U.S. stocks had a great three months during the 3rd quarter, propelled by favorable corporate profit reports and overall good economic news. The tax overhaul bill passed late last year, which cut the corporate tax rate sharply, has sent company profits up and their share prices reflect these benefits. The Dow Jones 30 Industrial Average was up 7.2% through the end of the third quarter while the broader Standard & Poor’s 500 index gained 9%. Technology companies represented much of the gain, increasing 19.2% so far this year with biotech companies up 27% year to date and Internet companies up 29%. Utilities were down (0.4%) as were REITS, (real estate investment trusts) and insurance companies. Corporate profits are expected to increase in 2018 to 19% over profits in 2017, which in turn were 25% above 2016. Companies that have much of their business overseas, such as Johnson & Johnson, Coca-Cola and eBay, are suffering due to the strong U.S. dollar.
Global markets, excluding the U.S., were down 5.2% through the end of Q3, 2018. The biggest factor was the decline in China, down 12.6% and Shanghai, down 14.7% due to investor fears about the impact of a trade war with the U.S. Natural resource-based New Zealand was the best performing international market, up 11%. In Europe, the 600 largest companies declined, on average, 1.5%. Norway was the best performing international market, up 17% while Turkey was the worst, down 13%.
The benchmark U.S. government 10-year bond is now paying 3.05%, which is up for the fifth consecutive quarter. The 10-year bond sets market rates for mortgages and consumer loans. Year to date, the broad US bond market declined 1.7% which means that bond prices have gone down more than the interest income that the bonds earned. U.S. corporate bonds in the aggregate were down 2.4% while long-term, high-grade bonds declined 5.7%. International bonds, U.S. municipal bonds and U.S. high-yield bonds have all experienced a similar downturn, so it has not been a happy year for people in bond mutual funds as their principal value has declined. Our portfolios are made up of short-term, high quality individual corporate bonds so we are in good shape.
On the commodity front, crude oil has been one of the biggest gainers in 2018, up 21.2%. Natural gas has barely increased, up 2%, and so it continues to be a much cheaper source of domestic fuel. Gold has declined 7% so far in 2018 while silver declined 14%, in line with other commodities such as copper, coffee, and sugar. I wonder why prices at Starbucks haven’t declined since their cost of goods sold has gone down so much?
The Federal Reserve bank hiked their benchmark rate by one quarter of 1% in late September. This was the third time rates have been raised in 2018 and the eighth increase over the last three years. We expect interest rates to continue to rise through mid-2019 so that the Fed has some leverage to lower interest when the next recession hits. These increases in rates have not yet severely impacted U.S. stock markets but they have severely dampened the rate of returns on bonds.
Whatever the outcome of the upcoming elections, short-term volatility will likely be replaced by continued strength in the markets because the economic fundamentals in place are mostly positive. If you are tempted to buy and sell your stocks based on the results of a particular election, a recent study by Bloomberg shows that no matter which side of the political fence one sits on, getting out of the market when your opponents are in office is a bad idea. Our approach to stock investing is with a long-term view, so whatever allocation to stocks one makes, that portion should stay relatively fully invested for the best results. Likewise, bond investing should be done in much the same way, i.e., on a buy and hold basis. We stay with relatively short bonds, those lasting no more than 5 years.
The U.S. is growing at a rate of between 3% and 4% per year. GDP, or gross domestic production, is well over 4%, which has helped create a high demand for technical jobs around the nation. Unemployment overall is said to be at the lowest level since the late 1960s and worker participation, the % of people who want to be working who have jobs, is highest in the over 55-year and older group. Workers in the 20-year-old to 50-year-old group have experienced neither gain or loss in jobs so far in 2018. Employment levels for black Americans has declined by 12% over the last five years though recent quarters have shown some turn around and improvement.
The U.S. economy remains one of the best performing in the world, alongside several countries in Eastern Europe, such as Poland and the Czech Republic, which have seen their economies grow by leaps and bounds due to a re-emphasis on industrial production. On the other hand, several countries around the world are in the midst of severe economic downturns that have resulted in low domestic output, high unemployment, high inflation and increasing budget deficits. Chief among the countries facing hard times are the Philippines, Turkey, Argentina, Greece and Italy, alongside Brazil, South Africa, and Pakistan.
Interestingly enough, even though our economy is strong, the U.S. budget deficit as a % of the economy is equivalent to that of Argentina and Pakistan. The nations with the greatest trade surplus are Hong Kong, Germany and Norway. The U.S. dollar continues to dominate world trade because America is considered a safe haven and global investment flows into our country continue to underwrite our high budget deficits, thereby keeping interest rates lower than they would otherwise be. U.S. deficits are increasing as a result of the 2017 tax cut though it is still too early to know whether long term revenues will increase, as theories state they should, due to decreased regulation and increased business activity, or if this is a “flash in the pan” syndrome where corporate profits have run up due to temporary infusions stemming from business-friendly legislation whose impact is one time and brief.
The U.S. trade deficit with China is unlikely to be reversed no matter what trade agreements are eventually negotiated. The Chinese have already gained the upper hand in several important areas: biotech, energy technology, and next- generation artificial intelligence. They are in the process of constructing the world’s largest telescope, the world’s most advanced elementary particle research facility, and the world’s most extensive alternative energy generation facilities. In addition, they maintain a substantial lead over the U.S. in the area of biomedical research. One reason for the explosion in their applications for new patents is that there are no prohibitions or restraints on genetic cloning and other research regarding human genomes, access to and widespread use of fetus/embryo tissues for research, or prohibitions against pretty much any kind of biotech experimentation. This is both frightening and amazing and will likely lead to some remarkable discoveries over the next several decades.
Thoughts on “The Big Picture”
The State of the Democracy:
One cannot ignore the recent national debates concerning the Supreme Court nominee process and the impact of that event on people of all ages and political persuasions. It is evident that the hearings were divisive and emotionally trying, no matter which side of the aisle one is on. It is sobering to contemplate the effect that this event has had on the national psyche and it is impossible to identify “winners” and “losers”. One never knows how a particular individual will be changed by the solemn office of the nation’s highest court. America will go on and eventually pull together despite strident appeals by some to maintain stances of disunity.
While many of our nation’s basic institutions and ideals seem to be under attack, we remain optimistic that the end result will not be an abrupt ideological shift of the court to the left or right but that it will land somewhere in the center, which is where most Americans live.
Traveling through the Deep South recently, Mississippi and Alabama in particular, I was struck by the relatively high degree of inter-racial harmony at work sites and eating establishments throughout the region. Being a native New Yorker, I remember the Mississippi Freedom rides of the 1960s, and, being an adopted New Mexican, I am aware of how different cultures can live side by side in relative peace.
We tend not to congratulate ourselves on many things, not to soak in our country’s unusual cultural accomplishments. Yet, in the arena of race relations, I believe we have come through to a place where most Americans are happy living, studying, working and recreating in places where black and white people are integrated. The relevance of this to the recent Supreme Court nominee controversy is that our nation is a reflection of the people’s will. We have confidence, in the long-term, that if the majority of Americans have a strong opinion about highly charged issues such as a woman’s right to choose, the Supreme Court will not infringe upon the public’s right to have this freedom of choice. This will soon be tested as challenges to partisan gerrymandering is a case that is on the fast track to reach the Supreme Court in October.
Technology and Humanism:
The pre-eminent position that personal computers and hand-held technology have taken on in terms of the quality of our lives cannot be over emphasized. Over the last year, we have begun to see some major challenges to the premise that more access to the internet and faster communication is always a good thing. Recent studies have shown that there is an increased efficiency and efficacy to business people if they can manage to be unplugged for certain periods each day, week and even for extended periods of time during the year. The problems of constantly filtering information and responding to other people’s demands for our attention is now recognized to be debilitating for certain kinds of mental activity. Focusing for long periods of time on screens, not only takes us away from where we actually are at a particular moment but is starting to be understood as damaging to both our psyches and physical bodies. The dominant technology companies are well aware of the subtly ungrounding impact of their devices and the addictive nature of their services on the general public. Politicians and regulatory bodies are looking into whether or not these companies have abused their powers.
The European Union has taken the lead in dialing back the rights of the major content and processing companies such as Google, Facebook, Apple, Amazon, etc. and is now trying to institute privacy laws and ensure the ability of consumers to unplug from the system. The investment advisory business is almost totally dependent on the internet, the Virtual Cloud Network, and electronic communications of all sorts. We get more done, have more choices, and stay in touch to a high degree with our technologies. Yet, how much of a good thing is too much? We believe that these qualitative challenges coming from such diverse quarters as childhood development, mental health, law enforcement, medical doctors, educators, and corporate human resource departments may present a very real challenge to the continuation of unfettered use of electronic devices. If this is the case, the current stock market dominance of the big technology companies may come to an end and their sky-high valuations, which has driven the stock market up over the last three years, will abruptly come back to planet Earth!
With the resolution of the formally deadlocked talks between the U.S. and Canada and the U.S. and Mexico, many people feel that President Trump is on a roll and that he has created a template for negotiating favorable trade pacts with other nations. The salient provisions of the pacts with Canada and Mexico include a requirement of higher worker wages in those countries for producers of specific goods that are being exported to the US as well as the adopting of U.S. rules and standards on the protection of intellectual property. It remains to be seen whether the EU and Japan will agree to these conditions as they have their own free trade zones with other non-aligned nations. The U.S. administration is also taking aim at currency manipulators and demanding the right to withdraw from a trade deal if that partner forges a separate deal with China. This is a high-stakes gamble on Trump’s part that the country cannot afford to lose. The U.S. agricultural sector will receive government money to take some of the sting out of their battlefield losses, but we need the world’s markets for our exports.
The Chinese both respect and fear Trump as a negotiator, but it remains to be seen whether they will give in to his demands for reciprocal protection of copyrights as called for under international law. We know that China has four times as much to lose as the U.S. in terms of the gross value of their exports, and their stock market declines so far in 2018 reflect investors’ beliefs that when push comes to shove China will lose what appears to be an impending trade war with the U.S. I say ‘appears’ because nothing is as it appears, especially as it is presented in the media. There is some reason to think that the Chinese will capitulate over time, but only if we are willing to go eye to eye with them on these macro trade disputes and face them down over their expansionary military policies in the South China Sea region.
Real Estate Opportunities – Lending and Owning:
During my recent travels to locations around the country, I have developed a particular interest in what are called “Opportunity Zones”. The long-standing and popular tax strategy of exchanging one commercial property for another, thereby deferring indefinitely capital gains taxes on the sale, is known as a “1031 exchange”. This widely used method for deferring taxes may be supplanted by a provision in the December 2017 tax bill that creates potential scenarios where the reinvestment of realized capital gains (from any source, not just the sale of previously owned real estate) can be delayed up to six years and be reduced by 15%. More importantly, reinvested capital gains in Opportunity Zones that meet several as yet undefined criteria, will be eligible for a complete exclusion from capital gains tax upon the sale of projects purchased with funds applied from previously sold profitable projects.
Many real estate markets on the East and West Coasts as well as popular destination locations in the hinterlands are becoming overheated. It is hard to find properties in these hot markets that are selling at reasonable valuations, and this is one reason why we have been emphasizing direct, community-based lending on both coasts and in the Southeastern portion of the United States. Protection of capital is always our firm’s primary objective, and the production of a stable stream of relatively high income is the goal of many of our clients and their families. Direct lending satisfies these needs and we have had some good successes to date. Of course, there have been problems, but that is part and parcel of any disciplined investment strategy.
The search for property to purchase and hold/improve for eventual capital gains has become more difficult due to the current high prices in markets like the greater New York City area where the expected return on high quality corporate leased properties has fallen from 8% to 5% over the last several years. Our hands-on lending and investing in the North Carolina region have helped pick up the current rate earnings of our private lending portfolios into the 7% to 9% range and adds to their geographic diversity. This is rewarding but becoming increasingly difficult. Under the Trump Administration’s directives, banking regulators are permitting local banks to reenter certain aspects of the commercial real estate market, and competitors such as national and regional investment banks have come into the direct lending space.
Our real estate equity or direct ownership opportunities come from contacts around the nation, and we continue to partner with locals in each venture. Clients who are in their 60s and 70s often approach us about wanting one-story, garden style living which includes property management and medical service offerings, access to public green space and transportation to shopping, cultural events and restaurants. Separate but near to hand living quarters for service families would make this type of housing markedly different than the current model of building housing communities that have an age requirement of 55 or older, or of the large- scale model provider model of continuing care retirement centers. Around 10,000 baby boomers turn 65 every day, and this massive demographic change of life will go on for close to a decade. Demographics drive demand and demand drives markets.
We believe that it may be a worthwhile investment effort to help conceive and perhaps participate in providing a new kind of “aging in place” solution, one that provides both capital growth and income. That being said, it will take a good bit of effort to research and find appropriate locations for this kind of high-end cluster housing. 54% of U.S. households with annual incomes between $48,000 and $95,000 don’t have enough money saved to maintain their current quality of life through their elder years. We don’t use the word retirement often anymore, since people now, by choice or necessity, have multiple careers and interests and a desire to stay active throughout later life. Please let us know if you have an interest in the kind of real estate project described above.
Rob: My travel schedule continued apace in the 3rd quarter, with stops in California, Colorado, New York, North Carolina, and Louisiana rounding out the roster. In each of these locations, I am looking at existing private investment projects as well as scouting out potential new ones. Since all work and no play is not a recipe for sustainable activity, I try and do at least one outdoor event at each location – whether on bicycle, foot, or otherwise. With such a capable staff in place at the office in Santa Fe, including a built-in home for my dog, I feel fortunate to be able to work from the road and to continue to expand our investment horizons while at the same time having some fun.
Kyle Burns: In August, my wife, Tabitha, and I celebrated our ten-year wedding anniversary. Our anniversary was during a busy time for both of us, but we were still able to slip away for a night and celebrate. Our boys just started third grade and have had a good start to the year. They have been riding their bikes and walking to school on their own, and we believe that the morning exercise probably helps them focus during the day. My wife’s latest clinical placement for her nurse practitioner program is in Tucumcari, NM, which leaves the twins and I on our own two nights a week. I always enjoy getting to spend some alone time with them.
Contessa Archuleta: Thankfully, the monsoon season finally arrived, providing much needed rain across the state which allowed the forests to open following their closure back in May. We were able take advantage of a few camping opportunities in both northern New Mexico and southern Colorado. In August, my family and I traveled to Telluride, Colorado, where we spent 4 days saying goodbye to summer and spent some quality family time together. We stayed in Mountain Village, which is conveniently connected to the Town of Telluride by a gondola that boasts of being the only free public transportation system of its kind in United States. The 8-mile, 13-minute ride, provides incredible views of the surrounding mountains, wildlife and descending view over the town itself. It was a wonderful place to visit and we hope to return to the area during the winter months to see if the skiing is as good as folks claim. As our kids have gotten used to their school day routine, and as the days get shorter and evenings get cooler, it’s always nice to reflect on the blessings that surround us, including the hot air balloons flying over our heads, fall colors, and last, but not least, the smell of roasting green chile in the air. We have high hopes for an abundant snow fall this winter.
Keren James: Summer ended with a trip to San Francisco with my son where I was also able to attend the Schwab Solutions conference. I was grateful for the opportunity to further immerse myself in the industry and to learn more about the ways in which we can increase and improve our digital workflow in the office for our clients’ benefit. As always, when in the Bay area, my son and I devoured as much dim sum as possible (always happy to share recommendations) and visited with dear friends and family. We returned to the beginning of his fifth-grade school year and the ramping up of my duties as Treasurer of the Acequia Madre Elementary PTC Board. We are now hard at work planning our annual fall fundraiser for the school. The leaves have turned on the mountain, and it is my hope to hike up to see the aspens before they drop. I look forward to Thanksgiving as it is my favorite holiday of the year.
Anthony Penner: It’s hard to believe fall is here. As sad as I am to see Summer go, I am looking forward to all the activities fall brings. Recently we visited the Ski Basin to see the fall colors, while listening to music and enjoying the company of family and friends. Next up is Balloon Fiesta. My daughter sees all the commercials on tv and keeps asking to go, and, weather permitting, we hope to take her one of the days. Moriarty, NM, hosts the wonderful McCall’s Pumpkin Patch, which is perfect for our annual family trip to pick a pumpkin and get lost in the corn maze. As Halloween gets closer, my daughter will have to make the difficult decision of picking out a costume and thankfully she is currently down to 3 choices.
Patrick Gendron: The end of the monsoon brought much needed rain, but also flooded the ARTsmart building causing over $70,000 in damage. This has been my first big challenge as Board President and we are grateful for the outpouring of generosity from the community. With the arrival of cooler temperatures and changing colors, I am reminded of how much I love the fall season in Santa Fe. Not only is it easier to sleep at night as it gets cooler, but I find myself staying home and cooking more. I am not excited about the time change because it will limit my after-work biking and photography escapades, but I am looking forward to getting ready for Snowboarding season. Hopefully, this will be a wet winter.
Jeff Sand: My wife retired from St. John’s College a few months ago. However, since then she has been spending a lot of time in Phoenix caring for her elderly mother and so she says that she still doesn’t know what it feels like to be retired yet. Our daughter recently visited us from Colorado and we had fun catching up, hiking and eating out. I have several music projects coming up in October and November and I have been busy learning songs, writing charts, and rehearsing.
Gayle Johnson: What a fast summer; I did manage to take some personal time off. My summer visitors included my granddaughters and gosh we had fun. Their parents came along for the visit as well! I love the fall season and am busy preparing for yearend portfolio activity with an eye out for what to expect from the 2019 markets…will keep you posted.
Please join us for our quarterly gathering at 2218 Old Arroyo Chamiso in Santa Fe to discuss economic and market related events on Wednesday, November 28th from 3:30 to 5 p.m. which is the week after Thanksgiving. (MT). The call-in” tea” will occur on Thursday, November 29th from 3:30 to 4:30 p.m. (MT). The call-in number is 719.234.7872, code: 470070#.