Market Commentary: 2Q 2017

The second quarter proved to be another very strong period for global stock and bond markets but commodities struggled. Larger-cap U.S. stocks surged to 9.3% for the year while international indexes were each up in the mid-teens. Core bonds also delivered solid returns, rising 1.5% for the quarter. But since higher bond prices correspond to lower bond yields, the yield curve “flattened” considerably and the difference between the 10-year and 2-year Treasury yields ended the quarter at close to a post-2008 low. Conversely, commodity prices and energy stocks detracted from the quarter’s returns and remain a weak spot amid a global rally in risky assets due to a 14% decline in oil prices.

The calm, as manifested in low measures of volatility across global markets, was briefly interrupted during the last few days of June. Global stock and bond investors were rattled by comments from the heads of the European Central Bank and the Bank of England suggesting they may be considering the potential end to bond buying policies designed to stimulate markets and a move to raise interest rates, respectively. They were further jolted by Fed Chair Janet Yellen’s statement that “by standard metrics, some asset valuations look high.” In response, bond yields quickly spiked higher, while currency markets saw large swings. Nevertheless, at quarter-end, the S&P 500 was only about 1% below its all-time high.

Here are the broad index returns through the Second Quarter of 2017:

U.S. Large Cap Stocks 9.3% Emerging Market Stocks 18.4%
U.S. Small Cap Stocks 5.0% Commodities -5.3%
U.S. Real Estate 2.7% U.S. Aggregate Bonds 2.3%
Overseas Stocks 13.8% International Bonds 5.8%

U.S. stock investors seem a bit complacent now. The VIX index, an indicator of the S&P 500’s expected 30-day volatility, fell to a 23-year low in early May and remained low throughout the quarter. The U.S. stock market’s calm ascendance seems to fly in the face of ongoing political uncertainty in the U.S. and geopolitical tumult around the world. The extremely low market volatility and high stock market valuations implicitly discount a very rosy economic scenario but economic growth has been noticeably meager so far this year. Interestingly, a U.S. stock market correction (a decline of 10% or more) hasn’t occurred since February 2016 when, on average, they typically occur about once per year.

However, there is room for hope in the most recent economic data. The Atlanta Federal Reserve recently forecasted that the U.S. economy will grow at a 2.9% rate for the year’s third quarter. The unemployment rate is at a near-record low of 4.7% and wages grew at a 2.9% rate in December, the best increase since 2009.

How will the Fed respond to the contradictory data? In past years, the Fed’s actions have repeatedly converged to meet market expectations with a less aggressive rate hiking path than it originally forecasted for itself. The Fed is likely more hawkish at this point in the economic cycle with unemployment down to 4.3% coupled with its expectation that wage, and ultimately, inflationary pressures will emerge. This creates uncertainty and the risk that the Fed will tighten more than the economy and markets can handle. In fact, economist David Rosenberg writes, “If the Fed does what it says it’s going to do, the yield curve will invert sometime next year, with a recession all but an inevitability.”

An inverted Treasury yield curve has preceded the last seven U.S. recessions dating back to the 1960’s. But with global central bank bond purchases still depressing longer-maturity bond yields, this cycle may be different from prior ones. The Bank Credit Analyst sees the risk of a U.S. recession sometime in 2019, after a final burst of growth over the next year. And this being macroeconomics, there are intelligent counter arguments that the Fed is more likely to fall behind the curve (or already has) in tightening monetary policy, meaning a period of higher-than-expected inflation and interest rates will ensue but a Fed-induced recession may be delayed. Whatever the response, it is reasonable to expect additional volatility in the not-too-distant future.

Market Commentary: 1Q 2017

To no one’s surprise, the U.S. stock market has been on a tear. Over the last eight years, the S&P 500 index has returned more than 300% and the tail-end of this run seems to have accelerated the trend. The first quarter of 2017 provided the highest returns for U.S. large-cap stocks since the last three months of 2013. Additionally, the Nasdaq index has booked its 21st record close of the year so far and the index has recorded a whopping 30%-plus rise over the past 14 months, marking the fastest advance since 2006.

In addition to the great domestic stock returns, international investments have been soaring through the start of the year, especially in U.S. dollar terms. European stocks gained 8.6% for the quarter and EAFE’s Pacific ex-Japan Index gained 11.8%. In aggregate, the broad-based EAFE index of companies in developed foreign economies gained 7.4% in the first three months of calendar 2017. Emerging market stocks of less developed countries, as represented by the EAFE EM index, rose an impressive 11.5%.

Here are the broad index returns through the First Quarter of 2017:

U.S. Large Cap Stocks 6.0% Emerging Market Stocks 11.5%
U.S. Small Cap Stocks 2.5% Commodities -2.3%
U.S. Real Estate 1.0% U.S. Aggregate Bonds 1.0%
Overseas Stocks 7.4% International Bonds 2.4%

Across a wide range of measures, the global economy is in its best shape in many years. Economic growth in most countries and industries has been accelerating, albeit modestly. In fact, the Global Manufacturing Purchasing Managers Indexes, which have been correlated with global equity returns over time, recently made new multiyear highs in the United States, the eurozone, and China. A quick survey of the economic landscape suggests the environment should remain supportive of stocks and other risk assets, at least over the next six to 12 months. While unexpected macro shocks can occur at any time, the global macroeconomic backdrop offers reason for optimism that many of the reflationary trends that have benefited our portfolios in recent quarters can continue and the likelihood of an imminent U.S. or global economic recession appears low right now. Without a recession, history suggests a bear market in stocks is unlikely.

The European economy seems to have turned an important corner. Last year, for the first time since the 2008–2009 financial crisis, Europe’s economy grew faster than that of the United States. Improving economic growth ultimately leads to better sales growth and gets consumers and corporations to borrow and spend, furthering the cycle. According to the Bank Credit Analyst, private sector credit growth in Europe is up at the fastest rate since the financial crisis. The European Central Bank has revised upward both its inflation and growth projections for 2017–2018.

High current valuations will likely be a headwind to U.S. stock market returns looking out over the next five years but international stocks look attractive. Corporate earnings in the U.S. have not kept pace with the fiery stock market returns of the last few months and valuations have risen. In stark contrast to one another, it appears that European earnings are cyclically depressed while U.S. earnings are near cyclical highs and this relationship does not appear to be adequately reflected in their respective valuations. In Europe, corporate earnings have barely grown since the 2008–2009 financial crisis primarily due to the onset of a regional debt crisis in 2011. Meanwhile, U.S. company earnings have grown strongly, exceeding prior cyclical highs due to historically high profit margins, stock buybacks, and low interest expenses. This results in European stocks appearing to be relatively less expensive than U.S. stocks and more attractive for the long-term. It is impossible to know the precise timing or exactly what catalyst will lead investors to close the gap and begin shifting from U.S. investments to international holdings but history teaches that in time, there will be periods of international stock out-performance.

Market Commentary: 4Q 2016

You know that you are deep into a longstanding bull market when you see things like average pedestrians keeping one eye on the market tickers outside of brokerage houses to see when the Dow Jones Industrial Average has finally breached the 20,000 mark. Who would have thought that there was much good to come when the beginning of 2016 got off to such a rocky start, tumbling 10% in the first two weeks—the worst start to a year since 1930? Nevertheless, the markets eventually bottomed in mid-February and began a long, slow recovery. While the U.S. markets suffered a setback in June when the U.K. decided to leave the Eurozone, and endured another hard bump right after the elections, in the end, we were not disappointed.

The final quarter provided U.S. stock investors with impressive gains. The Wilshire 5000, the broadest measure of U.S. stocks, was up 4.54% in the fourth quarter of 2016 and ended the year up 13.37%. It was also a year to remember for investors in small company stocks. The Russell 2000 Small-Cap Index finished the year up 21.31% after producing an astonishing 11% return in November alone.

Unfortunately, rising U.S. equity prices came at the expense of core bond and international stock returns. The overall U.S. bond market gained 2.65% for the year, but that hid a fourth quarter decline of 3.2% as rising interest rates resulted in the worst quarterly performance for bonds in 35 years. Expectations for rising inflation, along with the Federal Reserve’s December decision to raise interest rates, further contributed to falling bond prices. Emerging Market stocks also declined, falling 4.8% in the final quarter. Nevertheless, the combination of portfolio increases and decreases still resulted in better than average returns across the allocations.

Here are the broad index returns through the Fourth Quarter of 2016:

U.S. Large Cap Stocks 12% Emerging Market Stocks 11.6%
U.S. Small Cap Stocks 21.3% Commodities 11.8%
U.S. Real Estate 8.6% U.S. Aggregate Bonds 2.6%
Overseas Stocks 1.5% International Bonds 1.9%

Core bonds are likely to continue to struggle over the next market cycle. The combination of the Fed’s plans for three additional interest rate hikes and an incoming presidential administration that promises to significantly increase spending could mean higher debt servicing costs for both consumers and the government (i.e., taxpayers). Placing a greater emphasis on flexible fixed-income strategies is essential to helping the bond portfolio contribute to the overall portfolio return but it cannot completely remedy the issue. Interest rates are still historically low, where the 10-Year Treasury is now yielding 2.45% versus an average over the last 58 years of 6.15%. The result can only mean lower portfolio returns than has been experienced on average in the last 50 years. Fortunately, inflation is also low and net “real” returns (your portfolio return minus inflation) should continue to fall within an acceptable range over a sufficiently long period of time.

Reflecting again on the financial markets’ rocky start to 2016, it is also important to remember how quickly trends can change. While it is unclear how 2017 will play out, since precise inflection points in market performance are impossible to predict, European corporate earnings and eventually stock prices are poised for recovery and valuations in Emerging Market stocks remain favorable. In contrast, U.S. stocks appear somewhat overvalued and have continued to increase despite their historically high price-to-earnings multiples. As interest rates rise, we may see a weakening in the support that the low rates of the past decade have afforded U.S. stock prices. Corporate tax cuts would likely help support higher prices, but over a full market cycle, valuations tend to matter materially while chasing baseless momentum is a recipe for disappointment. Optimistically, short-term market traders seem to be expecting a robust economic stimulus combined with lower taxes and deregulatory policies that would boost the short-term profits of American corporations. But it is helpful to remember that we are entering the ninth year of economic expansion, making this the fourth longest since 1900, and many economists are predicting a recession within the next few years. The best recipe for portfolio success is broad diversification to help ensure the portfolio has upside potential and downside protection across diverse economic outcomes.

Market Commentary: 3Q 2016

One hundred days after the Brexit scare and nine months after the most recent Fed rate hike, the markets once again confounded the instincts of nervous investors and went up instead of down. Last week, Federal Reserve Chairperson Janet Yellen told the world that the U.S. economy is healthy enough to weather a rise in interest rates. Nevertheless, the Fed governors met in September and declined to serve up the first rate hike since last December. That was reassuring news to the Wall Street traders and helped to provide yet another quarter of positive gains in U.S. stocks.

Larger companies were positive but posted the lowest gains. The Russell 1000 large-cap index provided a 4.03% return over the past quarter, with a gain of 7.92% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a gain and is up 7.8% for the year so far. Comparably, the Russell 2000 small-cap index gained 9.05% this quarter, posting an 11.46% gain so far this year.

Comparatively, the U.S. remains a haven of stability in a very messy global investment scene. The broad-based EAFE index of companies in developed foreign economies gained 5.80% in the third quarter but is only up 2.2% for the year. European stocks have lost 2.67% so far in 2016. In contrast, a basket of emerging markets stocks domiciled in less developed countries, as represented by the EAFE EM index, gained 9.03% for the quarter and is sitting on gains of 16.4% for the year so far.

Here are the broad index returns through the Third Quarter of 2016:

U.S. Large Cap Stocks 7.8% Emerging Market Stocks 16.4%
U.S. Small Cap Stocks 11.5% Commodities 8.9%
U.S. Real Estate 12.3% U.S. Aggregate Bonds 5.8%
Overseas Stocks 2.2% International Bonds 12.5%

What is keeping stock prices high while sentiment appears to be somewhat restrained? No one knows the answer. But a deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported in the press. Economic growth for the second quarter has been revised upwards from 1.1% to 1.4% due to higher corporate spending in general and especially as a result of increasing corporate investments in research and development. America’s trade deficit shrank in August. Consumer spending, which makes up more than two-thirds of U.S. economic activity, rose a robust 4.3% for the quarter, perhaps partly due to higher take-home wages this year.

Meanwhile, if someone had told you five years ago that today’s unemployment rate would be 4.9%, you would have thought they were highly optimistic. But after the economy gained 151,000 more jobs in August, unemployment remained below 5% for the third consecutive month and the trend is downward. At the same time, average hourly earnings for American workers have risen 2.4% so far this year.

Based on their reading of the Treasury yield curve, economists at the Federal Reserve Bank of Cleveland have pegged the chances of a recession this time next year at a low 11.25%. In general, a steep yield curve has been a predictor of strong economic growth, while an inverted one, where short-term rates are higher than longer-term yields, is associated with a looming recession. They predict GDP growth of 1.5% for this election year, which is comfortably ahead of the negative numbers that would signal an economic downturn.

The U.S. returns have been so good for so long that many investors are wondering: why are we bothering with foreign stocks? A recent Forbes column suggested the answer: since 1970 foreign stocks have outperformed domestic stocks almost exactly 50% of the time, meaning the long trend of U.S. out-performance that we have become accustomed to could reverse itself at any time.

No one would dispute that the economic statistics are weak tea leaves for trying to predict the market’s next move. However the slow, steady growth we’ve experienced since 2008 is showing no visible signs of ending and it is hard to find the usual euphoria and reckless investing that normally accompanies a market top and its subsequent collapse of share prices. At the current pace, we might look back on 2016 as another pretty good year to be invested.

Market Commentary: 2Q 2016

U.S. markets were initially range-bound for most of the quarter until June, when the relative calm in global stock markets came to an abrupt end. Upending most forecasts and taking world financial markets by surprise, the United Kingdom voted to leave the European Union on June 23. In the wake of the vote, British pound sterling fell 11% overnight against the U.S. dollar, its lowest level since 1985. The euro fell 2.4% to 1.10 versus the dollar. Global equities plummeted.

 Then in the week following Britain’s historic vote, global equities rallied despite significant uncertainty regarding the economic, political, and financial market implications of Brexit.When the dust had settled, developed international and European stocks remained in the red, while U.S. stocks edged into positive territory. The big winners in the quarter were emerging-markets stocks, which gained 2.6% and are now up 6.6% year to date.

As the second quarter ended, investors could be forgiven for feeling both bruised and battered. In the aftermath of the Brexit vote, global financial markets initially hit the panic button. Following the vote, stocks fell, bond yields dove, and both the British pound and the euro swooned. The markets demonstrated the typical flight to safety, with U.S. Treasurys, the U.S. dollar, Japanese yen, Swiss franc, and gold all rising sharply.

Here are the broad index returns through the Second Quarter of 2016:

U.S. Large Cap Stocks 3.7% Emerging Market Stocks 6.6%
U.S. Small Cap Stocks -2.2% Commodities 13.3%
U.S. Real Estate 13.3% U.S. Aggregate Bonds 5.3%
Overseas Stocks -4.0% International Bonds 10.7%

There are a number of positives in the U.S. economy. Historically low oil prices and high domestic production have lowered the cost of doing business and the cost of living in the United States. Both are a boon to the economy, which is on track to grow at a 2.0% rate this year. Although hardly dramatic, this growth rate is sustainable and not likely to overheat the different sectors of the economy which could lead to a recession. Manufacturing activity is expected to grow 2.6% for the year based on the numbers so far, and the unemployment rate has fallen to 4.7%, below the Federal Reserve target. The unemployment statistics are almost certainly somewhat misleading in the sense that many people are underemployed, and a sizable number of working-age men are no longer participating in the labor force. But for many Americans, the employment picture is much better now than a few years ago. By a number of measures, the U.S. economy seems to be comfortably plodding along.

Uncertainty remains in the Eurozone. A recent report by Thomas Friedman of Geopolitical Futures suggests that the EU, at the very least, is going to have to reform itself and the vote in Britain could be the wake-up call it needs to make structural changes.  The Eurozone has been struggling economically since the common currency was adopted.  It is still dealing with the Greek sovereign debt crisis, a potential banking crisis in Italy, economic troubles in Finland, political issues in Poland and a wealth disparity between its northern and southern members. Nevertheless, Friedman thinks the UK will be just fine, because Europe needs it to be a strong trading partner.  Britain is Germany’s third-largest export market and France’s fifth largest.  Would it be wise for those countries to stop selling to Britain or impose tariffs on British exports?  Cooler heads are likely to prevail.

The quarter’s market upheaval was yet another reminder that successful investing requires patience. Investing is part of a process, not a one-off decision, toward achieving your long-term financial goals. On the first day of July, the Dow, S&P 500 and Nasdaq indices were all higher than they were before the Brexit vote took investors by surprise. This suggests, yet again, that the people who let panic make their decisions lost money while those who kept their heads sailed through.  There will be plenty of other opportunities for panic in a future where terrorism, a continuing mess in the Middle East, a refugee crisis in Europe and premature announcements of the demise of the European Union will deflect attention away from what is actually a decent economic story in the U.S. There will be inevitable and unpredictable shorter-term market ups and downs along the way, and through these periods, it is our job to remain focused on the long-term objectives of our clients, maintaining a consistent investment discipline to guide our decisions over time.

Market Commentary: 1Q 2016

It was a tale of two halves in the first quarter of the year for global financial markets. Stock markets plunged early on, but then sharply reversed, staging a furious rally into the quarter-end. Emerging-markets stocks led the charge, gaining 5.8% for the quarter. Larger-cap U.S. stocks also finished in the black, up 1.3%, though domestic small-cap stocks trailed, down 1.5%. The 10-year Treasury yield fell .49% year to date and core bonds gained 3.0%.

As is often the case, there was no single obvious catalyst for the turnaround that began on February 12. There was speculation in the news that major oil producers might be ready to cooperate to cut oil output. At the same time, the head of the Federal Reserve Bank of New York dismissed the likelihood the Fed would need to adopt a “negative interest rate policy,” lowering the interest rates to below zero in order to encourage lending and investments, given the U.S. economy’s strength and momentum. Then, over the following weekend, the head of the Chinese central bank stated it saw no basis for further yuan depreciation. Amidst other positive data points, these would ultimately lead to additional investor optimism.

Governmental policies helped to continue to fuel the rebound. The rally continued in March on the back of better economic news in the United States, dovish European Central Bank (ECB) and Fed actions during the month and monetary and fiscal stimulus in China. On March 10, the ECB went deeper into negative rates, cutting its policy rate to negative 0.4%—its third rate cut since adopting their negative interest rate policy in June 2014. The ECB also expanded quantitative easing bond purchases by €20 billion per month (to €80 billion) and will also now include investment-grade, non-bank corporates in the program, boosting prices for such bonds. Their actions are intended to add liquidity to the economy and boost growth.

Here are the broad index returns through the First Quarter of 2016:

U.S. Large Cap Stocks -1.3% Emerging Market Stocks 5.8%
U.S. Small Cap Stocks -1.5% Commodities 0.4%
U.S. Real Estate 5.8% U.S. Aggregate Bonds 3.0%
Overseas Stocks -2.9% International Bonds 7.7%

Economic Outlook
In the United States, the Federal Open Market Committee held its mid-March meeting and did not raise the federal funds rate, stating that “global economic and financial developments continue to pose risks.” But it also highlighted solid U.S. economic fundamentals, lowered its projection of the number of rate hikes for the rest of the year (from four to two) and communicated both a slower pace and a lower trajectory of rate hikes than what it had projected in December. Financial markets responded positively to the Fed announcement, with stocks and oil/commodities continuing to rally and the dollar falling. After peaking in late January, the dollar (whose prior rise was likely driven in part by anticipated higher U.S. rates) ended the quarter down more than 4% for the year.

More generally, global monetary policy is moving deeper into uncharted, historically unprecedented territory, bringing with it unknown and unintended consequences. This continues to be a key uncertainty and risk as we construct and manage investment portfolios for a range of potential outcomes. How and when will the current extreme monetary policies be “normalized” and how will they impact the global economy and financial markets? No one knows.

The investment outlook—both in terms of potential return drivers and risks—has not materially changed over the past quarter. But in the context of the market’s recent gyrations, there are reasons for optimism that the relative performance trends (e.g., recent outperformance of foreign stocks versus U.S. stocks) may be sustained for a while. For example, last year marks the 6th of the last 8 years that the U.S. market has outperformed foreign stocks. This is the longest run of U.S. stock outperformance since the inception of the index in 1970. Unfortunately, much of the most recent appreciation in the U.S. stock market has been concentrated in growth stocks which have become expensive relative to historical benchmarks. In fact, lower cost “value” stocks have underperformed higher cost “growth” stocks for nearly the last 10 years. This has been the longest run of underperformance for value stocks on record going back to 1930. In contrast, developed international and emerging markets are almost a mirror image of the U.S market, with below-normal earnings and the potential for faster earnings growth from current levels. And valuation multiples have room to expand somewhat from current levels as earnings improve, thus increasing stock prices and enhancing portfolio returns.

Market Commentary: 4Q 2015

As we look back on the financial markets in 2015, returns were poor across the globe and across asset classes (stocks, bonds, commodities, etc.). Among the major global stock markets, the United States was the best performer. Unfortunately, the S&P 500’s whopping 1.4% return was driven by a handful of large tech/Internet companies (e.g., Facebook, Amazon.com, Netflix, and Google) which generated huge gains and helped propel the index into positive territory. The equal-weighted S&P 500 index actually fell 2.2% for the year.

The difference in the U.S. economy and monetary policy versus other major global economies was one striking feature of last year’s investment environment. In December, the U.S. Federal Reserve was so comfortable with the outlook for economic growth and the potential for inflation to eventually normalize that it made its first increase in interest rates in nearly a decade. Outside the United States, regaining more normal economic growth and inflation has remained more challenging due to sharply lower commodity prices (most notably oil), Middle East tensions, and China’s slower economic growth. Year-end foreign stock prices ended lower, reflecting this bifurcation. As in 2014, the strength of the dollar exacerbated foreign markets’ underperformance for dollar-based investors, detracting 9% from emerging-markets stocks and 6% from developed international stocks Ccompared to their local-currency returns. Commodity indexes were down on the order of 25% as oil prices hit an 11-year low in December and fell 30% for the year.

Fixed-income offered little respite. The core bond index gained just 0.6%, high-yield bonds were down close to 5% and floating-rate loans lost 0.7%.

Here are the broad index returns through the Fourth Quarter of 2015:

U.S. Large Cap Stocks 1.4% Emerging Market Stocks -14.6%
U.S. Small Cap Stocks -4.4% Commodities -24.7%
U.S. Real Estate 3.2% U.S. Aggregate Bonds 0.6%
Overseas Stocks -0.4% International Bonds -5.3%

Economic Outlook

The investment thesis for European and emerging-markets stocks has not changed materially over the last few months. Analysis suggests both markets are undervalued relative to their normalized earnings potential looking out five or so years. Those investments should benefit from stronger-than-expected earnings growth and the current allocations to European and emerging-markets stocks should yield outsized returns over a reasonable time frame.

Conversely, when it comes to U.S. stocks, the tactical outlook over the coming five years is much less positive compared to emerging-markets stocks and European stocks. Analysis suggests that U.S. valuations are still high and with U.S. corporate profit margins also well above normal, there is the potential for disappointing earnings growth and slow growth in stock prices over the next few years.

Effective portfolio allocation is based on a long-term view of the market. Financial market history is a history of cycles, like the swings of a pendulum, moving from one extreme to another. Market history teaches that undervalued assets can fall further and overvalued markets can overshoot on the upside. The tech bubble of the late 1990’s is one recent example of this. This type of volatility is simply the reality that comes with being a long-term equity investor.

Nevertheless, sound investment philosophy is based on the belief that fundamentals ultimately drive investment returns. The value of an investment is generally determined by the cash flows the investment generates over time. This type of valuation is a very poor short-term market indicator. But over the longer term and over full market cycles (five to 10-plus years), history has shown that valuation is a powerful driver of returns. Simply enough, studies show that if you buy an investment when it is relatively expensive, your returns will likely be lower over time. Alternatively, if you buy an investment when it is relatively inexpensive, your returns will likely be higher. Buying undervalued assets pays off, but it may take a little while for the markets to turn in their favor. To be successful, one must be disciplined and patient.

Financial Planning (Not Investment Returns) Insures Retirement Success

After mediocre (or negative) returns like the markets have produced over the last couple of years, investors often begin to question the underlying assumptions and the expected returns for their portfolios. Retirees often begin to fret over the viability of their long-term goals, fearing that they will eventually run out of money.

It is the helplessness created by the seemingly random series of returns that creates worries. However, there is a solution: At the intersection of “What Matters” and “What You Can Control” is the area where you should spend your energy. We all know what matters: living comfortably through retirement, giving to those in need, having peace of mind, etc., but what can we control? We know that we cannot control when the market goes up or down or what our return will be in the next few years. However, there are a number of things you can control to insure you are able to achieve what matters:

1) minimizing income taxes

2) consistently rebalancing to insure you are buying when stocks are cheaper

3) maintaining a long-term perspective

4) controlling spending and the timing of expenses relative to the portfolio value

5) lowering portfolio costs

6) diversifying the portfolio to mitigate risk, etc.

Take the worry out of the portfolio volatility by allowing BFA to assist you in developing your financial plan and staying focused on the things you can control. This is how you can insure that you are successful in the long run.

Market Commentary: 3Q 2015

The Third Quarter proved to be quite an eventful one this year. 

Increasing concern about China’s economy, accompanied by a surprise devaluation of the yuan currency, helped trigger a sharp drop in global equity markets.  In late August, the S&P 500 fell 12% from its high reached just a month earlier. It then bounced briefly from its August 25 low but dropped an additional 2.5% in September, ending the quarter down 6.5%. This marks the first negative quarterly return for the index since 2012. Developed international stocks, as measured by the Vanguard FTSE Developed Markets ETF, also dropped 12% intra-quarter, from high to low. For the quarter as a whole, they were down 9.7%. Emerging-markets stocks fared the worst, dropping 21% from their intra-quarter high in early July to their low on August 24. For the quarter, the emerging-markets stock index was down 18%. That return includes several percentage points of losses to dollar-based investors from the continued depreciation of emerging-markets currencies against the U.S. dollar.

In fixed-income markets, the core bond index gained about 1% during the U.S. stock market’s 12% intra-quarter drop. While this was strong relative outperformance versus most other (riskier) asset classes, with yields on core bonds so low (around 2.3%), their potential to generate strong absolute/positive returns over any meaningful time frame is very limited.

Here are the broad index returns through the Third Quarter of 2015:

US Large Cap Stocks -5.2% Emerging Market Stocks -15.2%
US Small Cap Stocks -7.7% Commodities -15.8%
US Real Estate -3.8% US Aggregate Bonds 1.1%
Overseas Stocks -4.9% International Bonds -4.2%                       

Economic Outlook

The recent correction was not a surprise. Given the market’s historical pattern of corrections, there was no surprise in the volatility the market exhibited in the third quarter. That is not to say that we were predicting a correction would happen or what the triggers or catalyst might be. Short-term market predictions are a fool’s errand, and history doesn’t exactly repeat. Nevertheless, knowledge of the market’s history and its cycles are useful for putting the present moment into context and thinking through different potential scenarios, risks, and investment opportunities. Otherwise, fundamentally, the economic outlook has not significantly changed from earlier this year.

The big question looming for the markets over the quarter was whether the Federal Reserve was going to raise interest rates for the first time in more than six years. Ultimately, the Fed decided to hold off on a rate hike, citing that “recent global economic and financial developments may restrain economic activity somewhat…” Fed Chair Janet Yellen pointed specifically to the recent developments in China and emerging markets as factors that gave them pause. Nevertheless, thirteen out of the 17 Fed policymakers indicated they expect to raise rates at least once this year, with six of the 13 expressing a preference for two rate hikes. The next FOMC meeting is scheduled for October 28th.

Declines create tax-loss opportunities. The reality of owning stocks is that, inevitably, the portfolio will experience bear market losses. In fact, just since 2010 the U.S. market has experienced 5%+ declines a total of 23 times!1 Owning bonds and other “safe” assets help mitigate the declines, but this interim volatility also creates opportunities to capture tax losses. By selling off some of the positions that have declined and reinvesting in similar positions, a portfolio can capture losses to reduce overall tax liability while still participating in any market recovery. Essentially, it’s making lemonade out of the markets’ lemons.

What Fly Fishing Taught Me About Investing

If you’ve ever met me, you know that I love to fly fish. It’s one of my biggest passions. Recently, I was with a friend fly fishing from the beach in Ft. Morgan. I had made this trip many times over the summer without much luck. The weather wasn’t great, but we both had a couple of hours free so we decided to go anyway.

Upon arriving at the beach, it didn’t feel like our trip was going to be worth the effort. However, we were already there, so we decided to give our best shot. We both came prepared with a multitude of flies since we weren’t sure what the fish would be biting that day. The first hour of the day was spent walking towards the end of Ft. Morgan and casting in places that looked promising along the way. We managed to reach the point without a single bite.

I fished the point for a short while, trying different flies in hopes that something would be enticed. This trip started to feel like the many trips I had made before. With no luck, we decided to make our way back down the beach.

As I walked back, I continued casting in places I thought the fish might be holing up. (Many were the same places I had already tried.) About half-way back, I stopped to make a few casts in a spot where the water looked deeper. After a few casts and no bites, I decided to make one more cast and if nothing took the bait, we would head home. As I stripped the fly in, THUMP! I had a bite! Little did I know that I had finally found the perfect spot and in the next two hours, we caught over 60 speckled trout. It was an incredible experience. I had not had a day like that in years!

Investing in the market this year has been rough for many. This year’s performance has amounted to about as much as my many trips this summer before I finally caught fish. It has been tough for the investor who faithfully contributes to his portfolio only to see very little impact to the bottom line.

Markets like we have experienced this summer seem like the perfect time to pack up and go home. Much like my fly fishing trip, the conditions do not look promising. However, like that trip, there are great opportunities that may be in store. Some of the top-performing days often occur during these times of uncertainty, which reinforces the need to stay fully invested despite the volatility. BlackRock recently published the chart below which shows the negative impact of missing the top-performing days over the last 20 years.

Don't Miss Days in the Market

From the chart, you can see that missing just 5 of the top-performing days could have cost you $196,137. When the portfolio misses the best 10 days over the 20 year period, the return is reduced by 50%! Since no one can accurately predict when the market will rise or fall, it is critical to stay invested throughout the volatility. I had no way of knowing which day I would catch fish, but I continued to go fishing knowing that over time the likelihood of me catching fish improves. It is impossible to know which day the market might soar, that’s why it is so important to maintain a long-term perspective. The longer you are in the market, the greater your chances of realizing positive returns.

So what do you do in times like these when you’re feeling the pressure to pack up and head home? You continue to work a strategy that has proven successful. On all of my fishing trips, I bring multiple flies because on some days one fly works well and others do not. I cast my line in places that I know are conducive to catching fish, and I am persistent in making the trips—even when the conditions don’t look so great. The same is true for your portfolio. You should continue to invest, even though the conditions look poor; you should keep your portfolio diversified because it is hard to know what is going to perform well next; and you should remain disciplined and dedicated to your goals.

It’s like my grandfather always said, “There’s a reason they call it ‘fishing’ and not ‘catching’… you don’t always win.” On any given day, the same is true about investing. But with time and discipline, you are almost sure to find your perfect spot.

1http://www.blackrock.com/investing/financial-professionals/advisor-center/conversation-starters/strategies-for-volatile-markets

 

Retirement Planning: More Than Just Numbers

If you are like many people that are finishing up their last few weeks, months, or year of work; chances are you have a lot on your mind as the first day of retirement approaches. How do you feel? Are you excited? Anxious? Worried? What thoughts are swirling around in your mind? Are you thinking about freedom and relaxation, or are you unsure what you will do with yourself when the day comes and you no longer have to wake up at 5 AM to get ready for work? Regardless of how you feel or what you’re thinking about, you are not alone.

We hear stories from retirees each day about what their step into retirement looked like. For some, retirement fits like a glove. It’s as if retirement is a long lost friend with whom they have just reunited.

For others, they had big plans for all of the things they were going to do to keep them busy. They were going to golf every day, lounge by the pool, or spend time in the garden. Once they realized they couldn’t or didn’t want to do these activities every day, it was difficult finding new things to fill up their free time.

Still, there are others who never thought about retirement until they walked out the door on their last day of work. Many of them managed to figure out how to fill their time, but some couldn’t quite come to terms with being retired and decided to rejoin the workforce.

From what we have gathered, each of these three experiences correlates with how much planning the individual had completed prior to retirement. Those that truly thought through what they wanted to achieve during retirement had the least amount of difficulty transitioning. Those that never considered what retirement would be like had the most stress and anxiety as they made their way.

So, what can you do to prepare and ensure you have a smooth transition into retirement? There are many things to consider, but here are some ideas to get you started.

  1. Ask yourself what you will do with this newly found “free time.” After you come up with some ideas, ask yourself what you will do if and when those things aren’t enough to keep you busy. From what we hear, it happens quite often.
  2. Think about the people you normally spend time with during the day. For most of us, it’s our co-workers. Now that you are not seeing them each day, think about who you want to spend your days with. This will also help you determine where you want to live. Some prefer to be closer to town and social events while others prefer being further away. Maybe you want to move closer to children or grandchildren.
  3. Begin experimenting with things that will help you feel a sense of purpose or self-worth outside of your work. What skills do you have that you can contribute to others? Do you want to volunteer, be a mentor, or help take care of family? Don’t wait until you are retired to get started. Getting involved in these things now will also help you form relationships you can carry into retirement. This may just be the most important aspect of transitioning into retirement
  4. Map out your goals and future endeavors. As you get closer to that day, it will give you peace of mind knowing that you have a plan in place. No more worrying about what you’ll do. It’s already laid out.

Don’t let that first day sneak up on you. Start trying on your retirement shoes today. Each step today will help you feel more comfortable when you finally take that first step into retirement.

If you would like to know how we can help you think through these things and uncover your life’s goals, give us a call or click here.