"Kee" Points with Jim Kee, Ph.D.

US GDP growth for the 3rd quarter was reported last week and came in at 1.5% (that’s called the “advance” estimate). That was below expectations but slightly above the 1.1% estimated by the Atlanta Fed’s GDPNow model, which continuously updates as various pieces of economic data get released (a process called “nowcasting”). I’ve mentioned before that I use the GDPNow estimates as a good (though conservative) real-time estimate of what the economy is doing.

 

Mediocre growth, low inflation numbers, and on-going international concerns are certainly not pressuring the Fed to raise rates, and the Fed indeed held pat during last week’s FOMC meeting. They (the Fed Governors) decided to keep the short-term rate (federal funds) target in the 0%-.25% range. The odds of a rate hike in December based upon the futures market have increased to about 50-50, which seems about right. With recent, somewhat disappointing manufacturing data from China and the US, I wouldn’t be surprised if that futures-based probability estimate comes back down a bit by December. Of course, a lot of this is a media event anyway at this point – individual investors’ long-term outcomes have absolutely nothing to do whatsoever with guessing the timing of Fed rate-hike decisions.

 

Companies are also reporting their profits or “earnings” for the 3rd quarter (the period immediately following each quarter is called “earnings season” by analysts). Two thirds of the S&P 500 companies have reported so far. Of those, about 72% have beat analyst estimates for earnings (“bottom line), while only 43% have beat analyst estimates for sales growth (“topline). Sales have been a challenge for companies, which is a function of slow global growth in general (i.e. slowing China, strong dollar, weak energy capital spending, etc.). One implication of investing in an environment like this is to think, “individual companies over broad indexes”. Global monetary easing and asset purchases have reduced the fears of a global financial crisis, which is described by financial economists as a lowering of the “equity risk premium.” This “rising tide lifts all boats” shot in the arm from global monetary easing has, in my opinion, largely run its course (less so perhaps in Europe, which started later). The key to investing in such an environment is to find those companies able to grow in spite of a mediocre global backdrop, rather than to rely on broad 500 or 5000 stock indices. In other words, strong sales growth is relatively scarce, and the market is likely to pay a premium for it. And remember that peer-reviewed research (i.e. scientific as opposed to self-promoting) shows that risk-adjusted returns, or investors’ returns after accounting for the risks they are taking, are maximized over the long term when a growth strategy is used in conjunction with a value strategy, so you want to own some value stocks as well (not either/or!). Doing this is a cornerstone of STMM’s investment policy.

 

Finally, I spent part of last week at the Financial Times’ Investment Management Summit. This was held in New York for the Financial Times Top 300 Registered Investment Advisors*, of which STMM is a proud member. Here are some key takeaways that you might find interesting (taken from my notes, so I wouldn’t call them straight quotes from the speakers):

 

The Global Panel was cautiously optimistic regarding the global economy, feeling that China was stabilizing and that global credit growth was improving. Still cautious on emerging markets though, largely because growth in global trade had slowed from twice the rate of global GDP growth in the 2000s to just even with GDP growth today (i.e. if global GDP growth = 2.5%, then global trade growth = 2.5%).

 

On Fed rate hikes: The market just wants them to get the first hike over with because it is causing anxiety.

 

Oil: Best bet for upward pressure on oil prices would come from the Saudis helping Russia (by restricting output to raise oil prices) in return for Russia helping to keep ISIS out of Saudi Arabia.

 

Debt: Only the US is making progress on debt/deficits, and the only way to adequately deal with global debt is global growth. That’s why trade agreements like the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership are so important.

 

US is by far the leader in technological innovation.

 

Low global interest rates: There is a growing acceptance of the notion that global demographics (aging) is what has been driving the global search for yield (e.g. retirement assets) and the global liquidity glut (which should keep interest rates lower, longer). I’m quite familiar with this thesis but it has gone from conjecture to consensus without a lot of hard data to back it up (note: that’s always a concern to me).

 

Fixed income panel: Low rates have pushed people into complicated structured products and derivatives, most of which do not make sense. “Unconstrained” bond funds really mean just taking on credit/default or “spread” risk. Duration is probably the most misused term in fixed income investing because the “time element” is excluded. Duration measures the sensitivity of a portfolio to interest rate changes, but it is a mistake to assume that you cannot make money with a bond portfolio of a given duration in a rising interest rate environment. That’s because there is a big difference between an investor’s return when bond yields rise a lot in say, 12 months, versus if they rise a lot over 10 years or so. You can make money in a gradually rising rate environment with a laddered bond portfolio by consistently reinvesting at increasingly higher rates. It happened in the 1950s when 10-year Treasury yields got as low as 2 percent.

 

Municipal bonds are fair valued to cheap, as the Chicagos/Detroits of the world have created opportunities in safer municipalities.

 

Convertible bonds never really recovered after the financial crisis, and the market is so small now that it is not worth acquiring the expertise. They are concentrated in technology, and very technical in nature (i.e. obscure risks).

 

 

*The Financial Times Top 300 Registered Investment Advisors is an independent listing produced by the Financial Times (June 2015). The FT 300 is based on data gathered from RIA firms, regulatory disclosures, and the FT’s research. As identified by the FT, the listing reflected each practice’s performance in six primary areas, including assets under management, asset growth, compliance record, years in existence, credentials and accessibility. Neither the RIA firms nor their employees pay a fee to The Financial Times in exchange for inclusion in the FT 100. STMM was also named to the FT Top 300 RIA firms in June 2015, 2014.