MARKET COMMENTARY - Fredric W. Williams

Do Trees Really Grow To The Sky?…

Despite the German proverb about the limits to upside expectations of any sort, be they arboreal or financial, the equity markets continued to march steadily higher post the 2016 election and through the first three quarters of 2017. Of late the indices hit a succession of new highs in the face of a multitude of geo-political uncertainties, as well as a paucity of domestic legislative progress that was originally cited as the justification for the move higher almost a year ago.  Most traditional valuation metrics continued to be stretched, suggesting future gains may have been pulled into current quarters, while volatility (as measured by the VIX) hit record lows not seen since 1993.  These dynamics were evident when the record for consecutive trading days absent a 5% pull back (which had been 333-days starting on 11/23/94) was passed early in the 4th quarter.

Whether or not this might be the proverbial quiet before the storm will only be determined with the benefit of 20/20 hindsight, but a couple or non-traditional anecdotes suggest “perceptions” may have once again donned some of John Lennon’s rose-colored glasses from the ‘60s:

“On the CNN Fear & Greed Index fear was nowhere in evidence on Thursday (Oct. 5th). The index closed at 95 on a scale of zero to 100, a score deemed to be “extreme greed.” With all due deference to the movie Wall Street’s fictional Gordon Gekko, greed is not good when it gets to extremes. As with pride, another of the seven deadly sins, greed often goeth before a fall when it comes to markets.”

  • R. Forsyth, Barron’s 10/6/17

Similarly, the normally risk-averse institutional pension community apparently considered looking at the S&P 500 as a place to “park money for a few months”, according to one consultant:

“The ruler like ascent (has) given the impression the index was ‘the new money market fund’. Hardly – the absence of risk does not mean the elimination of risk, just as the absence of rain does not mean there will never be another storm.”

  • C. Bilello, Pension Partners Blog, Oct 2017

Lastly, a more traditional measure of relative valuation – one that looks at the market within the context of the gross domestic product that supports it – provides another touchstone to frame the question as to where we may be in the cycle:

“Compared with the U.S. economy and corporate earnings over the longer term, however, the valuation(s) are more stretched. As a percentage of gross domestic product, the value of the U.S. equity market has topped the levels reached in 2007, the peak before the financial crisis…The only time it was higher was during the heady dot-com daze of 1999-2000.”

  • Smedley & Bush, Guggenheim Investments

Combine the reality of these measurements with the expanding popularity of passive index investing, and it’s possible that the self-fulfilling feedback loop of blindly making investment decisions based on recent performance is starting to resemble the antics of some of our politicians in our nation’s capital (as described by one of our great social commentators that we recently lost):

                                                “Into the great wide open,

                                                 Under them skies of blue

                                                 Out in the great wide open

                                                A rebel without a clue”

  • Tom Petty, 1991

We touched last quarter on the mathematical concerns we had about how index investing causes investors to buy high continually, thereby pushing up the share prices of the recent biggest and best performers, regardless of their relative valuations, given that market capitalization weighted index funds take their incoming investor dollars and buy proportionally more of the larger companies at the expense of the smaller one – thereby perpetuating the cycle. Our issue is with what happens on the inevitable downside of this nearly 10-year run up?

“Exchange-traded fund assets have grown exponentially in size the past five years, and these passive investments have never been battle-tested by panicked selling. What if ETF investors begin to abandon their shares in reaction to a run-of-the-mill market correction? Perhaps that turns into a nasty rout, as ETFs are forced to dump stocks, too, potentially initiating a vicious cycle of stock selling.”

  • V. Racanelli, Barron’s 9/20/17

So, in the spirit of Mark Twain and his reputed comment about history not repeating itself, but often rhyming, we looked back to see if there were other analogous times that could lend some insight as to where we are, and might be headed. Given the current “FANG” fascination that we’ve discussed previously, and its impact on the aforementioned index funds given their present relative market cap, one other similar time that came to mind was the “Nifty Fifty” from the late 60’s and early 70’s. These 50 stocks were identified by Morgan Guaranty Trust as the country’s fastest growing companies and sparked a move by both institutional and individual investors toward “growth at any price” and away from the “value” mentality that had existed since the crash in 1929.

At their peak, they traded around 42 times earnings – or about twice the S&P 500 at the time – and comprised the stalwarts of the then American business community…including Eastman-Kodak, Sears, Simplicity Pattern, Polaroid and S.S. Kresge (which is now Kmart). And although some of the “Fifty” remain (Coca-Cola, General Electric, Texas Instruments, etc) many of the originals were decimated in the bear market of 1974, or replaced by new strategies and technologies not yet developed at the time.

Another period of elevated valuations, and more familiar to many, was the dot-com bubble at the turn of the new millennium. The S&P 500 traded at an elevated 29 times earnings in 2000, but was dwarfed by the NASDAQ and its earnings multiple of 175. Remember the short-lived start-ups like Pets.com, Webvan.com, Drkoop.com and Kozmo.com, just to name a few? The subsequent tech crash brought the Nasdaq down by almost 78% - a chasm from which it took almost 17 years to recover from.

Which then brings us full circle to “FANG” (along with its newest iteration “FAANG+M” which adds Apple and Microsoft) and their current relative valuation comparisons. As noted previously, the S&P 500 is trading in excess of 20 times earnings, having averaged around 16 over the last one-hundred plus years. The “FANG” average price-earnings ratio is now at a lofty 138 (although somewhat “muted” by FB and GOOGL trading in the mid-30’s) suggesting that investor expectations are that these companies, perhaps similar to those in the Nifty Fifty and dot-com crazes, have a limitless growth potential. A further concern this time around is that unlike the plethora of companies in the previous two episodes, our current fixation may be significantly under-diversified.

“The “FAANG + M” stocks…are woefully concentrated by both size and industry and therefore could be vulnerable to a massive sell-off the moment they hit their natural limits of growth.

Ultimately, the lesson of the Nifty Fifty is that a company is not its stock.

 It may have a wonderful, viable business for many years to come, but the natural competition of the marketplace makes it extraordinarily difficult for any company to remain dominant for perpetuity. That’s why valuation matters.

 Ultimately the thrill of the gain gives rise to the agony of the loss and those investors who are unabashedly bullish on the current crop of superstar stocks would be wise to learn their stock market history.”           

  • B. Schlossberg, CNBC 8/7/17

Somewhat predictably, absolute market extremes – both on the upside and downside – will have as contrarian indicators the level of investor optimism or pessimism. The recent nadir on the pessimistic side was during the first quarter of 2009 (at the bottom of the stock market), when you couldn’t give shares away because of investor fear after the 2008 market decline. Juxtapose that to our current scenario where, once again, your cab (or Uber) driver, golf buddies, and hair stylist’s sister are waxing eloquently about their recent prowess in the markets. The Wells Fargo/Gallup Index of Investor Optimism just recently returned to the pre-crisis levels of late 2007, and is currently trending towards the pre-dotcom-bust record high hit in September of 2000…all of which might gently remind us of Mr. Twain’s aforementioned observation about history sometimes rhyming.

We are neither Pollyanna’s nor Cassandra’s, but believe that relative and absolute valuation analysis provides the objective parameters that can help cut through the emotional tunnel-vision of the herd.  We, for example, find a number of less “stretched” sectors, particularly overseas, although domestically as well, that can provide ample opportunities to secure lower P/E and higher dividend-yield allocations for capital. Our goal has never been to attempt to “time” the market, but instead focus on investment themes that increase the likelihood of finding an empty chair when the music inevitably stops.  



 Encore Une Fois...                                                                      

Third quarter market action was, by most measures, a repeat of the second quarter. Global equity gained at a rate that again significantly outpaced underlying economic growth. To put recent U.S. stock gains into perspective, since the elections in November the S&P 500 has gained 19%. That is 7th best return for 11-month period following an election; the largest was the 41% rise after FDR’s election in 1932.

Investment capital continued to flow into riskier investments, particularly overseas. Inflation and market volatility remained distant memories. But there were some variations from the recent past: renewed weakness in both the US dollar and US Treasury issues and significant strengthening in commodities after a surge in energy prices.

The U.S. economy grew slightly more than expected during the second quarter of 2017, with growth accelerating to an annualized rate of 3.1%. The US economy has grown for 99 months, a period of time without a recession only exceeded in length twice 1900. The S&P 500 returned over 4.5% for the quarter. The index was led by the 8% gain in the technology sector, closing the quarter at a new record high and bringing its return for 2017 to over 14%. The Nasdaq also benefitted from tech strength with a gain of nearly 6% for the quarter and 20% for the year.

International equities were propelled by improving growth and rebounding earnings. A weaker dollar, the result of dwindling hopes for a Congressional stimulus package, also improved foreign market returns. The developed market, EAFE index gained 5.4% in the quarter and nearly 20% YTD, while the emerging market index gained nearly 8% and stands nearly 28% higher on the year.

All major world economies showed strength this quarter as conditions improved virtually around the globe. Close to 90% of countries are now in expansion territory, up from only 50% a year and a half ago. US economic reports showed a pickup in new orders and employment, despite hurricane-related disruptions. Marked strength in Germany and France pushed the Eurozone’s Purchasing Managers Index (PMI) to post-recession highs. China’s PMI is at its highest level since 2012 and the Japanese PMI is at four month highs.

The ride for stocks has been abnormally smooth during this climb. The largest decline so far in 2017 has been less than 3%. North Korea fired two ballistic missiles over Japan in August and the markets did not react. It also ignored hurricanes, the rise of the far right in Germany, and violence on the streets of Catalonia. Since the rapid reversal of the decline following the Brexit vote, market mentality has gone to buy the dips.

The bond market sold off in September as rates moved higher in anticipation of future rate hikes from the Federal Reserve. The Treasury yield curve continued to flatten in Q3, as it has for most of the year. The spread between 2 year and 10 year Treasuries has narrowed from 1.25% at the start of the year to around 0.85% now. Investors often worry that a narrowing yield curve is a predecessor to recession.

The global appetite for risk was reflected in the fixed income sector with corporate debt outperforming government issues.  Default rates remain low and investors looking for higher yield poured funds into emerging market debt and high-yield junk bonds.

The confluence of growth across all major world economies should benefit central banks as they make steps to normalize monetary policy and move away from the ultra-low interest rates policies of the past 10 years. The banks will seek the right balance between raising interest rates and keeping economic growth chugging along. The U.S. Federal Reserve is not alone in this effort. Canada has begun with two successive rate hikes. The Bank of England is in the unenviable position of trying to control measurable inflation, not killing economic growth while dealing with the uncertainty about Brexit negotiations.

In navigating this myriad of factors influencing the capital markets, the team at Old Port Advisors will continue to be vigilant with management of, and finding opportunities for, our client portfolios.

Sector Overview - Richard “Chip” Harlow

The crisp cool mornings of Autumn are with us once again, a favorite time of year for many. As the summer drew to a close, the Hurricane season began, and with it a shakeup of sector leadership and volatility in the markets.


Technology has been the best-performing sector globally this year, accounting for roughly half of U.S. and emerging market (EM) Asia equity returns so far; up 27.4% in the US through the end of Q3. Yet investors are torn between optimism on this fast-growing, high-earning sector and skepticism given its meteoric rise and memories of the dot-com bust.

The many intricacies of tech tend to be outshone by high-flying headline makers: the U.S. FAANG stocks (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) and their powerhouse equivalents in China —BAT (Baidu, Alibaba and Tencent). Both groups have propelled their regional stock markets higher year-to-date. FAANG returned 35% compared to 10% for the remainder of the S&P 500, while BAT returned 81% versus 26% for the remainder of the MSCI China Index. 

The technological disruption has only just begun: Digital has yet to permeate many industries; e-commerce represents fewer than 10% of all retail sales; traditional devices are becoming connected via the Internet of Things (IoT); and artificial intelligence (AI) is starting to transform processes. Healthy corporate earnings and upbeat forecasts have been the drivers of technology performance. Many companies beyond the popular acronyms have strong fundamentals and hold appeal for long term diversified portfolios.


Healthcare was the second best performing sector on a YTD basis at 20.3% vs the S&P 500 at 14.2%, continuing to outperform on the backs of biotechnology stocks, despite the continued political wrangling over Health Care reform.


Since the middle of August, the S&P 500 energy sector is up 11.5% compared to just 3% for the broader index as a whole. Many observers have chalked this outperformance up as a reaction to a deep oversold condition or a short covering bounce, but a growing amount of evidence suggests it may be more than that. Energy has in fact been outperforming since mid-June, just not US energy companies. There are fundamental reasons that suggest the rotation into energy may be structural in nature.

From a supply side perspective, US inventories of petroleum products peaked in mid-2016 and have been falling since then, as has the days’ supply of oil. Falling inventory levels are positive for the price of the commodity, and as such WTI crude has rallied from $43 to $52. At the same time, there is reason to believe inventory levels will continue to fall. While the rig count has risen since mid-2016, it has recently topped out and looks set to fall again. Market breadth indicators are also very positive. Finally, energy valuations are favorable. The median Developed Market energy company trades at just 1.6x book value while the median Emerging Market energy company trades at exactly book value. Both made valuation lows in 2015-2016 that exceeded the lows seen in 2009 and in both areas, valuations could rise considerably before getting back to an average level. Perhaps a sector to watch!

As widely expected, The Federal Reserve (Fed) announced that it will begin inching away from its audacious post-crisis monetary experiment in October. The European Central Bank (ECB) and even the Bank of England (BOE) are also sounding progressively less lenient. Equities are still expected to outperform Treasuries in such a scenario.

Historically the equity sectors that have tended to do well in this backdrop are the more cyclical areas of the market such as Industrials and Financials. For the Industrials, a reviving backdrop for investment around the developed world amidst buoyant business confidence suggests that this sector has decent earnings prospects. For the banks and wider financials, higher interest rates will be very helpful for profitability, which in turn should speak well of the prospects for further loan growth.


Stop Me If You’ve Heard This Before…

…but the Department of Labor’s Fiduciary Rule timeline just got more complicated.  The DOL requested an 18-month delay in implementation of the oft-discussed and much maligned rule change.  The Office of Management and Budget approved the proposal in late August.  After a comment period, the final rule will be proposed by the DOL, probably sometime in October.  The end result? The rule, if adopted, would change the date of required compliance by investment advisors from January 1, 2018 to July 1, 2019.

As reported by Investment News on August 30th, “the primary purpose of the proposed amendments is to give the Department of Labor the time necessary to consider possible changes and alternatives to these exemptions”.  These changes revolve around easing certain restrictions if advisors use so-called “clean shares” which are fund shares that don't have expenses paid by the investor that are funneled back to an advisor, such as front-end loads or 12b-1 fees.  For our part, OPA recommends the use of “clean shares” (preferably lower cost institutional shares) in all retirement plans.  It will be interesting to see if any other changes come out of the 18-month delay.

On a side note, to further complicate things, the Securities and Exchange Commission is also developing their own fiduciary rule.  In early October SEC Chairman Jay Clayton testified before the House of Representatives Committee on Financial Services that the SEC would like to establish a uniform fiduciary standard.  The silver lining?  They are supposedly coordinating their efforts with the DOL.  We’ll have more on this as the SEC gets their rule to proposal stage.


College: Applying Early?   

After a significant drop in admission applications in the 1990’s, many colleges and universities adopted a strategy of taking early applications and accepting students early.  The general concept is if a prospective student wanted to attend a specific school, and could afford that school without needing financial aid, the student could apply for early acceptance and get a decision from the school well ahead of the regular pool of applicants.  The schools liked this for two primary reasons:

  1. The most competitive schools strive for low college acceptance rate (some with rates as low as accepting only 4.5% of all applicants) and high percentages of accepted students attending (over 97% of the 4.5% accepted students matriculating).  The early acceptance programs helped improve these ratios.  There is a certainty in knowing that you have a commitment from a student to attend.
  2. If the early acceptance students pay full freight, it is more beneficial to the bottom line.  If you had 20 cars for sale and 15 people that would pay full price and 10 that want to negotiate, who are you going to sell to first? 

While there are varied opinions about the early admission process and its perceived catering to the wealthy, it may be right for some.  Early Decision (ED) and Early Action (EA) are the two choices for students that want to be admitted early.  Note:  some schools may offer other variations, but these are the typical formats.

Early Decision

ED can be a great option if the student knows which college they want to attend.  It is great for legacy students.  Just be aware that ED is binding:  they can only apply to one school for ED (they can still apply regular decision to other schools); they agree to attend the ED institution if admitted (while they can get out of ED, it is frowned upon and could carry repercussions depending on the school).

  • Pros of ED
    • Higher acceptance rates – up to double the acceptance rate of regular admission
    • Reduced stress- they get their answer early, almost 5 months before regular decision
    • Financial aid is not an issue – you know you can afford the school
  • Cons of ED
    • Loss of a better package - they must withdraw all applications to other schools if accepted
    • Change of heart – remember, they’re a stressed-out teenager, things change
    • Less time to improve – ED applicants use previous year transcripts; not current 
    • Time crunch- if they are rejected for ED, there is little time to submit other applications

Early Action

EA allows the student to apply early to many schools and receive a decision earlier than the regular pool, usually January or February; it is more flexible than ED but can take longer. 

  • Pros of EA
    • Reduced stress – decision a few weeks after ED, but before regular admission pool
    • Flexible - can still evaluate all other offers and choose best without repercussions
    • Higher acceptance rates than regular admission pool, lower than ED
  • Cons of EA
    • Time crunch- if they are rejected for EA, there is little time to submit other applications
    • Less time to improve – EA applicants use previous year transcripts; not current

Applying early could be a great option for the right student and family.  For those that can afford it and have extensively researched the college (academically, geographically and socially), found it to be a match and determined that the student meets or exceeds the institution admissions profile for grades/test scores/etc., it can be a good fit.  If not, the early application process is probably not the right choice.  



OPA Out & About:

We’re continuing the time of year when a variety of non-profit organizations further their annual fundraising efforts so they can continue to enhance the fabric of our community. Although by no means complete, the events below are but a sampling of the organizations that our firm, employees, colleagues and clients are involved with, should you want to consider supporting their missions.

Armenian Cultural Association of Maine – Held its annual summer picnic at Camp Ketcha on August 13rh and OPA was one of the event’s sponsors. Additional information about the association can be found at http://armeniansofmaine.com

Center For Maine Contemporary Art – OPA was part of the host group for CMCA’s first anniversary of the opening of their new gallery space in Rockland on August 18th – more information regarding the Center’s work can be found at http://cmcanow.org

Maine Sports Hall of Fame – Had its annual benefit to support the recognition of Maine’s scholar-athletes and leaders on October 2nd at Sable Oaks and OPA was one of the sponsors for the event. Information about their history since 1972 can be found at https://www.mshof.com/about/

Portland Trails – Is hosting a rooftop gathering on October 4th at 118 Congress Street to overview their community work through trails and active transportation – more about the organization can be found at www.trails.org

A Pink Tie Party – We are part of the host group for an event October 5th at Vinegar Hill Music Theatre in Arundel to support The Maine Cancer Foundation. Additional information can be found at https://www.facebook.com/events/237623283382448/

St. Lawrence Arts – OPA joined the host committee for a rooftop fundraising concert by two-time Grammy nominee Cidney Bullens to support Munjoy Hill’s neighborhood art center. More information is available at http://www.stlawrencearts.org/

Maine Coast Memorial Hospital – Will be holding its annual Poinsettia Ball on December 2nd to benefit its foundation, and OPA will be one of the sponsors again this year. Additional information can be found at  https://www.mcmhospital.org/home.aspx                  

Also, please feel free to visit our new website (www.oldportadvisors.com) as we continue our rebranding efforts and build out more of our online capabilities.

Old Port Advisors was founded more than 20 years ago as Investment Management & Consulting Group (IMCG), with a vision to create a boutique independent investment management firm centered on the best interests of our clients. Our principles were simple and still ground us today: a values-driven, personalized, collaborative, and strategic approach to investing, wealth management, and fiduciary consulting. We changed our name to embark on the next 20 years, but our leadership and our calling remain. We’re excited to build on our past experience and success to deliver on our promise of building a secure future for our clients.