It has been 10 years since the financial crisis, the economic recession that bought the global economy to its knees: spawning a domino effect with a U.S. housing crisis. 10 years later, two things are clear: (1) the economic recovery was far from uniform (2) the best minds on Wall St. were unable to predict the last recession, and it is unlikely they will predict the next economic downturn. This month’s issue of The Samra Report takes a look at 3 metrics that may have gone unnoticed, and provides insight on what investors can do to protect their portfolios from a déjà vu scenario.
Regardless of economic trends and financial data, investment companies continue to place a positive spin on market conditions, looking to generate greater inflows into their respective funds. Although investors and the SEC should really be asking why, the answer was provided by Charlie Munger during a 1995 talk at Harvard Business school called “The Psychology of Human Misjudgment:” If you want to predict how people will behave, you only have to look at their incentives.
Since the late 1990’s, a growing trend towards outsourcing began, in the 2000’s a trend towards offshoring followed. As we head towards 2020, it is evident that U.S. corporations are investing in technology over human capital. Although the trend is not new, the scale of this transition is, especially when factoring this into our GDP equation, of which consumption makes up 68%. In layman’s terms, as more companies spend on technology over an increased labor force, less wages flow into the economy, leading to less consumption. Given consumption makes up a large part of this metric at 68%, lower wages lead to an equation that is unsustainable. Further translation: at Samra Wealth Management, we believe a recession in the next 2 years is likely. The Observed Metric: The U.S. GDP equation.
“The Big Short,” a Michael Lewis New York Time’s best seller, turned Hollywood Hit, focused on a handful of Wall Street nobodies, who successfully predicted the demise of some of the largest investment firms. Institutions that survived the great depression, were fundamentally flawed this time around. How did this handful of Wall Street nobodies predict what would become the great recession? They observed consumer mortgage default rates. As we look towards the near term and factor in low interest rates with a low inventory of homes for sale, the metric observed at Samra Wealth Management is consumer loan default rates, as we do not expect to see an uptick in mortgage defaults alone. The rationale here is quite simple, the underwriting process in mortgage lending has become more stringent, however, consumer loans such as credit cards have ballooned since the financial crisis, suggesting the underwriting process may be flawed. To bring things into perspective, since Q1 2016, we have seen a steady increase, quarter-after-quarter in the percentage of delinquencies on consumer loans, as shown by the chart below.
The 2016 Presidential election solidified that although the stock market was in its 8thyear of recovery, not all American’s shared the wealth effect. Whereas the financial crisis that led to the U.S. housing crisis discriminated against all. The recovery saw those with better educations, and those located near metropolitan areas sharing in the recovery to a greater degree. However, this growth was anything but uniform: take into consideration a family who have lost their home, working in rural Pennsylvania or West Virginia on a median household income of $56,516. With 24% allocated towards taxes, it is unlikely this family contributes much to a qualified account. Even though the S&P 500 has experienced annualized returns of over 13% over the last decade, this means little to a family holding no brokerage or retirement assets. The metric we continue to observe at Samra Wealth Management is: Median household income per state. Although the economy in your area may be thriving, this false sense of security comes from a lack of exposure to those communities which have seen little to no economic recovery.
No CFA, No Ph.D, no Harvard Business School Graduates, and no managing directors at Wall Street’s finest firms predicted the last financial crisis. What makes you think they’ll get it right this time? Wall St. is betting big on 2 factors:
The amount of cash on side lines
Earnings, relevant to historical data
According to the Fed there is approximately $19.4 trillion sitting on the sidelines in cash. With the U.S. stock market capitalization estimated at over $41 trillion, fund managers are under the impression a time will come when these funds re-enter the market. Unfortunately, the fund managers seem to have forgotten one of the cardinal rules of the capital markets: investors are irrational. As a result, the cash on the sidelines story has little basis for becoming reality. More believable, however, is the fact that earnings ratio are below historic averages, and far below where they were prior to the financial crisis. Again, fund managers and analyst seem to neglect the fundamentals of finance, knowing that “past performance is not indictive of future results.” With uncertainty on the horizon, investors should remain cautious as the market is off to a strong start to the year, however, how much higher can we go from here? At Samra Wealth Management, we have to date recommended against domestic fixed income, however, believe clients should start to allocate towards a balanced strategy by no later than September 2019. Our advisement towards a strategy of fixed income is not to necessarily dampen volatility, but more of a tactical approach. We recommend investors look away from pooled investment vehicles, and focus on separately managed accounts with a fixed income mandate, individual bonds, structured notes and ETF’s covering convertible bonds. Should we see the start of a recession in 2019, it is highly likely the FOMC would decrease interest rates, creating an opportunity to sell the fixed income portion of the portfolio at a gain. To learn more about this strategy, and how a portfolio x-ray can identify areas of excessive risk, please contact one of our advisors. References Butters, J. (2019). [online] Factset.com. Available at: https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_120718.pdf [Accessed 29 Mar. 2019]. Federalreserve.gov. (2019). [online] Available at: https://www.federalreserve.gov/releases/z1/20181206/z1.pdf [Accessed 27 Mar. 2019]. https://fred.stlouisfed.org/series/DRCLACBS. (2019). St. Louis Federal Bank: Delinquency Rate on Consumer Loans, All Commercial Banks. [online] Available at: https://finance.yahoo.com/news/map-united-states-unemployment-rates-194229070.html [Accessed 30 Mar. 2019]. Jilani, Z. (2019). CHART: Top ‘U.S.’ Corporations Outsourced More Than 2.4 Million American Jobs Over The Last Decade. [online] Thinkprogress.org. Available at: https://thinkprogress.org/chart-top-u-s-corporations-outsourced-more-than-2-4-million-american-jobs-over-the-last-decade-2ea66dfc0e35/ [Accessed 30 Mar. 2019]. Lakos-Bujas, D. (2019). 10 Years After the Financial Crisis | J.P. Morgan. [online] Jpmorgan.com. Available at: https://www.jpmorgan.com/global/research/10-years-after-crisis [Accessed 30 Mar. 2019]. Martin, E. (2019). This map shows how much money Americans make in every US state. [online] CNBC. Available at: https://www.cnbc.com/2018/12/07/median-household-income-in-every-us-state-from-the-census-bureau.html [Accessed 30 Mar. 2019]. Martin, H. (2019). The S&P 500 P/E Ratio: A Historical Perspective. [online] ValueScope. Available at: https://www.valuescopeinc.com/resources/white-papers/the-sp-500-pe-ratio-a-historical-perspective/ [Accessed 30 Mar. 2019]. Moneychimp.com. (2019). CAGR of the Stock Market: Annualized Returns of the S&P 500. [online] Available at: http://www.moneychimp.com/features/market_cagr.htm [Accessed 29 Mar. 2019]. Rosewicz, B. (2019). Fiscal 50: State Trends and Analysis. [online] Pewtrusts.org. Available at: https://www.pewtrusts.org/en/research-and-analysis/data-visualizations/2014/fiscal-50#ind0 [Accessed 30 Mar. 2019]. Vernon, P. and W. Moultrie, D. (2019). Private Client Research. [online] Bbtscottstringfellow.com. Available at: http://bbtscottstringfellow.com/Media/Default/Publications/U.S.%20Equity%20View%20Commentary.pdf [Accessed 1 Apr. 2019]. Ycharts.com. (2019). S&P 500 P/E Ratio Forward Estimate (Quarterly). [online] Available at: https://ycharts.com/indicators/sandp_500_pe_ratio_forward_estimate [Accessed 30 Mar. 2019]. All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The information and material contained herein is of a general nature and is intended for educational purposes only. This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.