Quarterly Investment Newsletter OCTOBER 2016 STAY BULLISH

Quarterly Investment Newsletter OCTOBER 2016

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by

STAY BULLISH MY FRIENDS

After seven consecutive

quarters of declining

earnings, the collective

earnings of the S&P 500

companies are expected to

start rising again in the

fourth quarter. As you can

tell from the chart below,

earnings have already

stopped declining and the

expectations are for a big

rebound next year. Some of

the factors holding back

earnings the past couple of

years have been a strong

dollar and the massive

decline in oil prices. These

issues have largely been

resolved as the dollar has

stabilized and the price of oil

has rebounded. If we do have

an earnings revival next year,

as expected, that will go a

long way to alleviating some

of the concerns investors

have with the lack of growth

and valuations. Since stocks

tend to take their cue from

earnings, it may help propel

the market on its next leg

higher.

Aside from the afore-

mentioned improvements in

the dollar and oil prices,

consumer spending will also

be a significant driver of the

earnings rebound. As the

true mainstay of the

economy, consumers have

been keeping the economy

afloat the past couple of

years, as other areas of the

economy struggled. They’ve

been able to do this due to

rising income. A recent

report from the Census

Bureau indicated that

household incomes rose

5.2% in 2015, which was the

first gain since 2007. It was

also the largest annual gain

since they started releasing

such data in 1967!

Source: S&P; Raymond James Research

S&P500 Operating Earnings

“An investment in knowledge pays the best interest.”

~ Ben Franklin, Founding Father


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If there’s one thing that keeps

me up at night (besides the

baby), it would be negative

interest rates. The fall of

interest rates worldwide the

past few years, has morphed

into negative rates through-

out much of the developed

world. As shown in the chart

to the right, as of July, over

$13 trillion bonds around the

world have negative yields,

up from practically none just

a couple of years ago. The

longest maturity Swiss bond

stretches almost 50 years and

now has a negative yield, as

do 80% of all German and

Japanese bonds. Lately we’re

seeing the yield grab

spreading to bonds with

riskier credit profiles. The

more investors search for

yield, the more bond yields

fall.

Some critics of the Fed and

other central banks around

the world have observed that

by keeping interest rates near

zero, or even below,

monetary policy may actually

be a significant factor as to

why growth has been so

sluggish. Savers are earning

less on their savings and are

forced to save more and

spend less. Corporations are

using cheap money to buy

back their shares rather than

invest in their businesses as

it’s a more cost effective way

to boost their earnings in a

low growth environment.

This reduced level of

spending and investment

leads to slow growth,

reinforcing the perceived

notion of keeping interest

rates low. Think of it as a

catch-22 for central bankers.

My big concern is how this

comes unwound. The current

trend of continuously falling

interest rates can’t last

forever. At some point the

pain becomes too much to

pay interest on your own

money. If interest rates finally

start to rise, then anyone who

owns a negative interest rate

bond stands to lose a great

deal of money. Maybe I

missed that day, but I don’t

recall learning about the

ramifications of negative

interest rates in my economic

classes. Maybe I needed to

have the head of the

European Central Bank Mario

Draghi as my professor.

Rising Tide

The pool of global negative-yielding debt is climbing.

$50 trillion

Positive -

yielding

debt

Negative -

yielding

debt

Source: Bank of America Merrill Lynch THE WALL STREET JOURNAL .

Negat ive Nancy


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Source: J.P. Morgan THE WALL STREET JOURNAL .

One reason why the stock market remains at these elevated levels is due to the declining number of companies that are publicly traded. Between the lack of new companies going public and the increase mergers and acquisitions (M&A) the amount of companies that are available to buy is roughly half of what it was a couple of decades ago. As shown in chart 1, according to the University of Chicago, the amount of publicly traded companies is just 3,267, which is the lowest since 1984!

Initial public offerings (IPO’s) have been the big culprit of late. As of the third week of September, just 68 companies have gone public so far this year, raising $13.7 billion according to Dealogic. At this point of 2015, 138 companies had listed, raising $27.3 billion, which was itself down 62% from 2014! There are numerous reasons why this has occurred, primarily due to cost associated with going public, but more recently from the increase in available funding for private companies. Additionally, the ability to grow their companies largely out of the public eye has great appeal to this recent wave of entrepreneurs. In years past, companies like Uber and Airbnb would have gone public long ago, but that is no

longer. I’m not sure if the IPO market is ever coming back as robustly as it once was.

Money Flows

Even with the stock market near record highs, the limited amount of speculation and palpable excitement is rather remarkable. Two major bear markets in the past 15 years will have that affect. Still, its surprising to see the amount of net new money coming into stock investments is actually negative on the year, while low yielding bond

investments have seen positive flows. As you can see in the chart below, this is the first year since 2008 that we’ve seen negative fund flows from stocks, and that was near the bottom of the bear market! With this level of cautiousness and apprehension towards stocks it would be highly unusual for the market to decline significantly from here. In fact, the contrarian in me sees this as a strong buying indicator. If everyone who wanted to sell has sold, then all that’s left are buyers!

Where Art Thou IPO?

ƚ Net flows into global equity and bond funds

Chart 1: Number of stocks in CRSP data lowest since 1984

Number Of Companies

Source: Center for Research in Security Prices (CRSP®), The University of Chicago Booth School of Business; Jefferies.


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Below is a chart of the Vanguard index of emerging markets relative to the S&P 500 Index. During

much of the bull market from 2003 to 2008, emerging markets were the place to be, far outpacing

domestic based stocks. In fact, even including the significant decline of 2008, emerging markets

outpaced the S&P 500 by an absurd 16.11% annually from 2003 to 2010! Since that time it’s been a

different story, with the emerging markets underperforming the S&P 500 by 7.85% annually.

That has started to change of late, with emerging markets breaking out of its long-term downtrend

and starting to outperform the S&P 500 once again. Considering the lengths of the previous cycles it’s

quite possible this reversal of fortune could last for years to come. At the very least, this indicates to

me that the long-term under-performance in emerging markets is likely over.

Source: StockCharts.com

Emerging Markets

One of the more surprising bits of news I’ve read lately is that Australia hasn’t had a recession in over

25 years! You have to go all the way back to 1991 to see the last time their economy has declined for

two quarters in a row, which is the general definition of a recession, according to the IMF. Amazingly

their 101 consecutive quarters of growth without recession isn’t even the longest ever, as they are

rapidly closing in on the Netherlands record of 103 consecutive quarters, which ended in 2008,

according to the chief economist at Commonwealth Securities. With the US’s last recession having

ended in March 2009, we’ve just reached 30 consecutive quarters without a recession, which seems a

rather long time, yet pales in comparison. So the next time you hear that this economic recovery is

getting on in years, just remember our friends from down under who have proven that if managed

correctly, economic growth can last a lot longer than ever thought possible.

“The trouble with committing political suicide is that you live to regret it.” ~ Winston Churchill, British Statesman

Crikey!


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Election Prediction

In this crazy election cycle,

it’s probably foolish to listen

to any one pundit’s prediction

about who may or may not

win. I don’t recall many

correctly forecasting how this

would all play out. The stock

market, on the other hand,

has a long history of

accurately making such

predictions. According to

Strategas Research Partners,

the stock markets trajectory

in the three months prior to

the election has correctly

forecast the outcome in 19 of

the 22 presidential elections

since 1928, and every year

correctly since 1984! That is,

if the stock market is up the

prior three months before the

election, then the incumbent

party wins and vice versa.

Reflecting the tight race,

stocks have traded about flat

since the beginning of August,

so no real indication yet as to

who the winner will be. But if

you want to know who will

win, the market’s likely to tell

you well before the votes are

cast. Looks like one way or

another we’ll get an October

surprise!

Stay Bullish My Friends

After nine years, one of the

most successful advertising

campaigns ever has come to

an end. Sadly, Dos Equis

“Most Interesting Man in the

World” has been retired. In a

relatively flat beer market,

Dos Equis managed to triple

their business during that

time, just as the stock market

has done since the nadir of

the bear market back in early

2009. With the way this

market has gone this year,

I would expect a choppy

market to continue,

particularly over the next

month before we all decide

who the leader of the free

world will be. If we do get any

significant pullback in the

market, it should be looked at

as a buying opportunity, as

historically the stock market

rallies after the election,

regardless of who wins. The

market abhors uncertainty

and generally rallies upon its

removal. With the ongoing

search for yield, income

stocks should continue to

outperform. So to paraphrase

the Most Interesting Man’s

famous tagline “I don’t always

buy stocks, but when I do, I

prefer dividends”.

Justin T. Adams, CFP® CPWA® CERTIFIED FINANCIAL PLANNER® Certified Private Wealth Advisor ® Managing Director Senior Vice President, Investments RAYMOND JAMES® (415) 538-5708 [email protected]

Sharlene Asuncion Sales Associate RAYMOND JAMES® (415) 538-5718 [email protected]

San Francisco Office 575 Market Street Suite 3900 San Francisco, CA 94105 (415) 538-5700 (800) 346-5544


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Opinions expressed are not necessarily those of Raymond James & Associates. The author's opinions are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. There is no assurance these trends will continue or that forecasts mentioned will occur. It is not possible to invest directly in an index. The S&P 500 is an unmanaged index of 500 widely held stocks. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ. The NASDAQ Composite Index is an unmanaged index of all stocks traded on the NASDAQ over-the-counter market. The Wilshire 5000 is a market capitalization-weighted index of the market value of all stocks actively traded in the United States. The Russell 2000 index is an unmanaged index of small cap securities which generally involve greater risks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. These international securities involve additional risks such as currency fluctuations, differing financial accounting stand-ards, and possible political and economic instability. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. Dividends are not guaranteed and will fluctuate.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER ™ and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC

Year-To-Date Index Performance

INDEXES 12/31/2015 9/30/2016 % Change

Dow Jones 17425.03 18308.15 5.07%

S&P 500 2,043.94 2168.27 6.08%

Nasdaq 5,007.41 5312 6.08%

Wilshire 5000 21,167.86 22576.67 6.66%

Russell 2000 1,135.89 1251.64 10.19%

MSCI EAFE (Intl) 1,727.47 1697.82 -1.72%

Documents

Quarterly Investment Newsletter OCTOBER 2016 STAY BULLISH