TGIF – Action Plans and Execution

Bedell Frazier Investment CounsellingTGIF!

Action Plans and Execution

The headlines this week were dominated by tough rhetoric at the United Nations session regarding Geopolitical issues, with an emphasis on North Korea. The situation is concerning, without a doubt, and presents risks of great proportions. It’s been an issue for 7 decades but seems to be reaching a boiling point. That said, perhaps the most significant thing that occurred this week was the announcement that the Fed, for the first time, plans to begin the process of unwinding its $4.5 Trillion balance sheet, which was the result of aggressive policies to defend against the Financial Crisis 9 years ago to the date. It was a very risky and controversial quantitative easing experiment that took place under then Fed Chairman Ben Bernanke’s leadership. By most accounts, it worked. But not everyone believes that. The US Economy avoided a multi-year depression. The US Stock Market has nearly tripled in value. Taxpayers and investors made money on the experiment. Both the tactic and the length of time have been debated since day 1, and the debate continues.

Fighting the Financial Crisis

To combat the crisis, the Fed launched a couple of rounds of quantitative easing to help unclog the financial plumbing. The Fed bought troubled mortgages as well as Treasury bonds in order to increase the money supply, cut interest rates, keep borrowing costs low and help prevent further defaults. The Fed was a huge buyer of bonds in the open market which instilled confidence at a time when there was very little. Over the years, the Fed kept buying additional assets when the debt securities matured. It took the proceeds and kept buying new debt to keep interest rates low and ensure stability in lending. The result is a $4.5 Trillion bond portfolio. The make-up of the portfolio is $2.5 Trillion in Treasuries and $1.8 Trillion in mortgage-backed securities with the balance in other scattered assets.

Part of the Fed’s goal back then was to encourage investors to take a little more risk. The S&P is up 270% since the 2009 lows, making this current Bull Market the second largest and longest in US history. But investors who stayed in cash or bought CDs were disadvantaged. Now, for the first time since the crisis, the Fed will stop purchasing new assets with the proceeds from maturing securities. It is a passive strategy and something the Fed has signaled for quite some time. It’s yet another step towards normalcy in the aftermath of the Financial crisis 9 years ago. To be clear, the Fed is not selling any securities, something that would have a much greater impact, both mechanically and psychologically. But it’s no longer buying either.

A Really, Really Big Number

The Fed has never had a balance sheet this large in American history. It was $900 Billion pre-crisis. That in and of itself is a really big number. $4.5 Trillion is a massive sum of money. In other words, it’s $4.5 Million Millions. It also adds up to $13,000 for every American. How about that for perspective? The Fed’s goal is to get its balance sheet gradually down closer to $3 Trillion by 2020.

The process of unwinding its balance sheet could prove to be a little bumpy and isn’t without risk. In addition to the asset roll-offs, the Fed indicated its intent to raise interest rates one more time this year, three times next year, twice in 2019 and once in 2020. A lot will happen between now and 2020, but that’s the current plan. Central banks around the globe will be paying close attention, particularly in Europe and Japan who followed the Fed with aggressive monetary policies. The ECB and BOJ are still buying bonds today.

How this Fed unwind goes is anyone’s guess. Global markets were rattled in 2013 when the Fed started merely tapering the rate of its money supply injections. Interest rates spiked and global stock markets sold off. The Fed does not like to be the source of panic. Because of this, a very cautious path has been carved out for the balance sheet unwinding. There really is no case study to use to compare because it has never happened before. Taking such a large buyer out of the mix will have consequences, but the financial plumbing is so much healthier now. Fed Chair Janet Yellen said there is a high bar in place that would force a return to purchases. She said it would take a major shock to the system to switch gears and provide stimulus to the economy. Keep in mind, it remains unclear whether Janet Yellen will even be at the Fed after her term expires in February. So far, the Market has been taking it in stride, knowing this was coming for quite some time. But the actual doing is the most important part. Strategy and preparation are important, but it’s all about execution. As the great philosopher, Mike Tyson once said; “Everyone has a plan until you get punched in the mouth.”

We will be studying this very closely. We do expect some more bumps ahead. When the facts change, so do we.

Have a nice weekend. We’ll be back, dark and early on Monday.


The results are in from last week’s unscientific iPhone survey.

Despite only having 15% of global market share and 34% of the US market, over 90% of our survey responders own an iPhone.

Thank you to everyone who responded!

The numbers look like this: 

TGIF – The iPhone Turned 10

Bedell Frazier Investment CounsellingTGIF!

“Steve Jobs 1955-2011” by segagman (2011)
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The iPhone Turned 10

A Star is Born

10 years ago, on a warm Friday in June, our lives changed forever. It wasn’t obvious at the time. It sure is now. We had never seen anything like the device that went on sale that day. Now, you can’t go anywhere without seeing them. People are absolutely hooked. They bury their heads in them spending hours per day surfing, typing, listening, watching and talking to it. And it even talks back. It’s the iPhone, which was born in 2007, and it has revolutionized how people live their daily lives. It has so many functions. If you’re over 30, chances are you even use it as a telephone…

Before introducing the iPhone, Steve Jobs told people to “remember the moment: The moment before iPhone. Because, in the next moment, everything will change.” Mr. Jobs’ creation set the tone for the next stage of the digital revolution in which we live. It was the next big thing and it didn’t disappoint. The iPhone created an ecosystem for people to integrate devices and content, both remotely and in the home. It made it easier for companies to market and sell their products from anywhere. Transactions were made so much easier. It launched a flood of software start-ups who developed “apps”, a term Apple created when they started the App Store. Steve Jobs believed apps were an easier, faster and more personalized and eloquent way to engage content. Billions of people seem to agree with him.

The iPhone was not the original smartphone. Motorola, Blackberry and Palm all had theirs earlier. In fact, IBM’s Simon is considered the first smartphone, which arrived in 1992. It didn’t seem to make as big of a splash for Big Blue. The functionality of the previous devices was nothing like the iPhone. In 2007, Steve Jobs introduced the revolutionary multi-touch interface that let the iPhone smoothly pinch-to-zoom, scroll quickly, and the multitasking that allows you to seamlessly move from music to call to web to email and back. Indeed, we had never seen anything like it. Today, the iPhone accounts for 2/3 of Apple’s annual revenue. It’s that big!

The Next iPhone Super Cycle

This week, the most anticipated event for Apple, and perhaps Silicon Valley at large, took place in Cupertino. It was held at the brand new Steve Jobs Theater. The 10th anniversary iPhone was announced. It is called iPhone X; the Roman numeral 10 not the letter X. This was Apple’s biggest product launch in years and comes with many new features for the Apple ecosystem. The greatest attention getter seems to be the 3D Face ID Recognition feature. There’s no more need for passwords or security codes to use the phone. The device will directly capture a 3-dimensional image of your face, which will be required to open the phone and authenticate use of Apple Pay and other financial accounts. And Apple says that you need not worry if you grow a beard, or wear a hat or glasses, the phone will be able to identify the real you. They say only identical twins that are mad at each other are capable of unauthorized access. That will be a fun test at my house down the road. Of course, this Face ID function comes with its own controversies, but you can see the advancement in technology.

The new iPhone X is water resistant and has a powerful camera that would have been the envy in Hollywood just a couple of years ago. The phone is 70% faster with its A11 bionic chip. It will also come with a charging pad, so you’ll be able to get rid of all those cords. The screen is bigger too, taking up the whole face of the phone. The Home button is gone too. And the price tag starts at a whopping $999.

Augmented Reality

Perhaps one of the most important additions for this new phone will be its Augmented Reality (AR) functionality. This is the concept of superimposing 3-D objects into the real world. You football fans know how helpful the yellow first down stripe is on TV; that was a very primitive form of AR. The Pokémon Go craze last year was a great example of the capability and the global interest. It’s really just beginning. Video gamers know all about this, and it’s expanding. Retailers are starting to use Augmented Reality to help customers visualize what a piece of furniture would look like in their living room or to try on clothes for custom fitting. Augmented reality will be utilized in sports, further in television as well as in the stadiums and arenas. Augmented reality could be the next big thing for innovators and investors. I just hope it doesn’t prevent people from continued human interaction and enjoying the great outdoors.

Keep in mind, while all of this is new to the iPhone, Samsung has offered a lot of these innovations in its Galaxy phones. Samsung uses Google’s Android operating system, which has over 80% of global market share for smartphones. Apple has just 15% of the total market. But most smartphones in circulation are much cheaper and don’t offer the same functions as an iPhone. The iPhone has a 34% market share in the United States. Apple might not be the innovator like it was under Steve Jobs, but the company continues to produce cool, must-have devices at a consistent pace and its loyal customers continue to pay the high prices. Over 500 Million people visited an Apple Store last year. This new super cycle led by the iPhone X will be a big test. The stock has had a nice run in anticipation. There is a common theme with Apple’s stock and its iPhone launches. Of the previous 11 events, the stock declined on 9 of them. That happened again this week. That’s what you call a “sell-the-news” event. The stock historically sells off for a few weeks after an iPhone launch, but 6-months later the stock was lower only 3 times. Stocks price in anticipated future events. This event didn’t disappoint.

Have a nice weekend. We will be back, dark and early on Monday.


TGIF – Dollars and Sense

Bedell Frazier Investment CounsellingTGIF!

Dollars and Sense

The US Dollar continues to slide to multi-year lows. It is never exactly clear why, but the potential for military combat in North Korea, the diminishing probability of another Fed interest rate hike and the increasing likelihood of the European Central Bank’s Quantitative Easing plan coming to an end are all contributing to the falling Dollar. Normally, with heightened geopolitical issues, investors around the globe flock to the Dollar for safety as the Universal Currency. That just isn’t happening now. As we all know, this environment is anything but normal. But Corporate America, with substantial revenues overseas, is really enjoying the weak Dollar. It makes American products much more attractive overseas.

The Euro jumped above $1.20 this week. That is the first time the European currency has seen that level since December of 2014. The Dollar and Euro were near parity as we started this year when the Euro touched $1.03. The Euro has surged 14% since, which is a really massive move for a currency. A strengthening European economy with low inflation is helping fuel the move. But European exporters are feeling the pain as American products are more attractively priced on the open market due to currency conversion. And that $350 a night hotel in Paris is now $420.

But it’s not just the Euro that the US Dollar has been losing ground to. The Dollar has also has been falling against the Japanese Yen, the British Pound, the Swedish Krona and even the Mexican Peso, which was battered off the Presidential election with debates about NAFTA and the Wall. Keep in mind, the Dollar spiked higher off the election results last November. Expectations of tax-reform and other pro-growth policies saw money from around the globe pour into Dollars. It peaked in January and has fallen ever since. At this stage, the prospects for comprehensive tax-reform this year are approaching zero. Even simple tax cuts appear unlikely in 2017. It seems like it’s been more of a move away from the Dollar rather than an aggressive move into these other foreign currencies.

Interest rates continue to fall too, with the 10-Year Treasury yield down to 2.06%, the lowest of the year. The Bond Market is telling us things are far from perfect. The yield curve is flattening, which does happen periodically, but is one of those signs to pay attention to. The 30-Year bond yield is down to 2.67% while the 1-Month bill is 0.96%. The front-end of the curve has been rising while the back-end has been shrinking. It is much healthier when the yield curve steepens. Think about it this way; would you want to take 20 more years of risk for just an additional 0.6% increase in income yield? For the vast majority, the answer is categorically no. But for insurance companies with liabilities who need to spread out reserves and foreign buyers looking to get money out of their country and get some yield with the currency conversion benefit, the answer is yes. Right now the spread between the 30-Year Treasury and the 1-Month is the tightest it’s been since 2007. For perspective the Yield curve inverted in 2006, more than a year prior to the stock market decline. We are still a long way from inverting now, but it is something we always keep a close eye on.

In July, the Market was pricing in a greater than 50% chance of another interest rate hike by year-end. Now it’s assigning just a 31% probability, and shrinking daily. The US economy continues to grow at a very sluggish pace and inflation remains benign. The thinking is why raise when there is little risk of an overheated economy. Most representatives at the Fed are in the dovish camp. That means they are cautious with monetary policy and prefer to provide support until it is absolutely clear it is no longer needed. The Market has known this all along since 2008 and has rather enjoyed the magic Fed elixir. This week the Vice Chairman of the Federal Reserve, Stanley Fischer, announced he will step down in October. This was an interesting and rather unexpected event, but it actually has us thinking that it enhances the chances that Janet Yellen stays as the Fed Chair when her term is up in February. But right now February seems like a long way away.

Looking under the hood, this Market has some issues that need addressing. It’s what a correction is all about. The Bond Market is the smartest of markets. It’s telling us that September into October should provide more turbulence. There’s just some weird stuff going on which has us on guard. We’re on it and we have your back.

Have a nice weekend. We’ll be back, dark and early on Monday.


TGIF – Harvey and the American Spirit

Bedell Frazier Investment CounsellingTGIF!

Harvey and the American Spirit

Hurricane Harvey proved a menacing force. It devastated Southeast Texas. Harvey could wind up being the most expensive natural disaster in American history. But it couldn’t wreck the American spirit. This matters for so many reasons. 

Houston is now the 4th largest city in the U.S., by population and economic output, behind New York City, Los Angeles and Chicago. Houston’s economy is heavily exposed to Energy, but is still fairly diversified with heavy exposure to Health Care, Aerospace and Tech. Its economy alone is roughly the size of Sweden. Southeast Texas has the largest oil refineries in the country. Roughly 20% of total the US refining operation was taken offline from the storm, which has driven gas prices to 2 year highs. It’s coming at a time where demand is strong for the Labor Day weekend. The national average for unleaded gasoline is now $2.52 per gallon. Prices really spiked along the East Coast, which receives a lot of their gas from the Gulf Coast. The precedent from Hurricanes Katrina and Rita in 2005 suggests that the impact will still be felt for several months. You can see the impact the hurricane will have on the US economy.

For those of you surprised that this Market has gone higher in the face of some really concerning events, consider this: An important factor has been the lack of volume this week, which is normally very light heading to the Labor Day weekend. This week had the lowest volume since Christmas. Low volume sessions are generally bid up. The DOW jumped back above the 22K level Friday before closing just below it. We’ve been seeing lower highs and lower lows. Next week will be telling when trading desks are full again and the focus turns to issues and year-end. The speed will pick-up significantly. We still think lower levels will come too with a continuation of the correction before a year-end rally. The risks at this stage are greater than the potential rewards in our estimation.

The devastating storm in Southeast Texas decimated the region, but not the spirit of the people. How the first responders and the people in the greater Houston area rallied together is truly inspirational. The best in human kind was brought out with people from all walks of life coming together to help each other get through the pain. It is indeed going to be a long road ahead in recovery for the Gulf Coast region. Let’s hope the message of unity and togetherness will last far longer.

The Houston Astros return home to play the Mets tomorrow. The team is giving away free tickets to first responders. They’re also sending 10,000 player jerseys to local shelters. The Astros are in first place in the American League right now. Imagine what it would mean for this city to see this team make it to the World Series. I’m pulling for Houston. That would be very cool.

After the Market closed for the week, our team began assembling backpacks with school supplies, which are now headed to homeless and underprivileged kids in Houston. These kids didn’t have much to start with and lost everything they had during the storm. We were inspired and wanted to help. Hopefully they will be inspired and these materials will help them begin the rest of their lives in pursuit of their dreams. Great things start with a dream. The thought makes me smile.

Have a nice weekend. We will be back, dark and early on Tuesday. Our office will be closed Monday for Labor Day.

Mike Frazier

TGIF – Here Comes Amazon, Again…

Bedell Frazier Investment CounsellingTGIF!

Here Comes Amazon, Again…

Remember back in the day when you drove to the grocery store, navigated the crowded aisles, had to wait in line to pay and sometimes even had to bag your own groceries? The concept will be a distant memory a couple of decades from now. My kids often join me every Sunday at the grocery store loading up for the week. The chances are very slim that their kids have the same experience. Grocery shopping will take place on the couch or in the kitchen, like a digital magic wand. Amazon is changing all of it. It will be great for consumers… well, sort of.

I spent the last 2 days in San Francisco meeting with industry leaders discussing present day issues and hypothesizing where things are headed. The topics ranged from Artificial Intelligence to driverless cars to digital currencies to geopolitics, and so much more. It was all in the context of innovation and investment. I plan to cover these fascinating topics over the coming weeks. I’ll start with the Amazon Effect.  I touched on it a few weeks back when news broke of the Whole Foods deal. This is a follow up with a fresh perspective as to where things might be headed as we see it.

The Amazon Grocery Store

Amazon will officially own Whole Foods on Monday and they have already announced major price cuts. Rival grocers are shaking in their boots, ill-prepared to compete head-to-head. Fresh is going on sale next week and Amazon Prime will become the Whole Foods customer rewards program. You just know it won’t stop with price reductions on bananas, avocados, meat and eggs. Amazon has over 60 Million Prime members and it is estimated that over 60% of Whole Foods customers are members of Amazon Prime. The synergy is already there. The door is wide open for more cross-selling for Amazon products.

The thing is, Amazon has been a brutal competitor in every aspect of their operation. Amazon notoriously sells items at break-even or even at a loss to gain market share in sectors it sees as a priority. That strategy will no doubt be utilized in groceries. Grocery stores are already low margin businesses. Amazon has the ability to squeeze margins even further as they look out longer-term. Most grocers don’t have that luxury.

Amazon now has a network of nearly 500 physical stores in some of the most desirable locations throughout the country. These retail stores could also become a distribution point, not only for grocery deliveries, but also for Whole Food’s prepared foods in an attempt to compete against startups like GrubHub and Foodler and crush other delivery providers like UberEats. Some of these stores will soon have Amazon’s in-store lockers for package pickups. The lockers could be a first step in reducing Amazon’s delivery costs by offering customers more pickup or delivery options. Those white vans that you’ve been seeing in your neighborhood with increasing frequency; it’s Amazon. We’ll be seeing them more and more in the coming months. But they won’t have human drivers forever. Self-Driving vehicles will be next as well as drone delivery. Oh yes, Amazon wants to send stuff out with drones. Amazon recently filed a patent application describing large, multi-story drone towers in urban centers. The hive-like towers will have loading docks and warehouses on the lower floors and bays for drones higher up. And the drones may be repaired and supplied by robots. This is just mind-blowing.

It’s All About Logistics

Amazon has been hyper-focused on its plans to create the world’s most efficient order-fulfillment system. That includes a network of warehouses and the means to deliver the goods efficiently and expeditiously. Last year, Amazon started a shipping subsidiary called Amazon Maritime to transport goods on cargo ships from China to the United States. Amazon has built out a robust digital storage operation over the years called Amazon Web Services with a who’s who customer list of Fortune 500 companies and small start-ups, including Netflix, NASA and the CIA. Amazon competes directly with IBM, Microsoft, Google among so many others. Amazon pretty much competes with everyone.

Amazon’s Magic Wand

You might have met Alexa, but have you seen Amazon’s Dash Wand? It’s a handheld device that comes equipped with a speaker, microphone and a barcode scanner. It is powered by Alexa, which has been a big success in the Artificial Intelligence arena, and is seemingly just getting started. The Dash Wand is battery operated and has a magnet that lets it stick on the refrigerator. It was primarily designed as a grocery scanner and is meant to hang around the kitchen. You can either tell the Dash Wand to order an item or scan a barcode to automatically add that item to your cart on Amazon. Prime Members will get their items at their door within 48 hours.

Things are coming full circle with home delivery. Remember the milkman coming to your house? Well, it’s making a comeback, and in a much different form. These are fascinating times in this digital age in which we live.  It’s all investable.

Have a nice weekend. We’ll be back, dark and early on Monday.


TGIF – Market in Correction Mode

Bedell Frazier Investment CounsellingTGIF!

Market in Correction Mode

I’m just going to say it:

This is by far the most bizarre investment environment that I’ve experienced in my 20+ year professional career. 

This Bull Market has proven its resiliency time and again throughout its 8-year run. It has faced tremendous pressure and uncertainty in 2017, but very little has slowed it down. It’s not our job to be political. We stay away from that. But it is our job to interpret politics as it applies to your investments. It’s been quite a challenge. There is so much confusion and so many moving parts, which have been extremely difficult to analyze and understand where things are headed. Despite the increasing divide politically and socially in our nation, the Market has remained focused on pro-growth policies like tax-reform all year, even as it was looking less and less likely. But this week was different.

The Market’s Guy

The Bull got tripped up by a confluence of events, namely Corporate America walking away from the White House and more terrorist attacks overseas. Corporate America has been losing confidence in the President’s policies at a rapid rate and the mass exodus from the Corporate Councils, which led to complete dissolution, is a big reason why the strong gains for the DOW and S&P shrunk. Perhaps the biggest key is Gary Cohn, the President’s chief economic advisor, who was rumored to be considering resignation. Thursday’s selloff gained serious momentum when whispers circulated that Cohn was leaving. Gary Cohn is the architect of the growth plans and is widely considered the favorite to replace Janet Yellen at the Fed if she does not continue on next year. There has been massive turnover in the White House. For the Market, Gary Cohn probably matters most. As it stands, tax-reform and the other pro-growth policies are very much at risk. Without Cohn, they’re pretty much dead in the water. Gary Cohn is a Market guy. The Market likes Gary Cohn and does not like the prospects of his departure.

The S&P 500 saw only its sixth 1% decline of 2017 this week. It’s been over a year since it experienced a 5% selloff, something that historically occurs every 10 weeks. It has been way overdue for a snapback. We’ve already seen some cracks. The recent rally has not been broad-based. Leadership has narrowed sharply. Only 4 of the 11 S&P sectors have outperformed the overall index, and it has been dominated by Tech. The S&P is up 8% on the year, but the average S&P stock is only up 5%. The S&P 500 is naturally market cap weighted, and has been dominated by the 35% gains in Apple and 30% gains in Amazon. Small Caps are actually down on the year now. Energy has struggled mightily. The correction has begun.

Fundamentally Sound

Q2 Earnings Season is coming to an end, with over 90% of the 500 S&P companies having reported. It’s been very solid. Earnings have grown 12% year-over-year on the back of 5.5% revenue growth. Revenues are key, because it is the purest measurement of demand. It’s been strong. Corporate earnings have accelerated since the 2-year earnings recession came to an end last year. It’s earnings that drive stock prices, and these strong earnings should keep a tight floor under the Stock Market. But, the end of Earnings Season means the Market will be more susceptible to Geopolitical issues. And they’re certainly on the rise. Considering events surrounding North Korea, Russia, Venezuela and Spain, many around the world believe the US has become the biggest geopolitical risk. Think about that for a minute.

Normal Seasonal Weakness

We prepared for a correction. We wrote about it 2 weeks ago. We raised cash, we have used options as well as other Market hedges firmly in place. We also have heavy Gold positions, which are demonstrating strength. We are long-term investors who know how to deal with short-term risks. We’ve got one on our hands right now. It’s all about a strong defense. Historically, selloffs begin in August, accelerate in September and find a bottom in October setting up for a year-end rally. Though there has been nothing normal about 2017, we could definitely see this Market pattern play out. A correction was only a matter of time. It is normal and healthy, but never fun. We will get thru it just fine.

Have a nice weekend. We’ll be back, dark and early on Monday.


TGIF – Long-Term Trajectory

Bedell Frazier Investment CounsellingTGIF!

Long-Term Trajectory

The Stock Market’s long-term trajectory is based on growth, or lack thereof. That growth is valued based on Earnings of the companies which comprise the S&P 500 or Dow Jones or Nasdaq Composite. Think of these earnings much like an engine of a car. A healthy engine can last quite a while, but the longer it continues working hard, the more in need of maintenance it becomes. When we get our vehicles serviced and our radiator is cracked or our battery dies, we don’t chop the whole car up and call it totaled or broken. That would be foolish, we instead service and fix the problem area and continue to run our vehicle forward.

The stock market as stated above has a longer-term trajectory based on fundamentals. Counter, on the shorter-run markets can trade based on sentiment, psychology and human emotions. Much like we emotionally want to blow a gasket (no pun intended) when our radiator actually cracks. And as much as we want to throw our car away….well it isn’t the best decision. Just like market corrections. Throwing away our investments or bullish thesis longer term is not the best decision.

The key is to distinguish those potential “sentiment or emotional” driven times, vs real fundamental changing times. The S&P 500 hit a high this week of 2491. We had laid out a 2500-2550 target for 2017. As we enter our target range we update our dynamic analysis on the fundamental and technical front. Earnings so far continue to come in strong on the aggregate and support a fairly valued market up at these levels. This means the market is not truly cheap, but it is not outright expensive either. So under the surface the market is still very fundamentally strong, but it is now trading at levels which we expected and the risk to reward balance is no longer as favorable. Growth abroad is also continuing to surprise to the upside. With Earnings Season coming to an end, the Market will focus more on political and geopolitical issues which will be bumpy.

Technically the Market hit strong resistance levels and clusters as the internal structure has been weakening. Technically, the Market is now entering the area where a swift, strong corrective pull-back makes more and more sense. We have very strong support on the S&P 500 at 2325-2275. The upper end of that range would be about a 7% pull-back. The lower end closer to 9%.

Our expectation is that a “sentiment or emotion” driven correction is what is in order, not a fundamental or earnings driven down turn. Bear Markets happen based on fundamentals, not “emotional corrections”.

We thought this would be a worthwhile exercise. The chart below has highlighted the last 5 greater than 5% corrections.

Highlighted Market Events:

  • January of 2014 (lasted 1 month): based on Emerging market worries and a China banking shadow scare. The S&P 500 dropped 6.25%. It was fast, it was violent, it shook many people out of the market.
  • October of 2014 (lasted 1 month): based on the big Ebola scare and OPEC no longer supporting oil prices. The S&P 500 dropped 10%. It was fast, it was violent, it shook many people out of the market.
  • June of 2016 (lasted 1 month): based on the Brexit vote or the UK formally voting to leave the EU. The S&P 500 dropped 6.25%.  It was fast, it was violent, it shook many people out of the market.
  • September 2016 (lasted 2 months): based on the presidential pre-election jitters. The S&P 500 dropped 5.25%.  It was fast, it was violent, it shook many people out of the market.
  • The BIG prolonged green highlighted period July 2015 to February 2016 or 7 months was a larger 15% correction and was based on an actual earnings slow-down and fundamental deterioration in the economy.

Hopefully you are starting to see the difference.

As our analysis suggests we have entered a window in which a correction is more likely. We will not be surprised to see a strong event which stokes fear in the market and provides the necessary “emotional sentiment” to create a fast, violent, market downturn, which will shake many people out of the market.

It came as no surprise to us that North Korea seems to be the news driven reason for a potential correction. Maybe something else news driven will come out, we shall see.

Worried about the state of the world? Read our previous TGIF on this subject.

BUT, with a strong fundamental underpinning and higher technical targets yet to be hit for this Market, it gives us confidence to believe this potentially swift correction will be a buying opportunity. Therefore, we are positioned with increased cash and hedges to take advantage of an adverse market move.

For fun, here was the CNN Money Headlines on October 15, 2014, the EXACT day in which the LOWS of the 10% correction where hit:

“The Ebola epidemic is starting to contaminate sentiment on Wall Street, which is already losing sleep over countless crises”

“The arrival of Ebola in the U.S. has coincided with a period of extreme turbulence in the stock market, which has tumbled about 8% from record highs. The deadly virus is clearly not the only factor behind the market slide, but it’s a major unknown that is increasingly weighing on market psychology. That was the case again on Wednesday as the Dow plummeted as much as 370 points and health officials revealed a second health-care worker in Dallas tested positive for Ebola.”

The S&P quickly recovered to new highs by November and was much higher by December. We will surely see plenty of articles like this published.

Have a great weekend!

Mike Harris

TGIF – Tools for a Market Correction

Bedell Frazier Investment CounsellingTGIF!

Tools for a Market Correction

Volatility is at multi-year lows. So far in 2017, there have only been 4 trading sessions that experienced a 1% move. It has been a very tight range. We think that’s about to change. The DOW keeps hitting fresh new highs, reaching 22,000 for the first time this week. It has been 9 consecutive record closes for the price-weighted index of 30. You know what’s not at new highs? The S&P 500, which consists of the 500 largest US companies and is a cap weighted index. That is the US Stock Market, and it has been trading sideways for a couple of weeks, very near all-time highs. It just hasn’t broken out to the upside, which suggests a potential stall. Small Caps have already stalled. The Small Cap Russell 2,000 is actually down 3% in 2 weeks. It’s telling a different story about the health of the overall Market. It has us moving towards playing defense.

Defensive Strategies

The first thing we do is trim or sell positions that we believe are overbought and vulnerable to a selloff. We raise cash to help insulate portfolios from declines. The next step is to put on some portfolio hedges that will provide even more insulation, and in some cases, will go up when the Market goes down. Option strategies are one of our preferred methods of providing protection. Options can be very risky and speculative, but that’s not the way we use them in general. We primarily use options as a defense mechanism. Our goal with option trades is to enhance returns while simultaneously reducing risk.

As a reminder, an option is a derivative whose value is derived from an underlying security, commonly a stock. Options are contracts, between a buyer and a seller, which give the buyer the right to either buy or sell a particular security at a specified price on or before a specified date. Puts and Calls are the most common forms of options. A call option allows the buyer to purchase a security. A put option allows the buyer to sell a security. Options expire on the 3rd Friday of every month. They trade daily.

Covered Calls

A CALL option is considered “covered” when you already own the stock. Covered Calls are a great strategy to generate additional income off a stock that has increased in value and might be due for a breather. We normally sell “out of the money” calls, which means a price above where the stock is currently trading. An example is selling an October Apple $165 call when the stock is at $155. You might get $1.50 in cash for this call. In this scenario, if Apple’s stock went above $165 between now and mid October, it could be called away. The seller has capped their upside on Apple for the next couple of months. But with the stock already up nearly 40% on the year, it seems like a reasonable assumption that the stock might be due for a breather. If it stays below $165, the seller keeps the cash and the stock. The Call seller took in $1.50 in cash up front, which provides immediate downside protection to $153.50. Another way to look at it is the Call seller just increased Apple’s dividend by 60%. That’s a big raise! For a longterm investor, covered calls are a great way to enhance returns while simultaneously reducing their risk. And for investors, that’s the name of the game.

Buying Puts = Insurance

Most of the time, we sell options in our portfolios. But when we look for ultimate protection, we will buy a PUT. We consider buying a PUT to provide protection against a Market decline. A PUT is like an insurance policy. With The DOW and S&P at or near all-time highs, a PUT can provide the opportunity to lock-in the gains. PUTS are generally cheap when volatility is low and stocks have performed nicely. It’s the same thing with insurance policies; premiums are naturally cheaper when the house is in good shape and the driver’s safety record is flawless. However, the cost of insurance skyrockets when the house is on fire or after a car wreck. In that vein, the value of a PUT spikes in price during a selloff, so the time to buy them as an insurance policy is before there’s a problem. If you buy a PUT when the DOW is at 22K, you have locked in your sale price at all-time highs and have protection against a Market decline.

It has been a completely wild, eventful and bizarre year. There’s quite a bit more to go. Our feeling now is the risk/reward balance has shifted and it has us wanting some insurance. It feels overbought at current levels with valuations getting a little stretched and people that sold around the election have been chasing a bit. DOW 22K is a big round number that was destined to happen but we think it will prove to be a near-term top. The time is ripe for a good shakeout before the uptrend resumes. That has us switching out our long-term investor hats with our short-term defensive helmets.

Have a nice weekend. We’ll be back, dark and early on Monday.


TGIF – What’s Too High?

Bedell Frazier Investment CounsellingTGIF!

What’s Too High?

This week, the 3 major US indexes: the DOW, S&P 500 and NASDAQ all hit fresh, all-time highs. It’s been a theme pretty much all year. What’s made things more surprising to the masses is this rally has continued while turmoil has increased in Washington and beyond. We emphasized in our 2017 Outlook that earnings are the primary driver of stocks and earnings were set to accelerate this year. So far, that’s been the case. We just completed the busiest week of the Q2 Earnings Season, and the numbers look pretty solid.

All About Earnings

Just over half of the S&P 500 companies have reported earnings. 73% of them beat expectations. The S&P 500 is on track to earn roughly $130 per share this year. That would be a new record by a long shot. Even more importantly, 71% of the companies have beaten on revenues. This is way above the long-term average of 59% revenue beats. This statistic is critical because earnings can be engineered to an extent with methods like cost cutting and stock buybacks. Revenue is the purest sign of demand growth, and demand is growing. That’s very important.

Naturally, with the Stock Market at all-time highs in a maturing Bull Market with increasing risks around the globe, people are worried that a correction is in order. We share those concerns and are prepared for a healthy correction. We actually are looking for one to clear out the excesses and test this uptrend before it continues higher. But we’ve heard a growing perspective that the Stock Market is “too high”.

What’s Too High?

Sure, the DOW and S&P have never been this high. But S&P 500 earnings have never been this high either. There’s nothing negative about new highs. It’s the opposite, it’s very positive. That said, stocks do get overbought and need corrections. There have been many within this 8-year Bull. There are certainly many more high Dollar stocks today. You don’t see stock splits like you used to. For whatever reason, companies are letting their stocks run well over $100 and even $1,000, without splitting the shares. It makes it hard for smaller investors to buy the stocks and gives the impression that they’re expensive. That can be very misleading. There are plenty of cheap high Dollar stocks as well as many expensive low Dollar stocks. The key is how the stocks are valued, looking at various metrics like price-to-earnings, price-to-sales and how fast they’re growing. Currently, the S&P 500 is trading at 19X this year’s estimates and 17.5X next year’s. That’s definitely not cheap. But when you consider low interest rates and the current earnings yield of 5.25%, it’s still attractively valued. A 6% earnings yield has provided strong support throughout this Bull Market, while 4% has triggered selloffs. It’s right in the middle today.

Rising Price, Shrinking Supply

Another important thing to consider is the fact that there are far fewer stocks in circulation today. The S&P 500 is considered the US Stock Market, because it represents the largest 500 companies and is the primary benchmark for investors. However, the Wilshire 5,000 is the Total Market. It consisted of 5,000 stocks when it was introduced in 1974. It ballooned to over 7500 stocks in 1998 but has been cut by more than half to just 3,600 stocks today. This is a result of acquisitions, defaults, and companies deciding to stay private. There just aren’t as many stocks to own anymore.

Even the stocks in circulation don’t have as many shares available. Corporate buybacks have been a theme for years, retiring shares. The float is the actual number of shares a stock has available for trading. A company like GE, over 100 years old and an original DOW component has nearly 100% of its shares floating. However, Amazon, founded in the 1990’s has only 83% of its shares outstanding available to investors. When you combine strong investor demand with limited supply, you get higher prices. Amazon has been a monster mover this year even with today’s selloff. No surprise, Founder and CEO Jeff Bezos owns 17% of the shares outstanding which made him the richest person in the world this week for a few hours.

Ready For Defense

As Earnings Season comes to an end, the Market will no doubt start paying more attention to the political and geopolitical issues at hand. The situation in North Korea is quite concerning as is the divisive activity in Washington. We are gearing up for a defensive position in anticipation of another correction. It’s been well over a year since the last 5% selloff, which is rare. It’s only a matter of time. Price action was abnormally choppy this week. But we certainly don’t think this Bull Market is coming to an end and we don’t think the Stock Market is too high. Demand for US stocks is still very strong. We remember investor angst last November and into the New Year. We were bullish and it certainly wasn’t consensus. Earnings are supporting the rally and should continue to do so. It just won’t continue in a straight line.

The Survey Says…

Thank you to everyone who responded to my unscientific survey last week! I received a whopping 86 responses. The tally was, 48% read last week’s TGIF on a PC (which includes laptops), 31% read it on their phone and 21% read it on a tablet. Also of note, Apple devices were by far the most popular. I’ll have to try one of these again…

Have nice weekend. We’ll be back, dark and early on Monday.


TGIF – Gone With the Big Screen?

Bedell Frazier Investment CounsellingTGIF!

Gone With The Big Screen?

What’s your favorite method of getting news, sports or entertainment? There are so many mediums in today’s digital age and longterm norms have been turned upside down. Remember when a phone was a phone? When I moved back to San Francisco from New York in 2002, I didn’t get a landline phone, and thought I was cutting edge. Today, a growing population certainly don’t have landlines, and don’t have cable or even television sets!

The average American adult spends over 12 hours per day consuming media content. A recent study by Deloitte found that we check our phones over 8 Billion times per day. That translates to an average of 46 times per person. Not surprisingly, the younger you are, the more often you check. Americans 18-24 on average check their phones 74 times per day. Chances are they’re not using it as a telephone either. The 18-24 demographic really stands out with media statistics.

Consumer behavior has changed so much over the years. Cable is a great example. It took off in the 1980’s, and my old boss Ted Turner was the pioneer. Before 1980, less than 20% of Americans had cable television. It surged to over 60% by 1990. Pay TV usage expanded over the years with satellite added in and topped out in 2013 with roughly 87%. It’s expected to fall back towards 75% by the end of the decade. 2 Million people cut the cable cord last year. That means they got rid of their cable service and are accessing content directly from the web. Nearly 15% of the country now access content away from the traditional pay, multichannel TV model. Netflix has over 80 Million subscribers, of which half of them watch on a video game console. Over 40% watch from their computer. A small but growing 6% watch from a cell phone.

Attention spans have changed too. Nearly 70% of Americans online watch television while they’re simultaneously on their phone or tablet. Does that sound like someone you know? It’s expected to be over 90% next year. Americans are consuming content like never before. Over 40% of Americans get their news on Facebook. For those of you who still enjoy the morning paper delivered to your home, you’re not alone. Over half of Americans that read the paper get it in print. That also means that nearly half don’t. Just 17% of Americans 18-24 read a newspaper at all.
Do you love going to the movies? Summer is huge for the box-office. Did you know that movie theaters generate nearly 50% of their revenues across the 3-month Summer season? But people don’t go to the movies like they used to. And some argue the art of Hollywood has been lost with quality story telling being replaced with high-priced action films and re-runs. Whatever the case, the traffic trend is undeniable.

In 1946, 57% of Americans went to the movies at least once per week. It was at the theater where people socialized and got news updates, particularly during WWII. They also saw cutting edge cartoons and other shorts. It was a destination. It was a way of life. The advancement of televisions in the home reversed the movie traffic for good. Last year, 71% of Americans saw a movie in a theater at least once. Nearly half went at least once per month. The age group that frequented theaters the most were age 18-24, averaging 6.5 movies in 2016. This was surprising on one hand, as this is the most tech-savvy segment of our population. But with many in the group in College, or not working, they have a little more free time. Then there’s this stat: 75% of frequent moviegoers own at least 4 different types of technology devices such as smartphones, tablets and video-game systems. The tech savvy still like the cinema experience.

Movie tickets have increased in price over the years. Today, a movie in the Bay Area during primetime costs $12. A ticket to see Gone With the Wind in 1939 cost 23 cents. The original Star Wars cost $2.23 to see it the Summer of 1977. Would you pay $30 to get a blockbuster film on your High Def screen at home the same day it opens at the box-office? You just may get the chance soon. Online video is available on-demand, all the time, giving users significantly more power to choose what they want to watch when they want it.

Americans don’t seem to have the patience anymore to sit back and relax with a box of popcorn in the quiet sanctuary of the movie theater. They can’t sit still in their own living room long enough without picking up their phones. They’ve ditched the big screens for smaller screens. Disruptive business models have shaken the traditional norm to its core. Content providers have had to make drastic changes. Content distributors have been squeezed. Advertisers have to re-think everything. These trends have been disruptive. They’ve been evolutionary. And they most certainly have been investable. We pay close attention.

Have a nice weekend. We’ll be back, dark and early on Monday.


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