Rockets’ red glare, redux

When you live near Washington, as I do, the military is never far from your mind. As I mentioned in this post, Fort Washington, which failed to defend the area in 1812, was not far from my home when I was growing up. You can’t drive down any street in Northern Virginia without running into a historical marker about the Civil War. The Pentagon, Arlington National Cemetery and the World War II Memorial are an easy drive from here.

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One of Fort Washington’s guns. 

Back in July 2015, I noted that defense stocks seemed like a decent investment idea, given the enormous amounts of money the nation spends on the military — currently $619 billion. I’m happy to report that the two aerospace & defense ETFs mentioned in the post,  iShares US Aerospace & Defense (ITA) and SPDR Aerospace & Defense (XAR), have risen at an annualized 13.94% and 11.14%, respectively, since I published the post. The Standard & Poor’s 500 stock index has risen at a 6.92% pace.

Before I do a victory lap in a shiny new F-35, however, I should note that timing is everything. Before the election, SPDR Aerospace & Defense (XAR) lagged the S&P 500, rising at a 2.11% pace, vs. 3.32% for the S&P.  iShares US Aerospace & Defense (ITA) faredm s0mewhat better, gaining 6.05%.

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Hey kids! Let’s go to the Civil War reenactment! It will be fun!

The stocks have popped because of the incoming administration’s pledge to increase military spending. Betting on what any administration can and will accomplish is, of course, a risky bet. Congress isn’t in a particularly spend-y mood, even given the election results. And judging from Mr. Trump’s objections to the cost of a new Air Force One (actually two, and it’s only Air Force One when the president is in it), some penny-pinching may be in the future for defense as well as the rest of government.

At least a fairly major increase in military spending has already been built into defense stocks. The iShares offering now sells for 21.56 times its past 12 months’ earnings, while the SPDR fund sells for 22.37. (The latter fund tends to have more small-cap stocks). The S&P 500 is at 19.86 times earnings, which is well above its average of about 16.

Could they go higher? Sure. Americans don’t object to defense spending the way they do to social spending. And everyone seems to remember that the massive spending in World War II helped push the nation out of the Great Depression. (This was a massive government spending program that we still haven’t paid off, but never mind.)

 

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The cemetery at Gettysburg. 

Bear in mind, however, that you need two conditions to make a profitable war. First, of course, you have to win it. (Ask Germany and Japan). Second, it’s best not to fight it on your own ground. (Ask France.)  The best use for a cannon is not to use it at all.

 

 

The bulls are back in commodities

By and large, the only people who rejoice when the price of raw materials rise are the people who produce raw materials. And according to Bloomberg, those folks are doing a happy dance these days:

“The broad-based recovery in commodity markets this year has tipped several markets into bull market territory,” Mark Keenan, head of commodities research for Asia at Societe Generale SA in Singapore, said by e-mail. “Overall, sentiment is good but remains cautious, the market is evolving significantly, specifically across the oil markets.”

By general agreement, a bull market is a 20% rise from a low, and commodities have been engulfed in a bear market for nearly four years. The most recent low for the Bloomberg Commodity Index was January 20. It’s still down 50% from its high. So this is a nascent bull market, if it indeed is one.

Typically, rising raw materials prices means — duh — higher prices for stocks of miners. The most egregious is the jump in the price of gold mining stocks: The average equity gold fund is up 68% this year, while natural resources funds are up 10.51%. Broad-based commodities funds are up 7.62%.

It’s also an inflation warning: The price increases for things like steel, oil and zinc pass through the manufacturing chain and ultimately to the consumer. While the Federal Reserve has to be wary of the rotten jobs report Friday, it also has to be aware of the risk of inflation from rising commodity prices.

The Fed is also in a peculiar bind. The next chance to announce a rate hike is during the Democratic convention. After that, the Fed runs the risk of raising interest rates during a presidential election, which will, no doubt, have politicians crying foul. It may be that your best move might be to add a bit of inflation protection to your portfolio, either in the form of Treasury Inflation-Protected Securities (TIPS), or small doses of commodity-sensitive funds.

Other things to watch this week: Not a lot. Fed Chair Janet Yellen speaks today at 12:30, but it’s unlikely she’ll say, “Better refinance that mortgage now, if you know what I mean.” Wall Street is likely to overreact anyway. The biggest number to watch is Friday’s consumer sentiment survey from the University of Michigan, especially consumer’s outlooks for pay hikes.

And take a moment today to remember the day. June 6, 1944 was a very big day for many brave young men.

 

 

This darn house

Those of you who own your own homes know the guilty pleasures of real estate porn. Thanks to sites like Zillow, you can see what your house is worth, what your neighbor’s house is worth, and what the inside of the tract mansion down the street looks like. (A six-screen entertainment room? Really?)

addamsIt has been a decent year for housing, helped by an average 30-year mortgage rate of 4.17% in 2015. But mortgage rates aren’t the only factor that push up housing rates, or even, necessarily, the determining one. Home prices soared in the mid- to late 1980s, when a 30-year mortgage averaged 10.21%.

What matters more is having enough income to qualify for a mortgage. Unless you can find a true cowboy lender — and they’re rare these days — your total mortgage payment needs to be less than 31% of your gross income. Someone who earns $75,000 a year would be able to afford a total monthly mortgage payment of $1,937.50.

Other rules restrict the amount of total debt you can have when applying for a mortgage. But overall, home prices depend on affordability and demand. Baby Boomers could buy houses in the 1980s despite high interest rates because their incomes were rising and home prices were low in the early part of that decade. And they were of the age when a house made sense for raising children.

The National Association of Realtors publishes a housing affordability index, which takes into account the household income, home prices and mortgage rates. The higher the reading, the less affordable homes are for the average family. affordability

As you can see, houses aren’t terribly affordable, despite low mortgage rates. The reason: Real household income has flatlined, and home prices have soared since the start of the housing bust in 2006. Homebuilders have largely concentrated on high-end housing, causing the prices of mid- and low-priced homes to creep out of reach for many families.

With luck, real — that is to say, inflation-adjusted — incomes should improve next year. Korn Ferry Hay expected U.S. workers to get an average raise of 2.7% next year, which is entirely reasonable, given the surge in corporate profits the past five years. And homebuilders are starting to ramp up production of more modestly priced homes.

Millennials, who are a larger generation than Boomers, will be slow to enter the housing market, however. They have too much college debt, and they’re paid too little to buy the few modestly priced homes on the market. Assuming mortgage rates will remain modest, it could be a few years yet before the next housing boom.

 

 

 

 

 

 

 

 

This year’s market: Better than it looks

We all have certain rituals for the end of the year. Some of us make contributions to charity. Others take down the Christmas decorations. Yet others light bonfires and bathe in the blood of an oak tree. It’s all a way to mark the end of yet another rotation around the sun, and celebrate a new one.

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Janus, the two-headed god of beginnings and endings.

Those of us who write about personal finance like to look back on the year’s market performance, which, unlike detonating fireworks over the neighbors’ roofs, is legal in all 50 states. And the basic takeaway this year was that it could have been worse. As of yesterday, the Standard and Poor’s 500 stock index was up 3.08%, assuming reinvested dividends.

Boring, yes? Yes. But still a better return than the average money market fund — 0.02% — and intermediate-term corporate bonds, which returned 1.08%.

The top-performing funds had two things in common. First, they avoided energy, which fell more than 20% for the year. Of the 10 top-performing diversified U.S. stock funds in the Morningstar database, not one had any exposure to energy.

The other: At least some exposure to the MAGS — Microsoft, Amazon, Google and Salesforce. Polen Growth Institutional (POLIX), the current top-performing diversified fund with a 16.8% gain this year, has about 8% of its assets in Google. Brown Sustainable Growth (BAFWX), up 15%, has Amazon as its largest holding. Prudential Jennison Select Growth, up 14.5%, has Amazon, Google and Salesforce.

All of which will tell you nothing about what will work in 2016, a year with an unusual number of variables: A presidential election with no incumbent, the first year of rising interest rates since your bond manager graduated college, and some of the lowest commodity prices since the Taft administration. It should be an interesting year.

 

 

The week ahead

“You’ll want all day tomorrow, I suppose?” said Scrooge.
“If quite convenient, Sir.”
“It’s not convenient,” said Scrooge, “and it’s not fair. If I was to stop half-a-crown for it, you’d think yourself ill-used, I ‘ll be bound?”
The clerk smiled faintly.
“And yet,” said Scrooge, “you don’t think me ill-used, when I pay a day’s wages for no work.”
The clerk observed that it was only once a year.
“A poor excuse for picking a man’s pocket every twenty-fifth of December!” said Scrooge, buttoning his great-coat to the chin. “But I suppose you must have the whole day. Be here all the earlier next morning!’

christmas_carolWe have a holiday-shortened week this week, with relatively little to make Scrooge smile. Today, the only indicator of importance, the Chciago Fed National Activity index, fell to -.30 in November from 0.17 in October, indicating a slowing economy. Employment was up, meaning that Mr. Scrooge might have to give his clerk a raise, but housing and consumer spending were down.

Tuesday, we have gross domestic product, expected to dip slightly in the third estimate for the second quarter. This could indicate relatively low inflation for the rest of the year, something that will make trading commodities a bit more problematic for Scrooge.

Also Tuesday: Existing home sales for November, also expected to fall somewhat, thanks to the declining fortunes of the oil patch.

Scrooge had a very small fire, but the clerk’s fire was so very much smaller that it looked like one coal. But he couldn’t replenish it, for Scrooge kept the coal-box in his own room; and so surely as the clerk came in with the shovel, the master predicted that it would be necessary for them to part. Wherefore the clerk put on his white comforter, and tried to warm himself at the candle; in which effort, not being a man of a strong imagination, he failed.

Wednesday is the EIA petroleum inventories report, which could prompt Scrooge to switch from coal to oil. Oil prices continue to plunge, and home heating bills should be modest this year, should it ever get colder.

Also on deck Wednesday: University of Michigan consumer sentiment, which has been on the rally recently, thanks to increased hiring and low gas prices. This will not impress Scrooge.

 

“A few of us are endeavouring to raise a fund to buy the Poor some meat and drink, and means of warmth,” said the gentleman. “We choose this time, because it is a time, of all others, when Want is keenly felt, and Abundance rejoices. What shall I put you down for?”

“Nothing!” Scrooge replied.

“You wish to be anonymous?”

“I wish to be left alone,” said Scrooge. “Since you ask me what I wish, gentlemen, that is my answer. I don’t make merry myself at Christmas and I can’t afford to make idle people merry. I help to support the establishments I have mentioned: they cost enough: and those who are badly off must go there.”

“Many can’t go there; and many would rather die.”

“If they would rather die,” said Scrooge, “they had better do it, and decrease the surplus population.”

Finally, on Christmas Eve, we have jobless claims, currently at their lowest level since 1972. Expect the four-week average to remain at those levels. And, of course, be on the lookout for ghosts.

 

Time to buy high yield?

Not just yet.

The time to sell junk bonds was in June 2014, when junk bonds were yielding an average 4.83%, at least according to the Barclay’s Capital High-Yield Index. (Department of minor victories: Don’t say I didn’t warn you.)

junkCurrently, the index yields 8.72%, which is a pretty fancy payout, considering that the 10-year Treasury note yields 2.25%. Those high yields are inspired, in part, by the shocking meltdown of the Third Avenue Focused Credit Fund.  But high yield was in trouble well before that.

Before you reach for yield, consider a few things:

Junk bonds are long-term IOUs issued by companies with shaky credit ratings. Just like your deadbeat friend Ralph, these companies have to pay high interest on their debts because of their dubious credit histories. Yields rise in the junk-bond market because traders think that risks are rising.

Junk bonds, like stocks, typically fare best when the economy is punk but looking better. At least in theory, companies that issue junk bonds can grow their earnings enough to improve their balance sheets and be better able to handle their debt payments.

The economy is still subpar, and few are predicting it doing a happy dance in 2016. A sluggish economy is probably the best we can hope for. According to Moody’s Investor Services, corporate defaults are likely to continue rising next year, particularly in the energy patch.

Furthermore, while short-term interest rates are low, the Fed has embarked on a campaign to raise them. Rising short-term interest rates act as a brake on economic growth, particularly for smaller companies. You’ll note that most banks raised their prime lending rates about 20 seconds after the Fed announcement. That will increase interest expenses for vulnerable companies.

The all-time high in junk yields was 22.14% in 2008, during the height of the financial crisis. We’re a long way from that. But it might be a good idea to see if junk yields go a bit higher — and prices a bit lower — before wading back in.

 

 

Savers: Whee!

If the Federal Reserve nudges short-term interest rates higher today, long-suffering savers can start to earn a little money on their hard-earned cash, right?

Federal Reserve Building, Washington DC, USA
Federal Reserve Building, Washington DC, USA

Ha! Ha! Not much. Most money market mutual funds are absorbing expenses, which is a polite way to say “losing money every day.” Think of it this way: If it costs, say, 0.35% to run your fund and you’re earning 0.15% a year in interest, you’re losing money. Most fund companies are chipping in the difference between their money funds’ income and outgo.

And they’re not doing that because they are swell people who just want everyone to be happy. They’re absorbing expenses because if they didn’t, the funds’ share prices would fall below $1 per share, which is the money-fund equivalent of picking your toes at the table at a state dinner. “Asset managers will be celebrating more than investors after this first rate hike,” says Peter Crane, publisher of Crane Money Fund Intelligence.

And it’s not like the Fed is likely to be boosting rates to the good old days. A 0.25% hike in the fed funds rate might result in an increase in money market fund yields to 0.10% to 0.15%, Crane says. On the positive side, that’s a 400% jump in yield. On the negative side, it will take you 7,200 years to double your money at 0.10%.

What about short-term bank deposits, such as money market accounts and CDs? Those rates depend largely on how much banks need deposits, and most banks don’t particularly need them at the moment. You can, however, get some decent yields (for these times) from a few select banks on money market accounts. Synchrony Bank, once a division of GE Capital, currently offers the highest-yielding money market account, with the princely yield of 1.05%, according to Bankrate.com.