Here comes a Rip Your Face Off-Type Rally

I suspect much of this year’s first-half-December weakness was the result of heavier than usual tax-loss-selling pressure and Fed rate jitters.

Raymond James chief investment strategist Jeffrey Saut said that “the market has the potential for a rip your face off-type rally! It’s human nature to read into negativity, what happened last Friday, but it really doesn’t deconstruct the bullish case right here. You’ve got massively oversold conditions in the equity markets. You’ve got a December’s option expiration in the trillion plus dollars that everybody is worried about – it typically has a bullish tilt to it…. The setup is pretty good for a rally to the upside that's going to surprise a lot of people. I think you could make new highs by the end of the year – new all-time highs.”

Typical first-half-of-December weakness was a bit magnified this year. The lackluster performance of the stock market this year, Fed-rate-hike handicapping, new lows in crude, and a mini-run on junk bonds all exacerbate normal yearend tax-loss selling. But this appears to be setting the market up for a yearend Santa Claus Rally.

The Santa Claus Rally is a very important signal as to what to expect in 2016. Yale Hirsch defined the Santa Claus Rally in 1972 as a seven-trading-day period that spans the last 5 trading days of the year and the first two of the New Year. If the Santa Claus Rally does not happen stock markets are usually negative, flat or suffered a bear market.

The other reason the Santa Claus Rally is so important is that it helps drive up beaten down bargain stocks.

Investors tend to get rid of their losers near year-end for tax purposes, often hammering these stocks down to bargain levels. And this year is a pretty good example. Over the years the NYSE stocks selling at their lows on December 15 will usually outperform the market by February 15 of the following year.

If it does not transpire it is not a great sign for 2016. Stay tuned!

This weeks wild stock market swings:

The U.S. stock market gained 2.05% on Friday, the biggest one-day gain for the S&P 500 index since early September.  Of course, this comes after the same index was down 1.1% (Wednesday) and 1.4% (Thursday).

What’s going on?

Of course, no person alive knows exactly what drives the psychology of millions of investors, despite the confident analyses you read in the papers and see on cable financial news channels.   Yes, on Wednesday and Thursday, some investors may have been disappointed that the European Central Bank provided only the stimulus to the European economies that it had promised—when everybody seemed to be expecting more.  Analysts said that the rally on Friday was due to the encouraging jobs report issued by the Labor Department, which told us that 211,000 net jobs had been created in November, rather than the 200,000 that had been forecast. 

But does any of this make sense?  Stimulating the European economy means more potential buyers for American goods and potentially more euros to buy them with.  Shouldn’t that cause American stocks to be MORE valuable than they were before?  The jobs data, meanwhile, means there will be more competition for workers, which often leads to higher wages and correspondingly diminished corporate profits.  Above and beyond that, the reassuring employment picture means that the Federal Reserve Board is now nearly certain to allow short-term interest rates to rise on December 16.  Shouldn’t that cause stocks to be less valuable?

The truth is that none of these events causes stocks to change their real intrinsic value in the least, and you should be skeptical every time you hear journalists draw links between headlines and stock movements.  The magnitude of the shifts should be a clue; how can a company—let alone a basket of 500 companies—be worth 2% more one day than it was yesterday?  Did they all win the lottery?  Did they all get caught making significant accounting errors that understated their earnings?  How much more likely is it that investors have to make guesses—sometimes wild ones—as to the value of companies, getting it more or less right over time, but constantly over- and under-shooting in their daily guesses?  If you follow this line of reasoning, it is helpful to note that the value of U.S. stocks, despite all this back and forth action, was essentially unmoved for the week, and pretty much unmoved for the year.

The markets may go back down on Monday, or they might soar.  This year may or may not end with a net gain.  None of that matters to your portfolio, which is slowly increasing in value to the extent that the companies you own are building value in ways that have nothing to do with the headlines.  If the world comes to an end, that will have an impact on the markets that we can measure with some precision.  Short of that, short-term market movements, and particularly the explanations that writers and pundits attach to them, are entertainment—and not especially entertaining at that.

Our recommendation?  Go watch a movie instead.

Mark Zuckerberg Fool or Genius?

You may have read that Facebook founder, chairman and CEO Mark Zuckerberg has announced plans to gift substantially all of his Facebook stock to a philanthropic entity called the Chan Zuckerberg Initiative, named after himself and his wife Priscilla Chan.  The gift would be worth $45 billion, instantly becoming one of the largest philanthropic pools in the world.

The donation is remarkably tax-efficient.  By making the gift in shares rather than cash, Mr. Zuckerberg will get a charitable contribution deduction on Schedule A of his 1040 form, with the deduction based on the fair market value of the shares.  At the same time, he will completely avoid having to pay capital gains taxes on the appreciation of those shares.  The LLC can then sell the Facebook stock or hold it and dole it out to charitable organizations and pay no tax regardless of how big the gain.  Basically it means that one of the world’s great fortunes will never be taxed, while Mr. Zuckerberg will be able to shelter billions of dollars worth of other income from federal taxation.

The Paris Attacks

Most of us watched news coverage of the multiple terrorist acts against the city of Paris, France, with a mixture of horror and dread.  The horror was our usual response to terrorism, the feeling that arises when we ask ourselves: how can people think this way?  And when we realize that, somehow, there ARE people who think that way, which is so far from our own reality that the realization triggers deep emotions somewhere far on the opposite end of the spectrum from inspirational. 

The dread, of course, comes from the realization that these attacks could have, and might still, happen here—that is, wherever we happen to be sitting, whatever concert venue or restaurant we might be planning to visit.

 

Hard on these emotions comes outrage, and that helps illustrate something that is seldom realized about terrorism.  In a recently published book entitled The Better Angels of Our Nature, author Steven Pinker points out that terrorism is far from a new phenomenon.  After the Roman conquest, resistance fighters in Judea—who called themselves zealots—would stab unguarded Roman officials whenever the opportunity arose.  In the 11th century, Shia muslims launched furtive assassinations on officials who practiced a different version of their belief system.  For 200 years, a cult in India strangled tens of thousands of people traveling through their country.  The assassination of President William McKinley was executed by a particularly ugly breed of of terrorist known at the time as anarchists.  Most of us remember days when London and Belfast were routinely rocked by Irish Republican Army terror strikes, and in the U.S., the Weather Underground of the 1960s had a terrible habit of setting off explosives in public places. 

The book lists many other instances of terrorist organizations, but all of them prove a point: eventually, each of these groups will go too far, provoke the consciousness of the general public in the wrong way, and turn sympathy to their cause into outrage.  Pinker cites statistics that show that virtually zero terrorist organizations ever accomplish their aims, and they tend to die out after their most visible credibility-destroying “success.”  One has only to think of the fate of Al Qaeda after 9/11 as an example of a terrorist organization whose relevance declined to near zero in the messy aftermath.

No doubt, the ISIS leaders who planned the attacks on Paris believed that this bloodletting would cause all Western nations to recoil in fear, and back off of their military efforts to contain the new caliphate to placate the caliphate so it wouldn’t strike again.  You and I know that this is pure nonsense.  The inevitable outcome will be a new resolve, a hardening, a coming-together of the Western nations in a display of solidarity with France.  Countries that were inclined not to get involved in the Middle Eastern messiness are now motivated to sign on for an international military campaign that will contain and perhaps completely destroy ISIS.  Leaders who feared that their citizens would revolt at the thought of military intervention can now count on the support of their outraged voters.  The next year or two will almost certainly reveal the ISIS attacks on Paris to have been a fatal mistake for those who dream of an Islamic, Sharia-governed caliphate in Syria and Iraq.

Today, you will see the world’s investment markets open lower, and probably close lower, as the horror of the events in Paris are translated into uncertainty about the world we live in—and, therefore, the safety of our assets, reflected in our stocks.  The markets always respond reflexively and negatively to threats to our safety.

But as the year proceeds through its last few weeks, the smart money always tells us that these downturns are temporary.  Fears that global enterprises are somehow worth less because blood was spilled overseas will prove to be overblown.  More importantly, after the events in Paris, the object of our horror and fear—the terrorist organization known as ISIS—is about to confront an opponent more powerful than its leaders have the ability to imagine: the resolve of the Western nations.  At the same time, it will have to endure the disgust and repudiation of moderate members of the muslim faith, in the Middle East and elsewhere.

The world changed over the weekend, but not in a way that affects the value of your investments.  The change will be felt most powerfully in the failed dreams of a caliphate whose leaders have made a grave and awful miscalculation, who are destined to pay dearly for their malicious stupidity.

Do you want to get the most out of your Social Security? Do this before May 2016!

On the surface, it seems too good to be true.  You have a married couple, where (let’s say) the husband has earned higher yearly income than his wife.  That means he has contributed more to Social Security over his working life.  The husband files for Social Security benefits at full retirement age (currently age 66) and then immediately files to suspend those benefits. 

As a result of this simple maneuver, the wife is now entitled to immediately receive Social Security spousal benefits equal to half of the husband’s full retirement benefits that were just suspended.  She would do this if 50% of the husband’s benefit is higher than she would have received if she had simply claimed her own Social Security payments.

Because he suspended his benefits, the husband can continue working, and wait until age 70 to start receiving Social Security checks in his own name.  Why would he do that?  Because each year of deferral allows him to accumulate more credits—effectively raising his monthly benefits 8% a year, which is considerably higher than the inflation rate.  At that time, the wife would stop claiming the husband’s benefits and start receiving her own Social Security checks.  If she was working at the time, she might have raised the amount she could claim under her own name. 

Presto!  More money now, more money later.

This popular Social Security claiming strategy is called “file and suspend,” and by this time next May, it may no longer be an option for retirees.  The Bipartisan Budget Act of 2015 that recently passed the House of Representatives would close what lawmakers are calling the “file and suspend” loophole six months after the President signs it into law.  You can expect that eligible seniors will be knocking on the doors of their Social Security offices before that deadline.  Meanwhile, those who have already filed and suspended will be allowed to continue as before.

The original rationale behind the file and suspend strategy was to encourage more seniors to continue working.  The rationale behind ending it is that it was becoming a drain on the Social Security system.  Moreover, Congress was looking for money to offset a huge increase in Medicare Part B premiums for individuals not yet receiving Social Security payments.  The provision is likely to pass the Senate, and could be the opening gambit of a broader discussion about how to “fix” Social Security’s messy finances.

Stock Markets Are Broken!

The turmoil Monday, August 24^th began when a steep selloff in Chinese stocks overnight in New York led to sharp declines in U.S. stock-index futures ahead of the market open. According to Black Rock, “This was one of the most extreme trading days in U.S. history. Markets opened under heavy selling pressure, with the New York Stock Exchange invoking “extreme market volatility” rules. In this unprecedented environment, over 40% of all U.S. equities did not open in the first 10 minutes of trading. Equities traded at extreme discounts, as did a number of ETFs.” Circuit breakers, which are designed to pause trading in single stocks and ETFs during big moves, were triggered nearly 1,300 times Monday.

Because this happened so quickly, many ETF market makers, or the broker-dealers who buy and sell those products, were unable to accurately calculate the value of the underlying holdings or properly hedge their trades. That caused them to lowball their buy offers and overprice their sell orders to ensure they didn’t take on too much risk. This sent ETF and stock market values tumbling.

Matt Hougan, chief executive of ETF.com, says his inbox lit up with people complaining about odd ETF trading Monday. He decided to run a screen for ETFs that were down more than 35% and found seven. Four of those were small, and odd trading occurs often in such ETFs, but the decline in the other three did appear to be anomalous. Guggenheim S&P 500 Equal Weight ETF, for example, simply holds equal weights of stocks in the S&P 500 index and should not have fallen by that magnitude.  According to Mr. Hougan, “It probably should have been down 6% on the open, but it proceeded to trade down more than 40%.”

The $2.5 billion Vanguard Consumer Staples Index ETF and the $5.8 billion Vanguard Health Care Index ETF both plunged 32% within the opening minutes of trading. The Vanguard Consumer Staples ETF was halted six times over the course of 37 minutes early in the day, according to trading records. The health-care ETF was halted eight times Monday. The declines in these and other ETFs were notable in that they exceeded the declines in the prices of their underlying holdings. In the case of the Vanguard Consumer Staples ETF, the value of the underlying holdings in the fund fell only 9%, according to FactSet.

“There needs to be a deeper examination of how the stock-market circuit breakers behaved on Monday,” said Joel Dickson, a senior investment strategist at Vanguard Group. “There was a major market-structure component to what happened.

While several big-name stocks and ETFs traded down more than 20%—and some more than 40%—Monday, they didn’t meet the standards to be canceled under the “clearly erroneous transactions” rule of the stock exchanges. During the so-called flash crash in May 2010, when some trades were executed at as low as a penny or as high as $99,999, which was determined to be erroneous and canceled. NYSE canceled all trades that day that were more than 30% beyond opening prices, though that only affected a handful of stocks and ETFs.

I have had to flash type crashed in the past, one in 2005 and the other in May of 2010.  Both times the trades were reversed. This time however, the markets chose not to reverse trades that were caused by the markets and market makers not working together and/or doing their job. To me the markets are now broken.

I am going to have a hard time trusting the stock markets and the market makers in the future.  It is time for action to be taken by the markets, Washington and who ever else their might be to change the current systems so this will not happen again.

Who am I kidding, the markets made money on this and they control Washington. So is anything really going to get done?