The world’s global stock markets keep churning along as stocks turned in their best first-half of the year so far this decade. Only four previous 6 month long rallies have matched 2017 and two of them ended in crashes while two marked the beginnings of new bull markets. Which trend today’s markets will follow, remains to be seen.
Here at home, the five largest technology companies powered the market higher due to the combination of the largest companies getting the most attention and the momentum of people adding money to index funds. The NASDAQ overall technology composite surged 14% while the more mundane Dow Jones Industrial Average and Standard & Poor’s 500 each rose around 8%. The biotech industry was the U.S. darling sector once again, with a gain of 25.5%, while oil service firms declined precipitously, losing 28.8%. It has been a wild ride for oil and gas investors these last few years.
Other stock markets around the world also turned in extremely strong performances including Japan, up 4.8% and Europe as a whole was up 5%, with Spain leading the way at a positive 11.7%. Israel brought up the rear with a loss of -2.5%, even though the Israeli technology market tends to match the U.S. in terms of actual real economic activity. The markets heaved a collective sigh of relief as anti-nationalist political parties took a beating all over Europe and France’s presidential election calmed investors as the establishment’s favorite son won the day.
Some analysts point to strengthening corporate earnings as justification for the stock market’s boom. On a visceral level, it appears that most investors feel that there is nowhere else to put their money so why not get in on a good thing while it’s still going strong. Interest rates continue to be suppressed by central banks around the world, even though rumblings are now being heard about a possible reduction in the size of government sponsored programs that expanded central bank’s involvement in most developed countries’ economies.
The Hong Kong market was one of the best performing in the world during the first six months of 2017, due to growing confidence that China is on track to challenge the U.S. for a major role in international trade. It, along with Korea, has shown that political uncertainty is no impediment to investor enthusiasm. Natural resource laden Australia had the lowest return, barely 1%. Overall, Asia roared ahead, up 14.1%. One reason for this is that commodity prices continue to be depressed, down 2.1%. Most Asian countries are heavily dependent on purchasing natural resources overseas to power their economies. The price of energy has declined by around 15% while gold is up 8%, continuing its low steady climb out of the doldrums.
In the U.S. bond market, U.S. treasury investors lost over 5%, on a total return basis, over the last year while municipal bond owners are down about – 0.60%. The overall U.S. bond market, including corporate and junk bonds, is up around 2% year to date but many traditionally conservative investors are realizing that the outlook is bleak for fixed income securities. The returns that bond investors enjoy come from both interest earned, which years of near zero interest rate policies has drastically reduced, and changes in the price of the bonds, which depend on demand and supply. With U.S. government bond rates going down from 2.7% to 1.9%, no more than extremely modest returns on principal are forecast going forward. There are several other reasons why bond returns may be just slightly above zero for some time to come: a shrinking population, considerable regulation, fewer market makers and a muted outlook for inflation. These all indicate that interest rates on bonds will probably not be rising in the foreseeable future unless some kind of unforeseen catastrophic event occurs.
This all plays back into the reasons why the stock market continues to go up. The Standard & Poor’s 500, the broad-based index of the largest U.S. companies, now trades at about 18 times earnings which is the highest level seen in 13 years. At the same time, on declining days, the market just doesn’t seem to want to go down. Even volatility, which measures how much the market fluctuates, is at a multiyear low. Household debt is higher today than it has been at any time since 2008 and many retail investors are encouraged enough to want to load up on index funds which, as noted above, directs money into the largest companies like Facebook, Amazon, Apple, Microsoft, and Google. Where will those companies go from here?
One noteworthy sign, indicating possible overheating of the bull market, is that startup companies have, over the last 12 months, raised hundreds of millions of dollars via new electronic exchanges that allow cryptocurrencies to be used in place of cash. Large multinational companies are using their cash to buy back their own stock, which boosts the price of their shares. They are also acquiring other companies in order to keep their growth rates up, hoping to sustain investors’ interest. Amazon just bought Whole Foods for way more than it’s worth, and then amazingly Amazon’s stock price magically increased by more than the amount that it just spent on acquiring this high-end grocery chain.
Value investing, which is what we practice here at our company, looks for long-term trends and we try and buy when others have turned away in disgust and sell when everyone is climbing aboard the train. New consumer service companies like Uber, have valuations that depend on maintaining positive consumer “buzz,” sentiment that can change dramatically overnight, and so they probably don’t represent a long-term investment opportunity for our portfolios. There are some great ideas coming into the marketplace but it’s highly uncertain which ones will survive the next sustained downward part of the market cycle.
Since consumer spending drives the majority of the American economy and spending often depends on income, whether earned by working or derived from investments, let’s look at the real employment situation to see if Americans are getting back to work. Official statistics say that the unemployment level is around 4.6%, which means that we are operating at or near what is perceived as “full” employment. However, only about 60% of Americans between the ages of 18 and 65 are actually working and so there is a major gap between government statistics and what we perceive from anecdotal knowledge of our local communities. Most people we talk with have friends and relatives that are under or unemployed.
This is due to several factors which are unlikely to change. America, along with most other developed countries worldwide, needs to face the fact that there is and will continue to be a shrinking demand for traditional, high-paying manufacturing jobs. This is due to automation and technological innovation. There are, however, a growing number of low-paying service jobs which do not pay enough for employed people to save much, purchase personal residences or fund their retirement. The major factors that have created this unsettling situation are demographics, increased longevity, advances in technology, and declining dependency ratios (which means the numbers of active workers available to fund retirees’ benefits).
Children born today will likely live 10 years longer than those born during the baby boom era. They are likely to have two or three careers in jobs that for the most part do not exist today. Ninety percent of the population in developed countries across the globe only have approximately 25% of the funds that they need to stop working and so, with increased longevity comes an increased need to work for a longer time. With interest rates low, workers cannot save enough and earn enough on their savings to fund a comfortable retirement and so retirement benefits will need to be cut. The Council of Economic Advisers, McKinsey Global Institute, and Science and Technology magazine all estimate that between one third and two thirds of all jobs that currently exist today will disappear due to technological advances.
At the same time, if people are living longer and have to work later in life, there will be less opportunity for younger workers to find meaningful jobs. With increased technology investment on the part of companies, most jobs will pay less. This may be good for keeping inflation in check but it makes it not too hard to understand how President Trump was able to tap into some very real and deep feelings that things are not looking up for the average American voter.
It is difficult to expect young people to work to put themselves through college when they have to go into debt anyway because of the astronomical rise in education costs at public universities and colleges over the last 20 years. Previously, a student could work a three-month summer job and basically make up the shortfall between grants available and tuition, room and board rates at in-state schools. This is no longer the case so student debt is rising precipitously. Social mobility, or the ability for working-class kids to move into the upper income lifestyles, has become much diminished so the problems of inequality, slowing productivity growth, stagnant wages, declining living standards and reduced ability to buy a home in many American cities are all formidable obstacles to reinvigorating the American workforce.
The American dream was created by World War II’s successful conclusion which wiped out our major competitors. The world is now full of up and coming countries with highly educated and motivated populations of newly minted engineers, entrepreneurs and technical workers. The rapid dispersion of new technology, which reduces the need for unskilled labor on assembly lines and in extractive industries, has changed the economy and destroyed many traditional jobs. We believe that as one door closes, another opens in that self-motivated individuals will have a wide variety of activities that they can involve themselves in that will “pay” for the American dream.
The US economy has some major challenges that are also opportunities for job creation and improving our competitive stature in the world. For example, America’s productivity is greatly hindered by our decaying infrastructure in terms of traffic on highways and flight delays. Training workers to help build and maintain new transportation modes would put some people back to work. It is possible that college education will move away from the liberal arts and towards advanced training in science and technology so that we can compete with other developed and developing nations.
The current debate over immigration is very relevant to the state of our economy because a generation of new businesses and job creators are having difficulty gaining entry into the country. Soliciting and encouraging talented foreign nationals to go to school in the U.S. and then stay here so they can start new businesses has always been a big part of US economic development strategy. The U.S. public school systems are not producing enough graduates with “broad skill development,” i.e., people who have the ability to learn new technology rapidly and critically deal with analytical problems. Hopefully, all of this would change under some broad restructuring of the educational system. It remains to be seen whether the Republican controlled Congress and White House can move towards cooperating with Democrats to get some of these things done. While we dawdle, other countries are moving ahead.
Healthcare and Tax reform
We are now six months into the new administration’s tenure with not much clue as to whether a comprehensive plan to address health care and taxes is forthcoming or whether the political acumen exists to get something done in either of these two areas. Any tax reform proposal is likely to face a long struggle but the outline of what the country needs seems clear.
Corporate tax reform, including lowering corporate tax rates while mandating the reparation of profits from overseas, is a no-brainer. Tax simplification and closing loopholes sounds good to everyone until it gets in front of special interest lobbyists, many of whom stand to lose their livelihood if certain tax breaks, such as those described below, go away. The real estate industry has enjoyed special tax deferral privileges, through the 1031 exchange provisions, for many years. Savvy investors use it to avoid paying capital gains tax by rolling over proceeds from selling real estate investments into new projects. This is akin to not paying capital gains on selling an inherited stock if another stock is bought with the sale’s proceeds within a certain amount of time, in other words a boondoggle!
There are special provisions for financial industry people to enjoy lower tax rates on their income than other working people by calling their profits “carried interest” as opposed to “taxable income from regular business activity.” The deduction of state income taxes benefits wealthy people for no good reason except that it helps people from the more populous and politically active states like New York and California. The complexity of business tax rules is legendary, to the point where very few entrepreneurs are able to file their own tax returns. Getting rid of complexity is part of the holy grail of tax reform.
Health care reform efforts have pretty much ended in a stalemate. No one wants to be responsible for undoing coverage for the lower income portions of the population yet the current system is fast losing traction as insurance companies pull out of Obamacare in many states. Bipartisan efforts seem to be revving up and this is a good thing because the country is pretty evenly divided between Democrats and Republicans (not counting Independents).
Having a weak president may turn out to be a good thing for the country because for Congress to move forward on topics like health care or taxes, there needs to be a consensus that working together is appropriate. This means taking the discussion out of the dogfight arena and putting it back into reasoned discussions. There is evidence that competition can be introduced back into the healthcare system, and when this happens, it does lower the cost of care for many Americans. The broad brush strokes of solutions that we envision to the tax code and health care reform debates share a striking similarity in that they put individual citizens back in the driver seat, as opposed to bureaucrats or corporate employees.
Rob: The summer garden here at the office was supposed to be small this year but it didn’t turn out that way. Robyn and I started by sprouting tomatoes, peppers and cucumbers from seed. We use the “grow dome,” a modified Buckminster Fuller geodesic structure that is in the backyard, for the first phase of cultivation. Every year, the asparagus and strawberry patches we planted when the office moved here nine years ago seem to thrive, no matter whether there is moisture coming down from the sky or not. It helps that we have a drip irrigation system in this dry climate. Out in the studio, I’m working on two panels, one in oil and one in egg tempera, both depicting lawn bowling scenes. We are pleased to welcome Contessa Archuleta to the staff (you can read more about her below) and to wish Robyn the best of luck in her tenure as a recently appointed Fellow at the Kennedy Center for the Arts, in Washington DC, in Theatrical Directing.
Kyle: My family and I kicked the summer off with a trip to Gulf Shores, Alabama. It was my first time visiting Alabama and I really enjoyed the warm ocean water and beach. After coming back, the boys started their summer program at the Genoveva Chavez Community Center. Each day, when we pick them up from camp, they are completely exhausted but they somehow manage to keep each other up with bedtime conversations. My wife started a nurse practitioner program and has been busy working and taking classes. I have been trying to hike in the mornings before work as a good way to start the day and which also gives the dog some exercise before the hot afternoon sun arrives.
Jeff: I attended a family reunion in North Dakota at the end of June. My late grandfather, Thor Eriksen, came from Sandsoya, Norway which is a small fishing village located way up in the north of Norway. He changed his name to Sand, derived from his home town of Sandsoya, when he came through Ellis Island. He was only 17 years old and he came with 2 of his buddies. They crossed the country together to North Dakota and then each of them homesteaded land and started farming. It’s very humbling and inspiring for me to think of the challenges and hardships that they endured and persevered through. The children of my cousins that still farm in the area impressed me so much in how they have been able to advance their family farms to modern agricultural businesses. I was amazed by the big machinery and especially the computers in the tractor cabs for tracking the planting, spraying, harvesting and the yields of each field.
Anthony: My daughter Amaya recently celebrated her 2nd birthday and although we were not able to have a backyard party as we had hoped, she had fun celebrating at The Santa Fe Children’s Museum. It’s amazing to think how fast the time has gone but it’s been a blessing to watch her continue to grow. Progress continues with our backyard project, finalizing a design and ordering our landscaping material. With a target completion of early August, there should still be plenty of time left to enjoy some fun in the sun.
Patrick: In April, my girlfriend and I went to Hawaii to attend the wedding of some close friends on the Big Island. It was our first time to Hawaii and so we made sure to take a few days alone together before and after the wedding festivities to explore the beauty of the island. Being desert dwellers, it was quite a treat to spend time around so much water! Things were busy for me upon my return with several successful fundraising events for the non-profit ARTsmart, on whose Board I serve. We are very grateful for the generosity of the Santa Fe community and surrounding areas and it looks like ARTsmart is on track to increase the number of art programs available to the youth of Northern New Mexico. The weather has been so nice that I have been spending as much time as possible outdoors: fishing and rafting on the Conejos River in Colorado, paddle-boarding and kayaking on Abiquiu Lake, hiking around Santa Cruz Lake, and mountain biking all around Santa Fe, all with a little time for photography on each trip.
Dana: Every day, I scan the sky for clouds that portend rain. We need some soon to keep the bloom cycle continuous for bee forage. In this hot and dry weather, the bees need water to drink so you might consider keeping a shallow dish of water out for them at your house. Line the bottom of the dish with stones that they can land on to prevent accidental drownings. I recently spent several days enjoying the river in Jemez Springs. There’s a good-sized pool below Soda Dam which is guaranteed to be refreshing!
Contessa: The Rikoon Group welcomes Contessa Archuleta who started in early June, taking over Robyn’s duties and adding much more to her plate! As background, Contessa was born and raised in Santa Fe and returned to the City Different following receipt of her Bachelor’s degree in Communications from the University of New Mexico and an MBA from the Anderson School of Management. For the past 17 years, Contessa worked as a paralegal for the Supreme Court of New Mexico and two private law firms. In addition, she helped develop a thriving lobbying practice and established long-lasting relationships with many of her clients in the State Legislature. Contessa is married to David and they have two young children, Ayden Rose (6) and Samuel (4), along with their dog Monster (13). She enjoys spending time with her family, traveling, cooking, and spending as much time outdoors in around the mountains of Abiquiu.
Please join us for our quarterly gathering to discuss economic and market related events. It will be held at 2218 Old Arroyo Chamiso in Santa Fe on Tuesday, August 22 at 3:30 PM. We generally go until 5:00 PM. The open mike conference call, available to out-of-town clients and friends, will occur the next day: Wednesday, August 23 from 3:30 to 4:30 PM. The call-in number is 719.234.7872, after which you will be prompted to enter the code: 470070#.