The world is in a rare state of flux, with a populist, anti-trade president newly installed in the White House, and populist, anti-EU parties on the rise all across the European continent. Economic conditions in the US and abroad, meanwhile, are showing positive trends, but it’s still to be seen whether the Federal Reserve and European Central Bank can successfully walk the thin line between growth and inflation. Join us for a one hour tour of our changing world on Wednesday, April 19th at 11:00am PT / 2:00pm ET during which we’ll share our analyses and recommendations for weathering whatever may come. During the live webinar, we’ll cover the following topics:
Economic conditions in the US and around the world.
The economic ramifications of political developments in Europe and Asia.
The outlook for the US and international stock markets and implications for your portfolio.
Tax and regulatory changes that will impact your finances.
At Yeske Buie, we use a few bond funds to obtain exposure to fixed income investments for our Clients. While fixed income may not be the most exciting piece of your portfolio, it is a necessary part of a sound investment strategy. The more “exciting” pieces of your portfolio are the stocks which typically receive much of an investor’s attention due to their role in creating higher returns as a percentage of the entire portfolio. However, fixed income positions, or bonds, play an equally important role because of their ability to help reduce the volatility of returns and the emotional volatility that comes with investing. They do this by diversifying your portfolio to create a buffer that provides a safety net and by earning a steady return through long-term holding strategies to reduce the overall risk in your portfolio.
But, what is a bond and how do we use bond funds in your portfolios?
Bonds represent an obligation for the borrower to pay a set amount of interest (current income) and to repay the original borrowed amount (principal) at the loan’s maturity date. Individual bonds can be selected to increase your exposure to the fixed income market, however there is a more efficient way to obtain the same exposure. The creation of bond mutual funds have made it easier for an individual to own a piece of hundreds of different fixed income obligations. With bond funds, the investor loses the fixed interest payment, however they greatly increase their exposure and therefore enhance the diversification of their overall portfolio. Bonds are inherently subject to interest rate risk and not all asset classes react the same way to interest rate movement. The ability to increase exposure of fixed-income positions through a bond fund ultimately allows for the smoothing of volatile returns in a changing economic environment. The chart below shows the performance of stocks in comparison to bonds if you had invested $1 back in 1926. The lines representing stocks are constantly rising and falling through their path to an increased return, however if you look at the bond’s path through the same timeframe it is a lot smoother. Bonds act as the “stable reserve” in your investments.
It is important to keep in mind that not all bond funds are created equal. When choosing a bond fund, there are some things to look for when determining which fund bests fits your needs. With the expected return on bonds already being relatively lower, you should ensure that the fund you choose has a low management fee. Expense ratios are a useful tool when comparing different funds and can be used as a deciding variable when investing. The percentage the manager takes ultimately affects your overall return. Next, look at the quality of the fund you’re purchasing and the exposure the fund manager has taken to the overall bond market. Looking for funds that have bonds with short-term to intermediate-term maturities and investment quality ratings is important to the overall financial health of your portfolio. High Yield or “Junk Bonds” create an opportunity for increased return, however the default risk is much greater than choosing a more highly rated bond.
When it comes to your portfolio, we use a few bond funds to obtain exposure to fixed income investments. For Clients who are still working and accumulating assets, the bond funds provide a pool from which we can take money and rebalance the stock funds. For a retired Client, we view the bonds as a reserve that provides liquidity for spending needs. Within the context of our Safe-Spending Policies, a client in retirement holds six years’ worth of spending in that “stable reserve.” In times of market turmoil, spending needs are strictly covered by the bond funds, giving the stocks time to recover and enabling us to avoid “selling low”.
Fixed income may not be the most exciting piece of your portfolio, but it is a necessary part of a sound investment strategy. As always, if you have any questions about any of the funds in your portfolio, we’re always here to talk!
The Dow closed above 20,000 for the first time on Wednesday, repeating the feat the following day. There are headlines any time the Dow crosses a 1,000 mark and that’s especially true of this latest milestone. Here’s our take.
First of all, and to state the obvious, 20,000 is just a number, no matter how much those four zeros excite the eye. Still, it’s hard not to ask what, if anything, do such milestones portend for the future. Not very much it turns out. If you look at the performance of the S&P 500 since 1926, it provided a positive return 80% of the time in the year following a new monthly high. Not much different than the 75% of the time it produced a positive one-year return following any month. Obviously, the stock market has a bias toward positive returns, notwithstanding the occasional reversal.
None of this means we can’t make quantitative assessments based on valuation levels, of course, and the Dow and S&P 500 are unquestionably at above average valuations just now. The current price-to-earnings ratio (P/E), a common valuation metric, is about 25 for the S&P 500, versus a long-run average closer to 15. There are two things worth noting: first, this is not a static number; one-year forward looking earnings estimate put the P/E closer to 17. It’s also worth noting that the average P/E is a function of both good periods and bad, with the P/E having sunk as low as 7 during the high interest and inflation rates of the late nineteen seventies. With interest and inflation rates currently low, albeit rising, and the economy chugging steadily along, including a nice uptick in the third quarter of last year, an above average valuation is not that surprising.
A lot of things drive market valuations, and not all of them involve investor expectations for earnings and interest rates. There’s also this thing called “sentiment” that can have a notable influence on valuations. Nonetheless, our starting hypothesis, as ever, is that investors are buying and selling at prices they believe will generate an attractive return going forward. Unpleasant surprises can upend those beliefs and send prices down, but over the long-run, betting against the collective wisdom of the market hasn’t been a winning proposition.
Overseas markets, meanwhile, are still sporting below-average valuations, which could suggest significant upside, especially if higher economic growth finally takes hold. There are headwinds, to be sure. The full effect of the U.K.’s Brexit vote has yet to be seen and is likely to be negative, though that assessment could be confounded if the country can maintain its dominate position in financial services after exiting the EU. It’s easy to stop a bushel of wheat or container of coal at the border, but financial services tend to be delivered over the Internet, where domicile may be less of an issue.
The other developments to watch are elections in the Netherlands, France, and Germany, where populist, anti-EU politicians are making a strong showing. Elections may also be called in Italy before the year is out, so politics will take center stage in the second largest market after the U.S. On the economic front, the EU has a good shot at boosting exports and sparking higher growth if the dollar remains strong. The greenback’s strength has been underpinned by the Fed’s stated commitment to a program of steadily rising interest rates, something that’s likely to continue, though we discovered last week that the new president is capable of sending the greenback into a tailspin with an offhand comment. So this will be another economic variable to watch.
So, enjoy the charts and fun facts that will no doubt fill the weekend papers in honor of the Dow’s latest milestone (it took 76 years to first cross the 1,000 mark!), but know that 20,000 is not a call to action, it’s just a number.
The markets, which is to say investors, hate surprises, though that’s pretty much all we get day-by-day. It’s called news. But some years carry bigger surprises than others and 2016 surely falls into that category. From economics to markets to politics, 2016 provided one plot twist after another. As far as markets are concerned, the year ended well, notwithstanding a bit of a roller coaster ride along the way. Herewith, we offer a brief recap of what happened in the economy, the markets, and your portfolio, with a nod to the year to come.
The Roller Coaster
The year opened with markets sliding worldwide. Our core stock portfolio fell by more than 6% in January before sliding another half percent in February, only to spring back with an 8% gain in March. And although there were three more down months through the balance of the year, the real theme was Onward and Upward. For the year as a whole, our core stock portfolio (which excludes bonds) was up nearly 14%, proving yet again that the markets are like San Francisco weather: if you don’t like what you’re seeing, just wait around a little while.
The Mighty Dollar
Before moving on to a breakdown of results by asset class, or investment category, it’s worth saying something about the dollar, which surged by nearly 20% against other major currencies back in 2014 and has remained strong ever since. The changing value of the dollar relative to other currencies is noteworthy for us, as half of our portfolios are invested overseas. All other things being equal, a rising dollar takes away some of the returns we earn on non-US investments when those returns are translated back into dollars, and a falling dollar does the opposite, boosting those overseas returns. The dollar continued our roller coaster theme by falling 7% during the first half of the year, only to rise 11% over the remainder, for a net 3% gain on the year. While the dollar is probably overvalued by most fundamental measures, these don’t mean much in the short run. In the long run, however, we can expect an eventual tailwind for our overseas investments as economic fundamentals reassert themselves. Until then, it’s a good time to travel overseas.
As you’ll see from the breakdown below, with the exception of Emerging Markets, which made a strong comeback in the latter half of the year, the biggest gains were to be found in the US. And the star of the show was surely small company stocks, which racked up gains of nearly 30% for the year, the best showing for US small caps since 2013, when they rose by more than 40%. The remaining categories chalked up gains ranging from 5% to 12%, with those non-US returns being shaved just a bit by the small net rise in the value of the dollar.
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Valuation levels in US markets are higher than the long run average, prompting some to ask whether the party is over. We have two observations on that point: first, valuation levels don’t exist in a vacuum, they’re also a function of interest and inflation rates, both of which are still very low. And while both interest and inflation have started rising and will likely accelerate in the coming year and beyond, stimulative economic policies may well keep a firm foundation under the market and even pave the way for continued growth. More importantly, for truly global investors, it’s worth noting that markets outside the US are sporting valuation levels well below their long-run average, suggesting plenty of upside if global growth continues.
For a more detailed look at the outlook for 2017 and beyond, please join us for a live webinar on January 18:
As Inauguration Day nears, the following questions may be on your mind. What impact will the new administration’s proposals have on the economy and the markets? How will rising interest and inflation rates impact your finances? What will happen to markets outside the US? And what about Social Security and Medicare? We invite you to join us on Wednesday, January 18th at 11:00am PT / 2:00pm ET as Dr. Dave Yeske hosts a free live webinar where you will learn:
What actions to take now to build more resilience into your financial affairs.
Strategies for dealing with rising interest rates.
How to plan for coming changes in the tax and estate laws, and more!
Register for the webinar today using the link below and if you have any friends, family, or colleagues who may find this seminar valuable, please feel free to share the link with them!
Will the Trump Administration be GREAT for your Finances?
Recently, our strategic partners at Dimensional Fund Advisors (DFA) shared with us a playful comparison between the process of making wine and investment management. We hope you enjoy the following piece by Vice President of DFA Australia Limited, Jim Parker.
A host of variables can determine whether a wine is great, good, mediocre, or undrinkable. These include the quality of the grapes, soil, position of the vineyard, weather, irrigation, and timing of the harvest.
And picking the grapes isn’t the end of it. The harvest must be sorted, the grapes crushed and pressed, then fermented, clarified, aged, and bottled. At any stage of the process, a lack of attention to detail can spoil the final outcome.
As in winemaking, investment management requires attention to detail—researching and identifying the dimensions of expected returns, designing strategies to capture the desired premiums, building diversified portfolios, and implementing efficiently.
Just as winemakers don’t have any say over the weather, investment managers can’t control the markets. Not every harvest will produce an excellent vintage, but expert professionals can still maximize their chances of success by putting their greatest efforts into things they can influence.
For winemakers, that may be taking extreme care in picking the grapes at a time that delivers the desired balance of acidity and sweetness. For investment managers, it can mean precisely targeting the desired premiums while ensuring sufficient diversification to lessen idiosyncratic risk in the portfolio.
Winemaking is as much an art as a science. While fermentation comes naturally, the winemaker must still guide the process, using a variety of techniques to ensure the wine is as close as possible in style and flavor to what he is seeking to achieve.
Similarly in investment, real world frictions mean that basing one’s approach purely on a theoretical model is unlikely to be successful. For instance, tradeoffs must continually be made between the expected benefits of buying particular securities and the expected costs of the transactions. Managing the effects of momentum and being mindful of tax considerations are among the other issues to be balanced.
Just as in viticulture, investment outcomes can also be affected by any number of external events—such as the imposition of capital controls in an emerging market, or changes in regulation, a severe financial crisis, or a major geopolitical event.
Dealing with uncertainty and navigating the “unknown unknowns” are part of the job. So investment managers must build into their processes a level of resilience— through diversification for instance—so they have sufficient flexibility to work around unforeseen events.
Ultimately, the benefits of discipline and attention to detail are easy to overlook. Great ideas count for a lot, of course. But great ideas without efficient implementation can mean even the best grapes in the world go to waste.
Whatever your politics, it has been clear in recent weeks and months that the prospect of a Trump presidency held enough uncertainty to make investors and world leaders alike more than a little nervous. No one likes uncertainty.
So here we are, asking ourselves what’s next?
We suggest that you hold fast to this: the resilience that’s built into your financial plan and your portfolio will continue to serve you. The dollar was down earlier this morning but since half your investments are outside the US, the returns to that part of the portfolio actually just got a boost. Not to mention the fact that, whatever the stock market futures were doing last night (at one point the Dow futures were down 800 points), most markets this morning are basically unchanged. At the end of the day, the US and world economy are too vast and too diverse to be sunk by any president. It has always been a truism among economists that presidents have less impact on the economy than people think. As in, they shouldn’t get credit when things go well and they shouldn’t get blame when they don’t, in most cases the president had little or nothing to do with it.
We also just had a text exchange with our niece in which she noted, somewhat surprised, “today I woke up and the world looked the same.” Indeed. For all the political maneuvering to come and for all the breathless headlines and overwrought CNN interviews (we think we’ll take a break from CNN, by the way, for the sake of our mental well-being), in most of the ways that matter to your finances, the world looks the same this morning.
Which is not to say that the list of escapist novels on our Kindle isn’t about to get a lot longer.
Although we’ve borrowed our title from Hunter S. Thompson’s book of essays on the 1972 presidential race, we’re here not to comment on Nixonian high jinks but on the closing days of the present contest. Fear and loathing seems an appropriate description of the public mood as we enter the final four days before that blessed release from our collective misery. As usual, the financial markets, ever sensitive to the public mood, have begun to vibrate in sympathy with ubiquitous anxiety. The All Country World Index and the S&P 500 have both slipped about 2 1/2% over the past four weeks, though some suggest that uncertainty about Federal Reserve actions have played a part. And the Fed governors are keeping their cards close to the vest, no doubt because of their own uncertainty about what will come November 8 and beyond. All roads lead to Tuesday.
Which raises the inevitable question: what, if anything, should we do now, on the eve of the election? The first thing we’d recommend is a stiff drink. The second is a good novel or movie (avoid the following: All the President’s Men, The Manchurian Candidate, and Recount). The thing we would absolutely NOT recommend is making any last minute changes to your portfolio for fear of what will happen on November 8.
“Reach for a stiff drink, a good novel, or a sappy movie, but leave the portfolio alone.”
We don’t any of us know for sure what will happen on Tuesday and we don’t any of us know for sure what the impact on the economy and the markets will be. The one thing we can be sure of, however, is that whatever happens the impact will be less than the speculative extremes now being floated. We’re all wired by evolution to overweight the possibility of bad outcomes, which made sense when not doing so increased the probability of being a saber-toothed tiger’s dinner. But it can work against us when we choose to violate the plans and policies that have been put in place for our investments. The whole point of having investment policies is to make it easier to know what to do when it’s hard to know what to do. Like now.
Another and even more important factor is the resilience already built into your portfolio. It is globally-diversified and spread across every single industry and economic sector. It is also spread across thousands of stocks, large and small, foreign and domestic. It contains a significant allocation to a stable reserve composed of cash and high-quality, short-term bonds. If you’re retired, that stable reserve is large enough to bridge you across a seven year span of whatever the outside world might serve up. In other words, it’s specifically designed to be resilient, so that you don’t have to turn to that ever-murky crystal ball. And, anyway, presidents have far less power where the economy and the markets are concerned than is popularly believed.
So, be of good cheer, remember to breathe, vote on Tuesday, and, in the meanwhile, enjoy two of our all-time favorite videos:
A few days after the first presidential debate, University of Michigan economist Justin Wolfers published a piece in the New York Times titled, Debate Night Message: The Markets are Afraid of Donald Trump. In it, he predicted that stock markets would fall 10% – 12% if Donald Trump is elected. He based this on an analysis of movements in the futures markets during the first presidential debate, during which stock market futures rose, seemingly in response to “prediction markets” lowering Trump’s probability of being elected. Nate Silver’s FiveThirtyEight website was giving Hillary Clinton a 55% chance of winning against a 45% chance for Donald Trump on the day of the debate, odds that have since shifted to 76%/24% in favor of Clinton. Nonetheless, trepidation is running high and we’ve received a lot of calls and emails from clients asking, “what if . . .”
Attempts to predict what impact a presidential election will have on the markets has a long history . . . and little value. For starters, there have only been 29 such elections since the beginning of the 20th century, a sample most statisticians would consider too small for robust inferences. Secondly, what little data exists is noisy, with only weak correlations to go by. Having said that, as a thought experiment, let’s take it as a given that a Trump victory would have an impact on the market, if for no other reason than it would be such a big surprise given current predictions. We know markets don’t like surprises. What recent parallels might we look to for guidance?
Brexit, of course.
In the weeks leading up to the June 23 Brexit vote in the UK, prediction markets and pollsters were giving the “stay” vote a narrow margin of victory. And since most economists and investors had concluded that a vote to stay would be good for the UK, the EU, and the world at large, markets around the world rose in the days leading up to that fateful vote. Then came the Friday morning hangover as the British voted to part ways with the European Union.
Between Thursday and Monday, world markets fell by more than 7%, while the British stock market fell by nearly 6%. However, as apocalyptic as the initial headlines may have been, investors quickly shrugged it off, as can easily be seen in the charts below, and the British market regained its pre-Brexit highs within a single week. The rest of the world took three weeks to do the same thing, by which time the British market was nearly 6% higher than its pre-Brexit highs. Both the British and world markets are even higher today.
The final thing we’d like to note is this: human beings and the economies and markets they build are resilient things. If you look at the past century of U.S. history you will see that the economy tended toward growth and the markets tended to rise during Republican and Democratic administrations alike, good and bad, competent and incompetent. The wealth chart below shows how $1 invested in various assets at the end of 1926 has fared over the intervening nine decades.
If Professor Wolfers’ “event analysis” is correct, markets aren’t going to like it if
Donald Trump is elected president. But they’ll get over it.
It is estimated that nearly 75 million Americans will play fantasy football this season. If you aren’t planning to play in a fantasy football league this year (and the odds are if you play in one, you will probably play in multiple leagues), then you almost certainly know someone who is playing. Fantasy football has been around since 1963 when Wilfred Winkenbach, a limited partner in the Oakland Raiders, founded the Greater Oakland Professional Pigskin Prognosticators League. The game really took off, however, in the late 1990s; all major sports media websites began offering competing versions of the game by the start of the 21st century.
A typical fantasy football roster has 16 slots, and leagues range in size from 8 to 12 teams. Each team’s manager names 9 players as starters each week and competes against their opponent’s starting lineup; each team’s respective players’ statistics are compiled to determine the team’s aggregate weekly score. The remaining 7 players on each roster sit on the bench, and their stats do not count toward the team’s score. It is the manager’s job to determine who should start or sit each week. Standard fantasy league rules stipulate that starting lineups are configured as follows:
2 Running Backs
2 Wide Receivers
1 Tight End
1 Defense/Special Teams
1 Flex Player (can be a Running Back, Wide Receiver, or Tight End, depending on league rules)
Yeske Buie has had a fantasy football league for the past four years. The league has become increasingly competitive over the last few seasons, especially with the addition of a trophy for the winner and a different kind of “prize” for the loser. Past winners include current team members Cristin Etheredge, Dorothy Navales, and Yusuf Abugideiri (Yeske Buie’s most ardent sports fan). In light of the upcoming season, Yusuf put together his thoughts about investing lessons that can be learned by playing fantasy football:
Don’t Overvalue Glamour: Just as a diversified portfolio may include some glamour stocks (i.e. stocks trading at valuations higher than the average) as a part of a broad market index, a functional fantasy football team must have a quarterback. Quarterback is the most highly paid position in the NFL, but that doesn’t directly correspond to their priority regarding fantasy draft status; just because something is expensive doesn’t mean it’s commensurately valuable.
Don’t Undervalue Low-Cost Investments: Research shows that, over the long run, value stocks (i.e. stocks trading at valuations lower than average) tend to outperform glamour stocks, and Yeske Buie’s portfolios are designed to capitalize on that. Similarly, a good fantasy football manager looks to add undervalued players (rookies or players new to their roles) to his/her roster with the aim of “buying low and selling high”.
External Factors Matter: Just as the markets can be influenced by geo-political considerations, non-football factors must be taken into account when configuring one’s starting lineup. A good manager must consider the weather in which the player will be competing, as well as nuances like distance traveled (ex. players from West Coast teams are notorious for performing poorly in early afternoon games on the East Coast, as their body clocks are still adjusting to the time difference). Of course, in the end, no matter how much one may try to manage these external factors, the results are driven more by random chance than anything else.
Yusuf’s approach to managing his fantasy football team is similar to that of an active investment manager trying to pick “hot stocks” (an approach that has consistently failed to beat the market over time) constantly churning his roster and looking to capitalize on a hot tip. While Yusuf believes that doing so in a fantasy environment can be justified because, as he puts it, “the potential benefits outweigh the costs because there are no costs,” we must nonetheless observe that, while he finished first in 2014, Yusuf came in dead last in 2013. An example, we think, of the relative importance of skill versus random chance. And, of course, when it comes to real-life investing, costs matter and trying to beat the market is an expensive enterprise. The best approach to investing accounts for the aforementioned “lessons,” and is one with which Yeske Buie’s Clients have grown familiar: diversify amongst and across asset classes, control costs, and rebalance in a disciplined fashion.
“Our deepest fear is not that we are inadequate. Our deepest fear is that we are powerful beyond measure. It is our light, not our darkness that most frightens us. We ask ourselves, Who am I to be brilliant, gorgeous, talented, fabulous? Actually, who are you not to be? Your playing small does not serve the world. There is nothing enlightened about shrinking so that others won't feel insecure around you. We are all meant to shine. And as we let our own light shine, we unconsciously give others permission to do the same. As we are liberated from our own fear, our presence automatically liberates others.” ~Marianne Williamson