Bob’s Journal for 11/27/19

Some Notable Events That Grabbed My Attention This Week

I wish all my readers a Happy Thanksgiving. I completed this week’s Bob’s Journal a day early to accommodate the holiday.

Stock investors certainly have a lot to be thankful for this year. The S&P 500 hit a record closing high on Nov. 1. In 12 of the trading days since then, it has set new record closing highs. That’s quite a streak, but by most measures stocks now are overbought.

Schwab Buys TD Ameritrade

The big news in the last week is Charles Schwab & Co.’s acquisition of TD Ameritrade. While some headlines refer to it as a merger or combination, there’s no doubt Schwab is taking over TD Ameritrade. The combined firm will do business under the Schwab name.

The deal combines the two largest discount brokerage firms and follows a series of changes in the industry. A few weeks ago, when Schwab, TD Ameritrade and other discount brokers announced they would eliminate commissions on most U.S. stocks, exchange-traded funds (ETFs) and options, I said more changes were coming.

Schwab and TD Ameritrade apparently decided they need to increase their scale and reduce costs because their leeway to charge fees and commissions is declining. TD Ameritrade probably was more in need of a deal, since it receives a far higher percentage of its revenue from commissions than Schwab does.

There shouldn’t be major changes in the way the firms do business for a while.

The deal first has to be approved by regulators. I anticipate the deal will be approved. Discount brokers face increased competition from technology startups and other sources. Last May, Goldman Sachs began competing against the firms after acquiring United Capital.

It will take until sometime after mid-2020 for the firms to complete the merger. After that, they must decide how they will merge their technology and operations, and then execute the plan. Initial estimates are that it will take at least 36 months to integrate the firms.

One benefit for clients is that a well-executed merger will allow the best features of each firm to survive and be available to clients. TD Ameritrade generally is considered to have better trading tools while Schwab has better market research and commentary.

The biggest initial risk to clients is the potential for snafus when the technology and operations are integrated. Both firms serve as brokers for independent financial advisors. Clients of those advisors are likely to have to execute new paperwork and might see other changes.

In addition, TD Ameritrade works with smaller firms that don’t qualify for Schwab’s independent advisor program. Those firms might be bumped out of the new firm.

We might see a number of advisors migrating their business to Fidelity or other firms. That’s partly to avoid hiccups during the merger and partly out of fears that the combined firm will try to poach their clients. A number of advisors already accuse Schwab of that. There’s a rumor among advisors that Schwab will start charging advisors for being the custodian of their assets. Fidelity does that now, but Schwab doesn’t.

There might be other changes after the merger is complete. Since the major motivation is cost efficiencies, clients might see reduced client service and might lose features or services they like but that few clients use. I also fear the combined firm might be less innovative than in the past, especially where technology is concerned. But we’ll have to wait and see.

Fidelity, which will be the largest competitor after the merger, was quick to strongly criticize the combination. Among other things, it said integrating the two firms would be a long and complex process and distract the firms from client service. Fidelity also criticized Schwab for offering investors very low interest rates for cash kept in brokerage accounts and “paying for order flow” when deciding where to direct client’s trading orders for execution. Fidelity management said it is likely to deliver better order execution.

I expect more mergers among brokers and other financial firms in the coming years, because technology is rapidly changing the business and clients are demanding lower fees.

Executors Might Need to Diversify Portfolios

Executors can be liable when bad things happen to a portfolio while they’re settling the estate.

In a recent case, a woman died in 2007, owning a portfolio worth just under $5 million. Her husband and daughter predeceased her, so the woman left her estate to a foundation named after her daughter.

About 86% of the portfolio was in General Electric (GE) stock. The executor didn’t diversify the portfolio. It declined in value during the financial crisis and continued to decline because of GE’s business problems.

Since the estate was left to a charitable foundation, the state Attorney General could act on behalf of the foundation. The Attorney General sued the executor, saying he should have diversified the portfolio within two and one-half months after the woman died. The court agreed. It held the executor responsible for the losses that occurred after that date, plus 9% interest.

The court said it would hold an additional hearing later to decide if the executor also should be responsible for the difference in returns between GE stock and a market index after the date the stock should have been sold.

State law varies on an executor’s duty to diversify. New York’s is particularly strict, imposing an almost unconditional duty to diversify concentrated investment positions.

The decision makes clear an executor is responsible for more than processing the estate. The executor has a fiduciary responsibility to review and manage the estate’s assets as a prudent investor would. (Matter of Kenney, 2019 NY Slip Op 51389(U))

The Data

Manufacturing is still doing poorly in most of the country, according to this week’s surveys from the Federal Reserve’s regional banks.

The Kansas City Fed Manufacturing Index was unchanged in November at negative 3.0. That’s still the second-lowest level in three years. Durable goods manufacturing is the weakest part of the index, though all components of the index were low.

Manufacturing in Texas also contracted in November, but at a slower pace than in October, according to the Dallas Fed Manufacturing Survey. The General Activity Index came in at negative 1.3 compared to negative 5.1 in October. The Production Index, however, tumbled to a negative 2.4, following a positive 4.5 in October. That’s the first negative reading for the Production Index since 2016.

The mid-Atlantic joined the regions where manufacturing contracted in November. The Richmond Fed Manufacturing Index declined to negative 1 after registering an 8 in October. Shipments and new orders declined significantly.

Yet, Durable Goods Orders for October were very strong and well above expectations. Orders increased 0.6% for the month, following a 1.4% decline in September. Expectations were for a 0.7% decline.

After subtracting the volatile transportation sector, orders still increased 0.6%, compared to a 0.4% decline in September.

Orders for the important core capital goods segment increased 1.2% in October, compared to a 0.5% decline in September. Core capital goods orders are a major indicator of business investment and have been very weak all year. It is a very positive indicator for economic growth if this is the beginning of a trend of growth in this segment.

Personal Income was unchanged in October, following a 0.3% increase in September. Consumer spending still increased by 0.3% for the month.

Inflation, as measured by the Fed’s preferred PCE Price index, increased only 0.2% for October and, after subtracting food and energy, increased only 0.1%. Over 12 months, those inflation measures increased 1.3% and 1.6%, respectively.

Consumer Sentiment, as measured by the University of Michigan, improved. The November index was 96.8, up from 95.7 in October. That’s the best reading since July. In the report, expectations improved but current conditions declined.

Consumer Confidence, as measured by The Conference Board, however, declined in November. The October measure was revised higher to 126.1, but November’s reading was 125.5, the lowest level since June. The reading for present conditions declined significantly, while expectations improved.

Home prices bounced higher in September, according to the S&P Corelogic Case-Shiller Home Price Index. The index increased by 0.4% in September, and August’s reading was revised from a 0.2% decline to a 0.2% increase. Over 12 months, the index is up 2.0%.

The FHFA House Price Index also bounced higher in September. The index found house prices increased 0.6% for the month and 5.1% over 12 months.

Both housing indexes indicate the decline in interest rates in August helped the housing market.

New home sales also are benefitting from lower interest rates. October’s new home sales were well above expectations, and September’s sales were revised substantially higher above the initial report issued last month. Over 12 months, new home sales increased 31.6%. But over 12 months, the median price for a new home declined 3.5%.

Yet, pending home sales declined 1.7% in October and are only 4.4% higher over 12 months, according to National Association of Realtors (NAR). The organization found that the decline in sales is due primarily to a shortage of inventory for sale.

The economy improved a little in early November, according to the PMI Composite Mid-month Flash Index. The services component increased to 51.6 from 51.0. The manufacturing component also improved to 52.2 from 51.5. The composite of the two improved to 51.9 from 51.2. The composite is at its best reading since April. New orders also were at their best level since April, but prices were “historically subdued.”

New unemployment claims declined by 15,000 to 213,000. That reverses several weeks of increases and was such a strong turnaround that the four-week average of claims declined by 1,000.

The second estimate of third-quarter gross domestic product (GDP) increased growth to 2.1% from 1.9%. Consumer spending was unchanged from the first estimate, but inventory and business investment were increased a bit.

The Chicago PMI for November increased to 46.3 from 43.2. The measure is slowly recovering from the steep drop in September. A reading below 50.0 indicates the region’s economy is in contraction.

The Markets

The S&P 500 rose 0.69% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.73%. The Russell 2000 increased 1.62%. The All-Country World Index (excluding U.S. stocks) added 0.12%. Emerging market equities edged up 0.05%.

Long-term treasuries rose 1.42% for the week. Investment-grade bonds increased 0.79%. Treasury Inflation-Protected Securities (TIPS) added 0.52%. High-yield bonds gained 0.58%.

On the currency front, the U.S. dollar increased 0.41%.

Energy-based commodities increased 3.02%. Broader-based commodities rose 1.42%. Gold declined 0.71%.

Bob’s News & Updates

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