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STA Weekly Report – “I’m Not Saying There Won’t Be a Little Pain” – President Trump

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INSIDE THIS EDITION:
“I’m Not Saying There Won’t Be a Little Pain” – President Trump
Private Equity Funding Continues to Grow
Weekly Technical Comment
Planning for Incapacity
401k Plan Manager

The 2nd quarter of 2018 got off to a rocky start for stocks. Large stocks, such as those in the S&P 500, fell nearly 1.4%. The smaller stocks of the Russell 2000 fared slightly better but still fell 1.0%. The worst performers, sector wise, were Technology and Industrials while Utilities and Energy sectors were nearly unchanged. On Friday we observed selling on higher volume and if you were watching what happened the three prior days, the buying was on weak volume. All major 11 sectors closed the week in the red.

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All three of the major indices are down in three of the past four weeks. The degree of volatility seems symptomatic of a market in transition. Nine of the past eleven sessions have seen the S&P 500 swing up or down 1% or more. So far this year, the number of such intensely volatile days already has tripled what we experienced in 2017.

Why has the market experienced trouble recently? Well, keep in mind that last year we spent much of the year with “animal spirits” following the U.S. election, followed by tax reform and lots of deregulation. Talk of trade wars has dominated the thoughts of investors lately. Both the U.S. and China have been raising the rhetoric in an unstable game of one-upmanship. Then you have the President tweeting Friday “I’m not saying there won’t be a little pain” followed by the Treasury Secretary saying “But there is the potential for a trade war.” Both were clearly phrases investors did not want to hear.

Friday’s employment report is an interesting read. The headline number of only 103 thousand jobs created (against a backdrop of economists’ expectations of 185 thousand) is disappointing. However, many of the underlying numbers are encouraging. We find, for example, in the last 12 months the number of entrepreneurs increased by about 300 thousand. Additionally, the breakdown between high and low wage jobs was essentially tied, which we haven’t seen for some time.

A final positive for stocks from the employment report was the one area with fewer jobs: regulators. For the fourth time in the last five months the number of regulators declined. While we all want clean air and water, too often businesses find regulators to be unnecessarily combative and hurt profits without comparable benefits. Going back to 2000 we find a declining number of regulators is generally associated with above-average stock returns.

There are a number of factors, like potential trade wars, that will likely cause angst. This, along with the market’s high valuations, can lead to unpleasant shocks to the market. During periods like this investors should avoid being too aggressive and use upward and downward volatility to respectively trim expensive and buy bargain securities.

 

If you read last week’s newsletter, you may remember that we discussed changing market dynamics in public equity markets. This week we shift our focus to the trends we see in the private equity space, as it has become an increasingly important part of the investment opportunity set that advisors should be talking about.

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Private Fund Managers Raising Record Amounts of Capital

Although the pace of private equity fundraising slowed somewhat in the first quarter of this year, record amounts of capital is expected to flow to private equity managers for some time to come. This is especially true as private equity has delivered positive cash flow to limited partners (LP’s) for the last seven years.

To give you a sense of industry capital raising activity, investment managers are currently in the process of raising nearly $1.4T for just shy of 4,000 funds in the private investment segment.

These funds are not being raising for investment in any particular sector. Instead, we are seeing a growing appetite for private investment opportunities across diversified sectors. Take for example two large funds being raised by BlackRock and Blackstone.

BlackRock, for one, is raising $2.5B for a fund that will provide direct lending to businesses or invest in the debt of companies in various forms of distress. Blackstone has raised approximately $1.75B to buy interests in infrastructure funds. Regardless how you look at it, $1.4T being raised today represents an extraordinary amount of capital to be deployed in the coming years.

The good news for investors is that with so many private equity funds investing in sectors like private credit, real estate, infrastructure, and venture, diversification in private equity is easier to achieve today than it has been previously.

Private Company Valuations Rising

With growing demand for private investments and more intense competition for access to private investment opportunities, valuations of private companies have been on the rise. Take for example, the prices paid for US Leveraged Buyout (LBO) transactions, which are commonly done by private equity funds.

With average purchase price multiples near a record high, it has become more difficult for general partners (GP’s) to find opportunities that offer returns in line with historical levels. In fact, in a 2016 survey by Preqin, approximately 1/3 of fund managers surveyed said that it had become increasingly difficult to find attractive investment opportunities compared to the prior 12-month period. And this was the case across fund manager assets under management (AUM).

Although that trend continues, it is important for investors to remember that even in the most competitive markets, there are often attractive investment opportunities to be had. However, there are two things that you need to take advantage of current and upcoming opportunities in the private sphere.

First, investors need access. Historically, private investments have been only available to ultra high net worth investors. As a result, many advisors have been slow to build the capabilities required to include private investments as part of their overall investment program. However, the landscape is changing and access is becoming more important to investors due to the diversification and return benefits private investments contribute to a portfolio. It is why we have put a great deal of effort building our private investment platform and capabilities over the last several years.

Second, it is absolutely critical that access to private investments is paired with a sound due diligence process. We follow a rigorous private investment due diligence process intended to improve the odds of success. This includes investigating fund sponsors and their track record, understanding private investment structure and fees, reviewing feasibility research and scrutinizing projections for each private investment opportunity. Just because an advisor doesn’t have a due diligence process in place doesn’t mean that they can’t stumble upon a good opportunity. However, it signals a low chance of success in the private investment sphere due to the absence of both discipline and objectivity required to sift through, and select the most attractive investments in the available opportunity set.

 

Third Tariff Threat Sinks Market

Just when it looked like the stock market was about to recover from the first two rounds of tariff threats, stocks were hit with a third and bigger $100 billion tariff threat after the close on Thursday.

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As a result, stock market indexes fell more than 2% on Friday with all market sectors in the red. That pushed all three major stock indexes back into the red for the week. Foreign stocks also fell sharply. After the first two tariff-induced selloffs, stocks rebounded on assurances that the tariff threats were a negotiating ploy; and that negotiations were going on behind the scenes between the U.S. and China. Friday’s negative reaction suggests that markets are no longer buying that story. The president talked about the possibility of short term “pain”, while his Treasury Secretary said on CNBC that a trade war was possible. Meanwhile, China denied that any negotiations were taking place. In that dangerous and unpredictable environment, it seems fair to suggest that any form of rational market analysis — whether it’s economic, fundamental, or technical — takes a back seat to daily headlines. Friday’s selling wiped out three days of gains. This week will likely see another test of underlying support levels. Chart 1 shows the S&P 500 falling back to its 200-day moving average. It bounced off its 200-day line twice in the last month (red arrows). A third test of support is usually the most important one.

Most Important Level To Watch On The S&P 500 Right Now

Everyone is looking at the S&P 500’s 200-day moving average. There’s another key support level that could provide a clearer signal of market distress.

If the market does decline further, the most important support level will be 2,581 on the S&P 500. That was the closing low on Feb. 8 and April 2. Any meaningful close below that level would raise a big red flag on the stock market over the near term.

When support and resistance levels are broken, it tends to indicate that the buyers have run out of ammunition or sellers have run out of stock to sell. The asset then sees a major move once those levels are broken. Moving averages help smooth out the erratic moves we see from time to time in the markets, so they are not quite as important to a traditional technician.

Weekly Snapshot of Global Asset Prices

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)

 

Written by: Scott Bishop

This Friday for “Financial Planning Friday” on the STA Money Hour (950AM KPRC Radio), I will be having attorney Molly Dear Abshire, a partner at Wright Abshire, Attorneys in Houston, on live to discuss “Elder Law and Medicaid Planning”.  As Baby Boomers and their parents continue to become an important aging demographic, taking care of their long-term care needs is becoming a priority for all Americans.  Elder Law experts like Molly Abshire specialize in the strategies to make sure that a long-term care event will not have a significant and devastating impact on their family – both emotionally and financially.

Aligned with this show, I am sharing a link to a presentation on “Planning for Incapacity”.  Please take a look at this article and tune into the STA Money hour this Friday April 13th. If you miss this show, you and your family may find yourself to be one of the unlucky families that have not properly planned!

 



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Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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