Isaac Newton is known to all as one of the world’s greatest scientists, the greatest perhaps. What’s lesser known to us modern-day folks is that in addition to his efforts toward optics, astronomy, physics, and calculus, Newton served as Master of Britain’s Royal Mint. And while Isaac enjoyed a profitable scientific reputation across his life, it was his gig at the Mint where he made the big bucks. Isaac Newton was, in fact, a very rich person. Along the way, though, the man who formulated the laws of motion nearly lost his bleached linen shirt to the South Sea Bubble.

“I can calculate the motions of the heavenly bodies, but not the madness of people.”

            Isaac Newton, author, Principia Mathematica

By way of 18th Century bubble background, the South Sea Company was a British joint-stock operation founded in 1711 to deal with the government’s rapidly accumulating stack of unsecured short-term debt. Given the authority, South Sea Company execs simply – and shrewdly, we might add – converted the short-term pile into a long-term one. Owners of the unsecured paper were invited to “subscribe” it into South Sea Stock, and many – including the man who built the first practical reflecting telescope – did.

“The Bubble appears to be a tale less about the perpetual folly of mankind and more about the continual difficulties of the adjustment of financial markets to an array of innovations.”

Larry Neal, Professor Emeritus of Economics, University of Illinois

And with good reason…the barely-understood investment swap was a huge success and the South Sea Company turned into a money-making machine. Newton was among the earliest to spot the potential of the enterprise and started buying South Sea stock around June 1712 – eight years before speculating in the company’s shares became a mania that swept up virtually all of England. In spring of 1720 – just before the mania went supernova – the man who made the first theoretical calculation of the speed of sound sold most of his stock and banked what would amount to a $4 million profit today.

“This is a tale about the perpetual folly of mankind in gullibly trusting the arrays of innovations that the finance industry concocts.”

Andrew Odlyzko, School of Mathematics University of Minnesota

But for reasons as mysterious as Newton’s interest in alchemy, the great scientist apparently panicked as the bubble continued inflating. Throwing logic to the cosmos, Newton bought his South Sea stock back for twice what he had sold it for only a few weeks earlier. By 1721, Newton is said to have had practically all his money in the much-depreciated investment. At this point, the man who helped develop infinitesimal calculus had become a desperate speculator.

“What goes up must come down, and what goes up the most will come down the hardest.”

Jason Zweig, Columnist, The Wall Street Journal

Newton appears to have lost as much as 77% on his worst purchases, and at least a third of his account value. He eventually diversified his hot-stock portfolio by moving about half its remaining value back into Bank of England equity, and continued with that mix until his death in 1727. But that a person of such ability – literally the man who formulated the law of universal gravitation – couldn’t recognize a market bubble when he was in one is stark reminder of how ominous these otherworldly things can be.

What the equity markets have been doing…

When Friday’s bell rang out the two-week stretch, the Dow was up a lot, the S&P was up a little, and the technology-heavy NASDAQ was actually down. Along the way, all three benchmarks touched intraday records highs before falling back late in the period. Among the sectors, Financials and Energy outperformed while Technology and Internet-related stocks took a hit.

In addition to real prospects for corporate tax cuts, the period’s economic data generally seemed to boost sentiment. Pending home sales rose were reported to have risen at the fastest pace in eight months, and the Conference Board’s gauge of consumer confidence surprised on the upside. The Commerce Department also slightly raised its estimate of third-quarter gross domestic product growth, which showed the economy expanding at an annualized pace of 3.3% – its best showing in three years.

INDEX Friday’s Close Two-Week Point Change Year-to-Date Change
DJIA 24,231.59 +873.60 +22.61%
S&P 500 2,642.22 +39.80 +18.02%
NASDAQ 6,847.59 -(41.57) +27.20%
Russell 2000 1,534.54 +15.46 +13.22%

 

What the fixed income markets have been doing…

The same news that boosted equites pushed Treasury yields marginally higher. Positive comments about the economy from Federal Reserve Chair Janet Yellen also helped push prices down. The investment-grade market was mostly focused on an active new issue calendar and moved little overall. The high yield market was quiet though the sector reported inflows for the period. Municipal bonds tracked Treasury bond prices lower, and a glut of new muni issuance amid the tax talks further weighed on the space.

FIXED INCOME Period Change YTD 12 Months Yield
U.S. Treasuries
+0.1%
2.2% 2.2% 2.4%
U.S. Investment Grade +0.1% 5.9% 6.5% 3.3%
U.S. High Yield   NC 7.2% 8.0% 5.7%
U.S. Municipals -(0.1)% 5.5% 5.7% 2.3%
Non-U.S. Developed   NC 9.1% 8.3% 0.7%

 

What Fund Architects has been doing…

The factors behind this year’s equity bull market – decent economic growth, strong corporate earnings, low inflation, and easy monetary policy – remain intact as we head toward the end of the year. Real prospects for a real tax cut can only add to bullish sentiment.

For our part, we remain fully invested in our equity allocation. Broadly speaking, the Multi-Factor Ranking System is showing preference to U.S. equities over international, and more aggressive sectors over defensive ones. Specifically, this month’s rankings place U.S. Large Cap and Consumer Discretionary stocks at the top of the list, replacing Global Industrials and Global Materials. Both of our previous overweights had occupied the top spots for several months,

Meanwhile, the fixed income markets have become more interesting. It’s particularly worth noting how the correlation of Convertible and High Yield bonds with equities has broken down over the past several months. The usually stable convertible bond space has also been increasingly volatile. Against this backdrop, our ranking system has signaled a sell on our Convertible Bond allocation, a position we’ve have held since February. The proceeds from this sale will be left in cash this month, as the system does not prefer any other parts of the fixed income markets at this time. Our overweight to Emerging Market Sovereign Debt remains in place for another month.

Our Thoughts

Equity markets have seen a bit of consolidation over the last several weeks, and that’s caused some investors to wonder whether we are heading for a more significant pullback. We don’t know, of course — we make no effort to predict the market. What we see in our rankings, however, leads us think the markets have further upside.

In the meantime, tax reform, should it become a reality – especially in the form of reduced corporate tax rates – will almost certainly be a positive for U.S. stocks. We’re confident the Fund Architects Portfolios are well positioned to take advantage.

What the pundits have been saying…

“While we all know that December is historically a bullish month, what also stands out is that this month has never once been the worst month of the year for the S&P 500. Considering March 2017 is the current worst month of the year, as it closed down 0.04%, this could bode well for the bulls in December.”

  • Ryan Detrick, Senior Market Strategist at LPL Financial

What the numbers are saying…

  • $3 billion

The amount in sales-tax bonds that Chicago could sell at a triple-A rating. The nation’s third-largest city has created a new company to sell debt, offering investors a dedicated first claim to the city’s sales-tax revenue.

What people have been saying…

“It’s premature. If the exchange giants’ efforts stumble, it could create a new headline risk that could set us back months or years.”

  • Paul Chou, CEO of LedgerX, on the launch of bitcoin futures

The views in this commentary are those of Fund Architects. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this commentary, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from Fund Architects or any other investment professional.  The information contained within this commentary should not be the sole determining factor for making investment decisions. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with Fund Architects. Information pertaining to Fund Architects advisory operations, services, and fees is set forth in Fund Architect current disclosure statement, a copy of which is available upon request. Fund Architects, LLC is an SEC Registered Investment Advisory Firm.

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