Resumption of Taliban negotiations: President Trump made a surprise trip to Bagram Air Force Base in Afghanistan this week, during which he announced the resumption of armistice talks with the Taliban, who is currently fighting both the Afghan government and NATO armed forces in an armed insurrection. An armistice would allow for the United States to disengage from the conflict while ensuring the stability of the war-torn country, as the Afghan conflict is now the longest military operation in US history. Talks were frozen several months ago when Taliban officials would not agree to President Trump’s demand that any signing ceremony happen at Camp David in the United States, and a subsequent suicide bombing in Afghanistan killed a US soldier. Engagement with the Taliban has been a hallmark achievement for the Trump administration, as previous administrations sought to avoid negotiations in order to maintain the legitimacy of the current Afghan government. The Taliban does not recognize this government and claims instead that it is a puppet organization of the United States. A successful armistice would allow President Trump to keep one of his most important campaign promises, and would continue with the current trend of disengaging the United States from many areas it had previously considered highly important to national security.
​

Dear Reader,

​The Market.

• Diversification: be careful about position sizing, consider where you have an edge in markets, and be careful of overexposure to risk from overweighed positions.
• BREXIT has caused Britain's economy to slowdown with a 0.2% drop in GDP.
• 75% of relationships started from a dating app.
• Growth in US oil production is heading for a major slowdown, from nearly 2 million barrels per day annual growth in 2018 to 440,000 barrels per day projected for 2020. Oil stocks have taken a huge beating (See graph below).
  • The energy sector is the largest and worst-performing sector within the US.
• Around $13 trillion of global fixed income assets are trading at a negative yield, a $5 trillion increase since the beginning of 2019.
• An overshoot on inflation by the Fed could pose problems for bonds and interest rates, and the valuation of stocks can be impacted. To hedge against this risk, consider investing in real estate, commodities, infrastructure, and TIPS.
• Material wellbeing is high, and Americans are doing well on average compared to other OECD countries. The US is experiencing high levels of consumer confidence which continues to drive the economy’s expansion. (See graph below)
  • Risks in the US economy include elevated leverage ratios in the corporate sector, rising trade tensions, increases in government spending and the rising debt levels.
• Globalization and automation have displaced workers, especially in the industrial sector.
• The death from drugs has become a concern in the last 5 years due to its increased growth and its effect on productivity and lost wages. (See graph below)
• Goldman Sachs’ top trade ideas: stay long 10-year US breakevens, go long the MCSI emerging markets index of stocks with a hedge, long cyclical versus defensive developing nation equities, short 10-year UK gilts, short the euro versus the pound, and long Italian over Portuguese sovereign bonds.
• Investors are selling/shorting Canada due to their very expensive housing market and how much debt consumers have.
• Wages and projected openings by occupation.

Financial Fallacies. Like in literature, we have fallacies in finance as-well. A fallacy is a belief/observed occurrence which seems logical, but in reality, it is unfounded and unproven by statistics. Common fallacies present in finance/investing are the sunk cost fallacy, gamblers fallacy, loss aversion bias, confirmation bias, and the self-fulfilling prophecy. Although these all play a large part in day-to-day investment decisions, most people aren’t aware they exist. The sunk cost fallacy is continuing to include previously spent, irrevocable costs into your current investment decisions. An example of this would be investing in an equity, solely because you spent time researching it. Personally, I believe the fallacy which plays the largest part in the overall market would be the self-fulfilling prophecy. This fallacy states that because one believes something will happen, that will play a part in it actually happening. An example of this could be because a large portion of investors believe we will see a massive sell-off in this last q4 of 2019, as we saw in 2018, it will occur in large part to these investors selling in preparation. 

A World in Protest. Over the past year, we have covered the rise of authoritarian leaders and “strongmen” across the world, who rose to power in the wake of people's frustration with their standard of living. It appears this trend may be coming to an end. In the U.S over the last two waves of state elections, the citizens of the U.S have stood up to the current administration and elected a significant number of Democratic candidates. Over the past few weeks, mass protests have broken out in Bolivia, Chile, Spain, Ecuador, Lebanon, Hong Kong, Iraq, and Iran. While these protests are separated by thousands of miles and have different causes, the same themes still arise. Except for Hong Kong, all of these protests can be tied to income inequality. Income inequality is a disparity of income distribution which the majority of income going to a small percent of the population. Economists have found that countries with high-income inequality have high rates of health and social problems. The graph below will give you an idea of where some major countries measure income inequality. In Bolivia after a brief period of recovery where their president cut extreme poverty in half in just a few years, the people now face increasing rates of extreme poverty. Chile has one of the highest income inequality rates in the world. In Ecuador and Iran, government actions lead to an increase in the price of fuel that acted as a catalyst pushing thousands of people to protest the increase in fuel prices combined with a low standard of living. While the government of Ecuador has met the demands of the protesters, the government in Iran had reacted to protestors by shutting down the nation’s internet and shooting at protestors. There is no doubt that the core issue in these countries is income inequality. While most of these countries are rich in natural resources much of that wealth goes to a very small percent of the people, creating a very low standard of living leading to social and health problems and frustrating the people of these countries. With any luck, these protesters will continue their momentum and lead to at least some improvements in their countries, because a more equal economy is more productive and able to grow at a steady rate.

Are you sure your investments are appropriate for you? High valuations or low valuations, overweight or underweight, bullish or bearish, growth or value, income or total returns, etc. are very important to consider when investing, but are not nearly as important as how the investments jibe with you personally. Here are some important factors to consider to help you judge the appropriateness of your investments:

• Your tolerance for volatility
• Willingness, ability, and need to take risk
• Where you are in your investing lifecycle
• Past experiences with gains and losses
• Ability to understand what you own
• Your tolerance for regret

Recommendations on How to Sustain Economic Growth. Output growth is strong, the tax reform has boosted business dynamism, inflation is moving up, unemployment is low, but regulations continue to hinder the business environment, infrastructure is under-supplied, participation remains low, and housing prices are high. What are the solutions to these problems? Incentivize corporations and consumers to spend more, raise interest rates at a gradual pace as long as inflation remains close to the Fed’s target, ease restrictions and regulations, remove exemptions from anti-trust law, reform housing finance and support the provision of affordable housing for low-income families. By solving these problems, we can help the economic expansion continue.

Impeachment. While following this process, a group of elected officials seeks to accuse another public official of criminal wrongdoing. In the United States, impeachment does not actually result in the removal of said official, but rather a successful impeachment becomes a formalized accusation that is put forward from the US House of Representatives to the Senate, where the House acts as a “prosecutor” of sorts, seeking to prove to the Senate the guilt of the accused party. The Senate acts as a “jury,” and the proceedings are presided by the Chief Justice of the US Supreme court. Importantly, impeachment is not a criminal process and is largely political in nature.
 
Impeachment Hearings to Date. On September 24, 2019, House Speaker Nancy Pelosi put forward a motion to initiate an impeachment inquiry into President Donald Trump as a result of testimony from a “whistleblower” from within the Trump administration. The whistleblower was responding to a phone call between the Ukrainian President, Volodymyr Zelensky, and President Donald Trump, alleging that the US President had withheld $400 million of American military aid from the Ukrainian government in order to pressure them to investigate former US Vice President, and possible presidential rival, Joe Biden. The impeachment inquiry began with a closed-door fact-finding session in the US intelligence committee, where both Democrats and Republicans interviewed potential witnesses for the upcoming impeachment proceedings. The next phase involves public hearings by witnesses that are called by both Democrats and Republicans, where both sides are permitted to ask questions. The first witnesses included members of the bureaucratic class of Washington, including Lt. Colonel Alexander Vindman, whose careers are meant to encompass multiple administrations and are therefore seen as generally impartial to partisan bias within their areas of expertise. The next witnesses called include officials specifically appointed by Donald Trump and would, therefore, be seen as potentially more loyal to the Trump administration. One of these witnesses, Ambassador to the EU Gordon Sondland, testified that he was instructed by his superiors to withhold aid from the Ukrainians in pursuit of the investigation of Vice President Biden. Mr. Sondland, a former hotel-magnate from the Pacific Northwest, was appointed by the President, and personally donated more than $1 million to the Trump campaign in 2016.

Keep Climbing,


The Alchanati Campbell and Associates Team

Dear Reader,

​The Market:

• The White House is the new Central Bank and Federal Reserve.
• Eight of the top 10 ESG funds own fossil-fuel companies, and they don’t keep their holdings secret. The funds that focus on index tracking seem to outcompete the ones that focus on ESG issues.
• Emerging markets are becoming more bullish.
• Hong Kong protests have been going on for 23 weeks straight.
• The stock market cycle rarely lines up perfectly with the economic cycle.
• “Ultimately, I want to be judged on our long-term absolute returns, not relative returns on a short-term basis”.
  • “One of the benefits of only reporting quarterly is that I do not have to attempt to explain the daily gyrations of the equity markets,  which have only been exacerbated in recent periods by the Twitter account of a certain elected official”.
• Survival- the pursuit of more time- is the best basic instinct.
• High-quality companies: asset-light businesses that require no additional capital, and have long runways for growth and high insider ownership (software companies).
• Assets flowing in to private equity has risen 12% per year for the last decade.
• How the business environment around the world has changed since 2010.
• Household delinquencies on credit cards and auto debt have been increasing. Banks are having to set more money aside to cover bad loans.
• Consumers are becoming more “skittish”.
  • Lower-income consumers are showing weakness.
  • 44% of consumers are not meeting their expenses.
• American businesses are holding back on investments.
  • Business investment makes up 15% of the US GDP while consumer spending makes up 70% of the US GDP.
  • With the slowdown in business investment, we can see the slowdown ultimately affect consumer spending as well.

Public Equity Picks. Our team does NOT offer investment advice. We are in the business of educating and sharing knowledge; knowledge that will be more useful and valuable than the day-to-day headlines we all see in the newspapers and media. But our team is full of like-minded individuals and we all share a growing passion for finance and investing. We have many insights, but here are three of our insights regarding public investments:

• With the annual fire season in California and the constant blackouts of electricity grids due to “further risk and liability”, electricity has become like a rare commodity. Solution? Generators, and the sale and use of generators have skyrocketed. How do we know? Because Generac (Ticker: GNRC) has increased ~64% in the last 6-months and they estimate an increase in annual revenue of $100-200 million in the next 2 years.
• With assets flowing into private equity at an extraordinary rate (due to the fact institutional/family offices/accredited investors are diversifying into alternative investments with high-returns, and them having record amounts of cash on hand), asset managers’ assets under management have risen at a very fast rate. KKR & Co. Inc. (Ticker: KKR) has grown ~24% in the last 6-months, pays a dividend of 1.70%, has net operating cash flow growth of 1049% in 2018, and has a market cap of $25.6 billion.
• Waste management and the treatment of water and sewage has become very important in the fight against pollution, the rapid melting of glaciers and the rise in sea levels, the death of cloud forests, and the extinction of species. The average person generates 4.5 pounds of trash per day (equaling 1.5 tons of solid waste per year) and 90% of all food scraps end up in landfills and the sewage system. Proper infrastructure for these waste systems and adequate maintenance of these systems will be in higher demand in the future. Xylem Inc. (Ticker: XYL) has grown ~17% in the last year, pays a dividend of 1.27%, and has a current mispricing of -51% so we wouldn’t buy into it now, but it’s a great pick to add to your watchlist.

CPI and Inflation. This week, the October consumer price index or CPI was released, showing a 0.4% increase over last month which was the largest gain since March. This is significant because the Federal Reserve uses the CPI along with the PCE and PPI to track inflation. The CPI is a measure that looks at the weighted average price of a basket of consumer goods and services that is calculated by the Bureau of Labor Statistics. By looking at the cost of household goods and services such as; food, transportation, medical care, and energy needs, the CPI can track the change in price and determine the buying power of the dollar. The reason the Fed uses other indices as well is that the CPI can be easily skewed by outliers in the data, which was exactly the case in October because energy prices rose 2.7% and are responsible for the majority of the 0.4% increase. The Fed targets 2% inflation measured by the PCE index as a guideline for underlying economic strength. October’s CPI brings the year on year basis to 1.7% showing that consumer inflation will likely be on target by the end of the year supporting Fed Chairman Jerome Powell’s resolution to hold rate hikes through the end of the year. 

Shiller PE Ratio. The Shiller PE ratio is a measure of the market valuation. Also known as Cyclically Adjusted PE Ratio (CAPE), it is aptly named after Professor Robert Shiller of Yale University; it is thought to be a more effective method of measurement than the commonly-used P/E ratio. This is due to the fact that the P/E ratio can vary widely depending on macroeconomic swings. Remember, in finance, measurements are all about consistency and stability. The goal of any measurement is to eliminate the fluke fluctuations and find the true number.Shiller PE uses earnings on an annual basis of the companies within an index, like the S&P, and adjusts for inflation (always, always adjust for inflation). Then, you simply average the earnings for the past ten years and the equation becomes the simple Price/Earnings that we all know and love. Right now, the Shiller PE is 30, far above the mean of 17.
How do we utilize this information? Well, generally speaking, the lower the P/E the better, but it depends on the industry. Given that the Shiller P/E right now is much higher than the average, the assumption would be that now is not a good time to buy. That doesn't mean that if the market is soaring, you should never buy. Rather, it might be wise to be more strategic with your investment choices (companies). If the Shiller P/E was lower, now might be a good time to buy.
As great as the Shiller P/E is, like any statistic, it is not an all-encompassing statistic. You need to look at other macro and microeconomic measures, as well as look into the past periods of economic expansion to see how the Shiller P/E behaved. Using past history and behavior, along with a plethora of current measures, you can be most assured of your beliefs.
The Shiller P/E has been reliable in foreseeing the Great Depression, Black Monday, and the dot com bust when the ratio was over 40. In all those cases, the ratio showed that earnings can be going off the charts and the resulting impact on equity is not always so hot. While the ratio has its doubters, who believe that the high ratio should be mostly ignored due to the fact that by nature it only looks backward in time, it has continuously demonstrated its ability to at least sniff out the beginnings of a crash.

Current Market Valuation. The S&P 500 is currently up over 23% YTD and the DOWJ is up about 20%. In the past, the S&P 500 has sat around a median 15 price/earnings, while currently its sitting north of 23. Although the price/earnings ratio has long been used to determine if an equity is under/overvalued in comparison to its counter-parties in its industry, some use it to determine how the overall market is valued. I personally believe the latter is changing quite fast. With the rise of globalization over the last 10 years and the ever-increasing importance of international trade, I believe the P/E ratio for stating the value of the overall market is becoming obsolete. I think we are heading towards a state where our market performs in comparison to how our economy is doing relative to other world economies. Although our economy is doing just OK in comparison to past years, relative to other global economies we are doing quite good. I believe this relative approach is what has given us this 23% gain over the last year and will continue to display gains into 2020 for the US capital markets.

Political Bar Talk
 
Freedom of Speech: Often referred to in the United States as one of the basic 1st Amendment guarantees, Freedom of Speech is a broad concept. Generally, it is known to encompass the freedom of individual and press organizations to express their opinions publicly without government censorship or retaliation. The most contentious form of speech in this context is usually political speech. The regulation, or lack thereof, or political speech can often be used as a barometer for how open or closed a society is. For instance, in the United States, statements in support or criticism of any sort of political cause or organization, so long as that statement does not cause or incite violence, is fully protected by the government. However, in countries such as the Russian Federation and the Peoples' Republic of China, statements, and protests made in criticism of the ruling party are often prosecuted with lengthy prison sentences and violent state action.
 
Protests in Hong Kong: On Sunday, March 31, 2019, monumental protests began in the Chinese territory of Hong Kong to protest a proposed law that would allow the extradition of Hong Kong residents to mainland China who had been convicted of crimes that the Chinese government considered especially dangerous. While Hong Kong is technically part of China, it maintains a largely separate judicial system, allowing it to maintain transparent legal processes vital to sustaining international business. This bill would have significantly eroded the independence of Hong Kong and was seen as a breach of the “One Country, Two Systems” agreement China agreed to in 1997, which guaranteed an autonomous Hong Kong, including its citizens' democratic rights, until 2047. Protests to this bill have exploded in popularity within the territory, with over a quarter of local residents rumored to have participated in at least one protest. While organizers largely maintained peaceful demonstrations, frustration with a lack of progress on grievances, as well as aggression by police, has pushed certain elements of protestors towards extremism and violence. While the Chinese government has generally allowed local police to contain the protests, civil action of this scale has been crushed by the Chinese military in the past. The future of Hong Kong’s relative independence hangs in a precarious balance, and a Chinese state intervention would likely mean the end of the only semi-democratic enclave in China.

Keep Climbing,


The Alchanati Campbell and Associates Team

The Market:

• The unemployment is at its lowest in 50 years at 3.6%, but wage growth and inflation growth are absent. When will the US economy be at full employment?
• The median price of a new home in California is $600,000, California has four of the country’s five most expensive real estate markets (Silicon Valley, San Francisco, Orange County, and San Diego), and California as a poverty rate of 12% of US population and 25% of the US’s homeless population.
• “Broadly speaking, there is no solution to the California housing crisis without the construction of millions of new homes,” David Garcia, policy director at UC Berkeley.
• Unemployment rate for recent college graduates is 4%.
• Rates of depression, hypertension, and high cholesterol among millennials rose to new highs.
• With 25% of global government bonds now yielding less than zero, investors seeking protection and income should consider real assets in private markets (private equity is the new stock).
• We are living in a 2-2-2 world: 2% growth, around 2% inflation, and a 2% 10-year Treasury yield.
• Success in the services industry is a function of your ability to communicate ideas and develop relationships.
• 80% of stocks are owned by the top 10% income-earning households.
• According to Fannie Mae, housing starts are projected to continue to grow and will start to decrease in Q1, Q2, Q3, and Q4. Growth in new housing starts were 3.9% in 2018, 1.1% in 2019 and 0.2% in 2020 (Graph below).

California’s New Rent Control Law. Assembly Bill 1482 is designed to guard tenants against rent hikes. This law becomes in effect on January 1, will be in effect until 2030, and California will be able to regulate how much Californians’ rent can increase every year limiting it to 5% plus the local rate of inflation (inflation averages around 2.5%). The California government has a goal of creating 3.5 million new housing units to help increase the housing supply and stabilize the housing market. Rent control will be applied mostly to apartments and other multi-family buildings along with some single-family homes. Condos and single-family homes will be exempt unless owned by a corporation or real estate investment trust. Also included in the bill, landlords would need to show just cause when evicting a tenant. If you’re a landlord, a way to get around this bill is: quickly hand out no-fault eviction notices to tenants who pay low rent or make frivolous requests.

Why Our System is Broken According to Ray Dalio. Lenders are lending out tons of money because interest rates (the cost of borrowing) are very low, Central Banks continue to buy financial assets adding money to investor pockets, investors are choosing to invest the money instead of spending it and they are choosing to take losses on their investments (accepting very low or negative interest rates when lending their money), and money is being thrown at start-ups at alarming rates (even when these not profitable tech start-ups already have too much investor money). Money is “free” for those who have money and creditworthiness, but it is becoming expensive to borrow for those who do not have the required creditworthiness (consumers being charged 50-200% interest on their borrowed money). The government deficit will continue to grow which will require the government to increase their debt, interest rates will remain low even though raising rates would help the government control their debt levels, and the world has been overly leveraged for a long time. Pension and healthcare liability payments are at risk. Pension fund managers are finding it increasingly difficult to find substantial returns that can meet their pension fund obligations. The US healthcare system is unstable and becoming more expensive for consumers. The three options to be able to fund pension and healthcare obligations would be to cut their promised benefits, increase the money supply or by raising taxes.
 
Signaling Theory. Signaling Theory is the idea that the actions of high-level executives and the companies they manage give signs as to how the company is performing and expecting to perform beyond the simple earnings report. It is most prevalent in dividends. When a company increases their dividend yield (the relative percentage of the stock price paid out to investors), it displays to the marketplace that the company is ok with retaining less of their earnings (the more dividends they pay, the less they keep). If a company is ok with retaining less of their earnings, it is likely because they know, or expect based on private information, that the company is performing well. That could mean more sales in a crucial area, a potential acquisition, a new product set to debut, and so much more. As a result, investors will buy more of the stock, because based on all the signs, the company is going to perform well in the earnings season. On the flip side, if a company decreases its dividend, it tells investors that the company can no longer afford to pay that much dividend, as it will eat into their decreased profits too much. In this case, investors will sell off the stock because, in their minds, not even the executives of the company have faith in their upcoming performance. In fact, signaling theory is so important that companies will actually take on new debt in order to keep paying out the same or higher dividend even if their revenue (and bottom line cash flow) is decreasing. 

The Economy and Equity Market. The economy, which has exhibited 1.9% GDP growth over the last 4 quarters, leads investors to believe the equity market, which has displayed over 22% growth since January 1st, will start a decline to follow suit. Although the economy and equity market usually follow each other, with the former acting as a quasi-leading indicator for the market, this is not always true. A professor from Chapman, Mark Skousen, put this best in one of his classes, and paraphrased from his book, “A Viennese Waltz Down Wall Street”, the market and economy can grow apart, like in the Viennese waltz, but will always come together at the end. In the current global atmosphere, we see a slowing global economy, with political fears present in China and the UK, leading capital to flow from these troubled countries to a relatively stable safe domain, the US. Although the US economy is showing just OK economic data, we are relatively doing better than most other countries. This relative point is what is leading the US markets to display what seems like irrational exuberance, in what looks like a faltering economy. As fears of a global slowdown grow, and sovereign debt continues to lead further into negative interest rates, we will continue this Viennese waltz, with the equity market making new heights, and the economy falling behind.

Why it's Better to Put Bonds in Retirement Accounts. When it comes to investing, it’s not how much you make that matters- it’s how much you keep after taxes. As a general rule, investments that tend to lose less of their return to taxes are good candidates for taxable accounts. The best investments to hold in IRAs and 401ks are taxable bonds and taxable bond funds. Outside of a retirement account, they’d be taxed much higher than your stock funds. There are many different types of bonds: US Treasuries, corporate bonds, high-yield bonds, and municipal bonds. Investors may be able to realize significant tax benefits by including bonds in their portfolios. There are also many different types of retirement accounts, but the most well known are the IRAs and 401ks. The Roth IRA is funded with after-tax dollars and grows tax-exempt. Bonds are generally taxed at a higher rate than stocks. If bonds are not held in an IRA, income from them is taxed as ordinary income (the federal tax rate for ordinary income can be as high as 37%). IRAs are especially attractive for holding Treasury Inflation-Protected Securities. Since the income produced by bond funds is taxable, it is better to put them in a tax-exempt account. But it is important to avoid holding municipal bonds in an IRA.
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$2 Trillion. In the early 1930s, a relatively small oil company known as Standard Oil of California was seeking new sources of oil from abroad when it stuck oil on the Arabian mainland and received drilling rights from the government. Several years later, Texaco bought a 50% state in the arrangement and helped find vast amounts of oil. In 1944 the company name was changed to the Arabian American Oil Company or Aramco. Aramco would go on to become the world’s largest oil supplier and support U.S oil needs as U.S policies and wars limited oil sources. In the 1970s the Saudi Arabian government began to increase its interests in Aramco and eventually took over full control of Aramco through the Saudi Arabian Oil Company. Today, Aramco is believed to be the world’s most valuable company, worth somewhere between $1.2 and $2 trillion dollars and most likely holds the title of most profitable company with a reported $111.1 billion in net income for 2018. Aramco also has the second-largest proven oil reserves and second-largest daily oil production. With stats like this, their December IPO should be a breeze as investors fight over shares, but that does not seem to be the case. Aramco’s IPO comes at a time when many investors are beginning to turn away from oil. American investors remain skeptical towards the IPO largely due to its valuation. The Saudi government originally estimated Aramco to be worth $2 trillion dollars but then dropped their valuation to $1.7, but many analysts think that geopolitical factors need to be accounted for an estimate a valuation closer to $1.2 trillion. Aramco remains at the center of several multinational disputes and is often the target of attacks aimed towards the Saudi government or western influence. The recent September attack, for example, cut Aramco’s oil production in half, such an attack on a large public company would be devastating for shareholders. Investors have also made the point that the Saudi government may only sell  2% of Aramco which would give virtually no say to minority shareholders. As if these issues weren’t enough there are reports that Aramco’s finances are heavily entwined with the government’s, stating that its profits have been used to boost government budgets and even pay for government officials' luxurious accommodations, which is something many shareholders will not stand for. These issues have to lead the Saudi government to pressure rich Arabian families to commit to investing millions in order to ensure a successful IPO. The Saudi government has also turned to China, the world’s largest oil importer to commit to the IPO. China is expected to commit around $10 billion in an effort to hedge against rising oil prices and support its Belt and Road program. There are likely going to be many more updates on this as the company prepares for their IPO and the December OPEC meeting so we will be sure to keep our readers updated. 

Keep Climbing,


The Alchanati Campbell and Associates Team