Despite the 3rd quarter turmoil, MCS client portfolios remained stable.
If MCS clients’ investments were treated as one large portfolio including their cash, the nine month 2015 return was 0.23%. Individual client returns ranged between -4.0% and 3.0%. The client with the lowest return was negatively impacted by higher stock exposure. Of the two clients with the highest returns, one had 11% cash, 60% bonds, 12% stocks and a 17% inherited Real Estate position (that did well enough to offset the drop in stock prices). The other client was not affected by the poor stock market performance because her holdings were entirely cash (18%) and bonds (82%).
Auxier sub-portfolios, on average, lost 6.1 %. The Auxier results are included in the total client results above. For comparison purposes, the S&P 500 Total Return Stock index lost 5.3% and the Barclays Aggregate Bond Index lost 0.1% for the period.
US financial markets remain very sensitive to the deceleration of global growth. The US stock market is struggling as it adjusts to an expected overall decline in earnings while the economies of China, emerging markets and Europe sputter. It’s not clear the US economy has enough economic horsepower to pull the globe out of its funk. At the International Monetary Fund’s conference in Lima, Peru this month, global finance leaders expressed concern at about the fragility of the global economic recovery.
Given the global risks, it isn’t clear that a December increase in the Fed Funds interest rate (overnight rate between banks) would have much impact on long term rates. Ten year US rates at 2.02% (as of 10/21/2015) are much higher than .568% (Germany) and .32% (Japan). Higher US rates, a strong US dollar and market turmoil attract more investment in US Treasury bonds as a safe haven, thus keeping longer term rates in a narrow range.
Interest Rates Declining
This chart shows interest rates declining — a sign of a weakening economic outlook about a month before the stock market (white) abruptly caught on.
Stock Prices and Future Earnings
The chart above shows the price of stocks (S&P 500) vs. their estimated future 12 month earnings. When earnings flatten (orange line) it’s a warning that stock price declines may soon follow given that prices (green line) have gone up faster than earnings. Since July of 2014, the gap between stock prices and earnings increases has been especially wide.
US Corporate Sector: Pricing Power Eroding Across Most Sectors
This chart shows the deterioration of US corporations’ ability to raise prices and increase sales. This is negative for stock prices. There is emerging talk of a profit recession; multi-quarter period when corporate profits decline while the economy grows modestly.
Wage Increases Sting
In my April 2015 newsletter, I spilled a bit of ink describing how middle class incomes have not kept pace with corporate profit growth and the nascent movement to increase minimum wages to a living wage. If the living wage movement gained real traction, over 5+ years higher wages should increase consumption and help the economy grow at a faster rate. Such an outcome would produce short run winners (labor) and losers (stockholders). In the long run, I think stockholders would win too based on increased economic growth.
To wit, on October 13th, Wal-Mart reported that earnings in fiscal year 2017 would decline 6 to 12%– the market was expecting a 4% drop. Wal-Mart CFO Charles Holley said that 75% of the reduction was due to higher wages. The stock dropped 10% that day. Is Wal-Mart a ‘living wage canary in a coal mine’ for stock prices? For retail, the answer is likely “yes”. It’s worth noting that Wal-Mart believes that higher wages will ultimately improve its profits because it feels higher wages will reduce employee turnover which was running a 5% per month or 60% per year. The stock pain will come before the gain.
We’re living the movie ‘Ground Hog Day’: stocks have rebounded from September lows on the belief that that the Fed will not raise rates in December due to the fragile economy. As we enter the 4th quarter, riskier assets like stocks are less attractive at current prices because corporate revenues and profits are under pressure. Bond prices have risen, acting a portfolio stabilizer. The ‘good news’ is that I expect more volatility to come and we have cash on hand to take advantage of it. We were active buyers and sellers during the third quarter.
1 MCS Family Wealth Advisors (MCS) consolidated client returns are dollar-weighted, net of investment management fees unless stated otherwise, include reinvestment of dividends and capital gains and represent all clients with fully discretionary accounts under management for at least one full month in 2015. Individual client returns represent client discretionary accounts under management for the entire period – starting on 12/31/2014 and ending on 09/30/2015. These accounts represent 100% of MCS’s assets under management as of 09/30/2015 and were invested primarily in US stocks and bonds (17% of client assets on 09/30/2015 were invested in tax-exempt municipal bonds). The Auxier sub-portfolio returns are dollar-weighted, net of investment management fees unless stated otherwise, include reinvestment of dividends and capital gains and represent all clients with fully discretionary accounts under management for at least one full month in 2015. These accounts represented 10% of MCS’s assets under management as of 09/30/2015 and were invested primarily in US and foreign stocks. The Stock Index values are based on the S&P 500 Total Return Index, which measures the large-capitalization US equity market. The Bond Index values are based on the Barclays Capital US Aggregate Bond Index, which measures the US investment-grade bond market. Index values are for comparison purposes only. The report is for information purposes only and does not consider the specific investment objective, financial situation, or particular needs of any recipient, nor is it to be construed as an offer to sell or solicit investment management or any other services. Past performance is not indicative of future results.