Tax Loss Harvesting is a subject that usually comes to the minds of investors’ right before the end of the year when they start thinking about taxes. While that is fine, we like to be a bit more tactical in finding the right opportunities to harvest losses throughout the year. Investments can be volatile and it’s entirely possible that an opportunity to harvest losses may arise earlier, only to disappear before year-end. It is of course preferable to have a loss disappear because you’ve either made money or broken even. Nevertheless, there is some strategy involved in finding an asset with a short-term loss, selling that asset, and buying another in its place in order take advantage of the tax deferral. This strategy can work to your advantage, when used at the right time.
The U.S. jobs markets may still have some structural problems to work out, but cyclical trends in employment have been on an upward trajectory for most of this year. At Pinnacle we monitor a broad array of employment indicators that have been ticking in a positive direction; here are a few examples:
- Non-farm payrolls have been over 200,000 for nine straight months. The unemployment rate has decelerated to 5.8% and is clearly trending down.
- Unemployment Claims 4-Week Moving Average, one of our favorite leading indicators of the job market, has been persistently under the 300,000 level for many weeks.
- Surveys of jobs hard-to-get are falling while surveys of job openings are picking up.
- Employment components within small business and regional Federal Reserve surveys are trending up.
- The Employment Trends Index continues to move in a positive direction.
According to the National Association of Home Builders (NAHB):
The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes.
Our proprietary work shows that the HMI Index is negatively correlated to changes in interest rates, with a lag of about one year. This means that when interest rates fall (or rise), the HMI index tends to move in the opposite direction a year later. The rationale behind this relationship is simple: lower interest rates make new homes more affordable, thus leading to a brighter outlook for housing, as measured by the HMI index. In turn, increases in the HMI index typically coincide with better performance for home builders stocks.
Earlier this year, we perceived significant risk inside the oil market: Large speculators had made extreme bullish bets in the futures market, and there was reduced demand from emerging markets. In response, we took half of our energy stock exposure and invested it in Master Limited Partnerships (MLPs). MLPs are natural resource activity companies, mostly involved in the distribution of oil or natural gas through pipelines. This side of the energy business is not directly tied to the price of oil, as oil needs to pass through pipes regardless of price. Additionally, oil supply in our country is skyrocketing and demand for the pipes is increasing. These two factors are major reasons why we were attracted to the investment, and why we remain constructive on the future of MLPs.
Renewed signs of economic weakness in Europe have spooked investors and led to a significant correction in European stocks. In particular, there has been a spate of disappointing economic releases from Germany with industrial production, exports, and business confidence all coming in below expectations. This is concerning because Germany has been the backbone of the overall recovery with better growth relative to other European countries.
With markets moving and volatility picking up, the investment team has had some lively discussions recently. When turbulence breaks out there is often a tangled web of items to sort through in determining what is the major driver. Our summary view is that we’ve had a collision between complacent markets that have lost momentum as the Federal Reserve’s quantitative easing program winds down, and a European growth scare that has moved to the forefront. Negative daily news headlines don’t help either (e.g., Ebola), though these are likely temporary factors.
The second quarter started in somewhat choppy fashion as small cap and other high flying momentum stocks continued to face pressure as investors decided to shed stocks with swollen valuation multiples. The major averages fared better than their risky counterparts, and after a brief dip stocks began their ascent towards record breaking highs on the back on improving economic data, decent earnings growth, and continuing liquidity support from global central banks.
Meanwhile commodity markets appeared to work off some of their overbought readings from earlier in the year as they treaded mostly sideways during the quarter. Within fixed income, the bond market also fared well as investors continued to flock towards anything with a yield, foreign bond markets bubbled, and a number of technical factors came together to keep bond investors satisfied despite meager nominal yields.
NOTE: There is a 100% probability that bull markets will be followed by bear markets. This article is not a forecast about imminent market behavior. For our latest views on markets, clients should read our market review. Financial fire drills are all about testing your emotional response to a bear market, which you should be doing all the time. (And it’s not a bad idea to check your emotional reaction to bull markets, as well.)
When I was a kid, my family lived in a two-story colonial in South Jersey. Once each year, to the great excitement of all concerned, my parents had my brother, sister, and me conduct a fire drill. We got to climb out of our bedroom window onto the roof of the garage, and then down from there.
Our house never suffered a serious fire, and we never had to make a rooftop escape, but my parents were still glad that we’d practiced what we had to do, just in case. It was a very good idea.