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Strategic Insights

Volume 7, Edition 34 | September 24 - September 28, 2018

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Fed up with Musk

Doug_Walters Doug Walters | Articles

Read Time: 5:00 min

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The Federal Reserve raised rates this week, while Tesla’s outspoken CEO Elon Musk provides a good teaching moment for stock pickers…

Market Review

Contributed by Doug Walters

U.S. stocks fell through Wednesday’s Fed rate announcement, only to claw back some of those declines later in the week. Tesla (TSLA) shares did not participate in the rebound, falling double-digits and providing a useful lesson for individual stock investors.

Rate Neutrality

The Fed raised rates again as expected. Following the third increase of the year, the Fed Funds rate now stands at 2.25%. The rate has been steadily increasing since 2015 when it was as low as 0.25%. Removed from the Fed commentary was the word “accommodative.” We discuss the meaning of this in our Spotlight section.

The drama continued with Tesla (TSLA). Recall in August (Talking Turkey) we discussed our belief that CEO Elon Musk might have gotten himself in trouble with the SEC with a loose-lipped tweet about a potential buy out. This week the SEC announced it was suing Musk, sending Tesla shares down double-digits.

We use this as an opportunity to discuss single-stock risk. We do not own Tesla stock in our strategies. It is not that we do not appreciate the quality of a Tesla car. Rather, it is that the roughly $50 billion value of the company is based primarily on speculation about future profitability. Stocks like Tesla can be exciting to watch and follow, but they are gambles, reliant on enduring hope and engaging CEOs. In such cases, there is no room for error. We recommend investors focus on stocks with sustainable profits and a business model that is not reliant on one dynamic visionary.

Spotlight: Fed Speak

The Fed’s stated objectives are maximum employment, stable prices, and moderate long-term interest rates. So, what does it mean that they view rates as no longer “accommodative”? Monetary policy can either be accommodative, neutral, or tight. Below we explain each. This week’s move indicates the Fed is moving closer to a point where economic growth will be self-sustaining.

Accommodative (or Easy) monetary policy

  • The Fed is pushing the economic activity accelerator by setting rates low enough to encourage an increase in lending and spending. For example, lower financing rates on an automobile loan should draw additional car buyers into the market.

Neutral monetary policy

  •  When rates are deemed neutral, the Fed is neither pumping the brakes or hitting the gas. They want to be at this rate when the economy has achieved full employment, stable prices, and steady growth. In other words, the economy is on cruise control.

Tight monetary policy

  • Above the neutral rate, the Fed is trying to press the brakes on the economy. An economy allowed to overheat could see a rapid rise in inflation. Tight monetary policy can act to keep growth moderated at a more sustainable level.

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Strategy Update

Contributed by Max Berkovich , Aleksey Marchenko

STRATEGIC ASSET ALLOCATION

Monday Morning Quarter-Lookback

U.S. equities retreated from their all-time highs, taking a breather after a tremendous quarter. 2-year U.S. Treasuries did not move much, despite the U.S. Fed raising the overnight lending rate by a quarter of a percent for the third time this year. While the week was somewhat uneventful in the U.S. equity and fixed income markets, the 3rd quarter was anything but…

  • U.S. value and growth stocks marched higher by over 6% this quarter, while small capitalization stocks advanced “only” 3%.
  • Gold and India were the biggest laggards due to the strengthening of the U.S. Dollar against a basket of major currencies.
  • Bonds declined over the period as Treasury yields advanced higher, with the 10-year hovering above the 3% yield mark.
  • At the end of the quarter, we added a new position to our international allocation by introducing iShares Edge MSCI Multifactor International ETF (INTF) to our portfolio. International equities have notably underperformed U.S. equities year-to-date, presenting an opportunity to allocate capital to stocks with cheaper valuation.

STRATEGIC GROWTH

No Deal

Industrials took the lead in the 3rd quarter thanks in large part to transportation-related stocks. The Energy and Materials sectors were the clear laggards. The biggest movers in the strategy were…

  • Ulta Beauty, Inc. (ULTA) continued its streak of growth with robust rollouts of its boutique stores. The company beat expectations and announced a partnership with highly influential model Kylie Jenner. The Kylie news received 94,000 likes and 14,000 retweets.
  • On the negative side NXP Semiconductors NV (NXPI) was the worst performer this quarter as its long entanglement with fellow strategy holding Qualcomm, Inc. (QCOM) ended in no deal, thanks to lack of approval from Chinese regulators.

STRATEGIC EQUITY INCOME

Drilling Down

Quietly, the Health Care sector was the best performer this quarter thanks to a nice run from two pharmaceutical holdings. Energy was the laggard thanks to…

  • Schlumberger Ltd. (SLB) was the worst performer despite crude oil marching above $70 per barrel. It seems that even with higher prices, oil services is not getting any love from investors. Also, the CEO claims that transportation bottlenecks in the Permian Basin are halting investment in production and investment from drillers.
  • On the positive side, the best stock was CVS Health Corp. (CVS) which moved up as approval of its Aetna, Inc. (AET) acquisition looks close. Also, it appears the company is facing few hurdles in raising the cash it needs for the $67.5 Billion merger.
Indices & Price ReturnsWeek (%)Year (%)
S&P 500 -0.59.0
S&P 400 (Mid Cap)-1.16.3
Russell 2000 (Small Cap)-0.910.5
MSCI EAFE (Developed International)-0.5-3.2
MSCI Emerging Markets0.0-9.2
S&P GSCI (Commodities)1.68.8
Gold-0.6-8.8
MSCI U.S. REIT Index-1.5-0.9
Barclays Int Govt Credit0.1-2.2
Barclays US TIPS0.0-3.0

The Week Ahead

Contributed by Aleksey Marchenko

Sometimes LESS is More

Labor will be in focus as monthly Nonfarm Payrolls, and wage growth reports will be released on Friday.

  • According to FactSet, the Nonfarm Payrolls survey consensus is 180,000 jobs created in September.

Earnings from Equity Income holding PepsiCo (PEP) and Strategic Growth holding Costco (COST) are scheduled to be released next week.

  • The PepsiCo acquisition of SodaStream (SODA), announced in late August, might be discussed in more detail during the earnings call. Analysts will want to know how PepsiCo will leverage their brand to sell more SodaStream products.
  • Analysts expect Costco to grow their sales by over 4% and earnings per share by over 13% versus the same period a year ago. Costco should benefit from rising prices, as the values of many commodities have declined in the past three months.

Speeches from Fed members Randal Quarles, Jerome Powell, Charles Evans and Federal Open Market Committee (FOMC) members Raphael Bostic, Thomas Barkin, Loretta Mester will provide opinion on the strength of the U.S. economy and most likely defend further rate hikes.

September Institute for Supply Management report (ISM) for both manufacturing and non-manufacturing is expected to show a slight decline. Other notable economic releases include the Purchasing Managers’ Index (PMI), Total Vehicle Sales, and Factory Orders.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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