Quarterly Investment Update: 2019 Quarter 2

by

The Desire to Believe

We love a good fraud story.  If you haven’t seen the documentaries about the Fyre Festival on either Netflix or Hulu, we highly recommend both.  Fyre Festival was supposed to be the biggest and best party of 2017.  Five thousand “lucky” attendees reserved tickets at prices ranging from $500 to $12,000 per night.  They were promised plush accommodations, gourmet meals and performances by more than 30 top musical groups, all on a private island in the Caribbean.  It turned out to be one of the biggest pop culture frauds of all time.  In the end, not a single musical group performed, attendees were lucky to get any food or water and there weren’t even enough of the rain soaked tents to go around.  How did so many people fall for such a fraud?

It seems that frauds, much like financial manias, always gain attention and power based on three key ingredients.

  1. A compelling narrative with incalculable upside
  2. Social proof (validation from friends or experts)
  3. The desire to believe

Fyre Festival was no different.  Potential customers were told a compelling narrative: they would be rubbing elbows with stars at an exclusive new music festival.  They were shown social proof through a coordinated social media endorsement campaign.  With so many social media influencers involved, it had to be legit right?  Lastly, and most importantly, the victims wanted to believe.  Particularly in the age of social media, the idea of Fyre Festival was exactly what young people wanted.  The opportunity to post beautiful images with celebrities at an exclusive event was too good to pass up.   In both frauds and financial manias, once people really buy in and begin touting the idea to others, it can become nearly impossible to persuade them otherwise.  Indeed, in every major financial panic and every fraud story we have ever studied, there were warnings that went unheeded.  For professional and amateur investors alike, keeping an open mind can be easier said than done.    

Executive Summary

  • The Quarter in Review
  • Sentiment & Value Update
  • Trade Negotiations
  • The Unicorns Are Coming!

The Quarter in Review

 On the heels of a sharp selloff, a frantic rush to buy pushed US stocks up in one of the strongest January’s and first quarters on record.  International stocks also rallied on optimism around trade negotiations.  Long-term bonds rallied powerfully as the Federal Reserve rapidly shifted from rate hiking mode, into neutral.  The yield curve inverted in late March, indicating that bond investors expect the Fed to lower interest rates later this year.  Almost all asset classes rallied.

Relevant Index Performance

Total Returns as of 3/29/19

            Index                                   Qtr. to Date                Last 12 Months

  • S&P 500                                  13.65%                         9.50%
  • MSCI World ex-US                10.45%                        -3.14%
  • MSCI Emerging Mkts.           9.92%                         -7.41%
  • S&P Municipal Index            2.76%                          5.12%
  • 10-Year Treasury                    2.13%                          5.03%

Sentiment & Value

Click to enlarge

The chart above shows our opinion on where various markets are as of March 29th 2019.  Many of the best purchase decisions are made when prices are cheap and sentiment is bearish or depressed (bottom left quadrant).  Conversely, many of the best sell decisions are made when prices are expensive and sentiment is bullish or euphoric (top right quadrant).  This chart and the comments below are intended as a behavioral guide, not as a timing tool.

Click to enlarge

US stocks have rallied back near all-time highs after a panic attack in December.  The investment media is touting the narrative that the Federal Reserve is once again prepared to prop up markets.  And investors certainly want to believe that the Fed’s safety net is once again ready to catch them.  We must admit that the Fed may be able to push markets higher for a few more years.

However, we would like to point out that we are in a textbook example of a late stage bull market.  At the end of the quarter, the yield curve inverted.  A yield curve inversion occurs when short-term US treasuries yield more than long-term US treasuries.  This unnatural occurrence is a sign that financial markets are very unhealthy at the moment.  A yield curve inversion has preceded every US recession since the 1960s.  After each of these yield curve inversions the Fed has eventually moved aggressively to support markets by cutting interest rates… to no avail.  In each case the US economy ended up in a recession all the same.  And in each case investors who waited in low risk assets were eventually rewarded with an excellent buying opportunity. 

We certainly hope to keep riding the markets higher, but we will treat further gains as opportunities to rebalance into more low risk assets.  Patient investors are likely to see a better buying opportunity in the next 18 months.  All things being equal, if the S&P 500 were to trade below 2,500, we would be interested in increasing our exposure to US stocks and if the 10-year treasury yielded more than 2.75% we would be interested in adding to our long-term bond positions.

Trade Negotiations

Issue: Trade negotiations between the US and China have been dominating the headlines.

Impact: The market is behaving very positively on any signs that the US and China are making progress toward a trade deal.

FC Advisors’ Take: We expect a deal to be announced eventually because both sides need a positive trade story to sell to their constituents.  Investors want to believe that a trade deal between the US and China will mean that we can get back to business as usual.  It also seems that investors are hoping for a big pop in the stock market when a deal is finalized, but we think trade negotiations are a classic “buy the rumor, sell the news” story.

Additionally, we disagree with the notion that a trade deal will be a big win for economic growth.  It appears that companies have begun making important changes to their supply chains in order to reduce their exposure to trade friction with China.  The investment decisions that US corportations have been making over the past year will not be reversed quickly.  As the US economy becomes less interconnected with China’s (and other nations) we expect that trade disputes will become more common.  We suspect that companies will continue to prioritize the stability of their supply chains over low prices.  In the long run, a less globalized economy may mean higher prices and more competition over scarce resources.

The Unicorns Are Coming!

Issue: The Unicorns are a group of privately held, fast growing, technology companies that are valued at over $1 billion each.  2019 looks to be the year that many of them finally go public.

Impact: For the past several years, investors without access to exclusive venture capital funds have been clamoring for an opportunity to invest in the “Unicorns.”  Now they are finally getting their chance.

FC Advisors’ Take: To paraphrase The Economist “The worst investments are often made during the best of times.”  Or to put it another way, what’s great for sellers is usually bad for buyers.  The level of enthusiasm for the Unicorn IPOs is extraordinarily high, especially because most of them have yet to turn a profit or even hope to do so in the next three years.  While there is no doubt that many of the Unicorns such as Lyft, Uber and WeWork provide services that customers want and need, we can’t help but point out that all three elements of a financial mania are present. 

  • They are all selling stories about the disruption of an industry, followed by incalculable profits somewhere down the road as a result of technological breakthroughs, massive scale, or even entirely new lines of business.
  • The financial media has been touting their growth prospects for years.  And customers know and love the services these companies offer.
  • Many investors who haven’t had the opportunity to invest in these companies yet desperately want to believe that the best is still to come.

Whether the Unicorns coming to market is a sign of the top, or only the beginning of a euphoric run higher remains to be seen.  However, we are quite confident that many better investment opportunities will present themselves when the pendulum swings in the other direction.  Sooner or later there will once again be a shortage of investors with the desire to believe.

If you have questions about these topics or any other financial needs, please contact

FC Advisors at:

415-528-2826

hello@fcadvisors.us

www.fcadvisors.us

Following Claire Advisors, LLC DBA FC Advisors is a Registered Investment Adviser. This brochure is solely for informational purposes and is not intended to provide investment advice. Advisory services are only offered to clients or prospective clients where FC Advisors and its representatives are properly licensed or exempt from licensure.  Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by FC Advisors unless a client service agreement is in place.