What's up 2019? And Hello 2020

Dear Reader,

The Market.

• An analysis of 14 years of market returns across about 1,889 companies finds that when they appointed female directors, they experienced two years of stock declines. The market value of a given company fell 2.3% by adding one additional woman.
• European companies with low debt ratios and high-interest coverage ratios are outperforming its weaker counterpart by close to 15%- the Europeans are looking for safety.
• Be careful with investing in Treasuries. Even though interest rate cuts raise bond prices, the Feds have no plans of cutting again soon and we can expect the 10-year note to continue to rise.
• With cash levels at the lowest level since 1997 and equity allocations near the highest levels since 1999 and 2007, it suggests investors are now functionally 'all in.’
• Historically, it’s taken about two years for a change in U.S. interest rates to be fully reflected in U.S. GDP.
• South Korea has the lowest fertility rate in the world at 0.88. South Korea spends billions of dollars every year in incentives like subsidized childcare, free nurseries, and cash stipends.
• Retailers are preparing for one of the biggest weekends of the year, where an estimated 165 million Americans are going shopping online and in-store.
• Housing prices are positively correlated with local labor markets: prices rise or fall together with local employment.
• The outcomes of the 2020 US elections presents major uncertainty to the market.
• Las Vegas has seen a sharper decline in homeownership rates than the US overall due to the markets’ high price variability.
• The US is one of two countries in the world that taxes its citizens regardless of wherever they live. But Ex-Pats can deduct taxes paid to host countries or take an exemption. Citizens with foreign assets must disclose them to the IRS and to the Foreign Crimes Enforcement Network.
• With 85% of investing coming from inactive investors and 15% coming from active investors, it’s very difficult to figure out market sentiment because there are fewer people playing.
• New tariffs are supposedly being placed on China on December 15, but I bet you a share of Amazon stock that either the tariffs will be delayed, or China and the US will create some type of deal (it’s a zero-sum game and both sides benefit from a trade deal).
• Below is a graph that shows the fraction of US wealth held by each generation.
  
• “Historically, when all of the indicators are suggesting the market has likely encompassed the majority of its price advance, a correction to reverse those conditions is often not far away. Regardless of the timing of that correction, it is unlikely there is much upside remaining in the current advance and taking on additional equity exposure at these levels will likely yield a poor result."

Technical Analysis. The best technical analysis consists of looking at the trends coming from monthly indicator charts. Is technical analysis a great way to base your investment decisions on? The graph below shows a similarity between Caterpillar and the Nikkei Index for a span of 5 years. Does it mean anything? You should base your investments on multiple analyses: technical, fundamental, comparative, and macro.
The Bulls are Charging. Investor sentiment is at an extreme high, with all market indexes hitting new highs. Investors are heavily invested in equity while holding the lowest cash reserves. With low levels of cash reserves and extreme investor confidence, how much longer can the markets sustain new highs? Key indicators to look at are manufacturing, consumer confidence, consumer spending, GDP growth, household-debt-to-GDP ratio, new home sales and the number of new homes being built. If we see a slowdown in any of these, it’s a bearish sign. Besides these economic indicators, the 2020 elections, the Feds hiking/cutting/holding interest rates, the slowing of the Chinese and US economy, and the US-China trade war are the events that will be dictating the direction of markets. Based on banking sentiments, cyclical stocks, emerging markets, and economically-sensitive sectors like financials, industrials, and materials will be good plays if the market continues to go up. If not, look for hedges in assets like TIPS, REITS, Treasury bills, VIX, and defensive stocks like consumer staples and utilities.

The Superiority of Investment Companies and Asset Classes. The comparison of the Vanguard Growth Index Fund ETF (VUG) and the Fidelity Growth Company mutual fund (FDGRX) is done to show how the difference in asset type, asset allocation, investment company reputation, and expense ratio influence fund performance. VUG is a Vanguard large-cap growth ETF with $95 billion net assets, the inception date of 2004, Beta of 1.04, an expense ratio of 0.04%, and a 1-year return of ~21%. This ETF is made up of large market cap US growth companies, with its top holdings being Microsoft (8.52%), Apple (7.87%), Amazon (5.81%), Facebook (3.59%), and Alphabet (2.93%). FDGRX is a Fidelity large-cap growth mutual fund with $41 billion net assets, the inception date of 1983, Beta of 1.20, an expense ratio of 0.85%, and a 1-year return of ~16%. This mutual fund is made up of large market cap US growth companies, with its top holdings being Amazon (6.44%), Apple (5.41%), NVIDIA (4.95%), Microsoft (4.37%), and Alphabet (3.93%). Now from a basic analysis, we can make the hypothesis of: because the Vanguard fund is more well known, has a lower expense ratio, has a lower Beta (lower riskiness), is an ETF (not a mutual fund), and has allocated their fund by buying more heavily into Microsoft, Apple, and Amazon (higher returning equities), they outperformed Fidelity’s mutual fund.
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China's Slowdown. China just posted its third straight month of declines in its industrial profits, being down 9.9% in October, over last October. This marks the steepest declines in industrial profits since 2011, most of which can be accounted for by severe overcapacity, with a lack of demand in the international economy, brought on by a harsh trade war. China, being the second-largest economy, has been in a trade war with the US, the largest economy, over the past year. Industrial profits have been falling severely for the last 6 months, with their equity market following suit, with fears of a looming global slowdown. With declines in industrial profits, China has been able to slightly offset this decline through growths in the mining sector, as-well-as utilities. This offset has not been enough to increase GDP growth past their historical growth, sitting currently at 6% over the last year. This overcapacity has led to decreases in raw materials, and final product prices, shown by a decrease in PPI (Producer Price Index). 
 
Political Talks.

Valuation at its Finest. You may have heard about how certain companies are overvalued, undervalued, “a great buy right now”, “stay away at this price level”, etc. Analysts from Goldman Sachs, J.P. Morgan, Morgan Stanley, Credit Suisse and the like make a living telling investors what to do. This is all great, except by the time you hear about the investment opportunity from them, it’s already too late. In a way, it’s almost a self-fulfilling prophecy. An analyst puts out an article saying how this stock is a great buy, expected to increase by 20% in the next year, etc. Everyday retail investors see this and then race to buy the stock before they miss out. All of these people buying the stock causes the price to increase (pumping or dumping), which then fulfills the prediction originally set out in the article. As you can see, the stock price is often shot up without a true dive into financials. This leaves us a higher price, with less evidence to back it up and renders it more prone to a drop. (Example: when LVMH Moet Hennessy made an offer to acquire Tiffany & Co., TIF jumped ~50%. Example #2: recently, Morgan Stanley downgraded Dollar Tree, Inc. When a big bank downgrades a company, it can cause a selloff of that equity.)The key to investing is to know when a drop is coming, and when a stock is about to soar. How do you do this? You have to use at least one valuation method. The most popular being Discounted Cash Flow; this involves projecting the Free Cash Flow (the money after all cash expenses to be distributed) into the future. Once you reach a certain point, it makes sense to stop projecting the annual cash flows and come to a terminal value (the value of a firm in that year for all the years going forward). After all of this is done, you must discount all cash flows and the terminal value back to the present day. This is the #1 rule of finance. Money today is worth more than money tomorrow. You must always account for it. The basic formula for Free Cash Flow is “Operating Cash Flow – Capital Expenditures – the annual net change in working capital. Discounting all the cashback to the present day will give you Enterprise Value. Enterprise value is the true amount you would have to pay to acquire the firm. For instance, if I were to buy a company outright, I would not only be acquiring all the operations, but I would be acquiring all the debt that the company owed which I would now have to pay off. Similarly, I would also be acquiring all the cash the company has. This leaves us with the formula: Enterprise Value + Debt – Cash = Market Capitalization. Take the market capitalization and divide by shares outstanding to get a true value for a single share of stock.
You may be wondering, “If it’s all based on the numbers, why do people come to different values?” The answer is that the numbers require reasonable assumptions to be made. Things like sales growth, research costs, etc. The skill of an equity analyst lays in their ability to make assumptions. That is what separates a fine analyst from a fantastic analyst. 


Keep Climbing,


The Alchanati Campbell and Associates Team