Big banks pass the Fed’s Stress Test

The Federal Reserve released the results of their annual stress tests on the nation’s biggest banks, and the positive impact can be a turning point in the stock market. Amid concerns that banks would not have enough capital to endure another financial crisis a la 2008, the results came through with flying colors and for the first time in 7 years, all 34 financial institutions passed[1]. The rigorous examination tests the stability and strength of these banks to withstand a severe recession. Each bank is put through a hypothetical scenario of harsh economic conditions– such as 10% unemployment or a GDP growth rate of -10.6%[2]. Regulators then determine whether the banks have enough capital to survive such conditions, as well as their ability to measure and manage risk when paying dividends or buying back shares.

Behind the positive results however, looms the ongoing campaign from the Trump Administration to reduce regulation. The Fed determines the minimum level of capital that banks must hold, and to pass these tests, banks must hold even more capital than they are required. With unemployment under 5% and GDP growing at 2%2, the tests in extremely dire situations can beg the question that the Fed’s capital requirements are perhaps too high. The Trump Administration campaigned on the premise of decreasing the Fed’s regulation, arguing that high capital requirements hinder bank’s ability to lend to small businesses and homeowners. This view differs greatly from Fed Governor Jerome Powell, who indicated that the Fed intends to further increase regulation and minimum capital requirements for the eight largest banks. In fact, recent data suggests that bank lending has increased to all-time high levels for commercial and industrial loans.[3] However, about 50% of loan applicants received smaller loans than requested, indicating that the conservative and risk-averse nature of bank lending is hurting the growth of younger and less proven applicants.

While the Fed will ultimately decide what direction capital requirements go in the future, investors can take comfort knowing that banks are strong enough to lend to households and business, even during a recession. Banks are now eligible to raise their dividends and buy back shares, which may help attract more investment in the future. Investors and shareholders of big banks can expect to see higher payouts in the coming weeks.

bank loan graph

Source: CNN Money

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.
[1] http://money.cnn.com/2017/06/28/news/economy/fed-stress-test-wall-street-results/index.html
[2] http://www.cnbc.com/2017/07/03/the-trump-administration-not-the-fed-has-it-right-on-bank-regulation-commentary.html
[3] http://money.cnn.com/2017/02/13/investing/bank-business-lending-dodd-frank-trump/index.html?iid=EL

Has tech’s run-up in the market ended?

Early this week, technology shares saw a sell-off across the sector after an analyst downgraded Apple (AAPL) stock from Buy to Neural.[1] Prior to the pullback, investors already had growing concerns about a potential “Tech-Bubble” reminiscent of the Dot-Com bubble of 2000, which would eventually result in a crash that disrupted the entire stock market. [2] These concerns were somewhat muted when the decline in the sector that has carried the stock market to all-time highs in the last year did not influence a wider market selloff.

The tech sector has become increasingly popular, mostly due to the performance of FAAMG, the acronym given to the Tech Giants that have dominated the US stock market: Facebook (FB), Apple (AAPL), Google-owner Alphabet, Amazon (AMZN), Microsoft(MSFT) Corp, and Google owner Alphabet (GOOGL). The Los Angeles Times has reported that the technology component of the S&P 500 alone was up 18% this year.2 The chart below shows how these 5 powerful companies have become the key drivers in major indices:

FAAMG chart

Source: Business Insider

But popularity can also indicate an over-crowded trade, and the fall on Monday is what can happen once these shares lose their momentum. The past few years have seen a steep rise in the technology sector and any amount of disruption can be brutal for shareholders.

However, even despite the run-up, the most powerful companies in the sector have recorded lower volatility than any other sector in the last 6 months, according to the Research Team at Fidelity Investments.[3] These are companies that people interact with daily; the fact that the tech sector’s biggest names are well-established and highly-profitable should dispel any fears of a dot-com-like bubble. Some might even view a pull-back as “healthy”, potentially allowing for more growth in the future.

It’s hard to imagine the FAAMG companies falling out of favor anytime soon, even with the new Trump Administration’s proposed trading policies that could impact tech companies specifically by imposing a border tax that could hurt profits.[4] But for now, investors shouldn’t sweat a 1 or 2 day move into the red for technology companies. Technology shares bounced back in Wednesday’s pre-market trade, and the short-term negative move can be seen as a small correction to a sector that has had a spectacular run.[5]

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

[1] http://www.nasdaq.com/article/close-update-wall-street-weighed-down-by-tech-sector-cm802337

[2] http://www.latimes.com/business/la-fi-markets-20170522-story.html

[3]https://eresearch.fidelity.com/eresearch/markets_sectors/news/story.jhtml?storyid=201706131450MRKTWTCHNEWS_SVC000421&provider=MRKTWTCH&product=NEWS_SVC&category=sectorNews&gic=45

[4] https://www.thestreet.com/story/14001605/1/these-are-the-trump-policies-that-would-hurt-tech-companies-like-apple-the-most.html

[5] http://www.nasdaq.com/article/technology-sector-update-for-06142017-msft-aapl-ibm-csco-googl-nok-mvis-cm803192

Athleisure’s Impact in the Retail Sector

Lululemon (LULU) stock slipped by more than 20% on Thursday after posting Q4 earnings for 2016 that missed expectations and gave a bleak outlook for the first fiscal quarter of 2017[1]. The brand that helped pioneer the “Athleisure” trend has seen less traffic in both their stores and on their website, partially due to the new-found stiff competition– and a dismal outlook provides an opportunity for their competitors to grow even more. So is the Athleisure trend dying, or is the market just oversaturated with leggings in the apparel industry?

Athleisure is a term that refers to active wear that is suitable for both exercise and everyday life, as described by Merriam-Webster dictionary.[2] The words Athletic and Leisure are antonyms that have been combined to create the newest phenomenon in fashion.  Hoodies and leggings are not only trendy, but appropriate for places outside of the gym, and their popularity has all but cemented the style’s place in the retail sector. Much of this is due to the cultural shift of increased health awareness, and driven by millennials who made it cool to wear joggers and sneakers to the office. Nike’s CEO Mark Parker confirmed this shift at the 2014 Women’s Innovation Summit, proclaiming that “Leggings are the new denim.”[3] Starting with companies like Lululemon, the trend of wearing leggings and yoga pants anywhere created its own niche in the market place by filling in a gap: clothes that are functional were now also stylish. The trend caught so much buzz that luxury fashion brands even showcased their expensive version of street clothes on the runway. Suddenly, price points ranged from basic Nike tees for $30 to Alexander Wang’s cashmere sweatpants for $295.

In an otherwise lagging apparel industry, which has seen low sales growth at 2% in 2015, active wear stands out, with a 16% increase in sales that same year.  Without the boom in athleisure trend, it was estimated that the industry would have declined by 2%[4]. But in the short span of about a year, athletic-based retailers such as Sports Authority and Quicksilver have filed for bankruptcy, and now Lululemon and Under Armour have seen sales-growth decline along with their stock prices. Yet despite these setbacks, athleisure doesn’t seem to be losing its popularity anytime soon; the trend is representative of a lifestyle shift with health and comfort as its main priorities. The decline in sales for these companies is likely do to an over-stretched market— from Wal-Mart to Lululemon to Alexander Wang, now enters the era of celebrity-based collaborations with athletic aesthetic top of mind (Stella McCartney with Adidas, Beyoncé with Topshop, etc.). The focus on fashion-forward active wear will leave many brands in the dust if they don’t continue to adapt to changing trends that appeal to their customers. Gym clothes are the uniform on the street now, whether they are worn for athletics or leisure.

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

[1] http://finance.yahoo.com/news/lululemon-lulu-plunges-q4-earnings-110711100.html

[2] https://www.merriam-webster.com/words-at-play/athleisure-words-were-watching

[3] https://www.nytimes.com/2016/03/17/fashion/nike-fashion-olympics.html

[4] https://www.forbes.com/sites/greatspeculations/2016/10/06/the-athleisure-trend-is-here-to-stay/#b244f7428bd4

US Household debt at highest level since 2008

The New York Federal Reserve’s quarterly report contained some startling news: household debt in the US totals $12.58 trillion, which means Americans are in nearly as much debt now as they were at the peak of economic turmoil in 2008 when household debt was at a record high of $12.68 trillion. Between the third and fourth quarters of 2016 alone, debt increased by $226 billion.[1]

Student loan debt is particularly alarming, as it increased by $31 billion in the fourth quarter of 2016. This isn’t particularly shocking, since college tuition has soared, but it’s a figure that many college graduates may not be in a position to pay off. Credit card debt is rising at a faster percentage, but whether people are living beyond their means, or just incurring more debt and managing can only be answered in the coming years.

While credit card debt and student loans are a factor, much of the debt is attributed to home and auto loans. Mortgage originations are at their highest levels since the Great Recession of 2008, and auto loan originations are at a record high, indicating that banks are more willing to extend credit. This might ring a bell to 2008, when banks overextended loans

While those numbers may spell out doomsday, it should be noted that the number of households in the US expands every year, therefore it can be assumed that debt would increase as well. [2] So considering that there were 125.82 million households in 2016 to 116.78 million in 2008 softens the blow a bit. Additionally, despite the increased debt, bankruptcies and foreclosures were at an 18-year low. Still, the huge spike in household debt in 2016 alone is a cause for concern, and the New York Fed doesn’t expect things to slow down in 2017, where we may just see record high levels of household debt.1

us-household-debt

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

[1] https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2016Q4.pdf

[2] https://www.census.gov/quickfacts/table/PST045216/00

Selfie-Effect in the Retail Sector

In general, 2016 was a bad year for America’s retailers. Even with employment on the rise and a slight increase in wages, consumers turned their backs on many brick and mortar locations, causing some of the industry’s biggest names to announce store closings.  A long list of brands have decided to cut costs by closing underperforming locations like Macy’s, Kohls, Walmart, Aeropostale, Sears and Ralph Lauren.  Others have opted to file bankruptcy, like the The Limited which was one of the strongest chains in malls at one point, and Sports Authority.  The trend has even spread to shopping malls as property managers continue to close locations or sell structures for pennies on the dollar.

Customer habits have shifted—people prefer buying clothes online at Amazon rather than brick and mortar stores at the mall. But despite this change that has been so detrimental to many traditional US retailers, the cosmetics industry has been a rare bright spot for an otherwise disastrous 2016.  According to market researchers Mintel, the beauty business is forecasted to grow 12% in the US by 2020.

Makeup has been an especially strong retail product line in the last few years. Top industry names like Ulta, e.l.f., and Sephora have proven that brick and mortar locations can succeed in this modern market.  Ulta and e.l.f have a history of double-digit sales growth.  Sephora, owned by luxury brand parent Moet Hennessy Louis Vuitton, experienced double-digit growth in both sales and profits in 2016.

So why aren’t online retailers sucking up the business of physical makeup stores like they’ve done to others? Some of it can be attributed to the shift in culture: we are now in a selfie generation, and social media (especially Instagram) has made looking good on camera more important than ever. But retailers like Sephora and ULTA also have rewards programs that accounts for much of their sales. Why would someone buy makeup from Amazon when they can’t get the benefit of points? Points and rewards help create a loyal customer base, so every time a tube of mascara runs out, they’ll keep going back to the same place with hopes of getting some freebies with those racked-up points.

Another reason: makeup retailers offer a better experience now than ever. It used to be that beauty shoppers only had the choice between a no-frills drugstore or a fancy department store. New retailers have found the happy medium, offering a wide variety of brands, trendy store design, and products for all price points.  And then there is the accessibility. Shoppers can test out the products for themselves, offering a compelling reason for the consumer to actually go into those stores. So while a customer waits in line to try on clothes at the Gap, a customer at Sephora can walk in, try on a few shades of lipstick, and send a selfie to their friends asking which is the most flattering as quickly as they would like.

retail-blog-graphb

Source: Bloomberg

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

Winners and losers of a stronger dollar

It is no longer news that the stock market has continued to rally since the election. Among many factors, expectation for changes in fiscal policy has helped the DJIA finally hit that elusive 20,000 milestone. But this is only the scaled average of 30 major stocks; the index is not broad enough to give an indication of the economy. Economic growth has been sluggish since the “Great Recession” of 2008, averaging around 2.1% based on GDP; average wages have remained flat and company earnings have been weak as of fiscal third quarter 2016. Some of these issues can be attributed to a strengthened dollar, which has appreciated against 6 major rivals by about 25% since 2014, according to FactSet.

Treasury secretary nominee Steven Mnuchin said that the strength of the dollar “has been tied to the strength of the US economy and the faith that investors have in doing business in America”. He did, however, also mention that an excessively strong dollar may have negative short-term implications on the economy. President Trump has stated that the US dollar may actually be too strong because “our companies can’t compete with Chinese Companies”. Anemic global economic conditions have encouraged foreign investment in the US because of its relative economic strength; the perceived safety and ability to achieve an acceptable rate of return on investments would in turn increase the demand for dollars. This strength is now in tandem with the proposed fiscal policies, which could cause further appreciation in the dollar this year—something many analysts agree on.

There are pros and cons to a strong dollar; it generally bodes well for American consumers to have a strong greenback. We get the most bang for our buck when traveling abroad, as goods and services in other countries become cheaper. That dream vacation to France would be much more affordable now than it would be a few years ago. Imports are cheaper, so those luxury cars from Germany will fall in dollar price. For US companies that import materials from other countries, they will see profit margins grow as a result of the lower cost of production.

But many US companies with international market exposure have had weaker profits over the last few quarters, citing the stronger dollar as a factor. Income earned from foreign sales decrease in value on their balance sheets. As the dollar strengthens against another currency, goods and services in the US become more expensive for people using that other currency; they might end up buying less of those American-made goods, which is ultimately bad for our domestic producers. Conversely, foreign imports become cheaper, making domestically produced goods become even more expensive abroad. Overtime, weaker demand for American goods and services creates a trade deficit, in which imports surge and exports plateau.

Essentially, a strong dollar is good for some and relatively bad for others. Economic theory suggests that currency fluctuations will eventually revert to an average level; cheap foreign goods will eventually see increased demand, raising their prices. Conversely, expensive domestic exports will both fall in demand and prices. Ultimately, equilibrium should be found. Time will only tell if this theory persists.

strong-dollar

Source: Bloomberg

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

New Year, Higher Rates: The domino effect of raising interest rates

As widely reported, the Federal Reserve Board in December raised interest rates by 0.25% for the first time in 2016 and only the second time in a decade. The DJIA fell by 100 points immediately after the announcement, but their action signifies confidence in the improving US economy. Back in 2008, rates were slashed to near zero in the midst of the financial crisis and eventual recession. Since then, unemployment has fallen to 4.7%, the lowest rate since 2007, and the economy has continued to grow for 7 years, albeit at a slow pace.

With new incoming administration comes plans for big spending on infrastructure that would spark demand for many goods, typically a precursor of inflation. Fighting inflation would involve raising interest rates at a faster pace in the next year, which the Fed has hinted at. However, as we saw in early 2016, hints create no certainty with the Fed. Last January they projected raising rates 4 times in 2016 until low oil prices and other economic setbacks put those plans on hold.

But if this rate hike reflects a strengthening economy, shouldn’t the stock market rejoice with a spike instead of the 100-point dip in the Dow? Raising interest rates creates a domino effect in the behavior of consumers and businesses that ultimately impact the market. The immediate effect of raising the federal funds rate is that it makes it more expensive for banks to borrow from the Fed. Banks then increase the rates they charge to customers to borrow money for mortgage or credit cards. This decreases the amount of disposable income that consumers can spend. If consumers spend less, business have lower revenues and profits. Additionally, if it becomes more expensive for businesses to borrow from the bank, they may borrow less money, slowing their growth and decreasing profit. Simply put: a decrease in profit for companies lowers the stock price of a company and if enough companies experience these declines, the whole market would go down.

Conventional wisdom suggests that when interest rates fall, fixed income investments are less competitive because of lower yields and stocks become more attractive; conversely, when rates rise, fixed income investments are more attractive because of higher yields. That is not to say that rising interest rates automatically result in dropping stock prices and falling interest rates mean more profit for companies. One of the reasons the Federal Reserve raises interest rates is to keep inflation down, which is good for businesses and may cause stocks to rise. This time around, however, things are actually different. Rates were at historic lows, and the Fed has never raised interest rates when inflation has been as low as it is today. But interest rate hikes typically occur during favorable economic conditions, and history shows that stock prices can keep going up despite interest rate hikes. Below, you will see that between 2004 and 2007 the stock market was at record highs, even with rising interest rates.

sp-and-rates

Source: Quora.com

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

 

What would a cut in the corporate tax rate mean for the economy?

With 2017 quickly approaching, we have seen the market rally to new highs. The expectation of economic change has consumer confidence running high, and a decrease in the corporate tax rate seems to be the most probable change in the near future. But what would this cut in tax rates really mean for the US economy?

At 35%, the US has the highest corporate tax rate in the developed world. It is charged on profits earned abroad minus foreign tax paid when repatriated. This incentivizes companies to book their profit in low-tax countries (such as Ireland) and outsource jobs abroad so as to avoid US taxes and only incur the low taxes of the country they choose.

But aside from high tax rates, corporate investment in the US have been on the decline; consumption and saving patterns have weakened demand. And most corporations don’t pay 35% because of very aggressive tax efficiency strategies, allowing them to owe less. The tax code is riddled with loop holes that enable said strategies; the proposal for cutting corporate taxes also includes plans to simplify the tax code and cut regulation.

The idea is that if corporations can save on taxes, their earnings will grow. CNBC reported that for every one percentage point reduction in the tax rate, this could “hypothetically add $1.31 to 2017 earnings”. The current tax rate is at 35% with a goal of reducing it to 15%; if this 20% reduction takes place that could mean $26.20 added to earnings on average. Aside from these savings going to the bottom line, extra capital can be used for other purposes: investing in equipment, mergers and acquisitions, or stock buybacks.

less-is-more-corp-tax-blog

Source: Barron’s

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.