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Manage the Funds Podcast

Expert insight on the financial topics that impact your bottom line

2018 2nd Quarter market outlook


A conflict free unbiased view on how we see economic fundamentals and the stock market coming together to drive our portfolio decisions. An inside look on how we do what we do for the second quarter of 2018. Guest host: Steffan Dye

Michael Carlin

Hi, this is Michael Carlin President of Henry+Horne Wealth Management with our 3rd. Quarter 2018 market outlook joined as always by the fabulous Steffan Dye. Hello Steffan.

Steffan Dye

Thanks for having me. Happy to be here.

Michael Carlin

Well thanks for being here. This is your first Arizona summer so you’re feeling it at this point 115 every day.

Steffan Dye

I like it. You know we got here in January and people say how wonderful it is. We came from Newport Beach California and people said you’re going hate the summer and I said, ok I know, and I had all these elaborate plans to deal with the heat and we got to May and I thought I kind of like it in the whole dry heat thing is a big deal. I went to Texas and it was 80 degrees and humid and I was sweating and hated it and I wanted to get back to 100 and dry. So, now we have 115 and a little bit more humid but I still I think it’s nice.

Michael Carlin

I really wasn’t sure what you were going say.

Steffan Dye

You know what else I like about it is everywhere you go you always can talk about the weather and the humidity to everybody all the time no matter how many times you’ve spoken with them about it. It’s just what you talk about here. What about you? You just got back from a trip to California. How was that?

Michael Carlin

Well, it’s a lot of work. Lego Land it’s like the young stepchild of Disney which is to say that it’s everything’s a little bit worse. It’s still good kids like it just as much at Disney but for parents we see the differences. I would say that kids loved it and I will never go again how’s that.

Stephan Dye

So, Dad and 2 girls. That’ not an easy trip, but they loved it.

Michael Carlin

Very easy for the girls. Yeah, smooth, terrific, but I’m glad we’re back.

Stephan Dye

Yeah. Did you tell them you’re never going back?

Michael Carlin

I said we’re going to go someplace else next time and they seemed okay with that.

Can we do some slides? I’d like that. So, first six months of 2018. It was interesting that we finally saw the resurgence of small cap. Small cap really well and conventional wisdom is small cap did well because there was a real tilt towards America first. Those that are going to benefit the most from tax reform those that are going to do well with the way the U.S. dollar moved in the first half of the year. There were a lot of tailwinds that pushed and propelled small cap for six months of the year up almost 8%. International markets in Europe, Japan you know certainly all other aspects of everything in the Europe with everything you’re dealing with Brexit we saw that negative 2.8 for six months. Emerging markets down almost 7 after having a great 2017. If you look to kind of set the table for what we’re looking at in the third quarter, we start to see the winds are changing a little bit with the market.

Steffan Dye

Yeah, it looks like it. The trends over one year and six months don’t align over most of the major markets. So, if you look at six months you see foreign developed markets are down. Emerging markets are down. China is down Germany’s down. UK is down. The S&P 500 is down. The only place you see any growth is in small caps like you’re talking about in technology. If you look a little bit longer and look at one-year trends you still see a lot of things are up, but they’re only up a little bit. Developed markets are up 3 4%, S&P 500 is up 5 6%. So, I think a lot of technicians start to get worried if the trends are down over one year. People are starting to get concerned, but small caps like you’re talking about outperforming and technology too although Twitter is being crushed today. Not sure when listeners you’re going to hear this, but Twitter crush today, and Facebook just destroy legendary.

Michael Carlin

Most market cap lost in the day ever for Facebook, that hurts.

Stephan Dye

Facebook lost the same amount of market cap as a total market cap for Netflix almost. In one day.

Michael Carlin

I got a great chart. The bull and bear market cycle. It’s kind of like the cyclical bull cyclical bear and it’s one of my favorites from this quarter and what it shows is you can really appreciate the magnitude of the run that we’ve had from 2009 to today. And if you look back you can see the cycles of when the market went down in 2007, 2008 dot com. You’ve got to go back to 1987 before that 1980, but as you look at this chart you can’t help but be prepared for what is shaping up as is something where it looks like we’re at we’re indeed headed towards a very difficult market cycle because you can see very clearly from this chart that the second longest running bull market history in stock market history 112 months in duration market up 325%. We finally have beat the long run after the Great Depression which was a 60-month 323% cumulative return. So, listen people are always asking how much longer. You’ve got a chart like this, there’s only one market to compare it to and that’s the dot com bubble and so that’s the debate we must have is can a part of the market push us to dot.com levels? If that’s the case maybe, we have another 20 to 30 months.

Steffan Dye

Maybe we do. I don’t know. I can say that we’re going to have a bear market. I know that I can’t say when it’s going to be right and can it run for a couple of years? I don’t know. We do call it a market cycle an economic cycle for a reason and that’s because it goes up and then it comes down it can’t go up forever. So, we’re wise to continue to talk about it, wise to continue to watch it.

Michael Carlin

What we’re trying to do is, we’re trying to figure out every day every week every quarter given what the data’s presented to us. Is it time for us to get more defensive and one of the things we’re looking at is the lack of breadth in the market meaning, that there’s certain aspects in areas of the market that are doing really well. Information technology energy health care those areas of the market have led us for the first six months of the year. They’ve performed well nothing better than I.T. that you know that technology area where you’ve got Staples, Telecom that’s not Staples the office supply. Telecoms financials real estate sector which has performed a little bit better as of late. Utilities also rebound a little bit better but all of those are down for the year. So, this isn’t the kind of market where we’re all areas of the market are moving higher. That’s just not what we’re looking at now.

Stephan Dye

What you’ve done and rightfully so is zoomed in we talked about developed markets and all the markets all over the world down. So, when we zoom in to U.S. markets we look at the different sectors and I.T. is up enough to make it seem like it’s not as bad as it would be otherwise. If I.T. were sort of flat then the S&P 500 would be down negative

Michael Carlin

Right, and when we take a step back we really need to get a sense for what we’re going to see from the rest of the world. Are we seeing the kind of robust global growth that’s going to push us for the rest of the year and into 2019 and if you look at global consensus global consensus for this year is that the globe supposed to go at 3.2% and that’s for the whole of 2018. That’s the forecast. If you look at the forecast for 2019 supposed to go at 3.1%. So, what you know is that analysts are expecting less growth next year and a big component of that we know is the tax cuts and job X that’s helped corporate earnings quite a bit. And you know it we as we look through this and we get the data recently that shows that the U.S. GDP up 4% for the quarter this is the best number we’ve had since 2014. You have Trump is saying no he wants to see 4 percent GDP growth for the remainder of the year. It flies in the face of what the analysts are forecasting and we’re starting to see a real dispersion between what people believe and when investor behavior is starting to translate.

Steffan Dye

Yeah, you know we spent some time I think last month or maybe the month before talking about how analysts get forecasts of earnings wrong, because they tend to forecast in a straight line right. Same thing is going to happen with GDP growth numbers. They’re going to continue to grow and they’re coming in strong. They look great, but when they start to turn down whenever that maybe it I don’t think that’s going to be soon. When they do they’ll start to disappoint because the projections will continue to be high.

Michael Carlin

Exactly, and I know some of our clients are sorry we’re retired CFO as controllers a big publicly traded corporations and they understand this very well. They’re not looking into the future when they’re making forecasts and they’re sharing their forecasts with Wall Street analysts and saying here’s how we’re going to earn less money next year.

Steffan Dye

By the way it’s going to get bad from here.

Michael Carlin

No they don’t do that, they’re looking squarely at their own marketing forecasts business plans growth targets where they’re helping make those decisions about how they’re going to grow next year and they’re not necessarily looking at the overall economy and thus there’s always a surprise.

Steffan Dye

Of course, and they’re human. They tend to forecast in a straight line. That’s just what humans do.

Michael Carlin

Humans do that. Humans also look at the Economic Surprise Index. What’s interesting to us is S&P put out a pretty good report that we grabbed here. Great chart which shows if you look at the Economic Surprise Index for the United States the Eurozone emerging markets in the whole global economy all of the surprise indices again, we’re trying to get a sense for forward looking economic numbers and trying to get an understanding for where economic numbers may go. All the surprise indices are going down. None more so than in Europe. It can’t help but believe that Brexit which is coming up is still undefined in terms of how that’s going to work. Yeah. Italy whose government bonds are now being priced as if there’s going to be a default which by the way they have or they seem to have enough cash and so it doesn’t seem very likely that it will happen. You’ve got Italy, Brexit, and you have tariff a potential tariff at one point there was a discussion which seems to have waned a little bit with a Trump administration said and suggested that they were going to put is a huge tariff on European autos that may affect the price here in the United States as much as seven thousand dollars a car. With all of those headwinds facing the U.K. economy it’s not a surprise to see that their economic surprise index is are down the most, but it’s surprising to me that there’s global UNISON.

Steffan Dye

So, this Economic Surprise Index talks a little bit about what we were just talking about so when data comes in less than expected, the Economic Surprise Index starts to go down and when data comes in better than expected the surprise index goes up. We’ve got unbelievably high expectations and we’ve had terrific growth, but the growth hasn’t been as high as expectations across the board just like you’re talking about. So, this could mean if you think about what’s going on for the future it could be that the surprises start first before the data turns and starts to follow the surprises. But at least expectations are going to have to come down.

Michael Carlin

Right, because valuations are a little screwy. Let’s look at international, let’s look at all areas of the publicly traded stocks and start with the S&P 500. If you look at the S&P 500 price to book, price to book as again a measure where you look at the share price versus the book value of the company to get a sense for whether it’s expensive. Price to book albeit not perfect, but a good indicator for us to pay attention to is so close so close to all-time highs for the S&P 500. The measure is at 3.27 and 3.45point four five being as high as it can get. The 15-year average price to book is 2.5 and it could be as low as1.6. If you’re looking at a scale and the graphs that I’m looking at show it really well you can see if it were a thermometer it’s almost at the top and if I’m looking for value on a price to book scale shows up well for the international market where we’re currently at a 1.6 in the 15 year average is 1.7. We’re less than average emerging markets which had again the great year last year. Rough start to the year. Price to book down to 1.6 average is 1.7. You can see some reasonable valuations there. Where the U.S. market it looks so expensive so, it’s on a valuation scale. It’s hard to justify the prices when you look at price to book. At the same time there’s just this overwhelming feeling that the quality is here in the United States in that if that were the economy that has the better surprise index. We’re the economy that has the best GDP. We’re the economy that has the favorable tax reform which has helped corporate earnings. So, we should have the best price and we should have the highest price to book and this is really the only haven in international and emerging markets seem to be thrown out right now.

Steffan Dye

Yeah. We’re also the economy the stock market with the most momentum and as you know the momentum over the last twelve months the indexes or the stocks that have performed the best tend to perform better, sorry for the last 12 months they tend to perform better over the next 12. So, everything looks good for United States stocks economy except for on a valuation basis where it’s just expensive. We also have a lot of people in the United States have what we call a home country bias where people all over the world tend to invest far more in their country than they do in other countries. I saw something interesting yesterday where there’s a I’d call it a home region bias where. In California investors allocate a lot more heavily to technology on the eastern seaboard around New York they allocate a lot more heavily to financials right. Whereas in Michigan they’ll allocate more heavily to manufacturing in a significant way. Texas is more oil so is Oklahoma and Louisiana. So, it’s interesting how people sort of go with what they know and where they are. For those of us have a value bias we start to look all over the world especially emerging market and then my concern becomes when I do that though is currency risk. Right, the dollar has been rallying against foreign currencies which has pushed emerging markets in dollar terms down even more.so trying to predict what the dollar is going to do is a little difficult to do but it’s something we want to pay close attention to. Or when we take our foreign curt when we take our foreign investments we can hedge the currency risk is something to really think about.

Michael Carlin

I got to mention what you may or may not have seen with the China currency did you have you seen how far how far down how much cheaper Chinese currency has gotten since the trade war started. Absolutely. It’s astounding. That’s an unintended consequence of tariff discussions in a way that China in some ways is winning an aspect of the tariff.

Steffan Dye

The currency is down. The stock is down. Growth is slowing and there are many who believe that the big story and maybe we’ll do this next month or the month after about growth and growth in China because growth in China has slowed and it could be contagious.

Michael Carlin

Markets only down 20 percent in China. Yeah. So that’s it so far. One of the things again we need to continually keep our finger on the pulse of this consumer spending because in the United States consumer spending still drives the economy. We are a consumption-based economy you know consumption is about 70 percent of our total economic output here in the United States. It appears working workers are living within their means. If you look at personal consumption expenditures on a year over year change basis and you weigh that over with paychecks are really adding up to again what people are taking in versus spending. There’s been a nice link where paychecks have gone up spending has gone up. The only little concern that I have is that there’s been a rash of an increase I say a rash an increase of consumer borrowing that has come up and it has not it is actually exceeded here recently what the paycheck number looks like. So, I’m a little concerned about the consumer spending number. Again, it’s been good. Paychecks have been good but I’m a little I’m seeing a little bit of a slowing down there and that leads us into and we’re going to spend a little bit more time on our on our special section this quarter on inflation. But inflation expectations are getting on the high side.

Steffan Dye

Yeah. They’re getting higher and I’m happy to see people are making more money I’m happy to see they’re spending appropriate amounts relative to the additional money they’re making. Last quarter the one before we talked a lot about the Federal Reserve and interest rates. What they’re watching is inflation and especially wage inflation. That’s when they will take the punchbowl away from the party when inflation gets out of control.

Michael Carlin

In that you’re seeing inflation specifically related to tariff and I don’t think enough people are talking about it. But we’ve got a couple of nice charts and that if you look at aluminum, lumber, wood, and steel three specific commodities that have been directly impacted by the tariffs those prices are up in some cases 25 30 percent. You want to talk about inflation. Those are the fundamental components of building blocks of so many different industries and parts of the economy. What’s nice is we’ve got another chart where there were seven tariff dates. There were seven dates with which tariff was mentioned and actions were taken this year. If you look each of those seven dates the tariffs were mentioned January 22nd, March 23rd, and April 2nd markets down every time. The market hates the tariffs. We’re fighting through it because corporate earnings are good, but you’re seeing lumber, aluminum, and steel prices are surging. It’s being mentioned in the market or again from the administration. The market’s reacting negatively to it and the tax situation started to hurt.

Steffan Dye

We’ve talked about this before about narrative economics, about stories move markets. One of the big stories that markets are moving on right now is the tariffs story. When you see aluminum, lumber, wood, and steel moving up as much as 8 10 percent over a three-month period right. That’s moving fast and we’re going start seeing it reflected in the prices we pay for building houses and riding cars and everyday items..

Michael Carlin

Building solar panels, the building constructions and solar power plants all of that stuff very much impacted. We turn our focus to interest rates. We want to mention this, and we’ve mentioned it once or twice let’s just keep mentioning it. There have been nine times that the yield curve has gotten negative and each of those nine times the yield curves gotten negative. It’s correctly signaled a recession.

Steffan Dye

That’s a perfect track record since 1955.

Michael Carlin

No, but it’s something we need to pay attention to because this spread difference between the short part of the Treasury and the 10-year Treasury got as low as 20 basis points which is to say two tenths of 1 percent which is to say very flat and we’re getting remarkably close to it. If you look through there are these recession dates going back from 1955 to today and every single one of them was led by this inverted or negatively slope yield curve. Now it doesn’t always mean that as soon as you get a negative sloping yield curve the next day the market goes down. I think the average is eight months or so about eight months. Yeah, I mean because I think it’s not it’s not understood enough because people are hear negative sloping yield curve and they think that it’s an immediate thing. What happens beforehand, but that’s not necessarily the case

Steffan Dye

Not in the economy but in stock markets sometimes it does. Over the last nine times we’ve seen an inverted yield curve. We’ve also had a bear market follow just as we’ve had an economic recession. I should say follow because two of the times the yield curve inverted the bear market began before the yield curve inverted so since what we care a lot about the economy we also care I’d say even more about our portfolio so we’re on high alert when we start to get near an inverted yield curve knowing that two of the last nine times the bear market started as levels similar to where we are today especially when we see the stock market down like we discussed earlier all over the world over the last six months.

Michael Carlin

Right. Well and so let’s do some of the key takeaways I know we’ve got so many graphs and charts we could sink a battleship. You should tell listeners how they can get these charts.

Steffan Dye

I mean if I were in your seat listeners I would want to see these charts Michael takes a ton of time to put them together they tell a wonderful story.

Michael Carlin

Everybody wants the charts. I love the charts, so send us an e-mail you can send us an e-mail at Michael@hh-wm.com  Send me an e-mail. Give me a call. I’m happy to zip it out to you. Let’s do the key takeaways because we’ve got a couple of charts that we’ll be strokes. I do want to spend some time on the inflation. Inflation is I think it’s one of your favorite topics.

Steffan Dye

I love it more than you do. You wrote a blog about inflation recently which makes you the king of inflation writers right now. See Michael’s blog on inflation and retirement it was terrific.

Michael Carlin

Thank you. So, we believe investors are right to be worried about the interest rate environment in that the interest rate environment with that negative sloping yield curve, with low rates getting higher because we know that the Fed they’ve increased interest rates seven consecutive times we believe it’s very likely ones coming in September maybe another in December. So, with the Fed moving the short part of the yield curve it’s unlikely to us that the 10 year and the longer part of the yield curve moves higher which means things get flatter. Things can start to a little bit negative. You now understand why we’re a little concerned about negative yield curve again because it’s an accurate predictor of what the economy is going to do. So, we think investors are right to be a little bit worried about rates here.

Steffan Dye

Absolutely. We’re watching the rates we could not watch their rates more closely. Last week there was an interesting move up in yields in Chinese bonds which pulled up yields in U.S. bonds a little bit on the 10 year and there was a moment where we felt like maybe the curve was going to steepen again because it was going to rise on the long end. Turned back down the neck over the course the next day or two. So now again we sort of feel like well maybe that’s not going to happen we’re going to stay flat. On the long end at the 10-year level and the Fed is telling us for sure we were going to be raising rates.

Michael Carlin

It would have to be something shocking for it to get them to change. That leads us into the other key takeaways from this quarter is that you can look at analysts’ expectations across the board and many are predicting growth to be very good for 2018 but 2019 starts to moderate a little bit. We continue to talk about this wildcard and that is will there be another policy something fiscally done from the White House that’s going to end up giving us another boost to the economy. To me I think that the one thing that stands out is an infrastructure package because if we got some kind of a 1 trillion at one point Trump mentioned a two trillion dollar infrastructure package and again that’s something that’s developed and an issue to help your roads, bridges, and airports things like that. The infrastructure package may really provide a huge boost which may make us rethink our 2019 earnings expectations because right now it looks like it’s moderating.

Steffan Dye

I’m a super proponent of infrastructure packages. We keep talking about China, but we’ve talked in the past about how Chinese growth is such an important part of global growth over the last couple of years and they’re investing in infrastructure incredibly there’s something that they’re doing they call the belt and road initiative where they’re building infrastructure to access markets far away from themselves. It’s the largest infrastructure project in the history of the world. Now they’re having to borrow a lot of money to do it and there’s some concerns about their debt and talked about that’s massive debts. There’s some concerns about it but I do think investing in infrastructure is great and now it puts money into the system it puts people to work and it gives us the opportunity to thrive in the future. I would love to see an infrastructure package.

Michael Carlin

We’re not assuming if it’s going to happen. So, our base expectation is that returns will be moderate over the next five years. There’s substantial risk to the market at these levels. We’ve highlighted it. We provide you the data that we’ve been talking about it. Our clients know that what we do is we proactively review these things so that as we see changes coming we’re going to do our best to get you out of the way or get you to safe water as much as we can.

Steffan Dye

That’s right. We want to access as much of the growth when it comes and protect from the downside when it comes. We position portfolios in a way that we don’t know what’s going to happen in the future. We’re trying to protect from all situations and take advantage of the breadth of growth.

Michael Carlin

We need to get Elizabeth to do some kind of like a sound graphic for special breakdown like thunder bolt or something fun like a horn. She’s over there nodding. I think she’s going to do that next time. Special break down inflation. Inflation, the question, is it becoming a concern? We’re going to take a quick step back before we dive into it because inflation again the cost of living going up every year we got that. Very few investors walk into our conference room understanding the problem that inflation can potentially hold for their finances. They just don’t think about it. They think about fees or they think about returns and prior performance. They think about a lot. Think about Trump. They think my administration. I’m telling you no one ever comes into the office worried about it. Now some of our longstanding clients now understand it’s a problem, but no one comes into the office panicked about inflation.

Steffan Dye

No, they don’t. What I hear about inflation is you making fun of me talking about it all the time and so I’ve been asking people lately because I do tend to focus on inflation a lot and let me tell you why. Why do we save money? We save money for the benefit of our future self and our future family so we’re sacrificing our current consumption our current self for future benefit. Then what do we do, we invest it so that it will have even more benefit in the future than it would have in the present. Inflation is going to happen between now and the future. My return what really matters is how much more than inflation I get. I’ve been doing this for the last week and a half asking very smart people who are in financial services what they believe reasonable expectations for future returns, inflation adjusted. They typically give me a reasonable number not inflation adjusted because they’re not accounting for inflation. These are people who should know I’m just not thinking about it that way. Prices go up over time.

Michael Carlin

If you don’t make sure that you have an investment that can grow significantly more than inflation and accounting for taxes too you’re not getting ahead of the game. Wages have been rising we talked a little bit about paychecks. We do want to see a little bit of wage inflation but not too much because it’s a huge component of inflation. The challenge is that we saw the CPI numbers, again the government headline inflation numbers which came out at 2.8. There’s many that are expecting I’m trying to think of who wrote the report but they’re expecting to see us get through that 3 percent inflation number. Which is a trend that’s something that we got to do. We have to share because they’re certain investments that are going to do well and others that well in a higher inflation world.

Steffan Dye

Keep in mind that the Federal Reserve’s target is between two and two and a half. When I go over that they want to take away the punch bowl.

Michael Carlin

I got a little history lesson and I think I can help explain why people don’t think about inflation. It’s in the chart. The chart will show you from 1870 to today and it’s going to show you there are periods of time where we had inflation which is the vast majority of the time again cost of living going up the prices going up over overtime. There are certain pockets where we’ve had negative inflation or deflation. We haven’t had one since the financial crisis but before that you can go back to the 1950s than we had any kind of deflation. Number one, the people that are alive today that and are consuming on a regular basis. They may have seen a deflationary environment but probably not. Again, we ought 2007-2008 that was a component but not a lot of people really felt it. It was very short-lived.  This race was very moderate and if you go back the 10-year average inflation number we’ve had is 1.64%. We’ve had a decade where no one has even mentioned the word inflation. I think that’s a huge component. It has really been since the 1980’s and the 1970s that we have had to even consider or think about inflation because those rates of inflation were in the 13%-14% range in the 70s it was in the 12% range and you got to go before that to get inflation that really ran out of control. Looks like here sometime in the early to mid-1940’s we haven’t had runaway inflation we haven’t had deflation but what we have had is a period of almost nothing. The cost of living not moving up a whole heck of a lot. So, it’s lulled people to sleep.

Steffan Dye

What I’m struck by looking at this chart. Listener’s you should see this chart. It’s very interesting but it goes back to 1870 and what you see is a lot of cycling between periods of inflation and deflation and significant deflationary period in the early 1800’s. Leading all the way up into really the 1940’s and ending in sort of 1940 1950’s the Federal Reserve said we don’t want to allow this kind of inflation we want to stabilize the economy and since then it’s basically been a story of inflation whether low or high rising and peaking in 1980 like Michael is talking about and then falling and falling and falling till we get to today. It appears to be rising again a little bit.

Michael Carlin

We want to be the first to educate you on it. I wish we could do trivia questions because the average inflation rate from 1870 to today two and a half percent, but the average inflation rate from World War 2 to today 3.8%. We’ve been averaging again 1.6 look for different numbers to come. If you look at certain areas of the market the economy. There are areas where we’ve seen some high inflation specifically energy which is a year over year inflation is up 8%. Transportation year over year up 4.1% housing up 3.4%. There are areas of the economy we’re not seeing inflation it’s massive and the challenges is that energy, transportation, and housing tend to be three that affect retirees the most.

Steffan Dye

Absolutely. Energy is fascinating to me. Housing in the last couple of days we’ve seen some interesting numbers. Housing sales numbers are down especially in California. That could be turning a little bit. I’m surprised to see medical care up 2.2%. I think of medical care inflating at 10 and 15% per year. If it’s only up 2.2% per year that’s interesting to me. I’d love to know what’s behind that number. Then commodities actually down a little deflation on the commodities.

Michael Carlin

I bet you Amazon and Jeff Bezos and Warren Buffett would say it’s us. Trump would say it’s him and you know that Trump did do he did have a discussion with Pfizer and they did reduce some prices of some of their medications so there’s been it seems like a real active movement to help push down medical costs.

Steffan Dye

I’m all in favor of pushing down medical costs.

Michael Carlin

Well we still got more work to do on that. When we look at energy prices that’s one thing we do want to spend a minute of time of course. One of the things your expert at Steffan. There are many and oil is one. Energy prices have been rising and in oil’s broken some support barriers it’s made some new highs and in the question we always need to ask ourselves is this going to be the ultimate price for oil is this where we settle in. This is what’s going to happen?

Stephan Dye

Oil prices are very difficult to predict as I have learned in the past I’ve been humbled by the oil markets and the natural gas markets dramatically several times. What’s interesting about oil prices to me right now is over the last quarter oil prices were moving up at the same time the dollar was rallying. Normally the dollar and oil prices will move inverse to each other. If the dollar were to turn around and begin to depreciate against other currencies to expect oil to rally more. Which is just something that’s surprising to me. There’s something else coming that’s I think interesting which is to take a quick tangent won’t go too far on it. About 18 months from now there’s going to be changes in the rules around what kind of fuel all ships can use and it’s going to reduce the amount of sulfur that the ships can use in the fuel. What that’s going to do it looks like what that means is refiners are going to use about three barrels of sweet crude low sulfur with the sour crude which is high sulfur. The refiners are going to have to adjust to this. What that means is going to be added demand for the sweet crude. You see a lot of sweet crude coming out of the Gulf of Mexico the United States. You see a lot of sweet crude coming out of the Permian Basin in the United States, but it looks to me like you’re going to see price increases especially from the sweet crudes and that starts only 18 months from now.

Michael Carlin

And we’re seeing so much more production here in the United States relative to where we’ve been that it seems to be very beneficial for us despite the higher prices at the pump because it’s a huge part of the economy that more jobs high paying jobs that kind of thing.

Steffan Dye

Yes. We’re also seeing I think interestingly the situation in Iran with the sanctions could lead U.S. oil producers to capture some of the markets that Iran typically feeds. We still trade West Texas Intermediate oil at a discount to the global crude which is called Brent. I wouldn’t be surprised over the next 18 months for the reasons we talked about for that spread to narrow which could mean West Texas Intermediate crude rising.

 

Michael Carlin

Don’t expect prices at the pump to plummet anytime soon.

Steffan Dye

Gas prices at the pump and oil prices aren’t as correlated as you think because you buy the gasoline from refiners who have their own economics and their own limited ability to produce this stuff. If oil prices go up and it doesn’t go up at the pump people are surprised but they’re not as related as you might think.

Michael Carlin

All right tackle global inflation if you look at a chart of the world. The vast majority of the world inflations is pretty calm. There are areas in pockets where you have inflation greater than 25 percent. Hello Venezuela.

Steffan Dye

You’re going say Venezuela aren’t you. Oh, my goodness.

Michael Carlin

Was it a million or a thousand percent inflation.

Stephan Dye

I had the same conversation with myself this morning. I think I saw a million percent a million percent per year. So, the currency is worthless.

Michael Carlin

Good luck. Try to buy a car or bread. Good luck trying to have a society. It is hard and sad what’s going on down there Rampant inflation is one whole thing which is interesting and is really again in South America. There is that component there’s also a few areas in Africa that have some problems too with inflation. Which leads us to the inflation scenario conclusions. Yeah. There are three ways that we see this coming down. There’s the good. There’s kind of like which is pricing pressures are easing or like a symmetric level of inflation where the cost of living is going up on a balance level or bad where the Fed outpaces inflation increasing rates too much causing an economic downturn. And thanks to our friends at hidden lovers that again have a great technological resource. If pricing pressures ease smoothly looks like the market they believe, and it seems likely to us that the market’s up 10%.  If we get a symmetric kind of a balanced level of controlled inflation they think the market moves higher 5 % but if the Fed moves too quick they see the market down 20%.

Steffan Dye

This hidden lever of technology is really impressive and those of you listening who are clients of the firm have seen this before. Those of your listeners aren’t clients of the firm should see the technology because it’s amazing what it can do it allows us to say, ok we believe that inflation might go up on a baseline of 2.5 %. What does that mean to the S&P 500 and you would need teams of PHD’s and analysts spend weeks of time to figure this out. We have software that kicks backs and you think in that case the S&P 500 is likely to be up about 5 percent over the next year. Well what if you think that inflation is going to slow from today’s levels and it’s going to be about 2 percent. What’s the S&P 500 likely to do. We take it to be up on the order of 10 percent and if inflation goes up to 4 percent we think the S&P 500 goes down 20 percent. What that allows us to do is position portfolios in such a way to anticipate the potential scenarios that people are concerned

Michael Carlin

Hopefully the Fed doesn’t move too quick. That’s the hope. That’s the market outlook in 45 short minutes. That was fun. That was terrific.

Stephan Dye

Next time we got to talk more about the girls.

Michael Carlin

Oh, my girls? Let’s talk about your son.

Stephan Dye

He’s just learned how to jump. You can tell when he’s happy because not only is he smiling, but he’s jumping.

Steffan Dye

I went when I was two  write my vertical leap was similar to his right now. I hope he’s better we need to track it and we’ll start we’ll start measuring vertical leap already.

Michael Carlin

Well thank you. Thanks again for tuning in. Steffan we’ll will be ready to do the next market outlook here in the next couple of months. Thanks for tuning in. Have a great day.

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