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 | October 2019


                                      
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The S&P 500 advanced for during the month of September climbing 1.87%.  Year to date the i ndex has advanced nearly 19%, posting its best first three-quarter start to the year since 1997.

If you read our newsletter on a regular basis you know that we are generally bullish on stocks; but this market's resiliency has suprised even us.  As the saying goes, "markets climb a wall of worry."   Wall of worry is the financial markets' tendency to overcome a host of negative factors (e.g., trade war, impeachment and recession concerns) and continue climbing.  

Stock prices are ultimately driven by corporate earnings.  Thus, until the negative news begins to adversely affect the economy, its hard to bet against the bull. 
Value's Revenge?

Aside from a couple of spurts in 2016, value investing (think Warren Buffet) has been out of favor for over five years.  The chart below shows the ratio of RPV (the S&P 500 "pure value" ETF) to OEF (the S&P 100 ETF symbolizing momentum).  Value peaked in the second quarter of 2014 and has been in general decline ever since (red trend line) aside from 2016 (green trend line). 


Over time, value outperforms almost every other strategy, e.g., growth. It is simply better to buy when stocks are undervalued. But it clearly doesn't work all the time.

The last time value underperformed for such a long stretch was the latter 1990s during the dot-com bubble. Interestingly, value performed great from 2000-2002 while the momentum stocks plunged. 
 
We are monitoring value as we expect it to experience a similar turnaround relatively soon. If and when value starts to perform, we'll adjust our portfolios and fund accordingly.
Repo Madness

The repurchase agreement or "repo" is basically the plumbing of Wall Street, where banks in need of short-term cash come for funding. On September 15, overnight repo financing rates reached as high as 10%, indicating a possible cash crunch in the system. 

Typically, repo agreements are financed at or near the Fed Funds rate (currently around 2%). As a result, many questioned whether our financial system has a liquidity problem. Liquidity is crucial to the proper working of the banking system. 

There is no liquidy problem according to Brian Wesbury, Chief Economist at First Trust, who observes:
  1. The jump in rates was limited to a couple of transactions. Most repos executed much lower than 10%, so this was not a serious system-wide shortage of reserves.
  2. There are $1.4 trillion of excess reserves in the banking system. Banks are wel-capitalized.
Wesbury blames the blip on recent banking regulations, the unintended consequences of which can create issues even when banks have ample capital, liquidity and profits. Specifically, banks must comply with a Liquidity Coverage Ratio (LCR) which forces banks to hold enough liquidity to last a month in a significant financial and economic crisis scenario where unemployment climbs to 10%.

So, the Fed would seem to have two choices: lower the LCR or engage in quantitative easing to pump its balance sheet even higher (creating even more excess reserves). We have a hunch it's going to be the latter.
In Closing

October has historically been the most volatile month of the year for stocks. 

 

October has also developed a reputation as a "jinx month" for stocks as a result of market crashes in 1929, 1987 and 2008. Those not-so-minor falls aside, October is historically average.  Our best guess is that the October will be a rough ride that finishes on an up note as we move into what is historically the best time of the year for stocks.

" During the day, I don't believe in ghosts. At night, I'm a little more open-minded."
- Unanimous

Sincerely,

Marty Kerns
President & Chief Executive Officer
Parker Binion
Chief Investment Officer
About Kerns Capital Management

Kerns Capital Management is a leading asset management firm with a focus on quantitative, liquid alternative investment strategies, including the KCM Macro Trends Fund.  We are value-oriented investors in long/short equity, credit and volatility, and apply the same attention to risk in the deployment of capital that has guided us since our inception as a fiduciary investment manager to corporate pensions, trusts and high net worth individuals.  Kerns was founded in 1996, and is based in Houston, Texas.

For more information on our products, including fund performance, please visit www.kernscapital.com or contact Martin Kerns or Parker Binion at 1 (800) 945-2125 or  ir@kernscapital.com
IMPORTANT DISCLOSURES

Performance data represents past performance and is not a guarantee of future results.   Performance current to the most recent month-end may be lower or higher, and can be obtained by calling 800-945-2125.

The S&P TR 500 Index is an unmanaged composite of 500 common stocks. This index is widely used by professional investors as a performance benchmark. Total return includes reinvestment of dividends. You cannot invest directly in an index. The Dow Jones Industrial Average is a price-weighted average of 30 of the largest and most widely held stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depository receipts, common stocks, real estate investment trusts (REITs) and tracking stocks.