What’s on Tap: Interest-Rate Cut Not Data-Driven

  • Interest-Rate Cut Not Data-Driven

  • Stock Buybacks and the Truth About Earnings

  • Annuity Basics: We Believe Investors Should Be Selective

  • Looking Ahead to Service Sector, Consumer Credit and Inflation Data

Though widely awaited and anticipated, stocks fell Wednesday on news that the Federal Reserve would cut interest rates by 0.25%. Then, as markets were on pace to recoup those losses Thursday, President Trump said he would add tariffs on many Chinese goods that had so far escaped his attention and stocks turned tail. The Dow Jones Industrial Average dropped 627 points from high to low, or 2.3%—the biggest intraday swing since January 4.

Between our emerging trade war with China, questions about monetary policy and uncertainty concerning U.K. Prime Minister Boris Johnson’s threat to Brexit without a deal with the European Union, it’s no wonder Wall Street traders are on edge.

For the year through Thursday, the Dow Jones Industrial Average and the broader S&P 500 index have returned 15.5% and 19.2%, respectively. The MSCI EAFE index, a measure of developed international stock markets, is up 12.4%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has declined to 2.39% from 3.28% at 2018’s end. On a total return basis, the U.S. bond market has gained 7.0% for the year.

Interest-Rate Cut Not Data-Driven

This week’s data revealed what we already knew: The driver of our economy, the U.S. consumer, is in solid spending shape—incomes, savings and confidence are all on the rise. Coupled with last week’s report that GDP rose 2.3% year-over-year in the second quarter and this morning’s news that businesses added 164,000 jobs last month while the unemployment rate held steady at 3.7%, one thing is clear: We’re not in a recession nor are we anywhere close.

We’re not in a recession nor are we anywhere close.

So, if you’re asking why the Fed cut interest rates for the first time since the Great Recession in 2008, the answer appears to lie in what may be policymakers’ attempt to “inoculate” the U.S. economy against the drag of a slowing global economy.

Such a preventative cut marks a shift from the Fed being purely data-dependent and reactionary to being more proactive. That could lead to unintended consequences, not the least of which is having one fewer deflation-fighting bullet in their chamber.

Stock Buybacks and the Truth About Earnings

Corporate stock buybacks are the media’s current Wall Street whipping boy, and pundits often claim that the sole purpose of a buyback is to inflate earnings per share (EPS) and prop up the stock market. Criticism has gotten particularly heated recently as companies repurchased more than $1 trillion in stock over the past two years. Apple, for one, has committed to billions of dollars in dividends and buybacks in an attempt to whittle down its copious cash reserves.

But a hard look at the data suggests the media is getting buybacks all wrong: During the stock market’s recent rise, buybacks have had little impact on EPS, and aren’t doing much to prop up the overall market.

Let’s take that earnings-per-share argument first by looking at the “buyback effect.”

To get a measure of the impact of stock buybacks on the S&P 500, we can compare total earnings growth for companies in the index with their earnings-per-share growth. Normally, these two numbers should be the same. The only way that overall earnings growth rates and EPS growth rates can differ is if the number of outstanding shares changes. If a company’s earnings are flat from one year to the next, but it buys back shares over the course of that year, then earnings per share will increase—not because the company earned more money but simply because of the reduction in the number of shares.

So, is this buyback effect providing a big boost to corporate bottom lines?

No. In aggregate, the buyback effect was small—on average just 1.4% from the beginning of 2017 through the end of 2018. Over the past two years, when companies purchased over $1 trillion of their own shares, buybacks increased EPS growth by less than 1.5%. On a quarterly basis, as the graph below shows, the “buyback effect” only boosted earnings per share by between 0.9% and 2.0%. At best, even during the market’s recent steep climb, buybacks were a mere wisp of a tailwind, not a major driver of EPS growth.

Source: S&P Dow Jones Indices.

Source: S&P Dow Jones Indices.

If stock buybacks aren’t major drivers of EPS growth, is it credible that they are propping up the stock market? If they were, then one might expect that the companies buying back their stocks would outperform peers that aren’t buying back stock. But this is not the case. While the S&P 500 returned 8.0% over the last 12 months through July, the S&P 500 buyback index, a measure of the performance of all companies engaged in buybacks, gained 5.9%.

Our analysts don’t believe it’s a valid argument to criticize buybacks for unrealistically boosting earnings per share or for somehow propping up the stock market. Their impact has been negligible. If you’d like to read more on the misconceptions and realities of buybacks, download a free copy of a special report from our parent company, Adviser Investments, Stock Buybacks: Public Enemy Number One?

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Annuity Basics: We Believe Investors Should Be Selective

 Some concepts in the financial planning world are intuitive. Annuities, which often combine investment options with different forms of insurance, are not. As a retirement income tool, they’ve received increasing attention of late. A new law currently winding its way through Congress—the Secure Act—is designed to give annuities a boost by encouraging 401(k) plans to offer them.

But annuity contracts are often confusing, hard to navigate and may not be the best solution for many retirees.  

At its core, an annuity is an agreement you make with an insurance company. You purchase the contract with either a lump sum or as a series of payments and in return the insurance company commits to making a series of payments to you for as long as you live. 

Two major factors distinguish one annuity from another—when you begin receiving payments and the form those payments take.

  • Immediate annuity: Also known as an “income annuity,” payments on an immediate annuity must begin within one year of purchasing the contract. Immediate annuities are always purchased with a single lump-sum payment. 

  • Deferred annuity: Payments begin on a future date you select. While you wait, your money in the annuity grows.

  • Fixed annuities: Predictable and steady, fixed annuities offer a guaranteed interest rate and a fixed payment amount. The tradeoff is that you might not benefit from any market growth. 

  • Variable annuities: You select among investment options, often mutual funds, for preservation, growth or a combination of the two. Your payout is determined by how your investments perform. 

One big disadvantage: Annuities can be costly and there are some liquidity issues to contend with. Any withdrawals made from your annuity before you reach age 59½ incur a 10% penalty, and you’ll owe income tax on any earnings. Most contracts also include a “surrender charge” of anywhere from 7% to 20% on withdrawals made within the first five to seven years of purchase.

At Braver Capital, we believe investors should be selective when it comes to annuities because of their complexity and high costs. An annuity may make sense if you’re concerned that you might outlive your assets, and they are a good fit for some people. But generally, we believe that with consistent savings and a well-built investment and financial plan, you can grow an asset base that will sustain you in retirement without taking on annuities’ high costs.

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Looking Ahead to Service Sector, Consumer Credit and Inflation Data

In contrast to this week, next week will be light on new reports: Service sector activity gauges, job openings, consumer credit and inflation make up the slate. With little fresh data to gauge the real economy, markets are prone to reacting more strongly to headlines and events—but we can hope that the dog days of summer will be dull days for the markets.

If you’d like to learn more about our tactical or fundamental investment strategies, please contact Steve Johnson at 844-587-7393 or info@bravercapital.com.

Please note: This update was prepared on Friday, August 2, 2019, prior to the market’s close.

This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations or personal investment advice, or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged. 

Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. 

Insurance information is general in nature; and is not to be construed as personalized advice. Braver Capital Management is not licensed to sell insurance products. 

Companies mentioned in this article are not necessarily held in client portfolios and our references to them should not be seen as a recommendation to buy, sell or hold any of them.

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