Marketline Monthly – December 2019
The rally continued through December, allowing stocks to end the year with very strong returns. The Dow rose 1.7%, the lowest return of the three indices we follow, held back by Boeing; the S&P was up 2.9% and the Nasdaq surged 3.5%. Over the course of the year stocks were up roughly 30%, give or take a couple percentage points depending on the index – a sturdy reward for putting up with a long flat period from early 2018 through mid-2019. While earnings have been decent, interest rates are playing a significant role in the valuation of stocks these days. Low rates here and abroad help support stock prices. Low rates and moderate growth also spur share buybacks, which have been a significant source of demand for stocks. Companies are generating significant cash flow, and with only moderate demand to meet with ever more productive plants and processes, it is difficult to justify expansion.
Looking forward, 2020 holds one major source of uncertainty in the US – the election. Volatility is likely around that event. Overseas, the analogous event is Brexit, which seems a ‘certain uncertainty’ now. Perhaps the decisive vote in Britain was one reason that the FTSE rose 2.7% this month, the best month since September. Now at least they know what they’re in for, which can clear the air and allow business to get back to business. Furthermore, in both countries, bills are being presented and passed that keep boosting federal (and state, see below) spending. The Fed here seems to have given up flailing around doing too much, and is standing pat – one of its best ‘non moves’ yet. These factors provide a beneficial backdrop for stocks.
Canada is flashing some warning signs lately. Housing prices are historically high, which in and of itself wouldn’t be an issue, but the country’s consumers have racked up a lot of debt at all levels. These high debts are starting to seep into bank results. We have largely jettisoned our remaining shares of Bank of Montreal. It doesn’t help that Canada is so eager to withhold dividends from US investors in Canadian securities; every couple of years we have to submit to you a form for your signature that is then sent up north to impress upon the authorities that they shouldn’t take 25% of your dividends into their coffers.
Last month the bond curve from ten years out corrected a few tenths of a percentage point, bringing prices down and yields up. The short end was basically flat. This contributed to a steeper yield curve. Note how we hear nearly nothing about a recession any longer, whereas just months ago, that was all anyone could talk about.
More granularly, we’ve decided to jettison some municipal bonds that we have placed inside IRAs. Buying municipal bonds in IRAs is a strategy that we began pursuing when Treasury yields plunged a few years ago. Municipals offer high credit quality and, back then, paid more than Treasuries. IRA owners cannot benefit from the tax exemption on municipal income, but it didn’t matter since we were earning higher yields anyway.
But municipals have outperformed other bond segments for several years during the last ten, bringing yields down. Credit quality –decent five years ago – has improved even more. States are flush with cash, and many are able to issue bonds to support new infrastructure projects without impairing credit ratings. Still, bond issuance has been restrained when considered against the landscape of a decent economy. Meanwhile, demand has surged as taxpayers facing limited SALT deductions pay more in taxes. For them, a 2.8% tax free yield isn’t bad at all.
Likewise, we are also de-risking by selling some low grade bonds that have shown losses and might take years to recover. This is a slow process, because liquidity has been severely hampered in the bond market over the last several years. Some days, no one likes a particular bond, or they just don’t like it enough. Trying again in two weeks can bring a better result. Fortunately, we are a small shop, so we don’t face big penalties for dumping large blocks of bonds on the market.
As far as reinvesting, we’re considering a wide variety of possibilities – stay tuned!
Marketline Monthly is produced by Cascade Investment Advisors, Inc. We specialize in value investing for individuals. We apply our approach across markets, looking for low-priced securities that offer above-average potential. We use imagination and hard work to bring performance and personal service to our clients. To learn more, contact Michelle Rand at 1.503.417.1950 or 1.888.443.9015; email to Michelle.Rand@cascadeinvestors.com. Our website is www.cascadeinvestors.com. A full list of stocks we invest in is available on request; mention of specific securities is not investment advice; such investments may or may not be profitable.