DWM 3Q19 Market Commentary

“Fancy a cuppa’?” “Anyone for tea?” Even though our beloved Chicago Bears were “bloody” unsuccessful in their visit to London this past weekend, I’m “chuffed to bits” to put a little “cheeky” British spin on this quarter’s market commentary… Let’s “smash it”!

After a volatile three months, the third quarter of 2019 is officially in the history books. The S&P500 finished only 1.6% below its all-time high, bonds rallied as yields lowered, and alternatives such as commodities and real estate rallied. It’s been a rather “blimey” year for investor returns so far, but there’s a lot of uncertainty out there about if these “mint” times can last. Let’s look at how the asset classes fared first before turning to what’s next.

Equities: Equities were about unchanged for the quarter, as evidenced by the MSCI AC World Index -0.2% reading for the quarter.  Domestic large cap stocks represented by the S&P500 did the best relatively, up 1.7%, but underperformed in the final weeks of the quarter. Recent trends show that traders are gravitating toward stocks with cheaper valuations instead of pricey, growth ones. International equities* underperformed for the quarter, down -1.8% but had a strong showing in September. Even with this so-so quarter, stocks, in general, are up over 15%** Year-to-Date (“YTD”)! Yes, “mate”, this bull market – the longest on record – continues, but at times looking “quite knackered”.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index ascended even higher, up 0.7% and 2.3%, respectively for the quarter and now up 6.3 & 8.5%, respectively YTD. “Brilliant!” Yields continue to fall which pushes bond prices up. But how far can they fall? The 10-year US Treasury finished the quarter at 1.68%, a full percentage point below where it started the year. For yield seekers, at least it’s still positive here in the States as the amount of negatively yielding debt around the world swells. Sixteen global central banks lowered rates during the quarter including the US Fed, all of them hoping to prop up their economies. As long as they’re successful, all is good. But what if our slowing US economy actually stalls? We could be “bloody snookered”…

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, showed a +0.3% gain and now up 6.1% YTD. Lots of winners in this space. “Lovely!” For example, there is a lot of money flowing into gold***, +4.4% on 3q19 & +14.7% YTD, as it is seen as a safe haven. And real estate, +6.3% 3Q19 and +23.5% YTD, has rallied from investors looking for yields that are more than the bonds like those mentioned above.

Frankly, it’s been a pretty great year for the balanced investor who’s now looking at YTD returns that around double-digits. But it’s not all “hunky-dory”. The main worries are the following:

  • The US-China trade war continues affecting the global economy. Sure, since the US exports less than every other major country, this shouldn’t affect us as much. But given the uncertainty, many companies are choosing to hold off on capital expenditure until we get clarity on this issue. Reports earlier this week that US manufacturing momentum has seriously slowed down led to one of the worst fourth quarter starts for the stock market in years. Politics will continue to make it volatile.
  • The Fed’s path of monetary easing. It’s gotten “mad” – it seems every time there is bad news, it’s good news for the stock market because traders are betting on the central banks around the world to support the markets. Seems “dodgy”, right?!? So the Fed must play this balancing act, always wanting to keep the economy humming along. Quite frankly, there really is no economic reason for a rate cut right now if it weren’t for the trade conflict. Figure we’ll have at least one more cut, possibly two, in 4Q19 and hopefully that’s it. Otherwise, if they keep lowering, it means we have fallen into a recession.

It’s in a lot of peoples’ interest to get a trade deal done. If it does, markets will celebrate it. The longer a deal plays out, the more volatility we’ll see and the higher the risk of recession becomes. The US economy is not “going down the loo”, but it won’t continue to go bonkers with everything mentioned above as well as the Tax Reform stimulus fading away in the rear-view mirror as quickly as a Guinness at the Ye Olde Cheshire.

This all isn’t “rubbish”. Actually, there is a lot of turmoil out there. So don’t be a “sorry bloke”. In challenging times like this, you want to make sure you’re working with an experienced wealth manager like DWM to guide you through.

Don’t hesitate to contact us with any “lovely” questions or “brilliant” comments, and Go Bears!

“Cheerio!”

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the MSCI AC World Index Ex-USA

** represented by the MSCI AC World Index

***represented by the iShares Gold Trust

****represented by the iShares Global REIT ETF

Climate Capitalists to the Rescue?

Record heat has hit the South. On October 1, it was 101 in Montgomery, AL. Record highs were hit in AL, TN, MS and KY. An acute lack of rainfall has dried out the Southeast as well and residents and farmers are hurting. Planet Earth continues to get warmer.

Look at the chart above showing the changes in temperatures from the 1850s until now. Each stripe is one year. Dark blue years are cooler and red stripes are warmer. The period 1971-2000 is the base line. At the same time, extreme events like Dorian are becoming more severe, more glaciers have died and seas and lakes are getting higher. The climate has changed.

The past century has seen major changes in the world. The Industrial Revolution has brought riches to some, higher standards of living to many, and the population has increased from 2 billion to 7 billion in that last century, and carbon dioxide (“CO2”) emissions have skyrocketed. Fossil fuels have been used to produce industrial power, electricity, transportation, heating, fertilizers and plastic. In 1900 about 2 billion tons of CO2 went airborne. For 2019, 40 billion tons per year will be emitted, with the biggest increase in the last 30 years.   Expanding use of fossil fuel and related increasing emissions of CO2 have gone hand in hand with the expansion of world growth. See the chart below.

GDP CO2

We humans also produce CO2, breathing and eating.  Trees and plants absorb CO2 and, with sunlight and water, convert it to food.   Compared to 1900, we have 5 billion more humans, expanded use of fossil fuels and, because of deforestation, we have less flora to absorb the CO2.

The first half of the 20th century scientists believed that almost all of the CO2 given off by industry and humans and not absorbed by plants would be sucked up by the oceans.  By 1965 oceanographers realized that the seas couldn’t keep with the CO2 emissions.   Climate change shouldn’t come as a surprise; we’ve known about it for decades.

There are lots of predictions about the impact of climate change in the future. No one can predict the future. But certainly, as our beloved Yogi Berra always said, “The Future is not what it used to be.”

The Economist recaps it this way: “Climate change is not the end of the world.”  Humankind is not poised teetering on the edge of extinction.  The planet is not in peril.”  However, climate change could be a dire threat to the displacement of tens of millions of people, it will likely dry up wells and water mains, increase flooding as well as producing higher temps and more severe weather.  The Economist concludes that “the longer humanity takes to curb emissions, the greater the dangers and sparser the benefits-and the larger the risk of some truly catastrophic surprises.”

Addressing climate change will also provide substantial business opportunities in the coming years.  Already some countries are abandoning coal to generate electricity. Britain, e.g., has developed a thriving offshore wind farm industry used to generate power. Germany recently announced that it will spend $75 billion to meet its 2030 goals to combat climate change, primarily in the transportation area with electric vehicles.

In addition, “climate capitalists” want to do good for the planet and well for themselves.  Elon Musk has invested billions into batteries and electric vehicles.   Chinese BYD’s Zhenzhen sprawling campus is a major provider of solar cells, electric cars, heavy machinery and other items needing energy storage.  Warren Buffet has invested $232 million into BYD.  American billionaire Philip Anschutz has spent a decade promoting a $3 billion high-voltage electric grid. Bill Joy, a co-founder of Sun Microsystems, is now backing Beyond Meat, a maker of plant-based alternatives to burgers.  Microsoft’s Bill Gates established a $1 billion company to bankroll technologies that “radically cut annual emissions.”  Even Pope Francis is using the Vatican Bank’s $3 billion fund to help fight climate change.

The UN’s one day climate summit last week concluded with a number of new announcements.  65 countries and the EU have committed to reach net-zero carbon by 2050.   Unfortunately 75% of the emissions come from 12 countries and 4 of them, India, American, China and Russia made no commitment.  However, certain businesses such as Nestle, Salesforce and have made commitments to reach net-zero by 2050 or before.

2050 will be here before we know it.  Yet, technological change can be adopted quickly, particularly when people are provided a better alternative.  In America, the shift from horse-drawn carts to engine-driven vehicles took place within a decade, from 1903 to 1913.  Let’s hope climate capitalists all over the world do well for themselves and good for planet as soon as possible and we humans and our countries do our parts as well.

 

Indiana Jones and the Fountain of Wealth

With current markets swirling with questions of trade deals, recessions, inverted yield curves, and various other political and financial uncertainties, should we be fearing a near future “Temple of Doom” scenario like intrepid archaeologist Indiana Jones in the much acclaimed 1984 movie?!? Perhaps we can learn some tidbits of info – clues, per se – from Indy that can help us in our quest for our prized possession: financial serenity, wealth management’s version of the Holy Grail. While this ultimate goal may look a little different for each of us, and the journey this may be wildly different, some of the steps we take will likely be extremely similar, and the clues below, inspired by Indy, can provide some guidance as we take those steps!

Clue #1: Diversifying your arsenal, and your portfolio!

You’ve heard it before. In fact, diversification is a word that has been mentioned so many times in TV and movies that it’s become hard to think about investing without discussing how diversified one’s portfolio is. We’re here to tell you that this relationship makes sense! Various studies have shown over the years that having a well-diversified portfolio can significantly benefit investors in the long run.

Figure 1: Hypothetical Growth of $100,000 showing Diversified versus Undiversified Portfolio*

As shown in Figure 1, having a globally allocated, well-diversified portfolio made up of investments that have low correlation to one another, with pieces of each being from the equity, fixed income, and “nontraditional investments” (or alternatives), can help investors try to protect their assets during market downturns, and participate in market upswings. Much like Indy’s arsenal of guns, knives, and his famous whip protected him, using multiple asset class holdings with low correlations can protect investors’ portfolios from extreme danger.

Clue #2: Be Educated!

As a professor of archaeology at Marshall College, Indy’s extensive years of research have provided him a wealth of knowledge to work off of when he begins each search for ancient (and sometimes alien) artifacts. Despite this, he learns quite a bit along the way on his quests that leads to his success in discovering these items. Much like Indy, our pathways to financial health and peace often seem clouded in mystery, and are often filled with confusing directions and puzzles that can lead us astray from the path to our goals. These puzzles and directions, luckily, can be illuminated in most cases by educating one’s self in the complex and intricate business of finance! Whether it’s subjects of Arks, mysterious stones, or crystal skulls, a.k.a. topics of investments, insurance and taxes in finance terms, a little bit of knowledge can go a long way towards creating the ever important map to the desired goal! Blogs like these help our clients become educated and better prepared for the financial journey ahead!

Clue #3: A Little Help From Our Friends

No matter which adventure he’s on, Indy always has a crew of fellow explorers with him to help on his search. Each play their own integral role in supporting his journey as he brushes with Nazis, Russians, and Thuggee cults. In a similar manner, wealth managers like DWM can act as your “Short Round” (an ally) in your continual journey to financial serenity and success, helping guide you through the sometimes dark and perplexing pathways. Our expertise in these “ruins” of sorts can assist with dodging the pitfalls in your financial plans and portfolios.

With or without headlines coming out about recessions or inversions or trade deals or anything else, by following these three clues, and sticking to them for the long-term, an investor can create a stable pathway to success. Just as Indy never gives up on his quests, neither should we.  Our steps may alter in ways over our lives, from accumulating wealth, to protecting it, and then to financially planning for our legacies, but each of these has the underlying pursuit for peace of mind. Please feel free to reach out to DWM if you have any questions about how we can accompany you on your hunt.

*Source: https://www.schwab.com/resource-center/insights/content/why-global-diversification-matters

REINVENT CAPITALISM?

Kraft Heinz (KHC) and Unilever (UL) have many things in common. Both companies own hundreds of global consumer brands- KHC includes not only Kraft foods and Heinz Ketchup but also Planter’s peanuts and Grey Poupon mustard. Unilever owns Dove soap and Hellmann’s mayonnaise, Lipton’s tea and Ben & Jerry’s ice cream. Both have been in business since the 1920s. Both employ tens of thousands of employees.

In early 2017, KHC offered to buy UL for $143 billion. UL’s then CEO, Paul Polman, fended off the takeover attempt because of a “corporate culture that couldn’t have been more different from Unilever’s.” Since then, KHC’s share price has dropped 70% and UL’s has increased about 35%. If we look at some of the differences between KHC and UL we will see why Mr. Polman didn’t want to merge with KHC and why he would like to see capitalism “reinvented.”

After receiving his M.B.A., Mr. Polman joined Procter & Gamble which provided the foundations for his leadership approach. In his recent NYT interview, Mr. Polman indicated that “P&G has enormous values that permeate all levels and all places in the world that it operates. Ethics, doing the right thing for the long term, taking care of your community is really the way you want a responsible business to be run.”

Fast forward to 2009. After 10 years of decline, UL hires Mr. Polman as CEO. Annual sales had dropped from $55 billion to $38 billion. Mr. Polman felt UL had good brands and good people but had become too “short-term focused.” A change was needed.

Mr. Polman brought back values from the 20s that were at the roots of Unilever’s success. He felt a more responsible business model was needed. He came up with a bold plan to double Unilever’s revenue while cutting the company’s negative impact on the environment in half. And, he committed his entire team to focus on the long-term, not the short-term, in solving important issues.

In short, Mr. Polman believes “We need to reinvent capitalism, to move financial markets to the longer term.”  He felt that “KHC is clearly focused on a few billionaires that do extremely well, but the company is on the bottom of the human rights indexes and is built on the concept of cost cutting.”

This long-term vs. short-term focus is at the heart of a recent best seller, “Prosperity” by Colin Mayer, a former dean of Oxford’s Said business school. Dr. Mayer believes that a great shift in businesses, here in the U.S. and abroad, started about 50 years ago with the overwhelming acceptance of Chicago economist Milton Friedman’s simple doctrine that “the one and only responsibility” of a business is to increase its profits for the benefits of its shareholders, as long as it stays within the rules of the game.” This has been a “powerful concept that has defined business practice and government policies and has molded generations of business leaders.” It has resulted in a huge emphasis on quarterly reporting and quarterly behavior.

Dr. Mayer believes, on the other hand, that the purpose of a corporation should consider its customers, employees, suppliers, and communities as well as its shareholders. Historically, family-owned businesses were cognizant of and responsive to all the constituencies that compose a business and focused on the long-term. Today, almost all corporations in the UK and many US corporations are no longer owned by the founders or their families. This change has accelerated due to the focus on short-term profits, often by simply merging and cutting costs. Dr. Mayer also pointed out that corporations can also have dual-class share structures (typically voting and non-voting shares) which can allow the founders and their like-minded successors to control the company and therefore focus on its long-term purpose rather than quarterly earnings reports. Ford, Google, and Facebook all have this structure. This is a positive trend.

Robert Reich’s new book “The Common Good”, sums it up this way, “In the corporate world, the single-minded-pursuit of shareholder value has displaced the older notion that companies are also responsible for the well-being of workers, customers and communities they serve.” “The common good is no longer a fashionable idea.” He defines common good as “consisting of our shared values about what we owe another as citizens who are bound together in the same society.” Regardless of political party, all Americans should embrace contributions to the common good.

For 50 years, there has been a huge focus on financial capital with less attention paid to human capital, intellectual capital, material capital and environmental capital. All five of these components of capital should be considered for the overall long-term growth and common good of America and the world.

Reinventing capitalism would require companies to focus on more than quarterly profits. Consideration of all of its constituents- customers, shareholders, employees, suppliers, communities and the environment for the long-term-could certainly benefit the common good and likely produce even better stock market returns in the long-run as well.

Dealing With Investor Anxiety: Think Long-Term

Stock prices reflect a mix of emotions, biases and rational calculations. The bond market reflects the economy. Historically, bond markets had done a better job in predicting recessions.

The two big bond stories last week were 1) the “inverted yield curve”- when interest rates on short-term bonds are higher than long-term bonds, and 2) yields below 2% on 30 year treasuries- indicating investors expect low inflation and a weaker economy for a long time.

We all remember the 2017 income tax cut that boosted the economy and produced stock markets returns of 20% or more in 2017. These tax cuts were supposed to lay a foundation for many years of high economic growth. Since mid-2018, however, the economic data has been confirming what many of us expected. The tax cuts provided a short sugar “high,” which is now over. Instead, we have trillion dollar deficits and lack of large promised business investments, including infrastructure, which never materialized. The economy has reverted to its pre-stimulus growth rate of near 2%.

This shouldn’t surprise us. No major economy is growing as fast as it was before 2008. In almost every country, the national discussion focuses on what must be done to revive growth and ignores the fact that the slowdown is happening everywhere. The working population is declining in 46 countries around the world, including Japan, Russia and China. Demographics are a key driver of economic growth. So, we can expect to see recessions (two quarters of negative growth) more likely in the future as working populations contract. BTW- the U.S. population is growing at less than 1% per year.

Over the next few decades, we will likely see more growth decline. Ruchir Sharma, author of “The Rise and Fall of Nations,” suggests that new benchmarks for economic success should be 5% growth for emerging countries, 3-4% growth for middle income countries like China, and 1-2% growth for developed countries like the U.S. and Germany.

Yes, there are uncertainties in the market, including US-China trade tensions, a weakening European economy, and concern about a recession. These produce a huge dilemma for U.S. business owners, trying to make plans for the future. So, there are lots of piles of cash, waiting for clarity. We may or may not soon have a recession. Yet all of this uncertainty produces increased volatility and anxiety. And studies show that a 3% down day, like last Wednesday, feels about ten times worse than a 1% down day. What’s an investor to do to reduce anxiety?

We understand it is difficult to think long-term, but we highly recommend it:

1) Recognize that equities will likely produce lower nominal returns in the future. However, with inflation also likely lower, the real returns of equities will likely outpace fixed income and alternatives. Equities will continue to provide the primary engine of growth.

2) Use all three asset classes. A diversified portfolio composed on equities, fixed income and alternatives has been shown to reduce risk and increase return.

3) Review your long-term financial plan and determine what rate of return you need to meet your financial goals. The expected return of your asset allocation must be sufficient to meet your goals or you need to revise your goals and plan.

4) Review your risk profile to determine your appropriate asset allocation. Using the assumption that equities could drop 40% and you can’t tolerate a loss of 10% or more in your portfolio, then your allocation to equities should not exceed 25%. Of course, this allocation would severely limit your upside.

5) Stay invested. Don’t try to time the market. A recent report from Morningstar shows that “low cost funds”, (like those used at DWM), “lead to higher total returns and higher investor returns.” First, for efficient markets, the active managers in the high-cost funds overall produce gross results equal to the benchmarks, but then the additional costs of 1% or more is subtracted. Second, studies show that active managers attempting to time the market have failed and this subtracts another ½% per year from performance. Even highly-paid active managers can’t time the market successfully.

Lastly, in this time of overall investor anxiety, fee-only total wealth managers, like DWM, are here to rescue you. Yes, we execute a detailed process to add value every day in the areas of investing, financial planning, income taxes, insurance and estate planning. Yet, one of our most important tasks we have is to protect our clients from hurting themselves in the capital markets. Investors overall have a very human tendency to do exactly the wrong thing at the worst possible moment.

We understand it’s hard to think long-term. Today’s world moves at a very fast pace. And, the news is often designed to instill fear. Don’t succumb to emotions. Reduce your anxiety. Allowing your portfolio to compound quietly over time can be boring, yet very successful.   If your allocation or the markets are making you anxious, let’s talk.

EQUIFAX’S BIG PAYBACK: SHOULD YOU FILE A CLAIM?

It was just two short years ago when Equifax went public with the realization that access to about 150 million users had been obtained by a third party still unknown to top security officials. Without knowing the perpetrators, motive behind this breach has yet to be concluded, generating worries about criminals using the identities stolen to cash in through the sale of said data or something more nefarious, including spy scandals.

While advanced cyber security and dark web professionals sift through to try and find the data, Equifax has been trying (and being forced to) make up for their mistake with the millions of Americans whose information was violated. On July 22nd, 2019, the Federal Trade Commission, in conjunction with several other agencies and all 50 states, agreed in court to a settlement of roughly $700MM to be paid out in reparations to those affected by the breach in accordance with allegations that the company did not provide and monitor security measures to protect against this attack. This is on record as the largest settlement ever dished out for a data breach in U. S. history.

Of that $700 million dollars, at least $300 million is to be used to offer the plaintiffs access to years of free credit monitoring service in order to ensure that any data stolen from Equifax during the breach was not used to steal individual’s identities, and also allows for free credit freezes as well for those who are more concerned. The other payout option they provided was $125 for anyone who files a claim for it. An extremely small payout on an individual level considering the fortunes that could be lost if a person’s identity was indeed stolen, but still a payment nonetheless. Should you file for one of these checks?

Well, unfortunately, Equifax has turned around and in the blink of an eye, stating that the amount of people filing for this $125 payment has surpassed the allocated funds for paybacks. According to the FTC, “because of high interest in the alternative cash payment under the settlement, consumers who choose this option might end up getting far less than $125”. Beyond the fact that this amount may be smaller in scope than originally planned on, the filing process isn’t as easy as filling out a form. Instead, those who file are required to gather documents related to the hack that show losses, and provide ancillary information and documents in the process of filing your claim. Many of those who have started the process are turned off by the fact that they need to proceed in presenting further information to the company that they already don’t trust to keep their information safe, and several scammers have set up websites to further deceive you into entering personal information. However, regardless of all these issues, millions have, and are continuing to file their claims which will remain open until January 22, 2020.

While the $125 (or likely much less) payment option may not be the best call, the alternative option for free credit reporting, monitoring, and freezing is catching on with some of those affected. Included in this package is free credit reporting, most importantly from all three major credit bureaus, which in theory is worth “hundreds of dollars a year” according to Robert Schoshinski, the assistant director for the FTC’s Division of Privacy and Identity Protection. To add to this value, included in the credit reporting is up to $1 million dollars in identity theft insurance and individualized identity restoration services. All in all, this secondary option may not be the source of direct money in your pocket, but rather can save you huge amounts of money in the case that something malicious were to occur as a result of this breach.

Here at DWM, we are always monitoring ways we can protect our clients, and we will continue to do so. While Equifax may not be giving out the $125 check anymore, free credit monitoring might be a very nice way to go if you’re willing to go through the process of filing a claim. This can essentially mean spending five to ten minutes of your time for 10 years’ worth of peace of mind, and roughly $2,400 worth of value ($20 per month of monitoring for 10 years). While it may seem like pocket change in comparison to the value of the data stolen from you, this can definitely serve as great protection in the case that any of this information is fraudulently used in the future.

 

If you would like to file a claim, please visit Equifax’s claim website: https://www.equifaxbreachsettlement.com/file-a-claim

Did You Ever Dream That You Forgot Your Pants? No Problem.

dream_not_wearing_pants.jpg

Have you ever dreamed that you are walking into a college final exam and you have done no studying for it?   Better yet, in the dream, have you walked into the exam and forgotten your pants? I can tell you from personal experience, I have had dreams where both events occur. Fortunately, I’m pleased to report, this has never happened in real life and likely and hopefully never will. More importantly, though, I now know that my dreams have served an all-important psychological function-working out my anxieties in a low-risk environment and preparing for the future.

Most of the emotions we feel in dreams are negative; including fear, helplessness, anxiety and guilt. Yet, this night-time unpleasantness may, in fact, provide an advantage during the day.

All sleep is not the same. Dreams typically occur in REM (rapid eye movement) sleep, when our brains are more active. You cycle between REM and non-REM sleep. First, comes non-REM sleep followed by REM sleep and then the cycle starts over again. Babies spend 50% of their sleep in the REM stage, compared to only 20% for adults. Deep sleep which is non-REM is known for the changes in your body, not your brain; when your body repairs and regrows tissues, builds bone and muscle and strengthens the immune system.

REM sleep is crucial for mental and physical health, yet we generally slough off the dreams as being silly, juvenile, and self-indulgent and simply get on with our day. Because dreams seldom make literal sense, it can be easier to discard them than to try to interpret them. In fact, according to Alice Robb, author of “Why We Dream,” dreams can help us “consolidate new memories and prune extraneous pieces of information.” Further, they may provide a time for the brain to experiment with a wider array of associations of the facts and outcomes and sometimes help solve problems.

Finnish evolutionary psychologist Dr. Antti Revonsuo studied the perplexing question of why our minds subject us to something so unpleasant. He reasoned that if our ancestors could practice dealing with dangerous situations, perhaps battling a mastodon, as they slept, they might have an advantage when they had to confront them in the next day. Research on animals fits into this theory. REM deprived rats struggle with survival-related tasks such as navigating a maze, while rats with REM sleep apparently dream about this upcoming challenge and perform better.

In 2014 researchers at the Sorbonne interviewed a group of aspiring doctors about to take their medical school entrance exam. Nearly all of the 719 students who replied had dreamt about the exam at least once beforehand and, understandably, almost all of those dreams were nightmares. They had dreamed that they got lost on the way to the exam facility, that they couldn’t understand the questions and that they had written their answers with invisible ink. Ouch. But, when the researchers compared the results of the exam with dreaming patterns, they found that students who dreamed more often performed better in real life.

Ms. Robb suggests that, while we tend to focus on and discuss dreams that are strange, most dreams are less bizarre than we think. A study in the 60s by psychologist Frederick Snyder of 600 dream reports showed that “dreaming consciousness” was, in fact, “a remarkably faithful replica of waking life.” He found that 9 out of 10 dreams “would have been considered credible descriptions of everyday experience.”

In another study, Dr. Revonsuo and Dr. Christina Salmivalli, analyzed hundreds of dreams from a group of their students and discovered that the emotions in the dream were usually appropriate to the situation, even if the situation itself was unusual. “The dreamer’s own self was ‘well preserved.’” Effectively, even in dreams, we know who we are.

So, go ahead and get a good night’s sleep tonight and look forward to the REM dreaming phase. It may feel negative and not be all that comfortable. However, it just might give your brain some time to work through some important matters and find solutions.

ECONOMY CELEBRATES 10 YEARS OF GROWTH: IS IT TIME TO PARTY?

Next week will mark the 121st month of the current bull market- the longest business cycle since records began in 1854. Based on history, a recession should be starting soon. Bond rates now form an “inverse yield curve” with shorter term rates above longer term, which typically signals a downturn. Business confidence is down. However, 224,000 American jobs were created in June and equities continue to soar, rising 16-20% year to date. Is it time to party or not?

The business cycle appears to be lengthening. The current expansion, coming after the worst financial crisis since the Great Depression, has been unusually long and sluggish. Average GDP growth has been 2.3% per year, as compared to the 3.6% annual growth in the past three expansions. The workforce is aging. Big firms invest less. Productivity has slipped. And, Northwestern Economics Professor Robert Gordon continues to assert that American’s developments in information and communication technology just don’t measure up to past achievements including electricity, chemicals and pharmaceuticals, and the internal combustion engine.

However, the changing economy may now be less volatile for a number of reasons. 1/3 of American’s 20th century recessions were caused by industrial declines or oil-price plunges. Today, manufacturing is only 11% of GDP and its output requires 25% less energy than in 1999. Services are now 70% of our GDP. Furthermore, the value of the housing market is now 143% of GDP, as compared to a peak of 188%. Banks have lots of capital.

Finally, inflation has been very low, averaging 1.6% in the U.S. (and 1.1% in the euro zone) per year during the current expansion. In earlier business cycles, the economy would surge ahead, the jobs market would overheat, causing inflation to rise and leading the Federal Reserve to put on the brakes by raising interest rates. Today, it’s different. Even though the unemployment rate is at a 50 year low of 3.7%, wage growth is only 3%. As the Economist pointed out last week in “Riding High,” American workers have less bargaining power in the globalized economy and are getting a smaller percentage of company profits, keeping inflation down. The Fed recently announced that it is less concerned about rising prices and more concerned about growth slowing and, therefore, will lower interest rates at its meeting next week.

Changes in the economy to slower growth, more reliance on services and lower inflation all contribute to longer business cycles. Yet, the changing economy, particularly globalization and technology, has also produced new risks.

Manufacturing that was formerly done in the U.S. is now outsourced to global producers. These chains can be severely disrupted by a trade war. This could produce a major shock- imagine if Apple was cut-off from its suppliers in China. Also, take a look at the impact that the prolonged grounding of Boeing’s 737 MAX is having on the U.S. economy. It’s hurting suppliers, airlines, and tens of thousands of workers, while $30 billion of the MAX sit grounded. Global supply chains are extremely interconnected these days.

IT is significantly linked as well. Many businesses outsource their IT services via cloud-computing to a few giants, including Alphabet (GOOGL).  85% of Alphabet’s $100 billion annual sales comes from advertising, which in the past has been closely correlated to the business cycle. GOOGL invested $45 billion last year, 5 times more than Ford. In fact, the S&P 500 companies invested $318 billion last year, of which $220 billion was spent by ten tech companies. The big IT companies are now facing regulatory issues worldwide. What would be the worldwide impact if GOOGL, Facebook or others get their “wings” clipped?

Also, finance issues could disrupt the expansion. Although housing and banks are in decent shape, private debts remain high by historical standards, at 250% of GDP, or $50 trillion. And, if the prime lending rate continues to decline, banks’ profits and balance sheets will likely weaken.

Lastly, politics is a big risk. There are the threats of trade wars with China and physical war with Iran. The big tax cut that pushed markets up in 2017 could now produce lower year over year earnings for companies. On Monday, July 22nd, Congressional leaders and White House negotiators reached a deal to increase federal spending and raise the government’s borrowing limit. This would raise spending by $320 billion, at a time when the annual deficit is already nearing $1 trillion, despite the continuing expansion.

Conclusion: Changes in the economy have produced reasons why business cycles are longer, yet more sluggish. Those changes have also added new risks for a continuing expansion and bull market. No one can predict the future. Focus on what you can control: Make sure your risk level is appropriate for your risk profile. Make sure your portfolio is prepared for the next downturn. And, yes, stay invested.

Pizza Meets Technology

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What’s your favorite pizza? In Chicago, I love Lou Malnati’s deep-dish, in the Lowcountry, Grimaldi’s Brooklyn Bridge, with ricotta and Italian sausage, is amazing. And, now, thousands of years after pizza was invented, it too is being impacted by technology. Recently, the WSJ, in their “The Future of Everything” section, focused on the impact technology is having at Domino’s Pizza.

But first, let’s take a look at the history of pizza. Archeologists in Sardinia have found ancient remains from the 1st millennium B.C. of flattened bread that was apparently very popular. Writings in the 6th Century B.C. mentioned soldiers baking flatbread and covering it with cheese and dates. Stone ovens are mentioned in the 3rd B.C. when Roman historians described “flat round of dough dressed with olive oil, herbs, and honey baked in stones.” Excavations made in Pompeii show that in the 1st Century B.C. retail shops were making and selling pizzas.

Modern pizza seems to have come from Naples in the 16th century. Tomatoes from the New World combined with bread and other products to produce the earliest form of modern pizza. The Queen of Naples in the mid-18th century had a special oven in her palace for making pizzas. Antica Pizzeria Port’Alba, the first modern pizzeria, opened in Naples in 1830. By the end of the 19th century, citizens of Naples were consuming pizza for breakfast, lunch and dinner.

In the early 1900s, the first Italian pizza in America was introduced by street peddlers who walked up and down Taylor Street in Chicago. New York City got the first pizza license in 1905. Pizzerias spread across the U.S. in the early 20th century. In 1943, Chicago’s Ike Sewell invented the deep-dish pizza. In the 1950s, celebrities of Italian origin, including Frank Sinatra and Joe DiMaggio, promoted pizza. The first frozen pizza was released in 1957. Pizza Hut started in 1958, Little Caesar’s in 1959 and Domino’s in 1967.

These days, pizza is a huge business. According to 2018 “Pizza Power” report, the worldwide pizza market was $134 billion, with U.S. the top country, at $45 billion annually. There are 75,000 U.S. pizzerias and the top 50 chains have average unit sales of almost $600,000, with annual growth overall at 12%. The big winners were reported to be those who focused on consumer needs by embracing “websites, social media, online ordering and delivery technology.”

Domino’s, with 6,000 U.S. outlets is the world’s largest pizza company. Yet, their just-issued 2Q19 quarterly report showed slower growth. Their stock has gone “cold”- investors have “lost their appetite” for Domino’s Pizza. Technology has fueled new and improved competitors, delivery apps, online ordering and quality.

The growth of online ordering through companies like Grubhub and Door Dash has impacted Domino’s business. Domino’s, with its own delivery drivers, has declined to form partnerships with them. Also, food delivery companies, such as Uber Eats and Postmates, have jumped into the business aggressively with free or discounted delivery during the March NCAA tournament period with great success. Even though Domino’s hasn’t raised their prices on pizzas in over a decade, increases in same-store sales are slowing.

Ritch Allison, CEO of Domino’s, was recently interviewed by the WSJ for its “The Future of Everything” section. Mr. Allison was clear that “Pizza will endure. However, almost everything about how a pizza is made and transported to the customer is undergoing a high-tech shift.”

Domino’s has maintained that it won’t outsource delivery. Instead it will invest in operations to make delivery more efficient and better for customers. Low unemployment and rising minimum wages in some cities are pushing up labor costs and making it harder to find drivers. They’re working on a driverless vehicle smaller than a golf cart, with compartments that can be heated up or chilled. They are looking at drones and even deliveries by bike and scooter riders.

Mr. Allison indicated that they are working on upgrading their “Dom” automated telephone answering service. They’ve been missing customer calls during busy times. Their goal is to answer every call and hopefully build bigger orders as well. They hope improved data on customers will help them produce better menus, adding and deleting items over time based on demand patterns.

For Domino’s “Robots will help, but not replace human pizza makers.”   Robots can put dough balls on trays, but Mr. Allison wants to “keep the magic of pizza making” with humans. Domino’s is currently using, in locations in Australia and New Zealand, artificially intelligent cameras to photograph and grade each pie based on different criteria. This quality audit is designed to ensure that a subpar pizza never reaches a customer’s door. They hope to extend this quality method to operations worldwide.

Yes, even our beloved pizzas, that humanity has been eating for thousands of years, and hopefully for many more thousands as well, are being impacted by technology. Hopefully, that will make it easier in the future for all of us to get our perfect pizza at the perfect time.

DWM 2Q19 Market Commentary

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Summer is finally upon us! Weather is steamy, kids are out of school, and it’s the midst of carnival season. Merriam Webster has several definitions of carnival including:

  • An instance of merrymaking, feasting, and masquerading
  • An instance of riotous excess
  • An organized program of entertainment or exhibition

Sounds a little bit like the markets we’ve seen in 2019 so far: it’s certainly been an entertaining program with all asset classes parading higher. But does this Fun House continue or is it all just a House of Mirrors….

Equities: You win a small prize! Equities continue to be the most festive part of the fairground, with many stock markets up over 2-4% on the quarter and now up around 12-18% on the year! Domestic and large cap stocks continue to outperform value and smaller cap stocks, which is typical of a late-stage bull market, this one being over a decade-long!

Fixed Income: You can trade in that small prize for a medium prize!  Like a Ferris Wheel where one side goes up, the other side comes down; yields and bond prices operate the same way. With the 10-yr Treasury now down to around 2.06% at the time of this writing compared to 3.2% last November, it’s no surprise to see strong returns in bond land. In fact, the Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index popped another 3.1% and 3.3%, respectively for the quarter and 5.6 & 6.1%, respectively year-to-date (“YTD”).

Alternatives:  You can trade in that medium prize for the largest prize! The merrymaking continues as most alternatives we follow had good showings in 2Q19, evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, up 1.3% and now up 5.7% YTD.

It almost feels like you could go over to the Duck Pond and pick up a winner every time. There are indeed a lot of positives out there:

  • US stocks near record highs
  • A stock-market friendly Fed
  • Historically low unemployment with inflation that appears totally under control
  • Americans’ income and spending rising, leading to relatively strong consumer confidence

But this carnival has some roller coasters in the making given some riotous issues including:

  • US-China trade tensions most likely not ending with a solid deal anytime soon, which will fuel anxiety
  • A weakening European economy due to tariffs and other issues, which could bleed over to all markets
  • Slowing US economic growth here as the Tax Reform stimulus wears off
  • A relatively expensive US stock market, evidenced by the S&P500’s forward PE ratio now at 16.7 times versus its 25-year average of 16.2

It definitely wouldn’t be fun if the yummy funnel cake turns into spoiled fried dough…Yuck! We don’t know exactly when or what will happen, but we do know that at some point this bull market will indeed end. You cannot time the market so forget about getting out of the Cliff Hanger before the time comes. That said, you want to stay invested and continue to control what you can control. Don’t wind up being on the bottom end of a Whack-A-Mole game; make sure your portfolio is prepared for the next downturn, which includes making sure your risk level within is appropriate for your risk tolerance.

So don’t wind up being a carny clown. If you want to continue hearing “winner-winner-chicken-dinner!”, work with a proven wealth manager and you’ll be the one controlling the Zipper!

 

Zipper