Clients and Friends of our Firm:
It’s Hurricane Season again. Our thoughts are with those in Texas still dealing with the aftermath of Hurricane Harvey. As we mark the anniversary of the hurricane that stuck the home of many of our clients and our home office, I am reminded of the parallels between hurricane warnings and the early indicators for our next significant market storm.
We didn’t worry about hurricanes in California. That changed when I moved my family cross-country to the South Carolina coast. “What’s your hurricane plan?” I’d ask friends after I moved here. “Leave early and avoid the traffic,” said some. “Take back roads and avoid the major highways at all costs,” said others. “Aw, it’s not going to hit us. Just another false alarm,” was a popular response. I discovered that hurricane planning differed as much as the individuals themselves. For the first ten years of living here we had some close calls but never needed to evacuate. But on September 22, 2016 a blip on the satellite image appeared off the west coast of Africa. It strengthened into a tropical storm and by October 1st was a monster Category 5. Hurricane Matthew turned north out of the Caribbean and crawled up the Florida coast. One friend was almost giddy. You see he owns a backhoe. And a generator. And a truck with a wench, chainsaws, and a boat. It’s not that he consciously wished the storm our way. But it was hard for him to hide his excitement as he thought of all the toys he’d get to use. Meanwhile, the more cautious residents were out of here days before the first drop of rain and well before the first gusts. My Green Bay Packer-loving friend from Wisconsin found it an irresistible experience. Let’s see, the last hurricane to hit Wisconsin was… never. He stayed through the storm, and lived to tell the tale.
Me? I took the accumulated local knowledge and developed my own plan. It was pretty simple. In short: prepare early, leave late. A week before as the Hurricane turned north out of the Caribbean I booked two hotels rooms 100 miles inland. But it was just an early precaution. Surely this hurricane would veer away just as all the others had done. With the hotel booked we watched daily as Matthew neared. We fueled both cars, again just in case. Matthew held course. The evacuation orders went out. From our home we could see the bridge leading from the island to the mainland. Fleeing residents made their way across in bumper-to-bumper traffic at all hours. Matthew bore down. Hotel booked and plan in place, we moved everything that could be blown or flooded to the second and third levels or our home. With Matthew’s leading edge less than 24 hours out, we were not panicked. We had prepared and done all that we could. By then the traffic was basically non-existent. We closed the house and drove the nearly deserted route away from the coast at a modest speed. Safe in our hotel rooms before the first drops of rain hit, we watched the Weather Channel reports as Matthew came ashore within miles of Hilton Head in the early morning hours of October 8th.
EARLY FINANCIAL STORM WARNINGS INDICATORS – LEI AND INTEREST RATES
Hurricane season overlaps with a historically volatile period for the U.S stock market. Traders typically return from vacations after Labor Day and volatility picks up as a result. “Black Monday” was in October 1987, the 9/11 attacks and subsequent market decline was September 2001, the Financial Crisis of 2007-’08 burst to the forefront in September of 2007 and hit with fury through the Autumn of that year. At all times, but especially during this season, we take a hard look at the data that serves as an early warning for the next financial storm. There are two warning indicators to which we are particularly attuned:
1) LEADING ECONOMIC INDICATORS (LEI)
We watch LEI because simply stated, no recession has started in the U.S. without an advance fall in the aggregate LEI index. So, what’s the LEI Index doing now? It’s still trending up.
2) INTEREST RATES
We’re watching interest rates? Why? If rates rise substantially fixed income investments (bonds, savings accounts, money market, etc.) become more attractive at the expense of equity investing. Higher rates provide incentive for investors to take money out of stocks in favor putting funds to work in fixed income investments. Additionally, higher rates can strangle the fuel on which the economy feeds. Everything from new business formation to new home construction to consumer purchases can go stagnant. At present we’re looking at a threshold rate of 2.4% or higher on the 10 Year U.S Treasury that would serve as an early warning indicator. Today’s rate? The 10 Year Treasury closed at 2.1%. The 10YR yield threatened to break higher in early July closing as high as 2.38% on July 7th, but backed away from that level in in succeeding days. So for now, rates remain historically low and continue to serve as support for the equity market. We’re keeping a vigilant eye on interest rates.
GUT INSTINCT AND WHY YOU SHOULD IGNORE IT
My gut says we’re due for a correction this Fall. North Korea is launching missiles. We have rioting in our streets. Our political system is a mess. You know what you should do with that information? Nothing. My fears, biases, and concerns can cloud my judgement. So we don’t trade on gut at Blackwell Boyd. We trade according to a disciplined process. We have moved away from risk this Summer and Fall, but we are still invested because the data supports it.
If the storm does hit this Fall, that’s what financial advisors will say. We will say it because it is good advice, but also because we need time to think and want everyone to be calm while we do. But it’s hard not to panic if you are unprepared and chaos reigns around you. It’s not as difficult when you have planned in advance. We’ve done just that. We have been taking steps in your portfolios throughout the course of this year to reduce risk. Specifically, in most portfolios we have added a protective hedge designed by our partner, WST. And we have moved to sell higher multiple growth stocks in favor of lower multiple value stocks. This article is not intended to cover the details of those moves, but we’re happy to delve into the specifics with any of our clients who would like a better understanding.
Have a wonderful Labor Day weekend. Meanwhile, Hurricane Irma is strengthening and making her way westward across the Atlantic this weekend. For those in the potential path, prepare early. I am booking a couple of rooms inland in Augusta, Georgia. Probably won’t need them and will cancel the reservations as Irma chances course, hopefully out to sea. But, we’ll be prepared.