Trend Management, Inc. 2015 First Quarter Report
In the first quarter, the stock market traded with more volatility than we are used to seeing. It finished slightly up, which sounds boring, but it wasn’t. We find it interesting the market went nowhere--in a hurry.
The average, intra-day change in stock prices was 1.1%. A definition of churning would be sixty- one days of the market rising or falling 1.1%, with no meaningful change in the price of the index. The stock market is rushing to go somewhere, but it can’t figure out where.
As you know, in the first quarter, we raised some cash for the first time since the crash. Reasons were outlined in the last quarter’s report, and we’ll elaborate more now.
The chart illustrates a broad basket of commodities and the S&P 500. From late 2008, until the first quarter of 2013, stocks and commodities operated in tandem. This is fairly normal and makes sense, when you think about it. If business is good, stocks will rise, as will the demand for commodities.
From time to time, the balance goes out of whack. Cases in point: the economy entered a recession in late 2007, but commodities rose for a year, before entering a bear market. In contrast, stocks today are at record highs, yet commodity prices have collapsed. Something is wrong with this scenario. The price of commodities should indicate business is bad, but stocks are saying the opposite. Which is correct?
We think the commodities’ market is right about the state of business worldwide. In our opinion, the U.S. is the exception to a global recession, and commodities have declined as a result. GDP growth in this country is sub-par, versus history, but China, Latin America, Russia, India, and Europe experiencing recession leaves the U.S. to carry the ball. Because this economic imbalance can’t work forever, how should we play this?
At the bottom of the 2008 crash in stocks, the S&P was trading at 666. At the same time, the CRB index (the basket of commodities) traded at 203. Fast-forward to today: the S&P is at 2070, for a gain of 210%. The CRB index is at 217, for a gain of 7%. However, before the crash occurred, the CRB index was at 470. From its high, it remains down over 50%, while the S&P 500 is up over 35% from its 2007 highs.
As we have previously stated, when our Federal Reserve and world banks decide to print money, the bond and stock markets are helped first. We think money-printing has distorted the relationship between commodities and stocks. We have benefited by being invested in stocks, and very thankful for it. However, the system can’t detach forever. Either stocks will decline, or commodities will rise. Because the world’s central banks continue to print money, we think it makes more sense to invest in commodities, which are within 7% of their crash lows.
After our last report, we were asked if we thought stocks were way over-valued. Our answer then, and now, is no. Stocks are a little over-valued, but commodities are way under-valued. Our current best- guess at what will occur next is a reversion to the mean. Commodities will rise to a more normal level, and for a while, stocks will trade in a range. We think the margin of safety is to own stuff, versus paper, with the cash we have on hand. Sometime this quarter, you will probably receive confirmation by mail (or email) that we have bought a commodity-related Exchange Traded Fund (EFT). We have studied these funds for almost a year. The initial investment made will be in the actual commodities, using the ETF as the vehicle. We want to first own the commodities, rather than stocks in companies producing those commodities. (Time may reverse that thinking, but not this year.)
The next step is to invest in some combination of currencies and bonds denominated in foreign currencies. Finally, we may actually own the stocks of companies not headquartered in the USA.
If you’re keeping score, this equals four investment strategies based on one simple idea: commodities are too cheap. Historical relationships between commodities and currencies also tell us to own the commodities first. To date, we have dedicated over a thousand hours to this plan of action. Timing the exact bottom is impossible, but commodities are very close to their crash lows.
We don’t anticipate your portfolio owning more than 5% in actual commodities. We are saving our cash to next own the currencies and bonds. The hope is the dollar continues at record highs, while everyone else’s currency tanks. (So far this year, that’s been happening.) A sudden, higher move in the dollar this quarter may speed up our foreign-based investment strategy.
By now, I’m sure you’re thinking, “What about the stocks we have now? What will we do with them?” The answer is very little. We like what we own. We think they are fairly priced, and most importantly, think their earnings will grow. Get a stock-story right, where the earnings grow, and the market is less and less a factor in how the stock-price does over time. Get it wrong on earnings, and the market is a bigger influence on how much money you make than we like. For now, we think the companies we own will earn enough over time to compensate for a potentially sloppy market in the near future.
Below are a couple of charts we find interesting, that affect your investments. The first reflects the amount of debt owed on residential housing. We watch this as an indicator of confidence returning to Main Street, America:
The public is not levering up and buying homes like it did before 2008. Seven years post-crash, the public’s residential debt is one-trillion less than before the crash. This lack of borrowing reflects too- zealous bank regulators, and a skittish public. So far, the latter’s reluctance to take on more debt means the economy is not yet running at full-throttle.
Emerging market currencies are near their crash lows. The chart illustrates the carnage occurring in the world’s financial system. (For really bad currencies, check out Latin America. It’s not pretty.) To us, this indicates six billion people who own those currencies are experiencing decreases in their purchasing power. At some point this will end, but it hasn’t yet.
Financial history buffs should study 1937-38. The Great Depression started in 1929, and by 1937, the Federal Reserve was worried about inflation. The stock markets didn’t handle the fear of a Fed tightening very well, and declined. (Today, many financial gurus say today’s market reminds them of that period. We hope not.) What ultimately fixed world economies in 1938, was a massive World War. The fiscal spending wars demand put people back to work, but at an awful cost. Perhaps we can avoid that fate, this time.
We also want to point out, the decline in Asia in 1997-1998, affected commodities in a way comparable to today. We view the disaster in Europe starting in 2012 as similar to the 1997 Asian crisis. The dollar went up, like today. The U.S. stock market was strong, like today. And commodities tanked, (like today) because Asia was in a horrible recession, while the U.S. was not (like today).
We think this period is the best blueprint for current indicators. If that’s the case, commodities will bottom soon, the stock market will become very selective in what it buys, and highly leveraged investments should be avoided.
On a very happy note, Kelly is expecting child number two any day now. She will be out of the office for most of this quarter, which means you have to rely on Brandon and Mark for paperwork and operations. These aren’t their strong suits, so please have patience with them.
We look forward to reporting to you in the future on your investments. Thank you for your continued support.
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR