April 2018 Market Letter

“Mourn as a nation, rule as a mob… kill for an insult so slight… the further they plummet, the blinder they are… each one believing they’re right.”

“I’m the monster, I exist… On this summit I am lost… On its slopes I’ve seen… The world as she was meant to be seen…”

You can interpret these lyrics from the 2009 song Insatiable (Two) by the Austin alternative rock band And You Will Know Us by the Trail of the Dead however you like. Yes, it’s the apex of tax season, and I’m working more hours than ever before. At the same time, I need to comment on this week’s massive market selloff. The last five days were the worst week since January 2016. All major averages are well into the red for 2018, and the VIX, or Volatility Index, has risen by over 150% in the last six weeks. The sheer weight of the numbers is crushing- the Dow Jones Industrial Average shed over 1400 points to its lowest level since last November, the S & P 500 Index lost over 5%, and NASDAQ broke through the 7000 mark. What caused all this, and where are we headed?

There are several reasons for this correction, not the least of which is that moves of this type are normal. However, this week was immensely ugly, exacerbated by a confluence of events leading to an atmosphere of utterly no certainty on Wall Street. In no particular order, here’s what happened (remember that I’m only hitting the highlights and it’s only for one week):

1) After walking back on most of the rhetoric of his steel and aluminum tariffs, President Trump announced a new multi-billion dollar set of tariffs on China. The Chinese quickly retaliated with a list of ten US industries that they would potentially impose tariffs upon, and gave detailed evidence and specifics. As is typical of the President, there were few specifics of his plan, and it appears as though the Chinese have the upper hand here. They own a significant amount of our Treasuries, and could elect to dump them for spite if nothing else. We also import far more of their goods than they do ours. I can agree with the idea of negotiating a more balanced trading relationship between the two countries, but this rash act sent world markets reeling. It’s ironic that President Trump was touting his record as the greatest creator of equities wealth ever, but isn’t addressing Wall Street’s reaction to his edict.

2) The Federal Reserve raised interest rates ¼ % on Tuesday afternoon. While this move was almost universally expected, the tone of new Fed Chairman Jay Powell was perceived by some as a bit hawkish. In another ironic twist, even though rates were increased, the yield of Treasuries actually decreased in the face of the tariff brouhaha.

3) Speaking of hawkish, President Trump fired National Security Adviser H.R. McMaster (although McMaster allegedly resigned) and replaced him with former US ambassador and Fox News analyst John Bolton. Many of us remember Bolton as the far-right fringe of the neocons in Bush Two’s administration. As of late, Bolton has written op-ed pieces in the New York Times and Wall Street Journal calling for intervention strikes in Iran and North Korea. He also stands by his decision to have promoted the wars in Iraq and Afghanistan.  A note of further irony here as few pundits have brought up Trump’s anti-Iraq war stance during the nomination process.

4)   Former CNBC personality Larry Kudlow took over as Chief Economic Adviser. Even though Kudlow has long been an ardent supporter of free trade, he took the job nonetheless. It is rumored that Kudlow had to agree with the President’s decision on Chinese tariffs in order to be offered the job.

5)   Facebook was guilty of a massive data scandal last weekend. Their top executives, Mark Zuckerberg and Cheryl Sandberg, violated every basic principle of public relations by waiting until Thursday afternoon to offer apologies. No independent investigator has been named to ferret out the reasons for the breach, and the stock lost over 12% on the week.

6)   If Robert Mueller’s investigation weren’t enough to make the President seethe, three women have recently accused him of having an affair with them and then paying hush money through a third party to keep them quiet. Let’s not forget that the road to President Clinton’s impeachment proceedings began with his lying to a grand jury about his dalliances with Monica Lewinsky and Paula Jones.

A lengthy list to be sure. As the noted 1960’s satirist Tom Lehrer said, “That was the week that was”.

Despite all of these newsworthy events, I refuse to panic. I mentioned in my last missive that traditionally a double bottom forms following an initial correction. From a charting technical perspective, that’s what we’re watching here. We’re testing the 200 day moving averages as we speak. The usual leaders in the markets, technology and financials, have been replaced by energy and utilities. That’s certainly not a good sign because the latter two sectors comprise a very small percentage of market capitalization. Sentiment seems to be getting more bearish, but that might be a decent harbinger that we’re getting a bit oversold.

Let’s be realistic. Facebook’s gaffe isn’t going to send the masses searching for another social media platform. There might be more government scrutiny ahead for the companies making money from our data, but Facebook basically prints money, and a lot of it. I am, though, worried about Trump’s White House now being almost wholly comprised of sycophants. Only Chief of Staff Kelly and Secretary of Defense Mattis remain as potential dissenters to Trump’s ever-evolving worldview.

In the end, markets have weathered political crises throughout history. A nasty trade war wouldn’t bode well for anyone, but Trump has walked back from the brink many times. He’s gone from trolling Kim Jong Un to scheduling meeting with him. On Friday, he signed a government extension spending bill even though it didn’t satisfy his DACA wishes or fully fund his border wall. The fact that November’s midterm election currently looks problematical for Republicans could influence policy. Even Trump has to realize that a Democratic takeover of the House and/or Senate would effectively neutralize him.

In the meantime, try to breathe normally. Basic fundamentals haven’t changed much even with all of the extant noise. We must all try to cut out the clutter and stick to our long-term plans. I’ll report back after the tax dust settles.

Sincerely,

 

Bill Schiffman

Registered Representative

 

The opinions expressed in this letter are those of William Schiffman and should not be construed as specific investment advice. All information is believed to be from reliable sources; however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Diversification cannot assure a profit or guarantee against a loss. Indices are unmanaged and do not incur fees, one cannot directly invest in an index.

Long-Term Problems for Long-Term Care Insurance Providers

Insurance companies always win, right? Well, that hasn’t necessarily been true when it comes to Long-Term Care insurance carriers.

What began in the late 1970’s as “nursing home only” products, LTC insurance increased in popularity in the 1980’s and 1990’s as contract language broadened to cover assisted living, adult daycare, and in-home care. However, actuarial miscalculations combined with adverse market conditions has led to serious problems for today’s LTC industry.

Original policies were drastically under priced. This was due to actuaries thinking more policy holders would die younger and less would continue paying for their LTC policy. The opposite occurred. People were living longer and proved unwilling to give up benefits they’d paid years of premium for. As a result, claims rates were much higher than anticipated, and the carriers were on the hook to pay the benefits.

Insurance companies also underestimated inflation related to health care. According to the National Association of Insurance Commissioners 2016 annual report, the $35 billion LTC industry in the late 1980’s exceeded $225 billion as of May 2016.* Not only were there more claims, but also a higher cost per claim than expected.

Interest rates hit historic lows. This caused performance of the general account portfolios of insurance companies to suffer, as they rely heavily on fixed income assets. Additionally, many carriers were stuck paying fixed guarantees on other products (e.g. annuities) offered in higher interest rate environments.

There were once more than 100 carriers selling traditional LTC insurance. According to Forbes, 17 were left standing as of 2016.** Each of these companies have raised premiums on existing policyholders. Many have done so more than once, and rate hikes on older, in-force policies are expected to continue in the future.

New policies available for purchase today are supposed to be priced correctly. The problem is – they aren’t selling. LIMRA, an industry research company, cited LTC sales declines of 60% since 2012.*** Press has been negative. New issue policies are expensive. Underwriting is strict, and premiums are still not always guaranteed to remain level. By the way, if you never need care, you get nothing.

These factors have pushed consumers toward the certainty of linked-benefit and rider-based products.  These plans typically have 3 components: a cash value, a death benefit and a LTC benefit. Both allow for access to at least a portion of premiums paid should one need to withdraw cash or elect to cancel their policy. They are not “use it or lose it” like traditional LTC insurance, yet they can be just as expensive.

LTC continues to be a costly problem to solve for retirees, whether one buys insurance or not. Time will tell how the industry evolves from here.

* http://www.naic.org/documents/cipr_current_study_160519_ltc_insurance.pdf
** https://www.forbes.com/sites/howardgleckman/2017/09/08/the-traditional-long-term-care-insurance-market-crumbles/#482af23b3ec3
*** http://news.morningstar.com/articlenet/article.aspx?id=852616
The opinions expressed in this article are those of author and should not be construed as specific investment advice. All information is believed to be from reliable sources, however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.
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March 2018 Market Letter

It’s baaaaaaaack!

I guess that it was simply too good to last. January’s market performance was nothing short of perfect. Stocks continued their upward trajectory and the atmosphere for investors was as placid as a serene summer pond. In stark contrast, February had more action than all of 2017 combined. At the heart of it all was the return of that multi-headed hydra of angst and turmoil called volatility.

The VIX, or Volatility Index, was at historic lows throughout most of 2017, with readings breaking below the 10 mark on several occasions. Equities and their owners acted as if they hadn’t a care in the world. But when we had our first whiff of corrective behavior, it was the proverbial “Katie, bar the door!” The VIX jumped to the mid-30’s level almost instantaneously. What happened to put rocket fuel into antacid sales this month?

As I’ve mentioned several times in these missives, we’ve been long overdue for a correction. According to Birinyi Associates, stocks have historically experienced downward moves of 5% every few months, with a 10% haircut at least annually on average. Corrections of 20% and beyond are less frequent, but still part of statistically “normal” market behavior.

In February, we had a pullback of nearly 10% that was both swift and merciless. Once the reversal began, it got ugly in a hurry. My feeling is that the train left the rails quickly because of margin leverage exposure leading to investors needing to sell stocks to raise cash. In addition, there were a couple synthetic products that basically vaporized because they were betting on volatility not returning in the short-term. Thankfully, we don’t use margin or reckless hedging products in any of our accounts.

At around the 10% level, fundamentals began to re-assert themselves and equities moved higher. By the end of the month, the major averages had recovered a decent portion of the pullback. We’re now a tad better than break-even for the year. While that doesn’t measure up to 2017 standards, I guess that if our portfolios are at par thus far in 2018 after enduring a correction, we should feel relieved. As we enter March, the salient questions become “Is the corrective phase finished? Will volatility return to last year’s low levels?” My hunch is no on both counts, at least in the near term.

Don’t get me wrong. I’m heartened by the fact that equities rebounded so nicely. I’m also a believer in the strong underpinning of fundamentals led by strong corporate earnings, solid balance sheets, consumer confidence, historically low interest rates, and tax reform. However, corrections often seem to have a mind of their own. There’s some historical math logic to my thinking that we’re not done yet. Without getting too technical, market troughs are a part of the major averages demonstrating reversions to the mean. If we flip a standard coin, we know that there’s a 50% percent chance that it will come up heads. If we did this ten times, you could get ten heads as an unusual result. If we did the experiment 10,000 times, though, the ratio would be far closer to 50-50. The larger the sample size, the more the results revert to the mean. Equities prices have done this forever, and today’s technology doesn’t negate old school math.

The other factor comes from a charting perspective. The rapid V-shaped bottom that we saw early last month is one that generally gets re-tested at some point in order to create what’s known as a “double bottom”. This classic technical pattern has been shown on many occasions to be a harbinger of better times to come. The market shakes out weak players a second time, and consolidates positions of strength. My guess is that a re-test will happen before the bull market gets new legs.

Along with these arithmetic truisms, there’s a wild card in our midst as well. New Federal Reserve Chairman Jay Powell had his first testimony before Congress on Tuesday, and he spooked Wall Street quite a bit. While his comments were generally benign, he did postulate that the economy “could be in danger of overheating”. Traders took this to mean that four 2018 interest rate hikes might be in the offing instead of three. The bond market reacted adversely, and took equities down with it. We’ll soon see if this is a “one off” event, or part of an underlying trend. I’m watching the levels on the ten year Treasury. The closer to a 3% yield that it gets, the worse it is for stocks. At 2.8% or below, it’s a more positive sign. Fixed income may actually lead the next equities move.

The true object lesson for February is that you cannot give in to panic at the first sign of a downturn. Corrections are totally normal. Stocks almost always go down faster than they go up. It’s painful watching portfolio values decline, and we haven’t honestly felt the roller coaster for a while. This doesn’t mean, though, that we deviate from our long-term objectives. Inflation remains low, and there appears to be little evidence of a recession any time soon. Yes, it looks like the Federal Reserve will be tightening in earnest, but equities have done well in these types of environments before. I’ll begin to get worried if I see corporate earnings wane.

In the meantime, while it’s difficult to enjoy the ride, just know that it’s normal market behavior. Reversion to the mean is a powerful concept that finally showed its colors again last month. Volatility is closer to 20 now instead of 10, so we’re probably not out of the nervousness woods yet. Hang in there, and don’t forget to breathe.

As always, I appreciate your trust and support. Please feel free to give me your thoughts. I look forward to talking with you soon.

Sincerely,

 

Bill Schiffman

Registered Representative

 

The opinions expressed in this letter are those of William Schiffman and should not be construed as specific investment advice. All information is believed to be from reliable sources; however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.  Diversification cannot assure a profit or guarantee against a loss. Indices are unmanaged and do not incur fees, one cannot directly invest in an index.