Bob’s Journal for 12/12/19

Some Notable Events Grabbed My Attention This Week

I’ve frequently warned my readers to ignore the noise that dominates so much of the financial media.

I’ve also warned you to closely scrutinize stories when planning your investments and finances. Nobel Prize laureate economist Robert Shiller recently published a new book that makes the same points in more detail.

In Narrative Economics: How Stories Go Viral and Drive Major Economic Events, Shiller wrote that investors need to know that stories drive markets and the economy. The stories that prevail in the media and in conversations often influence people’s behavior.

Investors especially need to know which stories have gone viral and how they are influencing markets. You don’t want to be caught up in a viral story, because it likely isn’t accurate. A story is likely to lose its viral status, and its effect on the markets will be reversed.

Shiller said he found people usually don’t select their investments through any systematic method. Instead, they respond to what people are talking about.

Shiller reported that artificial intelligence (AI) is a major story these days. For the moment, it’s a positive story. But he’s concerned one day the AI story will focus on lost jobs and will cause consumers to worry about potential negative effects of AI and reduce their spending.

President Donald Trump also is a powerful story. Again, Shiller conveyed the story is positive for now. Trump focuses on success and the American dream and encourages people to pursue both. Shiller added that is part of what’s driving the economy and markets. But he’s concerned that story, too, could become negative.

Shiller wrote it is difficult for most people to determine what’s true and what’s not in most investment stories. They risk being caught in a narrative that drives an investment to an artificial, unsustainable level.

But an investor who can analyze narratives and judge which are accurate and which aren’t can use that talent to increase investment returns. It’s difficult, because narratives are inspired or spring from real events. They’re rarely completely false or artificial.

For most investors, Shiller says the best response is to diversify and avoid investments based on what people are talking about.

The Great Stock Sell-Off

The market indexes have strong returns in 2019 and have set a number of record highs during the year.

Yet, investors are selling shares of stock funds at a record rate.

In 2019, investors have withdrawn the most money from equity-focused mutual funds and exchange-traded funds since investment data provider Refinitiv Lipper began tracking the data in 1992.

Investors have been withdrawing money from stocks since the second quarter of 2018. This trend coincides with the escalation of the trade conflicts between the United States and China.

Most of the money has been shifted to safer investments, such as bonds and money market funds. The apparent good news is this means the stock indexes are rising without individual investors chasing gains as they did in the technology stock bubble of the late 1990s.

The data covers only fund flows. It doesn’t include purchases of individual stocks.

The data also doesn’t include money flows of investors other than individuals. It is likely that individual investors have only a relatively small influence on investment prices in 2019. Institutions and professional investors who move around hundreds of millions or billions of dollars probably influence prices more.

Also, stock buybacks by companies aren’t included in the data. Corporate stock buybacks have been significant for several years and increased in 2019. A number of analysts commented stock buybacks have been a major support of the bull market the last few years. In 2019, corporate stock purchases are likely to far exceed the cash flows of all individual investors.

The issue for investors is how long corporations are likely to continue the rate of stock buybacks they’ve engaged in the last few years and what will happen to markets if buybacks dwindle.

The Quiet Deaths of 1,000 ETFs

Exchange-traded funds (ETFs) have reached a key point in their life cycle.

ETFs caught the investment world’s attention in the early 2000s. The then-new investment product became a genuine phenomenon, reportedly growing faster than any other new investment vehicle.

Investors were attracted to ETFs by their simplicity, low cost, tax efficiency and transparency. Most ETFs were and are index funds.

It wasn’t long after their introduction that there were more ETFs than publicly traded stocks. To participate in the phenomenon, financial firms were issuing ETFs with some unusual investment themes or that tracked obscure indexes.

As with all fads, the ETF boom was overdone. Many ETFs couldn’t attract enough investors to pay the funds’ costs. Often trading in these ETFs was so infrequent that there could be a large spread between the net asset value of an ETF’s shares and the shares’ trading price. These unprofitable funds became known as “zombie ETFs.”

For several years, ETF sponsors were hesitant to close unprofitable ETFs. But the leading ETF sponsor, BlackRock, finally began to liquidate or merge ETFs aggressively that weren’t profitable. Other ETF sponsors followed suit.

This year a new benchmark was reached. Recently, the number of liquidated ETFs hit 1,000, according to a Bloomberg report.

More ETFs are likely to disappear. Bloomberg estimates there still are about 400 “zombie ETFs.”

As happens in most industries, three fund sponsors now dominate the ETF market. There is room for other firms to profitably issue ETFs if they attract enough investors and are operated efficiently. But it looks like the boom and fad period for ETFs is behind us.

The Data

Consumer Sentiment as measured, by the University of Michigan, increased to 99.2 in December from 96.8 in November. This is a seven-month high and is well above expectations. The increase was due largely to a significant improvement in views of current conditions. Expectations also increased, but not nearly as much as the views of current conditions.

Small business owners also are more optimistic. The Small Business Optimism Index from the National Federation of Independent Business (NFIB) rose to 104.7 from 102.4. That was the largest monthly increase since May 2018. The index now is comfortably above the recent low of 101.2 recorded in January 2019. But it must improve some more to return to the cycle high of 108.8 reached in August 2018.

Inflation continues to be moderate. The Consumer Price Index increased 0.3% in November, compared to a 0.4% increase in October. Excluding food and energy, the index climbed 0.2% in November, the same rate as in October. Over 12 months, the two measures have increased 2.1% and 2.3%, respectively.

Wholesale prices were even more tame. The Producer Price Index was unchanged for the month of November. After excluding food and energy it declined 0.2%. Over 12 months, the two measures increased 1.1% and 1.3%, respectively.

Factory orders increased by 0.3% in October, following a 0.8% decline in September. The October increase followed two months of declines. Over 12 months, factory orders are down 0.4%.

Last week’s Employment Situation reports were more positive than expected, registering 266,000 new jobs for November. The unemployment rate declined to 3.5%, the lowest rate since 1969. Average hourly earnings increased by 0.2% for the month and now are up 3.1% over 12 months.

Manufacturing jobs increased by 54,000. The report was somewhat distorted by the end of the strike at GM, which resulted in an increase of 41,300 manufacturing jobs. Even so, the numbers were much better than expected, showing the economy still can create a high number of new jobs after 10 years of economic growth.

There was a big reversal in new unemployment claims. The claims increased by 49,000 in the latest week to 252,000. That’s the highest level since September 2017. Investors shouldn’t over-react to this report. The claims numbers tend to be volatile during holiday periods.

The Markets

The S&P 500 rose 0.95% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.96%. The Russell 2000 increased 1.11%. The All-Country World Index (excluding U.S. stocks) added 1.23%, while emerging market appreciated 2.46%.

Long-term treasuries fell 0.04% for the week. Investment-grade bonds increased 0.21%. Treasury Inflation-Protected Securities (TIPS) added 0.14%. High-yield bonds gained 0.74%.

In the currency arena, the U.S. dollar declined 0.45%.

Energy-based commodities increased 0.64%. Broader-based commodities rose 0.92%. Gold gained 0.14%.

Bob’s News & Updates

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