Tag Archives: forward guidance

The Costs & Consequences Of $15/Hour – The Update

In 2016, I first touched on the impacts of hiking the minimum wage.

“What’s the big ‘hub-bub’ over raising the minimum wage to $15/hr? After all, the last time the minimum wage was raised was in 2009.

According to the April 2015, BLS report the numbers were quite underwhelming:

‘In 2014, 77.2 million workers age 16 and older in the United States were paid at hourly rates, representing 58.7 percent of all wage and salary workers. Among those paid by the hour, 1.3 million earned exactly the prevailing federal minimum wage of $7.25 per hour. About 1.7 million had wages below the federal minimum.

Together, these 3.0 million workers with wages at or below the federal minimum made up 3.9 percent of all hourly-paid workers. Of those 3 million workers, who were at or below the Federal minimum wage, 48.2% of that group were aged 16-24. Most importantly, the percentage of hourly paid workers earning the prevailing federal minimum wage or less declined from 4.3% in 2013 to 3.9% in 2014 and remains well below the 13.4% in 1979.'”

Hmm…3 million workers at minimum wage with roughly half aged 16-24. Where would that group of individuals most likely be found?

Minimum-Wage-Workers

Not surprisingly, they primarily are found in the fast-food industry.

“So what? People working at restaurants need to make more money.”

Okay, let’s hike the minimum wage to $15/hr. That doesn’t sound like that big of a deal, right?

My daughter turned 16 in April and got her first summer job. She has no experience, no idea what “working” actually means, and is about to be the brunt of the cruel joke of “taxation” when she sees her first paycheck.

Let’s assume she worked full-time this summer earning $15/hour.

  • $15/hr X 40 hours per week = $600/week
  • $600/week x 4.3 weeks in a month = $2,580/month
  • $2580/month x 12 months = $30,960/year.

Let that soak in for a minute.

We are talking paying $30,000 per year to a 16-year old to flip burgers.

Now, what do you think is going to happen to the price of hamburgers when companies must pay $30,000 per year for “hamburger flippers?”

Not A Magic Bullet

After Seattle began increased their minimum wage, the NBER published a study with this conclusion:

“Using a variety of methods to analyze employment in all sectors paying below a specified real hourly rate, we conclude that the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent. Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

This should not be surprising as labor costs are the highest expense to any business. It’s not just the actual wages, but  also payroll taxes, benefits, paid vacation, healthcare, etc. Employees are not cheap, and that cost must be covered by the goods or service sold. Therefore, if the consumer refuses to pay more, the costs have to be offset elsewhere.

For example, after Walmart and Target announced higher minimum wages, layoffs occurred (sorry, your “door greeter” retirement plan is “kaput”) and cashiers were replaced with self-checkout counters. Restaurants added surcharges to help cover the costs of higher wages, a “tax” on consumers, and chains like McDonald’s, and Panera Bread, replaced cashiers with apps and ordering kiosks.

A separate NBER study revealed some other issues:

“The workers who worked less in the months before the minimum-wage increase saw almost no improvement in overall pay — $4 a month on average over the same period, although the result was not statistically significant. While their hourly wage increased, their hours fell substantially. 

The potential new entrants who were not employed at the time of the first minimum-wage increase fared the worst. They noted that, at the time of the first increase, the growth rate in new workers in Seattle making less than $15 an hour flattened out and was lagging behind the growth rate in new workers making less than $15 outside Seattle’s county. This suggests that the minimum wage had priced some workers out of the labor market, according to the authors.”

Again, this should not be surprising. If a business can “try out” a new employee at a lower cost elsewhere, such is what they will do. If the employee becomes an “asset” to the business, they will be moved to higher-cost areas. If not, they are replaced.

Here is the point that is often overlooked.

Your Minimum Wage Is Zero

Individuals are worth what they “bring to the table” in terms of skills, work ethic, and value. Minimum wage jobs are starter positions to allow businesses to train, evaluate, and grow valuable employees.

  • If the employee performs as expected, wages increase as additional duties are increased.
  • If not, they either remain where they are, or they are replaced.

Minimum wage jobs were never meant to be a permanent position, nor were they meant to be a “living wage.”

Individuals who are capable, but do not aspire, to move beyond “entry-level” jobs have a different set of personal issues that providing higher levels of wages will not cure.

Lastly, despite these knock-off effects of businesses adjusting for higher costs, the real issue is that the economy will quickly absorb, and remove, the benefit of higher minimum wages. In other words, as the cost of production rises, the cost of living will rise commensurately, which will negate the intended benefit.

The reality is that while increasing the minimum wage may allow workers to bring home higher pay in the short term; ultimately they will be sent to the unemployment lines as companies either consolidate or eliminate positions, or replace them with machines.

There is also other inevitable unintended consequences of boosting the minimum wage.

The Trickle Up Effect:

According to Payscale, the median hourly wage for a fast-food manager is $11.00 an hour.

Therefore, what do you think happens when my daughter, who just got her first job with no experience, is making more than the manager of the restaurant? The owner will have to increase the manager’s salary. But wait. Now the manager is making more than the district manager which requires another pay hike. So forth, and so on.

Of course, none of this is a problem as long as you can pass on higher payroll, benefit and rising healthcare costs to the consumer. But with an economy stumbling along at 2%, this may be a problem.

A report from the Manhattan Institute concluded:

By eliminating jobs and/or reducing employment growth, economists have long understood that adoption of a higher minimum wage can harm the very poor who are intended to be helped. Nonetheless, a political drumbeat of proposals—including from the White House—now calls for an increase in the $7.25 minimum wage to levels as high as $15 per hour.

But this groundbreaking paper by Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, and Ben Gitis, director of labormarket policy at the American Action Forum, comes to a strikingly different conclusion: not only would overall employment growth be lower as a result of a higher minimum wage, but much of the increase in income that would result for those fortunate enough to have jobs would go to relatively higher-income households—not to those households in poverty in whose name the campaign for a higher minimum wage is being waged.”

This is really just common sense logic but it is also what the CBO recently discovered as well.

The CBO Study Findings

Overall

  • “Raising the minimum wage has a variety of effects on both employment and family income. By increasing the cost of employing low-wage workers, a higher minimum wage generally leads employers to reduce the size of their workforce.
  • The effects on employment would also cause changes in prices and in the use of different types of labor and capital.
  • By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some of those families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers. For those reasons, the net effect of a minimum-wage increase is to reduce average real family income.”

Employment

  • First, higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices, and those higher prices, in turn, lead consumers to purchase fewer goods and services.
  • The employers consequently produce fewer goods and services, so they reduce their employment of both low-wage workers and higher-wage workers.
  • Second, when the cost of employing low-wage workers goes up, the relative cost of employing higher-wage workers or investing in machines and technology goes down.
  • An increase in the minimum wage affects those two components in offsetting ways.
    • It increases the cost of employing new hires for firms
    • It also makes firms with raise wages for all current employees whose wages are below the new minimum, regardless of whether new workers are hired.

Effects Across Employers.

  • Employers vary in how they respond to a minimum-wage increase.
  • Employment tends to fall more, for example, at firms whose sales decline when they raise prices and at firms that can readily substitute machines or technology for low-wage workers.
  • They might  reduce workers’ fringe benefits (such as health insurance or pensions) and job perks (such as employee discounts), which would lessen the effect of the higher minimum wage on total compensation. That, in turn, would weaken employers’ incentives to reduce their employment of low-wage workers.
  • Employers could also partly offset their higher costs by cutting back on training or by assigning work to independent contractors who are not covered by the FLSA.

Macroeconomic Effects.

  • Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.
  • A higher minimum wage shifts income from higher-wage consumers and business owners to low-wage workers. Because low-wage workers tend to spend a larger fraction of their earnings, some firms see increased demand for their goods and services, which boosts the employment of low-wage workers and higher-wage workers alike.
  • A decrease in the number of low-wage workers reduces the productivity of machines, buildings, and other capital goods. Although some businesses use more capital goods if labor is more expensive, that reduced productivity discourages other businesses from constructing new buildings and buying new machines. That reduction in capital reduces low-wage workers’ productivity, which leads to further reductions in their employment.

Don’t misunderstand me.

Hiking the minimum wage doesn’t affect my business at all as no one we employee makes minimum wage. This is true for MOST businesses.

The important point here is that the unintended consequences of a minimum wage hike in a weak economic environment are not inconsequential.

Furthermore, given that businesses are already fighting for profitability, hiking the minimum wage, given the subsequent “trickle up” effect, will lead to further increases in automation and the “off-shoring” of jobs to reduce rising employment costs. 

In other words, so much for bringing back those manufacturing jobs.

Kevin Warsh May Be the Next Fed Head: Let’s See What He Really Thinks

As reported earlier this morning by the Wall Street Journal, President Trump and Treasury Secretary Mnuchin met with Kevin Warsh yesterday to discuss the potential vacancy at the Fed next February.

Warsh already has central banking experience, having sat on the Federal Open Market Committee (FOMC) from February 2006 until March 2011.

Two and a half years after he resigned from the Fed, he emerged as a vocal critic of FOMC policies, including those policies he helped craft. He published an op-ed in the WSJ on November 12, 2013, and it was quite the editorial. As that happened to be the first week of hunting season, we suggested that Warsh had declared open season on his ex-colleagues, and we came up a gimmicky picture to go along with our reporting:

But we also thought his op-ed needed translation. It was written with the polite wording and between-the-lines meanings that you might expect from such an establishment figure. He seemed to be holding back. We offered our guesses on what he was really trying to say. And with today’s breaking news, we thought it would be a good time to reprint our translation.

So, if you’re wondering what the current frontrunner as Trump’s choice for the Fed chairmanship really thinks, here are Warsh’s comments on nine topics, followed by our translations.

Quantitative Easing

“The purchase of long-term assets from the U.S. Treasury to achieve negative real interest rates is extraordinary, an unprecedented change in practice since the Treasury-Fed Accord of 1951.

The Fed is directly influencing the price of long-term Treasurys—the most important asset in the world, the predicate from which virtually all investment decisions are judged. Earlier this year the notion that the Fed might modestly taper its purchases drove significant upheaval across financial markets. This episode should engender humility on all sides. It should also correct the misimpression that QE is anything other than an untested, incomplete experiment.”

What he really wants to say:

We’d all be better off if the central banking gods (myself included) hadn’t been so damn arrogant to think that we actually understood QE. We don’t, and it never should have been attempted.

The Fed’s Focus On Inflation

“Low measured inflation and anchored inflationary expectations should only begin the discussion about the wisdom of Fed policy, not least because of the long and variable lags between monetary interventions and their effects on the economy. The most pronounced risk of QE is not an outbreak of hyperinflation. Rather, long periods of free money and subsidized credit are associated with significant capital misallocation and malinvestment—which do not augur well for long-term growth or financial stability.”

What he really wants to say:

The inflation target is stupid. It’s not the CPI that’s killing us, it’s the credit booms and busts. The best way out of this mess is to lose the inflation target and go back to the old-fashioned approach of “taking the punch bowl away when the party gets going.”

Pulling Off The Exit From Extraordinary Measures

“[T]he foremost attributes needed by the Fed to end its extraordinary interventions and, ultimately, to raise interest rates, are courage and conviction. The Fed has been roundly criticized for providing candy to spur markets higher. Consider the challenge when a steady diet of spinach is on offer.”

What he really wants to say:

Pundits who praise the courage of our central bankers are clueless. The true story is that we consistently take the easy way out. If the current cast of characters wanted to show courage, they’d man up and replace the short-term sugar highs with long-term thinking.

The Fed’s Relationship To The Rest Of Washington

“The administration and Congress are unwilling or unable to agree on tax and spending priorities, or long-term structural reforms. They avoid making tough choices, confident the Fed’s asset purchases will ride to the rescue. In short, the central bank has become the default provider of aggregate demand. But the more the Fed acts, the more it allows elected representatives to stay on the sidelines. The Fed’s weak tea crowds out stronger policy measures that can only be taken by elected officials. Nobel laureate economist Tom Sargent has it right: ‘Monetary policy cannot be coherent unless fiscal policy is.’”

What he really wants to say:

And if we don’t man up, you can count on Congress to continue its egregious generational theft and destroy our nation’s finances, just as Stan, Geoff and I have been warning.

Who Benefits From QE And Who Doesn’t?

“Most do not question the Fed’s good intentions, but its policies have winners and losers, which should be acknowledged forthrightly.

The Fed buys mortgage-backed securities, thereby providing a direct boost to balance sheet wealth of existing homeowners to the detriment of renters and prospective future homeowners. The Fed buys long-term Treasurys to suppress yields and push investors into riskier assets, thereby boosting U.S. stocks.

The immediate beneficiaries: well-to-do households and established firms with larger balance sheets, larger risk appetites, and access to low-cost credit. The benefits to workers and retirees with significant fixed obligations are far more attenuated. The plodding improvement in the labor markets offers little solace.”

What he really wants to say:

Unbelievably, my ex-colleagues still don’t acknowledge their policies are killing the middle class to support the plutocracy. Their silence on this is wholly unacceptable and has to stop (and so do the policies).

Domestic Versus Global Policy Considerations

“[T]he U.S. is the linchpin of an integrated global economy. Fed-induced liquidity spreads to the rest of the world through trade and banking channels, capital and investment flows, and financial-market arbitrage. Aggressive easing by the Fed can be contagious, inclining other central banks to ease as well to stay competitive. The privilege of having the dollar as the world’s reserve currency demands a broad view of global economic and financial-market developments. Otherwise, this privilege could be squandered.”

What he really wants to say:

We really need to climb out of our shell and look at things from a global perspective. The rest of the world knows that we’re selling a bill of goods and won’t continue buying it forever. If we don’t change, you can kiss the dollar goodbye.

Forward Guidance

“Since QE began, Fed policy makers have tried to explain that asset purchases and interest rates are different. Hence their refrain that tapering is not tightening, and that very low interest rates will continue after QE. Investors do not agree. Once the Fed begins to wind down its asset purchases, these market participants are likely to reassert their views with considerable force.

Recently, the Fed has elevated forward guidance as a means of persuading investors that it will indeed keep interest rates exceptionally low even after QE. Forward guidance is intended to explain how the central bank will react to incoming data. Fed projections for example, may show below-target inflation and a residual output gap justifying very low interest rates several years from now. But words are not equal to concrete policy action. And the Fed hasn’t received many awards for prescience in recent years.”

What he really wants to say:

Forward guidance is a load of crap. First, you won’t convince the market of any of your dumb ideas. Investors can and will think for themselves. Second, talk is cheap. And talk that’s based on the Fed’s ability to foresee the future? C’mon, that’s ridiculous.

Transparency

“[T]ransparency in communications about future policy is not a virtue unto itself. The highest virtue is getting policy right. Given manifest uncertainties about the state of the economy, oversharing policy deliberations is not useful if markets are led astray, or if public commitments reduce policy makers’ flexibility to call things the way they see them.”

What he really wants to say:

Transparency, shmansparency. I’ve had it up to here with taper, untaper, maybe taper, maybe not taper. I’ll trade a transparent central bank for one that knows what it’s doing any day.

Obama’s Nomination Of Janet Yellen As The Next FOMC Chair

“The president has nominated a person with a well-deserved reputation for probity and good judgment. The period ahead will demand these qualities in no small measure.”

What he really wants to say:

The president made a bad choice.

Disclaimer

These are only our guesses, not actual thoughts from Kevin Warsh, who hasn’t told us what he really wants to say.  We don’t even know if he hunts.  (We’re guessing no.)

Our Up-To-Date Reflections

Back to the present now, we’ve reread our translations and have to admit that the last one—on the Janet Yellen nomination—was purely smart-alecky. But we don’t think the others were far-fetched—they seem consistent enough with Warsh’s carefully expressed opinions. If we were right, we could be facing big-time changes at the Fed. Then again, many Trump supporters expected a less war-mongering foreign policy from the presidential candidate who claimed we were being overly aggressive overseas.

So, if Warsh is indeed appointed as Yellen’s replacement, the key question is this:

Will the individual change the institution, or will the institution change the individual?

We’ll see…

3 Things: Retail-less, Valuation, End Of The Bear?

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Retail-Less

Despite all of the cheering by the mainstream media that the economy is “doing great” and “no recession” in sight, a look at small business sales trends and retail sales certainly suggest a very different story.

We recently saw the “retail sales figures” for March which were, to say the least, disappointing. I say this because these numbers expose the flawed economic theories of the mainstream proletariat that the abnormally warm winter and exceptionally low energy prices should boost spending due to the relative savings.

Retail-Sales-2-041416

Despite ongoing prognostications of a “recession nowhere in sight,” it should be remembered that consumption drives roughly 2/3rds of the economy. Of that, retail sales comprise about 40%. Therefore, the ongoing deterioration in retail sales should not be readily dismissed.

More troubling is the rise in consumer credit relative to the decline in retail sales as shown below.

Retail-Sales-Credit-DPI-041416

What this suggests is that consumers are struggling just to maintain their current living standard and have resorted to credit to make ends meet. Since the amount of credit extended to any one individual is finite, it should not surprise anyone that such a surge in credit as retail sales decline has been a precursor to previous recessions.

We can also see the problem with retail sales by looking at the National Federation of Independent Business Small Business Survey. The survey ask respondents about last quarter’s real sales versus next quarters expectations.

NFIB-Retail-Sales-041416

Not surprisingly, expectations are always much more optimistic than reality turns out to be. However, what is important is that both actual and expected retail sales are declining from levels that have historically been indicative of a recession.

Today, consumer credit has surged, without a relevant pickup in spending, to more than 26% of DPI. Given that it took a surge of $11 Trillion in credit to offset a decline in economic growth from 8% in the 70’s to an average of 4% during the 80’s and 90’s, it is unlikely that consumers can repeat that “hat trick” again. 

A Different Valuation Measure

I recently discussed the effect of stock valuations on future long-term returns. To wit:

“I believe in long-term investing. I do think that you should buy quality investments and hold them long-term. However, what Wall Street, and many financial advisors miss, is the most important point of this argument which is ‘at the right valuation.’

Valuation, what you pay for an investment, is the single biggest determinant of future returns.

According to Dr. Roberts Shiller’s data, the Cyclically Adjusted P/E Ratio is currently hovering around 24x earnings. It is here that the problem for long-term investors currently resides. The chart below shows the average real (inflation-adjusted) 20-year returns of a $1000 investment made when P/E ratios first hit 20x or 10x earnings.”

20-Yr-Returns-Start-20x-10x-Earnings-031616

As you can see, valuations make a huge difference.

However, not surprisingly, shortly after I published the article I received numerous emails citing low interest rates, accounting rule changes, and debt-funded buybacks all as reasons why “this time is different.”  While such could possibly be true, it is worth noting that each of these supports are both artificial and finite in nature.

Currently, the aging U.S. economy, where productivity has exploded, wage growth has remained weak and whose households are weighed down by surging debt, remains mired in a slow-growth funk. This slow-growth funk has, in turn, put a powerful shareholder base to work increasing pressure on corporate managers not to invest, and to recycle capital into dividends and buybacks instead which has led to a record level of corporate debt. 

These actions, as suggested above, are limited in nature. For a while, these devices kept ROE elevated, however, the efficacy of those actions has now been reached.

Corporate-Profits-ROE-041416

Importantly, profit margins and ROE are reasonably well-correlated which is what creates the perception that profit margins mean-revert. However, ROE is a better indicator of what is happening inside of corporate balance sheets more so than just profit margins. The current collapse in ROE is likely sending a much darker message about corporate health than profit margins currently. 

Corporate-Profits-Earnings-PerShare-Deviation-041416-2

While the decline in reported earnings, which are subject to accounting manipulations and share buybacks have indeed declined, it is not nearly to the extent as shown by both ROE and Corporate Profits After Tax.

While traditional P/E ratios have surged to 24x earnings recently, Price to Corporate Profits Per Share (P/CP) has exploded to the second highest level on record.

Corporate-Profits-P-CP-Ratio-041416

Historically speaking, it is unlikely that with reported earnings early in the reversion process that we will see a sharp recovery in the second half of the year as currently expected by the majority of mainstream analysts. The suggests that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy will continue to stretch to extremes. The end result of which has never “been different this time.” 

Did The Fed Kill The Bear?

Speaking of the Fed, the surge in the market over the last couple of days have many scratching their heads despite deteriorating economics, weak earnings and poor geopolitical news. Of course, given the series of emergency Fed meetings, the markets are currently beating on a much longer time frame to the next, if ever, rate hike. 

Most interesting is what investor sentiment, both individual and professional, has recently accomplished.

AAII-IINV-NetBullish-Sentiment-041416

Accordingly, the chart above, investor sentiment suggests the market has just completed a recessionary “bear market” with virtually no substantial losses. This can also be seen by looking at just the amount of “bearish” sentiment in the market as well.

AAII-IINV-Bearish-Sentiment-041416

As noted, the 13-week moving average of bearish sentiment has reached levels currently that are more normally associated with bottoms to corrective processes as seen in 2010 and 2011 when the Federal Reserve intervened with QE2 and Operation Twist. What is interesting is that all of the support during the current correction has been strictly “verbal” with no real change to market liquidity or accommodation.

“Make me promises, just tell me no lies.”

However, while this surge in bearish sentiment has occurred, which normally denotes a substantial level of fear by investors, there has been no substantial change to actual allocations.

AAII-Allocation-Survey-041416

While stock allocations have fallen modestly, cash and bond allocations have barely budged. This is a far different story than was seen during previous major and intermediate-term corrections in the market.

This suggests, is that while investors are worried about the markets and their investments, they are too afraid to actually make changes to their portfolio as long as Central Banks continue to bail out the markets.

What is clear is that the Federal Reserve has gained control of asset markets by gaining control over investor behavior.

“Are you afraid of a market crash? Yes. Are you doing anything about it? No.” 

Again, it’s back to fundamentals versus expectations. Someone is going to be very wrong. 

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

The Costs & Consequences Of $15/Hour

What’s the big “hub-bub” over raising the minimum wage to $15/hr? After all, the last time the minimum wage was raised was in 2009. The argument for increasing the minimum is to create a “livable wage” for those working at that level.

Given the amount of table pounding that has ensued after the current administration proposed increasing the minimum wage, you would have assumed that a vast majority of American workers were trapped at this horrifically low level of income. Let’s take a look at some numbers.

According to the April 2015, BLS report:

“In 2014, 77.2 million workers age 16 and older in the United States were paid at hourly rates, representing 58.7 percent of all wage and salary workers. Among those paid by the hour, 1.3 million earned exactly the prevailing federal minimum wage of $7.25 per hour. About 1.7 million had wages below the federal minimum.

Together, these 3.0 million workers with wages at or below the federal minimum made up 3.9 percent of all hourly-paid workers.”

Of those 3 million workers, who were at or below the Federal minimum wage, 48.2% of that group were aged 16-24.

Furthermore, the percentage of hourly paid workers earning the prevailing federal minimum wage or less declined from 4.3% in 2013 to 3.9% in 2014 and remains well below the 13.4% in 1979. 

Hmm…3 million workers at minimum wage with roughly half aged 16-24. Where would that group of individuals most likely be found?

Minimum-Wage-Workers

Not surprisingly, they primarily are found in the fast food industry.

“So what? People working at restaurants need to make more money.”

Okay, let’s hike the minimum wage to $15/hr. That doesn’t sound like that big of a deal, right? Let’s do that math:

My son is just turning 16 in June and is going out to get his first job. He has no experience, no idea what “working” actually means, and it about to be the brunt of the cruel joke of Federal taxation when he sees his first paycheck. Let’s do the math of $15/hr assuming he works full-time this summer.

  • $15/hr X 40 hours per week = $600/week
  • $600/week x 4.3 weeks in a month = $2,580/month
  • $2580/month x 12 months = $30,960/year.

Let that soak in for a minute. We are talking paying $30,000 per year to a 16-year old to flip burgers.

Governor Jerry Brown recently caved to Unions and passed legislation to hike the minimum wage in California to the magical level of $15. According to the Huffington Post, this will affect about 567,000 workers in Los Angeles. Here are those numbers (thanks to B. Eshelman for the math.)

  • In 2015 Annual Salary $18,720 x 567,000 = $10,614,240,000
  • In 2020 Annual Salary $31,200 x 567,000 = $17,690,400,000The overall total Gross for 2016 / 2017 / 2018 / 2019 / 2020 works out to $76,658,400,000 – 76.6 Billion dollars in wages.

An increase in wages of $76.6 billion in wages will be passed onto consumers in the form of higher costs of products.

However, here is the real reason that California, New York, and the current Administration are pushing for a higher minimum wage. If we only look at the increased portion of wages that will be paid under the new standard we find an increase of $23.5 Billion Dollars in Los Angeles alone which equates to:

  • An Increase takes in of $764,678,880 California State Taxes.
  • An Increase takes in of $342,014,400 Medicare Taxes.
  • An Increase takes in of $1,462,406,400 Social Security Taxes.
  • An Increase takes in of $3,423,971,250 Federal Taxes.
  • Plus the employer pays equal amounts in taxes to what the employee pays. 

Not a bad way to boost tax revenue when you extrapolate Los Angeles nationwide. 

But there is also the inevitable unintended consequences of boosting the minimum wage.

The Trickle Up Effect:

According to Payscale, the median hourly wage for a restaurant manager is $11.00 an hour.

Restaurant-Manager-Salary

Therefore, what do you think happens when my son, who just got his first job with no experience, is making more than the manager of the restaurant? The owner will have to increase the managers salary. But wait. Now the manager is making more than the district manager which requires another pay hike. So forth, and so on.

Of course, none of this is a problem as long as you can pass on higher payroll, benefit and rising healthcare costs to the consumer. But with an economy stumbling along at 2%, this may be a problem, just as Oregon is finding out:

“Facing concerns from the right and the left that her minimum wage proposal was an obvious job killer in Oregon, Gov. Brown blinked on January 28 and has scaled back her proposal to only a $.50 raise per hour statewide July increase, from $9.25 to $9.75-per-hour.”

This move followed a recent report from the Manhattan Institute which concluded:

By eliminating jobs and/or reducing employment growth, economists have long understood that adoption of a higher minimum wage can harm the very poor who are intended to be helped. Nonetheless, a political drumbeat of proposals—including from the White House—now calls for an increase in the $7.25 minimum wage to levels as high as $15 per hour.

But this groundbreaking paper by Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, and Ben Gitis, director of labormarket policy at the American Action Forum, comes to a strikingly different conclusion: not only would overall employment growth be lower as a result of a higher minimum wage, but much of the increase in income that would result for those fortunate enough to have jobs would go to relatively higher-income households—not to those households in poverty in whose name the campaign for a higher minimum wage is being waged.”

This is really just common sense logic. If we look at the total number of businesses in the United States we find the following breakdown:

Total-Business-W-Employees-040716

Out of a whopping 26 million registered businesses in the United States, only 23% actually have employees. The rest are “inactive” companies that have no sales, profits, customers or workers.

Let’s dig a little deeper.

Total-Business-W-Employees-Breakdown-040716

Of the 6,000,000 businesses that actually employee people 63% have fewer than 4-employees. These are the “mom and pop” shops owned by people who aren’t building a business as much as they are building a life. Most of these businesses operate on very thin margins and there is little ability to absorb dramatically higher payroll costs.

The 5-99 employee businesses likewise are generally much more sensitive to changes in costs and customer demand and would also be adversely affected by higher costs without higher levels of aggregate demand.

Problems With Hiking The Minimum Wage

  1. Minimum wage jobs are “starter jobs.” These are the jobs where individuals learn how to work within a business environment, make mistakes, get fired, etc. without it impacting their long-term employment prospects. Down the road when applying for a real job, employers don’t care so much about your days “flipping burgers” or “waiting tables” as much as your education and current skill set.
  2. Minimum wage jobs are not meant to supply a “livable wage.” Most minimum wage jobs, as stated, are just a quick “test” position for an employee. Once they prove themselves capable and dependable, they tend to be quickly promoted up the employment ranks. This is why only 3-million jobs out of 160 million are at or below the minimum wage. If you have been working at a job for longer than a year at minimum wage, the problem is probably you. 
  3. As an “anti-poverty” tool, it is a blunt instrument. Many minimum wage earners are second or third-job holders in households with other income. That could include a teenage summer employee whose parents both have jobs. Other minimum wage workers may include retirees with income from savings and Social Security who own their homes mortgage-free.
  4. Wages reflect the value employees add to final output. Given that businesses exist in a competitive environment, wages reflect the skills and market value of what an employee is capable of producing. If an employee’s production creates more income for the business his “worth” is higher and is reflected in his wages. If a firm underpays a skillful employee, another firm will recognize that talent and pay more to get it.
  5. Higher wages may hurt those it is supposed to help.  First, when Seattle hiked their minimum wage, employees wanted less hours to remain on welfare. While a higher wage sounds good, after taxes it produced less income for low-income households by reducing their welfare benefits. Secondly, as stated above, the number of jobs that will likely be lost to automation will increase. A one-time cost to increase technological innovation in a restaurant is quickly repaid given a substantial increase in payroll costs.

Automated-Restaurant

Don’t misunderstand me. I am not bashing anyone that wants to hike the minimum wage. It doesn’t affect my business one bit as no one I employee makes minimum wage.

Should we raise the minimum wage from $7.25 an hour to say $8.00 an hour? Probably. The cost of living has risen since the 2009 wage hike and a $0.75 increase would likely be more palatable than a doubling.

Importantly, the unintended consequences of a minimum wage hike in a weak economic environment are not inconsequential. Furthermore, given that businesses are already fighting for profitability, hiking the minimum wage, given the subsequent “trickle up” effect, will lead to further increases in productivity and “off shoring” of jobs to reduce rising employment costs. 

So much for bringing back those manufacturing jobs.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Fed Levitation, Employment, Savings Rate

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Fed Levitation

What is going on at the Federal Reserve? On Tuesday, Janet Yellen comes out and announces that despite inflation being on the rise and employment below 5%, she is not going to raise the Fed Funds rate 4-times this year, nor even two times this year, but rather most likely none. Of course, this “one and done” scenario is what I suggested back in December following the first rate hike given the ongoing deterioration in the underlying economic backdrop. 

However, on Wednesday, Chicago Federal Reserve President Charles Evans comes out and suggests he would support another interest rate increase in June.

So what is it? Are we “data dependent” or are we more concerned about “global economic weakness?”  Or, is this just part of the Fed’s careful orchestration to support asset markets?

I think it may just be the latter as the Fed comes to the realization they have gotten themselves caught in a “liquidity trap.”  Here is their dilemma?

  • Low interest rates have failed to spark organic economic growth which would lead to an inflationary pressure build.
  • While QE programs fueled higher asset prices, the “wealth effect” did not transfer through the real economy as the programs acted as a “wealth transfer” from the middle-class.
  • The Fed cannot afford to have a major reversion in asset prices which would crush consumer confidence pushing the economy into a recession.
  • The unintended consequence of announcing rate hikes was a surge in the U.S. dollar, as discussed earlier this week, as foreign funds chased higher yields. This surge in the dollar crushed corporate profits and oil prices putting a further strain on economic growth.
  • Further monetary policy accommodations would risk a surge in asset prices that expands the current over-valuation of markets and magnify the eventual reversion.

The Federal Reserve has carefully orchestrated a very balanced messaging process to support asset markets but taper enthusiasm by sending contradictory messages. Yellen suggests ongoing “accommodation” which pushed liquidity into “risk” assets. That excitement is immediately tapered by a contradictory message that “less accommodation” is still likely. 

The Federal Reserve is trying very clearly to accomplish several goals through their very confusing “forward guidance:”

  1. Keep asset prices above the recent lows to avoid triggering a rash of potential “margin calls” that would fuel a more rapid price reversion in the markets.
  2. Talk down the “dollar” to provide a boost to exports (which makes up roughly 45% of corporate profits) and commodity prices. The Fed-assisted boost in oil prices also gives TBTF banks the room necessary to off-load bad energy-related debt exposure before the next price decline and run of defaults.
  3. The Fed also realizes they cannot allow market prices to overheat to the upside and, therefore, use offsetting language to quell expectations.

SP500-MarketUpdate-033116

It’s genius.

Like the “little Dutch boy,” the Fed currently has a finger stuck in every hole of the dike. The only question is how long is it before the Federal Reserve runs out of “fingers” to plug the next leak?

Employment Not All That It Seems

A couple of weeks ago, I hosted a presentation for a packed ballroom discussing the outlook for the markets and economy over the rest of the year. (I will be posting the video next week.)

Since all eyes are on the “employment report” tomorrow, I thought I would share with you two slides from that presentation on the real state of employment in the U.S.

For example, take a look at the first slide below.

Employment-BirthDeath-Analysis-033116

This chart CLEARLY shows that the number of “Births & Deaths” of businesses since the financial crisis have been on the decline. Yet, each month, when the market gets the jobs report, we see roughly 200k plus jobs created as shown in the chart below.

Employment-Trends-031516

Included in those reports is an “ADJUSTMENT” by the BEA to account for the number of new businesses (jobs) that were “birthed” (created) during the reporting period. This number has generally “added” jobs to the employment report each month.

The chart below shows the differential in employment gains since 2009 when removing the additions to the monthly employment number though the “Birth/Death” adjustment. Real employment gains would be roughly 4.43 million less if you actually accounted for the LOSS in jobs discussed in the first chart above. 

Employment-BirthDeath-Adjusted-033116

The chart above assumes that ZERO jobs were created through the start of new businesses since 2009. However, as both Gallup and the data above show, we have been LOSING roughly 70,000 jobs a year due to “deaths” outnumbering “births” making the numbers above even worse. 

Think about it this way. IF we were truly experiencing the strongest streak of employment growth since the 1990’s, should we not be witnessing:

  1. Surging wage growth as a 4.9% unemployment rate gives employees pricing power?
  2. Economic growth well above 3% as 4.9% unemployment leads to stronger consumption?
  3. A rise in imports as rising consumption leads to demand for goods.
  4. Falling inventories as sales outpace production.
  5. Rising industrial production as demand for goods increases.

None of those things exist currently.

The issue lies with the “seasonal adjustment” factors which run through the entirety of economic data published by the various government agencies. Many of these seasonal adjustments have been skewed since the financial crisis due to the economic ramifications following the crash. Furthermore, due to El Nino and La Nina, winter weather patterns have swung from extremely warm (2012 and 2015) to extremely cold (2013 and 2014) which have wrecked havoc with reporting.

All of these seasonal adjustment factors have led to an overstating of headline economic data. Unfortunately, when digging below the surface, the truth is ultimately revealed.

Is it intentional? Probably Not.  Is it relevant? Absolutely. 

The Savings Rate Conundrum

Interesting take from Tom McClellan on the savings rate:

“When money market funds were created in the mid-1970s, Americans were suddenly confronted with the opportunity to earn a more appropriate reward for deferring their compensation, and for instead saving their money.  But curiously, Americans did not do as B.F. Skinner would have suggested they would do.  They did not increase their savings behavior in response to the greater reward for doing so.  Instead, they started a long downward trend in the savings rate, saving less and less of their income even though they could earn more in real terms for doing so.  And that downward trend in the savings rate just happened to coincide with a secular bull market for stock prices.

But since 2005 we are seeing the monthly savings rate data show an upward trend.  This change in behavior makes complete sense.  Baby Boomers are facing imminent retirement, and thus they are mounting a last-minute campaign to save up enough to live off of without eating cat food, or turning to their formerly helicoptered children for support.  At the same time, the “Millennials” or “Echo-Boomers” are just now moving out of their parents’ basements, and have not yet become a major economic force.  So the Echo-Boomers are not yet making up in consumption for what their parents are saving.”

PersSavRate_Mar2016

“One problem is that episodes of this behavior of people saving more tend to be associated with negative growth rate periods for stock prices.  That’s a bummer for stock market bulls.  So what you should do as a prudent bullish rat is to save your own food pellets while simultaneously encouraging your neighbors to eat all of theirs, and thus make the stock market indices rise.  Good luck with that plan.”

Tom is correct in his assessment about what is currently happening with savings. However, he missed one very important component about what happened in the 80-90’s as savings fell – the rise in consumer leverage.

Savings rates didn’t fall just because consumers decided to just spend more. If that was the case economic growth rates would have been rising on a year-over-year basis. The reality, is that beginning in the 1980’s, as the economy shifted from a manufacturing to service-based economy, productivity surged which put downward pressure on wage and economic growth rates. Consumers were forced to levered up their household balance sheet to support their standard of living. In turn, higher levels of debt-service ate into their savings rate.

The problem today is not that people are not “saving more money,” they are just spending less as weak wage growth, an inability to access additional leverage, and a need to maintain debt service restricts spending. For Millennials, yes, they may be emerging from their parents basements, but they are also tasked with trying to pay-off student loan debt with a low-wage-paying service job. 

GDP-PCE-Wages-Struggle-033116

It is indeed a “new economy.” 

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report”. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: 80% Or Bust, Mind The Gap, It’s A Bunny

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


80% Or Bust

Not surprisingly, the recent sharp reflexive rally has brought the bulls out in full force as noted by a recent comment on my post earlier this week on “4% From The Highs:”

“…by the time you get confirmation with the long term indicators above, you will miss out on 20 to 30% of the rally.”

It’s a fair point if you are a short-term trader looking to time the market. I’m not. As a long-term investor, and specifically as a manager of “other people’s money,” I am much more concerned with the specific inflection points where market dynamics change from a generally positive trend, to a negative one.

Yes, I will most definitely miss both the bottom and the top of markets. As shown in the chart below, the technical indications of a change in trend are slow to occur. However, I am only really concerned with capturing, or missing, the 80% between the tops and bottoms of major market cycles.

SP500-MarketUpdate-032416

Further, the majority of the “Best-10” and “Worst-10” days are contained primarily within those 80% spans.

Math-Of-Loss-122115

So, yes, I am absolutely going to be “wrong” at the tops of markets and at the bottoms while I await confirmation of a longer-term “trend” to emerge. For those that are inherently “bullish” who choose “hope” over what prices are “actually” doing, the historical outcomes have been brutal, to say the least.

As I have said before, my methodologies are my own. They are not new ideas. They are not innovative. They are simply the lessons I have been repeatedly taught over the last 30-years of managing money. If the markets reverse the current long-term sell signals, I will happily put a lot more money to work. Until then, I will wait rather than trying to “draw to an inside straight.” 

Think about it this way – if betting in the markets was really the way to build wealth, wouldn’t the vast majority of Americans be wealthy versus just the top 1%? Just a thought.

Mind The Gap

I have discussed the problems with earnings and earnings estimates in the past stating:

“In a 2010 study, by the McKinsey Group, they found that analysts have been persistently overly optimistic for 25 years. During the 25-year time frame, Wall Street analysts pegged earnings growth at 10-12% a year. Unfortunately, earnings only grew at 6% which, as we have discussed in the past, is the growth rate of the economy.”

Yardeni-EPS-123115

“The McKenzie study also noted that on average “analysts’ forecasts have been almost 100% too high” which leads investors to make much more aggressive bets on the financial markets. “

My friend Salil Mehta from Statistical Ideas recently published a great piece on this issue.

“The gap between the 2016 forecasts and the YTD returns through January is 13% (8% target minus the -5% YTD). Annual returns have a nearly 20% standard deviation (or 19% if you only look from the end of January onward). So it is still plausible — though rather unlikely, with only a one in five probability — to reach the 8% target gain for 2016. (For statistics wonks, the test statistic decomposes the 13% gap to a ~9% move in addition to the typical 4.5% annualized return, and then factors in a 19% standard deviation.) Now that we are further into the year (mid-March), euphoria and complacency are back to extreme market top levels.

It’s also worth noting that strategists at major firms are consistently bullish, year after year. The sources of the most optimistic prognostications also don’t change. Sorted from most to least bullish, they are Federated Investors, JP Morgan, Prudential, Bank of America, and Columbia.”

SalilChart-1

“In the table below, two pieces of information averaged among the 10 firms listed above are presented:

  1. The difference between the target and the January YTD returns.
  2. The rest of the year returns.”

SalilChart-2


“If these analyst forecasts were mostly in the right direction, you would expect a positive linear relationship between 1 and 2. Regrettably, there is a negative relationship instead. Never mind that the market continued its drop in February, even after the revised forecasts, and the rebound leaves the market still below many firm’s 2016, 2015, and even 2014 targets!

In other words, the larger the gap in January between the YTD returns and the year-end target, the more unlikely the chance the market will recover to the target by the year’s end.

Think about this: For 2016, the 13% gap noted earlier (after the standardization adjustment) is the largest gap among this data.”

As Salil concludes. “That’s not a good omen.”

It’s A Bunny

Since it is Easter, I will leave you with a story about a bunny.

James Paulsen, Chief Investment Strategist for Wells Capital Management, recently penned an excellent piece with respect to the ongoing “bull/bear” debate.

“The accompanying exhibit illustrates the U.S. stock market since WWII with recessions shown by the grey bars. In the last two expansions (during the 1990s and again in the 2000s), the stock market was uninterrupted by a bear market posting solid and steady returns until the economic recovery ended with a recession. So far, despite some volatility in 2011, this has also characterized the contemporary bull market. Without a bunny market in more than 20 years (as shown in Exhibit 1, the last bunny market was in the mid-1990s), most investors currently seem to accept that either the bull market will soon resume or we are nearing the end of this expansion. Since there has not been one in some time, few consider that stocks could simply be headed for another bunny market.”

Paulsen-SP500-Chart2

Most bunny markets occur in the latter part of an economic recovery. Stocks initially recover aggressively after a recession. However, as the recovery matures, cost-push pressures, inflation, and higher interest rates begin to pressure the bull market. This often resolves into a bunny market for the balance of many economic recoveries.

I have modified his chart to notate both secular bull and bear market periods. During secular bear markets, as we most likely currently remain in, volatility swings and prices declines are substantially larger than during secular bull market periods. This elevates the risk of emotionally driven investment mistakes during periods of markedly higher volatility which leads to lower rates of investor returns longer term.

Just some things to think about.

Happy Easter.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Fed Failure, Valuations Matter, Chasing Returns

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


“Data Dependent Fed” Ignores Data

I wrote on Tuesday of this week:

“The Fed currently finds itself in a tough spot from a “data dependent” standpoint. Last December, when the Fed Funds rate was increased, the Fed discussed the potential for further rate hikes in 2016 as inflation and employment data strengthened. With that data improving, along with the strong rebound in the financial markets, the Fed runs the risk of losing credibility if they DO NOT hike rates again on Wednesday OR give a very strong indication they will do so at the next meeting.”  

Fed-MeasuresOfInflation-031516

Employment-Trends-031516

My personal take is that the Fed will likely NOT hike rates tomorrow, however, stronger language about further rate hikes this year will be included.

The question is whether the market likes the outlook for stronger economic growth more than a further reduction in monetary accommodation?”

Given the “data” the Federal Reserve is supposed to be looking at, I have to admit I was more than a bit stunned by the lack of action given the more “hawkish” revisions to the Fed’s statement.

The Fed noted that economic strength had expanded in recent months, household spending has picked up and housing had improved further. Employment gains remained strong and indicators point to further job gains ahead. Inflation had also picked up but continues to run below the Fed’s 2.0% target level. All of this suggests that the Fed should have hiked rates at this meeting. However, it was ongoing global risk that kept them at bay

But was it really just “global risk?” The answer was found in the Fed’s “forward guidance,” as their projections explained why they didn’t increase rates. As shown in the chart below, once again the Fed lowered expectations further for economic growth and reduced the number of rate hikes this year from 4 to 2. Yep, “accommodative policy” is here to stay for a while longer which lifted stocks yesterday’s close.

FOMC-Economic-Forecasts-031616

Besides being absolutely the worst economic forecasters on the planet, the Fed’s real problem is contained within the table and chart above. Despite the rhetoric of stronger employment and economic growth – plunging imports and exports, falling corporate profits, collapsing manufacturing and falling wages all suggest the economy is in no shape to withstand tighter monetary policy at this juncture.

Of course, if the Fed openly suggested a “recession” could well be in the cards, the markets would sell off sharply, consumer confidence would drop and a recession would be pulled forward to the present. This is why “what the Fed says” is much less important than what they do.

The question is whether the market will buy into the “forward guidance” and push higher, or “call their bluff.” 

With the ECB and the Fed policy meetings now behind us, all eyes will turn back to economics and earnings. Unfortunately, neither one of those are particularly supportive at this juncture. 

Valuations Matter A Lot

On Monday, I wrote an article about the problems “long-term, buy-and-hold” investment advice. To wit:

“There are two primary reasons Millennials aren’t saving like they should. The first is the lack of money to save, the second is the lack of trust in Wall Street.

What Millennial’s, and everyone else, is starting to figure out is that Wall Street is not there to help you, but only to help themselves. “Long-term” and “buy-and-hold” investment strategies are good for Wall Street’s bottom lines as the annuitized revenue stream accrues each year. Unfortunately, for individuals, the results between what is promised and what actually occurs continues to be two entirely different things and generally not for the better. 

Of course, there is always plenty of push back when I lash out against the Wall Street proletariat with such heresy.

Let me be clear, I believe in long-term investing. I do think that you should buy quality investments and hold them long-term. However, what Wall Street, and many financial advisors miss, is the most important point of this argument which is “at the right valuation.”

Valuation, what you pay for an investment, is the single biggest determinant of future returns. In other words, it is not “IF” you should invest but “WHEN” you invest that is the differentiator between achieving your investment goals or not. Let me show you.

According to Dr. Roberts Shiller’s data, the Cyclically Adjusted P/E Ratio is currently hovering around 24x earnings. It is here that the problem for long-term investors currently resides. The first chart below shows the average real (inflation-adjusted) 20-year returns of a $1000 investment made when P/E ratios first hit 20x or 10x earnings.

20-Yr-Returns-Start-20x-10x-Earnings-031616

As you can see, valuations make a huge difference. The following two charts show the 4-secular bear and bull market investment periods defined by 20x (bear) or 10x (bull) valuation levels and the subsequent return of a $1000 investment.

20-Yr-Returns-Start-10x-Earnings-031616

20-Yr-Returns-Start-20x-Earnings-031616

With the exceptions of 1932, during the “Great Depression,” and the 1993 “Tech Bubble,” investors fared much better by investing when valuations were at 10x earnings or less. Even with the series of bubbles from 1993 to present, returns were eroded by repeated valuation reversions. The psychological impact of those bear markets made the “buy and hold” approach much less profitable and unrealistic for most.

While I have simplified the analysis above to a great degree, a look at all 20-year annual forward returns since 1900, from all valuation levels, shows the same story.

20-Year-Returns-From-All-Valuation-Levels-031616

Given current valuations near 24x earnings, returns are likely to be closer to 2% over the next 20-years versus the promises of annualized 6%, 8% or 10%.

Of course, this does not mean that every year will be 2%. It does, however, imply that the “bull market” that yielded a roughly 200% return from the March 9th lows will revert back to its long-term mean taking a bulk of those gains away. This is just how markets throughout history have worked, and this time will likely be no different.

This is why managing your money to avoid major drawdowns, especially at high valuation levels, is especially important. The one thing you can’t regain is the “time” lost trying to get back to even.

You can do better.

Proof Why Chasing Returns Is Bad For You

One of the biggest mistakes that investors continually make is chasing last year’s “hot” performers. “Hindsight” bias is a dangerous psychological issue that drives individuals to abandon their investment discipline the fear of “missing out” on returns overrides logic.

Simply put, it is “greed” rearing its ugly head which remains one of the 7-deadly investment sins.  As shown in the Callan table of periodic returns, chasing last year’s “winners” has repeatedly led to this year’s “losers.” 

The chart below shows major asset classes. I have drawn lines through the S&P 500, Emerging Markets, Bonds and S&P 500 Value indices.

Callen-Periodic-Table-Returns-031616

What is important to notice is that the S&P 500, Emerging Markets and Bonds have all spent time being both the best performing and worst performing asset classes. Take Emerging Markets for example, by the time individuals realized how great the returns were last year, they were often pummeled with losses soon thereafter. Even bonds, on a price performance basis, have had strong and weak performance years.

However, from an investment perspective, buying valuation based stocks delivered consistent and more conservative returns. For true buy-and-hold investors, the stability of returns made it far easier to adhere to an investment strategy amidst ongoing market volatility. When coupled with fixed income, volatility was reduced further and forward returns increased as interest income and dividends buffered price volatility. S&P 500 Value stocks were never the best performing sector, nor were they ever the worst. But over the long-term, lower volatility, and fewer emotionally driven investment mistakes have been the backbone of investment success.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In