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Tariffs, Rising Interest Rates, and the Drain on FAANG - But 2021

By Richard M. Baker

November 28, 2018 

Like three creepy criminals committing assorted crimes, the above trio has been recently robbing the stock market in somewhat different ways.

Investors in general are concerned, and you may be too, I am writing this analysis to help explain what has happened since the start of that oft-hated month of October, where we are now, but yet also to encourage and advise you of the magnificent opportunities that have emerged as a result - more on that later.

Nobody should be surprised at any monthly statement from October or November. Here are the numbers:

In October, the Standard and Poor Index of 500 stocks fell 6.9 percent, the Dow dipped 5.1 percent, the worst since January, 2016, and the NASDAQ 100 index was a negative 9.2 percent, the largest hammering since November, 2008, the eye of the storm of the financial crisis.

And last week alone, the Dow fell 4.4 percent, the S&P 3.8, and the Nasdaq 4.3.

Two reminders – any statement is nothing more than a snapshot of one moment, the last day of a given month at 4 p.m. It is not a bank account. It tells you that if you needed all the money, all at once right then and there, and you sold everything in the account at the prices listed, that’s what the check would be. That is hardly ever the case.

Secondly, there is a tendency for most people to think that whatever direction something is going is going that way forever, whether it’s a traffic jam that’s seemingly never going to break, or in the world of sports of which I am familiar.

As many of you know, I had a hobby of covering sports for The Springfield Republican for over 30 years. I’m a Los Angeles Dodger baseball fan. In 2017, they were running away at a record-setting pace when while snoozing in September, they lost 16 of 17 games. I was furious, they were going to blow the division, and not even make the wild card. It was surely headed for the biggest choke job in baseball history. But they ended up making it to the 7th game of the World Series, just like this year. I overreacted. We all do it, human nature. And c’mon diehard Red Sox fans, how many of you always thought David Price’s next start was going to be horrible?

But with 34 years of investment-advising experience, I’m able to take a much calmer and fact-based approach to such stock market downturns. I’ve seen everything, starting with the 1987 crash.

Like an enabler, the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google -now called Alphabet) have given passive index investors the comfortable feeling they were going to keep going up forever along with their index fund. Since market capitalization-wise, the FAANG stocks are such a large part of the index, they carried the heavy burden of the load - the higher the market capitalization a company has, the higher percentage of the index. So, when owning the S&P 500 index, the FAANG stocks hid what in most cases was severe overvaluation. Barron’s reviews each of those stocks in this week’s edition.

But after the concerning news of Apple’s iPhone issues, the decline snowballed, and the large institutions that steer the market then treated those supposedly passive low-fee index funds like one high-flying stock, and started taping their fingers to the sell buttons.

These were the same people that felt they had to own all those FAANG names. Why? To keep up with the index - now they feel they have to get rid of them or go down with the index. Everyone is trying to get out the same door they all came in. None of their wild Bitcoin-style trading has anything to do with you meeting your long-term or income goals.

And for clients of Income Works where dividends and inherent underlying company values are a foundation of portfolios, there aren’t too many who can afford to buy Amazon, now $1,502.06 per share with no dividend. So, except in mutual funds in which we partner where it may be one of the holdings, we don’t own Amazon.

Yet, there is a long shopping list of many companies though which are paying safe dividends over 3.7 percent annualized, and dividend checks don’t bounce.

The market value drop since November 1 in the FAANG stocks has been $402 billion, according to this week’s issue of Barron’s. And from their highs of the year, Facebook is down 39.4 percent, Amazon, 26.4; Apple 25.8; Netflix 38.2; and Alphabet 19.9.

So, while the FAANG stocks cloaked the averages, many other fine businesses have seen their stocks pushed down by the fear of the continuation of the existing and possibly even higher future tariffs. The result has been higher raw material costs, a strong dollar, and the fear of a global economic slowdown, all with the added pressure of the Federal Reserve’s intention of higher interest rates. Markets, like crazed Dodger fans, don’t like the fear of the unknown.

When our interest rates go up, especially the 10-year treasury (now 3.04 percent), foreigners purchase the bonds to obtain a higher-yield, and to gain the addition boost of the currency exchange. Except when inflation really needs to be cooled, higher interest rates are an enemy to investors, home buyers, variable-rate home mortgage owners, car buyers, small business borrowers etc.  On the investment side, bonds typically go down in value when rates go up as has been the case this year. The strong dollar also hurts the profits of our multi-national companies that do business overseas as their products become more expensive. It also hurts international stocks and bonds, which perform well with a weak dollar. There has been no hiding place.

The sectors hit have been numerous – automobile related companies, industrials, materials, and semi-conductors just to name a few.

So that’s where we are, so what is the good news?

In two years, by January 2021, we aren’t going to be worried about any of the three major issues I reviewed today.

The trade war will have ended, cooled off, or at worst at least been accepted.

Interest rates will be more likely to begin to decline then, especially if the global economy does slow somewhat as feared. If rates do go higher, it will be because the economy is strong, company profits are high, the consumer is spending, and the jobless rate remains low.

And some sectors benefit from higher interest rates, such as banks. They take their time pushing up your checking account interest rate, but immediately raise their long-term loan rates, such as for mortgages, cars, home equity loans, and business loans.

And despite the slowdown fears, in 2021 there will still be need for cars, tires, infrastructure, technology, and even boxes as well as numerous other products deemed severely damaged by current conditions.

The dollar, many analysts say, may soon be peaking, good news for multi-national companies.    

And we are not even close to a recession. A recession usually is forecast by short-term interest rates becoming higher than long-term rates, and even then, the recession starts about a year after that.  We are not there, and the recent market decline may persuade the Fed to cut down on its number of rate hikes next year.

And even now, the market is reasonably priced with a Price to Earnings ratio (called PE ratio) of about 16 after starting the year at 18.2. A lower price earnings ratio means you’re not paying as much for future earnings. The market is not expensive.

So, this is simply a correction, not the end of the financial world as we know it.

At Income Works we will be positioning ourselves to take advantage of strategies within our expertise to capitalize on these opportunities that are now in front of us.

And while all of us like to see market values always going up, it is also a good feeling to deploy current or future dollars at lower prices, although human nature tends to do the opposite.

There’s the old hockey story of when the great Wayne Gretzky was asked how he was able to be successful. He said it was because he went to where the puck is going to be, not where it is. That’s the approach now. How will those companies that have fallen so far in the last seven weeks be positioned at the start of 2021?

In closing, I would like to reiterate the Income Works philosophy:

“We start this world with nothing, and we leave this world with nothing. If there happens to be enough money left over for family and/or charity, fine.”

(However, the family part doesn’t always work well. In one case, we’ve had siblings so mad about how the assets were to be split so they’ve never settled the estate.)

“So, the key is to set a plan to receive the income you need from your investments so that money is not a distraction. That way you can take the gifts God has given you, and use it to the best of your ability, and hopefully help people.”

I love to help people reach that goal.

In the meantime, we will be in the process of connecting with all of you to set up times for updates on your short and longer-term goals, any changes in your situation, and further educate you on, and answer any questions on investments.

All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.