The Stock Market Looks Vulnerable

On this week’s show, Karl discusses the items that have investors worried and why the stock market is vulnerable to a correction right now.  From the President’s overseas trip to the worrisome chart circling trading desks right now, Karl covers it all on this episode.

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Karl Eggerss:                      Hey, welcome to the Eggerss Report. It’s your investing playbook. Thanks for joining me, appreciate it. My name is Karl Eggerss. I am your host. I am the President and CEO of Eggerss Capital Management. We’re an independent, fee-only, Registered Investment Advisor, and we’ve got a website that you can go to. Eggersscapital.com is the website, E-G-G-E-R-S-S capital.com. We revamped it a few months ago, and I think it’s simpler. I think it’s got a lot of good information on there that you can use, and it’s really broken down into three big pieces. One of them is financial planning, which is what we do for folks, and those are things that really answer questions like, do I have enough for retirement? Could I convert to a Roth IRA? Should I be contributing at my company’s 401(k) in a Roth, or should I be doing things pre-tax? Do I take social security earlier? Do I delay? Do I take a lump sum or a pension for my company? These are things we answer during the financial planning process.

We do have, on our website, a free Track Your Finances tool under the financial planning section. That’s a free tool for you. Then we also do investment management. How do I increase my investment income, these are questions we get fairly often, how do I reduce the volatility in my portfolio? Do you guys look at my 401(k) and help me make decisions on that? Are there things outside of stocks and bonds that I can invest in? Those are all questions that we get a lot during the investment management process.

Then the third thing is financial education, and really, that’s our blog, if you will, that that’s where post our articles, our podcast, et cetera. You can go on eggersscapital.com. In fact, you can sign up for the blog for free. Any time there’s an article posted, we will send that to you. 210-526-0057‘s our telephone number. 210-526-0057. On the blog, we wrote an article on Thursday, I believe, and really, it was an article/interview. I did an interview Thursday morning on a San Antonio radio station as I do every Monday morning typically, I did it Thursday last week, but where we discuss some things that could derail the stock market. It’s been a good stock market for a while now. I think there are definitely some risks out there that investors need to realize, and I think this is a very important time to look at your portfolio and really know what you own, why you own it, and do some stress-testing.

Now, stress-testing’s kind of difficult because we all prepare for things that we know of, and what about things that are hard to quantify? Stress-testing isn’t a perfect science, but I do think people don’t have a clue what they own sometimes, and that’s really, really dangerous. As the market matures, as it goes up, there are things that are very, very expensive. There’s things that are in a bubble, so knowing what you own is important.

The Stock Market Is VulnerableNow, as we were discussing this on the Trey Ware show on Thursday morning, the three things that could derail the rally. I brought up the three points, and you can go listen to the interview, but some of them, I wanted to discuss those, what they are.

I think number one, the things that could derail the stock market are, we’ve been seeing the last several years that companies, when they have free cash flow, meaning they have more money coming in than it’s going out, essentially, they have choices what they’re going to do with that. They could give their employees a raise. They could increase benefits. They could go invest in research and development. They could buy more property and build another plant. They could do all sorts of things. They could acquire another company, but they could also, if they’re publicly traded, go buy their stock in the open market.

What does that mean? Just like you and I can go buy the stock, they can too, and when they do that, it reduces the shares outstanding, and so if you own that stock, your piece of the pie gets a little bit bigger. Companies have been buying back their own stock for several reasons, and a lot of people have criticized those companies saying, “That’s not the most productive things you can do.” I disagree with that. I don’t think it’s always the most productive thing they can do, but I think they have the right, the prerogative to do that, and a lot of them have been doing that, but as those buybacks are slowing down, that could be a headwind for the stock market.

Obviously, as the stock market’s going up, those companies say, “You know what? We’re going to use our money elsewhere.” Obviously, less demand for stocks could mean that the stock market goes down. That is number one that could happen, that could de-risk, or derail the market stock market.

Number two I think would be the Federal Reserve who has raised interest rates for a while now, a few times, is planning on raising them in December, quarter of a point, and then the plan is to raise them three more times in 2018.

Now, follow me on this. If they do that and they raise rates four more times, let’s say a quarter of a point each. That’s another 1% move up, if long-term interest rates do not go up, they will, what’s called, invert the yield curve, meaning short-term interest rates are going to be higher than long-term interest rates. Every time that’s happened, it’s signaled that a recession is coming, so the Fed could cause a recession, and basically, what happens is, and think through this, when they raise interest rates, that signals to the market they think things are growing too fast, and they need to slow them down. They’re worried about inflation.

The market sees that and says they’re going to be successful slowing things down, so they start buying bonds, which pushes long-term interest rates down, so it kind of accentuates that inverted yield curve. That’s something to watch over the next few months. If the economy, nothing changes and they do raise rates too aggressively, there’s no question that the stock market would sell off because the stock market has done very well due to low interest rates for a number of years, and now that they are ending quantitative easing, they are raising rates, that is something that could derail the stock market, not only here, but around the world. I mean, what if quantitative easing and all the stimulus in other countries slows down as well? That’s a big tail one that’s not there anymore. That’s number two on the list.

Number three on the list, and I said it on Thursday morning, if we don’t get tax reform in fairly short order, I think the stock market would sell off. It is pricing that in, and investors want tax reform. I mentioned this Thursday morning. Before the Senate came out with their proposal, I said, “If the Senate comes out with their tax proposal and it looks dramatically different than the House’s proposal, stock market’s not going to like that.” Well, on Thursday, we did see the Dow down 250 points at one point during that day, and I think it was directly what I said was that that proposal came out, and it wasn’t in line or in sync with the House’s.

Now, both sides would probably tell you that they’re not that far off. Maybe they’re more similar than we think, but there are some big differences in those proposals, and so can they compromise, can they get something done, everybody’s on the same page? Hopefully, they can, and some of the bigger differences would be the number of tax brackets. Some of the differences would be the corporate tax cut wouldn’t go through until 2019, that’s something that the stock market obviously did not like, and how they treat pass-through companies, so an S corporation, many of you are familiar with that, is company that whatever their profits or losses are flow to the owner’s personal income tax, their 1040, and they’re taxed at the same rate they are personally. There was some discussion about, “Let’s change those rates so that it’s more favorable for small business owners to have two tax brackets. One of them would be on their corporation and one of them would be on their personal stuff,” and the Senate may change that, so those two things are at odds.

Of course, the reason they’re trying to push back this corporate tax cut until 2019 is because they’re saying, “Well, how are we going to pay for this tax cut?” Well, if they would cut spending, that would, quote-unquote, “pay” for this tax cut, but they’re not looking at cutting spending, they’re looking at where else can we get tax dollars from? It’s still a messed up system, but the stock market has clearly been pricing in some sort of tax reform, and if it doesn’t happen and it keeps getting delayed and there’s more fighting, the stock market would be ripe for a sell-off. Those, to me, are the three main things that could derail the stock market.

Couple of things that happened this week, one of the big ones was we are sitting here now, a year past the election. We’re sitting here a year past the election. It’s been a year. What types of things have we seen? Well, we’ve obviously seen a good stock market. Stock market’s up since election day. Based on the S&P, up about 20% or so since that time. Remember, the election night when the results were coming in, the Dow futures were down over 800 points, and then by the next day, they were still down but down like 100 or 150 points, and then of course, if was off to the races, but part of the reason it was off to the races was because of less regulation, which we are getting that part done now, health care reform and tax reform, and those other two big items haven’t been done yet, but the thought was Trump’s going to be much more friendly to small businesses so that’s why we got this bump.

It was one of the bigger bumps. It was probably, I think maybe like the seventh biggest jump in the first year of somebody’s … FDR had a bigger jump, FDR up 35% his first year in office. Clinton’s was big, 32%. Obama’s was actually bigger than Trump’s. Bush one, low 20s. We’ve seen some big move. We’ve also seen some down moves. Bush two, junior, down 22% his first 12 months. Now, what’s interesting is when you take the average, and some of this information’s from Bespoke, they said the second year, the average after the first year, during that first year has been 5%. The second year has been an average of 3%. Here’s where it gets interesting, though. When the president has a stock market in their first year of office that’s gone up more than 20%, which has happened seven times, the next year, the stock market’s been down 6.5%. Odds would suggest that we would have a tougher next 12 months.

Now, you can’t take this stuff in a vacuum, and the reason why is if you look, there’s a lot of data that suggests a very low volatile stock market like we’re in leads to bigger gains, and we have a very, very quiet and calm stock market right now. Now, I think the volatility will pick up, but we have had a very quiet stock market. That’s just something that happened this week, this one year kind of anniversary, which is amazing to think how fast time flies. We’ve got mid-term elections coming, just that quickly, and so I think there’s pressure on the Republicans while they control all of this to get the things done they want to get done, and it doesn’t seem to be happening just yet.

The other things that happened this week, probably the, I would say, the chart of the, I posted it on Friday on Instagram. I have an Instagram feed, Eggerss Capital Management if you want to go check that out. We posted it on our Twitter feed @KarlEggerss and @etfcharts. Those are both ours as well. I posted this picture of high-yield bonds versus the stock market. You look at that and say, “What does that have to do with anything?” Well, when investors that invest in bonds are excited, optimistic, they will tend to invest in riskier bonds. High-yield bonds are bonds that are issued by companies, debt, but they’re less quality, lower-quality companies. They’re called high-yield, or you’ve heard the term junk bonds, and so when people want to invest in bonds, and they’re optimistic, they’re going to go invest in lower-quality, higher income-producing bonds called high-yield bonds.

Those high-yield bonds track the stock market pretty well. If you put a chart on top of each other, they track pretty well. Sometimes, what happens is those junk bonds will start to fall, and it’s a precursor to the stock market falling as well. I like to look at … These charts circulate now, and of course, everybody has their own adaptation, so I went ahead and create done as well just to say, “This is the most popular chart I’m seeing out there right now on Wall Street,” and you can go check it out on some of our stuff but it is, it’s a picture of junk bonds on top of the stock market.

What you will notice is that they were tracking pretty closely, June, July, August, September, and probably in the middle of October, junk bonds peaked, and they started to fall. They haven’t fallen dramatically, but it’s definitely a gap. It’s a warning, I think. Either, at some point, the stock market does have to come down, which it did late in the week, or junk bonds are a great buying opportunity. That will be reconciled, but it’s one of those pictures that we had to share because it’s circulating and it’s something that a lot of people watch, and if a lot of big money’s watching that, that could lead to selling, in other words, a self-fulfilling prophecy, a little bit.

Some of the things that were moving on a lot of this news this week, let’s go through some of those items. Volatility. You can, and we’ve talked about this before, you can invest in volatility. If you think, hey, volatility’s been low, I think it’s going to get more, there’s ways to invest in that. Volatility was a good investment this past week or a good trade. Energy did very well this week, and probably surprising to some people. I think it’s a time for maybe energy to pause a little bit. It’s had a big run. I mean, from the, if you look at the XLE, which is the ETF that really tracks a pretty good basket of energy stocks, that is up somewhere around 13% from the middle of August, so we’ve had a big move. It’s gone above its 200-day moving average.

I think oil singing up at these high 50s is something that many people didn’t see coming, and when you think about some of the areas for potential upside, we may see, at the beginning of the next year, this rotation out of some of the things that have been working in to some of the things that have not been working, and energy may be sitting there ripe to continue to go up. It had this down-trending picture, really, for most of 2017 making lower lows, lower highs, just cascading down. Then it kind of found a bottom, and now it may be turning the corner doing the stair-stepping back up. Energy did very well this week, especially the oil and gas exploration production companies, the equipment service companies did very well.

We also saw a little bounce back in things like the home builders. Remember they took that, drop that dam when the GOP proposal came out because they wanted to limit the interest deduction that you, the amount you can deduct for your mortgage interest. They wanted to limit that. The Senate proposal does not have that limitation in there, so housing stocks went right back up to where they were prior to the GOP’s proposal coming out. We saw gold miners have a decent week, so that’s some of the stuff that was kind of on the high side.

Bitcoin, having a little trouble this week after a pretty monster run, so we may be in kind of one of these zags versus the zigs. We keep getting up and then pause and then up and then pause. There is some, you can read about them, I’m not going to go into it because, frankly, some of it I don’t understand, but there is some discussion on splitting Bitcoin, there’s Bitcoin cash. Some of these folks said, “Let’s not do that, splitting it, because we’ve got to keep this thing together.” We saw futures come out on the Chicago Mercantile Exchange, which means we’re probably going to see more ETFs surrounding Bitcoin. That’s going to move on that news because, yes, you would think that’s more ways for people to invest in it. It’s also more ways for people to bet against it, frankly. Let’s watch. It’s going to continue to be extremely volatile. We know that, but Bitcoin was a big, big mover this week.

The banks, really getting hit the last few days. Watch the banks. They’re probably in a decent place to maybe have a short-term rally. It’s all about interest rates with them, but the banks were down 4-5% this week, so they had a really tough time.

Biotech. Biotech’s interesting too. The long-term uptrend in biotech stocks, and we own a couple of individual names, but as far as a basket, an ETF, which IBB and XBI are the two big ones, that thing had been on an uptrend, really, since February of, excuse me, February of ’16, 2016. That uptrend’s still in place. We’re probably looking at … If biotech pulled back another 3-5%, that uptrend would be broken. Then you’d have to start looking going, “Maybe this thing is, this little run’s ending,” but they’re still on an uptrend and kind of coming to the lower. If you think of it as a channel, you got the nice pretty lows, nice pretty highs in this tight range, they’re on the lower end right now, whereas if you look at the Dow Jones, it’s on the upper end of that. There may be some rotation out of some Dow Jones-type stocks into biotech-type companies.

Transportation stocks had a pretty rough week, and that’s something that obviously a lot of people are watching for economic reasons, kind of hey, how’d those go, the rest of the world may go. In the middle there was the stock market, which really didn’t move a lot, so you got these kind of fringe things, some things did very well, up 3, 4, 5%, some areas down 3, 4, 5% on the week.

I think we’ll wrap up with this this week. Twitter expanded their characters from 140 to 280 characters. What do you think about that? I haven’t, I don’t think I’ve used the full 280 yet. A lot of people are. If you use Twitter every day like I do, it takes longer now to get through your stream because people are using more characters. I don’t like it. I kind of felt like I needed a few more characters. It would’ve been good had they gone to 175 or something because I don’t need multiple paragraphs. I don’t want to read multiple paragraphs. I like the concise thoughts. That’s what makes Twitter what Twitter is, which is very useful because it’s very quick to get through a lot of news, which I like I do, quickly.

Now, we’re getting all these opinions that are long and drawn out, so I’m not a big fan, but it did get rolled out worldwide, so if you use Twitter, A, you’ve got more … They don’t count the characters anymore, it’s got this little, this circle, and it goes around the circle how much you’ve used, and you can tell where you are, but if you’re reading it, you’re going to notice that, yeah, a lot of these tweets are much, much longer. That’ll be interesting to watch the president and how much detailed he gets in his tweets because, of course, he has not slowed down tweeting.

In fact, somebody tweeted this week that if you would’ve told most people how many, think he’s had something like, I don’t know, 1,600 tweets since he’s been president or something like that, but if you would’ve told somebody he has that many tweets over his first year, and yet we’d be in the calmest stock market ever, you probably would’ve lost money on that particular bet.

One other piece of news before we go. Of course, president traveling around saying he’s making a bunch of deals. Again, those things are probably very good. We don’t have a lot of the details on them yet, but I do think he is going in there, and this is where … I think this is, the people that voted for him are saying, “This is what we wanted. We wanted a president going in as a businessman, and the country being his business, and making deals,” and it seems to be that we’re seeing that he’s trying to convince foreign countries doing some of their IPOs on the New York Stock Exchange, having them buy some of their products from U.S. companies, getting companies that are overseas to come back home. We’re seeing that happen.

You’re hearing just thousands of regulations that are getting easier, a lot less red tape. Those are all very positive things that aren’t as headline-making as health care reform and tax reform. I still think we need that tax reform for sure, and certainly, we’re closer than we were, but not necessarily on the same page between the House and the Senate just yet, so that’ll be a fluid situation, but certainly, the stock market looked a little vulnerable this week.

Again, know what you own, know that if we do get a pullback, have a plan in place. “Hey, if the market pulled back 5%, what would I do? Would I sell some things, or would I buy some things?” If you have some momentum names, you may be looking to sell. I mean, if you have a basket of semiconductors right now, which if you do, you’ve made money, but you have to, at some point, go, “When would I sell? When would I take some profits?”

Frankly, we’re in the last 45 days of the year. If people that have unrealized gains, taxable gains on semiconductors or any other area like that, may wait until January 1st to sell those things. The losers do tend to go up, excuse me, down into this time of year as they just, more selling pressure, and the things that are going up don’t get sold until next year, so look for that January rotation. I think we touched on that last week.

Some of these things are looking vulnerable, so look at that. If you have some things that are way up there that you’ve made money on, this may be the time to either look at stops, stop losses, or how they condition if under which you would sell if that momentum slows down because there’s a lot of momentum things working, and if they turn the corner, obviously, they could fall very fast. Watch that, but the market definitely had some cracks this week, and I think a lot was based on the tax reform or lack therefore.

Don’t forget, eggersscapital.com. We’re on Twitter, we’re on Instagram. We’re also in the process of getting our podcast got approved recently to be on Spotify. You have to go through approval process, which they gave me the thumbs up after several months, so that is good. We’ll be on Spotify. For those that listen, you can get the podcast on there. We’re on Stitcher. Obviously, Apple iTunes is one of the best places to get it, and you can put comments, share it, all that kind of stuff, so lots of ways to get our information. If you just need to talk to us, 210-526-0057, and make sure you tune in every Monday morning 7:20 Central Time, KTSA.com. You can stream it if you’re out of San Antonio. If you’re in San Antonio, it’s AM 550, and we’re on at 7:20 a.m. for a live usually 5-10 minute interview discussing the markets.

All right, folks, have a wonderful weekend. We will see you back here next week on the Eggerss Report. It’s your investing playbook.

Announcer:                        This show is for entertainment only, and information provided by the hosts, guests, and this station should not be deemed as advice. Your investment decisions should be based on your own specific needs. You should do your own research before you make those decisions. As President and CEO of Eggers Capital Management, Karl Eggerss may hold securities mentioned in the show for himself and his clients. Just don’t buy or sell anything based on what you get from radio or TV. Use your own judgment, or get yourself a trusted advisor.

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