Market Update - January 2020
2019 was a year that taught investors they should not rely solely on the “experts” and their forecast. You might recall the sentiment at the end of 2018 - the bull market is over, prices are going down, and the sky is falling. Recession was the resounding message.
Scientists say the human brain is hard wired to see the storm cloud, not the rainbow, so it is not surprising when investors gravitate toward negative advice and act upon it. Those that thought the storm was coming and felt compelled to sell missed out on a major boost in net worth in 2019. But if you buckled down through the darkness, and owned stocks during the year, you were a likely beneficiary of the Federal Reserve transitioning to a more accommodative monetary stance and the corresponding lift in asset prices.
It is once again that time of year when “knowledgeable investors”, “experts”, and “seasoned professionals” provide their outlooks, or in the case of this year, a glimpse into the next decade as we embark on “the twenties.” Our advice would be to limit your information consumption. Most forecasts are of little value since they generally prove to be wrong. Most fail to see a change of circumstances during the year since those circumstances are impossible to predict. Case in point: raise your hand if you heard anyone predict the S & P 500 was going to be up around 30% in 2019. Hmmm….thought so.
Given the aforementioned track record of crystal ball gazers, we are not going to attempt to guess what will happen in 2020. However, there are positives to consider. The tax cuts passed in 2017 have helped to keep total federal tax receipts at a low level relative to GDP, even though actual tax collections have risen due to the strong economy. This is very stimulating for stock prices. In addition, we can’t forget this is an election year. That in itself will probably provide for some volatility. However, historically the 12 months leading up to an election are generally positive, although that is not always the case. Couple all of this with the accommodative stances of Central Banks around the world and we see a reasonably friendly environment for the stock market. But let’s put this positivity into check. What occurred in 2019 theoretically is a once in 20 year event and there is plenty of geopolitical risk to go around.
We feel positive about the coming year, but think expectations should remain grounded. The current investor mood seems almost polar opposite from last year and quite optimistic. This can carry on for a while, but you never know. As “Ace” Greenberg, the head of Bear Stearns said during the 1987 crash, “stocks fluctuate.” Times like this serve as a good reminder to assess your investment goals and make sure you are allocated correctly regarding risk. Ideally, you want to put your winter tires on before the snow falls. It may seem odd to use that phrase in the middle of January, but you get the market metaphor.
Emotions drive stock market decisions and we’re fairly confident there will be plenty of emotion to go around this year. You hire us to try and keep the emotions out of your investment decisions. We will do our best to fulfill that obligation.
Market Update - April 2019
When the stock market reaches your target return for the whole year in the first three months, what’s an investor to do?
The answer is stay disciplined. The S&P 500 index rose 13.1% during the first quarter, the largest first quarter gain since 1998. The natural inclination is to take your chips off the table and go home. But “natural inclinations” are rarely the right thing to do in the stock market. This latest rapid market upswing makes more sense when put in perspective by expanding the performance time period a bit. If you look at the numbers, we have now returned to nearly the same levels as the end of last year’s third quarter. In addition, one needs to take valuation into consideration. The S&P 500 is valued at a price/earnings ratio at or near the long-term average, hardly excessive.
Yes, there was a harrowing downturn between September and now, which got everyone’s attention. That sell-off was triggered by fear of the Federal Reserve continuing to raise interest rates. It’s possible the decline in the stock market changed their mind, but Fed speak quickly turned from somewhat hawkish to somewhat dovish, prompting the market to rally strongly. For an investor, trying to outsmart these market swings is a fool’s game. Usually that results in doing the wrong thing at the wrong time, as evidenced by the abundance of mutual fund money outflows during the month of December. Investors were scared, and they responded by taking cash out of the market. We certainly got calls from some of our clients during that time as emotions took over. Our advice was to stay the course and stick to our discipline. Keep in mind that, historically, when the market has a fixation on an issue, and the overwhelming commentary begins and ends with details and scenarios that support that fixation, the issue is likely to be of limited, lasting impact. In this case, most of the scenarios at the end of last year were doomsday in nature. As we now know, doomsday didn’t happen.
The current popular topic of discussion is recession. Market strategists are trying to predict when the next one might happen and using an inverted yield curve as the basis of their concern. An inverted yield curve means that shorter interest rates are higher than longer rates. This is abnormal and happened briefly in March. The argument is that inverted yield curves generally are a precursor to recession. In theory, this condition creates a disincentive for banks to lend money long term. In an inverted yield curve environment, lenders pay a higher rate on their cost of funds, which are short term, and higher than what they would receive by loaning to individuals and businesses longer term. Again, in theory, this phenomenon causes economic growth to slow and end up in recession. The truth of the matter is that recessions are notoriously difficult to predict and the yield curve is an imperfect indicator. This entire subject probably falls into the aforementioned “market fixation” discussion. If everyone is focused on it, it may be a non-event for the near future.
For now, the global economy is still growing and the Federal Reserve has indicated their willingness to be patient and data dependent. That allows for a decent backdrop for economic growth and the stock market. This year won’t be without its challenges, but we haven’t seen a year yet that has been a picnic all the way through. Since the S&P is at the top of its trading range, caution is in order. Volatility for the remainder of this year is likely to rise as news flows from the likes of an on again off again China agreement, Brexit, tariffs, or something currently unknown continue to ebb and flow. The key to our discipline is the long term, and we use volatility to take advantage of opportunities.
Market Update - April 2018
You may recall our 2017 year-end letter expressing our sentiments that 2018 would likely be a more challenging year for the financial markets and that the current backdrop would be supportive of further, albeit more modest equity gains. Furthermore, we suggested that there was a good chance of a correction at some point in the future. We had no idea it would be so soon! Volatility has returned to the markets with a vengeance as investors attempt to comprehend the news flow in a series of developments now unfolding.
The initial catalyst for the abrupt decline was centered on interest rate normalization and quantitative tightening by central banks. The current cause of the ruckus is about Washington D.C., Syria, tariffs, trade, and rapid-fire bombs being tossed into the news cycle, which has led to a duck-and-cover mentality and continued volatility. The Nielsen Company recently reported that 26 of the 40 most watched programs on cable TV the week ending March 30 were political shows on MSNBC and Fox News. Just three scripted entertainment programs made the list!
Last year was characterized by historically low volatility. The typical year is much different. Research done by JP Morgan,[1] follows the intra-year declines for the years 1960-2017. To put it into perspective, the average intra-year drops are 13.8% and markets were positive 76% of those years. 2018’s reversal from the highs on January 26 through the early February lows and subsequent retesting has been 11.8%. This study should hopefully ease your mind that volatility is normal and investors can still make money, although the ride is rarely like 2017.
Human nature is a funny thing, particularly when it comes to investing. The market has a way of toying with emotions; it entices you to do the wrong thing at the wrong time. While momentum investors have had the majority of the investing glory of late, ultimately, if one pays too much for a company, realignment with true value will almost always take place; it is the timing that is not predictable. We found a study that addressed this issue: Which style of investing -- buying popular stocks or low P/E stocks – performs better over the long term? The study covered a ninety-year period from mid-1926 through 2017 and during that time, the low P/E value approach to investing outperformed buying the popular growth stocks 94% of the time over a rolling fifteen-year period and 75% of the time over a rolling five-year period.[2] Past performance is no guarantee history will repeat itself in the future, ninety years of data says that this value tilt puts the odds in your favor.Stock prices will continue to move up and down. Therefore, we will continue to execute on the plan to take advantage of the inefficiencies that have been created by the volatility. We are excited about our prospects and are confident that this volatility will give us a chance to suggest to you some world-class companies at attractive prices.
As always, thank you for your trust and confidence.
[1] JP Morgan Annual Returns and Intra-year Declines - Guide to the Markets/March 31, 2018
[2] Dimensional Fund Advisors Historical Performance of Premiums over Rolling Periods/US Markets
“Headlines, in a way, are what mislead you, because bad news is a headline, and gradual improvement is not.” – Bill Gates
The stock market continued its post-election strength into the first quarter of 2017. Historically, romances with new administrations are not uncommon, especially when there is a change in party. Oftentimes, however, these rallies fizzle by Inauguration Day. To use baseball parlance, the continuation of last year’s second half rally into 2017 caught a lot of investors looking!
While we are certainly enjoying this lift in the market, we are cautious here. From a sector perspective, technology provided a big assist in Q1 as it was the leading gainer. Two sectors that were attractive in the second half of 2016 took a breather in the period, as energy and financials lagged. Financials, however, have regained momentum recently as momentum on tax policy has picked up again.
For the first time since the Great Recession, we see gradual improvement as most major global economies seem to be growing in sync. Despite the ongoing uncertainties posed by politics and policy around the world, this growth may help stabilize the environment for risk assets. In the U.S., we are in the midst of Q1 earnings season and as of Friday, April 21, 72.6% of companies who have reported have beaten EPS estimates and 62.1% have beaten revenue estimates. The revenue surprises are higher than normal and may indicate acceleration in the economy. Additionally, the housing industry, which is a significant contributor to economic activity, has a long way to go to catch up to the demand for housing in many areas of the country as housing was underbuilt for several years coming out of the financial crisis. We would highlight that S&P 500 earnings peaked in 2014 and have a long way to go to regain that level.
We mentioned taking a cautious stance, but what does that look like? There is no magic bullet. By its nature, our value discipline helps. We continue to look for companies that are priced, in our opinion, relatively more attractive than the market in general. This can provide a measure of comfort if broad market valuations continue to stretch. In addition, cash that we have on hand allows us, to use another baseball analogy, to look at pitch after pitch after pitch. We prefer to let prices come to us.
Headlines sell advertising and there will be an endless stream of headlines from all corners of the globe trying to unseat investors from a thoughtful investment plan. Life’s biggest investment mistakes tend to be behavioral, and while self-discipline is one of the least glamorous, most challenging aspects of any investment strategy, it is what makes sense.
If you haven’t reviewed your financial plan with us recently, we encourage you to visit our new office. As always, thanks for your trust and confidence in us.
As Financial Advisors, we can’t remember a period of time so dominated by spirited discussions with clients.
Emotions can, at times, be dangerous when it comes to investing. Picking a discipline isn’t terribly complicated, but sticking with it is. The constant barrage of so called experts making confident predictions doesn’t help. We can’t begin to count the number of people who were inclined to follow commentator advice to sell before the election and buy back on a market slide in the event of a Trump win. It is our job to make sure that clients don’t buy into group think. We are committed to our process, even when the crowd becomes frantic.
Certainly sentiment has changed to the upside since the election. As was the case pre-election when psychology was too negative, the current positive celebration also needs to be kept in check. During the last week of the year, consumer confidence climbed to the highest in nine years. This was not driven by current economic conditions, but hopes for the future.[1] While we, too, are hopeful, we are realistic enough to know that no one person has a magic wand. Fixes to programs and the economy take time and face hurdles.
Since the November 8 election, the stock market has staged a powerful rally based on this increased optimism and confidence. This is fairly normal action when a new President gets elected from a different party. That optimism typically fades when reality sets in.[2] As they say, the devil is in the details and the details are devilishly complex.[3]
This certainly doesn’t mean we are bearish. Quite the contrary, many of the potential proposals on the table are positive for stocks. However, successful investors act continuously on a plan, and we will continue to act on our plan. As longtime money manager Birinyi Associates said, “The internet has given individuals who have nothing to say a place to say it.”[4] Our job is to attempt to decipher between what is real and what is not. When crowd behavior causes an overreaction in our view, we try to use it to our advantage. We believe the rally since the election has given us that opportunity in certain cases. We have taken profits where warranted and will look to put that cash to work when given the chance.
After a difficult start, 2016 was generally a satisfying year to be invested in the stock market. It was especially rewarding for us during the second half. We are hopeful this trend toward Value will continue in 2017.
We wish you a very Happy New Year and look forward to reviewing your portfolio with you soon. The New Year will bring a new home for our office. Barring any unforeseen circumstances, we are planning to relocate our office in early February and will send our new address card in the mail by the end of January.
[1] Barron’s, January 2, 2017
[2] The McLellan Report 12/20/216
[3] Sightlines 12/2/2016
[4] Reminiscenses – Birinyi Associates – June 2017
Fear - An unpleasant emotion caused by the belief that someone or something is dangerous.
At the end of 2015, only six short months ago, the prevailing “fear” was that oil prices were heading “lower for longer.” News outlets were relentless in speculation that oil was headed for $20 a barrel. That, coupled with the continued strong dollar versus a basket of currencies (bad for multi-national companies) and higher interest rates rattled the markets and investor nerves.
If you bet on any or all of those fears becoming reality, you would have lost. As is often the case, investors were better served to take the stance opposite the herd. At the end of June, oil is trading near $50 per barrel, interest rates are back near historical lows, and the dollar has retreated from 2015 highs.
Yet, once again, there is plenty to be nervous about as we face a different cast of characters. Lingering doubts about the strength of the U.S. job market, global economy, concerns over the direction of Federal Reserve (Fed) policy, and a cliffhanger referendum with the Brits deciding to exit the European Union. Amid the kitchen sink of woe and worry, investors have ramped up their holdings of good old fashioned cash. As usual, they appear to be taking their investment advice from the evening news.
According to Merrill Lynch’s most recent fund manager survey, investors have the highest percentage of net holdings in cash since November 2001[1]. Recall that at that time we were mired in recession while dealing with the fallout of the tech bubble bursting and the September 11 terrorist attacks. Similarly, there currently seems to be an abundance of investors anticipating something bad may happen! Markets rarely give investors their way when they are leaning too far in one direction.
For almost two years, the domestic markets have been stuck in a trading range. Broadly diversified portfolios have seen little or no returns. In these environments, investors grow impatient and seek investments with promising recent rear-view track records. We have seen this movie too many times to fall into this return-killing behavior. Successful investors will stick to a well-thought-out plan for life. Few investors have one, and when fear takes center stage, they do exactly the opposite of what they should.
We have not wavered in our belief that taking the long-term view in investing is the right path and that no factor is as important to returns as valuations. This is far from the first time in which the patience of long-term investors has been tested.
[1] Myles Udland, “Investors haven’t hoarded cash like this in 15 years”, Business Insider [Online]. http://www.businessinsider.com/investors-hoarding-cash-2001-level-2016-6 (June 14, 2016)
“Getting deliberately rich or achieving consistent financial performance is at least as much a psychological problem as it is a logical problem.”[1]
Emotion is one of an investor's greatest enemies. 2016 opened with the Dow Jones Industrial Average having its worst five-day start in history. Despite the hand-wringing declines to begin the year, the market has bounced back nicely. By the end of the quarter, the average diversified U.S. stock mutual fund had clawed back enough to close down less than 1% for the first quarter, and the average international stock fund closed down 1.7%.
Fear makes it hard to remain optimistic about holding shares whose prices have declined; just as envy makes it hard to refrain from buying the appreciating assets others are enjoying owning. We have recently endured our share of pain in a handful of cyclical companies. We have gone through these cycles in the past, and they are never any fun. However, we keep a balanced mix of exposure for this very reason and are confident that our current holdings are well positioned to buoy portfolios.
Time and time again, we have discussed the benefits of value investing and the importance of staying with it through thick and thin. It was refreshing to read a recent article which complements our beliefs. In the March 14, 2016 Barron's publication, the article within this edition entitled, “It's Time for Value,” sited “After nine years of underperformance, value stocks look poised to shine.”[2]
But in the framework that value is built upon, you must have the right mindset when you digest this news. The Barron's article reiterated this point as well, “After such a long period of disfavor, value investing could be on the verge of a multi-year comeback. But it could require patience.”[3]
We whole-heartedly agree.
[1] Morris, W. T., HOW TO GET RICH SLOWLY, BUT ALMOST SURELY, ©1973 (There is no sure way to wealth.)
[2] Barron's, March 14, 2016, It's Time for Value
[3] Barron's, March 14, 2016, It's Time for Value
The Dow Jones Industrial Average is an index that shows how 30 large, publicly owned companies based in the United States have traded during a standard trading session in the stock market.