or explicit government guarantees. Such a transition does not reflect on the general state of credit or the economy.
• Loan defaults caused by fraud always garner headlines. Private credit is not fundamentally riskier than public, it is just less transparent. While there has been some credit softening observed, credit spreads for bonds of both high and low rated corporate borrowers do not indicate a broader systemic issue.

Nov 1, 2025 | Commentary

The Resurgence of Gold

• The doubling of gold prices in less than two years has captured widespread attention while raising questions about why this is happening and what role gold might play in portfolios.
• Many reasons are offered to explain this move. Prominent among them are a weaker dollar, geopolitical risks, increased central bank purchases and concerns about the resurgence of inflation caused by large and continuing federal deficits.
• There is an adage that says the best cure for high prices is high prices. Gold is a physical commodity ultimately priced by supply and demand. With today's price above $4000 an ounce, there are powerful incentives for miners that generally can produce gold near $1500 an ounce to increase supply, but this takes time.
• Large purchases of gold related ETFs in 2025 suggest considerable excitement by retail investors. Gold prices may continue to rise, but as they do there is a heightened risk of an eventual correction. Holding gold as a hedge against current geopolitical uncertainties has an appeal, but there is likely an opportunity cost versus buying equities that have shown a better long-term track record in growing economies.

Aug 1, 2025 | Commentary

Are Foreigners Boycotting U.S. Treasuries?

• News reports in 2025 highlighted global disapproval of the trade and foreign policies of the new administration. Tangible evidence of this attitude can be found in sharp declines in foreign tourist visits as compared to a year ago.
• There has long been a desire by much of the world to lessen its dependence upon the dollar as the world's reserve currency and U.S. Treasuries as the standard for financial safety. These desires, however, have not translated into any tangible movement away from the dollar.
• Foreign gross purchases of Treasuries have grown consistently in the 21^st Century. This has been a function of general increased globalization of trade and, more recently, a rapidly increasing U.S. trade deficit caused by a spike in imports attempting to avoid pending tariffs.
• The general dissatisfaction about U.S. policy may have shown up in some economic metrics like tourist visits and airline flights, but the most recently reported Treasury market activity suggests there has been a marked increase in foreign buying.

Jun 1, 2025 | Commentary

What Does the Moody's Downgrade Mean?

• The recent Moody's downgrade of U.S. sovereign debt follows similar actions by S&P and Fitch in 2011 and 2023, respectively. The recent media reaction followed past pessimistic lines.
• Even after the downgrade, U.S. debt poses little risk of default and remains the largest and most liquid bond market in the world. Predictions of global flight from U.S. debt ignore the facts that the debt is still quite strong and there are no practical alternatives in the world.
• Significant deficit spending in the U.S. has been the norm since the Global Financial Crisis. Since then, debt to GDP has risen from 64% to over 100% and is projected to keep rising. A return toward historical interest rates has raised the share of the federal budget devoted to debt service to 14%, second only to Social Security's 22% among expenditure categories.
• Despite the rapidly rising federal debt, interest rates have not been pushed higher by "bond vigilantes." This is likely due to fundamental buyers from pension plans and insurance companies along with the Fed's willingness to step into the bond market whenever they see demand falling well short of supply.
• History has shown that continuously rising debt levels are not sustainable no matter what the recent past suggests. There could be a tipping point where the demand for borrowing exceeds the Fed's ability to keep rates under control, leading to higher inflation and a crowding out of private investment. We are not near that point now, but politicians should not dismiss the possibility in the future.

May 1, 2025 | Commentary

Gambling and Leverage

• Gambling has always been a feature of most cultures around the world and America is no exception. Until recent years it was generally viewed negatively and discouraged. Today there are many industries actively promoting it as a socially acceptable pastime.
• Nowhere is this more obvious than in online sports betting, which started at zero in 2018 and has become a multibillion-dollar industry expected to grow at more than 12% annually over the next decade.
• This culture is not confined to sports and casino gambling. It has permeated our capital markets. Highly leveraged stock index options that expire the same day they are created are a prime example. Trading these options from the long side can be compared to buying lottery tickets. Managing the implicit leverage arising from writing such options often creates additional daily volatility.
• Volatility on any given day is exacerbated by leveraged traders with exceedingly short time horizons, which is the antithesis of what long-term investors should focus on. This is mainly noise with little informational content about the state of the real economy.

Apr 1, 2025 | Commentary

Not All Tariffs Are the Same

• Tariffs have been part of the U.S. economic landscape since the nation's founding. By the 20^th Century they had become a minor contributor to national revenues. Today, however, tariffs and other trade restrictions have risen to the status of front-page news as they are being used as a tool in foreign policy negotiations.
• Narrow tariffs have existed for decades, nominally protecting U.S. producers from cheaper foreign producers. Consumers pick up most of the costs of these programs.
• Broad tariffs have less to do with particular domestic industries. They are increasingly the result of alleged national security concerns and complaints about the fairness of other nations' subsidies of their companies and trading rules that hinder U.S. exports.
• It is hard enough to try to estimate the impact of tariffs on specific companies. Analysts will try to forecast the broader macroeconomic impact of tariffs, but the vast interconnections that have developed around the globe make it almost impossible to do with assurance.

Mar 1, 2025 | Commentary

Are Business Cycles Obsolete?

• For much of the 20^th century academic economists strove to explain why economies experienced regular business cycles.
• Much of the cyclical nature then could be traced to agricultural and manufacturing ebbs and flows which were often exacerbated by rigid currency rules like the gold standard.
• The 21^st century U.S. economy looks nothing like it did 100 and 150 years ago. Services, which generally show little cyclicality, and floating exchange rates have eliminated many of the causes of the traditional business cycles.
• With the exception of the short pandemic-induced recession in 2020, all U.S. recessions since 1990 have been the result of unwinding extreme financial leverage in some part of the economy. There is nothing regular to these events, making the notion of a predictable business cycle obsolete. Trying to adjust portfolios around such a notion is likely to fail because exit and re-entry points are impossible to predict.

Feb 1, 2025 | Commentary

What is a “Normal” Yield Curve?

• Market analysts seem obsessed with trying to guess the path of Federal Reserve policy decisions and therefore the future of interest rates. Most of this activity is focused on short-term trading. Long-term investors should be more concerned with their portfolio balance of risk assets and safer assets, which should be determined by what to expect over a longer horizon.
• A normal Treasury yield curve starts with the shortest maturities matching inflation and longer maturities containing a term premium to compensate the buyers of that paper for taking additional market risk until maturity. The yield curve today reflects the Fed's restrictive policy to lower inflation further which provides a premium to inflation for owners of short treasuries.
• In addition to the duration of fixed income, credit risk is a critical decision factor. With credit spreads near historical lows, the risk of reaching down the credit ratings now seems high relative to the modest pickup in yield.
• Market experience since the Global Financial Crisis has been anything but normal. If the Fed's policies on Fed Funds rates mesh appropriately with fiscal policies governing taxes, spending and tariffs, there is a chance the yield curve could settle back into a normal range, but there will likely be noise along the way.

Jan 1, 2025 | Commentary

The Good Inflation

• The recent Fed decision to cut policy interest rates by another 0.25% while simultaneously reeling in their expectations for rate cuts in 2025, has raised many questions about the direction of the economy, stocks and bonds.
• Almost all focus is on inflation as measured by consumer prices. This inflation is viewed as an unambiguous negative for the country. However, there is good inflation, which is when rising housing prices and the stock market increase wealth.
• The most recently available data from the Federal Reserve through the third quarter showed net household wealth to have increased by $13.3 trillion so far in 2024. This is the second year of strong gains. As a result, the continued growth in wealth should add to GDP growth as some of that wealth gets recycled into the economy as consumption and new capital projects.
• There is little in labor market or consumption data to suggest a U.S. recession is in the immediate future. This is good news on the real economy front, but a challenge for the Fed in their fight against stubborn inflation.

Aug 1, 2024 | Commentary

The Incredible Shrinking Stock Market

• People often speak about the stock market as if it were a monolithic, static entity. It is, in fact, constantly changing through time and two important long-term trends have been for fewer publicly traded companies in the United States and on average fewer shares outstanding.
• Both economic and regulatory reasons contribute to these trends. The rise of assets committed to various forms of private equity partnerships along with stricter accounting and disclosure requirements for public companies combine to push more of them away from exchange listings.
• The amount of assets devoted to the public markets is also growing as both individual and institutional investors expand their holdings. More money chasing a shrinking number of shares produces a gentle tailwind for equity market performance.

Jul 1, 2024 | Commentary

Word of the Day: Tariffs

• The use of tariffs and other trade restrictions as geopolitical and revenue tools has existed since well before the founding of this country.  In the last eight years their use has grown and in this election season the rhetoric from both sides is to expand them further.
• The rationale for tariffs includes additional revenue for the government, protection of domestic jobs and greater national security.  Each of these justifications has serious flaws when considered in the total picture of world trade.
• Tariffs are a tax, which generally gets passed on to the consumer. Increasing tariffs work against the goal of reducing inflation.
• In total, significant changes in tariffs have very little impact on the sources of government revenue, which predominantly fall on the shoulders of individuals through income, Social Security and Medicare taxes.
• After 2024 there will likely be an intensification of trade restrictions regardless of the election’s outcome.  When the mutually destructive nature of a trade war becomes evident and creates a political liability, negotiations are then pursued to ease the tension.  The economic disruption and losses along the way are, however, entirely avoidable.

Jun 1, 2024 | Commentary

Labor Market Dynamics Tell A Story

• As in all major recessions, unemployment jumped with the pandemic’s shutdowns fouryears ago, but not all segments of the labor market were hit equally. How different groupsof workers have fared since suggests where the recovery story is likely to go.
• Employment in retail had been flat for years before the pandemic. It has recouped therecession losses but shows no signs of further growth. This reflects a fundamental shift inhow Americans shop, continuing the trend toward e-commerce.
• The plateauing of professional jobs stands in stark contrast to the continued robust growthin construction. Leisure and hospitality have just recently returned to pre-pandemicemployment levels, suggesting more growth there can be on the horizon.
• The overall labor market is in better balance than it was two years ago, but it remains tightfor many labor groups. This will likely keep wage growth at least at the level of inflation,making the Fed’s 2% goal a challenging one to achieve.

May 1, 2024 | Commentary

The More Things Change...

• The expected federal deficit in fiscal year 2024 is $1.6 trillion, which is about 6% of GDP.This is unprecedented in a full-employment economy growing at more than 2.5% per year.
• Total debt outstanding held by the public is $27 trillion, which is almost 100% of GDP, a levelnot seen since the depths of WW II.
• The primary budget deficit is not projected to contract any time in the future mainly becauseof mandated programs like Social Security and Medicare and an aging population. Intereston the debt will continue to grow as a share of the federal budget, likely crowding out otherdiscretionary spending, which includes the military.
• In an increasingly fractious world, there are genuine risks to the dollar and the globaleconomy if U.S. debt continues to grow without bounds. Inflation would be the least badsolution to the debt problem. The consequences of default and restructuring are almostbeyond imagination. Both political parties should be looking for compromise solutions witha sense of urgency.

Apr 1, 2024 | Commentary

A Spike in Productivity

• The basic definition of productivity is how much is produced in each hour of labor. It is far easier to think about the concept than it is to measure it.
• The Bureau of Labor Statistics (BLS) maintains a series on productivity created by combining their data on hours worked with the Commerce Department’s estimate of GDP. As one would expect, productivity improves over time, but the quarter over quarter or year over year changes in measured productivity can be volatile.
• The most recent data shows an increasing rate of productivity that some are claiming is proof of AI’s benefits. AI’s direct impact so far is likely not large enough to explain the data, but it holds considerable promise for the future.
• The latest spike in productivity is largely the result of massive capital expenditures by companies desperate to find labor saving solutions in a market that continues to have many more job openings than qualified workers to fill them.

Mar 1, 2024 | Commentary

A Mountain of Cash

• Money market mutual fund assets recently passed an unprecedented $6 trillion and are projected to keep climbing. This has prompted speculation about what will eventually happen with this mountain of cash.
• These funds date back to the early 1970’s but it took almost 30 years before their assets exceeded $1 trillion. Through time, however, more individuals and corporations have come to embrace the liquidity and price stability the funds offer, likely making them a permanent addition to the asset management tool kit.
• Assets flow into money market funds at times of equity market stress as a safety valve for investors. The main drivers of flows, however, are the attractiveness of the yields being offered and the convenience and safety of the funds.
• Some analysts are predicting major shifts from money market funds to longer duration fixed income or the stock market once the Fed begins cutting policy interest rates. This won’t necessarily happen since cash is now a viable return-generating alternative in asset allocations. The good news is that bond and stock markets should not need this cash to sustain gains in a growing economy.

Feb 1, 2024 | Commentary

Can We Believe the Data?

• Collecting and disseminating economic data that are closely followed by market participants is a major activity of several federal agencies.  The voluntary surveys that support that data have seen multi-year declines in participation rates.
• Declining participation rates and regular revisions to previously posted data have led some commentators to suggest that the data are erroneous and are misleading analysts looking for market direction.
• Effective surveys canvass the relevant populations in a random and unbiased manner.  There is no indication that federal government surveys fail these standards even as response rates have declined.
• Traders who try to discern the direction and magnitude of the economy and market from the latest statistical releases are often likely to be acting on noise in the system.  This does not help long-term investment performance but does add to short-term market volatility.

Jan 1, 2024 | Commentary

Progress on the Inflation Fight

• The Federal Open Market Committee (FOMC) delivered a holiday present when it announced after its December meeting that it was stopping policy rate hikes and it expected modest cuts of 0.50% to be possible by the end of 2024.
• The stock and bond markets embraced this news and inflation data that showed progress versus a year ago to spur a sharp rally that built upon a strong November.
• While headline and core inflation are both drifting down, the gains have largely come from absolute declines in energy and other goods prices.  Service inflation has remained above the Fed’s target and in some cases has nudged higher. Rising home prices may cause shelter inflation to continue to prove troublesome.
• There is a reliable but little discussed seasonal pattern to inflation.  News early in 2024 may be less rosy than that of Q4 2023, leading to a potential for macro-driven market reversals.
• It is often counter-productive to try to time portfolio changes against anticipated macroeconomic events, but the discipline of rebalancing any outsized equity positions should be maintained.  There may also be tactical opportunities that arise in fixed income as the interplay of inflation and Fed policy rate positioning plays out.

Dec 1, 2023 | Commentary

How Healthy is the US Consumer?

• Recently there have been numerous reports about rising credit card balances and increasing delinquencies, suggesting that the U.S. consumer is in dire straits, which could lead to a major spending pullback and recession.
• Consumer spending accounts for about 70% of GDP, so the health of this important segment is of critical importance to the future path of the economy.
• A closer examination of consumption and spending shows that while the recent trends are in fact as reported, the burden of servicing debt obligations has remained below the historical norms over the past 40 years.
• The post-pandemic trend of job creation, low unemployment and gradual recovery from the extreme economic disruptions caused by Covid shutdowns make it difficult to see any real likelihood of a near-term recession.  A meaningful policy mistake by the Fed or a severe, unforeseen external shock could change this.

Nov 1, 2023 | Commentary

How Much Do Cities Rely on Property Taxes?

• Commercial real estate continues to be a source of ongoing stress in financial markets.  How this stress might translate into challenges for municipal bond owners should be of great interest.
• Examining the 37 American cities with more than 500,000 residents shows no consistent pattern of how much municipal revenue is derived from property taxes. Those jurisdictions that collect meaningful income or sales taxes rely less on real estate.  Other areas depend on real estate taxes for the majority of their revenue.
• Real estate is not homogeneous.  Residential can behave differently than commercial, and office buildings within commercial central business districts “are different from retail, hotels and multifamily housing.  How each behaves affects the reliability of property tax flows.
• While there are numerous factors contributing to the credit quality of any municipal bond, the state of commercial real estate property taxes will likely be a key element in determining whether a bond is appropriate for your portfolio for the immediate future and beyond.

Oct 1, 2023 | Commentary

What Are the Odds of That?

• Trying to predict the future can take up much of our time and attention. Since futureevents are rarely certain, we turn to odds to guide our thinking. How these odds aredetermined varies widely.
• In financial circles a popular activity is opining on the likelihood that the Federal ReserveOpen Market Committee (FOMC) will raise, lower or hold steady the Fed Funds Rate, theirprimary policy tool. There is an active futures market from which the odds of Fed actionmay be derived almost continuously from current market pricing.
• Quoting odds seems to give forecasts greater credibility, but this shows the risk of falseprecision. It is useful to remember a Yogi Berra line. “It’s tough to make predictions,especially about the future.”

Sep 1, 2023 | Commentary

Bitcoin Revisited

• In the last decade there have been moments of rabid interest in cryptocurrencies.  Over that time, it has become increasingly evident that these are primarily trading vehicles without a strong economic rationale as mediums of exchange or stores of value.
• Through most of Bitcoin’s history, volume of trading has been positively correlated with the direction of price.  Enthusiasm and interest ebb and flow with the price.  But in 2023 this is not the case.  The price has almost doubled from its lows, but trading activity continues to tail off.
• For many years, the major players have been unregulated, global entities. The FTX fraud was a stark, but not isolated, reminder of this.  Increased regulation in the U.S. may provide more protections, but in no way creates or endorses any legitimate economic purpose for cryptocurrencies.
• The Federal Reserve, by increasing policy interest rates over the last 18-months, has given investors something missing from their portfolios over the previous decade.  A positive return on the safest assets may encourage investors to return to more traditional allocations and perhaps be less attracted to optimistic schemes with questionable fundamental purpose.

Aug 1, 2023 | Commentary

An Atypical Housing Market

• The U.S. housing market is a closely watched indicator of the economy.  New and existing home sales and applications for building permits have often moved together and in concert with GDP.
• As the Fed began their interest rate hikes in the spring of 2022, mortgage rates followed, and the housing market turned down.  There was a broad consensus that this was a preview of the path to recession.  Neither housing’s demise nor the arrival of recession has happened yet.
• Since the Global Financial Crisis housing supply has fallen well short of demand spurred by rising populations and wealth.  The COVID pandemic only exacerbated this imbalance.  The recent reacceleration of housing starts surprised many but reflects the shortage of existing homes listed for sale and the continued demand of those wanting to become homeowners.
• Economic forecasts are often made by comparing two time series of data.  However, the pandemic disruptions were so big and of such a different nature that trying to analyze current events from historical data drawn from completely dissimilar periods is fraught with potential error. These simple data driven forecasts have often been wildly off the mark for more than a year.  Housing is just one vivid example.

Jul 1, 2023 | Commentary

Midyear Thoughts on the Equity Market

• Over the last three and a half years the stock market has experienced extreme shifts up and down.  Each move can be explained in hindsight, but none were well anticipated.
• Mid-year 2023 tells a tale of a highly split market.  The broad S&P 500 index has seen solid gains, but the vast majority of that progress can be attributed to the eight largest tech-oriented stocks in the index.  Many active managers not willing or able to take that level of sector or company concentration risk have lagged this year.
• There is also a considerable divide in valuations between the top tech stocks and the rest.  History shows such valuation gulfs eventually shrink, but timing the event is a nearly impossible feat.
• Stock traders have always looked for shortcuts to quick profits. The explosion of ETF index investing has encouraged this.  Trading is not investing, and in the long run fundamentals do matter.

Jun 1, 2023 | Commentary

The Inflation Path From Here Will Be Challenging

• Inflation peaked in the United States in June 2022, the result of rapidly rising energy, food and other goods prices brought on by supply chain disruptions, the war in Ukraine and strong demand spurred by aggressive monetary and fiscal policy.  Since then, inflation has been moving lower as many of those previous forces abate.
• A concerning element so far in 2023 is the rise of inflation in services to a level twice the norm after the Great Financial Crisis.  Accounting for almost 60% of consumers’ budgets, service inflation tends to be stickier.  A tight labor market will do little to ease the upward pressure on wages and those prices.
• The Federal Reserve continues to debate whether additional Fed Funds rate hikes are necessary to combat inflation that is moving back toward their 2% target at an “unacceptably slow” pace.  The likely decision for the next meeting in June is for a pause in rate hikes.  Monetary policy works with a lag and after the bank failures in early March credit availability is likely to contract.  Both should help slow the economy somewhat and allow inflation to move down further, but the path could be slow and challenging.

May 1, 2023 | Commentary

The Labor Market Revisited

• The COVID shutdowns turned a robust labor market into a disaster almost overnight.  It has been recovering since but remains short of pre-COVID health in many ways.
• 4.1 million new jobs have been added to the economy in the last twelve months and the pace in Q1 showed no material slowing.  Labor Force Participation still lags pre-pandemic levels but has been creeping upward, an encouraging sign that the recovery can continue.  This is vitally important in a consumer-centric economy like ours.
• When the Federal Reserve began raising policy interest rates to combat rising inflation, many experts saw an imminent recession on the horizon.  More than a year later with interest rates almost 5% higher, recession concerns persist but are still uncertain as to the arrival date or severity.

Apr 1, 2023 | Commentary

Silicon Valley Bank and FTX; Parallels and Contrasts

• In many ways the collapse of cryptocurrency exchange, FTX, and the regulated Silicon Valley Bank could not be more different.  There are, however, trends in how traders communicate and react that affected both similarly.
• It has been widely reported that social media messages by industry titans, Changpeng Zhao and Peter Thiel, appear to have triggered behaviors in tight communities that put the deposit runs in motion.  Higher volatility can be expected from the speed and scope of such communications.
• Regulators have always focused on past crises. There will no doubt be responses to both recent failures, but it is unreasonable to expect regulators to formulate rules to prevent potential problems that have never before surfaced such as the impact of long duration assets in a rising rate environment.
• Investors need to stay focused on the long run while experiencing periods of market stress.  Active fundamental managers should enjoy more opportunity to add value, but they need to build portfolios with an eye toward higher volatility name by name and possibly being out of step with their benchmarks regularly

Mar 1, 2023 | Commentary

The 21st Century Fed - Not your Mother's or Father's Federal Reserve

• The fight to reduce annual inflation back toward 2% is the Fed’s current top priority.  Tools at work include increases in the Fed Funds rate and a reduction in the Fed balance sheet, commonly known as Quantitative Tightening or QT.
• Quantitative Easing, or QE, began in the wake of the Great Financial Crisis (GFC) and accelerated in the COVID shutdowns and recession.  It is tempting to think that since on average the period of QE was favorable to risk assets like stocks, QT must be bad.  The relationship is more nuanced than that.
• The liability side of the Fed’s balance sheet now includes major items that were never significant before the GFC.  Increases in reserves held at the Fed, reverse repos and the Federal Government’s own checking account have acted as counterbalances to the massive growth in assets due to QE.  Just as they restrained inflationary growth during QE, they are acting as a rein on the worst potential outcomes one might expect from QT.
• The Fed’s main tool against inflation will continue to be the level and duration of higher Fed Funds interest rates.  Uncertainty about this alone adds volatility to risk markets.  The last 13 years have shown that the Fed can manage its balance sheet in ways unimagined before the GFC.  Investors looking at the Fed through a 20th Century lens are likely to err in their interpretation of the bank’s actions.

Feb 1, 2023 | Commentary

Real Versus Nominal Interest Rates

• The resurgence of inflation above 4% in 2021 has once again brought attention to the concept of real interest rates, the rate of return after adjusting for the purchasing power of money.  While inflation was running below the Federal Reserve’s target of 2%, real rates were easy to ignore.
• T-bills are generally considered the safest asset available to U.S. investors.  Since 1960, the real 3-month T-bill rate has averaged about 0.6% per year.  That average includes over a decade since the Great Financial Crisis when T-bills earned almost nothing on a nominal basis and were negative after inflation.
• With the Federal Reserve focused on higher policy rates to control inflation, T-bills are now earning more than 4.5% nominally, but are still lagging current inflation.  If the Fed is successful in bringing inflation back toward its target, and they do not go back to a zero interest rate policy, real interest rates will likely rise toward historical averages and stay there.
• Expected returns on all other risk assets like investment grade and high yield bonds, equities and real estate typically have a meaningful premium above the risk-free rate.  As that rate stays in positive territory on a real basis the likelihood of a diversified portfolio beating inflation through time improves.

Jan 1, 2023 | Commentary

Returning to Normal?

• From the Great Financial Crisis (GFC) through 2021 policy interest rates around the developed world hovered at or below zero. Viewed in some circles as a slain dragon, inflation returned with a vengeance in 2021 prompting central banks to raise rates as their best defense against further price acceleration.
• As 2022 drew to a close, the rate of U.S. inflation was falling but still running well above the Fed’s target of 2%. Uncertainty about how much higher policy rates may be raised, and how long they may be held at elevated levels, continues to create volatility across asset classes.
• The last time the Fed Funds Rate was above 5% was in Q3 2007, right before the housing market collapse and the severe recession that followed the GFC. Many believe that recent Fed action could precipitate a similar economic downturn. However, major parts of the economy, especially the strength of the banking system and the relatively less leveraged housing sector, are different today. Drawing simple parallels between the GFC and now is likely misguided.
• With higher rates, bonds can provide a meaningful contribution to target returns while providing some protection against equity risk. The traditional balance between stocks and bonds, essentially missing in the era of zero interest rates, is once again a viable possibility. We might be returning to a world considered normal prior to the GFC.

Dec 1, 2022 | Commentary

Currencies and Confidence

• Currencies are a curious creation that depend entirely upon the trust and confidence a population places in them.
• Sound currencies ebb and flow in value against each other reflecting shifting macroeconomic fortunes, but they retain value through time because users believe in their ongoing ability to facilitate transactions and be a reliable store of value.
• When governments destroy that trust by creating too much currency relative to the economy’s growth, inflation ensues. Taken to extremes, hyperinflation can completely destroy the value of a previously widely accepted currency.
• Bitcoin and other cryptocurrencies were supposed to eliminate those risks, but as recent events have shown the ecosystem around them has created many challenges to trust and confidence. Until blockchain currencies are created and backed by central banks, this new technology may fall well short of its potential to improve the efficiency of our global financial network.

Nov 1, 2022 | Commentary

Currencies, Credit, and Equities

• An index of the U.S. dollar measured against a basket of key foreign currencies has appreciated almost 25% since the start of 2021. Three-quarters of that rise has happened this year.
• A stronger dollar hurts U.S. exporters and reduces the value of profits earned abroad. In contrast, American consumer purchasing power for imported goods is enhanced. Measured U.S. inflation would be materially higher today if the dollar had been declining.
• One of the reasons for dollar strength is the Fed’s policy of raising interest rates. Another is generally benign corporate credit spreads that suggest defaults will not be severe any time soon. The combination of these and other factors when compared to conditions abroad paints an attractive picture for foreign capital seeking return and safety.
• The biggest challenges arising from a strong dollar fall mostly on nations in worse economic shape than the U.S. This and the basic currency translation partly explain the recent weak performance of international stock investments. U.S. investors should be aware that when the dollar cycle reverses those headwinds will turn into meaningful tailwinds for international stocks.

Oct 1, 2022 | Commentary

Where Is the US Economy Heading?

• As the Fed continues to raise policy rates, talk of recession risk grows, but not all recessions are the same.  It is unlikely that if the economy goes into recession the outcomes will be as severe as the Great Financial Crisis (GFC) or COVID-shutdown recessions in 2008 and 2020, respectively.
• Strength in bank, corporate and consumer balance sheets suggest that the preconditions for an extreme GFC-type recession are not currently present in the United States.
• A rapidly appreciating dollar reflects the relative advantages of the U.S. economy but it reduces earnings of global companies, makes our exports less competitive, and distorts global capital flows.
• Equities have been discounting bad economic and earnings news all year.  Paralleling that market, high yield credit spreads have moved from historically narrow levels approaching 3% to current spreads above 5%.  These near average spreads suggest the credit market is not expecting extreme defaults even in a recession.
• The Fed will likely continue to raise policy rates until they exceed a stabilized rate of inflation, which might not fall much below 4% soon.  That is the concern of the market, but the implications are not necessarily dire.  Business investment to repair supply chain disruptions is growing despite higher rates. The number of initial and continuing unemployment claims have been declining over the last several weeks.  If the U.S. is heading for recession, it is doing so from a much stronger position than it did in 2007.

Sep 1, 2022 | Commentary

Are We in a Recession?

• The Bureau of Economic Analysis last month released its estimate for the 2nd Quarter Gross Domestic Product (GDP) showing the second consecutive small decline in output for the economy. This prompted many observers to state that the U.S. was in a recession.
• While two consecutive quarters of negative GDP has been a convenient rule of thumb concerning recessions, the official designation is made by a group of academics at the National Bureau of Economic Research that considers many factors beyond GDP.
• Recessions have historically been most associated with rapidly rising unemployment and tumbling consumer spending.  Neither of these conditions holds today.
• There are pockets of economic softness, especially in housing, that could lead to a more prolonged downturn that bear watching.  But the U.S. economy, almost 70% driven by consumer spending, still has a forward push from a strong labor market.  As long as consumer demand is growing, businesses are likely to continue to invest to compete for those expanding opportunities.

Aug 1, 2022 | Commentary

Staying Ahead of Inflation - JOLTS and QUITS

• Inflation in the U.S. has accelerated to levels not seen in over 40 years.  Few are untouched by it and a common narrative is that it is crushing the consumer, which will soon lead to a recession.
• 70% of the U.S. economy is driven by consumer spending.  One of the best gauges of the future is the labor market.  Job and income gains propel consumer spending and recently the total number of private sector jobs passed pre-pandemic levels.
• Today the labor market is drum tight.  The unemployment rate is 3.6% and there are six million more jobs open than there are unemployed people looking for work. A lesser followed data series, JOLTS, is the number of people who quit their jobs each month.  Another labor data series, QUITS, shows every month so far in 2022 more than 4 million people have quit, with almost all of them moving into better opportunities.
• This dynamism of quitting for better pay and working conditions allows families to have a chance to stay ahead of inflation, maintain their lifestyles and contribute to the forward momentum the economy has shown to date.

Jul 1, 2022 | Commentary

Portfolio Diversification and Correlations

• Bonds are often thought of as diversifiers to stocks.  When stocks fell in 2008 and 2020 there was a flight to quality in U.S. Treasuries that reinforced that view.  So far in 2022 the decline in stocks has been largely caused by rising interest rates.  Diversification with stocks and bonds has not delivered the traditional expected benefits.
• Correlation is a key concept to estimate potential benefits from diversification.  The less correlated asset prices are the greater the reduction in portfolio volatility.  But correlations move around and increasing correlations have made 2022 particularly challenging.
• One of the arguments for Bitcoin has been its uncorrelated nature to traditional assets like stocks and bonds.  While true for many years, the pattern for cryptocurrencies like Bitcoin versus traditional stocks is now one of high correlation.
• Blockchain functionality is developing in many other ways to improve the efficiency and transparency of the traditional financial services. 
• The elevated market volatility observed so far in 2022 is likely to persist until there is greater clarity on Fed policy, inflation and geopolitical events.  While keeping a broadly diversified portfolio of stocks, bonds and real estate is important, adding non-traditional assets like Bitcoin may meaningfully further add to volatility.

Jun 1, 2022 | Commentary

Inflation

• Has inflation peaked or will it peak soon?  Where will it settle?  These are common questions today.    
• Not all inflation measures tell the same story, but they usually rhyme.  The Federal Reserve’s preferred measure is core Personal Consumption Expenditures (PCE) and while it generally runs below the more widely reported Consumer Price Index (CPI), it is currently well above the Fed’s inflation target of 2% which it believes is consistent with general price stability.
• It has been 40 years since the Fed has had to do much to control inflation.  Nothing in the Fed’s tool kit will miraculously fix supply chain problems or ease a tight labor market.  Their primary tool will be to slow down demand through higher interest rates.  This will involve a delicate balance between being too easy, and not bringing down inflation, and too tight, pushing the economy into recession.
• Do not be surprised if the Fed talks tough but ultimately settles on policy rates lower than the rate of inflation.  The bond market’s reaction to this would likely be a steeper yield curve, necessitating continued caution about extending duration. But negative real rates of interest will also keep liquidity in the capital markets plentiful and will allow the high national debt to GDP ratio to shrink.

May 1, 2022 | Commentary

The Strength of the U.S. Consumer

• Current personal consumption expenditures are close to 70% of GDP.  Consumer behavior speaks volumes about the health of the economy.  Lingering effects of the COVID shutdown, inflation and Russia’s invasion of Ukraine all potentially weigh upon the forward path of this important component of the economy.
• Despite the array of uncertainties, the average consumer is in strong shape.  Even after Q1, compared to pre-Covid, financial and real estate assets are up and the ability of consumers to service their debts is close to a multi-decade high.
• Both the aggressive monetary policies by the Fed and the large fiscal stimulus bills by Congress as a response to COVID contributed to this strength.  Stronger consumer balance sheets should help protect future consumption even as the Fed raises its policy interest rate.
• Sentiment indicators published by the University of Michigan and the Conference Board so far in 2022 suggest softness in consumer attitudes.  These data have not mirrored actual consumer behavior.  When anticipating the direction of the economy it is better to watch what consumers do versus what they say.

Apr 1, 2022 | Commentary

Accelerating Capital Spending is to be Expected

• The Ukraine invasion has added another layer of risk and uncertainty to a world severely disrupted by COVID.  Supply chains have been fractured. The labor market is stretched drum tight.  Addressing these challenges will take massive new investments.
• Capital expenditures, or CAPEX, are highly cyclical, contracting in recessions and growing in recoveries.  The recovery after the Great Financial Crisis was perhaps slower than in earlier periods because companies were investing abroad to lower costs.  Globalization was the norm. This trend is over.
• CAPEX is accelerating to remove uncertainties from the supply chain. Major expenditures on education and training, which are not captured in GDP accounting as CAPEX investments, are also being made to help close the labor market gap.  It would not be a surprise if CAPEX jumped above historical averages for the next several years, creating momentum through its positive multiplier effect on GDP.
• Ukraine has raised major risks and uncertainties not previously understood or acknowledged.  Investors should not focus solely on these risks and ignore the tailwinds in the economy. Long-term target equity allocations should be maintained.

Mar 1, 2022 | Commentary

Inventories and Economic Growth

• Q4 2021 GDP growth rate is estimated to be 7%. Economists cautioned that this was artificially high and not sustainable because 4% of the total came from additions to inventories.
• COVID caused early errors in judgement by businesses followed by a surge in demand for consumer goods that could not be met.  Retail inventories plummeted and remain highly depressed. 
• The Q4 2021 contribution of inventories to GDP was the proverbial drop in the bucket in terms of what is needed.  It is likely that inventory additions will be a positive contributor to the economy for many quarters to come.
• The same economists who badly misjudged GDP growth in Q4 and all of 2021 are now predicting a sharp drop off in the growth rate for 2022.  They may be missing how robust consumption remains, how much work still needs to be done to restore inventories, and how much investment will need to be made in people and physical capital to close the gaps created by COVID.

Feb 1, 2022 | Commentary

Interest Rate Increases and the Stock Market

• The Federal Reserve has clearly indicated its intention to end quantitative easing this year and begin raising policy interest rates.  With inflation well above target and unemployment below 4%, the market has long anticipated these moves.
• The most basic principle in stock analysis is that today’s price should reflect the discounted present value of a company’s future earnings.  As interest rates rise, and all other parts of the equation remain unchanged, stock prices should fall.
• The challenge is that all other parts of the equation never remain unchanged.  It matters why interest rates are rising and companies will be affected differently depending on how they respond to economic forces, their current versus expected future earnings, and their need to borrow to access capital.
• The market historically gets the general pattern of these changes correct, but it is a noisy process prone to exaggerated moves.  The alpha of successful active managers never displays the consistency of T-Bill returns, necessitating patience to avoid emotionally driven new investments or redemptions.

Jan 1, 2022 | Commentary

A Positive Case for Active Management

• Active managers often struggle to add value beyond their fees, but there are some environments where the odds tilt in their favor.  Our current environment may be one of those.
• Even long-term stock investors need to adjust their portfolios periodically.  Heightened volatility among individual stocks opens the door to thoughtful purchases at a discount and sales at a premium.
• Market volatility spiked with the pandemic sell-off in Q1 2020.  What is unusual today is how long after the initial jump the volatility has remained elevated.  A major pick-up in the activity of retail investors, many of whom have discovered the high-octane world of option investing, may be a contributing factor.
• Just because the opportunity exists for active managers to add value during volatile times does not mean it will happen consistently. Like in all volatile markets, patience and long-term perspective are most important to avoid emotion-driven missteps along the way.

Dec 1, 2021 | Commentary

What's Wrong With the Labor Market Today?

• The U.S. economy continues to enjoy a robust recovery from the sharp COVID-induced recession beginning in Q2 of last year.  Supply chain disruptions and a shortage of workers to fill more than 10 million open jobs have hobbled but not defeated the ongoing rebound.
• Many economic, demographic and policy factors combine to shape the supply of labor at any point in time.  The COVID pandemic caused a severe drop in the Labor Force Participation Rate (LFPR), which has since only partially recovered.
• Young workers may be reluctant to return to a traditional workplace because they have unvaccinated children at home that they fear could be infected.  Retirements have spiked in part because of COVID fears but also because the rising stock market and home prices make retirement more viable.
• As the economy evolves toward more onshoring of activity as discussed in last month’s Commentary on supply chains, this will add to the demand for skilled labor, further raising wages.  At some point as progress against COVID becomes more assured, people on the sidelines should be drawn back into the labor force by these economic incentives.
• Some of the changes in the LFPR are likely permanent.  If labor supply remains weak relative to demand, there will have to be large investments in labor saving technology and improved training for the existing work force.  This will ultimately improve productivity and provide support for further economic and market growth.

Nov 1, 2021 | Commentary

The Fracturing of Global Supply Chains

• Disrupted supply chains have delayed the production and delivery of many goods globally.  Higher prices and disappointed consumers have been the result.
• For decades, globalization and cheap transportation encouraged the use of foreign manufacturing to exploit lower costs than those available at home.  While wonderful for consumers when functioning smoothly, geopolitical events and the pandemic have demonstrated risks to the supply chain that are now being addressed.
• Globalization offered lower cost goods that acted as a natural regulator holding down inflation.  That moderating influence is missing at the moment.  As companies work to find solutions to their supply chain challenges, manufacturing cost structures will be under pressure. 
• Another trend in globalization has been the splintering of sources of inputs.  Different parts are shipped from all over the world leaving manufacturers vulnerable to a disruption in any part of the network.  The fragility of interdependencies in this process is clearly on display today as a shortage of computer chips from Taiwan has disrupted much of the auto industry.  Some of these problems have national security implications.
• Many of the supply chain problems stem from too much demand for products, not from too little.  This means business have strong incentives to invest in solutions that will likely be structural rather than cyclical in nature.  More emphasis will be placed on local sourcing of inputs and assembly to protect against supply chain disruptions.  This will likely mean a big step up in demand for both capital and labor as the transition progresses over the next several years.

Oct 1, 2021 | Commentary

Real Interest Rates

• Decades of relatively muted inflation have desensitized many investors to the important concept of real interest rates, which are the more widely followed nominal interest rates adjusted for the rate of inflation over the relevant bond’s maturity.  It is the yield you earn once purchasing power is held constant.
• Since 1997, the U.S. Treasury has issued Treasury Inflation Protected Securities, or TIPS, alongside its traditional nominal bonds.  TIPS began their history offering small but meaningfully positive real rates of interest.  Since the Great Financial Crisis, the real yield has been drifting lower and occasionally into negative territory where it is currently.
• Today, anyone lending to the U.S. for 10-years via TIPS is locking in a roughly -1.0% real rate (which is the nominal interest rate less CPI).  That converts to a guaranteed loss of about 10% in purchasing power over the decade.  Investors making this choice must be terribly fearful of accelerating inflation that would diminish the value of traditional bonds and stocks even more.
• While TIPS currently fail as a long-term holding, they might be useful as a shorter-term trading vehicle.  Differences in opinion about the pace of inflation and the economy can sometimes lead to exploitable mispricings.
• When real interest rates are so low the benefit accrues to borrowers.  As private parties identify accretive capital projects, productivity and profits should be enhanced adding to fundamental equity value.  As long as negative real rates persist, investors should acknowledge the meaningful tail wind behind equities while continuing to resist the negative real rates in TIPS. 

Sep 1, 2021 | Commentary

Stock Indexes; What's in a Name?

• 50 years ago, there were a small number of stock indexes calculated and disseminated to give investors regular updates on what the market overall was doing.  For decades these were usually price weighted averages like the Dow Jones and the Nikkei that could deviate meaningfully from the total market on any given day.
• With advances in finance theory, urging investors to “own the market,” capitalization weighted stock indexes like the S&P 500 moved to the forefront, though there continues to be a large population that follows the Dow every day.
• Today there are thousands of indexes calculated in real time by scores of providers, each claiming to be a superior representation of the country, cap size, sector or a style.  The cause of this proliferation is pure economics.  Indexes are cheap to create and calculate but if they get a following among index funds or ETF’s the royalty revenue streams can be quite large.
• In reality, there are very few differences for the average investor in the long run across indexes in the same category.  There may be variations from day to day, but across quarters and years these melt away.  Like generic versus branded aspirin, some people may prefer to pay a premium for a name brand index product, but the difference in performance will most likely reflect any difference in costs.
• It is convenient to think in index terms.  Each day there is a simple numeric metric calculated and communicated.  But investors should never lose sight that it is an asset allocation to U.S. large cap stocks or to all cap international stocks that is going to affect portfolio performance, and not the label put on the benchmark.

Aug 1, 2021 | Commentary

Do Stock Market Highs Predict the Future?

• U.S. equities over the past 40 years have reflected the growth in the economy and have been in a generally rising market.  Along the way, new record highs occur, though not continuously.  After a large market correction, it may take years to regain the top ground.  Once there, records can occur in bunches.
• Ironically perhaps, it is when the market sets regular records that commentators appear and start cautioning against the next big decline and urging defensive measures.  Many investors, naturally concerned about the impact of big losses, look to reduce risk through asset allocation shifts.
• Research based on daily U.S. stock market returns since 1980 shows that there is no identifiable connection between returns over 12 months and whether that period opened on a record day or not.
• The brokerage, banking and insurance industries are all motivated to have investors actively trade or buy products to shift their asset allocations.  Careful long-term investors address risk at the portfolio construction stage, anticipating the inevitable ups and downs.  This minimizes the influence of behavioral biases that make us susceptible to the urge to regularly do something with our portfolios.

Jul 1, 2021 | Commentary

Time Horizons of Investors and Traders

• Information is the lifeblood of markets.  Whether it is at the company, sector or macro market level, whenever new information appears it is analyzed and incorporated into current prices.
• Academics might think this is a neat and tidy process.  It is anything but.  New information can get to market participants at different times and analyzing its importance is rarely easy or definitive.  The result is a noisy path of prices.
• It does not help that market participants are heterogeneous.  Offit Capital looks through the lens of a long-term investor.  As important as this perspective is, considering the absolute size of long-term investors in the market, it represents little of the daily volume.  That activity is dominated by traders and market makers that have time horizons from a few months, weeks or days all the way down to fractions of a second.
• We are sometimes asked, “The S&P was down 3% last week.  What is that telling us about inflation, economic growth or employment?”  The honest answer is that the market drop might be pointing to a change in macroeconomics, or it might just mean that short-term traders have changed their mind for some other reason.  Anyone who tries to second guess those motivations and act on it shifts from being a long-term investor into a short-term trader, and often to no good effect.

Jun 1, 2021 | Commentary

Spending and Saving; The Odd World of the Pandemic

• Despite an economy that has progressed from the pandemic shutdown in Q2 of 2020, saving and spending behavior remains greatly distorted as compared with pre-pandemic days. The transitory nature of stimulus support is a key reason why.
• People increase spending when they perceive a permanent increase in income.  The supplemental income payments in response to the pandemic are anything but.  Theory and historical evidence suggest that a high fraction of such temporary income boosts get saved, and that is exactly what we are seeing.
• Banks are in an unusual position with deposits climbing while loans, including credit card debt, is falling.  Traditional measures of the money supply only look at the deposit side. This imbalance between deposits and loans has distorted any analysis of the increasing money supply and the ultimate impact on inflation.
• At some point the recovering economy will be more based on fundamentals and rising wages versus short-term fiscal stimulus.  When that happens, spending and borrowing will resume the pre-pandemic pace.  Everyone should carefully watch the ultimate impact on inflation.

May 1, 2021 | Commentary

Non-Fungible Tokens and Blockchain

• Non-Fungible Tokens (“NFTs”) have sprung upon the investment landscape in just the last few months.  They rely on blockchain technology to create a permanent and secure ownership record for unique digital items like artwork, music, video clips and other virtual collectibles.
• Like cryptocurrency, NFTs use the notion of scarcity to suggest economic value. 2021 has also witnessed social media fueled interest in some NFTs lead to staggering increases in value, prompting people on the outside to ask if they are missing an important investment opportunity.
• Humans in every culture collect things.  NFTs are a 21st Century version of collectibles, which some people will enjoy and want to buy while others will be completely befuddled by the interest.  There is no right side in this debate and the market will ultimately determine any worth like it regularly does for traditional pieces of art and antique automobiles.
• Blockchain is in the process of radically changing many parts of our transactions and investing lives.  Like all transformative technologies, there will be many great beneficiaries.  But it is also true that not every activity associated with blockchain will be worthwhile and create wealth.  NFTs and many, if not all, cryptocurrencies should be treated as trading vehicles by investors, but unless one has great skill as a trader, they should not be part of one’s long-term investment portfolio.

Apr 1, 2021 | Commentary

Special Purpose Acquisition Companies (SPACs)

• Special Purpose Acquisition Companies (SPACs) are a legal device where a proxy company with no business or revenues goes public in a simple Initial Public Offering (IPO) promising to find a merger candidate among private companies using the capital the SPAC raises.   Once the merger occurs, the private company becomes a public one.
• SPACs have exploded in activity over the last two years, contributing to a reversal of a two decade decline in the number of public companies. Proponents say this is because SPACs offer private companies an easier path to becoming public without having to follow all the regulatory steps in a traditional IPO.
• Another reason for the growth in SPACs is the highly attractive compensation the SPAC sponsors receive once a merger is completed.  This pay is highly dilutive to the SPAC owners. The sophisticated institutional investors in SPACs understand this and typically exit their positions between the time a merger is announced and when it is completed. Less informed public investors who are hoping to jump onto the next hot new public company are the typical buyers of these soon to be diluted positions.
• Academic research is already emerging showing how poorly SPACs perform on average in the year after the merger.  This is in part due to meaningful misalignment of incentives between the SPAC shareholders and sponsors.  Investors seeking access to attractive new companies are probably better off taking their chances to buy after the merged company becomes public rather than face the certain, significant dilution that comes from most SPACs.
• The spirit of clear disclosure and transparency of financial information in IPOs long embedded in SEC rules is being skirted by the SPAC process.  Investors buying SPAC shares after the merger announcement do not have access to key financial information with which to make an informed decision.  If a pattern emerges of weak companies being sold at too rich prices, the SEC may want to tighten SPAC activity to protect the public.

Mar 1, 2021 | Commentary

Strange Things Going On

• The stock market has always had the potential for extreme volatility.  In the 1920s and 1930s it was often characterized as a gambling casino with little to offer serious investors.  Over time, as more institutions and individuals embraced owning equities for the long run, the extreme characterizations waned.
• Recent events in small cap stocks touted on social media platforms like Reddit, Seeking Alpha and others remind us that not everyone trading stocks is well informed or motivated by long-term returns.  Rapid profits, and losses, become the typical experience of assets trading in a bubble.
• Whether through illegal means to manipulate or simply by the strong collective force of people on the same side of the market, prices sometimes move to extreme levels.  The experience of GameStop, a stock that began 2021 near $20 a share, reaching $483 in the last week of January before falling back to $40 on February 19, should remind us that ultimately stock prices do reflect the fundamentals of a company.
• When these episodes happen, there are concerns about the fragility of the system.  GameStop made a lot of headlines over the last two months, but most people do not understand that in small capitalization markets a modest amount of capital can have a big price impact, at least in the short run.  That is why many investors shun penny stocks and some frontier and emerging markets.  The likelihood of extreme volatility is simply not worth it.  Thankfully for the stock market as a whole, these side shows have lacked enough materiality to be a real concern.  But if the number of such events grows, it may signal more caution is warranted.

Feb 1, 2021 | Commentary

The Fed and the Dollar / Inflation Conundrum

• Popular market commentary has recently been focused on the declining dollar and the potential for accelerating inflation.  There are compelling arguments behind these perspectives, but the forces at work today have not produced firm linkages in earlier years, so there is room for alternative outcomes.
• Real interest rates, which adjust market rates for the impact of inflation, have declined in the United States as the Federal Reserve stays committed to a zero nominal Fed Funds rate policy and inflation has begun to inch up.  CPI inflation over the next several months is likely to show elevated readings as the economy recovers from the highly depressed levels of Q1-2020.  This should continue to press real interest rates lower.
• The dollar has fallen around 12% from its peak in March, raising concerns about secular weakness. Rarely mentioned is the fact that the March top occurred in reaction to COVID-19 concerns and a flight from risk assets.  Over the entire past year, the dollar decline is closer to 3%, and it remains well within the range of the last five years.
• Investors cannot ignore the potential risks from large deficits, potential inflation, and shifting currencies, but the right approach is a careful asset allocation that incorporates those risks, and not short-term macro themed trades trying to guess turning points and trends.
• The Federal Reserve can persist in their zero-interest rate policy and aggressive quantitative easing if inflation stays in a low range.  However, if growth and inflation move up real interest rates will ratchet further into negative territory, encouraging more borrowing.  There may be a tipping point where the demand for high quality debt is insufficient to cover the growing public and private supply.  If the yield curve steepens meaningfully the Fed may find itself no longer shaping the fixed income market but trying to catch up to it. 

Jan 1, 2021 | Commentary

2020, A Year to Forget – and Remember

As 2021 opens before us, thinking back on 2020 brings back many events that we would like to forget: a COVID pandemic that is still far from under control; the most fractious presidential election in memory; and volatility in investment markets that rivaled the worst of the Great Financial Crisis in 2008.  As much as we may be pleased to see 2020 in the rear-view mirror with no wish to travel those roads again, it will serve investors well to remember key themes from the year for future use.

Dec 1, 2020 | Commentary

Investment Statistics Can Be Fragile

• Investment statistics have over the last few decades gained increasing importance in the management and marketing of funds and portfolios.  Unfortunately, they can sometimes give the impression of more scientific basis and predictability than they can deliver.
• Beta – the common term for the sensitivity of a stock or fund with respect to the general market – is one of the most common statistics used in equity investing.  It provides an expectation for how a stock or a fund should behave in different market situations.  The COVID-19 market disruptions that began in February of this year were so extreme as to make many market betas almost useless as a predictive tool.
• Most long-only equity managers could deal with the statistical disarray as they more often use a wealth of fundamental information and insights to make stock selections versus a heavy reliance on statistical models.  Long-short equity and quantitative hedge funds that target low portfolio betas tended to be more challenged in 2020.
• Offit Capital considers and reports the standard investment statistics when evaluating managers and suggesting portfolio allocations but is never dependent upon them.  We understand that these statistics can be a useful diagnostic tool, but they should never be considered as reliable windows into the future.  2020 provided yet another reminder about how fragile investment statistics can be.        

Nov 1, 2020 | Commentary

Why it is Hard to Generalize About the Stock Market in 2020

• So far in 2020, investors have seen the fastest bear market decline and bull market recovery in history.  The V-shaped stock market does not match the much slower economic bounce back, raising questions about whether the market has come back too far, too fast.
• To evaluate those questions requires a deep dive into individual stock behavior.  The extreme dispersion of stock returns in 2020 shows a picture of clear winners and losers arising from the economic uncertainty surrounding COVID-19.  Some active managers have exploited this dispersion to their investors’ advantage.
• A better characterization of the U.S. stock market and the economy in general is a K-shaped recovery.  Online retailers, housing and the automobile sector are all on the rise. Energy, traditional retailing and workers in leisure and hospitality have seen little recovery and effectively are in a depression.
• Making general comments about the total market might be what index-oriented investors want.  2020 has shown dramatically how shallow and unhelpful those opinions can be.  It is not true that the only managers that have prospered this year are those piling into Microsoft, Apple, and the other mega-cap names.  The winning managers in the future are likely to be those that shun simple macro analysis and continue to do deep fundamental analysis to sort out their investment options.

Oct 1, 2020 | Commentary

Endowment Spending and the Pandemic

• For months now our lives have been disrupted by the COVID-19 pandemic.  Schools and foundations have been hit hard.  Expenses surrounding programs have risen while revenues remain highly uncertain.  How to best address these budget challenges is occupying a great deal of trustee and administration time and energy.
• Mechanical spending rules based on a moving average of endowment values are considered best practice and have the advantage of smoothing out volatile returns and providing more certainty to the budget process.
• In extreme times like these, it may be best to temporarily suspend the spending formula in favor of providing support for the basic mission.  As long as these extra outlays do not become a permanent feature, the first goal of fulfilling essential needs can be met without too great an impact on future generations.
• The objective of an endowment is not to grow without bounds, but to contribute regularly to the programs of the school or foundation and promote inter-generational equality while also serving as a rainy-day fund.  Suspend the spending rule and dip further into the endowment, as necessary.  When extraordinarily good parts of the cycle recur, do the reverse, and forego some of the outsized spending increases implied by the rule.  Allow that capital to keep growing in the endowment to provide better for moments just like this.

Sep 1, 2020 | Commentary

The Global Supply Chain Equation

• Supply chains are the steps in the production process that occur as manufacturing becomes more specialized.  For centuries it has had global elements, but the last 30 years has seen a rapid acceleration in the process as trade barriers were generally reduced and transportation improved.
• The evolving global supply chain is largely driven by manufacturers seeking competitive advantage from lower costs.  As long as trade was relatively free this process accelerated, first primarily to China and then to other low-cost countries around the world.  However, trade wars and the COVID-19 pandemic have added an understanding of uncertainty in the mix.
• Risk of supply chain disruption can be mitigated by taking control of more of the steps, owning directly more links in the chain and locating them where they are less exposed to political or natural uncertainties like pandemics.  All of this comes at a cost.
• The quest for the absolute lowest cost should never be the only focus of manufacturing decision making.  Being able to sleep well at night, knowing that supply chains are secure, is worth somewhat higher prices.  When these price increases show up in CPI and PPI, they may appear inflationary.  But such cost increases are mostly one-time events, and unless the manufacturers have been awarded monopoly or cartel power, there should be no sustained pressure on inflation.

Aug 1, 2020 | Commentary

Ambiguity Aversion; One Factor in Market Corrections

• Risk and uncertainty are two concepts that are often confused.  Risk is probabilistic and highly predictable.  Uncertainty, sometimes referred to as ambiguity, is amorphous and full of surprises.
• Investors have long been asked about their attitudes toward risk, which importantly help shape portfolios.  More recently, economists have been trying to characterize aversion to ambiguity as a factor in human behavior.  Concern about uncertainty could explain phenomena as diverse as toilet paper shortages and bank runs.
• In the first quarter as the market was rising, those with the greatest optimism held more equities.  As the market began to tumble, they were more likely to sell after the decline.  Investors with more cautious outlooks tended to ride out the volatility with only minor portfolio changes.
• If enough people are averse to ambiguity, any major disruption in the market can trigger a series of sell responses that snowball into the kind of decline seen in the first quarter.  The best defense against these moments is an accurate appraisal of one’s emotional compass and a portfolio composition designed to anticipate that surprises will always be with us.

Jul 1, 2020 | Commentary

How Relevant is OPEC Today?

• The oil market is generally volatile, but the first half of 2020 has seen extremes.  A mixture of controlled national producers and free market participants has created a combustible environment that should give any market participant pause.
• Part of this volatility stems from the sharp reversal in the 40-year downward trend of U.S. oil production in the last decade.  On the back of fracking technology, the U.S. has passed Saudi Arabia to become the world’s largest producer.
• In April, Saudi Arabia and Russia brokered a broad agreement across OPEC+ countries (the official OPEC members and other sympathetic oil exporters) to cut almost 10 million barrels of production a day.  These cuts along with the swift decline in North American output due to low prices has helped to restore better supply and demand balance.
• The one universal across OPEC+ is that the producers are state controlled enterprises.  This group commands over half of the world’s production and 90% of the known oil reserves. They sometimes work in partnership with global private corporations, but the major decisions are made by the home country’s governments, not always driven by normal business economics.
• Seeing how quickly the market responded to the OPEC+ supply cuts is a reminder that the organization is still highly relevant, at least in the short run.  Its continued relevance in the coming years may face many challenges.  Ascendant market driven producers will continue to take advantage of any prices above the all-in cost to boost production.  OPEC should also be wary of the spread of fracking technology globally that will further lower costs and reduce the incentive for any one country to participate in the cartel. 

Jun 1, 2020 | Commentary

Unemployment: Insurance and Incentives

• Since widespread pandemic economic shutdowns began, every week has seen millions of new jobless claims.  The total is now over 40 million.  This has naturally raised questions about how much strain this is placing on the budgets of states that have primary responsibility for managing unemployment insurance (UI) programs.
• The good news is that UI anticipates big macroeconomic shocks.  Once the insurance pool is depleted, states can borrow without limit from the federal government to pay the unemployed.  These borrowings have low interest rates and are paid back from rated employers paying future payroll taxes.  There are many factors that are challenging to state budgets these days.  UI payments are not among them.
• In the rush to create fiscal stimulus and help workers laid off because of the virus, Congress allocated extra money to supplement normal state UI benefits.  This has had the unintended consequence of paying most of the unemployed more for staying home than they received working full time.  This is the wrong incentive to promote economic recovery as businesses begin to reopen.
• If extra federal benefits are extended past their scheduled termination on July 31, large parts of the labor force will choose to remain on the sidelines, slowing the economic recovery and permanently damaging survival probabilities for millions of small businesses.

May 1, 2020 | Commentary

The Federal Reserve at the Forefront

• As the COVID-19 virus spread across the United States the first policy response consisted primarily of shutting down broad segments of the economy.  Predictably, stock and bond markets sold off dramatically as investors rushed to cash and treasury securities.
• In the midst of this sell off, credit markets almost seized up completely.  Mutual fund and ETF liquidations pushed dealer inventories up against regulatory and risk limits. Liquidity was almost non-existent even for highly rated corporate credits.  In mid-March the Fed stepped in, buying and lending against a wide range of assets, easing the stress points.  This has allowed the markets to trade and work toward healing, avoiding a complete collapse that could have crippled the capital formation process in this country for years.
• Equally important through this process is the fiscal response of the Federal government and the spread of the virus itself.  Trillions of dollars have already been allocated with more to come if deemed necessary in an election year.  The challenge will be in the efficiency of administration of these massive relief programs.
• There are some encouraging signs the curve may be flattening, though disappointments on that front should be expected.  Pressure will build to allow more of the economy to open.  The market will be actively scouring all data to anticipate future earnings and defaults, but that too will be a noisy process. 
• We believe the Fed is completely on the case and this sets a powerful foundation for economic stability that the market will not ignore.

Apr 1, 2020 | Commentary

The Labor Market and the COVID-19 Virus

• The global COVID-19 virus pandemic has forced draconian changes in lifestyle, severely damaging economic activity and putting millions of people out of work.
• Uncertainty about the pace and medical impact of the virus, and its ultimate meaning for company earnings and the global economy, has produced the greatest market volatility since the financial crisis of 2008. 
• The Federal Reserve has acted quickly and decisively to ensure ample liquidity in the system.  Congress and the President have authorized a $2 trillion aid package that includes direct transfers to citizens and loan guarantees to affected businesses.  The challenge will be how quickly these programs can be executed to provide relief.
• As unemployment grows, talk of a 1930’s style depression will increase.  A depression is highly unlikely because of the initial strength of the economy when the shock hit, the layers of government assistance, and a belief that the fight against COVID-19 will be won as testing increases dramatically and vaccines and therapeutics come on line.
• How the labor market evolves will be both an indicator of current conditions as well as a sign of things to come.

Mar 1, 2020 | Commentary

Economic Growth: How Much is Enough?

• Market analysts tend to obsess on the most recent quarterly GDP figures as a guide to future market direction.  How one frames the same data often determines whether it is supportive of bullish or bearish opinions.
• China has been growing faster than the United States for decades, reflecting a very low starting level and the embrace of more market-oriented policies in the post-Mao era.  The fact that the growth rate is declining is a concern to China bears.  China bulls can take comfort from the large absolute gains every year.
• Economic growth fundamentally arises from population increases, capital spending and technological change.  Without immigration the U.S. growth story through history would have been considerably different. 
• There is no simple answer to how much growth is enough.  Each country’s path depends primarily on the starting point, demographics and investment.  Short-term fiscal and monetary efforts to boost growth for political reasons tend to have little permanent effect and can lead to inflation, market bubbles and the inevitable correction.

Feb 1, 2020 | Commentary

Active Versus Passive Equity Investing Revisited

• Recent market conditions including record index levels and the trillion-dollar valuations of Apple, Microsoft and Amazon have provided grist to the mills of both bulls and bears as well as active versus passive advocates. These debates lead many to question their own asset allocations.
• Index investing may appear totally passive, but it involves the implicit, highly active decision that the investor wants to own a portfolio that mimics the current allocation in that index. One should only invest passively if you think the index makes sense. History shows that is sometimes a short-sighted decision as demonstrated by the popping of the Japanese equity bubble in 1989 and the tech bubble a decade later.
• The large stock concentration in the S&P 500 today is slightly less extreme than it was 20 years ago. Seeing how the makeup of the top stocks changed rapidly between 1999 and 2000 is a reminder than no company’s place is guaranteed. It also suggests how truly active managers have the potential to add value by identifying both dominant winners and losers before the market.
• Index investing is widely believed to create momentum as money gets allocated disproportionately to the largest capitalization stocks. Any momentum is not permanent. Nothing prevents fundamental business evolution from ultimately dominating the index picture. Identifying that evolution before the crowd is what motivates active managers.

Jan 1, 2020 | Commentary

Impact Investing

• Socially Responsible Investing (SRI) has evolved through the years in many ways.  Environmental, Social and Governmental (ESG) screens try to identify passive investments that perform well across several dimensions.  Impact investing has emerged to be a more direct way to marry social objectives and economic returns.
• Impact investing is any activity that has an investment thesis oriented specifically to achieve a social objective.  Finance theory and available empirical evidence tells us that one should expect at least somewhat lower returns.  If higher returns occur, they will be from taking on different and incremental risks that could reverse and disappoint in the future.
• Examples of impact investments include micro-lending programs to provide financial resources to poor communities and developing countries, private equity programs to finance clean water facilities, and investments to promote clean energy or sustainable forests.  The range of opportunities, however, can cover any mission, limited only by the practicality of creating programs to execute against those goals.
• Billions of dollars are flowing into the ESG and impact spaces.  Fund and partnership providers see this and try to meet demand.  Sometimes this is with genuinely responsive offerings.  Too often it is with slight modification to and relabeling existing products in a process sometimes referred to as “green washing” designed to give them more marketing appeal.
• Measuring the true impact of one’s investments is the biggest challenge.  It is necessary, however, to evaluate whether any give up of return was worth the effort of tying together social and economic goals.  At some point it might be preferable to pursue a value-aligned traditional portfolio and use the returns to pursue independent projects designed to achieve the desired social impact.

Dec 1, 2019 | Commentary

Suppose Macro Policy Models Are Upside Down

• Current monetary and fiscal policy have a foundation in long-accepted macroeconomic theory that dates back to Keynes in the 1930s.  That theory says lower interest rates encourage productive investment by companies while also encouraging more consumption as an alternative to lower yielding savings.
• A decade after the financial crisis the recovery rate in the United States has been the slowest in history.  The economies of Japan and most of Western Europe are even less vibrant.  This has unfolded against a backdrop of ultra-low and sometimes negative interest rates.
• In 2010 Offit Capital first wrote about the invisible tax on savers created by zero interest rates.  The estimate was $300 billion then, a sum that has only increased through time as federal debt continues to grow.  Penalized middle class savers become uncertain and cautious consumers.  This in turn could make corporate CEOs hesitant, fearful that there will not be enough demand to justify new investments in plant and equipment. 
• It might be possible that the early 20th Century theories no longer capture the largely developed economies of the 21st Century.  Today ultra-low interest rates might actually be holding the economy back from its true potential.  After a decade of this approach and disappointing macro outcomes, it may be time to rethink our theories and policies.

Nov 1, 2019 | Commentary

What Do We Really Know About Wages and Employment?

• Recent employment statistics have been painted as a “mixed bag” for the economy.  Solid jobs growth and the lowest unemployment rate in 50 years were positives.  Slowing average hourly earnings growth was cited as a negative.  A deeper dive into the data reveals a more nuanced picture.
• Average hourly earnings are based on surveys of employers and do not account for the changing composition of the work force.  Recent research by regional Fed economists suggests that correcting for this bias indicates wages growing at more than 5% annually versus the 3% growth BLS has reported over the past three years.
• Arriving at the unemployment rate involves more than just counting the number of people currently out of work.  The denominator in the equation is the official labor force, which varies for both demographic and economic reasons.  Misreading the labor force can lead to confused notions about full employment and what wage pressures may or may not exist in the economy.
• The September BLS employment reports paint a solid economic picture.  Anyone calling for a recession in 2020 is implicitly relying on a significant external shock as a trigger because history shows that the kind of growth being currently experienced in this high employment, consumer driven economy does not reverse on its own.

Oct 1, 2019 | Commentary

The Fed's Plumbing is Fine: The Definition of Money is Not

• The Federal Open Market Committee recently lowered the target Fed Funds rate by 25 basis points and is expected to cut at least once more by the end of the year.  This came on the heels of open market purchases to inject cash into the short-term lending market that had seen an unexpected jump in the demand for cash.  In both instances the Fed properly used long-standing tools from their policy kit.
• Much of the Fed’s behavior over the last decade has been misanalyzed.  Quantitative easing and zero Fed Funds rates for many years were expected to create inflation that never materialized.  Many macroeconomic analysts erred in focusing on the base money definition that includes excess reserves.  Effective money supply, that is, money that has an impact on real economic activity, should not have included these isolated reserves.
• In a little noticed or commented-on move, the FOMC cut the interest rate paid on excess reserves by five basis points more the Fed Funds rate.  This was the first time they did not change the two rates in lock step.  If this signals a trend it means banks will have additional incentives to reduce their excess reserves held at the Fed and put those assets to work in the economy.
• The rate cuts and the change in excess reserve payments are both designed to expand the effective money supply and create liquidity in the economy.  This kind of liquidity has historically supported both real economic activity and asset values for investors.

Sep 5, 2019 | Commentary

Interpreting Stock Market Volatility... Noise or Signal?

• Recent stock market volatility appears to stem largely from macro concerns ranging from trade policy to the shape of the yield curve.  Despite the uncomfortable volatility in August, and recent minor downward revisions to GDP growth, the economy and corporate earnings seem to be holding up relatively well.
• Stock markets do not suddenly reverse simply because they are at or near record levels.  In the six years since March, 2013 when the S&P 500 regained the previous high mark set in Q4 2007, there have been more than 200 times when a new closing day record was set.  None of them presaged the end of the rally.
• As much as we might like a volatility pattern in stocks that looked more like T-bills (as long as we kept the returns!), history reminds us that is not how equity markets work.  Over very long periods, daily up or down moves of more than 1% happen 20-25% of the time, or an average of once a week. 
• The biggest question right now is the direction of global trade, which remains in a state of flux.  The market tries to discount each new bit of news on the topic, and as the news stream is erratic, the market is as well.  This volatility is discomforting, and one might hope for some kind of resolution in the near future.  But in reality, we simply do not know how trade negotiations will work out and their ultimate impact on corporate earnings and the overall market.  The essential portfolio characteristics of asset class diversification and liquidity have rarely been more important.

Aug 1, 2019 | Commentary

Negative Interest Rates Explained

• Negative yielding bonds invoke the image of creditors paying debtors for the privilege of lending them money.  This does not happen explicitly with negative coupons, but it does occur implicitly as bonds are purchased and held to maturity.
• In this world the newly issued bonds come to the market above par.  The issuing government or company receives more than 100 today as proceeds with the only obligation being to return par at maturity.  Whether the bonds have a zero or small positive coupon, the current price is high enough that the yield to maturity is negative as the owner of the bonds watches the price erode to par over time.
• Negative yields are more than an economic curiosity.  They also impose a severe burden on the banking systems in those regions as net interest margins get compressed.  This is an ongoing burden particularly on European banks that have already severely lagged U.S. banks in the post-crisis recovery.
• If the world of negative interest rates persists or grows, one can expect an acceleration in the push to eliminate physical currencies.  In a world where all transactions were done electronically, accounts could be tightly monitored for both tax and regulatory reasons.  It would also allow banks to actually charge depositors, since there would be no alternatives available to avoid the negative interest rates.

Jul 1, 2019 | Commentary

A Sea of Negative Yielding Red Ink

• Beginning in the fourth quarter of 2018 concerns about global growth spurred demand for the safest sovereign debt, pushing interest rates deep into negative territory for Japan, Germany and Switzerland.  Today there is almost $13 trillion of primarily sovereign debt outstanding with negative yields.
• $13 trillion is more than 20% of global GDP.  If these bonds average -0.30% yields, savers are annually paying these governments a voluntary tax of nearly $40 billion for the safety they seek.
• Negative 10-year rates imply a market expectation of no growth and negative policy rates for a decade.  There is nothing in current data to support such a dire outlook.
• Politicians love ultralow and negative rates.  They can borrow and spend with virtually no impact on budgets.  Today’s situation has evolved over the last five years and could continue for many more.  Investors, however, should not take this for a given, but instead keep an eye on the potential risks should the apparently insatiable demand for safe assets disappear.

Jun 1, 2019 | Commentary

The Psychology of Long-term Investing

• The tone of conversations around the equity market have changed from despair after Q4 2018 to a more constructive tone after the first four months of 2019.  Concerns about trade, Brexit and a litany of geopolitical events create uncertainty, but the U.S. economy and profits continue to grow supporting long-term stock investments.
• Swings in sentiment naturally lead to questions about when to buy and sell.  Short-term traders try to exploit these ups and downs.  Most do it badly.  True long-term investors largely ignore these swings.  They have an investment plan and stick to it, minimizing emotional decisions as they acquire and, most importantly, hold onto their stocks.  Missing even a handful of the unpredictable strong trading days can have a permanent major impact on returns.
• Some people believe there are mathematically optimal ways to manage a long-term equity portfolio, but they may be difficult to put into practice.  Averaging into positions over weeks or months is an example of suboptimal behavior, but it has the advantage of avoiding potential disappointment from buying everything right before a major correction. Such behaviors help preserve our sanity along volatile paths while doing little damage to ultimate returns, aiding our goal to be long-term investors.

May 1, 2019 | Commentary

Private debt is not a problem

• Despite increasing GDP, decent corporate earnings and low unemployment, “experts” have been predicting that U.S. and perhaps global recessions are just around the corner.  One of their red flags is the large size of household and corporate debt outstanding.
• More important than the absolute amount of debt is the ability to service it.  On that score U.S. households and corporations are in the best shape they have been in decades.  Only government debt, both here and abroad, is growing dramatically as a percentage of GDP.
• Modern Monetary Theory (MMT) is a relatively new school of macroeconomics that, in part, argues government debt issued in local currency is simply not a problem.  Default won’t happen because new money can always be printed to pay it off.  Inflation won’t occur if there is slack in an economy, and if it starts to appear, steps can then be taken to contain it.
• The past decade’s data from Western Europe, Japan and the United States seem to give empirical support to MMT.  But additional decades of experience across scores of countries suggest it is lacking in many aspects.  If the MMT theorists are wrong, the U.S. running trillion dollar deficits when the peacetime economy is at full employment is a recipe for serious problems when the next cyclical downturn inevitably arrives (which we do not believe is just around the corner). 

Apr 1, 2019 | Commentary

Well-being is not the same as gross domestic product

• Gross Domestic Product (GDP) is the most widely followed measure of a country’s economic status.  Based only on transactions that occur in formal markets, GDP misses much economic activity.  Since it also fails to account for non-market environmental factors and the impact of income inequality, it is far from a perfect reflection of a country’s well-being.
• Recently, researchers have created indexes that try to capture welfare.  These measures include traditional consumption, but also health, environmental and sustainability factors.  Not surprisingly, GDP and welfare are closely correlated but there are countries that get more welfare bang for the GDP buck than others, as well as nations where well-being lags meaningfully.
• Investors should care about this research because GDP is too often held out as a reliable guide to good investing.  Allocating across countries is more complicated than that.  Long-term stock market value is based on sustainable earnings which are likely more influenced by broad welfare measures rather than the narrow path of GDP.
• While there is definitely a long-term link between GDP growth and stock market valuations, there are potentially many pitfalls along the way if that growth does not also lead to better longevity, environmental quality or wealth distribution.
• While improvements in economic statistics have been encouraging, there is much work yet to do.  GDP statistics, largely developed almost 100 years ago, may have serious deficiencies when it comes to reflecting the activity in the 21st Century technology-driven economy.

Mar 1, 2019 | Commentary

Why is trading on macroeconomic data so hard?

• Many of the great trades in history have been based on macro themes. George Soros counting on a British pound devaluation and John Paulson buying cheap insurance against a housing crisis are just two well-known examples.
• While there are many other instances of profitable macro trades, history is also filled with countless examples of mediocre results and much worse.  This raises the question, why is it so hard to profit from macro themes and data?
• There are multiple challenges. One needs to get the theme and timing right. One also needs to identify the right trading vehicle to express the theme. One needs to do all of this before other act and prices have already adjusted. These challengess are heightened by the vast sums of money as allocated to these strategies today. 
• As more and more capital is invested in strategies trying to be less correlated with the equity market, competition for the best ideas has exploded. This has resulted in recent years in much reduced performance over what was enjoyed 20 years ago. Macro trading is a hard, highly competitive space, and is likely to stay that way.

Feb 1, 2019 | Commentary

What can we learn from equity valuations?

• After a challenging 2018 in global equity markets, investors are anxious to get some intelligence on what 2019 might bring.  January has started off favorably, but the honest answer is that nobody can predict with certainty what any individual calendar year will do.
• The U.S. equity market may have earned on average 8-10% annually over many decades, but specific years earning that average are exceedingly rare, and the range of outcomes is wide.  Looking at rolling 5-year returns reduces the variance of returns considerably and also lowers the chance of total negative periods.
• Equity market valuation, as captured by a simple forward P/E ratio, can offer some guide to future returns.  Buying stocks when they are historically cheap raises the chance of a good return in the future.  When the investment horizon is extended from one year to five, the last twenty-five years of U.S. history show few examples where stocks began as cheaply as they started 2019 that ultimately produced negative total returns.
• Last year P/E ratios for stocks around the world fell as indexes tumbled while earnings remained flat or grew.  On a simple comparison basis, P/E’s in the U.S. may be cheap versus 2018 and historical averages, but they are higher than in most global developed and emerging markets.  This is not an argument to swing portfolios to more international stocks. Economic and risk conditions outside the U.S. may warrant lower valuations.  It is, however, a hopeful sign for the diversified investor that their broad equity holdings have a reasonable chance of performing well over the next several years.

Jan 1, 2019 | Commentary

Just because something has not happened yet...

• Last April, we noted in our Commentary for that month that since 1950 there had never been a year when the S&P 500 was up over the first two months of the year and the year finished with a loss.  We cautioned against following such rules. This fourth quarter was proof why such caution is appropriate.
• The U.S. stock market peaked in September.  Despite strong employment, GDP growth, corporate earnings and a moderate inflation rate, market sentiment turned sour in Q4.  Selling momentum built rapidly in December after the Fed did exactly what it advertised, raising policy interest rates by 25 basis points.
• Some blame the political environment.  Others say the market is just anticipating an economic downturn in 2019.  The stock market has a long history of predicting recessions that never occur.  It is not comforting to be reminded that surprising volatility is an ever present risk to the long-term investor.  If it were not, we would all earn the risk free rate on our stock market investments.
• We know that markets reflect the intersection of emotion and analytics, but fundamental factors eventually guide sentiment appropriately and the market follows.  Stocks are valued today below historical averages.   Long-term investors who decide to sell and lock in their losses since September will be following the current sentiment of the crowd.  Offit Capital still believes in the long-term American and global growth stories and encourages everyone it advises to stick to their asset allocations.

Dec 1, 2018 | Commentary

The ABC's of ESG Investing

• Investing with an Environmental, Social and Governance (ESG) orientation has become a widely discussed topic lately. What this means exactly and how to best execute an ESG plan remains mysterious for many.
• Early ESG efforts were almost exclusively negative screen vehicles, avoiding stocks and bonds of companies that engaged in industries or geographies contrary to an investor’s values. Later, positive screens were created that try to identify virtuous behaviors by corporations in order to overweight investments in those companies. Both screens have their challenges.
• More recently an entire industry of ESG indices, funds and ETFs has appeared. Competing firms score thousands of public companies globally on a wide range of ESG metrics. The challenge has been on agreeing on how to measure and weight these metrics. Consistent measurement has been elusive to date.
• “Impact Investing” is typically designed to direct private capital to specific industries and activities to achieve ESG. Some have claimed that they can earn superior returns while directing an ESG agenda. Others argue that any really effective ESG program will by definition sacrifice profits, but the improvement to society is worth the lower returns.
• Another approach, which we dub the Hippocratic Oath strategy, says first do nothing in a portfolio that is contrary to an investor’s fundamental beliefs, and then invest to maximize returns. The investor is then free to use those profits anyway he or she chooses to try to achieve specific ESG goals. This has numerous advantages, not least being the donor should have more direct control over the ESG efforts versus being a shareholder or LP with limited influence over a company.

Nov 1, 2018 | Commentary

Libor: “The report of my death was an exaggeration”

• The London Interbank Offer Rate (LIBOR) has been the standard reference rate for floating rate loans, mortgages and interest rate swaps for over 20 years. According to the Bank for International Settlements (BIS) there are more than $300 trillion in interest rate swaps outstanding, almost all of which are LIBOR-based.
• LIBOR, in theory, measures the rate of interest that prime banks charge each other to borrow. It is calculated from a daily survey of those banks, which provide what they believe their borrowing costs would be if they sought unsecured funds from another bank. The process is subjective and has been shown to be open to collusion among responders and manipulation. Guilty banks have been fined billions of dollars and some bankers have been sentenced to jail.
• The highly publicized troubles with LIBOR have caused regulators around the world to look for replacement benchmarks. In the United States the leading candidate is the Secured Overnight Funding Rate (SOFR), which began reporting in April of this year. Despite the official endorsement of the Federal Reserve and other banking regulators, SOFR poses its own challenges. It may not be easy to manipulate, but the market it reflects moves with considerable volatility.
• Despite the widely publicized shenanigans around LIBOR, it remains the reference rate of choice for almost all floating-rate borrowing and swaps activity. If the market thought LIBOR was fatally broken, people long ago would have stopped using it. Like Mark Twain’s first assumed passing, the reports of LIBOR’s death may be exaggerated.

Oct 1, 2018 | Commentary

The financial crisis ten years later

• Ten years ago Lehman Brothers declared bankruptcy, setting off a chain of events that brought our financial system close to collapse. The recovery since has been filled withuncertainty, but generally characterized by steady growth that has brought us to a full employment economy and record highs in the equity market.
• After the crisis the response was typical. Legislators and regulators went to work to fix perceived weaknesses in the system. Some of the initiatives have added costs with littlebenefit, but others strengthened bank capital requirements and improved treatment of off- exchange derivatives. These appear to be permanent improvements that reduce systemicrisk.
• Financial crises and major market corrections almost always start from a highly optimistic environment and abundant leverage. Neither of these conditions are evident today. Investors seem not to trust the bull market and households are cautious in budgeting their debt. Economic and market cycles do not run according to a clock. As long as the fundamentals of the economy remain strong and typical excesses are scarce, investorsshould not be distracted from their long-term objectives.

Sep 1, 2018 | Commentary

Should we fear an inverted yield curve?

• The Federal Reserve pursued a zero interest rate policy from December 2008 until December 2015 when it raised the target Fed Funds rate to a range of .25-.50%. The next 25 basis pointincrease was a year later and since then there have been five more quarter point increases. Today the target range is 1.75-2.00% and the market widely expects another increase thismonth.
• The Fed controls the short end of the yield curve through its Fed Funds targets. On the other hand, the market largely determines the yield on longer maturities. Those rates haverisen as well, but at a far slower pace, causing the yield curve to become nearly flat. Many commentators extrapolate this trend to anticipate an inverted curve where short ratesexceed long rates. Historically, inverted yield curves in the United States have been followed by recessions and stock market losses.
• Flat yield curves can persist for a long time before inversions occur. 1995-1999 is one such example. For five years there were many faulty predictions of the next recession and bearmarket.
• The yield curve is not like a compass that independently points to growth or recession. The Fed controls the arrow, either lowering rates to stimulate or raising rates to slow inflationor cool an overheating economy. Market forces including massive demand for high-quality, longer duration bonds around the world may invert the curve, but that is no certain signalof recession or stock market retreat.

Aug 1, 2018 | Commentary

Further common sense thoughts on trade

• After World War II there was a gradual acknowledgement of the gains from global trade. It was only after 1984 that there was a rapid expansion of regional agreements. The globalfinancial crisis put a severe dent in the progress, and subsequent populist movements, like the Brexit vote in the U.K., signaled the first meaningful signs of actual retreat.
• Last month's Offit Capital Commentary discussed the importance of trade to the advancement of the global economy. Beyond the strong case for freer trade, however, liesthe reality that tariffs and other trade restrictions are often politically attractive. The changing shape of trade makes these debates particularly complicated because winnersand losers are not always easily identified.
• The rising tide of global growth in trade and national incomes has not raised all boats.
• Those left behind have shifted the debate to put freer trade on the defensive.
• Economic growth is not automatic. Technological change and population growth are essential ingredients. As a result, restrictions on the flow of goods, services and humancapital all work against broad economic progress. Public policies to retrain displaced workers can focus on alleviating any negative factors that might arise from trade andimmigration. We should work hard to not throw away many of the benefits of economic growth that we sometimes take for granted.

Jul 1, 2018 | Commentary

Some common sense thoughts on trade

• Trade is fundamental and essential to economic progress.
• Trade deficits are more a result of the economic cycle and less the cause of it. A strong U.S. and global economy typically leads to U.S. trade deficits.
• Trade today is vastly different than it was 50 years ago featuring many more services and intermediate factors of production versus the traditional concept of trade in finished goods.
• As long as the United States dollar is the preferred reserve currency of the world, a trade deficit is required to supply that currency to everyone else.

Apr 1, 2018 | Commentary

The calendar should not matter – but it might

• There is a long standing debate between traditional and behavioral economists as to how far from ideal markets really are. The traditionalists argue that in general there should be no simple trading rules that produce extraordinary returns. Behavioral economists argue that there are persistent psychological biases in humans that create such opportunities.
• Few markets are as closely studied as the U.S. equity market. The general experience has been when “anomalies” have been identified in the market data, traders step in and any pattern disappears. This is what one expects when people learn through time and there are potentially great financial rewards for the quickest students.
• Examining S&P 500 total monthly returns since 1950 suggests that where returns occur in the calendar may matter. If the year starts off on a positive note, as measured by performance across January and February, it seems the entire calendar year should be positive. Specifically, in the 68 years examined, there were 42 times where the first two months cumulatively were positive. Without exception those 42 years ended up with gains.
• Investors may indeed be influenced by the psychology of a good trading start to the calendar year, but this result may just be the result of luck in a generally upward trending market. 2018 will again test this trading rule. Remember that past performance is most certainly not a guarantee of future results.

Mar 1, 2018 | Commentary

The dark side of volatility

• The sudden spike in volatility in the first week in February should have reminded everyone that market risks never leave the stage permanently. With the rapid rise in trading products based on VIX, an additional dynamic has been introduced. Rapid trades in one area like volatility-backed ETNs are quickly translated back to VIX futures and options contracts and then back to the S&P 500 options and ultimately the stock market. This seems to be a case where the volatility tail wagged the stock market dog.
• Exchange-traded options on individual stocks began in 1973 at the Chicago Board Options Exchange (CBOE). A decade later the first index futures began trading on U.S. stocks with index options following shortly thereafter. These simple tools continue to be effective in managing risks inside equity portfolios, but they have spawned activities that have little to do with anything but short-term trading.
• The VIX is the most popular measure of stock market volatility, being based on the implied volatility of S&P 500 Index options. Once it was simply used as an indicator of market conditions, like temperature or wind speed. In 2004, VIX futures were introduced by CBOE and two years later options were introduced. These products made it easy to trade volatility directly. They also allowed the creation of Exchange-Traded Notes (ETNs) and structured products that are sold to the public.
• Most investors don’t understand the basics of options and how they translate into VIX. That has not stopped billions of dollars from being invested into VIX-based products, betting on either increases or declines in market volatility. From the perspective of long-term investors, these products have always been fundamentally deficient. Market events in early February brought these flaws into focus. Sadly the tuition paid by the owners of these instruments to learn about them was quite steep.
• Volatility should be managed through proper portfolio construction. Attempts to enhance returns by selling volatility and collecting implicit option premiums often disappointment. Retail-oriented products on either side of the volatility trade always come with careful disclaimers about how they might behave. It is time investors start taking those cautions seriously.

Feb 1, 2018 | Commentary

The tax code and the global stock market

• Late in December the President signed new legislation that affected many parts of the personal and corporate tax codes. By far the most significant change was a radical restructuring of corporate taxes that brought the United States into conformity on territorial taxation while slashing the top corporate tax rate.
• For many years the United States pursued a policy of trying to tax U.S. corporations on their world-wide earnings in contrast to virtually every other country that taxed only the income generated in their jurisdiction. The U.S. approach mainly encouraged the establishment of foreign based entities and the sheltering of global income, usually in lower-tax countries.
• As more investment and earnings by U.S. corporations occurred offshore and beyond the reach of the IRS, foreign-sited cash hoards grew, discouraging easy reinvestment at home. While this backdrop was in place, many other developed countries systematically lowered their corporate tax rates, putting additional competitive pressures on U.S. companies wanting to invest at home.
• There is no way to precisely estimate how much the out-of-sync U.S. corporate tax code cost the country in terms of investment, growth or job creation, but directionally the effects seem clear. The new tax code not only brings the U.S. into conformity in terms of what income is subject to tax, the 21% marginal tax rate is now near the lowest among developed and major developing countries.
• The U.S. marched to the beat of its own drum for many years, effectively advantaging other nations around the world. Now it has set the cadence for the entire parade. It is likely that more corporate tax rates will come down around the globe in an attempt to offset any new U.S. advantage. If that happens it will translate widely to more growth and earnings.

Jan 1, 2018 | Commentary

Bitcoin revisited

• Bitcoin and other cryptocurrencies cannot presently be considered viable substitutes for traditional money because their price variability makes them impossible to use for routine transactions and they cannot be considered to be a dependable store of value. They are trading instruments.
• Since we last wrote about bitcoin in 2013, its price has gone up 18x, and more than a thousand new cryptocurrencies have been introduced. While the supply of any single digital asset, also called coins or tokens, may be fixed, there is no limit to how many such products can be created cheaply and brought to market.
• Governments around the world are starting to wake up to various issues ranging from the uncontrolled flow of capital, tax evasion, circumvention of anti-money laundering and know your customer laws, and soon the ability to get around international sanctions against countries like Venezuela and Russia.
• Nobody knows how these cryptocurrency markets will evolve in the short run. They are created by people trying to exploit the psychological allure of easy wealth, and like all such schemes through the ages, they inevitably disappoint. When we are no longer talking about cryptocurrencies, we shall likely be benefitting from real advantages from blockchain innovations that will touch many other parts of our lives.

Dec 1, 2017 | Commentary

Unintended consequence of ultra- low interest rates

• The long economic recovery since the financial crisis has not uniformly lifted all corporate boats. A historically high percentage of small cap public companies are not profitable and have not been for many years.
• The policy of near-zero short-term rates in the United States, Japan and Western Europe has distorted yield curves around the globe. Unsurprisingly, many corporations have taken advantage of this and added to their debt burdens.
• Not all of these companies have great business models or prospects, but the availability of easy credit has allowed these companies a much longer runway toward hoped-for success. In some cases this just delays the inevitable failure.
• As interest rates rise, some of these companies will be unable to sustain their losses and will fail. This will have two major implications. It will likely usher in opportunities for a new profitable distressed debt cycle. It should also prove to be fertile ground for active equity managers versus passive investing where all names are purchased indiscriminately according to their current market weights.
• None of these risks would appear imminent. Economies around the developed world are expanding in a coordinated fashion for the first time in over a decade. Central banks are still accommodating and as a result liquidity is plentiful. The table is getting set, however, for the next cycle and each of these trends warrants close scrutiny.

Nov 1, 2017 | Commentary

Uncertainty at the fed

• The Federal Reserve began raising policy rates from a long-held zero base late in 2015, paused for a year, and then resumed the process into 2017 with three more 25 basis point increases. The market widely expects another 25 basis point hike in December. Public communication from the Fed suggests more hikes are planned for 2018 and beyond.
• Complicating this picture is the possibility of a new Chair in February when Janet Yellen’s current term expires. There are also currently 3 unfilled slots on the Federal Reserve Board and Federal Open Market Committee (FOMC), making today’s forecasts from the board and district bank presidents subject to considerable change.
• No matter who becomes the next Fed Chair, chances are good that policy making will continue to be carefully reasoned based on all the best available data and not a formulaic approach that would hamstring independent action by the FOMC.
• The leading names discussed in public for the next Chair terms are serious economists and bankers, expert in monetary affairs, which should ease most fears in the stock market. They do, however, present different philosophies that could lead to varying emphasis between growth in GDP and inflation in forming monetary policy. It is probably a wasted exercise to try to position portfolios anticipating either tight or loose monetary policy starting next year.

Oct 1, 2017 | Commentary

Hurricanes, energy prices and inflation

• The cost in lives and the physical destruction from hurricanes Harvey, Irma and Maria have made 2017 a year for the record books for the people of Texas, Florida and the Caribbean. Our deepest sympathies go out to everyone affected.
• Beyond the direct human and physical losses, such disasters also have an impact on key markets like oil and gasoline. Given the importance of the energy sector to the economy, it is natural to speculate how this will all play out in terms of growth and inflation.
• With property losses in the tens of billions of dollars, there will be a meaningful spike in construction activity in the affected areas. The big question is whether at today’s low unemployment rate enough labor resources can be marshalled to complete the recovery work quickly.
• The recent spike of August CPI to .4%, the highest since January, has prompted some to forecast a general up trend in inflation. While the energy sector has been disrupted, recent price action is likely to be temporary and reversed over the next several months. When inflation accelerates from its generally benign state, it will be from an expanding economy and higher wages.The cost in lives and the physical destruction from hurricanes Harvey, Irma and Maria have made 2017 a year for the record books for the people of Texas, Florida and the Caribbean. Our deepest sympathies go out to everyone affected

Sep 1, 2017 | Commentary

How do active managers add value to the investment process?

• The debate about active versus passive investing is often carried out on a superficial statistical level where the focus is on who has earned higher returns lately. A more fundamental question should be how it is possible for active managers to add value.
• There are only three broad avenues to added value: 1) having superior information; 2) seasoned judgment and analyzing public information with better models or technology, and; 3) managing investments with lower costs.
• A fourth element of trading success comes from taking advantage of other participants in the marketplace who either fall prey to emotional mistakes or are forced into trades because of liquidity concerns. This is again judgment in the form of relative trading skill, which may or may not be repeatable in all environments.
• When evaluating whether an active manager has a good chance of outperforming in the future it is critical to find the sources of past added value. It may never be possible to conclusively separate skill versus luck, but by doing a deep dive into past attribution and not relying solely on return numbers, investors improve their odds of associating with managers who have the best chance of long-term success.

Aug 1, 2017 | Commentary

The mystery of wages unraveled

• There is a mystery as to why wages appear to be growing more slowly than past recoveries given that unemployment is so low. Part of the answer lies in the composition of the official measures. The reported statistic gives the growth in the total wage pool. As the mix of workers changes either because of the economic cycle or demographic events like the retirement of peak earning baby boomers, the calculated average ebbs and flows in sometimes unintuitive ways.
• The official wage numbers offer some insights into the state of the economy, but they need to be considered in conjunction with other data points like total employment and the demographic composition of the labor force.
• Today’s real wage growth at roughly 2.5% per year is often cited as a disappointing statistic, but when combined with a growing, younger labor force it provides reinforcement for the belief that our consumer-oriented economy is on a steady upward path.
• Someday there will be the next recession and another bear market in stocks. We just don’t know when they will occur. There are pundits who have been calling for both on a regular basis since 2011, and they have been very wrong. Given the strong labor market and rising real wages, the Fed is probably wise to be raising policy interest rates and planning to shrink its balance sheet.

Jul 1, 2017 | Commentary

Unraveling the vix mystery, part 2

• VIX, defined and described in last month’s Offit Capital Commentary, continues to be at historically low levels, but with a large spread between spot and forward values.
• There are multiple ways to express an opinion in the volatility market. Professionals and retail investors alike can access S&P 500 options, VIX futures and a wide assortment of exchange traded notes (ETNs) that allow one to go long or short volatility. Each of these is connected back to the stock market through a web of professional arbitrageurs.
• Basic option time decay allows option writers to earn the time premium on average. This truism plus quieter than average markets has encouraged more and more money to come into the short volatility space. This has lowered the price of S&P 500 options and suppressed spot VIX. It has also increased the risk of a snap back should these positions all try to reverse at the same time.
• Long periods of quiet markets do not in themselves forecast a sudden jump in market volatility. What they do, however, is cause investors to diminish or eliminate their fear of market reversals. Writing options or trying to profit by being short volatility futures or ETNs is analogous to picking up nickels and dimes in front of steamrollers. Investors should never forget that there are always steamrollers someplace on the street and the aggressive investor will likely meet one when volatility spikes.

Jun 1, 2017 | Commentary

Unraveling the vix mystery, part 1

• VIX is the most widely followed indicator of stock market volatility, being based on the prices paid for S&P 500 Index puts and calls traded at the Chicago Board Options Exchange (CBOE). When writers of options demand high premiums to sell, and buyers are willing to pay up, VIX reflects this by increasing. Conversely, cheaper options produce lower values of VIX. Last month saw spot VIX drop below 10 twice, the lowest levels observed in over 10 years.
• VIX is not like most government statistics, which look backwards and capture events that have already happened. VIX is determined on a moment to moment basis by buyers and sellers of S&P 500 options, which can be highly variable.
• Spot VIX has very little predictive power for the direction of stock market changes in the short run. Time and again, history shows that VIX reacts to market moves. It does not predict them.
• Investors should recognize spot VIX on any given day is of limited utility in guiding their decisions. A better indicator is forward VIX, which reflects opinions about time horizons and portfolio insurance choices more relevant to most long-term investors.
• Traders can and do regularly influence measured VIX, and such trades may be more reflective of fund flows than they are fundamental volatility in the stock market. Next month we shall explore more deeply how trading in volatility based futures, options and exchange traded products may be distorting spot VIX and creating systemic forces in the stock market.

May 1, 2017 | Commentary

Equity market valuations: a deeper look

• Market commentators have for some time looked at the P/E ratio of broad U.S. large cap stock indexes like the S&P 500 and suggested that today’s near-record levels represent a severely overvalued market and a risk of a major correction.
• Market averages by definition consist of potentially divergent sectors. Most of the times the differences are small and evolve gradually. The shock to the energy sector that began in 2015 was neither small nor gradual and it may have warped our impressions of the market as a whole.
• Excluding the 7% energy sector recently from the S&P 500 Index creates a less dramatic picture of the general market. Stock market valuations have risen in the last few years, but the average stock is likely not as expensive as the total index would make it appear.
• Index distortions can also come from specific stocks. If Amazon, which has a trailing twelve months P/E ratio of 183 and a weight in the S&P 500 of 1.6%, had an “average” valuation, the P/E ratio of the entire index would be another .3 points lower. The lesson is that these numbers can move around a lot and nobody should obsess over where the recorded index is today versus historical values that may have very little comparability.

Apr 1, 2017 | Commentary

Should equity investors fear higher interest rates?

• The Federal Reserve pursued a zero interest rate policy beginning immediately after the financial crisis in 2008 until December 2015, when it started inching up policy rates. Since then there have been three rate hikes, totaling 75 basis points, with the Fed guiding the market that it expects further hikes this year and next.
• Traditional wisdom says that equity bull markets don’t die of old age but are usually killed off by an aggressive Federal Reserve raising policy interest rates. Since December 2015 the S&P 500 is up over 13%, running counter to that traditional thinking.
• Given current low interest rates, modest private leverage and inflation, and healthy but not stretched labor and stock markets, the course of rate hikes over the next year or two may not be terribly restrictive to the economy, corporate earnings or stock prices.
• It is in fact possible that these policy rate increases will help the consumer side of the economy as savers earn more interest income which then gets recycled as additional spending. This force is particularly important today with an increasing number of baby boomers retiring and depending on such income to support their consumption.
• There are always many factors that stock market investors should watch carefully, but rising interest rates today doesn’t seem to be near the top of the worry list.

Mar 1, 2017 | Commentary

Government debt: the forgotten topic

• The U.S federal debt over the last 15 years has grown steadily to a level relative to GDP not seen since the end of World War II. Near-zero interest rates have hidden much of the potential pain of this mounting problem.
• Mandated entitlement programs, including Social Security and Medicare, will explode spending obligations in the future as more of the baby boomer generation move into retirement. Currently there is no plan to pay for these added expenditures.
• The Congressional Budget Office projects that the ratio of debt to GDP will rise rapidly over the next 30 years. With that increase the percentage of federal spending devoted to interest on that debt will grow from 6% today to over 20% in 2046. There will likely be problems long before then.
• Debt crises typically deteriorate quickly. Markets sense the inability or unwillingness to pay. Credit ratings tumble. The cost of new borrowing skyrockets. It is far better to address the debt problem now than to wait for a future critical moment that could threaten the stability of the entire world’s economy.

Feb 1, 2017 | Commentary

Tax rates and tax revenues revisited

• As the new administration takes office there is considerable discussion surrounding reshaping U.S. personal and corporate income taxes. This discussion invariably leads to speculation about how any new program will impact tax receipts and the federal deficit.
• There is no simple relationship between tax rates and revenues collected. Tax rates change incentives to work or invest, but many other features of the tax code are at least as important in determining economic activity and total revenue.
• Every time there is a discussion of revising the tax code someone trots out the Laffer Curve to support or attack the proposal. The Laffer Curve has been around for over 40 years because it is one of the great generalizations in economics. It lacks, however, enough specificity to be of much use in debating among various tax plan proposals.
• Whatever ultimately arises as tax reform in the new administration will matter. Early stock market returns suggest considerable optimism that the changes will be supportive to income and investment. It remains to be seen whether what results is as consequential as the Reagan tax reform from 30 years ago or as insignificant as virtually all the changes since.

Jan 1, 2017 | Commentary

Paper money under attack

• Around the globe, governments are implementing plans to remove the largest denomination notes from general circulation. This is done with the stated objective to curtail corruption and illegal activity. A less public motive is for central banks to try to shrink the liabilities that outstanding currencies represent.
• At one end of the spectrum such plans merely stop issuing new notes. At the other extreme the retired notes quickly lose their legal tender status. When the latter approach is used in places like India and Venezuela great hardship befalls the poorest segments of society who have few resources but rely heavily on cash for their daily transactions.
• In the United States the $100 bill is the most widely circulated note by a wide margin, growing more than fourfold in 20 years. Some of this may be due to the grey economy and illegal activity. Many of these bills find their way abroad to meet the cash demands in countries with less reliable currencies.
• Radical currency exchanges and proposals to move to a cashless society may have reasonable motivations, but they have a darker side as well. Such moves always impact the freedom and anonymity of every citizen. Criminals and terrorists may have to work a little harder to keep their activities secret, but they have the motivation to do so. It is everyone else that pays the cost.