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STA Weekly Report – Cracks in the Foundation

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INSIDE THIS EDITION:
Cracks in the Foundation

How Technology and Innovation May Impact Opportunity and Risk
Medicare Open Enrollment Begins October 15th
Weekly Technical Comment
401k Plan Manager



 


The market rebounded nicely last week. The Dow rose 1.7% while small cap stocks advanced 1.3%. We saw 17 stocks advance for every 13 that fell in price but more impressively, we saw more than ten times the number of new highs than new lows. Finance and Basic Material stocks did well while energy and Non-Cyclical stocks fell.

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The S&P 500 has only had eight daily moves of 1% or more this year, the least for any comparable period since 1965 – the slow gains add up to a 14% rise in the S&P 500 so far in 2017.  The index has also recorded 43 record highs in 2017. The index is coming off eight consecutive record highs which, up until last Friday, we had not seen since 1997.  It would be good to remember that in that year complacency morphed into the Asian crisis. Then in 1987, we had a streak of six records in June, just a few months ahead of the October collapse.

Many investors have their eyes on the Federal Reserve and they are smart to do so. Our calculations show over 90% correlation between Quantitative Easing and the Fed’s activity on inflation in various areas. They found the Fed created an amazing increase in value of paper assets while economic growth, actual inflation and commodity prices were mute. In fact, commodity prices, other than precious metals, actually fell. The Fed says they are going to stop replacing some of the bonds on their balance sheet that are set to mature. This Quantitative Tightening will likely take a long time, but with over $1 trillion worth of Fed holdings maturing in the next five years, it will have a major impact on asset prices.

We choose to look at the stock market strategically.  We have taken a look back at items like valuations (the current cyclically-adjusted P/E multiple for the S&P 500 is 31x versus the long-run average of 17x), expected profits, price momentum, sentiment and macro-economic factors. These areas are causing us some concerns about cracks in the market’s foundation. While some areas are favorable, more are moving unfavorable. Historically, similar observations have preceded a twelve-month downturn in stocks over 80% of the time. Furthermore, over 70% of the time stocks actually fell by 10% or more. The poor conditions are infrequent so we cannot say this is a prediction but it is a concern worth keeping in mind.

The recent push for tax cuts has been a boost to bargain and smaller cap stocks.  For those betting heavily on tax reform, you may want to consider that McCain, Paul and now Corker now all seem to oppose the President’s tax plan. So tax reform as pledged has fewer than 50 votes thus far in the Senate. Definitely less than ideal for small cap stocks and for those securities purchased on the latest round of politically-induced enthusiasm.

Nothing looks to be on sale. Consider waiting for bargains to re-emerge and until they do, play some defense.


How Technology and Innovation May Impact Opportunity and Risk

The world is changing and disruption is accelerating across several industries. The ability to envision the future and understand the latest innovations are vital to stay on top of financial markets. Economic profits are likely to be made by whoever can capture tailwinds created by both industry and geographic trends.

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As a popular trading expression goes, “the trend is your friend”; markets embrace trends and as innovation accelerates, they quickly re-allocate capital and resources accordingly. In 2010, 6 oil companies and only 2 technology companies were ranked among the top 10 most valuable global companies by market cap. In 2017, the ratio has reversed: 6 technology companies are now on the list while only 1 oil company remains. In some ways, “Data is the New Oil”. As cited by Clive Humby in 2006, “data is just like crude. It’s valuable, but if unrefined it cannot really be used. It has to be changed into gas, plastic, chemicals, etc., to create a valuable entity that drives profitable activity; so data must be broken down, analyzed for it to have value.”

 

Online connectivity, backed by robust hardware and software, is booming. In 2008, the number of connected devices surpassed the world’s population for the first time. As an increasing number of people have become connected online, new habits of working and living have emerged, facilitated by smart devices that now serve as our newspapers, maps, travel agencies, credit cards, shopping carts, and more. The digitalization of our daily activities, in turn, creates huge amounts of data that serve as raw materials used for data mining and machine learning, which create fresh opportunities to improve business performance through improvements in marketing, supply-chain, products, processes and services.

The explosion of data usage and storage also demands cutting-edge cybersecurity that can effectively protect networks, computers, and data from attack, damage or unauthorized access. The importance has been highlighted by the recent data breach at credit-reporting agency Equifax, where sensitive information including the Social Security numbers of 143 million consumers was compromised.

While innovations like railways and aviation managed to transform the globe beyond what Christopher Columbus ever imaged, the revolution in data technology takes it a step further by allowing people to reach any corner of the globe by simply logging onto a “smart” device.

We have seen exponential growth in cross-border data flows as they have increased nearly 50-fold since one decade ago. According to McKinsey & Company, almost a billion social-networking users have at least one foreign connection, 2.5 billion people have email accounts, 250 billion people are currently living outside of their home country, and more than 350 million people are cross-border e-commerce shoppers. In contrast, global trade flows have been stagnant as anti-globalization sentiment has increased and global capital flows have failed to recover since the 2008-2009 financial crisis.

Digitization has also blurred industry boundaries. The 20th century was dominated by linear value chains, in which a series of value-adding activities were performed to produce final goods and services. This ecosystem then evolved to horizontal platforms, where computation and the internet became a powerful source of value creation, across various linear value chains.

Horizontal platform players including Google, Amazon, and Facebook currently account for five of the ten largest US companies by market cap. However, even horizontal platforms are being challenged in a new ecosystem that McKinsey Global Institute has named “Any-to- Any”. This is what the new wave of disruption looks like: asset-light and quick to dominate their industry. Examples of this new model are Alibaba, the world’s largest retailer measured by gross merchandise volume which does not own any warehouses; Airbnb, the world’s largest accommodation provider, which does not own physical real estate; Uber, the world’s largest taxi company, which does not own any cars.

Technological advancement is driving today’s rapidly evolving business landscape while
innovation is now determining how value is created and where capital flows. As a result,
investors must pay attention to shifts in technology and innovation to be successful in the long- run as they are likely to hold important information about not only exciting opportunities but also risks that if ignored could put investor capital at risk.


NASDAQ 100 Hits New High

The first chart below shows the Powershares QQQ ETF hitting a record high this week. It was the last of the major stock indexes to do so, and its breakout is a positive sign for the market. It also did slightly better than the rest of the market. The QQQ, however, has still been a relative laggard over the last month. That’s shown by the falling QQQ/SPX ratio since the start of September (blue line). This week’s upturn in its RS line may be a sign that some funds are flowing back into large tech stocks. But there’s more going on beneath the surface with the QQQ. For one thing, comparing the QQQ to the S&P 500 doesn’t fully reflect QQQ recent underperformance. That’s because the S&P 500 itself has been an underachiever over the last month (relative to smaller stocks). To get a truer picture we have to compare the QQQ to the groups that have been getting most of the tech money. Financials have been the biggest beneficiary of the past month’s rotation out of techs. That’s been tied to the upturn in bond yields, and growing expectations for another rate hike in December. The reasons why financials usually outperform techs when rates are rising have been described in previous reports. Let’s compare their recent relative performance.

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QQQ Has Done Worst Against Financials

Anyone still doubting that a significant sector rotation has been going on need only look at the next chart. The blue bars in Chart 2 plot a relative strength ratio of the PowerShares QQQ divided by the Financial Sector SPDR (XLF). The bars show the QQQ underperforming the XLF by a wide margin since the start of June, and again during September. Since the start of June, financials have nearly tripled QQQ performance (14% versus 5%). Since the start of September, financials have outperformed the QQQ by a 7% to 1% margin. Rising bond yields have been the main reason why.

Small Caps Have Done A Lot Better Than The QQQ

Another recent rotation has been from larger to smaller stocks. Chart 3 is a ratio of the QQQ divided by the Russell 2000 Small Cap Index ($RUT). The falling ratio since the start of September reflects underperformance of the QQQ relative to small caps. Since September 1, the RUT has outperformed the QQQ by a 7% to 1% margin. That’s tied to bond yields which started rising sharply in September. For reasons explained in previous reports, small caps do better in that environment. For one thing, small caps have a much higher exposure to financial stocks which have been market leaders. They stand to benefit more than large caps in any reduction of corporate tax rates. A bouncing dollar also favors small caps. Chart 2, however, also shows the QQQ/RUT ratio having fallen close to a potential support level formed at the start of July. And it’s starting to bounce. That suggests some unwinding of recent rotation trades (which could explain this week’s bounce in several big tech stocks).

It’s All About Relative Not Absolute Performance

The purpose of this week’s technical commentary is to demonstrate once again that subtle rotations have been going on beneath the surface in the U.S. stock market. One is the shift to more value stocks that do better with rising rates, and out of growth stocks (like technology). The second is the shift into smaller stocks that do better with an expectation of lower corporate tax rates. These rotations have had no negative impact on the direction of the overall market which continues to set new highs. This is more about “relative” than “absolute” performance. All the major stock indexes, and most market sectors, are rising. But some are rising faster than others. This also suggests where investors might want to do some rotating of their own to ensure that they’re properly positioned for the current economic environment.

Weekly Snapshot of Global Asset Class Performance

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Medicare Open Enrollment Starts October 15th

What is the Medicare open enrollment period?

The Medicare open enrollment period is the time during which people with Medicare can make new choices and pick plans that work best for them. Each year, Medicare plans typically change what they cost and cover. In addition, your health-care needs may have changed over the past year. The open enrollment period is your opportunity to switch Medicare health and prescription drug plans to better suit your needs.

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When does the open enrollment period start?

The Medicare open enrollment period begins on October 15 and runs through December 7. Any changes made during open enrollment are effective as of January 1, 2018.

During the open enrollment period, you can:

  • Join a Medicare Prescription Drug (Part D) Plan
  • Switch from one Part D plan to another Part D plan
  • Drop your Part D coverage altogether
  • Switch from Original Medicare to a Medicare Advantage Plan
  • Switch from a Medicare Advantage Plan to Original Medicare
  • Change from one Medicare Advantage Plan to a different Medicare Advantage Plan
  • Change from a Medicare Advantage Plan that offers prescription drug coverage to a Medicare Advantage Plan that doesn’t offer prescription drug coverage
  • Switch from a Medicare Advantage Plan that doesn’t offer prescription drug coverage to a Medicare Advantage Plan that does offer prescription drug coverage

What should you do?

Now is a good time to review your current Medicare plan. As part of the evaluation, you may want to consider several factors. For instance, are you satisfied with the coverage and level of care you’re receiving with your current plan? Are your premium costs or out-of-pocket expenses too high? Has your health changed, or do you anticipate needing medical care or treatment?

As a starting point, listen to our  interview on the STA Money Hour on maximizing your Medicare benefits. Open enrollment period is the time to determine whether your current plan will cover your treatment and what your potential out-of-pocket costs may be. If your current plan doesn’t meet your health-care needs or fit within your budget, you can switch to a plan that may work better for you.

How do you decide on what Medicare Plan is Right for you?

medicare                               Source:  2016 Medicare Brochure “Choosing a Medigap Policy”.

What’s new in 2017?

It is expected that we may have a rise in Part B Premiums, but they have not been announced the exact premium increases for 2017 as I write this article.  It is important to know your Adjusted Gross Income (AGI) since if your AGI is above $85,000, your premiums will increase as well.  The initial deductible for Part D prescription drug plans increases by $40 to $360 for 2016 and may also rise again. Most Part D plans have a temporary limit on what a particular plan will cover for prescription drugs. In 2016, this gap in coverage (also called the “donut hole”) began after you and your drug plan have spent $3,310 on covered drugs. It ends after you have spent $4,850 out-of-pocket, after which catastrophic coverage begins. However, part of the Affordable Care Act gradually closes this gap by reducing your out-of-pocket costs for prescriptions purchased in the coverage gap. In 2016, you would have paid 40% of the cost for brand-name drugs in the coverage gap and 58% of the cost for generic drugs in the coverage gap. Each succeeding year,

out-of-pocket prescription drug costs in the coverage gap continue to decrease until 2020, when you’ll pay 25% for covered brand-name and generic drugs in the gap.

Where can you get more information?

Determining what coverage, you have now and comparing it to other Medicare plans can be confusing and complicated. Pay attention to notices you receive from Medicare and from your plan, and take advantage of help available by calling 1-800-MEDICARE or by visiting the Medicare website, at www.medicare.gov.

If you have any questions please feel free to email me at Scott@stawealth.com

Scott

STA Financial Planning Department
Scott Bishop, Executive VP of Financial Planning, Partner
Patrick Fleming, Senior Director of Wealth Management
Elena Sharma, Financial Planner
Stephen Kirby, Financial Planning


Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

 

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