On this week’s show, Karl discusses the big moves in technology stocks after upbeat earnings. But, they’ve already gone up. What’s next to rise? Karl discusses a few areas that may be ripe to move higher in the coming months.
Also on this show, Karl discusses names be tossed around to head the Federal Reserve Chair position.
Karl Eggerss: Hey everybody, welcome to the podcast, it’s The Eggerss Report. It’s your investing playbook. My name is Karl Eggerss, I am your host. And for those of you who follow us each and every week, thank you for listening, we appreciate it.
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Alright, well pretty interesting week this week, had some things going on. Of course, in the big picture, what we have is of course, the … you can see the markets moving a little bit based on who the Federal Reserve chair is going to be, the next person that President Trump nominates. We got a glimpse that perhaps it’s not going to be Janet Yellen. So it looks like Powell is the leading candidate, who is very similar to Yellen, which the market would probably like.
And then of course, we’ve seen John Taylor, who we’ve talked about the previous weeks, who came up with the Taylor Rule, which is really a formula for where rates should be. And we put an article up this week, saying that interest rates could triple, if it was up to John Taylor. Remember the federal funds rate, the rate that the Fed sets, is around one and a quarter. According to his calculations, that rate should be 3.7%. And as you jump up and down for joy, and say, “Well that’d be great, why not put him in there? And then my money markets and my saving accounts would pay us three to four percent. How fabulous would that be?”
Well, the stock market may not like that, because rising interest rates cause companies and consumers to pay more interest. And therefore, it could slow down the economy. So every time John Taylor’s name is mentioned, you see interest rates move a little bit, gold moves a little bit, the stocks move a little bit.
So we’ll see. I have a feeling it’s probably going to be Powell. That’s at least the odds are that President Trump wants to continue this path, but have his own person in there. So that’s kind of something that’s floating out there that could cause some volatility in the market.
We did have a chart we put up on Eggerss Capital this week of the Dow Jones, and of course that’s just one market, but the Dow Jones has been doing very well, because a lot of those companies in the Dow Jones, there’s 30 of them, industrial companies, have been reporting really good earnings. And so, because of the way they calculate the points, there was a day where two companies accounted for half of the Dow points, the day it was up 200 points.
So we wrote an article basically looking at that the Dow was really due for a rest, and we’ve kind of seen that since we wrote that article. In fact, what we did was, we said, “Hey, go back 20 years, and every time the Dow Jones is 10% above its 200-day moving average,” so you look at the last 200 days, you get a number, that basically shows that the market’s going up at a pretty rapid rate right now, and it gets too far stretched, and it’s like a rubber band, it comes back into line.
Over the past 20 years, basically about 10 times, we’ve seen the Dow Jones get this stretched. And each time it’s been a pause, if not a pullback. Usually it’s some type of pause. Of course in 2007, it ended up being the worst bear market we had ever seen. But we certainly get some pause.
So the very next day, we wrote the article, we had the drop in the Dow, and it’s been kind of meandering since then. But what’s taken its lead over the last few days, has been the NASDAQ, which is primarily technology stocks. So you look at this economy and you know that technology is a big, big part of it nowadays. You look at the strength in the semiconductors, you look at the strength in technology stocks, you look at the Amazons, Facebooks, Googles, those companies are doing very well.
But you have to stand back and say, “Okay, I know they’re good companies, we all acknowledge that. What am I going to pay for that company?”
And it’s fascinating, because if you … we had a discussion in our office this week about private companies versus public companies. And many of you listening, I’ve talked to, you’ve owned companies, you’ve sold companies. Can you imagine if you got the valuation for your company that Amazon or Netflix or Google gets for their company?
You know, you hear things like five times EBITDA, that’s earnings before interest, taxes, depreciation and amortization, that dollar amount, and then times five, and that’s sometimes what people pay for it. Some of these companies are 30, 40, 50 times EBITDA. It’s amazing. And yes, they’re bigger, safer companies than your small company.
But it’s very interesting, if you were to literally use your hard-earned savings to go buy a private company, what would you pay for it? Would you pay 5, 10 times, 20 times annual revenue? There’s no way you would pay that. But we do it every day in the stock market. But you don’t have to. And so while these companies are going up, it’s very easy to say, “I should have bought that, or I want to buy that,” as opposed to looking the other way and saying, “What is a good deal right now?”
So I think there is this balance we have to strike, between what we would call momentum investing, the things that are working and continue to work, and may be expensive, but they may get more expensive, versus the things that are out of favor, deep value. And I think if you marry those together, you have a reasonably good portfolio.
Now … and the reason why Friday, we did see a big jump in technology stocks, because all these technology stocks are such a heavy weight in these indices, and they all reported really good earnings. So we saw a big jump in there. But one of the things that I think is out of favor, that we actually posted about, and actually purchased more of, are master limited partnerships.
Of course, that was the area that was probably the most loved area coming into 2014. It had been a fantastic investment, great income. These are kind of the pipeline companies. They’re just the toll road, we heard. They can’t go down, because they’re just toll roads, they don’t care what price oil is. Well, it didn’t really work that way. Master limited partnerships, of course, got severely hit, and we saw them drop 50, 60%, whatever it was. We saw Kinder Morgan, one of the best dividend companies there was, cut their dividend by 78%, which is ironically when the stock bottomed.
But what’s happening in … so those recovered. Those recovered into ’16, and into ’17. But around February of last year, about 9 months ago, we saw master limited partnerships peak. Since that time, they’ve fallen about 20%. But there’s this really nice pattern that they’ve developed, where they’re falling, so they’re making, if you can picture it, lower highs and lower lows. So it’s like a staircase going down the wrong direction.
Well, this week, we saw what almost looked like kind of panicked selling. Some of these master limited partnerships, as a basket, fell like 9 out of 10 days, something like that. So we own a small piece of it in our income strategy, which is a very conservative strategy, primarily for low-volatility income. It’s kind of our rendition of what the rest of the world would call a bond portfolio, but we don’t own just bonds. So the idea is to get the same volatility as a bond portfolio, with a little more income and long-term growth, and not be susceptible to rising interest rates, which can really hurt a bond portfolio.
So we have a small sliver of master limited partnerships in, which are paying us about 8% a year income. And they’ve been getting hit this year. So we saw this kind of panicky situation, and we went in and bought some more of it, and averaged down into it, and it bounced in the last 48 hours or so, nicely. And so that’s something that A, could have been a trade, and might still be a trade, but I think it’s not a bad investment.
Now you may be looking at some of these energy stocks and saying, are they telling you something about the future, and that’s a valid point, that sometimes stocks go down, people can’t figure out why, and then the commodity like oil follows it, and all of a sudden oil starts falling. But we didn’t see that Friday. We actually saw oil spike, and turn around and go up.
So I think it’s a good risk-reward from a short-term, medium-term basis. And I still think energy is a reasonable place to invest, but we need to obviously be selective. It’s kind of interesting because some of the energy stocks are moving one direction, and in a different space in energy, you’re getting some going the other direction. They’re not moving together. So watch that.
So tech’s kind of going parabolic right now. Energy’s been a mixed bag, but technically oil might be looking to break out here. The other thing we talked about in the last few weeks was gold, and gold looked like it was starting to run. We kind of showed you some charts. It reversed, and it’s pulled back, and I think it’s no coincidence, it’s pulled back when John Taylor was mentioned as a possible Fed pres. And we saw on Friday, Vice President Pence said that’s who he favors. So we’ll see. Gold, interest rates, are going to move based on who this next Fed chair is, but it looks like it’s not going to be Yellen.
Now this week, I was on a little later in the week. I do an interview on a San Antonio radio station, where they call me, kind of get a summation. Really, it’s whatever they want to ask me, I answer. But usually I do that on Monday mornings, 7:20 AM Central Standard Time. And this week was the gentleman, Trey Ware, was on vacation, so I did the interview on Thursday morning, very early, about 6:00 AM. He asked me about this scuttlebutt about 401(k)s. And if you haven’t listened to the interview, you can go back and listen to it, but I wanted to go into a little more depth than I was able to on that interview.
So one of the folks in Washington wants to … their budget, they want to cut the annual amount you can put into your 401(k), which is $18,000, they want to cut it down to $2,400. And I’ve been thinking about this, and A, I don’t think that will happen. President Trump has already said we’re not going to change the 401(k), we’re going to leave it alone.
But my point to Trey Ware was, you know what, let’s change the conversation to how people are doing their 401(k). I think there’s many of you out there that would benefit from choosing the Roth 401(k) option in your 401(k), not the pre-tax version. Remember, you’re already getting your match, if you have a match, on a pre-tax basis.
And the reason I say this is because you’re probably in a lower tax bracket than you think. Some people hit a tax bracket, and assume that’s where all their money’s taxed, and it’s not. When you average out your tax rate, your marginal rate is typically lower than you think, and many people would benefit from paying the taxes now, in exchange for that money never being taxed again, and the growth never being taxed again. And we see that all the time. Now it takes some analysis to determine, because everybody’s situation is different.
Trey’s point to me, his rebuttal to some degree, although later in the interview, he agreed with the Roth 401(k), was that hey, I want to get the deduction now, because I don’t know what they’re going to do later on. And what if I pay the taxes now, and then what if they tax Roth IRAs down the road?
I’m not as concerned about that. Can they change the rules? Yes. But generally, they grandfather things. They could abolish the Roth 401(k). They could abolish the Roth IRA. But that doesn’t mean that the existing ones don’t stay there. And when you start thinking about that, and saying, well that is a risk that they could tax me twice … of course, but there’s a risk in everything.
Isn’t there a risk that they say, “Hey, remember when we told you you had to take some of your IRA out at 70 and a half?” What if they change it to 65? What if they say, “Instead of taking out the amount at 70 and a half, based on your life expectancy, what if we say that you have to take out the whole IRA over a 10-year period?”
You see, my point is, they can change the rules however they want. So what we have to do is kind of take advantage of what’s in front of us. And I think the Roth 401(k) is an excellent option for a lot of people. I mean, it’s not just for 22-year-olds, this is for a lot of people. And it does take some analysis.
Of course, we can help with that if you need to, but that’s what we do, is we look at somebody’s situation and determine should there be Roth conversions, should there be Roth contributions, and put that all together with what else is going on in your life. So don’t believe just because I’m saying look at the Roth 401(k), I’m suggesting to do it. I’m saying analyze it, take a look at it, and see if it makes sense for you.
There may be something in between that I haven’t heard mentioned, but what if they left the $18,000 a year there, going up to $18,500, what if they left that there, but only made it deductible for certain people? What if you had to have a certain amount of income before you could even deduct it? Then that would force people to essentially do a Roth 401(k). That would allow the government to get more taxes now, and at the same time, that would probably benefit a lot more people. We’ll see. I don’t know. Just tossing that out there.
But it is a debate. I don’t think they will do anything with the 401(k), but my bigger concern is the amount of money that’s in 401(k)s is a tremendous amount of money. It’s sitting there, the government wants to tax that. And the inherited IRA, which is if you pass away, your spouse passes away, you leave the money to your kids, they can take it out over their lifetime now.
So the government really doesn’t get a lot of tax money in a short amount of time, because it’s stretched out. That was not the case prior to maybe 1997 or so. What you had was people would die, and all their money came out of their IRA at once, and was taxed, and it bumped, of course, the kids into a higher tax bracket. What if they abolished the inherited IRA?
You see, that’s where I think we should be focused. They may do that, because there’s money sitting in there that has never been taxed. How does the government want to tax it? And unfortunately, that’s the way they think. So we will see. There’s a battle going on, it looks like we’re getting closer to tax reform, hopefully we do. Trey and I did talk about the whole spending side.
You know, they’re trying to figure out how to tax us more, how about the spending side. Why doesn’t the government get their spending under control? Let’s do that first. So hopefully we get a little of both, where we get a cut in spending, and we also get some real tax reform, especially for small businesses. So that was something that was really a major topic this week.
So some of the winners and losers this week, right off the bat, when we kind of look at some of the big winners this week, technology obviously, oil was up pretty good this week. Japan, they’ve only had like one down day in the last, I think this month. It’s been a really unbelievable move for the Nikkei, which is their Dow Jones equivalent in Japan. Home builders had a good week, the railroads had a good week, and interest rates were higher.
You know, we posted some pictures going, hey look at this, this thing could be, interest rates could start to fall. But again, what’s happened is, with this Fed decision, it’s really affected gold and interest rates. So be flexible there, because depending on what happens, those can reverse really quickly. So don’t think that interest rates are destined to go higher or destined to go lower, or gold’s destined to go higher or destined to go lower. The news flow’s going to control some of that in the short term.
But those were some of the big winners this week. On the downside, some of the big losers, biotech stocks. Man, they look awful, and I told you a few weeks ago, we don’t have any biotech holdings in terms of baskets. IBB, XBI are the two main ETFs, and really what we’ve seen is about eight or nine straight down days, and really since they reached their high in early October, they’ve been down about 8 to 9%. It’s pretty much been a straight line. So really a bad week for biotechnology and pharmaceutical stocks.
Gold miners didn’t have a good week with gold falling. And another area we think is pretty interesting, is take a look at the airlines. Now this is not a technical trade. We purchased some airlines this week as a basket, and the reason we did is, we believe they are fundamentally cheap.
So this is not a trade, and I think that’s one of the biggest challenges we have in communicating to you the things we like and don’t like, is the timeframe. That’s why you can’t take what I’m saying, and go necessarily run out and do it, because you don’t know the context of where we bought it, for which folks we bought it for, and the timeframe of how long we’re going to hold it or plan for it. We try to communicate some of that, but we can’t with everything we do.
But the airlines are interesting on a fundamental basis. Many of them are very, very cheap, when you really tear down their income statements, their balance sheets, things happening right now, they’re cheap. We made pretty good money on them, as a trade, earlier in the year, in the spring. They had a nice run, we got out of them, they pulled back, and then they went on a second run, and now they’re pulling back again. So they had a rough week, and we think it’s a really interesting spot right here, again, for a longer-term investment.
Now when you get into specific areas like airlines, this isn’t like owning technology or an index like the S&P 500, you’re owning a very specific thing. So you have to determine, is that even something you want to do. So that’s why we put that in our aggressive strategy, because it is something we’re looking for longer-term, and it is more aggressive, because it’s one industry that can get hit. A lot of those, something happens bad or good to one of the companies, and it kind of trickles down to the rest of them. So they had a rough week.
Copper had a down week. We’ve seen some speculation in copper, even though the price has been going up, so copper could see some short-term weakness. So really the overall healthcare, some of the metals, those were some of the big losers on the week.
So before we wrap up, I did want to answer one question. I had a listener question asking about the home building stocks. And really it was after the hurricanes this person asked that. Home builders have been on a roll, I think they’re extremely overbought at this point. But I don’t like, necessarily the home builders as a hurricane trade. I think because some of those homes aren’t going to get rebuilt, home builders … remodelers is a different thing, but home builders don’t necessarily benefit from that.
But they’re very, very stretched. I wouldn’t touch the home builders right now in the short term. Fundamentally, they’re still fine, but technically overbought. But I did want to bring your attention to, there is ITB, which is home construction, and then there’s the home builders XHB ETF. They’re very different how these are constructed. You can look at biotech, there’s a lot of ETFs that some of them are concentrated into certain areas.
Like for example, XHB has been, over the years, more concentrated in anything having to do with home building. So it’s a little more diversified. It had, maybe paint companies, carpet companies, all those types of things, whereas ITB is strictly home builders, for the most part. So again, if you think you want the home builders, you go after one, not the other.
So really, when you buy an ETF, dig down, or a mutual fund, what do they really own, and how much? IBB, in the biotech space, versus XBI, very different. IBB has very heavy weights to some of the very large cap biotech companies. XBI is more equal weight. Well that’s great in certain circumstances. If those concentrated companies are going up, you do much better. But if it’s just a broad-based rally, you may do better in the more equal weight one. So the construction of ETFs is very important when you’re talking about buying them.
So that’s what I would say about the home builders, is yeah, they’re doing well, fundamentally they’ve done well. I think we owned … I don’t remember, I shouldn’t say when we last owned the home builders. We don’t own any right now, but I wouldn’t buy them at this point, given the run that they had, it’s just overbought, so I’d let them settle down a bit. Kind of like biotech did, to be honest with you.
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So we had a real big earnings week this week. Next week we’ll continue that, but we’ll probably, maybe we get a Fed decision next week on who the next Fed chair is going to be. Might cause some volatility, which has been absent in 2017. We have not seen hardly any volatility. So when people ask me, “Have we ever seen a market like this?”
I say, “We’ve seen a market go up like this, in fact much more. This is a fairly moderate year in terms of how much it’s gone up. But the path that it’s taking, and the lack of volatility is something that we really haven’t seen before.”
And that’s not something that will continue forever. We will have more volatility, so that’s why you have to mentally prepare for that now, as opposed to chasing low-volatility-type things, and things that have worked. Just be careful about that. Which again, we’ve talked a lot about what the next bear market will look like. So we’re going to continue that discussion in the weeks to come.
So have a great weekend everybody. We appreciate it, and we appreciate you listening as always. Don’t forget eggersscapital.com. Have a great weekend. Be safe out there.
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