SUPERHEROES SWOOP TO IN SAVE HEALTH CARE

On Tuesday, Jamie Dimon, Warren Buffett and Jeff Bezos announced that they are forming a new company, “free from profit making incentives and constraints”, to address the healthcare costs of their employees and “potentially all Americans”.  This news pushed most healthcare stocks downward and sparked a lot of buzz on what exactly this could mean.  The reactions varied from dismissive to “wow”, but in my opinion, this is another example of the biggest disruptive forces identifying a weakness and using their skills and means to try to solve a problem.  I certainly would not want to bet against a trio of Jamie Dimon, Jeff Bezos and Warren Buffett – it is like entering Lebron James, Michael Jordan and Wilt Chamberlain in a three-on-three basketball tournament.  They referred to healthcare costs as being a “growing tapeworm” feeding on the U.S. economy.  Many are excited about this trio attacking the tapeworm versus a group of bureaucrats.   MORE:  CEO Perspective On Healthcare Announcement 

Big Tech Boom

Microsoft, Amazon.com and Google all reported earnings last night and all beat expectations.  Many, including myself, believe that we are in the early innings of a new technological revolution.  Unlike past revolutions where new companies displace the complacent incumbents, it may be that this time around the incumbents (Amazon, Facebook, Google, Microsoft, Apple, etc.) actually lead the way into the new paradigm.  These companies have scale, massive R&D budgets and are so far leading the way in artificial intelligence, cloud computing and big data.  Here are some factoids related to today’s big moves in these stocks: 

Where has the blog been?

 

Stock Market Contest

Now is the time of year where people like to make predictions about the coming year, so please make your guess for the 2017 (12/31/2017 closing price on S&P 500) stock market contest by responding to this email or clicking here. You must respond before the next blog, which will likely be next week.  I hope many of you answer so we can have some “big data” on this subject matter.  Here is a five-year chart of the S&P 500 to help frame your guess:

S&P 500 (Five Years)

Congratulations to Todd Maugans, the 2016 winner who guessed 2240 – the S&P 500 ended up at 2238.83, so he was very close.  Interestingly, last year, the blog readers were somewhat bearish, guessing only a two percent rise in the market.  It turns out that the market beat 97% of your guesses (see chart below).  Last year’s guesses were split into two distinct groups, although even the bullish group mostly underestimated the end result.  I have some theories on how this year’s guesses will turn out, but I will keep those to myself so I do not bias you.  

Interest Rates and Stocks are Positively Correlated

Contrary to the theory we all learned in ECON 101 about the relationship between interest rates and stock prices, (watch this video for a simple overview of the theory), the longer-term correlation between stocks and interest rates has been POSITIVE for almost 20 years.  Take a look at the chart I created below.  In this chart, the top shows the S&P 500 against 10-year U.S. Treasury rates, the bottom shows the trailing 20-quarter correlation between the two.  Interestingly, there was a clear change in 1998, when stocks and interest-rates began to move more in tandem.  I would love to hear theories from the readers as to why this change occurred.   Here are a few related thoughts and observations:

 Muni Mayhem

 Since Donald Trump won the election last week, there have been measurable moves in several sectors and investment themes.  One of the most pronounced has been the move in the municipal bond space.  As the chart below illuminates, the amount of municipal debt for sale has spiked to an all-time high.  Not surprisingly, municipal debt funds have dropped notably in accord with this new influx of supply.   So, why is this happening?  For starters, it is worth considering who is invested in municipal bonds.  With the advent of ETFs and the proliferation of mutual funds, access to this space is easier than ever, so there is a new constituency of shorter-term investors in municipal bonds who are there as a result of yield chasing– similar to what I have written about related to consumer staples stocks.  Additionally, with a new expectation (and tangible evidence) of higher rates going forward, municipal bonds have become less attractive to many investors.  As such, investors and traders are rotating out of municipals and into areas that will benefit (or at least not get punished) by a higher rate environment.  As if these two pressures were not enough, there is a third dynamic taking place.  One of the things that makes municipal bonds attractive to many investors is their tax-exempt status.  Investors believe that the new president will lower tax rates.  If tax rates are lower, tax-free investments become less attractive.  RELATED:  Can the U.S. Bond Market See a Decade of Flat to Negative Returns?

Low Volatility ETFs

As I have mentioned before, over the past couple of years, investors have flocked toward high-dividend paying stocks which are traditionally lower volatility stocks.  Many of these stocks have been driven to all-time high valuations and the investor base has changed in that many holders are now there just for the yield.  While these stocks have historically been lower volatility stocks, if interest rate expectations were to strongly reverse, it is quite possible that these allegedly safe stocks might in fact be more volatile than the market.  As part of the proliferations of indices (read last blog post about this), investors can now invest in a wide variety of themes, including so called low volatility ETFs which invest in stocks that have exhibited lower volatility than the market over the past year.  Today is the biggest down move since “Brexit”, and guess what?  The low volatility index is down MORE than the market as a whole.  I have not fully analyzed it, but my hunch is that the low volatility ETFs consist largely of dividend paying and therefore interest rate sensitive stocks.  The chart below supports this case, illuminating the underperformance of “low volatility” versus the general market since the recent low in interest rates.  This reminds me a bit of 2008 when investors trusted backward looking volatility data and were blind to the fact that certain correlations will change when market conditions change.  

The Great Debate

There has been much debate on whether rates are going to rise or stay at historical lows and every time the Federal Reserve does something (or nothing), many of those paying attention seem to disagree.  MORE:  Yellen will regret slow pace of rate hikes.  Below is chart of 10-year Treasury rates over the past year. For the most part, rates have been downward trending, culminating (so far) in the synchronized bottom on February 11.